Manufacturing takes off in India

India is overcoming its reputation as an inefficient, low-quality producer and learning how to compete globally. Can it give China a run for the money?

By John Elliott, Fortune

October 19 2007: 5:19 PM EDT

(Fortune Magazine) -- The sleek, clean factory in the Delhi suburb of Noida seems more Taiwan than India. Engineers in white overalls and goggles watch over an automated production line that spits out four billion state-of-the-art DVDs and CDs a year. To get to the factory floor, you have to pass through three air-cleaning passages - a process that makes it clear you're no longer in crowded, dirty Delhi.

This is not some futuristic vision of India. It's the main factory of Moser Baer, a 24-year-old Indian company that was one of the first in the world to make high-definition DVDs and is now starting on flash memories and solar panels. And while not typical of most Indian factories, Moser Baer is one of a number of companies utilizing the same brainy ability that fueled the country's IT boom to remake its manufacturing landscape.

Godrej & Boyce: Making industrial high-pressure vessels

Maruti Suzuki: A worker on the assembly line carries a car door.

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The companies range from Bharat Forge, Bajaj, and Tata in the auto sector to Larsen & Toubro and Godrej & Boyce in specialist engineering, Ballapur Industries in paper, and others in pharmaceuticals and textiles, as well as Moser Baer. And they are showing that India is beginning to shrug off its reputation for appalling quality and reliability, and that it can compete internationally.

India is also emerging as an outsourcing design and production base for manufacturing, as it has been for software, with most of the world's autos companies - and many others such as Finland's Nokia (Charts) and Taiwan's Foxconn in mobile phones - sourcing components and assembling products.

Another example of the future is Tata Technologies, a Tata group design house based in Pune that operates in 12 countries. It has been involved in the design of Tata Motors cars and vans but does 74% of its work for foreign clients, including Chrysler, General Motors (Charts, Fortune 500), Boeing (Charts, Fortune 500), and Airbus.

An inside look at manufacturing in India

These successes show how wrong pundits were when they said five years ago that India had missed out on manufacturing because it could not sustain on-time deliveries and high levels of quality, and that the country's future therefore lay in software-led services. Manufacturing was then in the doldrums, at the end of a recession that started in the late 1990s before the economic reforms that began in 1991 had time to generate much change. There was a lack of both entrepreneurial self-confidence and industrial investment.

"People were disheartened and used software as a way of talking up India, saying - wrongly - that manufacturing was not material to the future," says Saumitra Chaudhuri, economic advisor to ICRA, a ratings agency part-owned by Moody's.

That belief was off target, though it reflects manufacturing's relatively small contribution even now of only 16% to India's GDP - less than half of what manufacturing contributes to the Chinese economy - and the fact that it only employs about 11% of the country's workforce. Government ministers have talked about increasing manufacturing's GDP share to 30%, which will gradually be achieved if the sector continues to grow at its 12% average of the past year (though it has slipped in recent months). That in turn would enable India to expand its exports and feed a growing home market.

The turnaround in Indian manufacturing began in the early 1980s when then-Prime Minister Indira Gandhi told government-owned Maruti to make a "people's car." She didn't get what she wanted because Maruti ended up producing a small car for the middle class, followed by larger models. But she did get a successful 50-50 joint venture with Japan's Suzuki that sparked the foundation of today's automotive industry, which has annual sales of $34 billion and $5 billion in exports.

The Maruti Suzuki joint venture began to unlock manufacturing strengths that had been suppressed after independence, when bureaucratic restrictions were imposed by Jawaharlal Nehru, the first Prime Minister, and then increased by Gandhi, his daughter. Nehru's aim was to develop a self-sufficient, socialist, and centrally controlled economy that benefited the poor, with a dominant public sector. Gandhi, who wanted to increase state control and curb the clout of powerful business families, extended public ownership. What they unwittingly created was an inward-looking, highly protected, and inefficient economy that did little for the poor, negated private-sector entrepreneurship, allowed public-sector inefficiency, and guaranteed infrastructure decay.

Generations of employees from the 1950s onward had little pride in their work nor any awareness of the need to satisfy or care for customers. "The concept of quality used to be that if it works somehow, it's okay, but it doesn't need to work all the time," says Baba Kalyani, chairman of Bharat Forge, which has grown in the past few years into the world's second-largest forging company. "No one could create a high-technology, high-capital-cost business. You waited a year for an equipment-import license, got less than you wanted, then paid an 80% import duty."

