When it comes to corporate life, the conventional negative narrative that is spun around India is that of crony capitalism. Since political parties routinely accuse each other of crony capitalism and the media loves carrying stories about billionaires who have gamed the system, this has become the default mental model used by many to understand India. Indeed, celebrated books are written on this subject, including James Crabtree's vividly written book from three years ago, 'The Billionaire Raj'.
However, as I explain in this piece, the conventional narrative around scams and cronies doesn't even begin to describe either the scale of the challenges or the opportunities India faces as it tries to make the transformation from what the World Bank calls a lower-middle-income country with around $2,000 per capita income to an upper-middle-income country (which are nations with a minimum per capita income of $4,000).
Let me begin with the challenges facing India before I go on to the opportunities.
Challenges facing India
As my colleagues and I have described in our new book 'Diamonds in the Dust: Consistent Compounding for Extraordinary Wealth Creation', the major challenge India faces is thuggery by business owners who are not crony capitalists - they are just corrupt businessmen. Many of these businessmen fly under the radar - they are not household names and when they run away from India after looting billions from their shareholders and from their lenders, it is not front-page news.
In our book, we have analysed this underbelly of Indian capitalism, companies that have meaningfully diminished your net worth, although you might not be aware of the same. For example, we have described at length a company called Cox & Kings. The company has a long and interesting history but if you look at the firm's accounts carefully, as the Enforcement Directorate recently did, you find that billions of dollars - raised in the stock market and from the banks - disappeared.
Whilst we have used forensic-accounting techniques to show how the money disappeared, the interesting thing is that for nearly a decade my colleagues have been reading Cox & Kings' accounts and were left perplexed that this company was so consistently able to raise so much money. Why weren't the investors heeding the published financial statements of Cox & Kings? Or of Amtek Auto or Dewan Housing Finance - companies whose accounts we have dissected in our new book.
Our research suggests that nearly half of all listed companies in India have significant accounting issues. Most of these companies are in sectors where the role of the state is modest at best. And hence by focusing on crony capitalism, we run the risk of focusing on yesterday's narrative whilst seeking remedies for today's problems.
Let me now move on to two more facets of modern India which pose, both, immense challenges and at the same time present opportunities.
Over the past decade India has been economically integrated as a nation. The National Highway network has doubled. The number of people taking domestic flights has more than quadrupled. The number of people with broadband connections has grown 50-fold over the past 10 years. Thirteen years ago, when I migrated to India, one in three families had a bank account. Now, nearly all families have a bank account. And of course, the Goods & Services Tax has meaningfully integrated the economy over the past four years ago.
The integration of India has handed over a decisive advantage to well-managed, efficient enterprises, which are spreading their wings nationally and in so doing obliterating smaller local and regional franchises. For example, as the economy gets integrated, lending, which was once dominated by regional players, is now seeing the emergence of a few national leviathans like HDFC Bank and HDFC, with both lenders now safely ensconced in the list of top 20 profit generators in India. Similarly, if you look at the 70 or so unicorns which have been created in India, almost all of them are in some shape or form formalising and consolidating industries which are informal and dispersed, for example, cab transport, food delivery, poultry consumption, groceries, employment classifieds and education.
The United States went through this phenomenon in the half a century prior to the Great Depression. Japan developed much the same way in the half a century after the Second World War. Ditto for South Korea after the Korean War.
In parallel, India is experiencing the same tech- and data-related opportunities that the Western world faces, i.e., smart lenders, insurers, retailers and consumer-goods companies are collecting data on your and my earning and spending patterns and tapping into our digital footprint to navigate their way around this vast and complex country which is ripe with opportunity.
In 'Diamonds in the Dust', we have provided case studies of extraordinarily able firms like Asian Paints, HDFC Bank, Kotak Bank and Pidilite that have built extremely powerful franchises in India by harnessing technology in the context of the modern Indian economy far more adroitly than their competitors.
In so doing, these efficient Indian companies are validating what John Sutton of the London School of Economics wrote 30 years ago in a prescient book titled 'Sunk Costs and Market Structure'. Sutton foresaw how the application of modern marketing techniques, R&D and technology would lead to the polarisation of profits.
Let me take a case study from our book and which illustrates, in the Indian context, John Sutton's theory.
Case study: Asian Paints
In 1970, Asian Paints invested Rs 80 million in the first supercomputer to be purchased by a private-sector enterprise in India. Asian Paints then used this computer to collect detailed data on paint demand - across its vast dealer network, for every colour, for every truckload delivered to every dealer. As a result, Asian Paints' management developed greater familiarity with understanding and managing data than any other paint company in India. Through the 1980s, 90s, and through to the current day, they fed this data into increasingly sophisticated software platforms which helped them predict demand, time their raw-material purchases and manage their inventory and production cycles such that the company's working capital cycle in its decorative business (i.e., receivables + inventory - trade payables - other current liabilities) shrank to a mere six days from 100 days 25 years ago.
A super crunched working-capital cycle gave Asian Paints free cash flows which were eight times better than those of its competitors. The company re-invested these cash flows in expanding capacity (which has grown 15-fold in the last 25 years) and in further technology investments, for example, around cost optimisation and around 3D visualisation technology at its 'Beautiful Homes' service.
This dynamic creates a synergistic spiral which makes it difficult for Asian Paints' competitors to compete with the firm (i.e., Asian Paints has better tech and more data and hence better cash flows, which in turn lead to greater tech investments from Asian Paints. These in turn lead to more cash flow and so on). Having grown free cash flows over 70-fold in the last 20 years, Asian Paints is amongst India's most consistent compounders.
So how is all this relevant for you?
The two facets of India that I have just laid out are transforming the corporate landscape. Today, no more than 15 companies account for 90 per cent of all corporate profits generated in India. A decade ago, the corresponding figure was just above 30 per cent.
Given this immense concentration of profits in the hands of a few companies, it should come as no surprise to you that just 16 companies accounted for 80 per cent of the wealth generated by the Nifty 50 over the past decade. By the way, very few of these companies are crony capitalists. This fact is lost on people who write learned editorials in newspapers, bemoaning the rise of crony capitalism in India.
Note: Asian Paints, HDFC Bank, Kotak Bank and Pidilite form part of many of Marcellus Investment Managers' portfolios.