Creating Reliable Manufacturing Ecosystem

1. Introduction: Market Realities and the Missing Ecosystem

The market share of Indian companies in this fast-paced growing multi-trillion-dollar Industry, is almost negligible. And why is that? Is it due to lack of accessible technologies? Surely, it can’t be due to a lack of skilled labour – given the number of professionals including technological experts our country churns out each year? Or is it because India is a cost-sensitive market and we simply prefer to import cheaper phones – perhaps.

I believe it is due to the lack of a reliable manufacturing ecosystem for Indian Manufacturers. In this article, I hypothesize and simulate a concept I’d like to call “Most Favoured Manufacturer (MFM)” and explore how a few key fiscal changes can create a thriving ecosystem for localized manufacturing which will eventually lead to a leveled playing field for Indian manufacturers, or perhaps even result in leading the market.

Government is already trying to facilitate manufacturing in a big way. As professionals, we Chartered Accountants can also encourage industry, wherever feasible, to adopt diversification and growth strategies in the area to save critical foreign currency, boost Indian business and generate employment.

Earlier this year, there have been many discussions lauding India for becoming the second largest mobile phone manufacturing hub in the world. While it certainly sounds positive, is there more to this than meets the eye?

2. The Manufacturing Evolution: From SKD to CKD to Real Value Addition

Let’s quickly take a few steps down history lane, right back to 2014, when India’s smartphone manufacturing sector was more or less limited to mobile phone devices in a Semi Knocked-Down (SKD) state, where almost all parts of a phone were assembled in countries such as China, Taiwan, South Korea or Vietnam and thereafter, imported to India. The “manufacturing” was limited to the insertion of battery and perhaps, adding locally sourced headphones along with a charger to the handset box.

Fast forward to 2017, India had advanced to Completely Knocked-Down (CKD) manufacturing, where parts such as screens, PCBs, semi-conductors, camera modules came in from different suppliers and were put together in assembly-oriented factories in India. They were then sold as “Made in India”, which begs the rhetoric: were they really “made in India” though?

Things have improved ever since and there are brands which claim that 99% of the phones sold in India are locally built, with as much as 65% parts sourced locally. India has also started exporting devices to Bangladesh and Nepal. However, that’s not the case for all manufacturers. Most manufacturers still rely on importing many parts (>50%), and why wouldn’t they?

The government, for one, has taken cognizance of this issue. Earlier this year Hon’ble Finance Minister Smt. Nirmala Sitharaman unveiled an INR 50,000 crore package targeting large smartphone makers operating in India, with Production-Linked Incentives (PLI) that involve cash benefits subject to meeting local sourcing, manufacturing and sales targets.

While the local manufacturing of parts would require huge upfront investments by smartphone manufacturers and component suppliers, the benefits would be enormous in terms of savings in import duty costs, which usually vary from 15% to 30% depending on the part imported, country of origin and a few other parameters.

3. The “Most Favoured Manufacturer (MFM)” Concept & Staggered GST Slabs

That being said, the fundamental policy question remains: “What more can we do to incentivize local sourcing of parts?”

I believe the usage of our current multi-level tax rate structure (GST), as a carrot-and-stick approach towards the manufacturer, would really help address this issue. Currently, 18% GST is levied on smartphones, but what if a manufacturer sourced 60% of its components locally?

On this premise, we progress with our vision which leads us to the question: could we perhaps grant them the status of “Most Favoured Manufacturer (MFM)” and levy only 12% GST on their phones – thereby making it a better value for money product compared to its counterparts, who continue to import more than 40% of the parts required?

