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January 25, 2006

Thinking Small: Entrepreneurship in India

Despite all the fuss about offshoring to Bangalore, Amar Bhide claims it can't transform India's economy. Here, he explains the reforms needed to spur business growth and put India on the fast track.


What overarching question were you trying to answer when you began looking at entrepreneurship in India?

My broad question was, to what degree do the patterns that I and others have observed in fast-growing companies in the United States hold true in India and, in particular, in Bangalore? The answer is, not very much. In the United States, many firms start small and stay small. But roughly 5 percent grow quite dramatically. In any metropolitan area, that 5 percent can be expected to grow at a compounded rate of about 15 percent over the next five years. I found in Bangalore that the proportion of firms that grow at this rate is of the order of 1 percent rather than 5 percent.

Another difference is that in the United States the expansion of existing firms accounts for roughly 75 percent more jobs than the birth of new firms. In Bangalore, the jobs created through the birth of new firms are 11 times more than the jobs created through expansions. I further found that to the degree that there are any large businesses at all, they were large to start with. So you see either businesses that have to be started on a large scale or tiny firms that never grow.

My research has focused on businesses outside information technology. IT is exceptional — there, firm growth outpaces firm births, and you see businesses operating on significant scale. But it’s a drop in the bucket. Bangalore has a population of 7 million people, which means it has a working-age population of about 3.5 million people. Our best guess is that about 200,000 people work in IT.

How do high-growth Indian firms compare to their counterparts in the United States?

I interviewed the few high-growth firms that I could find in Bangalore. These were high-growth firms by Indian standards, but not by U.S. standards. Interestingly, firms in both the United States and India start with roughly the same amount of capital: $10,000 in the United States and about $8,300 in India. So compared to local incomes, it seemed to take a lot more money to start a business in India than in the United States. Moreover, the U.S. firms grew in five or six years to revenues that were 378 times their initial capital, whereas the Indian firms grew to only about 20 times their initial capital.

And there are other noteworthy differences. In India, there’s virtually no ability to use external equity; there’s a much greater use of debt. In the United States, young firms try to have as few assets as they can and to subcontract as much as they can. In India, it’s the opposite: tiny firms integrate forwards and backwards as quickly as they can. Similarly, these firms are trying to become miniconglomerates before they’ve reached any scale.

Indian entrepreneurs have much higher working capital requirements. A U.S. entrepreneur can at least hope to collect on receivables in about 30 days. In India, they extend receivables to 90 days or longer. In the United States, virtually every entrepreneur I studied used rented offices. In India, almost the first thing they do is to acquire the property they are housing their businesses in. Someone might have 80 percent of his capital tied up in real estate and only 20 percent in his business.

This combination of things provides a first-level explanation as to why there are so few firms that grow and why their growth rates are low. There seem to be several things in the environment that have caused this pattern. High on the list is the tax system. India relies much more heavily on indirect taxes than does the United States. These indirect taxes can add up to 32 percent to your cost of goods sold. But small businesses are exempt. So you’re better off running 10 businesses, each under $10 million, rather than having one big business. There’s a similar story with labor. Once you get above about 20 people, you can have nonwage costs that add up to 50 percent of a worker’s salary.

Another factor is the unreliability of supplies from both government suppliers and private suppliers. Because you can’t count on the electricity supply, you have to have your own generator. Naturally, this ties up capital. Similarly, if you tried to run a virtual business, there would be critical links in the chain that simply would not deliver. Why people invest in land instead of in their business is puzzling. Maybe it’s because the businesses themselves are not that profitable. The physical infrastructure is horrible. That means that instead of having one national market of a billion people, you have many little local markets because it’s so hard to move stuff from point A to point B. So all these things contribute to creating a disincentive to grow large.

What do your findings show about the impact of globalization on the Indian economy?

Globalization is a highly visible phenomenon in Bangalore. The question is, to what degree has it seeped into the economy at large? The answer is, not very much. Things are probably way better than they used to be, but that is only partly a consequence of outsourcing. A more important factor, I think, has been the removal of a number of domestic impediments to economic progress within India. Things have changed. In my view they haven’t changed enough, but there’s no question that things are much better than they used to be.

What are the public-policy implications of your research on entrepreneurship in India?

The offshoring phenomenon is neither going to massively disrupt the U.S. economy, nor is it by itself going to transform the Indian economy. If the Indian economy is to get on the Chinese path of growth, it will have to be through reforms that accelerate the achievement of scale and scope in manufacturing rather than by promoting more software development. The actual pool of people capable of performing these outsourcing services is quite small. There is not a bottomless pit of trained engineers or people who can answer phones to the satisfaction of the U.S. consumer.

There are clear things in India that need to be fixed, most prominent among them being the tax system, which not only discourages businesses from growing to any size but also makes it impossible to raise much by way of taxes. If you can’t collect taxes, you can’t spend much on the infrastructure. And to the degree that there’s pressure to spend, then you get into deficit financing. People in both the government and the opposition now recognize that the system’s broken. There’s a movement for tax reform, and there is a consensus at the highest levels of the ruling party and the opposition in favor of sensible ideas. But illogical beliefs have created entrenched vested interests against reform.

In terms of the impact of outsourcing to India on the U.S. economy, I would say that the explosion of export-based manufacturing in China is a much bigger deal. The Chinese manufacturing sector has been transformative for China; you can’t say this about the software industry in India. Similarly, Chinese exports have had a huge impact on the U.S. economy; they are keeping down interest rates and prices. I don’t think the outsourcing of software has had a remotely similar effect. It hasn’t hurt many people, and on balance it’s a good thing, but it’s not a huge thing.

 

Amar Bhidé is the Lawrence D. Glaubinger Professor of Business at Columbia Business School.


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