The Need For Indian Companies To Take R&D Seriously With Naushad Forbes

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Mr. Forbes, thank you so much for joining me. So, I am picking up on an article that you wrote recently for the Business Standard called Innovation, Competition and Ambition, why Indian firms must invest more in Research and Development. Now, the headline figure here is that the Indian industry invests only 0.3% of GDP in in-house R&D compared to a world average of 1.5. And in the top 2,500 firms that do invest in R&D globally, India has only 23. And we have no presence in six of the top industries, which is technology, hardware, electronics, construction, healthcare, industrials and industrial engineering. And then there are further breakdowns in terms of industries like auto and pharmaceuticals, where clearly the numbers are very low.

GE: So, let me ask you the broader question first. Why is it that Indian companies not or do not invest sufficiently or enough in R&D?

NF: So, it's a question that I've tried to, first of all, Govind, great to be with you. And, you know, I'm a big fan of your show.

It's the way I start my day every morning before I go for my shower.

So, let me start by, I've tried to answer that question over the last few years. And the way I've tried to answer the question is by talking to friends in industry and asking them the question, you know, and sort of saying, sharing with them the data and then saying, why is it that we invest as little as we do? And I think the answer is shifting a little; in that we see more and more Indian firms that are starting to get more serious about R&D, but not enough yet to show in the overall aggregate data. So, it’s still, when I first came up with this 0.3% calculation, that's about five, six, maybe six, seven years ago. And the 0.3% is still 0.3%. So, we haven't yet shifted substantially enough in terms of the number of Indian firms that are making serious R&D commitments. There are individual firms, but not enough firms and not enough big firms, especially for it to show in the data.

So, when I've asked why, I think the general sense I get is that firms actually think they're investing a reasonable amount in R&D. They will come back with answers like, well, we do a lot of R&D, but it doesn't show in the data because it's R&D that's done on the shop floor. And it's shop floor innovation, which doesn't show in the official figures. That's true, but it's also true for firms worldwide. The shop floor innovation that happens worldwide doesn't show in the R&D data for other countries too. So, the comparison is still relevant of 0.3 to 1.5. Even if there is some undercounting that takes place, there's undercounting that takes place elsewhere too.

So, I think it's a mindset issue more than anything else. And mindset sounds like a cop-out. It sounds like a, you know, because how do you change mindsets? You change mindsets, I think, with data. And the data that I've tried to use is to go on sort of ad nauseam about this 0.3, 1.5% comparison to then try to get firms to do a benchmarking exercise for themselves with the top 10 or 20 firms worldwide in their industry. And then say, you know, what do we spend on R&D relative to the top 10, 20 in the industry? How many R&D engineers do we have? How does that compare with engineers worldwide? How do the qualifications of the engineers compare? And how do the outcomes compare in terms of the number of new products released each year, the proportion of, let's say, new products launched within the last three or five years in total sales? And using a bunch of benchmarking metrics as the way of trying to get this point across that there are big gaps between where we are as Indian industry in our investments in R&D and where world industry and the leading firms in our sectors actually are. Again, there are exceptions. There are Indian firms that take R&D very seriously. But unfortunately, they're too few to show in the overall aggregate data. And we need to become much more R&D intensive, much more focused on R&D. And we can talk about the benefits that would flow as a result.

GE: And so let me put that question first straight away and maybe word it a little differently, which is that what are companies losing out by not investing in it? And then could be the follow up, which is what is the perception currently on whether they're losing out or not losing out?

NF: Yeah. So, you know, clearly what we're losing out on is the ability to capture what economists call ‘innovation rents’. Innovation rents are the extra price you can get from the market because your product is differentiated, because you do something, your product does something either looks better, does something better, has functionality that is very different to what everyone else has on offer. And as a result, you can charge an innovation rent, you can charge a premium over what others charge. That's what firms seek when they invest in R&D.

