Multinational corporations are starting to see the country's potential.
India leads the market in offshored back-office services, but as a manufacturing center it lags behind China, Thailand, and the rest of Asia. The reasons are well documented: multinational companies operating in India must overcome erratic electricity supplies, poor roads, and gridlocked seaports and airports while contending with government policies that discourage hiring and hold back domestic demand for goods in many sectors.
Such obstacles can be considerable, but they haven't stopped some multinational manufacturers from setting up shop in India. The companies that have done so include ABB, Honeywell, and Siemens in electrical and electronic products; Cummins, DaimlerChrysler, and Toyota Motor in auto components and engineering; and Degussa as well as Rohm and Hass in specialty chemicals. Moreover, it is no accident that these particular companies have chosen India. All operate in skill-intensive industries requiring advanced technical expertise¡Xareas in which India is likely to become a primary sourcing and manufacturing base.
Indeed, McKinsey research supports the view that the next wave of global outsourcing in manufacturing will take place in just these kinds of industries. In addition to auto components and assembly, they include fabricated metal products, machinery, pharmaceuticals, and telecom equipment.1 Already just over half of all offshore manufacturing by US companies involves skill-intensive sectors, and that figure could rise to 70 percent by 2015.
With high-skill sectors accounting for almost 40 percent of the manufacturing output of India, it is in a good position to absorb some of that increase. For one thing, the country offers abundant engineering and technical talent: every year, it produces 400,000 graduate engineers, second only to China's 490,000. Companies might also be attracted to India (and to other developing countries) by the increasing availability of reliable suppliers, the chance to escape unrelenting price pressures at home, and the size of the domestic market. LG, for example, plans to make handsets in India to take advantage of its rapidly growing demand for mobile telephones.
Automotive components
Automakers in developed markets must contend with twin pressures: to innovate and, at the same time, to reduce costs. On the one hand, they must not only develop expensive new features to please consumers but also ratchet up their environmental and safety standards; on the other, the base price of a car is expected to remain flat over the next decade. This combination of factors is pushing companies to source more components from places where costs are lower.2 McKinsey analysis suggests that, as a result, outsourcing in this sector could be worth $375 billion by 2015, up from $65 billion in 2002.
We think that India could capture up to $25 billion of this amount, to become (along with China, Mexico, and Thailand) one of the developing world's top sourcing bases. Already, out of a sample of more than 400 Indian suppliers, 80 percent have ISO 9000 certification¡Xthe international standard for quality management.
Apart from low costs, India's auto components industry has the advantage of skills in process, product, and capital engineering¡Xcourtesy of the country's long manufacturing history and higher-education system. Its process-engineering skills, which can be applied to such tasks as the redesign of manufacturing processes to make them more labor intensive and less capital intensive, enable multinationals to reduce their overall costs substantially. "De-automating" the production processes used in Western factories, for example, can cut the overall manufacturing cost of some components by up to 20 percent.
In product engineering, one of India's strengths is using design to cut costs; a redesign of the Maruti Alto's steering system, for instance, reduced its weight by 15 percent. Indian engineers can also design products quickly, which helps reduce development costs and lead times. One Indian supplier, for example, took only six months to design a steering system for an automaker that had been trying for more than four years to develop a similar system with suppliers in other low-cost countries. Many automakers are now creating engineering and design centers in India to capitalize on these skills.
As for capital engineering, India's advanced tooling and machining industry makes it possible to produce capital equipment locally (and therefore less expensively). One leading Japanese automaker that moved its equipment design and purchasing to India found that its costs were 20 percent lower than they would have been in other developing countries. Similarly, the low-cost programming and engineering skills of Indian workers have generated savings of up to 85 percent when companies purchase secondhand capital equipment and refurbish it in house.
Almost all big global automakers already source components in India. The country's auto components exports, including those from multinational parts suppliers, grew at an annual rate of 25 percent in the five years to 2003 and are now worth more than $1 billion a year. But multinational companies have yet to maximize their success in other ways¡Xby making investments to develop suppliers, creating a dialogue with the government to help build goodwill and to provide input on regulatory issues, and developing strong Indian managers with the skills and authority to spot and solve problems as they occur locally. Nonetheless, our analysis suggests that, for example, a US-based auto components manufacturer could increase its potential return on sales by three to six percentage points if it shifted manufacturing to India and sourced 30 to 50 percent of its requirements locally. And that excludes the benefits of using Indian managers to provide the local oversight and autonomy that would bring products to market more quickly.
