Nation Building:

The SME Route

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Dear Reader,
The Indian SME sector holds the key to India achieving its economic and social objectives
in the coming decade. A lot has been said about the promise it holds. But the sector faces
many challenges that need to be overcome before its true potential can be realised. Our
cover story for this issue, Nation building: The SME route dwells on how India can bring
to fruition this enormous opportunity. A series of articles on the subject spell out the need
for an integrated entrepreneurial ecosystem, and bring forth perspectives on some of the
pertinent nancing and policy related issues.
The ISB recently played host to the Governor of the RBI, Dr D Subbarao for an interaction
with the students. Dr Subbarao also made time, amidst his busy schedule, to do an
interview with the ISBInsight. Our Leader Speak section captures Dr Subbarao speaking
to Professor Rajesh Chakrabarti on how the nancial crisis impacted the Indian banking
sector, and the role of the RBI going forward.
Our Face to Face section has an interview with a new member on the ISB Executive Board,
Mr Lakshmi Narayanan, Vice Chairman of Cognizant. He spoke to Professor Amit Mehra
and Associate Dean Deepak Chandra on a variety of topics ranging from his views on the
Indian IT Sector, to leadership, and philanthropy.
In other stories, we have a feature based on a research study conducted by a group of
students from the ISB on Knowledge Hoarding in organisations, an article on Value
Creation in Mergers and Acquisitions (M&A) where a framework is used to analyse some
recent high prole M&As, and other regulars including Knowledge Sessions and Book
review.
We look forward to your views on this issue. Please send your comments and suggestions
to me at editor_insight@isb.edu
Sriram Gopalakrishnan
from the editors desk
COVER STORY Winter 0-10
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Winter 09-10
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Cover Story
+TRlNSF0RMlT0NlL
FNTRFPRFNFURSHP
SMEs enhance inclusive growth by the
manner in which they evolve, leverage
local resources, and innovate to create
products and services. A well-thought out
SME-driven entrepreneurial ecosystem
can take the industry and India, to the
next level.
/FNlN0N0 SMFs N NDl
Small rms in India cannot rely on
informal sources to come to their rescue
when access to formal sources becomes
difcult. They may be excluded from all
capital markets at the same time. What
could be a possible remedy?
'( N0LUS0N. 0R0WTH. N
NDl, FNTRFPRFNFURSHP
0lN 00NNF0T THF D0TS.
Targeted policies aimed at the poor
and small businesses will allow
entrepreneurship to become an engine of
both inclusion and growth. But creating
an overall business-friendly policy
framework is more likely to be effective
than subsidies.
', SMF RF\TlLSlT0N. l 0lLL
F0R PlRTNFRSHP
A look at the role of industry, government
and academic actors in SME revitalisation.
Leader Speak
(&BlNKN0 0N THF RB
Dr D Subbarao, Governor, Reserve Bank
of India talks to Rajesh Chakrabarti,
Assistant Professor of Finance at the ISB,
about the impact of the global nancial
crisis and the Indian banking system.
Features
(+WHY lRF WF N l
RF0FSS0N?
Arguing against conventional wisdom
about the causes of the recession, the
authors say that the inability of existing
nancial and legal institutions to cope
with the huge increase in the worlds
labour supply in a very short time period,
led to the recession.
(/\lLUF 0RFlT0N N
MFR0FRS lND l00UST0NS
While the expected synergies from most
M&As are similar to begin with, the
ultimate success of the deal is determined
by the implementation of marketing and
COVER STORY ?I8S0T
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5B nsight Team: lshimo Sood, 0horilho Reddy, Loxmi Devi Ponl, Shrenik Roo, Srirom 0opolokrishnon,
Srulhi Kunnel, Sundeep Jommolomodoko, Tl\ Srinivos, \orshoo Rolnoporke
Design & 0over llustration By Tropeze r Resources: Leorning Resource 0enlre ol lhe SB
Printed ll Kolo Jyolhi Process Pvl Lld
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MF0HlN0lL, PH0T000PYN0, RF00RDN0 0R 0THFRWSFI WTH0UT SB`S PR0R WRTTFN PFRMSS0N.
For subscriplions ond odverlisemenls conlocl isbinsighlOisb.edu
business strategies for the combined
entity, and the effective integration of the
diverse organisation cultures.
))KN0WLFD0F H0lRDN0
Some individuals perceive knowledge
acquired during the course of ones job
as their personal intellectual property
and hence do not share it with others in
the organisation. A look at the impact of
incentives, personality types and gender
on sharing this knowledge.
Face to Face
)-lDlPTN0 T0 NFW
PlRlD0MS
Lakshmi Narayanan, Vice Chairman of
Cognizant, talks to Deepak Chandra,
Associate Dean, Centre for Executive
Education and Amit Mehra, Assistant
Professor, Information Systems, at the
ISB, about leadership lessons, innovation
and issues affecting the technology sector.
*'BRlNDS, N0T LlBFLS. THF
FUTURF 0F lPPlRFL
Vikram Rao, Director, Aditya Birla
Management Corporation Private
Limited, talks to ISB students about
branding, e-retailing and other issues
affecting the textile sector.
Faculty Close up
**0RFFN SYSTFMS
Gireesh Shrimali, Assistant Professor of
Information Systems at the ISB, plans
to combine his research interests in
computer networks and the environment,
and focus on the emerging eld of Green
IT.
Knowledge Sessions
*,STRlTF0FS F0R S0lLF
As part of the Khemka Forum on Social
Entrepreneurship, hosted at the ISB,
a panel discussion on the challenges,
strategies and roadblocks involved in
scaling up social enterprises was held.
*.W0RLD 0F LFlDFRS
Henry R Kravis, the Co-Founder, Co-
Chairman and Co-CEO, Kohlberg Kravis
Roberts & Co shares his views on the
private equity industry
In Brief
+& N BRFF
Management perspectives from the ISB
Book Review
+(B00K RF\FW
A review of The Aid Trap: Hard truths
about ending poverty, a book by R Glenn
Hubbard and William Duggan.
Cover Story
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India has an inspiring growth story. In a time when most
developed economies are still reeling under the worst
recession in decades, India is surprisingly untouched
and has emerged resilient by posting commendable
economic growth rates of over 6.5 percent in the FY
2008- 2009. This is even more remarkable when we
consider the unprecedented oods the nation had to
deal with in the same year. India posted a near stellar
7.9 percent growth in the second quarter of scal year
2009-10, with the manufacturing sector clocking an
even more impressive 9.2 percent.
There are several underlying assets that kept India
strong during this period: a large domestic market,
and a strong industrial base, including SMEs, and
relatively speaking, less dependency on an export-
oriented market. These factors, together with a large
potential demographic dividend, natural resources,
and a well-functioning market economy, continue to
give strength.
Indias incredible growth story, however, not
only amazes, it confounds. With so much going for it,
it still ranks very poorly on many global dimensions.
For instance, on the Human Development Index, it
ranks 132 out of 179 countries; on the Transparency
Index, it ranks 85 out of 180 countries, on the
Prosperity Index, 70 out of 104; on the Education
Index, 142 out of 176, and on the Global Hunger
Index, an embarrassing 66 out of 88. With high
overall GDP growth existing concurrently with poor
performance on many metrics, India has graduated
to a new problem: growing economic disparity.
The gap between the haves and have-nots is
growing at an alarming rate despite macroeconomic
indicators that should be painting a rosier picture.
For example, a recent report by an expert group
headed by Suresh Tendulkar now estimates poverty
at 37.2 percent, an increase of roughly 10 percent
over the earlier estimates of 27.5 percent in 2004-05.
Primarily, the major reasons for the gap are:
1 Weak employment and employability,
i.e., the need to create gainful employment for
hundreds of millions entering into the job market
in the coming decade. Efforts by the Indian
government to increase the gross enrollment ratio
to 30 percent (still lower than the 40 percent for
developed nations) from todays ratio of about
11 percent, alone adds an additional 70 million
with higher education looking for employment
by the year 2020.
DY RS/ T/UU
Transformational
Entrepreneurship
A holistic and integrated Iocus on 5MEs, supported by an entrepreneurial ecosystem, can reshape ndia`s socio-
economic landscape.
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~oo:essi:q ois~:ily
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2 Unbalanced urban migration, and mitigating
the large-scale migration of rural population into
urban areas
3 Micro solutions chasing mega problems, i.e.,
the lack of scale and multiplier effect to current
approaches relevant in the Indian context.
Creating socio-economic equity within a high-
growth environment is the pivotal challenge of the
country in this fresh new decade. It will be key
to guaranteeing economic security with growth,
access to affordable health care, education and
clean environment to all its citizens. Without socio-
economic equity, Indias hard fought successes will
largely evaporate, and be replaced irreversibly with an
entrenched, calcied system of stark disparities.
E:l:e:e:eu:i~y ocuseo SMEs c~:
~oo:ess :oi~s c~e:qes
The solution to Indias challenges lies in reframing
the question on poverty: from eliminating poverty to
fostering the creation of wealth by many across the
nation. A holistic and well-thought out approach to
developing Indias SME sector is the most effective
approach to addressing disparity.
Thus far, Indian SMEs have played a very
signicant role in India achieving its current robust
overall economic growth. The SME sector currently
contributes to over 40 percent of exports, and creates
over 1.3 million jobs per year. About 60 million are
employed in this sector. In addition, SMEs enhance
inclusive growth by the manner in which they evolve,
leverage local resources, and innovate to create
products and services. A well-thought out SME-driven
entrepreneurial ecosystem can take the industry and
India, to the next level.
/oo:essi:q le Cu::e:l 0~
In order to address this growing economic disparity,
Indian SMEs will have to play a far more signicant
role in the future, both in terms of employment
generation as well as contribution to Indias overall
GDP and exports.
In advanced economies, like the US,
entrepreneurial enterprises account for a large portion
of new growth. In a study conducted by the US-based
Kauffman Foundation in 2009, one-third of the over
$14 trillion US economy came from new enterprises
that were created within the last 25 years. Achieving a
similar benchmark is far more critical for India. It is
also very much possible, if India takes a holistic and
pragmatic approach to creating new enterprises, while
supporting the growth of the existing SME base.
India is aspiring to grow its economy by 9 percent
or more over the next decade. To achieve this level
of overall GDP growth, assuming a steady growth
of 2.5 percent and 8 percent in the agriculture and
services/manufacturing sectors respectively, the SME
sector (both existing and new enterprises) would
need to quadruple its GDP contribution from the
current level of $200 billion. This would mean that
both existing and newly created enterprises could
contribute as much as 28 percent of Indias GDP by
the year 2020, when the overall economy is expected
to reach USD 2.8 trillions from the current base of
USD 1.2 trillion in FY 2008-09.
India can achieve its socio-economic objectives
by focusing on gainful employment for millions of
educated youth and by helping millions of others
transition from an overburdened agricultural sector
to the small-scale manufacturing and service sectors
Dol exisli:q ~:o :ewy c:e~leo enterprises couo
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Se:vices
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SMEs
Excuoi:q SMEs
0DP /clu~s
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in the next decade. A strategic and holistic approach
of encouraging entrepreneurship can tap into Indias
entrepreneurial gene and redirect a few million
of the job seekers into jobs creators. Nationwide
entrepreneurship development with the appropriate
scale, scope and relevance can catapult India into the
higher orbits of socio-economic prosperity.
Source: Ministry of Micro, Small and Medium
Enterprises (2009); World Bank Data Finder; India
Brand Equity Foundation
/: /ciev~Le P:oosilio:
What are the key steps that would help both existing
SMEs and new startups contribute their share of over
28 percent to the overall socio- economic growth of
India in the coming decade?
1 Focus on SME Revitalisation Strategy
2 Nurture Transformational Entrepreneurship
3 Spark Indian Innovation
Focus o: SME Revil~is~lio: Sl:~leqy
Previous SME revitalisation efforts have offered
broad-based micro and SME (MSME) support in the
shape of government-initiated nancial incentives
and schemes. The MSME Act of 2005 is one concrete
example. These initiatives have had only a diffused
impact on the sector. However, with a sharpened
focus on sustainable enterprise creation and growth
of existing SME base leveraging local resources, the
Government of India can think beyond short-term
nancial infusions and simplied administrative
measures.
In order to accomplish this, the nation must
focus on creating a facilitative and pragmatic policy
framework. To be sure, this required framework
must provide clarity on providing timely credit
ows. However, a larger effort will be on technology
development and up-gradation, technical skills
development in the labour force, taxation, labour
reforms, establishing transparent ratings and
governance, and the revival of sick industries.
The government efforts should also focus on
ensuring geographic spread of employment generation
and gainful employment across the nation. This would
maximise socio-economic value, and mitigate regional
imbalances and ultimately, migration to urban areas,
thus attacking two of the major problems of economic
disparity outlined above.
The SME revitalisation strategy must also focus
on all phases of SME life-cycles, from startup, scale-
up, and turnarounds as well as growth.
u:lu:e T:~:so::~lio:~ E:l:e:e:eu:si
India is leveraging the inherent entrepreneurial
culture of its people through the adoption of modern
entrepreneurship models. Despite this growing
awareness, new ventures creation activity is still too
low. The result is islands of success disconnected in
an ocean of opportunities and scope. For example,
the context of entrepreneurship development
in India is different from the context that drives
entrepreneurship in the Silicon Valley. This may be
why adoption of Silicon Valley models leads to limited
success in India.
Transformational entrepreneurship goes beyond
the traditional start-up companys focus on nancing
resources. Instead, it concentrates on addressing
the core mega-challenges facing the nation, with the
appropriate scale, relevance and innovation.
To address these challenges, India needs to evolve
its own framework for entrepreneurship within a
nationwide ecosystem. The development of such an
ecosystem requires innovation through public-private
partnerships, and collaborative models of engagement
between government, educational and training
institutions, nancial institutions and the industry.
Such a framework that embraces collaborative
value chains also needs business labs to design and test
sustainable and inclusive business models supported
by indigenous and appropriate technologies. It needs
communities of collaborative enterprises, as well
as sustainable business value enabling policies and
regulations. An example application would be to
establish a better scal incentive and subsidy regime
to help build capabilities, productive assets and
competencies.
S~: :oi~: ::ov~lio:
Innovation under local conditions is another critical
element to help SMEs, both new and
existing, address Indias mega challenges.
First and foremost, any innovation must
think about the concept of scale in the
Indian context, the target customer size,
reach, price points, and how to leverage
local resources, given all attendant
cultural and regional sensitivities. To
address this, India needs to develop its
own indigenous models to make them
pervasive. It cannot simply emulate
established models from elsewhere.
India needs to reassess the applicability
of these models in the Indian context.
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Global multinational corporations have already
understood Indias ability to be a unique laboratory
for global innovations. A recent interview with the GE
CEO Jeff Immelt discussed the concept of reverse
innovation, where products innovated locally in
India will be adapted and taken to scale in more
developed markets, instead of the reverse, as has been
traditionally the case. A similar approach can be used
in entrepreneurship as well.
