#207 The Rise and Rise of Conglomerates

Anticipating the Unintended

India Policy Watch #1: Don’t Concentrate

Insights on issues relevant to India

— RSJ

In one of the recent editions on the Hindenburg short-selling saga, I had written about how easily the Adani group had spread itself into a diverse range of sectors. The group was highly leveraged because it was so keen on getting into newer sectors and then winning bids in them with metronomic efficiency. Generally speaking, it is difficult to run a conglomerate of different businesses. You might argue that each business can be handled by a competent management team who will use the brand name and deep pockets of the parent group to build a solid business. But it is easier said than done. Capital allocation decisions, which lie at the heart of executing a business strategy, are difficult within a single line of business. They become hugely complicated within a conglomerate of businesses. Misallocation of capital, lack of focus and inability to stay competitive against smaller, nimbler players eventually follow. Soon, the businesses need to be hived off, and you find companies convincing would-be investors on how they are doing fewer things and doing them well instead of spreading themselves too thin. This is the usual cycle.

Yet, you see conglomerates appearing on the business landscape across countries. In some cases, these are businesses integrating vertically or finding interesting adjacencies in their business. This kind of makes sense in the Coase-ian “Nature of Firm” way. I mean, if the transaction costs of finding someone to do a particular work are higher than you doing it yourself, sure, go ahead and do it yourself. But beyond that, there should be no economic reason for having conglomerates. Unless you have one of these conditions in the economy:

a) Cost of capital is high, and access to it is difficult. Newer players find it difficult to access capital to start new businesses while older, established players with free cash flow can muscle their way into unrelated but lucrative new sectors only because they have access to capital at a lower rate.

b) The playing field isn’t level for newer players to make a dent. Through a mix of friendly regulations, ‘working’ the networks and M&A activities, the bigger players continue to have an advantage going into a new sector over smaller players who might have expertise in cracking those sectors open.

c) There’s relatively little ease of doing business in those sectors or in the evening overall. The established conglomerates with an army of people, lawyers and consultants can get started relatively faster and capture the market than new entrants.

You don’t have to be a genius to see where the Indian policy-making framework is on the above conditions. There’s common and easy access to capital through a large number of PEs and VC funds but only for a particular kind of ‘flavour of the season’ variety. This also is getting difficult to access. The market for other forms of capital isn’t deep enough. In the same vein, long-term capital for greenfield projects where the credit risk has to be borne by the issuer isn’t available. There is always a whiff of regulatory capture especially in sectors where the government is closely involved bin decision making. Lastly, we might have moved up in the ‘ease of doing business’ rankings, but it isn’t clear yet how this has changed things on the ground. New businesses still find going tough for them.

All of the above means that in the past five years, we are reversing a trend seen since the ‘91 reforms. That of increasing salience of conglomerates in India. You don’t have to research too hard. Just take a look at any sector - already big or one that is emerging - you will have the same spectacle of a few large corporate groups getting themselves into all sorts of businesses, from defence to semiconductors or from airlines to carbonated soft drinks only because they believe they can take advantage of market distortions.

As if to illustrate this point further, here's news that’s only a day old. Here’s Moneycontrol reporting:

“The shares of Mukesh Ambani-led Reliance Industries Ltd (RIL) rallied 3.5 percent in the morning trade on March 31 after the company said secured creditors, unsecured creditors and shareholders would meet on May 2 to approve the proposed demerger of Reliance Strategic Ventures.

After the approval, the unit, which is the financial services subsidiary of the oil-to-telecom conglomerate, would be renamed Jio Financial Services.

Benefits that shall accrue on the demerger of the financial services business will be the creation of an independent company focusing exclusively on financial services and exploring opportunities in the sector, the independent company can attract different sets of investors, strategic partners, lenders and other stakeholders having a specific interest in the financial services business, a financial services company can have a higher leverage (as compared to the Demerged Company) for its growth and, unlocking the value of the demerged undertaking for the shareholders of the demerged company, the conglomerate said in an exchange filing.”

This isn’t out of the ordinary. If you search for similar news items from the last five years, you will notice the same pattern of large conglomerates (usually the big 5) muscling into other or newer sectors because they think they have the capital and they will be able to manage the sector well. While one cannot blame these conglomerates for their ambitions, this trend suggests we might have tipped over from being pro-markets to pro-business.

Coincidentally, as I was writing this, we had a paper authored by Viral Acharya (former Deputy Governor, RBI) on the opportunities and challenges for the Indian economy published by the Brookings Institution and being discussed in the media. Acharya has highlighted the concentration of power in Indian industry as a particularly worrying trend. He writes (I have paraphrased a bit):

“A striking feature of this rise in industrial concentration by private companies is that it is in part due to the growing footprint of “Big-5” industrial conglomerates, based on the overall share of assets in non-financial sectors in 2021. Data shows the following patterns.

