Sunday , September 20 2020

Why don't you look for investments? And, no, the saturation of demand is not the reason


By Abeek Barua

A comprehensive explanation of why a private investment pipeline continues to operate in the dry should look beyond the usual suspects, such as the use of low capacity and low demand. The fact that investors abstain because they have spare capacity is an empty tautology. What we need to know is why this capacity is spare.

It is best to extract a few things from this phase. The claim that demand is somehow "saturated" for many products is misleading. Take cars and trucks, the worst-hit segment of the current slowdown. Cross-country analysis of CDC car ownership shows that even at current levels of per capita income, car ownership in India falls under the curve.

So even if India's growth were to slow to zero, vehicle ownership should, at least in theory, increase. To put this in context, Brazil and China are overcrowded. For them, satiety is a problem.

The second interest is to identify cost and availability of funds as a constraint on investment. For one thing, study beams have shown that demand for investment in India is relatively insensitive to interest rates.

In addition, while average borrowing costs continue to be high – AAA bonds spread over 10-year government securities by one-third of a percentage point, while AAA bonds rose by a full percentage point from December 2018 – average loan flight security mask on the market.

In a liquidity-ridden financial system, both banks and bond investors have no choice but to chase "quality" producers and service companies and offer them low rates. For these companies, the decision to keep expanding capacity has nothing to do with the cost or offer of loans.

So why, then, this investment pessimism? First, consumer behavior and preferences show significant change. One of the key impacts of these changes on durable products, such as white goods or cars, is reducing the product cycle. In short, the shelf life of a new product has been significantly shortened.

The concern is sharing
This is fundamentally alternate to mathematical investment for companies. A few years ago, the carmaker could launch a new brand and give the investment a good six or seven years to pay for itself. Today, they have to return the investment in just three if they are lucky. The equipment in a very sensitive market like India is to think of ways to reduce the cost of increasing yields. This is easier said than done.

An interesting phenomenon in the car market are quasi-mergers and cost-sharing models. For example, Toyota and Suzuki have formed an alliance to share supply chain costs and together develop new vehicle technologies. Ford Motors is partnering with Mahindra & Mahindra, both of which will co-develop and strategically produce vehicles for each other.

Another significant change in behavior patterns concerns the Indian consumer demand for easy access to products. One of the factors driving this change may be the rapid penetration of e-commerce. If the news reports on Amazon delivering products on over 99% of the zip codes are accurate, then e-commerce is no longer just a major city phenomenon. So companies that were planning to rely on offline sales simply because their target markets were outside the big city plums need to revamp their plans.

In general, companies realize that Indian consumers even in deep rural markets now want easy access to goods and services. Thus, the "center" model – where customers from, as they say, neighboring villages, visited their district for their supplies – is falling apart. The ability to attract customers depends on getting as close to them as possible. So companies should consider alternative distribution models with small retail outlets instead of a large showroom in a central mall.

For service providers such as banks, an effective strategy may be to boost branch expansion and have smaller branches, but in as many locations as possible. Among FMCG companies, Patanjali and Darpamal Satyapal Group (DS Group) with Pulse sweets could be taken as successful examples of those who used this "small retailer" to rapidly increase sales.

Thus, the investment decision for companies is no longer a simple call based on capacity utilization and asset cost. For starters, they should look at their shoulders to see how technological change and automation impact their business.

Battery of options
The car manufacturer investing in electric car capacity needs to make sure that by the time its car hits the market, battery technology has not changed radically. A service company with significant back office operations will have to think about how much of the latter to automate, what technology to choose from, and ways to negotiate the risk of expiring.

Much has been written about the challenges of technological disruption.

Companies also face significant disruption to business models in key areas such as sales and distribution. This disorder is contained on the back of the new consumer profile, while the Indian consumer stereotype is "just that". So, it may be much harder to start the investment engine this time.

The writer is chief economist, CDC Bank. Views are personal

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