Co:cel i: /clio:. SEZs ~s ~ :ololye
A perfect prototype to accomplish the stated social
equity goals is to redene the concept of SEZs.
Usually this acronym stands for Special Economic
Zones, demarcated areas with economic laws more
liberal than the countrys typical economic laws, in
order to increase foreign direct investment, exports
and stimulate economic growth within that area.
Under the new vision of building social equity, they
can be redened as a network of coordinated Social
Equity Zones and Special Employability Zones, spread
across the country at village, mandal and district
levels, covering all 625 districts nationwide and linked
with various industry clusters. These new zones will
be primarily focused on sustainable social-economic
development aligned with local resources and needs
but with global aspirations.
From standpoint of their execution, these zones
will concentrate on building productive assets with a
focus on sustainable skills enhancement to support
micro and SME enterprises. While the physical size
of these zones will vary from a few hundred to several
thousands of acres, they will all follow the same basic
model. This model will focus on economic growth
and employability, coupled with environmental
sustainability and social viability driving their
development.

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To accomplish these objectives, a set of
transformational initiatives along several dimensions
are needed. These initiatives would focus on dening
and establishing an alignment between social vision
and economic vision driven by political vision. Social
vision focuses on people; the economic vision focuses
on achieving social equity while the political vision
focuses on simplied but detailed governance at
multiple levels. The focus must be on inclusiveness,
accountability, partnerships, local governance, and
transparency.
A holistic and integrated focus on building a
nationwide entrepreneurial ecosystem can reshape
Indias socio-economic landscape in the next decade,
and enhance its global standing enormously in all
socio-economic dimensions of growth. Nation-wide
entrepreneurship development with appropriate
scale, scope and innovation will make all the
difference.
Focuses o: 0ove::~:ce ~l :ulie eves
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Focuses o: eoe
Economic Vision
5ocial Vision
Political Vision
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5MEs in ndia Iace many challenges, but perhaps none more Iormidable than the challenge oI nancing, both short-
term and long-term. This article portrays the enormity oI this challenge and outlines a possible partial remedy.
Small and medium enterprises (SMEs) constitute an
important segment of the economy in India and in
other emerging countries. For those countries, they
often serve as the engines of growth. Using data
from the Micro, Small, and Medium Enterprises
(MSME) Ministry of the Government of India,
Shamika Ravi, Assistant Professor of Economics and
Public Policy, ISB has estimated that the MSME sector
accounts for 8 percent of Indias GDP, 50 percent of
total manufactured exports, 45 percent of Indias
total industrial employment, and 95 percent of all
industrial units
1
. The gures underline the importance
of the sector.
The ofcial denition of an SME differs for
manufacturing and services sectors. Under the MSME
Development Act 2006 of the Government of India,
a manufacturing rm with investments in xed assets
of plant and machinery below Rs. 100 million (about
US$ 2.2 million) qualies as an SME; for rms in the
services sector, the ceiling is Rs 50 million (about
US$ 1.1 million) in xed assets.
SMEs in India face many challenges, but perhaps
none more formidable than the challenge of nancing,
both short-term and long-term. In this short article,
Ill try to give the readers an idea about the enormity
of this challenge and outline a possible partial remedy.
My discussion is based partly on research underway
at the Centre for Analytical Finance (CAF) at the ISB,
and partly on the work we did for the Financial Sector
Reforms committee headed by Professor Raghuram
Rajan, Eric J. Gleacher Distinguished Service Professor
of Finance, University of Chicago during 2007-08.
In our ongoing research work, conducted
jointly with Franklin Allen, Nippon Life Professor of
Finance and Economics, The Wharton School, Rajesh
Chakrabarti, Assistant Professor of Finance, ISB, Jun
Qian, Associate Professor, Boston College and Meijun
Qian, Assistant Professor, National University of
Singapore
2
, we classify the sources of funds in four
broad categories:
utc:ual sou:ccs. uct ucouc atc: ddcuds,
depreciation, and provisions or funds set aside
but not spent
cxtc:ual uuaucug tl:ougl |auls aud otlc:
nancial institutions (FIs): debts and loans
0: ~: ~ve:~qe, ley qol o:y
1 e:ce:l :o: i:le::~
sou:ces, indicating l~l
ley ~:e ~: ess protable,
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c~il~ :~:els /s :uc
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~::u~ u:oi:q c~:e :o:
~le::~live sou:ces
Financing SMEs in India
DY S//R DE
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cxtc:ual uuaucug tl:ougl ua:lcts. cqut aud
debt raised from capital markets
altc:uatc sou:ccs o cxtc:ual uuaucug. cqut aud
debt raised from private sources including group
companies, promoters/founders, and friends and
family; trade credits, and other liabilities. Often,
though not exclusively, alternative nancing is
based on informal, non-contractual, relationships
between the supplier and user of capital. As a
result, this type of nancing is also called informal
nancing.
We nd that in recent years, large Indian rms
(the rms above the SME threshold by the ofcial
denition) obtained about 47 percent of their total
funding from internal sources, 19 percent from banks
and FIs, and 5 percent from capital markets. The
remaining 29 percent came from alternative sources.
For the SMEs, the nancing pattern was radically
different. On an average, they got only 15 percent
from internal sources, indicating that they are far less
protable, 25 percent from banks and FIs, and 10
percent from capital markets. As much as 50 percent
of their total annual funding came from alternative
sources. Friends and family equity accounted for a
huge proportion of their alternative nance, followed
by trade credit. In the same study, we
also nd that rm size is inversely related
to dependence on alternative nancing
sources; the smaller the rm, the higher
is the proportion of alternative nancing
in the total.
Our ndings are based on an
examination of the nances of a very
large sample of rms, over 12,000 in
total. The dataset was compiled from
the Prowess database of the Centre for
Monitoring Indian Economy (CMIE),
the most reputed purveyor of Indian
corporate data. The ndings paint a
somber picture of the state of SME nancing. Poor
protability and lack of access to formal capital
markets and institutions result in heavy dependence on
alternative nancing channels. Typically, funding from
those channels is considerably costlier than funding
from formal sources. This creates a most unfortunate
vicious cycle in the pattern of funding. High cost of
funding results in poor protability. Poor internal cash
ow generation limits ability to service formal bank
debt, and makes the rm less creditworthy from a
banks point of view. This, in turn, leads to greater
dependence on alternative channels.
To supplement the information from secondary
nancial data, and to get rst-hand opinions and
viewpoints of SME owners and managers, CAF we
conducted two sample surveys of Indian SMEs in
2005, one in Hyderabad and the other in Delhi. By
design, the surveys included the smaller SMEs. The
evidence from the survey data is equally stark. For
the survey respondents in the start-up phase, the
two most important nancing sources were friends
and family and trade credit. In the growth phase,
for the rms that have been in business for ve years
or longer, the same two sources were again the most
important. In other words, even for the SMEs that
survived for ve years, formal capital markets and
institutions remained inaccessible.
In another study that we just completed
3
, we nd
evidence that is even more sobering. There is credit
rationing in alternative markets. Credit providers are
reluctant to offer credit beyond a point, regardless
of the credit terms. To prevent voluntary defaults,
the loan size is appropriately limited below what the
borrower desires and the interest rate is kept from
rising to an excessively high level. While there is
widely documented evidence that rms in emerging
economies, especially the smaller rms, face credit
constraints in formal credit markets
4
, ours is the
rst study that documents similar access problems
Poo: :ol~Liily ~:o ~c o ~ccess lo o::~ c~il~ :~:els
~:o i:slilulio:s :esul i: heavy dependence o: ~le::~live
:~:ci:q c~::es Tyic~y, Iunding :o: lose c~::es
is co:sioe:~Ly costlier l~: u:oi:q :o: o::~ sou:ces
Tis c:e~les ~ :osl u:o:lu:~le vicious cyce i: le ~lle::
o u:oi:q
S~:~: De is le Execulive
Di:eclo: o le Ce:l:e o:
/:~ylic~ Fi:~:ce C/Fl ~l
le SD
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for informal credit. Our nding that credit rationing
exists in alternative credit markets has a major
implication. It suggests that small rms in India, and
possibly in other emerging economies, cannot rely on
informal sources to come to their rescue when access
to formal sources becomes difcult. They may be
excluded from all capital markets at the same time.
Is there a market-based remedy, not interest
subsidies or other types of handouts that are always
distortionary and usually ineffective, that can ease the
nancing situation for Indian SMEs? I proposed one
to the Rajan Committee on nancial sector reforms.
It was accepted by the committee and included in
its report
5
. As we have noted above, trade credit is
a critically important source of nance for Indian
SMEs. They could reduce their investment in working
capital, and thus their need for funds, signicantly if
the receivables owed to them by large rms could
be securitised. In principle, such receivables, if
accepted, are essentially commercial paper with the
high credit ratings of the large rms. Further, the
resulting balance sheet clean up would improve the
creditworthiness of the SMEs concerned.
Currently, a negotiable Bill of Exchange (BoE)
issued by a buyer against goods received on credit
provides a form of securitisation of trade credit. The
supplier can have the BoE discounted with a nancial
intermediary in a private transaction. The supplier
and the intermediary can also endorse the bill in favor
of any other party. Currently, it is mostly banks that
deal in BoEs. Typically, they keep the acceptance and
discounting levels under the credit limit set up for
the buyer. However, the nature of the transactions
and the physical format of BoEs rule out a sizable
secondary market in them. A more formal process of
securitisation involves special purpose vehicles (SPVs).
In this form, the individual loans or receivables are
assigned to an SPV (normally a trust) which in turn
issues tradable securities against the loans.
As yet, corporate trade credits are not securitised.
The existing RBI guidelines do not make it very
clear whether revolving assets such as trade credits,
working capital loans etc. can be securitised. Besides
absence of clear regulatory approval, stamp duty is a
major hindrance to the development of securitisation
in India. This duty is payable on any instrument
which seeks to transfer any rights or receivables at
an ad valorem rate, which ranges from 0.1 percent
to 8 percent across the states in India. The process
of transfer of the receivables from the originator
to the SPV involves a stamp duty, which can make
securitisation commercially unviable in several states.
Besides, there is the risk that stamp duty could also
be levied on the issue of securitised instruments by
the SPV to investors. Patil Committee on Corporate
Bonds and Securitisation (2005) recommended that
the Central Government should institute a process
leading to a uniform and affordable stamp duty rate
across all states. The recommendation has not been
implemented yet.
1
S~:i~ R~vi, E:l:e:e:eu:si Deveo:e:l i: le
Mic:o, S:~ ~:o Meoiu: E:le::ise Seclo: i: :oi~
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/ D~:e:|ee el ~ ZOOol :o l~l L~: c:eoil w~s sc~:ce
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:osl :ol~Le ::s

/ u:o:eo S:~ Sles, P~::i:q Co::issio:, 0ovl o

:oi~, ZOO'
COVER STORY Winter 0-10
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Inclusion. Growth. In India
Entrepreneurship Can
Connect the Dots.
Te c~se o: i:cusive q:owl
Inclusive growth has become a recurring mantra of
Indian policymakers. For instance, speaking at the
2009 India Economic Summit, the Indian Prime
Minister, Dr Manmohan Singh, asserted Indias
commitment to fast and inclusive growth, so that,
the benets of development reach out to all sectors
of our population.
Such calls are not surprising. Indian Gross
Domestic Product (GDP) has been growing at
an annual rate of 7 and 8 percent during the last
few years, but gains have been uneven despite the
doubling of Indias per capita GDP during the 7 years
preceding 2007-08. According to a report in the
Financial Times, Unicef, the UNs child development
agency, has taken India to task for not using its high
economic growth to lift large numbers of people
out of poverty. In a comparison likely to rankle, the
Unicef noted that India lagged behind China, South
Korea, and Singapore, which did better in investing in
their people during their economic booms.
Around 80 percent of Indias population
lives under two dollars a day, comparable to many
sub-Saharan African countries, and twice the
corresponding fraction for Chinas population.
Only two-thirds of Indians are literate, while over
90 percent of the Chinese are. Three-fths of the
labour force is employed in agriculture, but produces
less than one-fth of the countrys Gross Domestic
Product (GDP), and earning are correspondingly far
lower. Productivity growth in agriculture has been
about a fourth of that in services. This accounts for
the disparity in Indias growth
1
. Taken together, these
facts indicate that the Indian road to riches thus far
has been a kutcha rather than a pucca one.
E:l:e:e:eu:si lo le :escue
One of the considerations in fostering inclusive
growth is that policies aimed at promoting inclusion
should not signicantly deter growth, especially of the
high value added sectors that put India on the global
economic map in the rst place. This is an instance
of the equity-efciency tradeoff that economists
and policymakers have been concerned with for a
long time. One could tax the rich and successful and
redistribute to the poor to even out incomes, but this
process would reduce the very incentive to become
successful. Even the most patriotic Indian would
be reluctant to toil for the sake of the tax collector.
DY RS/ D UM/R
Fostering entrepreneurship can be a here and now policy option to stimulate inclusive growth. 0iven the potential
oI entrepreneurship to both reduce poverty and increase incomes, a natural question arises: do special policies
work? And what policy options should be pursued?
Te c~e:qe is lo e:~:ce
eco:o:ic participation
~:o:q lose ~l le Lollo:
:u:qs ~:o Iacilitate lei:
ci:L, wiloul l:ii:q u
lose wo ~:e ~l le iqe:
:u:qs
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The challenge is to enhance economic participation
among those at the bottom rungs and facilitate their
climb, without tripping up those who are at the higher
rungs.
Encouraging entrepreneurship in all sectors is
one way to address this dilemma. Entrepreneurs
contribute to economic growth by creating
new industries, increasing productivity through
competition, identifying viable new technologies, and
working efciently and intensively
2
. They serve as
a conduit for the commercialisation of knowledge
and contribute to economic growth over and beyond
the contributions of R&D and human capital
3
.
Entrepreneurship also reduces poverty. Indeed, the
microcredit revolution aimed at the poor was based
on viewing each person as a potential entrepreneur,
thereby fuelling tiny economic engines of a rejected
portion of society
4
. In other words, as a means of
wealth creation for the individual and the country,
entrepreneurship spans the socio-economic and
sectoral spectrum, from villager to venture capitalist,
from handicrafts to hardware.
No doubt, factors highlighted elsewhere, such
as infrastructure and human capital, are also very
important for economic growth
5
. Indeed, they all
aid entrepreneurship. However, entrepreneurship,
which by its very nature embodies creative approaches
to dealing with constraints, can take root even when
the above factors are still in the development stages.
Having many years of formal education is not a
necessary prerequisite for becoming an entrepreneur,
and this is highly relevant for a country where a
large fraction of adults have minimal education.
Sowing the seeds of entrepreneurship among Indian
farmers will increase agricultural productivity and
rural incomes, hasten industrial transformation,
and increase growth. Fostering entrepreneurship is
therefore a here and now policy option to stimulate
inclusive growth.