And there's a second piece to it, which is one is the innovation rent and the attractiveness of being able to sell at a higher price. The second is being able to access markets that one otherwise would not be able to access. Particularly true of international markets. If you look at many sectors, we've done some studies. We have a think tank called the Center for Technology, Innovation and Economic Research here in Pune. And we've done some studies from the Center interviewing Indian firms on competition that they face from China. And quite interestingly, we find that in many, many sectors, firms do not face competition from China. And we said, this is rather unusual. How come? And then when you actually talk to the firms in some detail, you find that in the products where they face competition from China, they've tended to exit those markets. Those markets have tended to be for somewhat more sophisticated technology areas.And they then focus on areas where there isn't that competition. So it's really been a move away from some quite attractive areas as a result of not wanting to compete with firms that are more significant investors in technology. So I think for two reasons, the two reasons why one should invest a lot more in R&D and in technology is first, because you can get innovation rents, you can sell at a premium. And second, because you can access markets that you otherwise would not be able to, particularly world markets. Those are the two compelling big reasons and rationale for investing in R&D. There's a third reason, which is a threat reason. And that if you don't invest in R&D, the chances are that someone else will come along and innovate, will come up with something that's better, and your existing customers will be lost to that competitor. So the threat of displacement, the threat of being pushed out of a particular area is a very compelling argument too. It's a negative argument if you like, but that's a negative inducement that can be more powerful sometimes than the two positive things that I mentioned.

GE: So if we were to go a little deeper into auto, which you've talked about, and you said how the four Indian firms, that's Tata Motors, Mahindra, Bajaj, and TVS, they figure in the top 2,500 R&D investors in the world; spend 3.8% of their turnover on R&D, but that drops to 1% if you take out Tata Motors JLR subsidiary, which is sitting in the United Kingdom. So that means it's essentially 1%. Now, why is it that firms like these, which are clearly in very competitive markets, including in India, but competing against global brands, are not able to or do not see the, let's say, the incentive or the push to actually invest more?

NF: So global R&D investment by auto firms is typically 3%, 4%, 5% of sales. So it's significantly higher than what we have in India. One of the reasons is that R&D is more expensive in other parts of the world. The main cost in R&D is the cost of engineers. Our cost of engineers in that sense is lower, and given that lower cost, we can get the same results at a lower cost, right? So that's one element.

But that, in a sense, should be an argument for doing that much more.So for actually scaling R&D that much more provided the returns to R&D are attractive, and all the data shows that the returns to R&D are actually very attractive. There was a World Bank study that was done about five years ago, I think, called The Innovation Paradox, and the study tried to estimate the returns to R&D, and it came up with numbers that were upwards of 80%. Now, if you have an 80% return, I mean, it's a no-brainer. You don't even try to calculate the return. You just invest, because it's such an attractive investment that you want to do it soon as possible. So the question then, again, is why do you have this Innovation Paradox? Why do you not invest enough? And it's because of these perceptions, these perceptions that, well, I'm already doing enough. I'm doing as much as I can. I'm doing as much as not… I don't think any firm is saying they're doing as much as they can afford. I think if you ask firms, by the way, and you ask them a question, and I've asked them this question in a few cases, that how many R&D projects have been proposed to them that they have turned down?

The answer is generally almost none. So it's not that there is this big appetite for R&D within the firm that the firm is unwilling to invest in. It's that the firm does not have an engine in place to generate enough of those proposals of what would be worthy R&D projects. And I think that’s where firms will need to start. They need to start with putting people into R&D who can think both from a technical perspective and from a business perspective and say, these are the kinds of projects that we should start experimenting with and start investing in.

A second question is, how many projects go nowhere? How many projects fail? And my sense is that the proportion of R&D projects that fail in the Indian industry is much lower than the proportion of R&D projects that fail internationally.

Now you might think that's a very good thing, but in R&D, I think it's a bad thing, because if R&D projects, if you can't point to several R&D projects that have gone nowhere, it's probably because we haven't tried to do enough cutting-edge things. And in a sense, having some level of failure of R&D projects would be a reflection of us trying to do enough.

GE: So if you were to look on the demand side, which is where I'm assuming a lot of other responses would come in, which is to say that the market doesn't need it, the market cannot afford anything, the market is not looking for any more innovation as we can see at this point of time for this class of products or this category of products.

NF: I don't think that's true. I think in sector after sector, we've demonstrated that people want new things.

Well, your show this morning, Govind, you had an interview and you were talking about auto sales. And you had this comment on auto sales, which said, it was almost in passing, but it was, we've seen that auto sales have become vibrant of particular models when these new models come in. So if you have a firm that introduces a lot of new models, that's the firm that sees growth in sales. So I think that's true of industry after industry after industry. You know, that the way in which, you know, classic, take the counter argument. Why would you replace a 10-year-old Premier Padmini with a new Premier Padmini, which looks exactly the same and performs exactly the same? That was the state of Indian auto for many decades.

