India’s Innovation Problem: Where We Fall Short

What ails innovation in India? It is nobody’s case that the nation excels in this department; the country, in fact, ranks poorly on global innovation indices. Also, even without going by indices, just look around and you will be hard-pressed to come up with notable instances of innovation at Indian companies. The hard truth is, we have few, and it is no use pretending that Indian labs of global multinationals such as GE or Google are building innovative products for the world. If that were more generally prevalent, our domestic companies would have more to show.

It is also misleading to point at “jugaad” as an example of native inspiration and innovation. Except for a few, most people would think of this concept as vestiges of a supply-constrained economy of the yesteryear, when workarounds had to be found to continue work, to produce, to make a living. Hence the stray case of re-designing a motorcycle engine to plow small farms or run a generator and produce electricity.

Innovation, in the modern sense, has three qualities, all of which are missing in such activity: it is institutionalised and built on repeatable processes, and invests in intellectual property. One could also add the element of global intent to pursue markets abroad.

As this writer looks at the innovation scene in India, or its lack thereof, it is clear we lack these essential ingredients – an industry structure that fosters a climate of innovation, organisational culture and nature of incentives to mould the psychology of behaviours.

Industry Structure

As with most things in contemporary India, our story commences with the overwhelming emphasis on, not to speak of a fascination with, state-led industrialisation. To this end, we erected islands of local monopolies in the form of public sector undertakings (PSUs), each of which was created with a specific intent. So, Hindustan Aeronautics Limited was to assemble aircraft in partnership with overseas companies, Bharat Electronics Limited to manufacture and supply critical electronics components to the defence sector, the Indian Telephone Industries to manufacture electro-mechanical telephone switching equipment and landline telephones on licence and Bharat Heavy Electricals Limited to undertake assembly and manufacture of heavy electrical equipment for power stations, to name only a few. When most of these PSUs were set up, the Indian private sector was mostly into trading and had little financial wherewithal or engineering expertise to contribute significantly.

Two aspects stand out from this planned industrialisation, which was being pursued in the 1950s through the 1980s: first, the powers that be had little appreciation of or faith in markets and competition, so each PSU stood mostly alone in its sphere of activity and sold all that it could produce to the government; second, there was equally little effort or encouragement of the private sector to pull up their collective socks and build expertise. The private sector, to put it mildly, was taxed heavily and left to its own devices.

Predictably, there were fall-outs from the creation of such an industry structure – an industrial state bureaucracy that saw no need to compete, chase markets or invest in research and development (R&D). The PSUs became increasingly ossified organisations that found themselves flat-footed when the economic reforms of the 1990s threw open the gates to all comers. A few have survived, barely, owing to preferential procurement by government or since they were exclusive vendors to the defence sector, but most have since largely either died or continue to exist in a comatose state.

Another fall-out was that the Indian private sector, led by erstwhile trading houses that began the journey towards eventually becoming conglomerates, when it saw opportunity in increasingly market-friendly environment was ill-equipped and bereft of hard-core research expertise. Licensing, therefore, became the means to secure a product portfolio, access markets and build brands.

In strategy theory, “Structure-Conduct-Performance” is an old saw that dates back to the work of Edward Mason in the 1930s and later in the 1950s and 1970s by Joseph Bain and Michael Porter, all at Harvard. The framework seeks to explain how the industry structure affects the conduct and performance of industry players. Originally used by the United States federal government in framing an antitrust policy, it was later embraced in the private sector by corporations, after it was popularised by Porter, in developing competitive strategy whereby extant industry structure could be used to model a competitive response such as output determination and in pricing of products in different market conditions.

A fundamental observation from the model is that when there are no barriers to entry in the market, competition will ensue and individual players will tend to be price takers. An individual company’s conduct is predicated on the number of players (buyers and sellers), barriers to entry, economies of scale and product differentiation. The market structure and its various components determine an individual company’s pricing and, therefore, profit maximisation. This framework, a “structuralist” approach, postulates that a company’s performance is based on conduct, which, in turn, depends on structural elements.

