Where’s the middle? India needs more midsize companies for economy to grow

IIn a previous column, I wrote about growth scenarios that will shape India’s journey into the ranks of middle-income countries (MICs). In this column I examine the role that a central figure in this story – the Indian company – plays and must play in India’s transformation.

I use the Prowess database compiled and maintained by the Center for Monitoring Indian Economyto estimate the age and size structure of Indian companies. It contains comprehensive data on 12,460 companies for the period 2016-2021. This group includes almost all publicly traded companies and many, but not all, privately held companies.

To get started, there are a few caveats to keep in mind. The database does not include the multitude of small businesses – from corner shops to corner shops – that make up much of India’s informal sector. It includes some of the fastest growing startups – including more than 100 companies that are unicorns today. For example, Flipkart, Zoho, and Zerodha are in the database, but BYJU’S, Udaan, and OYO are not. Many state-owned companies are excluded from the database. And some companies in the database are subsidiaries of foreign companies.

I use this database of 12,460 companies to answer two questions. First, what is the distribution of Indian companies by size and age? That is, how many companies are large (greater than $1 billion in annual sales), how many are upper-middle market (annual sales between $500 million and $1 billion), how many are lower-middle market (annual sales between $50 million and $500 million). US dollars) and How many small (annual sales less than US$ 50 million)? And how many companies are old (more than 10 years old) and how many are young (less than 10 years old)?

Second, how have the sales shares and sales growth rates of the individual size classes changed since 2016? Important: What do the sales shares and growth rates of each size class reveal in relation to the key policy issues that will shape economic growth over the next few decades?

Source: Ram Shivakumar|  Illustration by Soham Sen, ThePrint
Source: Ram Shivakumar| Illustration by Soham Sen, ThePrint

Table 1 provides a visual summary of the distribution of companies by size (along rows) and by age (along columns).

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“Missing Center”

There are five takeaways from Table 1. First, 91 percent of Indian firms are old, 78 percent are small, and 71 percent are old and small. Since the Prowess database does not contain many small businesses, the actual estimate of the proportion of small businesses in the total of businesses is likely to be much higher.

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Second, the 220 large companies represent less than 1.75 percent of all companies in this sample and, as a group, likely represent a much smaller proportion of the actual population of companies. Many of the old and large companies will be familiar to readers. This group includes Reliance Jio, Patanjali Ayurved, Amazon India, Apple India and many others. Of the 14 young and big companies, Kia Motors, Xiaomi, Vivo Mobile and Suzuki Motor Gujarat are subsidiaries of foreign companies. Some companies, such as Adani Power Mundra and Jindal Stainless, are new companies formed by established conglomerates.

Third, evidence of the “missing middle” – a shortage of mid-sized companies – can be seen in the table. Note that medium-sized companies make up more or less the same proportion of the sample as large companies. The ‘missing middle’ phenomenon is not unique to India. Hsieh and Klenow (2009) claim that many small firms in developing countries fail to grow into larger firms because of a lack of managerial skills and the lack of funding. Bloom, Mahajan, McKenzie, and Roberts (2010) provide evidence that the quality of management practices – particularly goal setting, monitoring performance, and providing incentives – is the primary reason why many small firms do not expand. Bloom and Van Reenen (2010), in their study of 620 Indian firms, find that a high proportion of Indian firms, like their counterparts in China, Greece and Brazil, perform poorly in many aspects of management practices.

Fourth, the 2,279 lower-middle companies account for 18.30 percent of all companies and make a significant contribution to India’s corporate revenues and revenue growth. Well-known names from this group are Coffee Day Global, Amalgamations, United Breweries, Audi India, Chettinad Cement and more. Lesser-known names from this group include Shri Mahavir Pulses, Penta Gold, Vantage Knowledge Academy, Maharani Paints, and MK Proteins.

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Fifth, the small companies, which make up 78 percent of all companies in this sample, likely make up a significantly larger proportion of the total companies. Significantly, 67 percent of all small businesses have less than $10 million in sales and are barely growing year over year. One might wonder why this is so. Hurst and Pugsley (2011) conclude that many small businesses stay small because their owners don’t have the ambition, worldview, or skills to grow. For those entrepreneurs who want to scale their firm but are unable to do so, factors such as lack of managerial knowledge, insufficient access to capital, compliance burdens and social capital (lack of connections) are the biggest barriers.

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Small but steady growth small business

Source: Ram Shivakumar|  Illustration by Soham Sen, ThePrint
Source: Ram Shivakumar| Illustration by Soham Sen, ThePrint

Figure 1 shows the shares of sales that are attributable to the individual size classes.

Three insights can be derived from Figure 1. First, large companies, despite accounting for less than 2 percent of all companies, have an outsized impact on revenue. Large corporations are and will remain the most important player in driving economic growth in India. You have the managerial skills, the ability to hire, train and retain the best talent, and the ability to raise financial resources. Note that the revenue share of large companies fell when the pandemic began in 2020, but regained lost ground in 2021.

Second, compared to lower-middle-market companies (in blue), upper-middle-market companies (in red) punched well below their weight (compare the red and blue lines). The upper mid-market accounts for just 10 percent of sales, which can be attributed to the “missing middle” – there simply aren’t enough upper-mid-market companies to drive growth at their size class. In contrast, small mid-market companies have achieved steady growth of over 23 percent of total revenue due to the small but steady influx of small businesses into their size class.

Third, small firms, though numerous, contributed only a tiny five to seven percent of total sales. While their share of revenue isn’t likely to increase much, an influx of startups and small businesses could be a force multiplier.

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The emphasis on market shares (in Figure 1) masks the volatility of earnings. Figure 2 shows the annual sales growth rates between 2016 and 2021.

Source: Ram Shivakumar|  Illustration by Soham Sen, ThePrint
Source: Ram Shivakumar| Illustration by Soham Sen, ThePrint

Figure 2 shows visually that the period 2016-2021 was difficult for companies. Note that each size class’s yield cycles have moved in parallel (as might be expected), although their amplitudes have been different. After tepid growth in 2017 and a slump in 2020, corporate earnings for all four tier sizes rebounded strongly in 2021. The strong performance of the upper-middle and lower-middle companies promises that many companies from these size classes could move up a notch or two in the next decade.

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Game changer at the base

The company is the engine of economic growth. Their most visible role is to combine labor, capital, and other resources to produce the goods and services that consumers want. His less visible role is that of a change agent, à la Joseph Schumpeter’s creator and destroyer. A 75-year-old economy certainly needs new ideas, technologies, business models and ecosystems to replace the old ones.

Public policy towards Indian companies must be directed towards two objectives. The first is to increase the number of companies of all sizes. Adjusted for GDP, India has fewer large and medium-sized companies than many other countries. The McKinsey Global Institute (MGI) notes that China has twice as many large Indian firms and South Korea three times as many. Grassroots efforts to make entrepreneurship a national passion could change the game.

The second aim of policy should be to help companies of all sizes increase their productivity. Even the largest and most productive Indian firms lag behind their foreign counterparts. The MGI reports that the average Chinese, South Korean, Malaysian and Thai company is significantly more productive than its Indian counterpart. India’s goal should be to create an environment that makes it easy for businesses to solve their problems effectively and quickly.

Ram Shivakumar is Professor of Economics and Strategy at the University of Chicago Booth School of Business. Views are personal.

(Edited by Ratan Priya)

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