Comparative ROI – Indian versus Chinese manufacturer of electronic component supplying to an Indian customer India
Manpower (in site of lower wages in India)
Marketing + All Other Exp
Refund of VAT 17% on Value Addition (Rs)
Total ROI %
Let us examine the profitability of two companies – one Indian and the other Chinese, engaged in the manufacture of an electronic component. This component has a value addition of 50%, meaning that the raw material is only half the sales price. Why an electronic component? This is a zero import duty item (since April 2005, under ITA-1,WTO) – making it a global business, with no protection whatsoever. Both companies are aiming to sell the component to an Indian customer who is willing to pay Rs 100 per component, which is of course the price quoted by the Chinese supplier. The example assumes the same incidence of all costs on both the Chinese and Indian supplier (I know this is a far cry from the truth, but for the sake of simplification we’ll agree). This does not include three costs – energy, logistics and finance, since these are beyond the influence and control of the supplier. We may refer to them as comparative disadvantage for the Indian supplier.
Energy in this case costs the Indian manufacturer 5 per cent against a much lower charge of 2 per cent for the Chinese factory. Electricity for industrial use in India costs Rs 8 per unit vis-à-vis Rs 5 (0.45 yuan) in China. Most factories in India have to install a back up generating system – using at least two generators (in India it is never a good idea to depend on one). In the case of electronic component manufacturing, the machines are sensitive, and must have access to good quality power. Hence they need the assurance of a large stabilizer and a back up UPS system, which must be installed in an air conditioned hall in order to ensure that it functions well when you need it most. This utility bank must be run by an efficient team under a watchful supervisor. The effective per unit rate in India is hence Rs 12.50. The comparative pricing of 5 per cent in India vis-à-vis 2 per cent in China is logical.
Poor infrastructure means higher costs of inbound and outbound logistics. Wire, which is used by both component manufacturers as the lead wire for their components – is manufactured at a factory in Shaoxing, 300 kms away from Shanghai. The cost of putting this wire on a truck, on to a ship at Shanghai port, up till berthing at Mumbai port is Rs 4 per kg. The shipping time is 21 days
Manufacturers in India are “hollowing out” – opting the route of trading rather than investing in manufacturing. In this case, the Indian manufacturer makes a 8 per cent net profit (which is optimistic), while the Chinese competition makes 14 per cent
(plus or minus one day). Once it berths in Mumbai, it can take up to seven days to be deberthed, inspected, cleared and transported by truck to Noida, New Delhi NCR. Now it costs Rs 14 per kg. This is just one example to arrive at a logistics cost of 2 per cent vis-a-vis 1 per cent in China.
Electronic component manufacturing is a capital intensive business – in fact almost any business that adds 50% value would normally be. The capital employed to turnover ratio is normally 1:1. For this example, we take it as 0.8. This means Rs 80 are employed to generate a sale of Rs 100. Interest costs to most SMEs in India are to the tune of 12-14% versus 5-6% in China. The figure stands at 3% in Taiwan and 1% in Japan, who are quite likely to be the financing source of such a factory in China. A five per cent finance cost for the Indian company versus a 2% for the Chinese is hence very plausible. This translates to a comparative disadvantage of 9 per cent. This is a set off by three per cent points in favour of cheaper labour wages in India. The much higher productivity in China is based on their worker hostels, 10-12 hour shifts at the rate of 1.5 times overtime wages, and a culture of efficiency. You will notice that the more value the Indian manufacturer chooses to add, the more will be the impact of these disabilities. No wonder then, that manufacturers in India are “hollowing out” – opting the route of trading rather than investing in manufacturing. In this case, the Indian manufacturer makes an eight per cent net profit (which is optimistic), while the Chinese competition makes 14 per cent. That is not all. The Chinese company enjoys a 17 per cent VAT refund on its exports – which brings in a further 8.5 per cent (50% of 17% VAT) to the bottom line – resulting in a Return on Investment (ROI) of 22.5%. Where will you invest? This 2.5 fold ROI is the gap in our competitiveness. Add to this the lack of an ecosystem, poor economies of scale, a lukewarm thrust on manufacturing and high transactional costs.
July-Aug 2018 ▪
India China Chronicle July-August 2018