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One of the greatest challenges in offshoring, of course, is working with suppliers. But their quality has improved because Toyota and other companies have used joint ventures to help build scale and provide financial muscle. Typically, a successful program of this kind offers training and processes to ensure that suppliers meet global standards. Working closely with Indian companies through joint ventures or other forms of collaboration has the added benefit of helping multinationals gain a better understanding of the evolving local market.
Toyota was the first automaker, in 2001, to see India as a source of components. After concluding that the advantages outweighed any near-term shortcomings, the company invested almost $200 million in six joint ventures to help local suppliers develop scale in their manufacturing operations. Toyota also focused on localizing the content of its Qualis and Corolla models. Local content now accounts for 74 percent and 55 percent of the cost of the Qualis and the Corolla, respectively. Through economies of scale in manufacturing, Toyota then turned India into a regional sourcing hub. It now exports transmission assemblies¡Xone of the most complex parts of any automobile¡Xfrom India; other automakers limit themselves to importing only simple Indian components. Toyota has also invested significant amounts to bring Indian suppliers up to its global standards.
Specialty chemicals
By contrast, the offshore manufacturing and sourcing of specialty chemicals has yet to take off: in most US specialty-chemical segments, for example, imports account for less than 20 percent of consumption. Moreover, developing countries have less than 20 percent of world trade in individual segments and a cumulative share of 10 to 15 percent. But price pressures and low profitability in developed countries, as well as the movement to Asia of a large number of industries that consume specialty chemicals, are giving multinationals incentives to look for new places to source, to manufacture, and to carry out research and development. The emergence of a maturing supplier base in countries such as China and India is furthering the trend.
Given India's capabilities in chemistry, engineering, and cost reduction, the country has the potential to become one of the developing world's top two exporters (along with China) of specialty chemicals and to increase its exports of them to as much as $15 billion in 2015, from $2 billion in 2002. A large pool of unskilled labor enhances its complement of engineers and chemists. As the head of the Indian unit of a specialty-chemical multinational put it, "We achieve European levels of labor productivity at our Indian plant, but at 20 percent of the labor cost." In a few important segments (such as customized performance chemicals, including advanced printing inks and adhesives), domestic demand is rising as well.
Moreover, a small but growing number of Indian companies are creating cost advantages by applying novel practices, mainly in process and capital engineering (Exhibit 2). Through innovations in plant design, for example, an Indian producer of performance chemicals reduced its changeover times for one product to two to three days, from the typical international standard of eight to nine, giving it lower inventory costs and greater flexibility. The producer also gained a cost advantage of 30 to 40 percent by producing significant quantities of all its raw materials. Degussa and Rohm and Hass have already set up plants in India; Bayer and DuPont see it as an important sourcing hub for intermediate chemicals (compounds synthesized not for direct use but for producing other useful compounds); and Sun Chemical has started sourcing ink intermediates there.
Clearly, multinationals can take advantage of a range of opportunities:
- In commodity-grade fine chemicals, where reliable Indian producers are now emerging, multinationals can establish arm's-length sourcing relationships with one or more local producers.
- In complex fine chemicals, standard performance chemicals, and inter-mediates for customized performance chemicals¡Xin which greater control over technology or manufacturing is required¡Xalliances might be more appropriate, though certain Indian companies are rapidly innovating in these areas. Where scale is sufficient, it might be attractive to establish majority-owned or fully owned plants.
- Multinationals also have a significant opportunity in customized performance chemicals, where their proprietary technology and insights from customers could provide a launching pad for innovative cost-cutting efforts conducted in India. Because of the high cost of employing skilled chemists in developed countries, for example, many multinationals can't explore all possible ways of reducing costs by changing production processes. These alternative means can be explored effectively and cheaply in India. The greater the customization, however, the greater the likelihood that the volumes required will be small, which could encourage multinationals to use capacity in their existing factories instead of building new ones in India. Companies must be sure that the benefits of using Indian employees and facilities to develop chemicals and then to produce them offset the advantage of using existing facilities.
Beyond manufacturing, multinational companies can develop compelling advantages by combining India's engineering and R&D expertise with their existing R&D assets. The specialty-chemical industry has, in general, been slow to seize this opportunity, but that is changing. General Electric, for example, has almost 2,000 employees at its Global Research Center in Bangalore, where at least 4 of the 11 laboratories are engaged in chemical-related work.
