The previous piece ‘Narendra Modi and Digital Revolution’, examined the possible directions Modi administration would take in terms of digital policy and also touched upon the broad contours of the current digital business environment. Since then, Mr. Narendra Modi (Modi) addressed Digital India Summit where he elaborated on his vision for Digital India. It is probably first time any political leader in India has elaborated on changing socio-business setting increasingly going digital. Observations like the ‘access to information have no barriers’ have far reaching implications. Yet one is apprehensive about these observations being either ignored or dismissed as rhetoric by the Indian digital intelligentsia.

Deciphering in depth these ideas need substantial space and need to be engaged separately. What this write-up attempts is to analyze two observations that might be viewed as rhetoric or reaction to events in some quarters, but nevertheless tremendously significant. The idea of India as hub of electronics manufacturing and secondly developing Northeast as hub of IT enabled outsourcing (ITES) need to be studied in detail.

Changing Dynamics of the Manufacturing Sector

Improved transportation and communication facilities, availability of cheap labour in China, South East Asia etc., cost arbitrage among other factors accounted for relocating production in the manufacturing sector to Latin America, South East Asia and later China. From mere relocation, the journey transited towards outsourcing manufacturing with both production giants and big retail sourcing their goods from China. Indeed it would not be an exaggeration to term China as the factory of the world.

Criticism about the declining importance of production (production as ‘tedious marginal chore’), emphasis on branding, advertising, marketing activities at the cost of labour have been routinely heard and not without justification (for anti-market position and critique, read No Logo). Studies have tried to trace the journey of production from US to other countries terming as a race to zero (Couple of books that try to examine can be found here and here). Similar arguments are made about the IT and IT Enabled Services (ITES) industry being relocated to India.

Yet a cursory glance suggests while China may host factories, almost all major giants in both technology and non technology sector still emerge from Western countries or Japan or Korea. Google, Microsoft, GM, GE, Sony, HP, Deloitte etc all demonstrate this. Very few Chinese or Indian names find themselves in this list. This represents a puzzle. Maybe as critics argue, the tradeoff for sacrificing labour interests to accommodate the marketing activities is probably one of the reasons. With large number of firms in countries like China willing to supply and produce for Western giants, the resultant monopsony bargaining power might also be true. Yet these explanations are partial at best. Stan Shih of Acer Group pondered over this puzzle and came with the concept of Smiling Curve which plausibly explains the dominance of Western/Japanese companies. The curve is explained in Fig. I

Fig-I
Simple Framework of Smiling Curve as developed by Stan Shih (The curve is an illustration of Smiling Curve and has been adopted from Wikipedia.

A typical value chain would start with R&D and end up with marketing and service offerings passing through the stages of Design, Production and Logistics. The Smiling curve results in U shaped curve representing a relationship between production stages (X-axis) and corresponding value addition at each stage (Y-axis). The maximum value addition happens at the conceptual stage. Anybody can assemble an iPod or an iPad given the blueprint but conceptualizing the integration of some 451 mostly generic parts into something valuable fetches the highest value. Therefore it should be no surprise that patents, technology origination, prototype all fetch higher values. As the good in question moves through the stages, the value addition diminishes with manufacturing/fabrication commanding the least value.

Further, competition is global in research and development (R&D). Anybody in the world could have conceptualized iPod and by winning the race, Apple is able to extract maximum value. Once the good is manufactured, the battle for consumer’s mind is local. More often than not, firms have to engage in hand to hand combat with competitors offering close substitutes.

An outcome of this gaining consumer mind share and later desire to buy followed by actual purchase involves series of marketing activities like advertising, sales, retailing, after sales service etc. These activities thus seem to add higher value and firms engaged in these activities benefit. Preliminary analysis of electronic goods seems to indicate low value proposition. The focus has to be clear on the production stages like R&D which offer high value additions. A heady cocktail of Stanford University, entrepreneurial culture, Venture Capital base all enabled Silicon Valley to extract the maximum of agglomeration economies and emerge as technology capital which prima facie is absent in India.

Is it universally Applicable?

In absence of strong education or financial infrastructure to sustain the higher end of value chain, what would be of significance is the positioning of Indian firms. Empirical evidence from China suggests that established multinationals are likely to command significant market positions in domains where both R&D intensity (R&D expenditure as % of sales) and advertising intensity (advertising expenditure as % of sales) are high. Yet many sectors wherein cost structure is predominated with production and logistics and product development and design is relatively stable.

These sectors ranging from industries like contract PC manufacturers, TV receivers, major appliances, certain segments of PCs etc, are precisely where overseas or domestic Chinese companies have made their mark. It is indeed possible that in segments like these Indian companies can build their competitive advantage over the rest. If production and logistics matter, the necessary infrastructure like roads, railways, inland waterways, power etc have to be given far higher emphasis.

To scale up in the value chain necessitates considerable investment in R&D. Further the academic infrastructure has to be geared up. Despite institutions like IITs, we still have long way to go to catch up with Western academic giants. Therefore it would mean large scale focus on building educational infrastructure. There is also need for large scale financial sector reforms to create easy access for entrepreneurial financial capital.

Yet to focus on these apparent barriers is to overlook certain significant pointers. Given the diverse socio-economic milieu, India is at several stages of developmental lifecycle simultaneously. Cities like Mumbai, Delhi, Bangalore, and Hyderabad who all benefited from changing business environment at different points of time will have to scale up the ladder. In constantly changing settings for business to flourish resting upon past laurels would not suffice.

If Bangalore were to face Detroit type situation, the new Detroit need not have to be in China. There is enough and ample opportunities for those Detroits to come in different parts of the country. In fact replacements for Bangalore of 1990s or 2000s could come from Lucknow, Patna, Indore or Guwhati etc. Enough space exists in Indian business locale for different stages of production to co-exist.

This backdrop makes Modi’s articulation of possible relocation of ITES industry to Northeast all the more significant. There may be barriers in terms of law and order etc, but those barriers are more operational than strategic. It is the recognition that India can accommodate diverse stages of production under geographical roof and not shift across borders. What spurred Mumbai ages ago and Bangalore and Hyderabad in 1990s and 2000s would percolate to those regions which have started their journey little later. It captures the beauty of incentive mechanism. The very fact that this thought process has received political attention is the reason why we should applaud and disseminate.

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Prashant Kulkarni
Prashant Kulkarni teaches economics, a digital economy and globalization at a leading B-School. His area of interest lies in dissecting resource contestations and human behavior at the intersections of digitization, urbanization and globalization.