In India, we had a reverse (not to speak of perverse) condition: individual PSUs were essentially monopolies in their areas and there were severe barriers to entry (the infamous “license permit raj” that C Rajagopalachari contemptuously referred to). But PSUs were no price makers in this situation, where they could get away with whatever price they chose; they largely took the price offered by their single buyers – the government – such as defence or posts and telegraph. Comfortable order books and secure tenure to staff kept everyone happy. There was little by way of R&D. Clearly, in retrospect, the conduct of PSUs was one of complacency and politically appointed bosses satisfied with serving out their careers to retire without rocking the boat.

Ironically, the structure – in the public and private sectors – predicated similar conduct. Both PSUs and the new private sector conglomerates invested little in R&D and licensed technologies, where necessary.

Organisational Culture

The culture of an organisation may be seen in a continuum, in terms of “institutional rigidity” and ranging from the very rigid to the very flexible. Organisations have rules, processes, norms, checks, approvals and so on. In other words, a bureaucratic structure, the nature and extent of which describe what and how people in the organisation can expect to accomplish, both in their individual capacity and within groups.

This has exceptions, of course. Bell Labs is a famous one. It was a captive R&D organisation tied to a monopoly telecommunications provider in the US but with severe constraints of federal rules in how they engaged with the parent company. It was huge and had institutionalised processes and layers of approval. It was also different: Jon Gertner (The Idea Factory: Bell Labs and the Great Age of American Innovation) recounts how the scientific workforce encouraged eccentricity and made it possible to become, literally, the laboratory for new ideas in the world and the source for some of the most important inventions of the twentieth century. You could be big and still be outrageously creative in output.

A culture of innovation, therefore, is not one predicated on size or the simplistic conclusion that ‘large’ necessarily delivers bureaucracy and sloth. Rather, it lies in the practice of innovation, one of organisational culture that builds talent and expects innovation as a matter of routine. When such a culture does not inhabit a company, where either sales goals, financial metrics or guaranteed franchise to a limited resource (“licence”, as given by governments to exploit oil, coal, spectrum and so on) occupy the minds of management, little innovation takes place. Whether a company becomes innovative or not is something management sets out explicitly to undertake by building a culture that nurtures and builds expectations of its people. Not mere exhortations or vision statements, but by doing it every day, day after day.

This writer recalls when his brother, after graduating from the Indian Institute of Science, joined the earthmoving equipment division in the late 1970s in Bangalore at what was, and is, one of India’s largest engineering conglomerates. The division was then called L&T Poclain, a nod to the partnership between L&T and the French company Poclain. Today, that same division is called L&T Komatsu, a licensee-partnership between L&T and Komatsu of Japan. This begs the question: L&T is an engineering giant with ample financial resources; could it not itself build expertise in all these years to become a brand leader in earthmoving equipment? Could they not have built the product expertise – and innovated mightily – to join the ranks of Komatsu, Caterpillar and John Deere? Yet, licensing is the norm and that begets little R&D.

This example illustrates that it is not just the PSUs but other Indian companies in the private sector as well, whose large businesses and market capitalisation give them deep pockets, that have an “innovation problem”. The problem is rooted in organisational culture and the inability of the management to articulate, and practice, the essence of innovation as a daily business.

One of the finest descriptions of what innovation really is, was spelt out by the legendary founder and long-time chief executive of Raychem Corporation, Paul Cook. Raychem remained, until its acquisition by Tyco in 1999, a highly innovative Silicon Valley company that was founded as a spin-off of SRI International. At its peak, the company had over 50,000 products being sold in over 30 countries, gross margins of over 50 per cent, annual growth in excess of 25 per cent and over 15,000 patents filed around the world. In an interview with Harvard Business Review, asked about the secret to being an innovative company, Cook responded: “There is no secret. To be an innovative company, you have to ask for innovation… not just from engineers, but from sales, service, or information systems.”