Does seci~ l:e~l:e:l wo:
Given the potential of entrepreneurship to both reduce
poverty and increase incomes, a natural question
arises: does special treatment work? Politicians in all
countries revere small-scale enterprises and provide
many a subsidy in their name. However, the efcacy
of these subsidies seems mixed. One study in the US
concluded, Policies designed specically to help small
businesses do not always have the intended effect,
because they end up beneting large businesses even
more than small businesses, or do not meet their
objectives at all. As common sense would suggest,
exempting rms below a certain threshold from
regulation hinders rm growth because rms near the
threshold for exemption, adjust their size to avoid
the more highly regulated market
6
.
In the Indian context, a team of RAND and
Indian School of Business (ISB) researchers recently
examined the efcacy of policies in encouraging
entrepreneurship in a project supported by the the
Legatum Institute. A state-level analysis showed that
policies aimed at the micro, small, and medium
enterprises (MSME) sector for instance, total
nancial subsidy for MSMEs had little or no impact
on the growth of the MSME sector, whereas more
general development policies such as expenditure on
infrastructure and access to nance had signicantly
more positive impact on the growth of this sector
across states over the last 15 years
7
.
When the research team looked at individual
entrepreneurial activity in a predominantly rural, low-
income sample, they found that individuals responded
better to policies that are likely to have a direct impact
on them (such as human capital and technology
assistance, and subsidy for capital and nancing) while
policies aimed at industries (subsidy for taxes, power,
and land, industry targeting, incentives for technology
clusters, Special Economic Zones, and Single Window
Clearance) had little or even a negative effect
8
.
When the effect of the Single Window Clearance
(SWC) policy was examined in detail by the research
team using rm-level data, they found that it had
the effect of reducing the time cost of regulatory
compliance across all types of rms. However,
enterprises do not appear to have experienced a
signicant net impact in terms of rm sales and assets
Entrepreneurs co:l:iLule lo eco:o:ic q:owl Ly c:e~li:q
:ew i:ousl:ies, i:c:e~si:q :oouclivily l:ouq co:elilio:,
ioe:liyi:q vi~Le :ew technologies, ~:o wo:i:q ecie:ly
~:o i:le:sivey
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growth. SWC reforms may have led only to net entry
into the urban/larger unorganised manufacturing
sector and growth in the large-scale organised
manufacturing sector.
While more research is needed, the results are
not strongly in favour of encouragement of small-scale
entrepreneurs. These results are consistent with the
literature on regulation that suggests that when SWC-
type policies have been successfully implemented,
their marginal impact on rm growth may still be
negligible if other barriers to entry and investment
remain high
9
. Evidently, as in the US, small businesses
in India also do not always seem to respond to all the
policies aimed at them.
\~l ~:e le oicy olio:s
Given these ndings, what policy options could be
pursued? The emerging picture suggests that creating
an overall business-friendly policy framework is more
likely to be effective than subsidies, which might end
up in unintended hands or lead to perverse behaviour,
providing an incentive for rms to stay small.
While India began dismantling its permit raj
since 1991, and has been making it easier to conduct
business, it still has a long way to go. In the latest
World Banks Doing Business rankings, India ranks
133rd (the worst ranking in the list is 183)! How did
the countries to which India compared unfavourably
according to the Unicef rank? Singapore ranked
rst, South Korea 19th, and China 89th. It is little
consolation that China does not rank that highly; it is
still about 45 places above India.
Indias ranking on starting a business is particularly
telling. It ranks 169th. (The rankings of Singapore,
Korea, and China, are 4, 53, and 151 respectively.)
C:e~li:q ~: ove:~
business-Iriendly oicy
:~:ewo: is :o:e iey lo
Le eeclive l~: suLsioies,
wic :iql e:o u i:
u:i:le:oeo ~:os o: e~o
lo e:ve:se behaviour,
:ovioi:q ~: i:ce:live o:
::s lo sl~y s:~
Figure 1: Details on starting a business - 0ross-country comparison
Number oI procedures
0ost I% oI income per capitaJ Minimum 0apital I% oI income per capitaJ
Number oI days
:oi~
Ci:~
o:e~ Re
Si:q~o:e
O 1O 1
:oi~
Ci:~
o:e~ Re
Si:q~o:e
O 1O ZO oO /O
:oi~
Ci:~
o:e~ Re
Si:q~o:e
O ZO /O oO 8O
:oi~
Ci:~
o:e~ Re
Si:q~o:e
O 1OO ZOO oOO
Sou:ce. \o:o D~:s Doi:q Dusi:ess D~l~L~se
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Figure 1 shows the details. The 13 procedures
needed on average to start a business in India take
30 days. The corresponding gures for Singapore are
three each. The cost of starting a business in India
is over 66 percent of Indias per capita income, and
the minimum capital requirement is a whopping 210
percent of per capita income. (The respective gures
for Singapore are 0.7 percent and 0 percent.) While
everyone would benet from a lowering of these
burdens, the poor would obviously benet more. It
is also not surprising that nancing assistance for the
poor is an oft-advocated policy.
The effect of entrepreneurship on growth is more
markedly positive in developed countries, suggesting
that this may, in part, be due to low levels of human
capital among developing country entrepreneurs
10
.
Indeed, Indian entrepreneurs in the US have the
highest incomes among all ethnic groups, and more than
40 percent of this difference with respect to native-
born whites could be attributed to human capital. It
would be a shame if Indians benet entrepreneurially
from their human capital in other countries but are
unable to do so at home, either because they do
not have a conducive policy environment or do not
have the requisite human capital
11
. As mentioned
earlier, for the many uneducated adults,
what is needed is not formal education,
but training aimed at starting and running
an enterprise effectively. A recent study
that provided thirty to sixty minute
entrepreneurship training to poor, female
micro-entrepreneurs in Peru, found
improved business knowledge, practices,
and revenues
12
.
Clearly, targeted policies aimed at
the poor and small businesses will allow
entrepreneurship to become an engine of
both inclusion and growth. But how little
special treatment they would need if the
overall policy climate became business
friendly and starting a business did not
take so much time and money!
1
u:~:, :is:~ D, Fooo o: Slo:~c, Fooo o: Touql,
SD :siql, Sele:Le: ZOO8, o'
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SD \o:i:q P~e:
8
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11
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Eco:o:ics` ~l le SD
COVER STORY Winter 0-10
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:oi~. Te Tiqe: wil ~ ew Missi:q
Sl:ies
The impressive growth stor y of India during the
past two decades is well known. What is less
known is that the transformation from a primarily
agricultural to a more diversified economy has been
slower than expected. As Ar vind Panagariya noted
recently in Business Standard, while the output
share of agriculture fell from 28.9 percent in
1993-94 to 19.2 percent in 2004-05, the absolute
number of workers employed in agriculture during
the same period increased by 27.3 million. More
significantly, the output share of manufacturing
during this period remained static at around
15.8 percent, with a marginal increase in its
employment share from 10.4 to 11.7 percent.
The skilled labour intensive industrial growth has
not enabled a significant shift of workforce from
agriculture to manufacturing. Further, the rate of
poverty reduction has been slower compared to
China and Brazil.
While the Indian economy is robust enough to
sustain the growth momentum of nine percent or
higher over the next decade, it needs to be fortified
with measures for diversification, accelerated
employment creation and poverty reduction.
The mantra of inclusive growth should entail
expansion of growth and employment opportunities
across the geographical, social and sectoral canvas.
This could be realised through sharper focus on
and attention to the growth and revitalisation of
the micro, small and medium enterprise (MSME)
sector.
MSME. Te Sle:oio
The MSME could be the steroid the Indian economy
needs at this juncture. The SME provides not only
the much needed boost for growth, employment
and exports but more significantly, contributes to
geographical and social equity. About 60 million
persons are employed in 26.1 million MSM
enterprises (according to the fourth National
MSME Census of 2006-07) and contribute about
45 percent of manufacturing output and 40 percent
of total exports. Overall, the sector has provided
ten times as many jobs as large enterprises for the
same level of investment.
Significantly, the MSME sector has maintained
a higher growth rate vis--vis the overall industrial
sector during the past decade. According to the
Confederation of Indian Industries (CII)-Outlook
Sur vey, exports from these enterprises have been
on the rise, despite increased cost of raw materials,
sluggish global demand and stiff international
competition. Today this sector produces a
wide range of products, from simple consumer
goods to high precision and sophisticated end-
products. It has emerged as the major supplier
of mass consumption goods as well as producer
of electronic and electrical equipment and drugs
While the government can be a Iacilitator oI growth and promoter oI equity, the role oI the large enterprise is also
critical. A look at the role oI industry, government and academic actors in 5ME revitalisation.
SME Revitalisation:
A Call for Partnership
DY R/MES \ PEUM//
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and pharmaceuticals. An impetus to the sector
is therefore likely to have a multiplier impact on
economic growth.
C~e:qes
Notwithstanding the small is beautiful rhetoric,
the sector is confronted with a plethora of
problems and not all of them small. Nearly
one-third of the SMEs in Andhra Pradesh (AP)
state are classified as sick by the third national
MSME census. Despite a doubling of credit
flow to the sector from Rs 1.27 lakh crores
($ 27 Billion) in 2006-07 to Rs 2.57 lakh crores
($ 57 Billion) in 2007-08, credit - particularly
for operational requirements - continues to be
a major constraint. Technological obsolescence,
paucity of skilled human resources, scarcity
of raw materials, infrastructure deficiencies,
marketing bottlenecks, sub-optimal quality
standards, competition from large enterprises and
management inefficiencies are some of the better
known challenges confronting the sector. First-
generation entrepreneurs, especially in the micro-
enterprise arena, are forced to swim in unknown
waters. Support systems for the nascent sector
are not robust enough to respond with required
sensitivity and effectiveness.
U:l~eo \e~l ~l le 0:~ss:ools
Through the collaborative efforts of the
government, civil society, community organisations
and academia, several states in India, with AP at the
forefront, have done outstanding work in fostering a
socio-economic powerhouse in the form of women
self-help groups (SHGs) and village organisations
(VOs). In AP alone, 10.2 million women have
been organised into 850,000 SHGs in 35,500
villages spread across the state. The credit flow to
these organisations from the financial institutions
exceeded Rs 6,967 crores ($1.54 billion) during
2007-08. This is in addition to the internally
accumulated savings of over Rs 3,200 crores
($0.71 billion). However, the investment portfolio
and the activity profile of these organisations
reveal low returns on investment with little or no
value addition. Consequently, the trillion dollar
grassroots potential has remained simply that.
0ove:::e:l. Te F~ciil~lo:
Recognising the importance of SMEs to growth
and employment, the government established a
legislative framework - through the MSME Act
2006 - and an institutional framework through the
MSME Ministr y. The Prime Minister established a
high-level taskforce for promotion of this sector
under the chairmanship of his Principal Secretar y.
This taskforces report is currently under the
governments review and hopefully will provide
the much-needed impetus to the SME growth by
addressing the challenges confronting the sector.
With an economy of $280 billion at purchasing
power parity, AP is the third largest economy in
India; with 86.6 million people, it is the fourth most
populous state. It is also the first state in India to
create a legislative framework and establish a single
window to streamline the approval process for the
establishment of SMEs. With the participation of
the government, industr y and the banks, AP was
also one of the first states in India to establish an
MSME Facilitation Council for quicker resolution
of conflicts. For the past decade, a comprehensive
policy framework has been in place for MSME
development, with primar y focus on fiscal
incentives and infrastructure support.
The government both central and state
have been implementing a slew of programmes
for MSME promotion. The national government
is financing the National Manufacturing
Tec:ooqic~ obsolescence, ~ucily o sieo u:~:
:esou:ces, sc~:cily o :~w :~le:i~s, i::~sl:uclu:e
oecie:cies, :~:eli:q Lolle:ecs, suLoli:~ quality
sl~:o~:os, competition :o: ~:qe e:le::ises ~:o
:~:~qe:e:l i:ecie:cies ~:e so:e o le Lelle: :ow:
c~e:qes co::o:li:q le seclo:
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Competitiveness Programme, the programme for
Quality Management Standards (QMS) and Quality
Technology Tools (QTT), a programme for building
awareness on intellectual property regimes, support
for entrepreneurial and managerial incubation,
and more. In addition, the Prime Ministers
Employment Guarantee Programme (PMEGP)
seeks to support micro-enterprises and traditional
handicrafts development. The government also
provides substantial support for clusters of MSMEs
by financing processing, storage and marketing
infrastructure.
The AP state government has been providing
fiscal incentives in the form of VAT reimbursements,
power subsidisation, and registration fee waivers, in
addition to investment subsidies, interest subsidies
and support for quality certification, technology
upgradation and entrepreneurship development.
The AP government is in the process of developing
a comprehensive MSME policy for 2010-15, with
ISB support and in partnership with the industr y
and the financial institutions.
/: /qe:o~ o: P~:l:e:si
The government can provide a proactive policy
framework, create an enabling environment for
SME growth, facilitate approval processes for
new investments, offer fiscal incentives, technical
assistance and capacity development support for
technology upgradation, quality certification,
skill development of the technical and managerial
functionaries, and incentivise installation of energy-
saving and clean energy promotion technologies,
process and systems automation, research and
development and support for diversification of
well-performing SMEs. The government also has
a key role in facilitating equitable geographical
spread and outreach to traditionally disadvantaged
social groups.
However, the government at its best can be
a facilitator of growth and promoter of equity.
The role of the large enterprise is critical in
creating iconic models for emulation, stimulating
ancillarisation, skill upgradation and in improving
competitiveness. The AP government is considering
the launch of a skill development mission duly
taking advantage of the national skill development
programme in partnership with the ISB, 540
engineering colleges, technical universities and
the industr y. R&D and academic institutions have
an important role not only in providing technical
assistance, technology development and capacity
development but also in enabling the establishment
of sustainable value chains and in designing and
testing sustainable and inclusive models, apart
from providing dynamic feedback to government
as well as industr y.
Financial institutions, especially the Small
Industries Development Bank of India (SIDBI),
have to ensure easy flow of credit to SMEs and
enhanced financing for technological development
and upgradation, technical and managerial skill
development, and infrastructure development.
Collateral free credit and easy working capital
support to micro-enterprises are essential inputs.
An SME Exchange, i.e., an institutional market
to raise equity capital required for expansion,
diversification and technology upgradation of
well-performing SMEs is another option.
Currently only about 8 percent of enterprises
are managed by women, but a significant number
of technical graduates entering the job market
are women. The contribution of women must
double in the next five years. Rural and traditional
enterprises contribute about 15 percent of the total
output and 40percent of the workforce employed
in the SME sector. The social capital formed
by the SHGs in this arena could be harnessed
and nurtured through infusion of appropriate
technology and skills, managerial innovation,
efficiency and productivity improvements, and
marketing support, unleashing a trillion dollar
enterprise that has remained hitherto untapped.
Overall, there are more than adequate reasons
for an optimistic prognosis. The economic growth
juggernaut of India will not only accelerate and
sustain at double digit levels but also secure
inclusion of hitherto excluded regions, social
groups and sectors through SME growth.
