The Indian Economy Blog

November 26, 2007

A Japanese Model for Indian IT Companies

…to counter the rising rupee.

Professor Kaushik Basu of the Cornell University believes that the rise of the rupee against the dollar is inevitable in the mid-term. He also believes that the sudden collapse of the dollar is unlikely but there is not much that India can do to alter the current dynamics of exchange rates.

In recent days the rupee-dollar exchange rate has been, on average, Rs 39.3 per dollar. A year ago it was 44.7. This means that the rupee has appreciated against the dollar by 13.7% in the last year.

A gentle depreciation of the US dollar over the medium term seems to be unavoidable, given America’s over-spending. The big risk for India and the world is a sudden collapse of the dollar. This is unlikely, since a dollar meltdown is against the interest of all major players, but not impossible. It needs to be understood that the source of the rupee appreciation is, largely, outside of India. Over the last year virtually all major currencies have been appreciating vis-à-vis the US dollar. The euro rose by 14.7%, the pound by 10.4%; the Canadian dollar by 23%, Sweden’s kroner by 13.7% – the same as the Indian rupee. Vis-a-vis all major currencies, outside of the US dollar, the rupee has changed very little. The exception is China. Its currency has appreciated but only by 5.7%. China has a different strategy. It wants to keep up a sustained subsidy to its exporters and continue to build up dollar reserves. This is costly but it gives China muscle against the US. [HT]

This is not very good news for Indian IT firms, whose revenues are generated in dollars and costs are denominated in rupees. The fear of a slowdown in growth and profits has led the IT companies to employ complex hedging strategies against a weakening dollar. Prior to taking over as the Dean of Singapore’s Nanyang Business School a few months back, Jitendra V. Singh (then with the Wharton’s management department) had argued that Indian firms should use the rupee’s strength to their advantage by adapting their business models in innovative ways, much as Japan’s automakers did during the 1980s.

I believe there is a strong parallel here from which Indian companies – especially, though not solely, the IT firms – can learn some important lessons. If Indian companies compete mainly on cost arbitrage, they will find that as their costs rise because of the stronger rupee, they will increasingly become less profitable. Of course, it is also the case that, as the rupee appreciates, net margins at some companies erode more than at other firms. Specifically, if Indian IT companies compete as low-cost providers of IT services, their competitive advantage will erode in a regime of rupee strengthening.

Instead, Indian firms should take advantage of this opportunity to adapt their business models. How can they do that? While the details of the two industries are quite different, the Japanese automobile industry can suggest some answers. Consider what leading Japanese firms like Toyota did as the yen strengthened against the dollar. For product lines where they made the highest margins, such as the Lexus, they continued production in Japan. However, for lower-priced models — where their profit margins were lower and would have been eroded further by the rising yen — they moved production to the U.S. They protected their margins on non-premium products by moving production — and therefore shifting costs — into dollar-denominated areas. They also reduced their vulnerability to further appreciation of the yen.

You may remember that during the 1980s, Japanese auto makers were facing a protectionist backlash in the U.S., and they were subjected to import quotas. Their strategy of moving production of lower-priced/lower-profit cars into the U.S. paid off in a couple of different ways. First, they were able to shift yen-denominated costs into dollars. Second, this was a quite savvy political move, because although these companies continued to gain market share in the U.S., there was little pressure to shut down their plants. Doing so would have meant a loss of American jobs.

I believe Indian companies should take a similar approach in response to this recent rising rupee regime. They need to consider how to adapt their business models. To the extent that they compete primarily on cost arbitrage, the rising rupee will work against them. One key question to ask is how to develop other sources of competitive advantage, such as building high-level capabilities which cannot easily be replicated by competitors, or how to change the mix of activities carried out in India versus other countries. Of course, in order to do this, they will have to change their mindset: They will have to stop thinking of themselves as Indian companies and think more like global companies of Indian origin. They will need to analyze their portfolio of costs and move production to where it makes the most economic sense. Notably, Indian IT firms are trying to address rising wage costs by moving production within India to lower cost regions — Eastern India (Kolkata, Bhubaneshwar) and to Tier II and Tier III towns. However, this will only offset a rising rupee to a limited extent, since the costs will still be in rupees. [IK@W]

This prescription may hold good for Indian IT companies and these companies would surely be considering taking the suggested route. However if the IT companies follow this advise blindly, it will have grave implications for the overall health of the Indian economic landscape. It helps to recount the happenings in Japan during that period -

But, by the late 1980s, the exporters found it harder to bear the burden. They were caught in a squeeze between high costs at home and a rising yen, which made it harder to pass on those costs in export markets. As a result, more and more of the efficient exporters were being driven overseas. They were investing in offshore markets rather than in Japan itself. Step by step, Japan’s efficient export sectors were being “hollowed out.” As this happened, the productivity of the entire economy started being dragged down to the level of the stagnant sectors.

