Strategy for FDI by Indian firms: A 2x2 classification for the leadership

All important global firms are multinationals. Many large Indian firms have initiated overseas FDI (foreign direct investment) activities. As yet, this is a field where the playbook and the capabilities are at an early stage.

 

Watching global firms utilising services production in India offers insights into the role of FDI. Global firms have played all possible pathways to meet their objective of harnessing the Indian workforce. They send work through arm’s-length contracting to Indian services firms. They do FDI into captives and global capability centres (GCCs). They use GCCs in India as a platform for negotiation and supervision of contracting out to Indian services firms. Harnessing globalisation requires such a sophisticated mix of contracts and FDI.

 

Why might Indian firms benefit from doing FDI? Successful FDI initiatives help enhance exports, permit global optimisation of operations, including improved domestic competitiveness, give access to the vast world market, and derisk the firm in slow periods in the Indian economy. A unique feature of the Indian environment, which is not found in global firms, is the gains obtained by reducing engagement with Indian taxation and capital controls. This is a sweetener which helps pay for the fixed costs of graduating to FDI.

 

It is useful to establish a 2x2 classification scheme. Indian firms come in two kinds: Those that do things which are readily sold to global customers (eg ball bearings) vs those that are wedded into the Indian landscape (firms with operational capabilities that are rooted in the Indian policy environment, into the quirks of the Indian landscape). And destination countries come in two kinds: Advanced economies and the rest.

 

Industries with high readiness for exporting and FDI: The simplest pathway to globalisation is available for firms that do things which are readily sold to global customers. For these firms, the journey of exporting and FDI holds unlimited potential in terms of expanding the business. They can aspire to become global firms which are particularly good at placing certain functions in India, where lower costs are feasible. The emergence of these capabilities in the world of Indian business is of great importance for India’s economic future. If 100 Indian firms graduate into becoming big multinationals — eg a balance sheet size of over Rs 10 trillion with over 50 per cent of the revenue from markets outside India — this will transform Indian GDP.

 

The management methods and the organisational culture that flourishes in India can run into difficulties when faced with the rule of law. Operating in advanced economies comes with the need to run a tight ship. For these firms, non-OECD (non-Organisation for Economic Co-operation and Development) countries can also be markets, but the market size is small when compared with advanced economies. India-centric management DNA might be particularly effective in operating in non-OECD countries, but the leadership needs to be wary of such quick wins as their main game is learning to operate and sell into the OECD. Arm’s length contracting into local firms is a good way to harness the market potential of non-OECD countries without fully learning how to operate in their messy institutional arrangements and lack of rule of law.

 

Industries with more connections with the Indian state: Things are a bit more difficult for Indian firms that are more wedded into the country’s landscape. They are in industries which require a high government interface (eg with regulators), in industries where the Indian state runs a central planning system. They may utilise quirks of operating in the Indian environment (eg connecting into public-sector monopolies) or they may be in areas where the Indian state is an important customer. For all these firms, their very strength in India — learning to function and flourish in close proximity to the Indian state — is a hindrance when it comes to succeeding abroad. For example, a successful bank in India that has mastered profitability while operating under the Reserve Bank of India’s central planning system, protected from foreign competition, and plugging into a variety of public-sector monopolies, is not ready to succeed in (say) the US in competition against US rivals that have not been similarly distorted and are increasingly effective in harnessing low-cost production in India through GCCs.

 

When these firms operate in OECD countries, there is the risk that their organisational culture, which is shaped by experiences of engaging with the Indian state, may raise eyebrows or break rules there. They would need a self-conscious effort to operate in OECD countries in ways that replicate local business culture and not the ways of the headquarters.

 

For these firms, operating in non-OECD countries, with more limited rule of law, is more analogous to operating in India. But building relationship to operate in a sustained way, across fluctuations of the political system, is also difficult when compared with the long years of experience and relationships that are in place in India. Hence, for these firms also, the optimal strategy for operating in a non-OECD country may be to rely on a partnership model. This is analogous to the way some global firms choose to partner in India, instead of going it alone, seeking political risk management through a well-entrenched Indian partner.

 

The questions for strategy: Shareholders, board members, and senior managers need to think strategically about these questions. Large gains are available from FDI, but this requires strategic thinking. The 2x2 diagram shown in this article helps organise the range of possibilities and shapes the development of the requisite capabilities in each project of firm internationalisation. Many interesting choices can be made, eg perhaps a private Indian defence manufacturer can step out of the category “industries with more connections to the Indian state” by ceasing sales to the Indian state. Portfolio strategists can also utilise these themes, with an emphasis on the best Indian firms which are readily able to do exports and FDI into OECD countries.

 

The writer is a researcher at the XKDR Forum