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D: R~:es \ Pe:u:~~ is le Co::issio:e:, De~:l:e:l o
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Leader Speak
What do you think are the long-term implications
and lessons oI the nancial crisis? Three years down
the line, once things get down to normal in ndia and
globally, would the crisis have Iundamentally changed
anything? 0r are we going to go back to the pre-crisis
world?
There are important implications and lessons to
be learnt from the crisis. First, we now know that
global imbalances need to be watched and that we
cannot afford to have global imbalances build up to
unsustainable levels. Second, we also now know that
decoupling does not work, that the whole world is
one, and that emerging economies will get affected
by big developments in advanced economies. Third,
there is an important implication for the global
framework for regulating the nancial system. It
may not be possible to establish a global regulator
but there can be an agreement on a framework for
regulating the nancial sector. Regulatory arbitrage
across jurisdictions should be prevented.
Fourth, I think there is going to be greater
coordination across countries in managing their
policies. As we have seen, the G-20 was a very
effective forum in managing the crisis, and now
in managing the recovery. Going forward, I think
G-20 will continue to be a prominent institutional
forum. Emerging market economies are going to
be important in the G-20. What they say, what they
do and intend what they dont do, is going to be
important for how the global economy will evolve.
And nally, I think there is going to be greater focus
on regulating risk and on pricing regulation of risk.
How will banking be aIIected? ndian banks have
actually done very well in the global comparison. Will
this situation give any permanent advantage to ndian
banks going Iorward?
There is a big debate about the utility and casino
models
1
. People say that one of the important and
root causes for the crisis was the repeal of the Glass-
Steagall Act in US. The repeal allowed investments
and non-traditional banking to be combined. There
is a powerful view that we must again divide them
into utilities and casinos.
I dont think that is a realistic proposition.
However, as I said earlier, there is going to be greater
focus on pricing and regulation of risk. This will take
the form of demanding higher capital and leverage
Banking on the RBI
0n a recent visit to the ndian 5chool oI Business I5BJ Ior a lecture, Dr D 5ubbarao, 0overnor, Reserve Bank oI
ndia IRBJ took some time out Ior a chat with Ra|esh 0hakrabarti, Assistant ProIessor oI Finance at the 5B, about
the impact oI the global nancial crisis, the ndian banking system and the role oI the RB.
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E:e:qi:q :~:el
eco:o:ies ~:e qoi:q lo
Le important i: le 0ZO
\~l ley s~y, w~l ley
oo ~:o intend w~l ley
oo:l oo, is qoi:q lo Le
i:o:l~:l o: ow le
qoL~ eco:o:y wi evove
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ratios, liquidity ratios and expanding the perimeter
of regulation to include not just banks but also near-
banks. The regulators will focus on macro-prudential
regulation, not just on individual institutions but at
the collective systemic level. There is also going to be
greater focus on nancial stability because we have now
learnt that price stability and macroeconomic stability
do not necessarily guarantee nancial stability.
As regards the second part of your question,
Indian banks have remained safe and healthy during
the crisis in part because of prudent and cautious
regulation, and in part because of the relatively
limited globalisation of the Indian economy. In terms
of regulation, we have always been quite prudent
in terms of demanding liquidity, mandating certain
leverage and in reckoning what sort of capital could
be counted as tier I capital
2
in provisioning for risk.
The nal part of your question was whether
Indian banks have any advantage on the way forward.
I think the crisis has shown that if the regulation is
prudent and proactive, you can reasonably expect to
maintain the safety of the system. The crisis has also
shown that Indian banks are trustworthy and that
they inspire condence.
t seemed at the height oI the crisis that nancial
reIorms would probably take a backseat Ior the years to
come but it looks like we are back to doing reIorms. 0ne
oI the ma|or steps recently has been the abolition oI the
RB license requirement Ior banks opening branches in
rural areas. This will be a big step in nancial inclusion.
What is your sense oI how much impact this particular
measure will have? Do you see banks taking up this
opportunity?
I do see banks taking up this opportunity. There
has been a demand for liberalising the branch
authorisation policy of the RBI. I must also add that
our branch authorisation policy was far less restrictive
than people believed it was, because we allowed banks
quite a lot of leeway in determining their branch
expansion. However, in the recent policy, we have
relaxed this further banks are now free to go and
open branches anywhere upto tier III towns. We have
indicated that banks commitment to rural banking
will be an important criterion in evaluating their
requests for branches in urban areas. I believe this
will encourage banks to go to rural areas.
Having said that, I must also add that there is
a great deal of nancial exclusion in the country.
There are roughly 600,000 habitations in the country
and only about 30,000 are covered by a brick and
mortar branch. While it is just not possible to cover
the remaining with brick and mortar branches, we
need to go for non-conventional methods, such as,
the business correspondent / business facilitator
models (BC/BF)
3
and Information Communication
Technology models. We have requested all banks to
work on plans to cover all villages with populations
above 2000 with banking facility.
Right now, given the distance restrictions that we have,
the B0/BF and other restrictions probably reduce the
reach, oI course understand the control requirements
and the caution that goes with it but is RB open to
slowly relaxing those a little bit?
Absolutely. We have relaxed the distance restriction
from 15 to 30 kilometres. We have also liberalised
the rules about entities that can be appointed as
business correspondents. It has been suggested that
there is no need for the RBI to decide the criteria for
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business correspondents and that we should leave it
to the banks. I think that is the way to go forward and
eventually we will get there, but I cannot say when.
The local area bank experiment was a short-lived
one, with only Iour oI these banks still surviving. Any
thoughts on their role in nancial inclusion?
Note that we have commercial banks and we have
the cooperative sector. In the cooperative sector
again, we have both, urban cooperative banks and
rural. Together, all these banks have a vast network.
I believe that this network is sufcient to penetrate
the hinterland, if the necessary policy framework is in
place and if the cost benet calculations work out. So
the important thing is not really to experiment with
another model but to investigate what needs to be
done in order to reduce costs and improve benets.
On the other hand, there are some questions
about the business model of local area banks. First,
are there economies of scale; second, concentration
risk. Third, there are concerns about the ability of
the low capital base of ve crore rupees to absorb the
losses. Fourth, can these banks rst attract, and then
retain talent. So while I am open-minded, I am not
certain that this model is something that we need to
push very hard.
Moving to a diIIerent sub|ect, with the crisis receding,
there is a resumption oI hot money ows. How do you
think we should balance the choice between capital
account liberalisation and currency management?
5hould currency stabilisation remain a core Iunction
Ior the RB in the Ioreseeable Iuture?
Yes, the currency function, to the extent of managing
volatility in the exchange rate, should be a function
of the RBI. The RBI does not have, and does not
intend to have, a target exchange rate. We intervene
in the foreign exchange market only to manage
volatility. And what the crisis has in fact shown is that
volatility in exchange rate can be more damaging than
we believe. It can threaten your nancial stability.
So far as nancial stability is a core concern of the
RBI, managing volatility in the exchange rate remains
an important function. I think external sector
management should continue to be with the RBI.
These days, we see a conscious move by the
government, with the RB oI course being a part oI it,
to a slightly more coordinated, iI not unied, regulator
mode. Where do you see the ndian system currently
being located on that spectrum? Do we need to move
towards more coordination or more unied regulation?
What are your views?
In the current regulatory architecture, we have four
regulators in the nancial markets. And there is also
the High Level Coordination Committee for Financial
Markets (HLCCFM) which I chair and on which all
the regulators and the government are represented.
At the moment, the HLCCFM is an informal body.
Internationally, there is a debate about what would
be the optimal regulatory architecture to take care of
nancial stability function. My view is that nancial
stability cannot be entrusted to a committee. It has
to be the sole undivided responsibility of a single
regulator because you need to act quickly. Oftentimes
you also need to act by surprise and somebody needs
to be accountable. And that single regulator, I believe,
should be the Reserve Bank or the central bank in
any country.
Sure, any system can always be improved further.
Our HLCCFM system has worked well. However, we
:oi~: L~:s ~ve :e:~i:eo s~e ~:o e~ly ou:i:q le
c:isis i: ~:l Lec~use o prudent ~:o c~ulious :equ~lio:,
~:o i: ~:l Lec~use o le :e~livey i:ileo globalisation
o le :oi~: eco:o:y
Leader Speak
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Winter 0-10
need to improve it in certain important respects in
order to make it more effective.
We are also seeing an attempt at consolidation oI
the banking sector. That also has its own pluses and
minuses. There is an argument that we need large
banks to be globally competitive. At the same time, the
crisis has shown the need Ior a certain circumspection
on `too big to Iail` nancial institutions. What are your
views on the levels oI concentration in the ndian
banking sector?
There is an argument that we must actively encourage
a few Indian banks to grow in size, because only then
will they be globally competitive. A counter argument
is that if a few banks grow too big, they will be too
big to fail, that oligopolistic patterns will emerge with
just a few banks controlling the market.
In India, this type of concentration is lower than
in many other countries. Our policy towards banking
consolidation has been to encourage voluntary and
organic consolidation, based on efciency criteria,
market synergies, business models and so on. So far,
we have encouraged mergers between weak private
banks and strong private banks. The government, at
the moment, is working on consolidation of public
sector banks. My view is that we must facilitate this
process without actively making the marriage. We
must leave it to the market and to the institutions to
manage this process.
n your lecture, you briey mentioned optimal
composition and management oI central bank assets
and the recent purchase oI gold that made headlines
across the globe. 5o what, iI anything, should one read
into the gold purchases? And going Iorward, what
mechanisms do you have in mind Ior asset management
in general?
The purchase of gold should be seen as part of our
constant and continuous efforts to manage our
foreign exchange reserves. To put this in perspective,
we had 357 tonnes of gold before the purchase, and
we added another 200 tonnes, making a total of
557 tonnes. This is about 6.1 percent of the RBIs
foreign exchange reserves, which includes both gold
and foreign exchange. So in proportional terms, gold
is relatively modest. We bought gold as the decision
of the International Monetary Fund (IMF) to sell it
provided us with a rare opportunity to buy a large
amount of gold outside the market mechanism in a
transparent manner at a price that is market linked.
But our purchase of gold should be seen for what it
is, which is that we invested a part of our reserves in
gold. Our decision was determined by three criteria -
safety, liquidity and return.
What do you think oI the way we have historically been
handling Ioreign currency reserves and assets oI the
central bank in general?
We have had our foreign exchange reserve
management audited by international auditors.
They have certied that we follow the best practices.
In fact, the RBI managers who manage our reserves
are much sought after for their expertise by other
countries! That should be a testimony to our ability
to manage the reserves.
1
Co::e:ci~ L~:s oe~i:qs wil oeosils, ~ov~:ces
~:o ~y:e:ls ~:e ole: vieweo ~s uliily c:ilic~ lo
le eco:o:y Lul sl~Le ~:o ow:is ~s ooseo lo
i:vesl:e:l L~:s l~l ~:e ie:eo lo c~si:os ~s ley oe~
wil :isy ~ssels ~:o i:vesl:e:ls
Z
Foowi:q le D~se ~cco:os, L~:s :eeo lo ee ce:l~i:
c~il~ ~s ~ :oo:lio: o lei: :isweiqleo oeosils o:
s~ely Tis c~il~ :equi:e:e:l co::ises :ulie lie:s
o i:sl:u:e:ls oee:oi:q uo: lei: iquioily ~:o :ice
sl~Liily Tie: 1 is le co:e c~il~ o ~ L~:
o
D~:s i: :oi~ ~ve o: ~ ew ye~:s :ow sl~:leo usi:q
D~:i:q Co::eso:oe:ls DCsl wo se:ve ~s ~qe:ls o ~
L~: L:~:c lo :e~c L~:i:qse:vices lo eoe D~:i:q
F~ciil~lo:s DFsl ~:e si:i~: e:lilies Lusi:esses o: 00s
wo :~y oo :ei:i:~:y c:eoil sc:ee:i:q ~:o ole: se:vices
o: le L~: : Lol c~ses, le L~: ~ys co::issio: lo
DCs ~:o DFs
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Features
(+ WHY lRF WF N l RF0FSS0N?
(/ \lLUF 0RFlT0N N MFR0FRS lND l00UST0NS
)) KN0WLFD0F H0lRDN0
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Features
Why are we in a recession?
Co:ve:lio:~ \isoo:
Folk wisdom blames the nancial crisis for the
recession. But what caused the nancial crisis? The
savings glut in Asia, says the popular press. A major part
of these savings ew into the US nancial system. This
led to too much money chasing too few opportunities
and too cheap credit becoming available in the US.
Then why was there so much saving in Asia? And
why did this saving ow to the US? The easy answer:
Asians simply like to save more, and Americans simply
like to consume more. By this logic, all that is needed
to ght such recessions in the future is to induce
Asians to save less and consume more. That denitely
does not sound right.
This paper argues that all these individual
phenomena the savings glut, easy credit, lax
regulations, and the nancial crisis - are interlinked
by a deeper and a central driving force. This force is
the sharp increase in worlds labour supply due to
globalisation. Understanding this development is the
rst step on the way to recovery.
0oL~is~lio: /:o Te Leq~ Sysle:s
:~Liily To E:o:ce Fi:~:ci~ Co:l:~cls
Technological innovation and globalisation have
led to a sharp increase in the developed worlds
labour supply in the recent past. With the advent of
offshore ofces and call centres, citizens of developing
countries have increasingly joined the workforce of
developed countries. Now combine the extra income
in these developing countries with the inability of
these emerging economies to absorb savings, and the
result is a lot of money owing to the US and the
rest of the developed world. With this excess liquidity
owing in and a breakdown of checks and balances at
various nancial institutions in the US, the stage is set
for a nancial crisis, which is the rst symptom.
Globalisation led to a global competition for
investments. Hence it ensured efcient use of
resources. In fact, the emerging economies of Asia
as a group experienced a growth rate in excess of 7
percent in real GDP over the period 1982-2008.
Another major consequence of globalisation was
the emergence of the dollar as the worlds currency.
What this means is that the inadequate domestic
nancial systems in emerging economies had the
DY R/\ J/0//T/, MUDT /P00R /D ERST SC/UMDUR0
The global economy is in a recession and unemployment rates are soaring. But the nancial crisis is a mere
symptom and not the disease itselI, say the authors in this article
Co:Li:e le exl:~ i:co:e
i: lese oeveoi:q
cou:l:ies wil le inability
o lese e:e:qi:q
economies lo ~Lso:L
s~vi:qs, ~:o le :esul is
~ ol o :o:ey owi:q lo
le US ~:o le :esl o le
oeveoeo wo:o
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Features
effect of channelling savings into dollar-denominated
assets. In order to defend their currencies after
the 1997 Asian crisis, most Asian countries started
building up dollar reserves as a buffer against future
macroeconomic shocks. The result was that the
current account surplus of the BRIC (Brazil, Russia,
India, China), NIAC (Hong Kong, South Korea,
Singapore and Taiwan) and ME (Middle Eastern oil
exporting countries) countries rose from $4billion
in 1996 to $798billion in 2007 roughly equal to
the US current account decit of $788 billion in
2007.