There was no incentive to invest in a new model. But when you have a really attractive new model that comes out every two years, then every five or six or seven years, you want to invest in a new car because you want something which has, if nothing else, it simply looks different and looks very attractive relative to the car that you're currently driving. So I think newness, innovation, new functionalities, new performance is what drives consumers. It's what drives consumers. It's what drives industrial users. That's the nature of creating attractive markets in firm after firm. And it's as true in India as it is in markets worldwide.

So, and when one says, and you do hear this argument, I agree with you, you hear this argument that, well, are people willing to pay for it? Okay. I mean, you can't price your products so high that, you know, you limit the number that would afford, that can afford the product. But does that mean that firms and individuals are not willing to pay 10 or 20 or 30% more for something that is a lot better and different? I think that's something that's been proven again and again, that consumers are willing to, even in price sensitive markets like ours.

GE: So you're, you're therefore saying that there is, there is hubris. And that is one reason why firms who particularly are doing well, because the other thing that struck me with the examples that you've quoted, or most of them, is that they're all very cash rich.So none of them have a problem of finding the funds to do more R&D. I mean, if, of course, such projects did come up.

NF: You take the IT services industry, the IT services industry has no shortage of funds.It continues to be very profitable. It continues to have a lot of cash sitting in the bank. Our investments in R&D within the, if you take the top 10 IT services firms in India, they invest under 1% of turnover in R&D. If you take the top 10 Chinese firms in IT services, they invest 8%. There isn't a good reason why there's that gap.

GE: So you've also said that, you know, pharmaceuticals, where again, the top five Indian firms invest about 6% of sales, the world average is 17%. So, you know, pharmaceuticals, one would assume is obviously an area where there has to be research happening all the time, or alternatively, we are obviously doing more contract manufacturing and therefore no real pressure to do R&D beyond a point. But the other question I have is, the talent to do R&D is also there in India, but maybe it's not in these firms. Is that something that also comes up?

NF: So the talent to do R&D is clearly available in India to a much greater extent. I don't remember the exact number.. I've written about this. But if I remember, I think it's around three quarters of the top 500 firms in the world have R&D development centers in India. So the top 500 firms in the world think that there's an abundance of R&D talent available in India. So there’ s R&D talent available in India. And this R&D talent that's available should be seen more and more in employed in Indian firms. So we should have hundreds of Indian firms that are each employing thousands of R&D engineers. Why should it be more foreign firms that are the thousand person R&D functions in India? Now, the nature of the R&D that these foreign firms do tends to be more routine than the broad conceptual R&D that’s needed, and then a lot of the detailed R&D that’s available. So we have many more people without question who can do the detailed, high volume R&D that’s needed. And we do have some constraints on the more conceptual, broader R&D, but that's more a matter of learning than anything else. We have to learn those skills. And we learn those skills only if we try to acquire them by coming up with products that are truly differentiated and unique. It takes a while. I mean, I can say from our own experience as a firm, it took us five years, before we had a regular flow of new products coming out of R&D that we could be proud of. In your first couple of years, you're putting a lot in, you're getting a relatively little out. It starts getting better and better and better as you learn how to identify what kind of product differentiation is both possible for the firm to do and attractive to customers to buy. So I'm going to come to the triggers in a moment of what makes companies actually go ahead. But the other point that you made earlier about companies that vacate a space rather than go head on into competition with, let's say, a Chinese product. Again, two parts to it…I wonder if you could illustrate that with any examples. And secondly, why perhaps, again, is it a more intangible issue that we have to tackle here rather than the tangible?

NF: No, I think this is a very tangible issue that we have to tackle. Are there examples that I can point to? I think we could look at consumer durable space. And I think you'll find not only some categories where we've sort of exited markets rather than compete with Chinese firms. But I think in some cases, we've exited the part of the market that is the most attractive and innovative. And once you exit that market, then getting back in it is tough because you lose that talent that you need to build on to really keep adding functionality and features.

There is a second piece there. A lot of consumer durable products have increasingly incorporated sophisticated electronics. And electronics is an area where we have very weak innovation capabilities. It’s one of those 10 leading sectors worldwide, electronic hardware, one of the 10 leading innovation sectors worldwide. And it’s a sector where we have zero firms in the top 2,500. And more and more, you need electronics capability running across sectors if you want to be cutting edge.