While the staggered rate benefits would certainly allow competitive pricing, that alone wouldn’t necessarily be enough. The MFM program should also encompass:

• Vocational Training Centres: Specialized centres where technical training for manufacturing and assembly of parts and electronics can be imparted onto semi-skilled workers. The training would not only upskill the semi-skilled labour available in our country but also generate employment opportunities, possibly in millions. This can be funded partly by the manufacturer and subsidized by the government. Technical and management institutes can also be encouraged to launch focused courses to impart specialized skills.
• Special Economic Zones (SEZ-Like Infrastructure): Government could allocate dedicated zones specially for manufacturers enrolled under this program. Infrastructure in such SEZs should be built by the government and leased out to manufacturers for a pre-determined period upon promise of fulfilling mutually accepted production quantities.
• Decade-Long Direct Tax Holidays: Along with physical infrastructure, decade-long direct tax holidays could incentivize and attract more global and domestic manufacturers to join the program.

The idea is to have a multipronged approach which is required and now inevitable to make India Aatmanirbhar in manufacturing mobile phones.

4. Methodology: Calculating Local Sourcing Percentage (Value-Oriented Approach)

The ideal solution would be to have a value-oriented approach. That is to say, if the value of materials sourced locally is more than sixty per cent of total material cost, the manufacturer qualifies for MFM status. In other words, the total landed cost of materials imported should not exceed forty per cent of the total cost of materials.

This would not just allow Manufacturer X to sell his finished product by levying a lower GST rate of 12%, but would also motivate him to procure more locally – thereby moving up in the MFM level scale. He may request his South Korean supplier (SKS) to relocate production capacity to India. Also, it would be safe to assume that manufacturer X isn’t the only Indian customer of SKS, enabling them to tap a potentially huge domestic market while achieving continuous savings in international shipping and freight insurance.

In a realistic scenario where a manufacturer has a broad portfolio of smartphones, the percentage of locally sourced materials for his portfolio collectively will be considered for MFM status.

5. Governance Architecture: Online Single-Window Administration & Appeals

A seamless and efficient process, with minimal manual intervention, is what we should strive for. This would ensure that the dreadful era of the “License Raj” is left behind once and for all.

This would involve the formation of a dedicated committee spearheaded by a high-ranking official with several industry and legal experts. The macro-level administrative workflow is outlined below:

MFM Status once granted will be valid for the financial year. For subsequent years, the manufacturer will file an annual self-declaration to renew the status, subject to audit by the MFM committee within 30 days. If the manufacturer achieves a higher MFM level during the year, a fresh application can be submitted for the enhanced level, with the earlier level prevailing in the interim.

Statutory Integration with Existing GST Laws

This program can and should be consciously merged into existing GST laws with adequate caution, while leveraging the existing framework of the “Make in India” campaign. An inclusion into the existing HSN rate charts is probably one of the few statutory changes required to integrate it seamlessly with our indirect tax laws.

6. End-Consumer Impact & Market Price Simulation

For the sake of simplicity, let’s simulate the market impact, presuming the smartphones manufactured by all four companies are of comparable quality and features, and are currently priced at INR 11,800/-:

As evident from the above simulation, Company D’s phones will be flying off the shelves faster than they can be produced, while Company A would eventually have to change their modus operandi to level the playing field.

Companies that source most parts locally under the MFM program would also avoid import duties ranging from 15% to 30%, and pay GST at lower rates to their local governments instead, reducing their overall manufacturing costs further.

7. Endnote: 100% FDI Automatic Route & The Broader Electronics Frontier

Our existent Foreign Direct Investment (FDI) policy permits 100% FDI under the automatic route for electronics manufacturing. This, for the uninitiated, is the equivalent of a red-carpet invitation to global electronics manufacturing companies.

This also leads us to the question: “Why stop at smartphones – why not all electronic devices?”

In my opinion, manufacturing has already begun its transformation as a “robot-intensive automated process” and not a labour-intensive process of yesteryears. We need to catch the train before it leaves the station forever.

If we are able to carefully weave this program into the “Make in India” campaign, we could achieve several tangible and immediate national benefits:

• Multiple new MSMEs and countless employment opportunities;
• Real Manufacturing in India, transitioning definitively beyond mere assembly;
• Big boost to the “Make in India” campaign and transforming India into a premier global export hub;
• Reduced economic and strategic reliance on imports from other countries; and
• Reduced retail costs to millions of end consumers.