Winner takes all: Big fish swallow the small ones amid demand slowdown

There has been a steady rise in market concentration in several sectors across manufacturing

Is the demand slowdown in the economy creating a situation in India Inc where the dominant firms corner most of the gains? The trend in corporate revenues in many sectors suggests a steady consolidation in favour of a few leaders in recent years.
 
The skew in favour of large firms is even starker if one looks at the distribution of profits and market capitalisation in many sectors.
 
Revenue trends for BS1000 companies suggest that consolidation continued despite a sharp recovery in top line growth in FY18 and FY19, driven by higher energy and commodity prices. The combined revenues of BS1000 companies were up 18.1 per cent year-on-year (y-o-y) in FY19, as against 11.5 per cent y-o-y growth a year ago.
 
Excluding oil and gas companies, the combined revenues of BS1000 companies were up 11 per cent y-o-y in FY19, as against 8.9 per cent a year ago.
 
The growth recovery, however, seems to have stalled, with the combined revenues of BS1000 companies having remained stagnant during the first nine months of FY20.
 
This, experts say, could trigger more consolidation, as smaller firms struggle to stay profitable in the face of the demand slowdown. “When the industry cycle is weak, smaller and marginal players struggle to make profits, and they are ultimately acquired by large players with greater staying power. This is what we are witnessing in some industries right now, especially in telecom, metals, cement and power, where many smaller companies are now undergoing bankruptcy proceedings due to large losses,” says Dhananjay Sinha, head of research, Systematix Group. 

 
The slowdown in top line growth has also created a wedge between growth and the return on equity. In six out of the last nine years, the return on equity or net worth has exceeded the average top line growth of BS1000 companies (see graph at top of page).
 
A higher rate of return on capital, compared to the growth rate, has consequences for capital accumulation and its distribution, according to French economist Thomas Piketty, the author of Capital in the Twenty-First Century.
 
Faster economic growth means greater opportunities for new entrants to grow their income and assets. Lower growth, on the other hand, favours incumbents, as income or profits from their accumulated assets continue to grow at a faster rate than the general income growth in the economy. This allows incumbents to grow their market share at the expense of smaller firms.
 
Market share rises for large firms
 
The process is most visible in the telecom space, where there has been a steady rise in the market share of the top two operators — Bharti Airtel and Reliance Jio — despite a general contraction in the industry’s revenues in the last three years, owing to price cuts. Reliance Jio is also an exception, as it has made a huge dent in the telecom industry despite being a newcomer, thanks to parent Reliance Industries’ deep pockets. This has now raised the possibility of a duopoly in the sector, as the bottom three operators in terms of size — Vodafone Idea, Bharat Sanchar Nigam Ltd (BSNL) and Mahanagar Telephone Nigam Ltd (MTNL) are now facing financial difficulties.
 
In the financial year 2018-19, Bharti Airtel and Reliance Jio together accounted for 63 per cent of the industry’s revenue. Five years ago, in 2013-14, the top two players — Bharti Airtel and Vodafone then — had a combined revenue share of 51 per cent. The revenue market share of the top two operators increased further to 66.4 per cent during the first nine months of FY20.
 
The skew in profits is even bigger. While government-owned MTNL and BSNL reported losses at the EBIDTA (earnings before interest, tax and depreciation) level in FY19, Bharti and Reliance Jio together accounted for 95 per cent of the industry’s combined EBITDA in the last fiscal, while the balance was accounted for by Vodafone Idea.
 
Poor profitability makes it tough for smaller operators to make incremental investments in airwaves and networks, unlike dominant firms, which continue to put more money into their networks.

Beyond telecom, there has been a steady rise in market concentration in many other industries, as measured by the Herfindahl-Hirschman Index (HHI), an indicator of competition within an industry. For example, the HHI score in telecom crossed 2,800 in FY19, as against 1,862 in FY14 (see bar chart above).

An industry with an HHI score of 2,500 or greater is considered to be highly concentrated, while an industry with HHI score of between 1,500 and 2,500 is considered moderately concentrated and an HHI of less than 1,500 means that the industry is competitive.

HHI is based on the revenue shares of all firms operating in a sector. This Business Standard analysis of HHI is based on the reported revenues of listed companies in a particular sector and key unlisted firms whose numbers were available. For globally diversified companies such as Tata Steel, Bharti Airtel and Tata Motors, we have considered their domestic revenues.

The United States Justice Department and competition watchdogs globally use HHI scores to evaluate mergers and acquisitions and their impact on competitiveness. On this metric, competition has receded in many key industries in recent years, as bigger players have become bigger while smaller players have either struggled to grow or have been acquired by their larger peers.

In the steel industry, for example, the HHI score increased from 1,791 in FY14 to 2,200 in FY19. This was largely owing to both expansion and acquisitions of bankrupt companies by the two top manufacturers, JSW Steel and Tata Steel, which added to their capacity. Tata Steel, for example, acquired Bhushan Steel, while JSW Steel bought out Monnet Ispat & Power, and has now has obtained approval from the National Company Law Appellate Tribunal to acquire Bhushan Power & Steel.