This excess inow of foreign investment into
US treasuries and mortgage pools from countries
like China was what led to cheap nancing of
government debt and mortgage debt. This, in turn,
facilitated lower taxes and cheap home equity
loans. Easy loans translated into greater demand for
houses and hence rising house prices, i.e., the real
estate bubble. Moreover, low taxes and rising house
prices made US households feel wealthy. With the
availability of easy debt, this spurred an increase in
consumption including imports.
To explore this phenomenon further, consider
the case of the Oriental Dragon and various
macroeconomic interplays.
Te Rise o Ci:~ ~:o L~Lou: Suy
Soc
China has beneted the most from globalisation. It
is one of the most important creditors and trading
partners of the US. Adjusted for purchasing power
parity (PPP), Chinas economy was 12 percent of
the world GDP in 2007, up from 2 percent in 1980.
This meteoric rise has been made possible by recent
innovations in communications and transport.
These innovations have helped open up the services
of Chinas enormous pool of underemployed labour
to the western world.
This export-led growth enabled the movement
of large segments of Chinas rural population
to the cities. Between 1990 and 2007, Chinas
urban working population increased by nearly
300 million, which is roughly 1.5 times the US
working population. This enormous labour supply
coupled with Chinas exports acted like a sudden
supply shock to the global economy. A shock of such
magnitude is likely to adversely affect some and
positively affect others in the short run, even when
everyone is better off in the long run. In order to
understand these effects, let us dig deeper into the
labour shock and the new globalised world.
With the availability of abundant cheap labour
in China, a lot of low-skill jobs moved from the US
to China. This inevitably meant job losses for certain
sections in the US. The other side of the coin was
that since the wages paid to these Chinese could be
much lower than the wages of those who lost jobs
in the US, the employees who retained their jobs in
the US would get higher salaries now. In a nutshell,
newly hired Chinese and Americans who retained
jobs were better off and Americans who were red
were worse off in the short run. In the long run,
however, those employees who were red could be
trained and employed in other productive activities.
This would increase the productivity and the GDP
of the US in the long run. Moreover falling prices
due to Chinese production would soften the impact
of short-term adversity.
According to the argument we have outlined
above, one should expect signicant investment in
China and increased Chinese exports to the US.
In fact, a lot of Foreign Direct Investors (FDIs)
in China came from South Korea, Taiwan and
Japan, and the Chinese trade surplus with the US
increased rapidly. Another interesting phenomena
accompanying Chinas increased income was the
increase in savings as a percentage of Income. But
Chinese markets could not absorb these savings. So
where did these savings go?
C~il~ Fows To Us
The increasing savings from China and other emerging
economies owed into US treasuries and other
Tis excess i:ow o o:eiq: i:vesl:e:l i:lo US
treasuries ~:o :o:lq~qe oos :o: cou:l:ies ie Ci:~
w~s w~l eo lo ce~ nancing o qove:::e:l oeLl ~:o
:o:lq~qe oeLl
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assets. This abundant capital ow had a two-fold
effect. First, it caused an undue downward pressure
on real interest rates in the US, and second, it led
to gradual appreciation of Chinese currency relative
to the US dollar. Articially low interest rates in the
US led to much higher consumption by US citizens
despite an increasing current account decit, while
the increasing value of the Chinese yuan threatened
Chinas export-driven boom.
To maintain the competitiveness of the Chinese
export sector, the Chinese government intervened
to maintain the yuan-dollar exchange rate. This
further increased Chinese dollar reserves. After the
stock market crash of 2000, this unabated capital
ow from China to the US got directed towards safer
xed income instruments and other government-
backed investments, such as Government Sponsored
Enterprises (GSE) mortgage pools. The ow of money
to securitised mortgage pools helped drive down the
cost of borrowing and created record prot years for
Fannie Mae and Freddie Mac. With the decreasing
spread on GSE mortgages, investment banks set
up their own pools of private label mortgages,
providing investors a higher yield at seemingly
negligible additional risk. This was how the ow of
capital funnelled into the US housing market, leading
to a housing bubble.
Most economists would agree that China could
effectively use its savings in real capital investments
domestically rather than in the US. But such
investments would not suit Chinese policymakers,
carrying as they do the danger of higher consumption
growth in cities and perhaps, social unrest in the long
run. As long as these sets of issues are not addressed by
Chinese policymakers, they will continue to impede
the long term sustainable equilibrium.
To sum up, the sudden increase in labour supply
from workers in developing countries because of
globalisation should have resulted in signicant
sections of the population in developed countries
experiencing a decline in living standards. However,
the cheap ow of liquidity created the illusion of
wealth among households, sustaining high levels of
consumption.
Let us now add other known culprits to the story.
\~ Sl:eels Fi:~:ci~ :qe:uily
The nancial ingenuity of Wall Street further facilitated
what was already a crisis in making. During the late
1990s, a urry of innovations in the mortgage industry
enabled otherwise unqualied buyers to qualify for
mortgages. Through their nancial engineering, Wall
Street and credit rating agencies transformed these
subprime mortgages into Asset Backed Securities (ABS),
making it difcult for investors to understand the
underlying risk. Given the low rates on alternative
investments, investors ocked towards subprime
loans, not realizing the potential delinquency levels
down the road. Subprime loans increased from $500
billion a year to $1500 billion a year between 2001
and 2005.
Eecls 0 ousi:q DuLLe
Money channelled into housing has a bigger price
effect than money channelled into other assets. A
small amount of money channelled into housing can
be leveraged by easily accessible bank loans, resulting
in a money multiplier effect on housing prices. The
same is not possible for asset classes like stocks where
there is no leverage effect in the aggregate. Hence, a
relatively modest housing bubble can have
more severe real effects than other asset
price bubbles.
Residential real estate constitutes a
greater percentage of household wealth
compared to stocks. Hence, declines in
prices of houses could have severe effects
on the overall wealth of households.
Recovering from recession often involves
households moving geographically to seek
new and better opportunities. However,
the recovery will be more difcult when
the recession is associated with a collapse
in housing prices. Hence, a housing
bubble burst has a much more severe effect
than a stock market collapse the stock
market downturn in 2001 led to a shallow
recession but the collapse of the housing
Te suooe: i:c:e~se i:
~Lou: suy :o: wo:e:s
i: oeveoi:q cou:l:ies
Lec~use o globalisation
souo ~ve :esuleo i:
siq:ic~:l seclio:s o le
ou~lio: i: developed
cou:l:ies exe:ie:ci:q ~
oeci:e i: ivi:q sl~:o~:os
R~vi J~q~::~l~: is
le Cic~qo Me:c~:lie
Exc~:qe/Jo: F
S~:o:e: Disli:quiseo
P:oesso: o Fi:~:ce
~l le eoqq Scoo
o M~:~qe:e:l,
o:lwesle:: U:ive:sily
~:o ~ Rese~:c /ssoci~le
~l le ~lio:~ Du:e~u
o Eco:o:ic Rese~:c
DERl
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bubble has led to the worst recession since the Great
Depression.
\y Dio Te DuLLe Du:sl
The export-led growth in emerging markets led
to an increase in prices of intermediate goods and
commodities. The ratio of Producer Price Index (PPI)
to Consumer Price Index (CPI) increased sharply
from 2005 to 2007, suggesting that there was very
limited pass-through of higher prices from producers
to consumers. This caused downward pressure on
wages in the manufacturing sector.
With this pressure on wages, some subprime
households defaulted on their loans, leading
to downward pressure on house prices due to
foreclosures. Spreads on mortgage-based securities
(MBS) tranches started blowing out, putting subprime
originators in trouble. Re-pricing of risk dried up
availability of teaser rate loans to home-owners with
Adjustable Rate Mortgages (ARMs).
All this had a downward spiral effect,
resulting in dramatically increasing
numbers of foreclosed properties in
bank inventories.
0le: :le::~lio:~ Ex~:es
A number of other countries apart
from the US experienced current
account (CA) imbalances and extremely
low saving rates. Interestingly, every
country running a signicant CA decit
also suffered a housing bubble and a
subsequent crash. These countries now
have the mammoth task of stimulating
their economy while credibly promising
to impose scal discipline, and all this,
without the benet of a reserve currency
at their disposal.
Te \~y Fo:w~:o
The fundamental cause of the crisis is the labour
supply shock and not the glut in liquidity which is
often blamed. A higher savings rate in the debt-
laden developed nation and greater capital ows
to the developing nation will correct the structural
imbalances in global capital ows.
In the US, institutions that allow households to
reduce their debt burden and policies that promote
household understanding of the public debt would
contribute to higher savings. Amongst the developing
world, Chinas export-led growth strategy would
be unsustainable in the long run and domestic
consumption will have to grow. The world will need
to nd a better way of handling the inux of millions
of rural labourers from China and India into the
productive workforce.
There are signicant challenges that lie ahead of
us. There is trouble brewing in commercial real estate
markets. Many regional banks could take a hit due to
excessive exposure to bad loans, resulting in further
delay in recovery. Additionally, as rms economise in
the downturn, there will be increasing outsourcing
pressure on them to cut costs. This would only add
to the underlying structural problems accentuating
the recession. Countries might be tempted to close
doors to outsourcing of manufacturing and other
activities while this may provide temporary relief,
it will accentuate other structural problems.
The paper, Why are we in a recession? The Financial
Crisis is the Symptom not the Disease! was adapted for
ISBInsight by ISB alums of the Class of 2009, Rakesh
Gupta and Sumit Popli.
E::sl Sc~u:Lu:q is
~ Se:io: Eco:o:isl ~l
le Feoe:~ Rese:ve
D~: o ew Yo:
e w~s :eviousy ~:
/ssisl~:l P:oesso: o
Fi:~:ce ~l le eoqq
Scoo o M~:~qe:e:l,
o:lwesle:: U:ive:sily
Muoil ~oo: is ~:
/ssisl~:l P:oesso: o
Eco:o:ics ~l le SD
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Features
Value Creation
in Mergers and
Acquisitions
While mergers and acquisitions are a very important
tool in a CEOs strategic toolkit, value creation in
mergers and acquisitions (M&A) remains a mirage.
Firms invariably tout synergies as the reason
compelling them to seek this medium of inorganic
growth. Synergy implies that the whole is greater
than the sum of parts. In other words, a merger or
an acquisition makes sense only if it leads to certain
operational and/or nancial advantages that the
individual entities could not harness by themselves,
thereby creating value for shareholders of both
protagonist rms. Academic research shows that
rms invariably overestimate possible synergies from a
merger or an acquisition particularly revenue-based
synergies. As a result, acquirers lose value on average
while the targets rake in the moolah.
Given such damaging evidence on M&As, what
are some of the factors critical to deal success? Could
contrasting a successful M&A transaction with a failed
one unearth common themes? Could it inform us
about the ingredients that go to make a successful
transaction?
Over fty teams, comprised of ve ISB students
each, set about answering these questions in an
elective course on Corporate Control, Mergers and
Acquisitions. Using frameworks learnt in class , the
teams picked and contrasted a successful deal with a
failed one, to separate credible sources of synergies
from the dubious ones. Their ndings provide
illuminating insights into M&As as a potentially
value enhancing, yet very challenging instrument of
corporate nancial strategy.
In this article, we summarize the broad ndings
from these studies. Also, we pick two of the most
insightful projects to highlight and illustrate the
specic ndings unearthed by ISB students. The rst
of these groups comprised Dipali Gupta, Dushyant
Sharma, Kamaldeep Raina, Manpreet Singh, Rashmi
Gupta and Toshal Sakhare, while the second group
was formed by Rohit Bhagwat, Venkataprasad Vedam,
DY RS/MURTY SUDR/M// /D STUDETS TE `C0RP0R/TE C0TR0L,
MER0ERS /D /C0UST0S` C0URSE /T TE SD
This article details some oI the Iactors critical to the success oI an M&A, based on a comparison between Iailed
and successIul deals.
/ :e:qe: o: ~: acquisition :~es se:se o:y i il e~os
lo ce:l~i: oe:~lio:~ ~:o/o: :~:ci~ advantages l~l
le i:oiviou~ e:lilies couo :ol ~::ess Ly le:seves,
le:eLy c:e~li:q v~ue o: s~:eooe:s o Lol
:ol~qo:isl ::s
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?I8S0T FEATURES
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Niranjan Janardhanan, Gaurav Bansal, Saurabh Jhawar
and Aarti Ganesh.
Our ndings suggest that while the expected
synergies from most M&As are similar to begin with,
the ultimate success of the deal is determined by the
implementation of marketing and business strategies
for the combined entity, and the effective integration
of the diverse organisation cultures. The contrast of
successful and failed mergers and acquisitions reveal
the following:
\s\s uudc:talcu tl tlc utcutou o uc:casug
market share can be value enhancing if the deal
leads to one or more of the following: (i) increases
the rms pricing power vis--vis competitors;
(ii) enhances the combined entitys bargaining
power with customers and/ or suppliers; and (iii)
is instrumental in enacting entry barriers.
vlcu u:us uc:gc to scll uultlc :oducts
using a set of common distribution channels, and
thereby reap operational synergies, consolidation
of such channels leads to greater success
compared to attempts at combining diverse kinds
of distribution channels.
Rccuuc suc:gcs stcuuug :ou c:ossscllug
of the acquirers products to the targets, and vice
versa are often unduly aggressive. Assumptions
relating to cross-selling of products must be
carefully scrutinized by senior management.
vlcu uuaucal suc:gcs stcuuug :ou tax
benets are the motivating factor in a deal,
thorough due diligence must be undertaken to
ensure that the value generated from tax savings
is not dwarfed by value destruction in other parts
of the deal.
:ucc colc ualc o: |:cal a dcal, lc c:souucl
in both combining entities must be identied.
Furthermore, compensation and incentive
schemes must be designed so as to ensure that
key personnel in both companies are retained.
iast |ut uot tlc lcast, adcquatc attcutou uust |c
paid to cultural integration to provide a suitable
environment to realize synergies.
Given below are examples which highlight the
underlying assumptions of the rms approaching the
deals, the projected synergies and the differences in
implementation strategies that led to success in one
case and failure in the other. ArcelorMittal (AM) and
DaimlerChrysler (DC) were pathbreaking mergers
seeking creation of large-scale synergies. The second
example, from the beverage industry, contrasts United
Spirits Limiteds slow consolidation with Shaw Wallace
and Quaker Oats failed acquisition of Snapple.
/:ceo:Mill~ ~:o D~i:e:C:yse: Me:qe:s
With careful planning and excellent execution,
ArcelorMittal turned out to be a success while
DaimlerChrysler remained mired in various cultural,
operational and nancial issues.
While ArcelorMittal and DaimlerChrysler
experienced very different outcomes eventually, the
deals were similar in many respects to start with.
Therefore, contrasting these two deals enables one to
control for several factors that may confound inference
about the effect of the M&A event. Both ArcelorMittal
and DaimlerChrysler deals were characterized by
the coming together of two market leaders. In both
the cases, one of the partners was operating in a low
margin volume-based business (Mittal and Chrysler)
and the other in the premium segment (Arcelor
and Daimler-Benz). Synergies were expected from
increased geographical presence by utilizing the
distribution channels of the partner entities. Both the
entities were expecting cost synergies by consolidating
support functions. For ArcelorMittal, the value of
expected synergy was pegged at $1.6bn whereas in case
of DaimlerChrysler, it was pegged at $1.4 billion in
Phase I and $3 billion in Phase II. Both the deals were
valued at approximately at $37 billion. Merged entities
in both deals operated in similar macro environments
cross-border presence, capital-intensive industries,
high industry-wide leverage.