…At the end of 1989, when Japan’s “bubble economy” was at its height, the country felt on top of the world. The crippling heart attack was but a few months away, but Japan felt stronger than ever. [BW]

India growth model has to focus on generating suitable employment for its large population. If the efficient sectors of the economy move out and only the inefficient sectors remain in the country, the employment inclusive growth plummets. It has serious social and political implications in a democratic society. In a sense, individual companies would progress but that growth would be at the cost of country’s economic well-being. It is nobody’s case that this movement of firms should be legislated against; such policy prescriptions are unviable, if not unthinkable, in today’s ‘flat world’ and damaging in the long run.

For other Indian exporters, such as from the manufacturing sector, of leather products and clothes, or of commercial produce like tea and coffee, who are in direct competition with other Asian countries (mainly China), this is not even an option. They will continue to seek RBI intervention to keep the rupee competitive against the dollar, and peg the rupee vis-a-vis the yuan. Notwithstanding the difficulties involved in managing the rupee-dollar rate, there is no option for the government but to manage the rates in the short to medium term. This will indirectly benefit the Indian IT companies as well; some of them may even defer the implementation of their long-term plans to their own detriment.

17 Comments »

  1. [...] Cross posted at the Indian Economy Blog [...]

    Pingback by Pragmatic Euphony » Blog Archive » A Japanese Model for Indian IT Companies — November 26, 2007 @ 6:27 pm

  2. This makes a lot of sense. It does not make a lot of sense to have a lot of the low margin call center kind of business – makes more sense to take up the high end BPO kind of work. This means lower attrition, better employee satisfaction, higher rates. Even in the IT consulting area, the Indian companies are starting to have more people in client facing roles.

    Comment by Sajith — November 27, 2007 @ 1:10 am

  3. In the Indian context, the rise of the rupee is inevitable. But the idea of pegging the rupee to the yuan is very fascinating. It may re-write the economic scenario of the 21st century. As the power of India & China grows it may not be a far fletched as it seems at first thought.

    Comment by Rohit — November 27, 2007 @ 1:13 am

  4. At last nice realistic thought about the current situation. If India only concentrates on IT, it has to import food from other countries eventually. The raising real estate prizes in metros for no reason is adding more inflation as the other commodities getting costlier for no reason. In addition the raising pollution in metros is making more people valnurable to new kind of diseases.

    Comment by Madhavi — November 27, 2007 @ 1:18 am

  5. “…or how to change the mix of activities carried out in India versus other countries.”

    The Indian IT industry cannot follow the Japanese formula as suggested by you. When the Japanese transferred the manufacturing of lower-margin cars to the US, they were essentially offshoring it to a lower-wage country. Name one country that a)has lower wages than India, and b)yet has a qualified IT workforce.

    “India’s growth model has to focus on generating suitable employment for its large population.”

    Agreed! I read somewhere, probably right here, that India’s GDP has to do better than this (9+%) to absorb the exploding working population as its huge youth demographics reaches working age. Now, generating suitable employment being a relatively short-term challenge, with perhaps a 20-year window rather than 50, wouldn’t it make sense to tie the rupee to the US dollar rather than the Chinese yuan? Over the next 20 years, which economy, American or Chinese, is likely to be the biggest consumer of Indian output? After 50 years, I might say China. But in the next 20 years, American consumer is still the biggest patsy for every import.

    Incidentally, I have enjoyed this blog very much in the past, though I am no economist, merely an entrepreneur of Indian descent here in the US. I came back to this blog after months of absence and was pleased to notice that the interesting viewpoints and excellent comments are alive and well.

    Comment by Floridian — November 27, 2007 @ 6:46 am

  6. Given the current exchange rate, can anyone enlighten me on the actual size of the Indian economy. Has the GDP crossed $1T yet ? Also, in terms of per capita income, is India now ahead of Pakistan ? I believe in the past, India has trailed Pakistan in this statistic.

    Thanks!

    Comment by Neil — November 27, 2007 @ 10:01 pm

  7. @Sajith & Madhavi: Thanks.

