India Calling

A growing domestic market has spurred smartphone manufacturing but the development of a component ecosystem is critical to take it to the next level

Mobile phones have been the biggest agents of revolutionary change in India. Still, with only 20% mobile users owning a smartphone, India remains one of the largest underpenetrated smartphone markets in the world. Contrastingly, it is also one of the fastest growing smartphone markets. According to Counterpoint Research, the smartphone market in India grew 23% year-on-year in the third quarter of 2016, compared to the global growth rate of 5%. This latent domestic demand is the foremost reason why smartphone makers — both international and local — have been setting up indigenous manufacturing facilities at a rapid pace. The research also suggests that the number of brands manufacturing smartphones locally have increased from 10 to 35 in the latest quarter, with 70% of smartphones shipped locally assembled.

Prime minister Narendra Modi’s long-term target is to ensure net zero balance between electronics imports and exports. According to Ravi Shankar Prasad, minister of Information Technology, mobile manufacturing firms have generating 40,000 direct and 125,000 indirect jobs in the last one year. India’s mobile production capacity has shot up from 68 million units in 2014 to around 200 million units in July this year. Foreign direct investment in electronics manufacturing has also increased from Rs.11,000 crore in 2014 to Rs.123,000 crore in 2016. What explains this boom? And what’s the road ahead?

Level playing ground
The government has played a major role in this boom, by proactively encouraging indigenous mobile manufacturing through policy intervention. In December 2014, the Department of Electronics and Information Technology set up a 14-member Special Task Force to lay a roadmap to increase mobile and electronics manufacturing in India and reduce dependency on imports. The task force has set a target of manufacturing 500 million mobile phones by 2019 and a turnover of Rs.150,000 crore to Rs.300,000 crore.

The first step to achieve this was to change the counterproductive duty structure. India has historically followed an inverted duty structure for consumer electronics, where finished goods attract lesser import duties than the components. The government has tinkered with this. The duty on finished mobiles was increased from 6% to 12.5% in 2015. This has encouraged contract manufacturers like Taiwan’s Foxconn to set up base in India.

Mobile makers and the government have been working in tandem to encourage local manufacturing. In the FY16 Budget, the government made changes to the duty structure so that locally manufactured mobiles could reap the 12.5% duty advantage. However, mobile makers had been gearing up for this change in duty structure since 2014. Sanjeev Agarwal, chief manufacturing officer, Lava International, says that they started working on their Noida manufacturing facility in 2014 itself, and began operations in April 2015, soon after the Budget announcement. While it is still unclear the kind of impact the implementation of GST would have on the industry, the industry is not losing any sleep over it. “In its conventional form, GST can hurt the industry, but I’m sure the government will maintain the duty differential to maintain the brisk momentum,” says Pankaj Mohindroo, national president, Indian Cellular Association.

Developing the ecosystem
Indeed, the government and the industry are also working together to ensure the phased development of a component ecosystem in India. This will mean that local players start adding value and move up from assembling to manufacturing. “The government should identify components which can be sourced domestically and increase duty differential so we can attract global manufacturers here,” says Tarun Pathak, senior analyst, Counterpoint Research. Duty differential is the difference between duties imposed on imported goods vis-à-vis domestically manufactured goods. It seems the government is heeding Pathak’s advice. According to industry sources, it is now planning to increase the duty differential on some components to encourage global manufacturers to set up base in India.

“In the month of March, duties on batteries, chargers, PCBs, were increased. The industry association went to them, and the government agreed to give them some time; but it is quite possible that from the next Budget, PCBs, batteries and chargers will attract higher duties,” says Amitabh Khurana, head-manufacturing, Intex. What happened was that the government imposed a 29% duty on components, which the industry found to be excessive. They went to the government and pleaded about the lack of domestic suppliers, in response to which the government rolled back the 10% basic customs duty and brought in 4% special additional duty to bring it back to 12.5%, in line with the duty on the finished product. In addition, a 2% import duty on PCBs was also rolled back. “Currently, phased components manufacturing program is in the works. The details have not yet been finalised,” says Mohindroo.

Micromax Informatics, India’s largest handset maker is already in talks with its vendors for producing display panels locally. “We are very serious about expanding our local manufacturing capabilities. We have finalised details on a joint venture with one of our vendors to manufacture panels locally. While it may take some time for the component ecosystem, having our own manufacturing capabilities would give us better control over quality and make us more efficient,” says Rajesh Agarwal, co-founder, Micromax Informatics. Besides having manufacturing facilities in Rudrapur and Telangana, the company is planning to set up plants in Rajasthan and Madhya Pradesh taking its overall capacity to 4 million phones a month.  

Its closest local competitor, Intex is not far behind in localisation of components. “Manufacturing locally helps us to maintain quality and reduce delivery times. Our strategy is now focused on vertical integration for mobile accessories like chargers, batteries, packaging, earphones and cables by starting our own manufacturing units. We will be doing the same for Printed Circuit Boards (PCBs), which constitute 30% of the mobile cost, in another 2-3 months,” adds Khurana. As of now, Intex employs 3,000 people at its Noida facility with a capacity of 20 million smartphones per annum. It has achieved 30% localisation of components with the rest being imported from China and Taiwan. Khurana claims the domestic value addition for Intex is 30%. He says it will increase to 55-60% in the next seven to eight months. According to Pathak, India can always count on its software expertise to add value. “If India can leverage its software expertise and build an ecosystem, there will be value addition there,” he says.