0u: :oi:qs suqqesl
l~l wie le execleo
sy:e:qies :o: :osl M&/s
~:e si:i~: lo Leqi: wil,
le uli:~le success o
le oe~ is determined
Ly le i:e:e:l~lio: o
:~:eli:q ~:o Lusi:ess
sl:~leqies o: le co:Li:eo
e:lily, ~:o le eeclive
integration o le oive:se
o:q~:is~lio: culu:es
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Features
The differences in eventual outcomes arose from
several avenues. First, Mittal Steel invested substantial
time and effort in due diligence before approaching
Arcelor. Lakshmi Mittal made efforts to effect a
friendly merger before launching a hostile bid to take
over Arcelor. In contrast, Daimler seemed to have
compromised due diligence to avail tax benets ($1.3
billion every year) permitted under the German law,
for a fast track deal.
Second, in the case of ArcelorMittal, the
management consistently projected the deal as growth-
oriented rather than capacity rationalization, which
assuaged concerns about layoffs, enabling employee
cooperation while also retaining top talent. Several
channels were established to listen to and address the
concerns of employees.
In contrast, in the DaimlerChrysler deal, the
employees lived with a perpetual fear of job cuts due
to lack of transparent communication. Top executives
of Chrysler started leaving even before announcement
of the merger. Also, the inequity in layoffs between
German and American employees resulted in a feeling
of distrust in American employees towards their
German counterparts.
Third, in ArcelorMittal, all post-merger corporate
bodies like the Board of Directors had equal
representation from the two entities. The headquarters
of the new entity was moved to Luxembourg, the
former headquarters of Arcelor. This helped create a
sense of trust between the two organizations.
In contrast, for DaimlerChrysler, the executives
bodies formed were skewed in favour of the Germans,
which only got worse with the passage of time. The
structure was to have a parallel management with
two CEOs Robert Eaton (Chrysler) and Juergen
Schrempp (Daimler- Benz) and two headquarters
Auburn Hill (Chrysler) and Stuttgart (Daimler-Benz).
However these plans were not executed in spirit.
Robert Eaton left before his stipulated term got over
and the functional headquarters remained at Stuttgart.
This left Chrysler employees feeling shortchanged.
Fourth, ArcelorMittal made an effort to address
the concerns of various stakeholders through different
communication channels. Similar transparency was
absent in the communications of DaimlerChrysler.
The DaimlerChrysler merger was touted as a merger
of equals but in 2000, the CEO of Daimler-Benz
publicly said that the equal partnership was merely a
psychological gimmick to close the deal.
Finally, ArcelorMittal was able to derive value
from the synergies of the merger, which is evident
from the increased levels of protability compared
to the pre-merger individual entities. In contrast, in
2007, the nine-year merger of the two auto giants -
Daimler and Chrysler came to an end with Daimler
selling its 80.1 percent stake in Chrysler to Cerberus
Capital Management.
U:ileo Si:ils Li:ileo ~:o 0u~e: 0~ls`
Me:qe:s
On the one hand, United Spirits Limiteds (USL)
phased acquisition of Shaw Wallace & Company
(SWC) was a runaway success, thanks to effective
consolidation and competitive advantages realized
through operational, promotional and nancial
synergies. On the other hand, Quaker Oats' acquisition
of Snapple could be dubbed one of the classic disasters
in the history of M&A, due to overestimation of
revenue and operational synergies, as also integration
challenges due to incompatible cultures.
When USL merged with SWC, it led to an entity
with a market share of over 55 percent. This leadership
position resulted in greater pricing and bargaining
power. Further, margins were signicantly improved,
due to cost reductions resulting from consolidation
of distribution channels and lower number of selling
agents. As a result, the earnings before interest, taxes,
depreciation, and amortization (EBITDA) grew from
8 percent to 18 percent in rst half of scal year
2006-07.
In stark contrast, Quaker intended to combine
its distribution network with Snapples existing cold
distribution channel to achieve higher revenues
through cross-selling. In addition, Quaker planned
/:ceo:Mill~ w~s ~Le lo oe:ive v~ue :o: le synergies
o le :e:qe:, wic is evioe:l :o: le i:c:e~seo eves
o protability co:~:eo lo le :e:e:qe: i:oiviou~
e:lilies
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:is:~:u:ly
SuL:~:~:i~: is ~ \isili:q
Sco~: i: Fi:~:ce ~l le
SD
to capitalize on the presence of its energy drink,
Gatorade, in international markets to sell Snapple.
However, these synergies did not materialize because
of resistance among the channels to cross-selling. The
combination of two dissimilar distribution channels,
cold and warm, instead led to increased costs.
SWC and USL were erce competitors and
annually spent close to Rs 200 crores on promotional
offers to grab each others market share. Post
acquisition, their promotional expenses went down
drastically and their combined product portfolio and
brand equity created formidable barriers to entry. In
addition, SWC and USL positioned
their spirits as premium and mass brands
respectively to prevent cannibalization.
In the case of Quaker, Snapple
and Gatorade together had 37 percent
market share and were not in direct
competition. However, after acquiring
Snapple, Quaker was in direct
competition with larger players like
Coke and Pepsi, and this forced it to
increase its promotional spending.
The USLSWC deal was nanced
by borrowing $300 million from ICICI
bank. USL paid approximately Rs 203 per share,
against the expected synergy inclusive value of Rs
215.77, thereby retaining a signicant portion of the
expected value creation. USL also received a tax shield
benet of Rs 50.9 million because of the losses made
by SWC in scal year 2005.
The QuakerSnapple deal on the other hand was
an all-cash deal. Snapples share value had plummeted
due to its various acquisitions. The deal reduced the
interest expense of the combined entity, but left no
money on the table to provide Snapple an incentive
to integrate successfully with Quaker.
The integration of USL and SWC was a cautious,
phased process with employees given attractive
incentives that helped achieve a smooth transition.
In contrast, people problems were the key to the
failure of the Quaker-Snapple deal. This was primarily
because Snapple was quirky, entrepreneurial and off-
beat while Quaker was more organized and Gatorade
was considered a lifestyle brand.
It is evident from the above examples that while
USL systematically leveraged the resources and
capabilities obtained from acquiring SWC, Quaker
Oats failed to do the same because of incompatibility
of resources and cultures .
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Features
Knowledge Hoarding
In an increasingly complex and unpredictable world,
the development, exploitation and management of
knowledge are the keys to building a competitive
advantage for modern organisations. Most
organisations have formal knowledge management
initiatives that consists of information systems
designed to hold and distribute codied knowledge.
While managing knowledge is ostensibly critical
to professional rms, it is implicitly believed that
employees will share knowledge if they are provided
with adequate infrastructure and incentives (Zack
1999, OLeary 2002). This research is an attempt to
investigate the impact of different personality types,
various incentives and the role of gender on knowledge
hoarding. Knowledge acquired during the course
of ones job belongs to the organisation rather than
the individual. However, some individuals perceive
this as their personal intellectual property and hence
do not share it with others in the organisation. This
phenomenon of not sharing information is dened as
Knowledge Hoarding.
Rese~:c Melooooqy
A sample of 207 Indian corporate employees with
an average experience of ve years participated in
this survey. Respondents from a range of industries
(spread indicated below) were invited to participate
in the study. They were chosen randomly and cut
across industries as illustrated.
Each participant responded to a set of two written
scenarios depending on the particular experimental
condition to which they had been assigned. These
scenarios described opportunities to share acquired
knowledge with other co-workers that would
enhance employee effectiveness and productivity.
Responses were aggregated across the scenarios after
removing inconsistencies and formed the input for
further regression analysis. We evaluated two types of
personalities Self Monitoring people and Empathetic
people.
Self-monitoring theory is a contribution to the
psychology of personality, proposed by Mark Snyder
in 1974. The theory refers to the process through
which people regulate their own behaviour in order to
"look good", so that they will be perceived by others
in a favourable manner.
DY 0/UR/\ D/S/L, P/LL/\ M/L/ /D SUMT P0PL
This research article looks at the impact oI incentives, personality types and gender on sharing intellectual
wealth.
0ender nduslry Spreod
Fe:~e
Z%
M~e
o%
Solw~:e/Tec:ooqy Z'%
Fi:~:ci~ Se:vices ZO8%
Co:suli:q 1'1%
E:e:qy/0e:~lio:s/M~:u~clu:i:q 1/8%
Meoi~ ZZ%
Rel~i/FMC0 ZZ%
Teeco: ZZ%
e~lc~:e/P~::~ ZZ%
0le:s 1%
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Empathy, which literally translates as in feeling, is
the capability to share another being's emotions and
feelings.
Self-monitoring and empathetic personality types
were measured using a modied version of the scale
developed by Lennox and Wolfe (1984) .
Rese~:c Fi:oi:qs ~:o :ic~lio:s
Based on the survey responses and subsequent focus
group discussions with the respondents, we realised
that the willingness to share knowledge is indeed a big
predicament for the organisations. Firms which rely
on employees sharing proprietary information have
to rethink the design of their knowledge management
incentives systems. The ndings are summarised
below:
- Mo:el~:y & Recoq:ilio:L~seo
:ce:lives ~i.
Contrary to popular belief, the presence of
monetary and recognition-based incentives
actually deters people from sharing knowledge
with each other. The graph below (gure 1) clearly
indicates that the willingness to share knowledge
decreases in the presence of these incentives. This
is possibly because people do not want to be seen
by their teammates as very competitive persons
who only share when incentives are available. In
addition, people do not want to be treated as
commodities, to be controlled by providing
incentives.
This research has strong implications for
organisations that are wastefully spending large
amounts on incentives. They should rather
understand the motivation of different employees
to share knowledge and channelize their resources
on providing incentives to the entire team. This
might lead to a better culture of sharing amongst
employees.

- Peoe iq o: Se:o:ilo:i:q o:
E:~ly s~:e oie:e:ly.
We observed that personality has a very strong
correlation with the willingness of people to share
knowledge in the presence/absence of different
incentives. People high on self-monitoring tend
to prefer monetary incentives, while people
high on empathy tend to dislike monetary
incentives. This is possible because people high
on self-monitoring (impression managers) do not
want to be recognised for sharing information
since self-image management is critical for them.
On the contrary, people high on empathy believe
that monetary incentive is a cold-blooded
reward from the company. The graphs above
(gures 2&3) indicates the scenario for different
incentives.
This nding has strong signicance because it
highlights the importance of understanding the
need for different incentives for different types
of people.
- \o:e: s~:e ess l~: Me:
We also observed that the willingness to share
knowledge varies between men and women.
Figure 2: 5haring under diIIerent conditions by 5elI-monitors
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Figure 3: 5haring under diIIerent conditions by Empathetic People
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o :ce:live
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Figure 1: Likelihood oI sharing under diIIerent incentive structures
Average likelihood oI sharing
l
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e
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a
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Mo:el~:y Recoq:ilio: o :ce:live
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Winler O-1O
Women typically share less than men. This is
probably because historically, women in India
have been discriminated against in boardrooms,
which has forced them to be over-competitive, so
that they prefer to use knowledge as a weapon to
differentiate themselves from their counterparts.
Women may be wary of forging close ties and
sharing knowledge with other male colleagues in
the workplace. The graphs above (gures 4&5)
indicate the same.

This nding again illustrates the fact that more
and more female team members need to be
included in knowledge management initiatives.

In addition, when we tried to explore the
interaction between gender and different incentive
structures, we realised that in the presence of
monetary incentives, women are less likely to
share knowledge. This could possibly be because
75 percent of the women as per our survey were
high on empathy and they possibly associate
guilt with money. One key implication from this
nding is that organisations need to understand
intrinsic factors of motivation which drive men
and women to share knowledge.
Li:il~lio:s
Employees do not share knowledge either intentionally
or unintentionally. For the purposes of this study, we
have limited the research to intentional knowledge
retention in corporate organisations.
The study is also limited to two personality types
and in the future, can be replicated across
other personality types.
Co:cusio: ~:o \~y Fo:w~:o
This study has shown that organisations
may be mistaken in believing that
employees will share information if
knowledge management systems are made
available. Our research has highlighted
the importance of understanding the
motivations for knowledge sharing
amongst employees. Managers need
to understand the interaction between
different drivers such as personality,
gender, and incentives, amongst other
things, to foster a strong culture of
knowledge sharing in an organisation. Our
study further suggests that organisations
need not resort to costly monetary or
recognition-based incentives for sharing
to encourage free ow of knowledge.
This research is a continuation of ongoing
studies on designing effective knowledge
management systems. It may be read in
conjunction with other studies done in
the past, especially in the Indian context,
for a more holistic outlook.
The research can be extended further
by looking at the impact of other factors
such as the nature of the organisation,
employees association with teams
and organisations, family background,
religious beliefs etc, on sharing of
intellectual wealth in an organisation.
The authors wish to thank Dishan Kamdar,
Associate Professor of Organisational Behaviour
and Associate Dean, Academic Programmes at
the Indian School of Business (ISB) for his
guidance and mentorship
FEATURES
Features
Figure 5: Average Likelihood oI 5haring by 0ender & ncentives
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OZO
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OZO
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o

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~
:
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:
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0e:oe: sil o: :ce:l
M~e Fe:~e
Mo:el~:y
o :ce:live Recoq:ilio:
0~u:~v D~:s~ is ~ sluoe:l
o le SD, C~ss o ZO1O
P:io: lo |oi:i:q le SD,
e w~s wo:i:q wil ~
Fo:lu:e OO oi ~:o q~s
co:suli:q ::
P~~vi M~~:i is ~ sluoe:l
o le SD, C~ss o ZO1O
P:io: lo |oi:i:q le SD,
se w~s wo:i:q ~s ~
co:sul~:l wil ~ e~oi:q
co:suli:q ::
Su:il Poi is ~: ~u::us
o le SD, C~ss o ZOO'
e is cu::e:ly wo:i:q ~s
~ :~:~qe:e:l co:sul~:l
wil ~ e~oi:q co:suli:q
::
Figure : Average Likelihood oI 5haring by 0ender
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/ve:~qe ieiooo o s~:i:q
M~e Fe:~e
Cover Story
COVER STORY Winter 0-10
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?I8S0T FACULTY CLOSE UP
Face to Face
)- lDlPTN0 T0 NFW PlRlD0MS
*' BRlNDS, N0T LlBFLS. THF FUTURF 0F lPPlRFL
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Winler O-1O FACE TO FACE
Face to Face
Deepak 0handra: Let us start with your experiences
as a business leader. You have seen 0ognizant grow
into a ma|or player in the T space. Did you see distinct
stages oI growth? What were some oI your leadership
challenges and lessons in each oI these stages?
