4.7 The Role of Conglomerates and Business Groups in South Asia

FIGURE 4.7 The Role of Conglomerates and Business Groups in South Asia

Source of finance

Source of information

Supplier of goods and specialized services Source of technology and management capabilities Consumer of goods and services Identifies synergies with group firms Shepherd through early phase of new business Access to political connections to facilitate business 4 8

7 10 12 16 20 23

0 5 10 15 20 25

Percent

Source: South Asian Regional Engagement and Value Chains Survey. Note: Figure shows the percentage of respondents (N = 313) who chose each category in the question “How is your business group most important in facilitating trade and investment, and conducting business abroad?”

in capital markets, talent markets, and contracting. Although conglomerates tend to be regarded as less important in advanced economies, there is some evidence that they are equally or more profitable than firms unaffiliated with a business group. The results here suggest that business groups also act as a means of capturing the spillovers of knowledge generated outside the source firm by passing the knowledge to other firms in the group or even incubating new firms that could use the generated knowledge.11 Most of the pioneers in the case studies belonged to conglomerates. Only Timex Garments of Sri Lanka and Soorty Enterprises of Pakistan are not parts of conglomerates.

UNRELATED FOLLOWER FIRMS ARE LESS LIKELY TO SUCCEED BECAUSE OF “STICKY KNOWLEDGE”

The limited number of investors in the survey sample makes an econometric analysis with national follower firms in the same industry difficult. Although there certainly have been pioneering activities, the cascade effect or the herd effect has not been visible for investments. The closest evidence of an industrial cluster of national firms abroad in South Asia is the presence of some Indian, Pakistani, and Sri Lankan apparel manufacturers that have invested in Bangladesh. Both of Sri Lanka’s top apparel conglomerates have also invested in apparel manufacturing in India, albeit a decade apart. The success of CG Foods’ Wai Wai noodles has fostered a vibrant instant noodle industry in Nepal, with some firms exporting. Other than CG Foods’ investments in the NER, not many Nepali firms have invested outside the country. Similarly, although the growth of Bhutan Ferro Alloys Ltd. in Bhutan has led to the development of other ferrosilicon exporters, no exporters have engaged in trade-supporting investments. On the other hand, Bhutan Ferro Alloys’ growth has induced inward foreign investment from India.

Note, however, that the lack of an investment response from firms in Nepal and Bhutan reflects these countries’ restrictive OFDI policies, which restrain the private sector.

The missing herd effect may also point to information frictions in South Asia, that is, the transfer of knowledge gained from the experience of the pioneer firm to the cohort firms in the same industry at home is incomplete—“sticky knowledge.”12 This sticky knowledge is driven by motivational factors and information barriers. The South Asian Regional Engagement and Value Chains Survey data point to the fact that the incidence of national competitors abroad creates a sense of general awareness, but it seems that it does not provide sufficient information with which to make business decisions. In business, private information has significant value, and it may not be in the interests of the pioneer firm to share information (a motivational barrier) because the firm may be achieving high profits through a first-mover advantage. Further, some firms, such as family firms and unlisted firms that do not publicly release data, may be more cautious about sharing information. However, there may be benefits to having a national cluster abroad (for negotiation purposes, for example), which would suggest that such knowledge may eventually be diffused among nationally competing firms or at least among firms along a particular value chain.

LEARNING AND INFORMATION FRICTIONS

In the face of uncertainty and capital scarcity, firms may prefer not to be pioneers. Instead, they may prefer to learn from the experiences of pioneers and imitate them. Figure 4.8 captures the pioneer-follower diffusion effect in the framework of chapter 2. It presents a scenario in which, first, learning from the experience of pioneers reduces follower firms’ fixed entry costs of investing. The expected profit function shifts up and to the left, resulting in lower survival productivity cutoffs and expanding the range of potential investor firms. Follower firms related to the pioneer have lower fixed entry costs and higher expected profits compared with unrelated follower firms. Taking the specific case of a medium-productivity investor, figure 4.8 shows how learning from a competitor pioneer (gray to red profit line) may not lead to a change in participation mode, whereas learning from a related firm within a conglomerate does. This is explained by “sticky knowledge,” or greater information diffusion imperfections in learning from competing pioneers.

Figure 4.9 summarizes the connections between learning, information frictions, and the reduction of the sunk entry costs of investing through different types of learning. First, a potential investor firm could learn from its own experience through alternative engagements with lower fixed entry costs, such as exporting, management contracts (for example, by hotels), or franchising. Second, in addition to learning from their own experience, firms can learn from competitors’ experiences: the learning from unrelated pioneer firms reduces the entry costs of follower firms in the industry. Third, firms may learn from the experience of related firms within their conglomerate or business group