    @Rohit:
    The idea of pegging the Rupee to the Yuan is indeed fascinating. Even though I didn’t mean it in that sense. In any case, the Yuan is pegged to the dollar. Now that the EU has overtaken US as the biggest importer from China, Sarkozy has just asked the Chinese for a more realistic exchange rate. The Rupee-Yuan conversion is and will remain a pipe dream. What the RBI needs to do is ensure that the Indian exporters don’t suffer because Yuan-Dollar exchange rates and thus they will have to peg the Rupee to the Yuan, in an indirect way.

    @Floridian:
    Thanks. Lower wages are the result of a stronger rupee. Maybe the US or the EU could be an alternative. Mind you, this is not true today but may be in the near future, this would be the way to go to offset a strong rupee and high wages.

    @Neil: Even I would love to know those answers. Anyone?

    Comment by Pragmatic — November 27, 2007 @ 11:44 pm

  8. A lot of times I dont understand this hooplah around Software industry (disclosure: I work for a big software firm in Redmond). For Japanese had a different ball game than what Indians have now. Japanese had a real labour shortage as a small nation tucked in north pacific was trying to supply advanced stuff to whole world. We on the other hand dont have any real labor shortage and have enough of labor for doing simple stuff. If the companies and government work together to use up our decrepit arts and science instituitions we could get hundreds of thousands of graduates for doing the simpler jobs. So, we dont even need to move to Tier 2, Tier 100 cities… a lot of non-engineers could work for like 10K/month and the companies could still make big margins with a falling rupee.

    So, instead of pegging the rupee to yuan, we should instead help our manufacturing by liberalization, relaxation of rules, simplification and reduction of taxes, better capital access, greater labor reforms, more infrastructual investment and for the short term some subsidies. It is far more costly to maintain an artificially weak rupee than to provide a few billion dollar reforms and subsidies.

    We have a long way to go before we think that 1 billion strong society runs short of labor. We will never have short of labor, we will only have short of quality labor. So, moving simple stuff abroad will no way solve it. For now, having the complex stuff abroad and doing the simple stuff at home suits really India’s strengths and must be continued.

    Comment by Balaji Viswanathan — November 28, 2007 @ 5:45 am

  9. Nice blog. Came only today..
    For the india/ pakistan per capita income – check the site http://www.doingbusiness.org

    India 820$ Pakistan 770$

    But if you see the overall ranking.. we have fallen way below pakistan

    Comment by druva — November 28, 2007 @ 2:24 pm

  10. @druva: Do you have values that account for PPP? Thanks

    Comment by Prakash — November 28, 2007 @ 5:50 pm

  11. There is really no such thing as the “Japanese Model” (unless one is talking about girls and cars) and companies like Toyota are not entirely “Japanese” in their thinking, they are a rural company that challenged the traditional Japanese urban powerhouses.

    Taichi Ohno the inventor of the Toyota Production System exhibited a Japanese attitude to work, but it is was Fujio Choi who saw a cultural need to accommodate to global sensibilities, because he knew that Ohno’s approach would not be tolerated.

    Where any kind of thinking snowballs into a powerful force and keeps building momentum, it accrues from a rare set of circumstances that have more to do with learning from mistakes rather than learning from models.

    This blog does capture the adaptive qualities required to make the right entrepreneurial moves but what is a model other than the language of the automotive mindset.

    The article here talks about engaging a global mindset and the Toyota mindset may not be nationalistic but it is deeply cultural, the philosophical base of which is a way of being and not model. I have no idea what a global mindset is but I am sure it is branching out to pick value from a multitude of disciplines and deliver that value to meet real demand.

    Currency speculation and entrepreneurial mindset are two different thing, one plays with the value that the other creates, otherwise all the leading billionaires in the world would all be economists.

    Having said that I am here to learn how “global mindset” economists see the world and learn from them but I have not come here to create supply and demand diagrams or force myself through the mechanical torture that students of economists often are put through.

    The thinking of great economists contains much intelligence, if I can reach the practicality of it, for instance what business model exists to explain Adam Smith’s “invisible hand” other than replacing models with metaphors.

    M.

    Comment by Syven — November 28, 2007 @ 5:51 pm

  12. From Syven’s comment: “Currency speculation and entrepreneurial mindset are two different things,…”

    “but it is was Fujio Choi who saw a cultural need to accommodate to global sensibilities, because he knew that Ohno’s approach would not be tolerated.”