It has taken the 25 years since Maruti Suzuki started for manufacturing to emerge from the legacy of those dark years. Only now, as India celebrates the 60th anniversary of its independence, are some manufacturing operations emulating the country's successful software industry.

"It has taken all this time for us to become confident in ourselves," says Surinder Kapur, founder and chairman of the Sona group, which makes steering systems for Maruti and other companies, including Toyota Motor (Charts).

Pride is growing in meeting customers' needs and doing even better than necessary - especially if it means beating China. Bajaj Auto, India's second-largest motorcycle manufacturer, used to be famous for its exhaust fumes and for persuading the government to delay strict emissions regulations.

"Now we are proud that our vehicles beat the norms by 50%," says managing director Rajiv Bajaj, who has turned the family-controlled company around since taking over the top job from his father a few years ago and streamlining operations with robotic machines. "China can't challenge us on three-wheelers because they can't meet the norms."

India's retail revolution

Before Maruti Suzuki's cars appeared, the streets of India's cities were dominated by British Morris Oxfords and Italian Fiats based on 1950s designs - along with bullock carts and scooters. Only 46,000 cars were made annually, and there was no incentive to upgrade them because of small production runs and scant competition.

"Maruti brought to India the concepts of tight cost control and process engineering," says Gautam Thapar, chairman of Ballapur Industries, which he has built into India's largest producer and exporter of paper. "It brought the first wave of modern component technology with the concept of Indian entrepreneurs and Japanese companies together supplying Maruti as an anchor client."

There were no adequate component suppliers in India when Maruti started, and there was no concept of partnership. Maruti changed that with a Japan-backed supplier-development program, taking 25% equity stakes in some companies it helped to start and encouraging Japanese component manufacturers to do the same.

Clusters developed in three locations, one of them around Maruti's factory in Gurgaon on the outskirts of Delhi. Workers and suppliers were sent to Japan to learn lean manufacturing and quality-management techniques. The links continue today: Maruti design engineers worked in Japan on the Swift car that Suzuki launched in 2005.

Many tasks that would be automated elsewhere are done manually in Maruti's and its suppliers' factories by less-skilled labor. "Our body-assembly shop is 60% to 70% automated - in Japan it would be 90%," says Rajiv Gandhi, a Maruti general manager. "We could put in lots of robots, but we would have to justify it in terms of investment."

Maruti Suzuki, now majority-owned by Suzuki, expects to produce 770,000 vehicles this year for a market share of more than 50%, even though foreign and domestic competitors that have emerged since the early 1980s include names like Honda, Hyundai, Toyota, Ford, and Tata.

But there is still room for improvement. One supplier was seen delivering car seats to a Maruti factory last month in rusting trolleys, underlining the lack of pride in quality traditionally associated with Indian manufacturing. Maruti's priority now is to persuade its suppliers to put pressure on their second and third levels of vendors, where there has not yet been much change.

Moser Baer began making eight-inch recording discs around the time that Maruti was set up. "We stumbled on quality and deliveries, but we learned to be honest with customers and not to overpromise," says Deepak Puri, founder and managing director. "Since then we haven't looked back." It is still a small business - sales totaled $500 million in the year ended March 31 - but it is growing by 25% to 30% annually.

The company is now the world's second-largest producer of DVDs after CMC of Taiwan. It exports 85% of its output and supplies 60% of the Indian market. It is also one of three primary suppliers of optical discs to Imation, a U.S. data-storage company. Imation says it chose Moser Baer because its costs, quality, and ability to produce in quantity are similar to those of Taiwanese companies.

Products have been developed by mixing in-house expertise - including that of Indians enticed back home from jobs overseas - with inputs from international technical and financial partners. One of those partners is SolFocus, a photovoltaic company in California that had planned last year to produce solar cells and panels in China. It chose India instead because it has much better intellectual-property protection, says SolFocus CEO Gary Conley.

He was also impressed with the focus on cost and reliability. "Moser Baer controls the thickness of the silver applied to their DVDs and CDs to within one micron," Conley says. "They have spent years shaving microcents off the cost of manufacturing."

There was another center of excellence in the 1980s - Larsen & Toubro, founded as an import company 100 years ago by two Danish engineers. It has grown into a highly regarded heavy-engineering firm, with sales last year of $4.1 billion and an order inflow of $7.9 billion. One of the company's strengths is that, unlike other Indian manufacturers, it has always been run by professionals. M.V. Kotwal, a board director in charge of heavy engineering, calls it "an Indian company with European foundations," adding that in contrast to many family-controlled companies, management "does not have to look at what serves family interests."