First, until 2010, the Big-5 increased their footprint in more and more industrial sectors, broadening their reach to 40 NIC-2-digit non-financial sectors. After this breadth first strategy came the depth-next strategy. Starting in 2015, the Big-5 started acquiring larger and larger share within the sectors where they were present. In particular, their share in total assets of the non-financial sectors rose from 10% in 1991 to nearly 18% in 2021, whereas the share of the next big five (Big 6-10) business groups fell from 18% in 1992 to less than 9%. In other words, Big-5 grew not just at the expense of the smallest firms, but also of the next largest firms.

Next, this growth of Big-5 appears to be driven in part by their growing share of overall Mergers & Acquisitions (M&A) activity. Even though the aggregate number of M&A deals has dropped since 2011, the share of M&A deals by the Big-5 has doubled from under 3% in 2015 to 6% in 2021, without such an increase being seen in the next five biggest groups. Arguably, this growth has also been supported by a conscious industrial policy of creating “national champions” via preferential allocation of projects and in some cases regulatory agencies turning a blind eye to predatory pricing. Equally importantly, given the high tariffs, Big-5 groups do not have to compete with international peers in many sectors where they are present and derive most of their revenues domestically.”

Acharya then goes on to list the usual downstream problems of such an increase in market power concentration - inefficient allocation of capital, favouritism in project allocation, regulatory interference, related party transactions, over-leveraging while becoming too big to fail and crowding out new players.

But he also makes an important claim that this concentration of market power is one of the reasons for persistent core inflation. He concludes:

“In summary, creating national champions, which is considered by many as the industrial policy of “new India”, appears to be feeding directly into keeping prices at a high level, with the possibility that it is feeding “core” inflation’s persistent high level.”

I won’t go as far as Acharya yet on this thesis. As he admits, there’s more work that needs to be done here, but his conclusion on pricing remaining high because of industry concentration does pass the smell test. And it should concern policy makers. I know there are many who will ask what’s wrong in creating ‘national champions’ like the tiger economies did between the 70s-90s. But there are a few differences in our case.

Firstly, the focus on creating national champions elsewhere was to choose specific sectors where they might have a comparative advantage, invest in them, especially on technology and then win in global markets through an export-oriented strategy. It is a somewhat flawed approach, but it still makes sense for a low-income economy to do this. But we aren’t really doing this in India. Our so-called national champions are focused on domestic markets where there’s no particular need to have them. In fact, there is only a monopoly risk here with the attendant problems of price cartelisation and poor customer service. Also, the limited focus on exports that these big five domestic players have as of now is largely linked to natural resources and not large-scale, job-creating manufacturing setups. It is unclear how the broader economy is benefitting from this apparent design.

Secondly, the successful national champion model in other economies didn’t need high import tariffs to support their ambitions like it is now the case in India. We have written about this many times in the past. Higher tariffs will reduce the competitiveness of the domestic players in those sectors to compete globally. It is counterintuitive to have a high tariff regime if you want to build national champions. After all, global markets are much larger than the domestic market, and that’s where these conglomerates must be competing.

Thirdly, what’s the government getting out of the apparent tilting, if it is intentional, of the playing field in favour of these players? If the idea is to have national champions despite the obvious flaws in this intent, it makes sense to have stakes in these ventures to participate in the value being created.

Lastly, the overall economy will benefit if the process of creating such champions leads to factor market reforms and real ease of doing business for other participants in the process. Else, the larger players will continue to get ahead not because of better products or innovation but simply because they know how to manage the system. In other words, it is the 1970s all over again with a tadka of markets.

It is difficult to see how we can trace our way back from this path, given the apparent lack of opposition and the already dominant position of these conglomerates in industry and media. Also, any walking back will require some bold antitrust kind of measures (it is what Acharya suggests) which is quite impossible in India. Possibly, the only medium-term scenario is these conglomerates start stepping on each other's toes as they continue to diversify their businesses and that competition alleviates the problems of concentration. But that might be too late in coming, or they might have a tacit understanding of the rules of the game in competing with one another. It will distort markets further. Maybe this is a tad alarmist, but it is important to acknowledge there’s way too much diversification among the top conglomerates in India and that’s always a sign of market distortion.

India Policy Watch #2: We Need an Agnipath for India’s Diplomacy

Insights on issues relevant to India

— Pranay Kotasthane

In edition #198, I highlighted that at least three areas of the Indian executive need a quick state capacity boost. These were: the Ministry of External Affairs, Ministry of Electronics & Information Technology (MeitY), and economic regulatory bodies such as the Competition Commission of India (CCI).

Then I came across this tweet from the External Affairs Minister, which acted as a positive reinforcement for this line of thinking.

Managing these engagements in an unsettled world order needs an immediate boost in India’s foreign policy capacity. Solutions like incremental increases in the Indian Foreign Service (IFS), while required, will be too slow.