    Correct on both counts. Multinationals are far less influenced by currency speculation when selecting manufacturing locations across the globe and far more by simple business fundamentals, such as the quality of the workforce, infrastructure, government assistance or hindrance, political climate, transportation network and so on.

    You are also right about the sordid truth behind the eventual Americanization of the Japanese companies. In the seventies and eighties, we saw in America a rising tide of anti-Japan sentiments. Lawmakers were calling for increased tariffs. A business leader as respected as Lee Iacocca declared America a colony because it exported raw materials and imported finished goods – in the form of cars. A popular bumper sticker read – “Hungry? Eat your Japanese car.” The Japanese decided to preempt a fatal backlash to their business by increasing local content of their cars, and that is why Toyota and Datsun (renamed Nissan later) set up plants in the US. So it was not a currency driven decision at all. I am sure that the non-UAW, non-Detroit, low wages in places such as Smyrna, Tennessee made the offshoring to the US that much sweeter for the Japanese.

    If there is anything to be learned from the Japanese model, it is that free economy does not tolerate any tampering, and the dangerous exercise called planned economy is not found only within communism. Japan, too, had a quasi-planned economy in which certain national priorities, chiefly export, took precedence over a truly market-driven, consumer-driven economy. I remember visiting Japan a few times in the eighties, and I saw $500 dresses and suits on sale in the finer department stores in Ginza and hardly any Japanese on the street wearing them. Heck, most middle-class Japanese could barely afford cars, while saturating the world with cars they made for a living. That, I knew even as a non-economist, was not a very happy situation.

    On the other hand, this is not a plea for unbridled capitalism, but simply a word of caution to India – plan very carefully, and plan lightly, because most plans will eventually poison the economy.

    Comment by Floridian — November 28, 2007 @ 10:17 pm

  13. Floridian I take Shakespeare’s maxim to heart “there is nothing good or bad, but thinking makes it so, to me it is a prison”. What I love about Japanese culture is no different to qualities that are present in Indian history, an intelligent type of behaviour which can be easily lost via wholesale homogenization.

    The difference with the Japanese IMHO is their cultural response, the response to the defeat in World War II found its expression in the world of enterprise, Japan military is restricted by Article 9 of the Japanese constitution, but it’s understanding and application of soft power is what I feel is worth studying, it is what explains to me how a person who sought to continuously improve a weaving machine, led to the creation of an automobile giant who is still continuously improving.

    Today thanks to the Japanese I am conscious of muda in what it is one grain of sand in a sea of personal development that I must find, and even this thought I am exploring here is muda if it does not move me personally towards a greater purpose. I can define our purpose or have this purpose defined for me, but there is a subtly in thinking that has to be learned the hard way. I have not come here with a megaphone, I have come here with humility.

    Where I think economics is a treasure is that it demonstrates that there are no easy answers, there maybe simple ways but it requires of us, a willingness which is contradictory to the way we relate to modern media. There is no sound-bite or twitter in learning, once one knows what they are doing and where they are going, only a few maintain and sustain a rigorous and effective pathway.

    I never thought about dipping into the discipline of economics until this year and sites like this are certainly going to educate me, but already I can see the thinking which mirrors the very conspicuous consumption that companies like Google avoid and a sea of information that are not blogs but well written books.

    I have one on my desk right now called “Uncertainty & Expectations in Economics” edited by C.F. Carter and J.L.Ford – does it answer the economic problems of the world? No. But it is written as a series of essays to honour G.L.S. Shackle, and why do I find Shackle interesting – because intuitively I recognize that Shackle has something that I can learn, which is not a part of my formal thinking.

    Beyond that, I focus on what it is I do and yes I do fear the narcissism of modern media, but I trust a good grounding in economics will keep me away from it and untouched by its ignorance. Of course the book I have talks about ignorance but ignorance as a economist see’s it. I don’t have interest in what others think I think, I want to think about how I think and in so doing escape mediocrity, which is not worth me personally reflecting on, because that would be muda.

    M.

    Comment by Syven — November 29, 2007 @ 1:37 am

  14. “Heck, most middle-class Japanese could barely afford cars”

    That’s simply not true… dude, visit Japan, or at least do a google search before dragging stuff out of the air

    Comment by CA observer — November 29, 2007 @ 1:41 am

  15. If I am to focus on any three words in the blog or the comments, those three words would be “COMPLEX HEDGING STRATEGIES”. The article here talks about a “Japanese Model”, which I consequently said is a mechanical way of looking at things, but if one is advocating a “Japanese MINDSET to Indian IT companies” then begin utilizing that mindset.