Early movers among the multinationals do face some risk, and developing their suppliers and internal processes does require extra effort. But the upside is that getting started now will enable these companies to gain support from the government by dint of their position as "lighthouse" investors, to forge exclusive relationships with the best suppliers, and to attract the best talent. Many multinationals already have a head start in India because they serve the domestic market through subsidiaries or joint ventures. All told, the benefits far outweigh the risks.
Electrical and electronics products
India made a late entry into the huge world market for electrical and electronics products. But the same advantages that have attracted automotive and specialty-chemical companies will probably attract multinational electrical and electronics manufacturers. They should focus their efforts on custom-based products, such as industrial actuators and sensors, or on nonelectronic parts such as power assemblies, cables, and connectors¡Xareas in which Indian companies are strong. We believe that the country could exploit these strengths to export electrical and electronic goods worth up to $18 billion a year by 2015.
Some Fortune 100 companies already source and manufacture electrical and electronic products in India. They confirm that their Indian operations, though small, reach or exceed global cost and productivity benchmarks. Many products are now 30 to 40 percent cheaper to produce in India than in the United States or Europe.
ABB is among the overseas companies producing custom-based, low-volume electrical and electronic goods in India. It sources circuit breakers and magnetic actuators there; indeed, its Indian plant was the first of its facilities anywhere in the world to make certain outdoor circuit breakers, all with local employees.
Meanwhile, Honeywell Automation India (formerly Tata Honeywell) has redesigned many of its domestic automation products for global markets. (These include devices¡Xcustom made for India's climate¡Xthat control the air conditioners used to cool mobile-telephone base stations.) Such changes reduced costs by 20 percent, thereby facilitating price cuts that increased demand in the domestic market and in some other developing markets.
Tecumseh Products, the world's leading manufacturer of compressors, not only exported goods worth $20 million from India in 2003 but is also the third-largest branded player in the domestic market. Its plants in Delhi and Hyderabad are its only Asian facilities producing compressors. Siemens sources many components for power transmission and distribution equipment (mainly castings and forgings) in India, typically for savings of 25 to 30 percent as compared with US and European cost levels.
In nonelectronic components, India's main advantage stems from the established ecosystem of its mechanical and electromechanical manufacturing base: high-quality suppliers and technology partners enjoy mutually beneficial and self-sustaining relationships (Exhibit 4). Consider the experience of the Indian company Moser Baer, a leader in removable data storage media such as CDs and DVDs. The presence of reliable suppliers of raw materials such as polycarbonate plastics, aluminum, and acrylic¡Xcoupled with an evolved tooling and machining industry¡Xhelped the company to expand its sales to more than $355 million in 2003, from about $22 million in 1998. It is now the world's third-largest company in this product area.
When multinationals evaluate India as a hub for offshore manufacturing and sourcing, its engineering capacity and existing network of suppliers and related companies are important inducements. But before the manufacture of electrical and electronic products can take off, the country must address three issues: low domestic demand, a lack of manufacturing clusters, and an unreliable transportation infrastructure.
For many of these products, India's domestic market, constrained mainly by the higher retail prices resulting from high indirect taxes and import duties, lags behind China's. Efforts to create manufacturing clusters for electrical and electronic gear have met with only minor success, owing to severe restrictions in the Special Economic Zone policy, including limits placed on the use of contract labor and complex administrative and customs procedures. As a result, companies remain geographically dispersed even if they have strong networks of suppliers and partners. And problems with the capacity and turnaround times of India's ports reduce its competitiveness in time-sensitive industries.
While these problems might be difficult to resolve, concerted action by companies and the government could resolve them. Recognizing the need for change, India's Commerce Ministry has proposed alterations to the Special Economic Zone policy. More can be done, however.
Multinationals willing to make the effort to source and manufacture products in India are likely to obtain first-mover advantages such as exclusive relationships with the best suppliers, access to the brightest talent, and government support. Overall, these companies will learn how to cut their costs more quickly, to improve their returns, to increase their competitiveness in Western markets, and to position themselves for leadership in Asian ones. What's more, India's combination of a highly educated workforce and a large, lower-income, and underserved population could help companies learn lessons and develop products with applications in emerging markets around the world.
