Are Indian companies scaling up fast enough

Updated: Aug 11 2014, 14:53pm hrs
Companies, which lead in value creation by definition, combine high return on capital with consistent growth over long period of time. Quite naturally these companies, apart from being well managed and driven by innovation, tend to operate in industries which have favourable characteristics such as large size and high growth rates. What is also critical is an ecosystem which enables the company to scale up easily covering aspects such as infrastructure, human resources, legal system etc..

As a reflection of an economys ability to nurture such companies and provide the necessary ecosystem, it is interesting to look at the pace of value addition by the best companies in India and put it in global context. As a rough proxy, the market capitalisation less net worth can be viewed as the value added by a companyeffectively this is the current value of the company less all the capital invested in the business by shareholders. This, divided by the number of years of existence, can give us a sense of the pace of value addition.

Admittedly, this is a coarse measure for a number of reasons. First, the net worth does not capture time value of capital invested in the business. Second, the years of existence may not be a very accurate measure of the time a business model has taken to scale up since frequently there are material changes to the model itself. Also, market capitalisation of a company is volatile so the numbers can change over time. However, with all these shortcomings, if the data shows up order of magnitude difference, it should still give us some food for thought.

By this parameter, the list of Indian companies with the fastest pace of value creation is dominated by the heavyweight sectors of the stock market IT, private banks and pharma. The average of the top ten comes to R5,200 crore (about $850 million) with the highest being R10,300 crore ($1.7 billion). The top ten includes three software companies, three financials and one pharma company. The average age of the top ten is 28 years.

Taking a broader set of top 25 companies brings down the average to R3,100 crore ($500m). Most of the additional companies are from FMCG, auto, software and financials. The average age of this sample is 34 years.

Compare these numbers with the global giants. The standout performance on this scale comes from the technology leaders. Google, with a market cap of approximately $400 billion, has added $19 billion of value per year of existencemore than ten timesthe highest by an Indian company.

Facebook, in its relatively short lifespan of 10 years, has a run rate of $17 billion.

Apple, the largest market-cap company founded in 1976, rings in at $12 billion, though it went through a challenging period in the 1990s.

Retail giant Wal-Mart grosses up $3 billion on this measure. From an Asian perspective, the Taiwanese semiconductor major TSMC is an interesting case. Started as a joint collaboration between the government and Phillips in 1987, it too has notched up a score of $3 billion.

This brings to light a few important lessons. First, while it is not realistic at this stage of economic development to expect Indian companies to have the level of innovation of global leaders, the rapid pace of value creation by leading technology firms underscores the need to increase the level of R&D in the country. A big concern is that in the recently published Global Innovation Index, India has actually fallen by ten notches to 76th, while the rest of the BRICS peers have moved up.

Secondly, it is imperative to reduce the friction in business transactions which can enable companies in sectors like retailing, logistics etc. to scale up quickly, which in turn, will increase productivity through economies of scale, technology, etc. The efficiency of the US economy is reflected in the fact that Wal-Marts top line has increased at a compound annual growth rate of 21% for 45 years (1967-2012) adjusted for inflation.

Finally, as the example of TSMC shows, strategic collaboration between the government and industry to pursue high growth sectors can be a vital source of momentum for the economy. An environment in which the private sector can develop healthy links with the government and academia is critical for increasing the pace of value creation.

Manish Gunwani

The author is fund manager, ICICI Prudential Asset Management