    The western mindset (aka also colonial clone/chumpcha) is blog – respond – new blog – new response – blog respond – new blog – new response – and if that is the case, does this not resemble the familiar pattern of a production line mentality?

    Besides the soft power issues what the best in Japanese mindset brings is the ability to see any mistake and turn it into gold. The west however punishes mistakes and what is India BTW but a country whose institutions mirror the discipline of the British Empire, which are the people who helped give the world the education to admire life in the industrial age. Sweeping statement yes, but you can find it on Google – No. Is there are a new way to learn how to see life and the nature of emergent work or complex systems or systems thinking – Yes.

    How do we as thinkers get the blog out of the industrial age? Want to follow a Japanese mindset, then think about agile development, think about continuous improvement, think about flow. These are concepts geared to the creation of the information age. But what about COMPLEX HEDGING STRATEGIES?

    The Japanese Model if you want to call it that, takes one stand, follows it all the way and improves on that strand, then it goes back into the system and repeats the process over and over and over, until the net effect is a change to the overall system – a bit like the surprise one gets with compound interest when the time comes to see what emerged at the end of that rainbow.

    So if I took the words COMPLEX HEDGING STRATEGIES as one of my chosen strands, then in no time I can use the real power of Google, that of extending my thinking so it changes the way I think and use media. Instead of raising alarm at the practice of complex hedging strategies , that I have no power to control, I seek to find out more – and what do I find that surprises me – that farmers already have this expertise in abundance, so that means that a person who runs an Indian IT shop can break out the bubble of linear thinking and talk to farmers who well versed in these derivatives where commodity is their chief business.

    I don’t want to take up any more space here, but there are words of value I read last night in Brian Tracy’s book “Something for Nothing” where he says:

    “You are always free to choose. The only thing in the world which you have complete control is your thinking. Only you can choose and decide what thoughts to think and dwell upon. Your entire life today, in every respect, is the sum total of the choices and decisions you have made up until now. Since you can make the choices and decisions that affect your life, you are completely responsible for everything you are and everything you become”

    Here is a Western thinker who possesses a wise mind and it also reinforces what sits behind the “Japanese Model” – successful Japanese people let their people think, less so let them enjoy the soft power of obesity – so in the end of the day, our nationality does not dictate the quality of our thoughts, WE DO through trial and error, through life as a practice, through new paradigms, it is our thinking that makes the world of difference.

    In the general scheme of things, the Japanese have simply adapted more towards the information age than have other nationalities, but we all make mistakes – but how does an economist measure things in terms of learning from mistakes and connecting economics with life, after all the word eco means “our home” not “our work”.

    If mistakes are not a valid economic criteria then try another Westerner with wisdom, Henry Mintzberg and his review of how Honda made strategic decisions compared to the Boston Consulting Group. Find that yourself, I came here to think, what anyone else says or does is their own business.

    M.

    Comment by Syven — November 29, 2007 @ 8:17 pm

  16. good to see such comments on rising rupee but some how I feel lot of attention is being given to IT firms where as even bigger sectors like textile ,leather,manufacturing and small scale handicrafts who have lot of demand abroad definetly rising rupee hits exports be it exporting services or exporting goods but best way to encounter this threat for any buisness would be lowering cost to sustain margins ,RBI’s intervention mopping up dollars and for short term specially when budget times are around subsidies

    companies should not mind asking for subsidies be IT or NON IT as most of the developed nation (first world) do give it to their agriculture sector and other industry as and when required

    apart from that there have been recently lot of buzz on US recession but scenario in 2001 was because of US corporate spendings and this time around its drop in consumers and sub prime mortgage loans and for this US banks are only responsible as I feel that some or most of the parameters were ignored while loaning out sum to an individual in race of getting major market share

    For indian IT firms now would be to set global footprints and make their presence apart from US to some other nation in asia pacific,south america and europe which would also help them out in hedging their funds

    Comment by @dhairya — February 12, 2008 @ 10:36 am

  17. Hi,

    Yes, this makes a lot of sense – I believe many of the companies have started billing in Euro considering it as a strong currency.

    Have also seen quite a few companies booking forward contracts for $ and suffering heavy losses now.

    Too sad, but all said an done, seems to be a part of doing business.

    Best Regards,
    Shreya

    Comment by outsourcing — August 25, 2008 @ 11:49 am

RSS feed for comments on this post. TrackBack URL

Leave a comment

Powered by WP Hashcash

Powered by WordPress