When companies take the easy way out and depend on government contracts, or as oligopolistic players hitting pay dirt in a sector experiencing explosive growth, or other relatively easy forms of generating revenues, they are essentially building a culture that is not supportive of innovation. Government of India’s ritual chant of the “transfer of technology” mantra and the penchant of Indian private sector companies for technology licensing from overseas partners is to be seen in this context. We have become addicted to borrowing technology than to pushing ourselves to develop it.

This is not just in the case of technology – it would be fallacious to think innovation is just about technology – but in other spheres as well. So our cut-and-paste endeavours in e-commerce and other new areas that were successful in their home countries, which get the nod, and the money, from investors who have little risk appetite to encourage genuine innovation, which seeks to exploit specific domestic conditions, circumstances and constraints.

Behavioural Psychology and the Role of Incentives

If industry structure and organisational culture – as they exist – inhibit innovation in India, how do we go about changing the status quo? Herein comes a role for understanding behaviours – both individual and organisational – and to craft policy that aims at encouraging specific outcomes. Sadly, Indian policies are exercises in bureaucratic repetition that often get lost in mindless minutiae and legalese. The state is used to working by fiat, not as experimentation based on cutting-edge research.

Consider foreign direct investment (FDI). For decades now, Indian civil servants have been obsessed with control and the percentage of foreign ownership. Should it be 100 per cent? Maybe 79? 59? Or 49? Any businessperson would tell you that control is a matter of perception, and real control is one of power balance. Who holds the balance of power in a relationship? Google could partner with an Indian entity that is given 99% per cent ownership, but real control in terms of the brand, the technologies and the power to pull would clearly remain with Google.

A wealth of new research has been gathering in the past 15 years or so from the field of behavioural economics, borrowed from behavioural psychology, on what motivates human behaviour. The new field, predictably led from the front by behavioural psychologists, goes back to research, by Herbert Simon, on bounded rationality. But it really began to attract attention subsequent to the work by Daniel Kahneman and Amos Tversky in the late 1970s. Both Simon and Kahneman went on to win the Nobel prize for their work.

The basic idea revolves around how framing alternatives influences choice, preference for risk, and inter-temporal choice – i.e., our preference for immediate gain or pleasure rather than rewards in the future. Hence, individuals tuck in fast food while fully aware of the long-term consequences in the form of obesity or higher cholesterol. Behavioural economics has a rationale for this; it is called discounting the future. As individuals, we do this all the time. How many of us take diligently to daily exercise and choose our diet? We know it’s the right thing to do, that an hour of such prevention every day can save us from catastrophic illnesses in the later years. But that scenario is for tomorrow. We will worry about it… tomorrow.

The same behaviour can be seen in the collective: organisations (that represent collective thinking and decision-making) prefer short-term strategies to longer-term options that call for sacrifice today for huge wins tomorrow. When publicly listed companies chase quarterly numbers rather than focus on what’s good for the company in the long haul, they are behaving exactly like any of us.

The preference of Indian companies, public sector or private, for licensing brands, franchises, technologies and so on may be seen in this light. This is always the easy option, as shown by L&T’s disinclination to homegrown R&D in its earthmoving division. But it is only one example in a sea of similar behaviours.

Crafting Policies to Incent Organisational Behaviours

In this environment of temptation for instant gratification, how does a company innovate? In fact, how could the government induce behaviours in corporations or startup ventures that rewards genuine creativity and innovation and direct them away from easy options? Incentivisation that embeds core principles from behavioural psychology and economics is one way and one that needs conscious attention by policy makers.

A few countries, notably in Scandinavia, have figured out how to orient individual behaviour in specific ways. It is based on “choice architecture” that Richard Thaler of the University of Chicago describes in his book Nudge. Choice architecture essentially seeks to simplify decisions. Nordic countries implemented automatic tax returns – pre-filled tax returns for those having no incomes, no itemisations or deductions, and only a signature to file it in. Tax departments saw huge savings from automation while tax compliance went up.