What we need today is a ‘surge hiring’ strategy. The external affairs ministry, in fact, was the first union ministry to experiment with a broader lateral entry for government officers in 2015. It also opened up positions in its policy planning and research division for people in academia and the private sector. However, these tentative trials seem to have lost steam. The underlying reason is the internal resistance from the foreign service officers, who see such attempts as a threat to their career progression.

The surge hiring strategy should try a different approach. It should attempt to hire a much larger number of people below ambassadorial positions. This way, the cadre protection impulse can be side-stepped. Instead of targeting joint secretary levels, two fellowships could be attempted: one for fresh graduates and another for young professionals working within and outside the government (thanks to Nitin Pai for this idea). Given the growing prominence of technology and economic issues as foreign policy domains, this approach would help build institutional knowledge within the ministry. More importantly, the surge should target staffing for the headquarter functions in Delhi for managing various engagements and new initiatives. Indian missions abroad can continue to be led by IFS officers.

Past attempts at lateral hiring were advertised as single posts in the unreserved category. By opening up a larger number of positions concurrently, the government could retain existing norms on reservations and quotas. Finally, the surge hiring strategy should have a sunset clause and a well-defined recruitment target. If it is conceptualised as a non-recurring measure keeping the current geopolitical situation in mind, it will resonate with the opposition and the parliament.

With the Agnipath experiment of the defence ministry, the idea of short-term employment within the government has gained some acceptability. It is no longer anathema to the government but an idea whose time has come. Without a surge in foreign policy capacity, we will only have great ideas but tardy implementation, resulting in a perennially underperforming foreign policy.

Matsyanyaaya: Reflections on the Quad

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Last week, I attended a US State Department sponsored programme that aims to invigorate think tank research on Quad collaboration in the four countries. As part of the first segment of this programme, five representatives from each country’s think tanks were hosted in the US. What follows are my reflections on the Quad as a geopolitical formation, based on what I saw in this programme.

* Quad ranks higher on the US foreign policy agenda than I had expected. My prior assumption was that given the multiple alliances that the US leads, a new, amorphous grouping such as the Quad wouldn’t rank high on its priority list. However, the interactions with the officials suggested a conscious effort to infuse energy into the Quad.

* The Quad is being positioned visibly and intentionally as a positive force that would bring benefits to the Indo-Pacific at large, rather than as an anti-China “alliance”. This is the reason why the interactions as part of the grouping have spawned into six leader-level working groups—on COVID-19 Response and Global Health Security, Climate, Critical and Emerging Technologies, Cyber, Space, and Infrastructure, and at least three initiatives—Indo-Pacific Partnership for Maritime Domain Awareness, Semiconductor Supply Chain Initiative, and the Quad Fellowship. The strategy, if there is one, seems to be to throw several balls up in the air, knowing fully well that some of them will get dropped, while others might be caught on their way back by all four countries, or only a subset amongst them.

* As the Quad is not a traditional security alliance, its success metric will also be different. Not all cooperation will be Quad-labelled, and some of it might come in bilateral or trilateral formats. So, the increased cooperation between Japan and Australia on defence ties, and between India and Australia on economic ties, are also indicators that the Quad is moving in the right direction.

* While the rationale for Quad collaboration in many areas is often “common interests” or “shared values”, an underrated frame is “mutual complementarities”. In many spheres, especially in technology, the Quad is an attractive forum for cooperation precisely because each country has complementary strengths.

* Positioning Quad as a force for good in the Indo-Pacific—rather than a geopolitical grouping against China— in many areas runs the obvious risk of underperformance and loss of credibility. In international affairs, efforts at providing benefits to another country are usually known by their failures more than their successes. For instance, in May 2021, the Quad Vaccine Partnership targeted the provision of 1 billion COVID-19 vaccines. Even though the four countries individually delivered 670 million doses, including 265 million doses in the Indo-Pacific, the demand for vaccines waned by the end of 2022. The dominant narrative was that the Vaccine Partnership had failed, even though it had made a significant contribution.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] We were on Shruti Rajagopalan’s excellent podcast Ideas of India to discuss our book and the Indian State’s many puzzles.

* [Podcast] A Puliyabaazi on citizencraft featuring Nitin Pai.

* [Paper] This paper by Isha Bhatnagar offers evidence that gender equitable preferences are rising in India. From the abstract:

Over more than a quarter-century period (1992–1993 to 2019–2021), I find a significant decline in son preference from 40 to 18 percent and an increase in gender-equitable preferences among most subpopulations. Multivariate analysis shows that for all survey years, education and frequent exposure to television significantly increased the odds of gender-equitable preferences. In the last decade, community norms supporting women's employment are also associated with gender-equitable preferences. In addition, decomposition analysis shows that compared to compositional change, social norm change accounts for two-thirds of the rise in gender-equitable preferences. These findings suggest that rising norms of gender equality have the potential to dismantle gender-biased preferences in India.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com