Larsen & Toubro started manufacturing when imports were restricted under Nehru. It made dairy equipment, then fertilizer-plant heat exchangers, then cement plants. "When we see a competitor come in and we don't have an edge, we upgrade ourselves to higher-technology products," says Kotwal.

In the 1960s the company moved into nuclear technology and rocket casings. Its current work includes building reactors for the nuclear industry in India and abroad, ten coal-gasification plants for China, and a nuclear submarine hull for India's navy. Along with a few other companies, it is also starting to build ships - India accounts for only about 1% of world shipbuilding - in the belief that demand will outstrip the capacity of Japanese, Korean, and Chinese shipyards.

The company sees defense as a major growth area and hopes to build complete ships for the Indian navy. Only a few private firms, including Larsen & Toubro, Godrej & Boyce, Tata, and Mahindra & Mahindra, have dabbled in defense, mainly because it is dominated by the public sector.

But it has also been difficult to get orders abroad. "Indian companies have not been welcome in the West to participate in strategic programs because of the international worries over leakage of dual-use technologies," says Jamshyd Godrej, chairman of Godrej & Boyce Manufacturing, which makes rocket parts. "Ever since India's two nuclear tests, we have been isolated." India's proposed nuclear deal with the U.S. could open up new areas, he says, because "NASA might then consider an Indian company, which today it will not."

India's global reach

The nuclear deal could also provide more sophisticated work for joint ventures with foreign suppliers such as Boeing, Lockheed Martin, Honeywell, General Electric, and Raytheon. Orders are expected from a new government program, under which foreign equipment suppliers will have to spend 30% to 50% of defense contracts in India. Such offsets could generate as much as $10 billion in orders over five years.

For all of India's gains in recent years, two problems threaten to slow manufacturing growth. One is a serious labor and skills shortage. Pune, an old industrial city about three hours' drive from Mumbai, where Bharat Forge is based, illustrates both the problem and some of the solutions. Kalyani says Pune's 30 engineering colleges turn out 6,000 engineers a year, but demand, boosted by software companies and call centers expanding from Bangalore, is for 15,000, and will rise to 20,000 next year. "The best ones go abroad," Kalyani says, "the next go to IT, the next do an MBA, and manufacturing is at the bottom of the heap."

Bharat Forge's workforce of 4,000 is 85% white collar, compared with 85% blue collar 15 years ago. "We took farmhands and made them into factory workers," Kalyani says, "and now we take engineers out of university to run the shop floor." He has an engineering college on Bharat Forge's Pune campus running a 30-month master's program with Britain's Warwick University.

It "creates my future managers," says Kalyani, adding, "Sending them away is okay, but then you lose half of them, and the colleges don't teach what we need." He also has a bachelor's program run with an Indian institute "enabling workers to become engineers." Below that, there's a "talent pipeline project" with technical colleges in rural towns, developing courses and identifying bright students who work at Bharat Forge during vacations.

The second problem is India's infrastructure, especially power shortages and the grossly inadequate highways and ports that make it difficult to transport goods. New highways are helping, but growing urban congestion is making the problem worse, and there are seemingly endless bureaucratic and physical delays at ports.

"Moser Baer avoids power shortages by having its own power plant, but it cannot construct the roads and ports which its products must traverse to enter the stream of international commerce," says Joe Gote, Imation's European director of legal affairs and corporate strategy.

The government is trying to help industry in others ways, with reduced duties, simplified tax structures, fewer restrictions on small-business activities, relaxed foreign-investment rules, and encouragement for industrial clusters that share infrastructure facilities.

Special economic zones, or SEZs, can also help - Moser Baer has one on part of its Noida site for its solar-panel production. Nokia and Foxconn both have factories in southern India on small SEZs, where they are showing that Indian farm workers can be trained to do low-technology production making mobile-phone cases and assembling finished products.

As India begins to shed its image of inefficiency and poor workmanship, it is proving that it can produce internationally competitive products. Carlos Ghosn, CEO of Renault, which is manufacturing its Logan car in India with Mahindra, has talked admiringly about India's "frugal engineering," where costs are controlled more instinctively than in Europe.

But perhaps only a third of Indian manufacturing deserves these plaudits. The rest is stuck in its old ways, with little care for, or pride in, quality. And until its infrastructure is improved, India's full manufacturing potential won't be realized.