 
Tata Steel and JSW Steel together now account for nearly 56 per cent of the industry’s revenues, up from 46 per cent five years ago. The calculation is based on Tata Steel’s revenues on a standalone basis, and includes the revenues of its subsidiary, Tata Steel BSL — the erstwhile Bhushan Steel.
 
A similar process is visible in the cement industry. The industry leader — UltraTech Cement — now accounts for nearly a third of the industry’s revenues, up from around 23 per cent five years ago. In recent years, UltraTech increased its market share by acquiring assets from Jaiprakash Associates, besides buying out Binani Cement, both of which were under the Insolvency and Bankruptcy Code (IBC). Together with the LafargeHolcim group in India that owns ACC and Ambuja Cement, UltraTech now accounts for 51 per cent of the industry’s combined revenues, up from 44 per cent five years ago.
 
Competition watchdog gets cracking
 
The consolidation has raised some eyebrows among regulators, especially the competition watchdog, which is trying to discourage companies from indulging in anti-competitive behaviour.
 
In August 2016, the Competition Commission of India (CCI) slapped a Rs 6,300-crore penalty on 10 cement makers and their trade body, the Cement Manufacturers Association (CMA), for cartelisation that allegedly led to higher prices for consumers.
 
In January this year, CCI ordered a probe against Asian Paints — the industry leader — for its alleged abuse of its dominant position in certain markets in southern India. The probe was ordered on a complaint filed by JSW Paints, a new entrant in the industry.
 
Asian Paints accounted for nearly 57 per cent of the combined revenues of the top five listed paint makers. The paint industry had an HHI score of nearly 3,900 in FY19, indicating a high level of market concentration.
 
Other industries with high levels of market concentration include copper, aluminium and civil aviation. In contrast, the competition increased in commercial vehicles, as the incumbent, Tata Motors, lost market share at the expense of smaller manufacturers such as Ashok Leyland and new entrants such as Daimler India Commercial Vehicles.
 
Others say that concentration has always been high in India, especially in industries such as metals, power and cement. “In most capital-intensive industries, the bulk of the industry profit is largely accounted for by the top five companies at best. This puts dominant firms at an advantageous position when growth and profits take a hit during a growth slowdown,” says Madan Sabnavis, chief economist, CARE Ratings.
 
According to him, concentration of profits and entry of newer firms is a better indicator of competitive intensity in an industry than revenue share.

 
Role of imports and tariffs
 
Competition experts also highlight the role of imports — or lack of them — in determining competition in the domestic market, especially in manufacturing industries.
 
“High import duties and barriers to trade discourage competition and largely favour incumbents firms,” says Amol Kulkarni, fellow, CUTS International, an advocacy group for consumer rights. “Tariffs are on upward trajectory in India. Besides, there is anti-dumping duty on many products. These protective measures should be reviewed periodically, to ensure that it doesn’t hurt consumers and innovation in industry.”
 
In the latest Budget, the government hiked import duties on nearly two dozen items, including furniture, footwear, toys, lighting and air conditioners, among other things.
 
Kulkarni says that there has been a general trend towards consolidation in many industries for various reasons, but the question must be asked if it is necessarily bad. “Rather than bother about a decline in numbers of players across industries, our focus should be to ensure that there is no entry barrier for new entrants and disruptors,” he adds.
 
However, as the growth slowdown gets prolonged, it will become increasingly difficult for second-tier and third-tier companies to survive. Lower market share and lower profitability create a downward spiral, creating a financially unviable condition.
 

Labourer loading cement bags in a container | File photo

Downward spiral
 
In many industries, equity investors have already placed all their bets on top firms, making it tough for smaller companies to raise fresh equity to fund new projects. In cement, for example, the two most valuable companies — UltraTech Cement and Shree Cement — together account for nearly 60 per cent of the industry’s total market capitalisation, nearly double their revenue share.
 
In November 2019, Shree Cement raised around Rs 2,400 crore by selling new shares to institutional equity investors. This was one of the biggest-ever equity issues by any cement maker, and the company plans to use it for capital expenditure and debt reduction. 
 
Ditto in steel, where Tata Steel and JSW Steel together account for nearly 60 per cent of the industry’s combined market cap, making it easier for them to raise fresh equity to invest in new projects or acquire their smaller peers. Smaller companies, on the other hand, largely depend on borrowings, which make them financially vulnerable.
 
In aviation, Spicejet’s market cap is less than a tenth of IndiGo’s, while the third listed company, Jet Airways, has shut operations. Other airlines, such as Air India, Vistara and GoAir, are not listed.
 
In telecom, the skew is even larger, with Bharti Airtel’s market capitalisation nearly 27 times that of Vodafone Idea’s, though both companies have similar sized balance sheets and liabilities. Bharti leveraged its market cap to raise fresh equity worth nearly Rs 40,000 crore in the 2019 calendar year to fund capex and adjusted gross revenue dues. Vodafone Idea, which was trading below its face value after its rights issue, has not been able to raise funds after the Supreme Court AGR order.
 
A decline in competition would hurt everyone in the long term, as prices rise and quality and innovation take a backseat. “In the long term, competition is good for every stakeholder, including companies, not to mention consumers. That’s why it’s important for policymakers to encourage the entry of new entrants, including foreign firms,” says Kulkarni.