T N Ninan: Banyan or sequoia?

Conglomerates, cover wider area like the Banyan, but haven't done as well recently as stand-alone enterprises, the sequoias that are usually taller than the Qutb Minar

The managing agency system was peculiar to Britain’s colonies—principally India, but also places like Hong Kong. Investors in Britain wanted someone to run their businesses in India—mostly tea gardens, collieries and jute mills. Local managerial talent was considered scarce or non-existent, so the agents/agencies took on the managerial responsibility of running disparate companies—in return for a share of profits, a percentage of the sales turnover, or commissions on transactions. You could argue that this was an early case of ownership and management being separated, something that management pundits have advocated in recent times. Given the peculiar conditions of the time, it worked quite well in the nineteenth century too.

But not for long. The managing agencies, having signed long-term contracts with the companies that they managed, enjoyed untrammeled power with little at risk since they usually had little or no equity stake in the companies that they managed. The incentive structure was such that they could line their own pockets at the cost of shareholders in the managed companies; these became progressively Indian, and were powerless. Company law provided few protections. Calls for greater control and reform gave way eventually to abolition, which took effect in 1970.

In between, many Indian businessmen had started their own agencies. Tata Sons created Tata Industries as a managing agency; Birla Brothers was another agency. JRD Tata complained at the time of abolition that the government was not distinguishing between good and bad agencies, but of course it would be hard to find legal definitions for such distinctions. It didn’t matter, because the French have a saying for what happens so often in India: the more things change, the more they stay the same. Out went the managing agencies, in came the business houses and the concept of the “promoter”.

The House of Tata is now a promoter group—with a managing agency-style charge on group companies for using the Tata brand. It has minority stakes in most group companies, the notable exception being Tata Consultancy Services (TCS) where it owns about three-quarters of the stock. But it controls the operating companies and, as recent disclosures have shown, many key decisions are taken at group level. It is not enough that an operating company’s management should be of a certain view, Tata Sons has to agree.

There are advantages in belonging to a group—a small group company would be able to command better financial terms, and hire better talent, than if it were a stand-alone venture. Even a large company like Tata Motors would enjoy group advantages when it acquires something like Jaguar-Land Rover. But this can be a mixed blessing; Tata Steel would have been saved from buying the much bigger Corus if it did not have the financial backing of the group, since most of the acquisition price was debt-financed.

On balance, how has it worked? Not very well, as made clear by an excellent report in the Economist (“Mistry’s elephant”, September 24, 2016). This said that seven of the nine largest listed companies in the group earn a return on capital that is less than the cost of capital—in other words, they are destroying economic value. This spectacular under-performance has been masked by the stellar performance of one company, TCS, whose sales revenue, profits and market value account for the bulk of group numbers. Jaguar-Land Rover contributes most of the rest.

Would individual companies, freed from group control, have done better? They would certainly have faced greater pressure to perform. Some would have responded well to pressure, others would have gone under or been sold—the creative destruction that is at the heart of capitalism. If you look around it is evident that conglomerates have not done as well in recent times as stand-alone enterprises. It is the old comparison, between the banyan tree that has multiple roots and gives cover to a wide area, and the sequoia which stands alone—with some sub-species usually taller than the Qutb Minar.