Indian Private Equity: Conversation with a CEO

I recently had a conversation with the CEO of an Indian industrial forging company that specializes in automobile and oilfield related products. Here’s what I picked up on the venture and private equity opportunity in India from someone with direct experience operating a middle-market company there:

He conceded what many already know – that venture capital, particularly for high technology, really doesn’t work well in India. Aside from the lack (or enforcement) of intellectual property rights, there’s simply too much of a “copycat mentality.” Innovation happens more with processes or at the business level, because innovation in technology lacks the right risk/reward profile. For example, most young IT professionals would much rather work for an outsourcing firm and take the compensation the jobs provide rather than risk trying to innovate. For this reason, private investment in India will not be heavy in venture capital for some time.

There are many companies and industries that will be able to ride the country’s GDP growth to success. But beyond that, at the operational level, what competitive advantages does India have that make a compelling case for private equity investment? For most Indian businesses, low cost labor is the core advantage. In fact the CEO I spoke to said low cost labor might be his company’s only advantage in the global marketplace. Energy, raw materials, equipment and technology costs are pretty much level globally, but when it comes to the much more lucrative business of exporting product, labor cost savings are a huge advantage. And it’s not just the direct cost of labor, but all other related or dependent costs, such as insurance or transportation (drivers, handlers) that collectively provide a huge advantage.

In most industrial and manufacturing businesses, labor unions are still not a major issue, but they are beginning to crop up in larger Indian cities such as Mumbai, Delhi and Bangalore. Smaller, more rapidly growing cities should be able to stave off issues related to labor unions for another decade in his estimation. So, the long term potential for growth and profitability still remains even if purely based on the low cost of labor, you just have to go to the right places. In this respect, the biggest impact should be for manufacturers, particularly those who export. In fact, exporters receive incentives from the Indian Government in the form of credits which can then be sold to importers on the open market. Domestically, he identified industries such as financial services and consumer products and services that target India’s growing middle class as areas of growth. Infrastructure plays too can take advantage of the low cost of labor.

When I asked about potential detractors for private equity investment in India, the biggest drawback he saw was the trouble PE firms have in obtaining controlling ownership (or even any ownership stake at all) in companies that are family owned. It’s one thing to buy smaller stakes in large companies, but if the buyout model is to really take off in India, it’s going to take gaining the trust of families who own a large portion of the private businesses in India.

Another issue for investors is bureaucracy. Conducting business in India can be slowed extremely by bureaucratic policies and procedures. These can differ state to state and even city to city. To navigate it all efficiently takes experience and relationships, something impossible for outside investors to bring with them. This point can’t be stressed enough and is why the most successful private equity investments in India will have to involve Indians with opperating exerpience in the various regions of the country.