Lakshmi Narayanan: At rst, Cognizant was captive to
one large customer; we did not have to focus on selling
because the business was right there. We needed to
focus on delivering, on making promises and making
sure that we delivered on the promises. So the focus
was on getting the best talent, and making sure that
the work was of the highest quality. It was a singular
focus. When you are in that kind of a position, the
leadership tends to focus on the details.
The next stage is instead of serving just one
customer, you go out and serve the market. This means
that you have to acquire two skills simultaneously.
First, you have to go out and sell and second, the
time for delivery is limited. So you have to let go, you
cannot continue to micro-manage. Behaviorally, this
is a very challenging stage because you have to start
believing that the people around you are better than
you, cleverer than you. Not that they are, but it is a
belief that you have to develop, so that you can let go
and empower.
In the third stage, you start looking at market
recognition. You need to dene what you want the
market to perceive you as. For a business leader, the
challenge is to live that, day-in and day-out. If you
want to project the image of a rapidly growing large
Adapting to New Paradigms
Lakshmi Narayanan, Vice 0hairman oI 0ognizant, the youngest nIormation Technology ITJ services company to
reach a billion dollar revenue milestone, talks to Deepak 0handra, Associate Dean, 0entre Ior Executive Education,
ndian 5chool oI Business I5BJ and Amit Mehra, Assistant ProIessor, nIormation 5ystems, 5B, about leadership,
challenges and opportunities in the T industry, education and the role oI philanthropy.
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organisation, the leader has to immediately display a
mindset of size and scale, and act as if he or she is the
leader of a very, very large company.
The last stage is continuing the established
message, sustaining that growth and letting the
organisations leadership develop.
0handra: How did you go about these Iour stages?
For the last two stages, we needed a fresh perspective
from outside the context of the IT industry, to
get a sense of what it means to lead a large, global
organisation. Such a requirement can be fullled by
an external mentor who has that perspective. In our
case, it was Ram Charan.
In the earlier two stages, the transition was helped
largely by the customers that we worked with. The way
to do it is to identify about four or ve customers with
whom you have been extremely successful and have
built a relationship. You take their advice on why they
work with you; what they nd different about you that
they dont get elsewhere. This can help you focus and
strengthen your advantages. Internally, there is often a
reluctance to share your problems with customers but
that is the best source to get the most innovative ideas.
0handra: With the global market becoming multi-
polar, will we see diIIerent market characteristics and
leadership capability requirements?
Over the last few years, emerging markets have
really been growing in size but innovation still
happens predominantly in the developed world. The
application of innovation happens in both worlds,
but perhaps far more rapidly in the developing.
So strategically, we look at both markets. But for
developing the corporations capabilities, you need to
have one foot rmly in the markets where innovations
take place.
Amit Mehra: You talk about little innovation happening
in emerging markets. But one can think oI the telecom
industry, Ior example, which is actually bigger and
more developed in 0hina and ndia than in the U5. 5o
can one expect more innovative activity in this sector
Irom emerging markets?
In terms of the market size, yes, India and China
etc are big. This is not to say that it is uninteresting
to look at the telecom market here, but from a new
applications perspective, it is a good idea to look at
developed markets. I have to be in the developed
markets to understand Android and Google phone.
This will then set the stage to apply them here.
Second, the type of innovation provides the
opportunity. For example, GE has developed a new
ECG machine and they say it costs Rs 19,000-20,000
per ECG and Rs 25,000 for the machine. The key
opportunity for companies like us is if we can develop
software where ECG-generated images can be shared
on a global basis.
Mehra: The T industry in ndia is seeing increasing
competition Irom 0hina and Latin America. They have
better inIrastructure than ndia, and English-speaking
educated people are available. t has also become more
costly to operate out oI ndia. 5o how do you actually
maintain the growth oI the business in the Iace oI this
competition?
In the face of competition, the one advantage that
India has in the model of outsourcing is innovation
itself. If you look at the evolution of the outsourcing
industry in India, particularly the IT sector in the
late 1970s and early 1980s, it was staff-linked. The
demand was for the talent to be physically present at
the client site.
The next stage of evolution was offshore
development, where things would be kind of thrown
over the wall. Texas Instruments setting up in Bangalore
is a great example of that. Then it became onsite and
offshore, with teams there and teams here going
back and forth. Next it became a very collaborative
onsite offshore, thanks to the availability of improved
communication systems.
Now the next stage people are talking about is
even more collaborative. The customer works with
four or ve partners and wonders why the partners
cant collaborate and provide solutions based on a
common knowledge platform? The customer doesnt
want to be worried about who is doing what.
All this is predominantly driven by the Indian
offshore industry, not by the developed world or China
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etc., because we have the history and the experience
of this evolution. So as long as we continue to innovate
on the model, we will have a signicant advantage that
will outweigh any cost, location or other parameters.
Mehra: The current state oI evolution oI the T
industry, with vendors collaborating Ior clients, is very
interesting. can think oI multi-sourcing deals in the
recent past where multiple vendors signed up to work
together, Ior example, ABN Amro`s multi-sourcing deal.
What would be the operational challenges in executing
such relationships?
Multi-sourcing happened earlier but in a more
hierarchical manner. There would be a prime
contractor who would sub-contract. Now clients pick
up different vendors, and divide up the work based on
their specialisations.
However, models and tools are still emerging for
effective operational collaboration between multiple
vendors. Once this happens, multi-sourcing will be
far more efcient. It is only a question of time. The
key thing you need is a common knowledge base on
which vendors can work with a set of common tools.
Right now, each vendor has their own toolset to
sculpt the project, as it were. Once they have to use
this common toolset, this common knowledge base,
the differences will go away and they will collaborate
much more.
Mehra: Do you Ioresee vendors collaborating at a
strategic level, too, Ior example, alliances oI vendors
bidding Ior contracts in order to maintain the competitive
edge?
At a strategic level, it is possible if the companies are
very differentiated. For example, if company A is
fantastic in dening the requirements and consulting,
company B is terric in development, company
C is a great testing company and so on, then it is
possible for them to strategically collaborate with one
common programm. But generally, this can happen
only if the customer involves strategic consultants like
McKinseys, BCG, Bose Allen, or Bain, and says, not
only will I buy your consulting report but I want you
to be responsible for the implementation. Strategic
collaboration can happen only if it is driven by the
market.
Mehra: You alluded to innovation being driven by social
collaboration. The homepage oI 0ognizant showcases a
collaboration platIorm. 0an you talk a little bit about that
and about Web 2.0? What opportunities is this technology
creating? How can ndian industry tap into it?
This is a platform that we developed purely for the
purposes of collaboration on the model of 2.0. We
call it Cognizant 2.0. The primary idea was to build a
knowledge management system. The philosophy was
that it was okay to make a mistake, but not okay to
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repeat that mistake. This means that any lesson learnt
has to go some place where it is available for every
other employee in the collaboration. That was the
idea on which this whole platform was built.
The customers came along and saw our developers
working on this Cognizant 2.0 platform. They wanted
their teams to use the knowledge base and collaborate.
Then, that also expanded. The customer has captives
in Philippines and in India. They want those people
also working on Cognizant 2.0. So this is almost like a
social network, in a development context.
There is still a barrier in adoption. It is OK for
customers to use it, but the fear is the customer might
be working with other vendors. What if one companys
intellectual property goes into the other? I would like
to break that barrier. If you dont allow others to use
the technology, they will develop it anyway. Then you
can get stuck ghting in this area. Instead of that,
why dont we focus on the next Cognizant 3.0, which
gives us some unique advantage, and open 2.0 for
everybody, including competitors.
0handra: Moving on, what can an T services company
do in ndia to gain access to better quality human
resources?
One way is to focus on students after they graduate
and enter the company, and then train and develop
them. But we have not focused on the training and
development of teachers. A majority of the IT teachers
in engineering colleges dont know what this industry
is about; they dont know what is happening in IT
companies. And yet we are asking them to develop
people who are company-ready or employment-ready.
I believe that if you get the teachers to visit good
campuses, and good companies, get them to look at
good projects, and equip them with better skills, then
they will be far more condent and will develop better
students, than if you bypass them.
0handra: There is a lot oI discussion about creating a
world-class education inIrastructure in this country and
the regulation to support this vision. What are some oI
the things that such regulation needs to look into?
The lesser the regulation in the area of education,
the better. No regulation would be ideal. It is like a
market. There are students who are willing to pay to
get skills, and acquire some talent. And as long as the
student has some ability, the institution can provide
that talent at the right price and so on, there is no
need for regulation, for somebody to come in and
talk about exploitation. I would say the government
should get away from the business of education and
allow much greater freedom.
0handra: Let us talk about the role oI philanthropy in
education. ndian levels are certainly not comparable
to what you see in the U5 or internationally. How
can such philanthropy be Iacilitated? What should
philanthropists expect? What can education institutions
do to position themselves?
If you want to do new research, or set up a centre to
research a new area, no student is going to pay for
it. The government may not be willing to pay for it
either. The people who will benet from it and may
fund it is industry. So philanthropy can work in areas
where the highest level research and new innovation
in unchartered waters happens. And the next level
higher education will have to be in a neutral area. It
will have to be paid for by the recipients, with perhaps
some government funding.
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5Bnsight: You have been in this eld a long time.
Please share with us a Iew lessons Irom your |ourney.
Vikram Rao: Philip Van Heusen (PVH) of the US,
one of the largest shirt makers in the world, had
just bought over the Calvin Klein (CK) brand and
company. I went to meet up with the CEO of PVH
to solicit the franchise for CK in India. I took him
through Maduras credentials, including the brands
we had built in India. At that time, he retorted
that what we had in India were labels and not
brands.
However, when PVH later saw how we developed
Louis Philippe, Van Heusen and Allen Solly in India,
they agreed that these were truly strong brands. India
denitely has the talent and capability for brand
building.
On another occasion, I happened to meet the
President of International Licensing for Polo Ralph
Lauren (PRL), again with a view to solicit their
franchise. We took along a business plan presentation.
After the presentation, he said, what you have shown
me are mere numbers. In no way did you tell me
how you will create an experience in the store to truly
romance the customer.
Romancing the customer is the most important
focus of PRL, from the minute the customer walks into
the store, through lifestyle display of merchandise,
store layout, ambience, the consistency of store
experience, the touch and feel, store personnel, and
all outdoor communications and events that relate to
the brand.
This was indeed an eye-opener. When I got back
to India, I asked the President of Madura to develop
the concept for three romance the customer (RTC)
stores, one each for Louis Philippe, Van Heusen and
Allen Solly. The whole exercise was to conceptualize
and then execute. This was indeed the beginning of
the journey of moving from product brands to retail-
represented lifestyle brands.
The President of Liz Claiborne, who I met in
the early 1990s, made a very valuable comment. He
said, Vikram, nobody needs one more shirt. But you
need to make them believe they do, and sell them
many. So think through carefully how you are going
to go about it.
The answer lies in superior brand building, with
merchandise and retail management at its core.
All these brands were developed Ior urban markets,
yet even people in rural areas are now wearing them.
Brands, Not Labels: The
Future of Apparel
n a Iree-wheeling discussion with the students oI the ndian 5chool oI Business I5BJ, Vikram Rao, Director, Aditya
Birla Management 0orporation Private Limited talks about rural markets, e-retailing, the entry oI Ioreign players
and other issues aIIecting the textile industry. Rao heads the Acrylic Fibre and 0verseas 5pinning businesses oI
the 0roup, with global operations in Thailand, ndonesia, Egypt and the Philippines.
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The second and third-tier markets are growing Iaster
than established urban markets. 5o what do you think
is the scope Ior rural brands? And do we need diIIerent
brands Ior rural markets or can we expand on existing
ones?
First of all, many of the regional brands already cater
to interior areas. National brands have evolved a
regional brand strategy, which goes out into second
and third tier towns. Peter England has 2700 stores
and sells in over a 100 towns.
That means that under the Madura umbrella, Peter
England has the highest awareness and acceptability.
But it is still considered part oI the elite group. t is
selling in second tier cities, but what about the lower halI
oI the pyramid? Every brand is interested in initiatives
that rural people can relate to and recognise as our
brand. Do you think Madura will also go that way?
No. I think the kind of distribution, culture, attitude
and the focus that you require are quite different.
It is an unorganised market, so you need an FMCG
kind of approach which would be led and driven by
a product and its associated image, rather than
through a lifestyle retail approach.
Apart from the distribution, the necessary
marketing and branding would also be totally different.
In rural India, they primarily relate to movie star
icons. They dont relate to Armani or those kinds of
brands.
In fact, many of the fabric companies, whether
they are Grasim, Siyaram, and so on, are all into this
game. Branded fabrics have rural acceptability and
have started to sell.
The apparel brands are not there yet. We have
to critically consider what our business model is and
what our positioning is before embarking on this
initiative.
What should be the pricing Ior a shirt in the rural
market?
We can make a customized shirt for Rs 199. But
then we need to look at net margins after costs of
distribution, brand building and more importantly,
discounts on leftovers. So to understand what will sell,
we need to study demographics and psychographics.
In India, in the same season, there are four
different seasons in each of the four regions. The
colours that sell in Kerala dont sell in Bangalore. It is
not easy to manage this.
s Madura on its way to becoming a retail company?
You have been promoting Planet Fashion as a separate
entity and you have started another store called The
0ollective Ior top-end clothes?
Except for The Collective, which is a retail brand, all
these other concerns are distribution channels. Retail
is a vehicle to sell, to make our brands stronger. Planet
Fashion is a retail arm which offers all of Maduras
brands under one umbrella in the suburbs of A and
B cities.
0ustomers are getting more and more used to discount
sales. Most brands have increased their overall product
price because they are making more sales in the sale
period.
Therefore, the brands have to be stronger. There has
to be a certain set of loyal customers who will wait to
buy fresh merchandise, and go and buy whats new.
The number of young Indians who want to wear
brands has increased and these are consumers who
can buy both at discount and also at full price. When
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they like something, they are not all going to wait for
discount sales to happen.
What do you think is the scope Ior e-retailing in ndia?
In India, e-retailing is a little bit complicated.
Shopping is an outing here. It is not necessarily a
chore. It is also a pleasurable pastime. So, in that
context, e-retailing will take some time, more so
in apparel which is a touch-and-feel game for the
consumer.
Now a question about corporate branding. 0nly some
oI your brands are very well-known as coming Irom
your corporate stable. Many don`t even know that Allen
5olly is one oI your brands, Ior instance. Does corporate
branding play any role in this sector?
We should not confuse the customer. The purest
relationship is between the mono brand (be it in
product or retail) and the consumer. Multiple
messages will take away the strength of the brand-
consumer relationship in many ways.
Moving on, what is your take on Ioreign direct investment
IFDJ in the apparel sector? A lot oI people are lobbying
against it. What is your opinion?
I am on the consumers side. I am all for consumerism.
Not as a retailer, as an individual.
As a retailer?
As a retailer, I want to protect myself. I will say no.
You talk about building brands. What kinds oI tools do
you use? You don`t see a lot oI the brands on television.
5o how do you go about building these brands?
