Reducing protection

Apart from a huge and growing market, there’s something else that India offers big multinational players: fat margins. With a few exceptions, most MNC subsidiaries in the country appear to have profit levels that are two to three times that of their parent firms.

Sometimes, the multiples are even higher, depending on industry structure, operating conditions and the domestic business cycle. All this goes to show that, warts and all, India offers a great investment opportunity for global companies.

One hopes that the officials responsible for facilitating foreign direct investment are beginning to use these numbers to the country’s advantage, especially in comparison with China, where the MNC profitability record has not been spectacular.

There is, however, another way of interpreting the higher margins in India: many MNC subsidiaries may be milking the market for what it’s worth, sacrificing long-term market development for short-term profits.

While that’s clearly not a charge that can be levelled against companies like Kellogg’s, Coca-Cola and Pepsi, which have incurred losses during the last decade in the country, it applies quite aptly to FMCG majors like Hindustan Lever.

The latter’s profit margins—till recently—have been so high that competitors have found it possible to drive a truck through them. Perhaps the same could also have been said of Maruti Udyog, which seldom cut prices till the market situation turned competitive around the late 1990s.

Clearly, the lesson for all MNCs is to concentrate on increasing market penetration through appropriate reductions in prices, as has been done so successfully in the telecom sector.

While firms like Maruti have seen impressive sales growth in the recent past, the continuing high profit margins point to the scope for further cuts in order to deepen the markets and grow marketshare in the future.

For companies that don’t do this, the markets have a way of striking back. Attracted by high margins, regional brands and MNC price-cutters are chipping away at Hindustan Lever’s dominance.

The biggest lesson in all this, however, is not for the CEOs of MNC subsidiaries, but the government of India. Fat margins are indicative of a protected market. Despite steadily falling average tariffs, India continues to be one of the most protected markets in the world.

While high import duties often result in effective protection rates of over 100 per cent, there are other restrictions (homologation in the case of automobiles, for instance) that result in reducing overseas competition.

Apart from generating higher profits for firms that operate in such closed markets, it means Indian consumers are forced to pay higher prices than their global counterparts.

And since restricted competition generally leads to lower efficiency levels, it also means Indian industry has not been given a sufficiently large incentive to become genuinely competitive. All the signals are pointing to just one thing: India needs to speed up the lowering of import barriers dramatically.