Another version of choice architecture is opt-in versus opt-out. In Thaler’s example, organ donors on their drivers license usually have opt-in as the default method in most countries. Germany, for example, has opt-in while Austria has opt-out (i.e., everyone having a licence is a donor by default unless they opt out). The results are stunning – 99 per cent of Austrians remain donors (i.e., don’t opt out) while only 12 per cent opt in, in Germany.

In a similar vein, New Zealand introduced an automatic savings enrolment plan for those starting on a new job that came with financial subsidies and included an initial sum of $1,000 (NZD). The rest of the workforce had to opt in to participate in the same. Auto-save outstripped opt-ins and was soon copied by the United Kingdom. Defaults do matter.

Israel did something similar for organisations when it came up with the radical Yozma programme to give fillip to, and also mentor, domestic investors and ventures. The programme, described in Start-up Nation by Dan Senor and Saul Singer, was innovative in how it sought to align the behavioural instincts of several stakeholders at once: it set up a $100 million fund that it carved up into ten venture capital firms, each of which represented Israeli venture capitals-in-training, a foreign venture capital firm and an Israeli bank. The government contributed $8 million for a 40 per cent stake if the new venture capital firm managed to raise a minimum of $16 million – but with an interesting twist. We don’t know if they were influenced by behavioural psychology, considering that the leading light of the new discipline, Daniel Kahneman, is himself from the country. All the same, the incentive was the kicker: the partners could buy out the government’s stake for the original amount plus nominal interest after five years if the fund proved successful. How successful? Israel’s venture capital industry investment in 2015 was $4.5 billion, mergers and acquisitions exits were $9 billion and average exit of $87 million (43 per cent above the 10-year average). Israeli venture exits in 2016 topped $10 billion. That initial behavioural economic spur was largely responsible for a surge in innovation and Israeli technology, which became the new identity for the country.

Behavioural economics, though slow on the uptake, has begun to see the use of choice architecture, of defaults and incentives, relating to re-orienting individual behaviours. Unfortunately, the spread has been much slower when it comes to incentivising organisational behaviours. It may be that this is where economies could see the biggest bang for their buck: in incentivising organisational behaviours that reward problem-solving, risk-taking and finding new ways to do things.

While India’s state interventions in the early decades were possibly necessary and inevitable – owing to the immaturity of the private sector, one wishes the huge investments were more in basic infrastructure, like road, rail, power, education, health and irrigation than in the huge state industrial complex that had built in features for eventual failure.

Today, as we stand at the crossroads of technological change, demographic churn and societal flux, a different approach is called for – one that explicitly encourages the private sector to innovate in all dimensions. That requires innovation in policy-making and in rewriting laws to support the endeavour in ways to induce change towards expected outcomes.

“Make in India” is a new initiative that could be the basis for such transformational thinking. At the moment, it has all the hallmarks of a traditional policy at work: tax incentives, subsidy support and possibility for huge government procurement such as in defence. But these would predictably deliver corporate behaviour such as in years past. We see that already in the private sector now being invited to participate in defence contracts. Individual companies are partnering with well-known companies abroad to manufacture individual items on technology license under joint-ownership. This will likely see an explosion of technology licensing with limited employment at such hi-tech production centres. You could almost bet that there would be a few instances of domestic innovation in the years ahead.

What if domestic enterprise were incentivised through funding rounds that are themselves incentivised, in increasingly large amounts, to come up with indigenous technologies in specific areas and selected on competitive performance criteria? What about evidence-based lower tax slab rewards for innovative products or services created within the companies that demonstrated clear outcomes such as superior solutions, better delivery, novel forms of employment, higher market share domestically and exports without external technology licensing or outright purchases?

Culture may eat strategy for breakfast, but policies that direct expected outcomes could help build and shape that new culture.

Also Read:

What Israel Can Teach India About Developing An Innovation Culture

Innovation Nation: The Indian Right’s Real Idea Is Disruptive Innovation