Tuesday, February 13, 2007

Firms losing their national identity; firms in a flurry of M&A

Business Standard has an edit on the evolution of the `firm' as becoming increasingly distinct from nationality:

In the good old days, the identification between a firm and a country was obvious. IBM was an American company through ownership, management team, value added and source of profits, and Sony was Japanese. One of the remarkable features of globalisation is the emergence of a new breed of firms where the one-to-one link between a firm and a country has become increasingly tenuous. The front page of this newspaper yesterday was dominated by stories which reflected this transition.

Does ownership define firm nationality? If so, firms like ICICI Bank and HDFC are not Indian any more. When Reserve Bank policies discriminate against Citibank and favour ICICI Bank, it is worth reminding the RBI that the ownership structures of the two firms are not very different. By the yardstick of ownership, Samsung is not a Korean company and Corus is neither British nor Dutch. The modern multinational corporation has a globally diversified shareholding structure, with owners spread all over the world, and is often listed at multiple locations in different countries. It is not meaningful to link a company to a country through ownership patterns.

Does the location of value added or profit define the firm? In a few years, it is likely that more than half of the profits of Suzuki would be in India, through Maruti, and it would sell more cars in India than it does in Japan—indeed, that may already be the case. Would Suzuki, then, be an Indian company? A series of Indian firms are shifting the focus of their investment overseas, partly in order to exploit the gains of globalisation, and partly to avoid policy difficulties in India such as labour law. If things go right for Tata Steel, the bulk of its business would come from outside India. Would that make Tata Steel a non-Indian firm? The modern MNC produces and sells all over the world; it is not meaningful to link a company to a country through either value added or profit.

That leaves the management team. Intuitively, Samsung is thought of as a Korean company because of a management team—in culture, ethos and style—that is primarily Korean. ICICI Bank is an Indian bank because it has a management team which is primarily Indian. By this yardstick, a lot of companies in the world are turning Indian, because even though they have ownership, value added or profits from all over the world, many of their top managers are of Indian origin. Arun Sarin, CEO of Vodafone, is of Indian origin, as is Indra Nooyi at Pepsi. In all the top 20 global financial firms, key second-level managers are already Indian. In a few years, there will be more Indian CEOs of global financial firms. Conversely, Indian firms are beginning to recruit foreigners—especially the new airlines and some of the hotel companies. In a few years, the top management team of ICICI Bank may not look very different from that of, say, JP Morgan, when it comes to nationality.

The last vestige of the national identity of a firm, today, is the culture, ethos, style and nationality of its management team. One could argue that a German company is very different from an Australian one. By this yardstick, Samsung is a visibly Korean company. But looking forward, this vestige may also be erased. India needs to gear up for this world by supporting a much bigger expatriate presence in the workforce of firms operating in India, and by shedding a sense that “Indian” firms are somehow different. Indian firms are going global; they must now think global.

Update: On 19th February, BS has another interesting edit on the nature of the firm, this time with a focus on corporate control transactions:

The newspapers are filled with tales of acquisitions. Firms, it seems, are spending more time buying businesses than building them. This is great for investment bankers, but is it right for India? In a more placid period, firms were generally controlled by families, and the family visualised running the firm forever. Even if a family was not particularly good at converting the capital and labour of a company into profits, its members tended to hang on. Many times, an acquisition comes about when someone talks sense into the family, that it is better to sell a business when the offered price is bigger than the net present value of the cash flows that might be obtained by keeping it in the family. Such acquisitions are good because they shift productive assets from less competent hands to more competent ones.

A feature of these transactions is the interplay with rupee convertibility. On display now is the full range of transactions—foreign companies buying Indian companies; Indian companies buying foreign companies; control of an Indian company changing hands outside India. These productivity gains through mergers and acquisitions (M&A) would not have been possible if India had not embarked on dismantling capital controls. More needs to be done in terms of removing policy and procedural bottlenecks caused by capital controls.

Also relevant in this context are the remnants of the licence-permit raj: government permission or support is still required for entry into too many areas. Global retailers can’t come into India through the front door, which encourages less qualified teams in India to go into retailing, knowing that in a few years, when the policy environment changes, they will be able to sell to the global firms. Similarly, the RBI does not allow foreign banks enough leeway to do business in India, which generates incentives for them to buy weak Indian banks. The land market in India is so distorted that the best way to be a hotel company in India is to buy a few hotels or an existing hotel company.

Virtually every large global firm faces a choice in India between building and buying. When building is hard—given the entry barriers in India—there is a bias in favour of buying. Such transactions enhance efficiency—it is surely better for India to have a good bank (foreign or Indian) buy up a less well-managed Indian bank. The flow of control transactions steadily erases history: a productive asset may have a certain incompetent owner for historical reasons, but this gets handed over to a more efficient management team. These transactions are healthy for India: they generate GDP growth out of thin air, and ratchet up competitive pressure in one industry after another. As the licence-permit raj breaks down, and entry barriers are removed in sector after sector, such transactions will diminish. Internationally, entry barriers are those created by the market, not by governments, and the make-versus-buy decision tends to be less distorted. Logically, no one should be surprised if there is a bigger M&A/GDP ratio in India than is found in the UK or the US.


  1. IBM's Samuel J. Palmisano had an article in Foreign Affairs May/June 2006 issue talking about the same issue, mostly about (non-Indian) global companies - called The Globally Integrated Enterprise

  2. Ajay, I thought you would be interested in this quote from today's newspaper!

    "We have told the Finance Minister that the people are more interested in atta daal than his fancy figures about high growth rate and a buoyant economy. And we are going to repeat it," said a senior Congress leader.


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