The same is true now in auto. The number of chips in a car or even motorcycle is growing all the time. And the electronics and the interfaces and so on are increasingly electronics. And we don't have a good capability yet. So I think where it's a nascent capability, it's something that's starting to improve. I think as it improves more substantively, we will see us starting to be able to get back into some of these sectors like consumer durables, which we've kind of vacated at least the high end of consumer durables with a lot of automation that's currently provided by these electronic capabilities.

GE: So one of the things that you've argued is that the reason maybe there is a lower incentive to invest in R&D is protection. And you can, of course, take it upon yourself and say, I'll go and compete in international markets and thus self-incentivise yourself to invest in R&D. But that may not happen in many cases or most cases. So my question really is, what then can be the big triggers? And let me ask you about both triggers. So one is internal, which is that you as a company wake up one morning and say, we have to do this. And you quoted your own example. And second is external. It could be policy led or it could be led by opening up of policy, which could include, of course, lowering of tariffs, but there could be something else as well.

NF: So it's ideal if the firm chooses to do it itself. Because you're making that choice and you deliberately seek more demanding users. The more demanding users can be those within the country who otherwise import products or the demanding users can be overseas. So both are fine, but it's ideal if you choose to do it yourself. But I would argue that it's really a policy question more than anything else, because being competitive is not a choice that should be left to firms. It should be forced on them. And the way in which you force competitiveness on firms is by removing tariffs.

And we can make various arguments and say, we need a level playing field. Our electricity prices are so high. Our infrastructure has these issues. But then we should argue and demand a level playing field. And we should argue and demand better infrastructure, much of which we've been getting. Better electricity supply, to some extent, which we've been getting. And really, and if you look at the bureaucratic overload, which was significant and continues to be as significant in terms of ease of doing business, we should demand that that improve as a way of enabling us to compete instead of then saying, OK, because we have these impediments, protect us. So I think getting rid of tariffs and seeing a progressive reduction in tariffs is the only way in which competitiveness can be actually forced on Indian industry.

We had seen tariffs come down to an average rate of 13% a few years ago. In the last six or seven years, it's gone from 13% to 18%. And that's one of the higher rates in the world among all emerging markets. And it directly affects, by the way, our ability to compete as firms. An economist would use a phrase, which is a tax on imports is a tax on exports. Because even if you can import items for export duty-free, you can't import everything. It's too cumbersome. So for example, if you're a garment firm, you might import, which is making garments for export, you might import the fabric such that it can be converted in for exports and so you import it duty-free. But you won't bother with the thread and the buttons and the liners and everything else, because it's too cumbersome. And that makes you less competitive overall.

So a tax on imports is a tax on exports. If we want to be a vibrant, strong international player in markets around the we have to reduce tariffs.

GE: So you said internally, one should really take it upon oneself as an organization and really not waste time. The external trigger that you're saying is tariff. Is there anything else?

NF: Free trade agreements. Another policy area is free trade agreements. And it's encouraging that in the last three years, we've turned around and have started signing free trade agreements again. We've signed a free trade agreement with the UAE, a very limited agreement with Australia. And we have a free trade agreement with EFTA, four countries in Europe. And we have big agreements underway and are being discussed with the UK and with the EU. All of this is very welcome.

But the world's supply chains are strongly Asia-based. Yes, China playing a big part in them. But Asia-based.

It's not only China, it's South Korea, it's Japan, it's Indonesia, it's Thailand, it's Malaysia, Vietnam. All are part of these supply chains. And we've sort of turned our back on Asia by dropping out of the RCEP-Regional Comprehensive Economic Partnership Agreement, a few years ago. It's the most attractive economic region in the world. You know, the ASEAN, the Association of Southeast Asian Countries alone doubles Indian GDP. If you add in Japan and South Korea and Australia and New Zealand, you add another two elements of Indian GDP. And of course, if you add in China, that's another five. So it's the fastest growing region in the world. It's the most attractive market in the world. And it's where a lot of manufacturing takes place. And if we want to be part of these supply chains, we have to again, look at Asia as a market that we should be engaging with for free trade discussions and free trade agreements. We didn't do RCEP.But let's look at what's called, these horrible acronyms, you know, the Comprehensive Trans-Pacific Partnership, or whatever it's called, which is the agreement that came out of the Trans-Pacific Partnership when the US left it.

GE: Right. Mr. Forbes, thank you so much for joining me.