The margin trap

Indian entrepreneurs must get on the innovation cycle and not fear a backlash over a short-term drop in profitability

- AKASH PRAKASH

One of the clear takeaways when speaking with senior people working with Apple is their disappointment at the lack of willingness among India Inc to step up and make the investments needed to bring the Apple ecosystem into India. While China is putting up obstacles, the profit focus of Indian entrepreneurs is also a stumbling block. Whether it is putting up the component supply chain or making large capital investments for display units, there is a lack of interest on the part of large Indian groups to commit capital.

They cite the low margins on offer and the intense scrutiny that Apple demands on quality and scale. In effect, it would take years of sustained effort to earn a reasonable return on capital—if at all. Is it worth it? Many believe they would be derated by their shareholders, who would not accept the initial losses and question the ultimate return on capital. With a drop in margins will come pressure on valuations and market capitalization—this is the common belief among Indian industrialists.

Indian markets are hyper-focused on profitability and return on capital, producing numerous multi-year compounders as a consequence. India has among the best long-term equity market return profiles in the world, and the focus on capital discipline has been a strength.

One reason India has delivered much stronger returns than China (over the past 25 years, China delivered 4 per cent real returns compared to India's 6.9 per cent) is this sharp focus on profitability and capital allocation. Global investors appreciate that Indian entrepreneurs understand the cost of capital.