Better highways, more flights helped large Indian companies to squash smaller rivals

"Behold the Leviathon: The Remaking of India's Capital Economy" a blog authored by Saurabh Mukherjee and Harsh Shah, CIO and Analyst respectively at Marcellus Investment Managers argues that the 20 most profitable firms in India now generate 70 per cent of the country's profits, up from 14 per cent thirty years ago.

It says that the rise of India's networked economy (highways, cheap flights, broadband, GST) has allowed large, efficient firms to use superior technology and better access to capital to squash smaller competitors.

In line with what is being seen in the US, the growing dominance of a handful of very large companies in India is changing the template of capitalism in India, it said.

The blog argues that it is time to rebuild the mental models of how India functions. Whilst several Western academics have published credible analysis of how their economies have become less equal, we haven't come across analysis of comparable quality in India.

An earlier blog hadhighlighted how in several sectors in India, one or two companies account for 80% or more of the profits generated:

"India is already an economy with extraordinary levels of profit share concentration in many key sectors. For example, in paints (Asian Paints, Berger Paints), premium cooking oil (Marico, Adani), biscuits (Britannia, Parle), hair oil (Marico, Bajaj Corp), infant milk powder (Nestle), cigarettes (ITC), adhesives (Pidilite), waterproofing (Pidilite again), trucks (Tata Motors, Ashok Leyland), small cars (Maruti, Hyundai) we already have one or two companies accounting for 80 per cent of the profits generated in the sector. Now this trend looks likely to spread to more fragmented sectors where hitherto the unorganised players had greater profit share," it had said.

"We decided to examine how the profit share of the top Indian companies has fared in the post-1991 era. What we found took our breath away," the blog said.

From around 14 per cent when the country was opened up in the early 1990s, India's top 20 PAT generators now account for nearly 70% of the profits generated in the world's sixth largest economy.

"So why are the largest Indian firms becoming utterly dominant leviathans?," the blog asks. A networked economy helps more efficient companies with more roads, more mobile phones, number of flights, broadband users, and bank accounts.

"As a result of this networking of the Indian economy, efficient companies with strong distribution systems have pulled away from regional & local players. For example, as the economy gets integrated, lending, which was once dominated by regional players is now seeing the emergence of a few national leviathans like HDFC Bank and HDFC with both lenders entering the list of top 20 PAT generators over the last 10 years," the blog said.

In addition, the regulatory burden is higher for smaller companies. Economists have long believed that onerous regulatory regimes hurt smaller companies more than larger ones. As highlighted, a newly incorporated Indian company has to obtain registrations under at least seven regulators and file a minimum of 18 to a maximum of 69 returns a year. Clearly, smaller players, with limited resources, must spend relatively more resources than the larger ones. Similarly, the cost of adapting to GST was negligible for a leviathan like Asian Paints but far more significant for a smaller paint company with a fraction of Asian Paints' market share.

"Interestingly, in this regard, social media has done a disservice to smaller companies - with regulators now worried that a small company under their watch will malfunction and thus cause a stink on social media, they have surrounded the small company with the same thicket of regulations which they used to foist exclusively on larger companies.

In fact, the ability to handicap smaller competitors by influencing regulation has increasingly become the hallmark of many of India's leviathans," the blog pointed out.

Technology can also be a barrier to entry: As per a survey conducted by McKinsey, smaller Indian companies have adopted the system of accepting digital payments more than the larger companies. However, they just do not have the resources for advanced technologies such as artificial intelligence and the Internet of Things. This is where the larger companies score over the smaller companies.

Lower cost of capital for the giants also helps. India's top 20 PAT generators fall into two broad buckets, private sector companies which have superior free cash flow generation thanks to their ROE being significantly above their cost of equity eg. HDFC Bank, ITC, HDFC, TCS, etc; and giant PSUs which get access to capital at a low cost because of their implicit sovereign guarantee.

"Smaller companies have access to neither source of capital. This in turn all but eliminates their chances of being able to compete with these leviathans. For example, ITC has over Rs 28K crore of cash on its balance sheet. In addition, ITC generates Rs 10K of free cashflow in a typical year. For any FMCG firm which isn't a leviathan, competing with ITC's cash machine is a difficult proposition," the authors at Marcellus wrote.