Its a combination of print and events. Retail itself is a
tool. What happens at the store is the key. The impact
is made there.
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Faculty Close Up
Shrimali joined the ISB in 2007, following a PhD in
Electrical Engineering from Stanford University. Prior
to that, he earned an MS in Electrical Engineering
from the University of Minnesota, Minneapolis, and
a BTech in Electrical Engineering from the Indian
Institute of Technology, Delhi.
Shrimali has over eight years of chip designing
experience. He spent ve of those years at Intel.
Analysis and design of high capacity networks, grid
computing and internet service provider peering are
some of the other topics he has researched.
Shrimali, who teaches courses on Mobile
Policy and M-Commerce and Green Technology
and Sustainable Enterprise at the ISB, says the
common thread connecting his areas of research is
his interest in policy implications. After investigating
the economics of telecommunications networks over
the last few years, he is currently transitioning into
energy research.
Talking about this transition, Shrimali explains
that he became interested in climate change and
sustainable development, because it is
the idea going forward. He notes that
we in India are going to be the hardest
hit by climate change.
His primary interest lies in
policy mechanisms for promoting
renewable energy. It is all about using
economic analysis to derive policy
drivers for promoting renewable energy
development, he explains.
While working in India can be a disadvantage,
given that the most cutting-edge research in his eld
is happening in the US, Shrimali nds that the ISB
offers a colourful and diverse environment. I get to
spend two to three months doing research in the US
every year, he says. The ISB does everything it can
to provide support within the limitations.
Shrimali is currently working with the Prime
Ministers ofce to disseminate cooking stoves that
emit less carbon dioxide, and benet both health and
environment. This project also serves as the basis for
collaborative research he is conducting with Stanford.
Citing this project among the advantages of working
in India, Shrimali says it helps him see problems that
are relevant to emerging markets.
Going forward, Shrimali plans to combine his
research interests in computer networks and the
environment, and focus on the emerging eld of
Green IT.
Green Systems
0ireesh 5hrimali, Assistant ProIessor oI nIormation 5ystems at the ndian 5chool oI Business I5BJ, researches
the economics oI inIrastructure, particularly the telecom and energy sectors and plans to Iocus on the emerging
eld oI 0reen T.
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Cover Story
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Knowledge Sessions
Strategies for Scale
Introducing the panel topic, Ajit Rangnekar, Dean,
Indian School of Business, argued that three things
mattered when looking at business models for social
enterprises speed, scale and size of the impact.
I do not believe that the over six billion people
on this earth are going to wait forever to get their
share of the worlds growth, he said. He added that
while it was great to work on one project affecting
10,000 people, it was important to gure out how
to do it for a billion people, and how quickly. The
size of the impact was important, Rangnekar said,
because we should not be in the job of making a
marginal change to the lives of people. We should
be in the job of transforming the lives of people.
Dr Pawan G Patil, Chief Economist and
Chief Economic Development Ofcer, Silatech,
said more thought was needed about the 1.3 billion
young people entering the labour market within
the next 10-15 years, with only 300 million jobs
available for them. Considering the decit, what
would happen to the rest? It is only through
entrepreneurship and the stimulation of new jobs
and new opportunities that this decit can be turned
into an opportunity, he averred, because then
these young people themselves become an asset and
are a dividend, not a decit anymore.
Nandita Sengupta, Senior Assistant Editor, The
Times of India, said that the stories that had made
it to the news over the past few years had a lot to
do with low cost schools, low cost maternity clinics,
low cost housing, insurance for the poor and so on.
These were all individual small enterprises scattered
around the country and they brought choice to the
poor. In all these stories, the question was always,
why stop here? Why not take it bigger? Why didnt
it work on a national scale?
According to Manish Sabharwal, CEO,
TeamLease, it was essential to understand if an
enterprise was a baby or a dwarf. Both babies
and dwarfs are small but a baby can grow, while a
dwarf will always stay the same size. The difference
between the two is not just money but DNA,
template, components, standardisation, technology
and human capital. The six elements that helped
in differentiating a baby from a dwarf were
opportunity, team, organisational design, strategy,
risk and resources, with opportunity being the most
important.
A Iourth oI ndia`s population, around 300 million people, still lives in poverty. 5ocial entrepreneurship seems to be
the way Iorward to promote inclusive growth. A panel oI industry leaders met to discuss the challenges, strategies
and roadblocks involved in scaling up businesses in this context.This report is based on ideas presented during
the panel discussion held as part oI the Khemka Forum on 5ocial Entrepreneurship, hosted at the ndian 5chool
oI Business I5BJ.
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Don Mohanlal, President and CEO, The Nand
and Jeet Khemka Foundation, cited statistics to
explain what scaling meant in the Indian context.
In India, every time a new moon came around, he
noted, there were another million people added.
He pointed out that the state of Uttar Pradesh
was bigger than Russia, Maharashtra was bigger
than Germany, Andhra Pradesh was bigger than
France and Tamil Nadu was bigger than the United
Kingdom. Seven hundred million people lived in
rural areas and yet India was home to 41 cities with
at least a million people, which had witnessed an
increase of 50 percent in just the last two decades.
Some 200 million of those people still lived in
slum settlements. This had enormous implications
for their access to healthcare, basic education and
services.
The other aspect of the sheer size of India was
the so-called demographic dividend. More than half
of the population would be under 25 by the year
2015. Nearly two-thirds of the current population
was under 35. This was the worlds largest school
of young people. Only 11 percent received higher
education in the 17-23 age groups. And in the last
parliamentary elections, 100 million eligible voters
were between the ages of 18 and 24. By 2012,
more than a billion people in south Asia would have
mobile phones. So it was not just scale in India, but
size and scale that mattered.
Dr Nachiket Mor, President, ICICI Foundation
for Inclusive Growth and Chairman, IFMR Trust,
said it was also important to take into account
Indias diversity when thinking about scaling. I
think its a mistake that we often make in regarding
this as a single countr y. We think that Bihar and
Andhra Pradesh and Tamil Nadu are one countr y,
he argued. But the reality is what works in Bihar
may not actually work somewhere else. Politically,
until the 1950s, India was not one countr y, he
said. The British, the Mughals, Ashoka all ruled
other rulers, and never the people directly. It was
only in the 1950s that a single political entity was
created.
Mor further distinguished between replicating
and scaling. He said that solutions from what
worked in a given state could then be used to
replicate the journey in another state. He also said
that sometimes the competitive advantage of a small
business lay in the fact that it was small. If you tried
to scale it, you actually lost that opportunity.
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World of Leaders
Kravis started his career in the 1960s, buying up
small companies for Bear Stearns. They were called
bootstrap acquisitions in those days, he recalled. No
one was doing what is now called private equity. In
1976, Kravis, along with colleagues George Roberts
and Jerome Kohlberg, decided to focus 100 percent
of his time on these acquisitions. The senior partners
at Bear Stearns rejected their offer of half of the unit
the group wanted to call KKR. This pushed the three
into starting off on their own.
After trying to raise a $25 million for a fund,
Kravis, Kohlberg and Roberts decided to talk to a few
insurance companies that they had worked with while
at Bear Stearns. And they said, look we love you,
absolutely we are going to support you but we want
to be the investment committee, Kravis recounted.
The three entrepreneurs decided against the offer.
After guring out the overhead for their venture,
Kravis, Kohlberg and Roberts worked out a plan
to get $ 50,000 each from any eight entities, for a
total of $ 400, 000. In return the trio would make
a commitment to work on the project for ve years,
during which period, the investors would have the
right to see every transaction and decide if they wanted
to expand their investments. And if they did decide to
invest, KKR would get 20 percent of all future prots
from the project.
The three soon found the magic eight. Among
them was the First National Bank of Chicago. After
At the inaugural 5B World oI Leaders speaker series event hosted by the ndian 5chool oI Business I5BJ, Henry
R Kravis, 0o-Founder, 0o-0hairman and 0o-0E0, Kohlberg Kravis Roberts & 0ompany IKKRJ, New York, interacted
with a select group oI ndian business leaders about how he started his enterprise, the |ourney so Iar and his views
on the private equity industry.
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Winler O-1O KNOWLEDGE SESSIONS
Knowledge Sessions
buying three companies in 1977, their rst full year,
Kravis, Kohlberg and Roberts decided to raise their
rst fund for $25 million. They managed to raise
$10 million more than that. But we told all of our
original investors that even though you dont have to
put up any more money, Kravis said, As long as you
are alive, you can come in at no fees and no carry
because you were there to help us get started. KKR
now trains their people to not forget those who helped
the group along the way.
Fast forward to the present. KKR has bought
170 different companies across a range of industries,
worth around $425 billion. Kravis described what
KKR did as nancial engineering. (We would) buy
a company and we would leverage the investments
tremendously. Among the high and low points of his
career, he included the RJR Nabisco deal, the dotcom
era, losing money on Spalding Sporting Goods and
investing in the Safeway chain of supermarkets.
Private equity really has to be value-added,
Kravis said. It has to (have) operational improvements
and it has to be about being a true partner with (the)
management and helping them grow, whether you are
in a minority position or whether you own 100 percent
of the company. In every case, the management will
be the future owner in one form or another. The
alignment of interests is important.
KKR is today an integrated global rm. We want
to make money, and we want to have good returns,
Kravis said. But the culture and the values are the
most important. (They) keep the rm going; (they)
keep it growing.
If I were to write a blueprint for a companys
nancial system, the most important things that I
would include are regulation and transparency,
Kravis further advised. He said that people wondered
why there was an economic crisis and the reason
was that a lot of people were at fault. This was not
something that happened over time but was being
built over the years. So what Im worried about is that
we need some regulations. Kravis said that we need
much more transparency than there is today. But we
are going to have so much government interference in
Europe and the US that this could stie innovation,
and innovation is what makes any country, capital
markets and corporation very great, he concluded.
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?I8S0T IN BRIEF
Talking about the global nancial crisis at the ISB,
Gurcharan Das, author of the recently released
book The Difculty of Being Good: On the Subtle
Art of Dharma, said that it was not capitalism that
had failed, but people. Das added that the tendency
to paint people in black and white is wrong. Not to
judge people on the surface is what the Mahabharata
teaches us. He added that while the Ramayana is
about characters that are perfect, the Mahabharata
shows us the awed nature of human beings.
Analysing the issue of dharma in India today,
he said that every generation should go back to the
Mahabharata to nd new meaning. Ambition is good
but there is a line between healthy ambition and
unhealthy selshness. And that is one of the meanings
of dharma, which means moral balance. It means
doing the right thing, he said.
Parallels from the Mahabharata
In Brief
GDP versus GDH
Emphasising the importance of focusing on Gross
Domestic Happiness (GDH) as opposed to Gross
Domestic Product (GDP), His Excellency Korn
Dabbaransi, Former Deputy Prime Minister, Thailand
said, It is important to stop and reect what the word
GDP growth, oil prices and stock market reports
reect. Dabbaransi was the keynote speaker for the
ISB Leadership Summit and spoke on Leading in
Todays Economy: The Multi-cultural Advantage.
He said that in Thailand the radio announces the
GDP and the stock market gures every morning. I
was once asked if the country is in a good condition
because the GDP growth is high. And I was also
told that we shouldnt be giving information that
is not relevant to the happiness of the people. He
concluded by saying, Policy should be generated from
the well-being of our own people, not of outsiders. It
is important to focus on GDH and not GDP.
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Winter 0-10
What makes a VC successful?
Westernising Indian Retail
How does a venture capitalist gure out if the
opportunity is good enough? John W Mullins,
Associate Professor of Management Practice and
Chair of the Entrepreneurship group at the London
Business School was at the ISB to guide a group of
budding VCs. The ability to execute under critical
factors is what makes a VC successful, said Professor
Mullins. A successful VC has the ability to look at
the future, connecting up and down the value chain
with suppliers and retailers. If you do these well, you
will make money, even if you get some things wrong.
If you dont, you struggle.
The key to succeeding in retail in India is to
understand how the Indian retail market is different
from other countries, said Dippankar Haldar,
Business Head Supermarket, Bharti Retail Limited,
during a talk at the ISB. He said that 95 percent of
the food in the US is processed food; while in India
fresh food gets purchased at least thrice a week. It
is not about giving India a western way of retail but
about westernising Indian way of retail, he said. He
concluded by saying that there are always two parts to
the Retail business what you sell and how you sell
it. The rich love discounts, the poor need it anyway.
So it is not an option any more to have a right price
value.
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?I8S0T BOOK REVIEW
Book Review
After the success of the Marshall Plan in reviving
the economies of Western Europe after the Second
World War, large-scale aid programmes have been
expected to kick-start economic development in
poor countries. For 40 years, aid was an important
weapon of the Cold War. Allegiances were bought and
sold on the basis of aid packages. After the collapse
of the Berlin Wall, the aid industry changed track,
employing morality to market itself. Books like The
End of Poverty by Jeffrey Sachs, and the bully pulpits
of rock stars hammered the message home.
However, critics have challenged the preaching in
recent times. The Aid Trap by Glenn Hubbard and
William Duggan of Columbia University asks the
question - does development aid ever
work? The road to hell, they argue, is
paved with the best intentions. Most
poor countries remain poor despite
the aid dollars that have poured in over
50 years. According to them, the only
thing that has ever worked effectively
to reduce poverty is the growth of
business.
The authors start with a historical
framework for capitalism, tracing back
commercial activity to the ancient
civilizations of Mesopotamia, India,
Egypt and China. Modern capitalism
originated around the Mediterranean,
and spread across Western Europe.
But if commerce demonstrably created widespread
prosperity in Europe, America and Japan, why should
it be any different in developing countries?
Any developing country that has more non-
business actors (like NGOs) than businesses will not
get very far in creating wealth. And yet this is exactly
the sort of approach that nds wide currency among
western governments, and multilateral institutions.
What can be done to change the status quo and make
aid more effective?
The authors suggest that we revisit the Marshall
Plan, which was not merely a conventional aid
programme, but also a mechanism to revive
commercial activity in Western Europe. The
surpluses generated were used by governments to
fund infrastructure. So, why not create a similar
mechanism for aid to developing countries today?
The taxes levied on increased business activity can
pay for public services and social safety nets for the
vulnerable.
The devil obviously lies in the details. Unlike
the original version, a new Marshall Plan will need
an unprecedented level of international cooperation
and coordination. The Second World War primarily
destroyed physical infrastructure, so pouring money
into promoting business worked because the required
policy reforms were macroeconomic. In developing
countries, the lack of human infrastructure is a hard
problem to tackle, especially in the short term. The
other problem with many developing countries is
that they are led by kleptocrats, ironically kept in
power by economic aid. Not even this version of the
Marshall Plan can work in such conditions. So we
need strong incentives for governments to sign on
and implement basic policy changes.
Despite these objections, my hope is that The
Aid Trap will, at least, provide additional points of
reference for future aid policies.
The Aid Trap: Hard truths about
ending poverty
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Indian School of Business
Gachibowli
Hyderabad 500 032
India
T +91 40 2300 7000
F +91 40 2300 7099
www.isb.edu