Announcement

Professor Niraj Dawar in the Financial Times

Prepare now for a Sino-Indian trade boom
By NIRAJ DAWAR
Financial Times

During the 1990s, the question in the boardrooms of multi-nationals was: "What is our China strategy?" More recently, the question has been: "What is our India strategy?" Now companies should be asking: "What is our strategy for China-India trade?"

The results of a four-decade old estrangement have been dismal for business between China and India. Total bilateral trade in 2004 amounted to no more than Dollars 14bn - about as much as is traded over the Canada-US border every week. But a geopolitical thaw is now reawakening trade between the two natural trading partners. With large populations, fast-growing economies and complementary industrial capabilities, the two countries have much to trade. The potential for growth is staggering. In April this year, the pair signed an agreement to boost trade to Dollars 20bn by 2008. But that figure will be surpassed within the current year, and some pundits predict it will reach Dollars 450bn by 2010.

Multinational companies around the world need to examine their strategy in light of this awakening. They should particularly consider the question: where will value be generated and ? -captured, and what role can they play? The question is important because the newly forged Sino-Indian partnership throws doubt on existing business ? -models upon which multinationals have built their China and India ? -strategies.

Over the past 20 years, the typical multinational's business model has been premised on arbitrage between low-cost Chinese manufactured goods and Indian services, and the higher prices that consumers in their home markets have been willing to pay. Two-thirds of China's current manufacturing exporters are multinational companies, which together account for half of all the country's exports. A pair of branded athletic shoes manufactured in China retails for 10 to 20 times its manufacturing cost in the markets of North America, Europe and Japan. The resulting high returns have customarily been ascribed to the multinationals' research and development, design, management and branding capabilities. They have allowed these companies to carry big overheads, and still provide a comfortable return to shareholders.

But Sino-Indian trade will increasingly call this model into question, for two reasons. First, while the business model of the multinationals has been devised to sell Chinese tools, toys and trinkets to affluent consumers, it breaks down when the buyers are Indian consumers. Indian consumers cannot afford the R&D, design, branding and management overheads. Chinese companies, with their razor-thin margins and low overhead costs, are better placed to cater to the Indian opportunity. In the other direction, some multinationals have indeed been selling Indian software and services to Chinese customers. But, increasingly, Indian rivals such as Wipro, Infosys and TCS are developing direct access to the Chinese market. They have already shown they can grab market share from Accenture, EDS and IBM inother Asian markets. Like the Chinese manufacturers, Indian software and services companies have the advantage of low overheads. Without rethinking their business model, will multi-nationals have to pass on the Dollars 450bn opportunity because of competition from local rivals?

Second, if local rivals do indeed seize the opportunity, they will be well positioned to pressure the multinationals' business model globally. The economies of scale that local players can build serving both their domestic and neighbouring markets will give them a formidable cost advantage in global markets. It will not be long before this advantage is deployed to challenge the R&D, design and brand-based advantages of the multinationals in their traditional developed-country markets.
What can multinational companies do? First, they must decide whether Sino-Indian trade is a big enough opportunity to merit a review of their business model. Clearly, participating in this trade boom will not be merely a matter of redirecting exports from China to the Indian market, or of competing for Chinese contracts from an Indian supply base. Neither action would increase multinationals' competitiveness against local rivals, as long as the products and services are made with the developed country markets and customers in mind.

The solutions are likely to reside in three areas. First, painful as it may be, multinational companies must shed overhead costs. How they do so may vary. Some may choose further to localise management and sourcing or acquire local companies or partners. Others may decide on more controversial approaches, for example, choosing not to allocate full global overheads on intra-region sales. Under this approach head office would not receive the same plump profit for a product manufactured in China and sold in India as it would for sales in the US. But it makes business sense to discount the products in India to capture market share, just as an airline would discount student tickets to fill its flights.

A second, related approach is to shed costs by spinning off local subsidiaries and listing them on local markets. This makes them accountable to local shareholders who will demand localisation of the cost base.

Finally, the old cliche of sticking to high value-added activities will need to be put into practice with renewed vigour, focusing on market-making, finance and knowledge-management activities. In this approach, multi? -nationals supply the R&D, design and branding skills that local companies need to play on the global stage. By playing midwife to tomorrow's global corporations, today's multinationals retain a piece of the future pie. If multinational companies are not already thinking about how to capture a share of the Dollars 450bn opportunity, they should be. The floodgates of intra-region trade are opening.

The writer, a professor at the Ivey Business School of the University of Western Ontario, is currently visiting professor at Insead in Singapore