It is also expected that over the next two to three years, most handset manufacturers would be making phones on completely knocked down (CKD) basis with the import components reduced by nearly 30% from current levels. With no component manufacturer of scale, handset manufacturers import most of the components with local value addition making up for just about 5-6%. 

It’s not just Indian manufacturers who are lining up manufacturing facilities. Chinese manufacturers have now snapped up 40% of the Indian smartphone market, the world’s second largest after China. Leading brands such as Xiaomi, Gionee, LeEco, OPPO, ViVo and OnePlus, most of whom have a local presence through their contract manufacturers or their own facilities, are also looking to expand their presence in India. Chinese smartphone maker Gionee, which clocked revenue of $1.4 billion in 2016, has announced its plan to set up a manufacturing facility in Faridabad at a total investment of Rs.500 crore with a capacity to produce 30 million phones and provide employment to 28,000 people in the next three years. Similarly OPPO, which has a manufacturing facility in Noida and also has a partnership with Foxconn to assemble phones locally, is looking to invest Rs.1,000 crore in a manufacturing facility at Andhra Pradesh.

Another major government initiative has been the Modified Special Incentive Package Scheme (MSIPS) that grants manufacturers a 20-25% subsidy on capital expenditure. Around 80 projects have been cleared and 70 projects are still in the pipeline. So far, projects worth Rs.18,000 crore have been approved with Rs.4,000 crore worth of subsidy to be released in the next 10 years. “The typical cost incurred in setting up a plant is around Rs.50 crore; the amount can go higher depending on how many assembly lines are set up in the plant,” says Counterpoint’s Pathak.

State governments are also offering a clutch of incentives such as capital subsidy and VAT reimbursement, with Uttar Pradesh, Uttarakhand and Telangana leading the way, according to Lava’s Agarwal. As of now, with the duty differential and the fact that labour cost in India is one-third to half that of China, mobile manufacturers incur a cost benefit of 3-8% upon manufacturing locally, compared to importing finished products.

However, manufacturers face challenges in hiring trained technicians. It is estimated that the industry will face a shortfall of 150,000-200,000 technicians in the next three years. Presently, manufacturers have to start from scratch when it comes to training the labour force. They typically hire ITI graduates, and then train them. “We face challenges in training assembly line employees. Skill levels are very low. We actually call ourselves an institute; we train them first and then, someone else takes them,” jokes Khurana of Intex. The training programme lasts three months, with on-the-job training commencing in the second week.

Lava International has tied up with Tata Institute of Social Sciences (TISS) to launch a ‘learn-and-earn’ programme for students. 800 students have enrolled in the programme so far. In this programme, students will receive training at Lava’s shop floors while simultaneously studying for a three-year course. At the end of the programme, students will receive a degree in Bachelor of Vocational Education in Electronics Manufacturing Services and will be able to join a handset manufacturer of their choice.

Global ambition
Meanwhile, manufacturers are not just restricting themselves to the domestic market but are also keeping an eye on foreign markets. Intex currently exports 5-8% of the mobiles manufactured in India to countries like Vietnam, Sri Lanka, Nepal, Qatar and others. It aims to increase this number to 25%. Lava also plans to start exporting locally made smartphones. “With an appropriate duty differential, it will be exciting enough for component players to not only start investing but also export from India. In SAARC and African countries, smartphone penetration is quite low. India can become an export hub, like how Vietnam has done in recent years. But we have to formulate policies that will encourage that,” says Pathak.

Regarding Vietnam’s success with mobile manufacturing, Mohindroo had said in a presentation to finance minister Arun Jaitley, “Vietnam offers a 30-year tax holiday window at just 10% tax on mobile manufacturing which further goes down to 100% exemption in the first four years and reduction of 50% in the next nine years.” He recommended that India grant a 10-year tax holiday in a block of 15 years ‘on all profit and gain from manufacturing or rendering of services in or in relation to the mobile phone industry for all fresh investment made in plant and machinery and other equipment of a durable nature.’

According to NITI Aayog, a policy favouring exports over import substitution will be necessary to develop a robust manufacturing ecosystem. It points out that rapid growth in the electronic industry will not be achieved by focusing on the domestic market. “ Through import substitution, we may be able to raise the output to some degree and generate additional profits for the existing producers, but we won’t be able to turn the industry into the dynamo it must become. Big success requires operating in the large world market, which amounts to more than two trillion dollars compared with only $65 billion in the case of the domestic market. Therefore, we must reorient our policy to ensure that the industry becomes competitive in export markets. This feature implies that trade policy and trade infrastructure must not handicap firms from becoming exporters,” states the government’s think tank.

It looks at China’s example and notes that export orientation is necessary to develop a large-scale manufacturing base and reap benefits of economies of scale. It recommends the government to be welcoming towards multinationals. “Global giants in electronics industry as Foxconn of Taiwan, Sony, Fujitsu and Panasonic of Japan, Samsung and LG of South Korea and IBM, Hewlett Packard, Apple and Dell of the United States have driven the rapid growth of electronic industry in China. The implication is that the policy regime should be friendly to multinationals. This is a more rapid and perhaps the only avenue to bring large firms to India. Any attempts to grow the large firms at home would take a long time and even then success may be difficult to achieve,” it notes.

Achieving large-scale manufacturing is especially difficult for certain components in the mobile value-chain. The biggest hurdle towards end-to-end indigenisation, for instance, is silicon wafer fabrication, a significant portion of the cost of mobiles. Analysts and industry players are unanimous in saying that India has missed the bus as far as silicon wafer fabrication is concerned. “For wafer, there is no roadmap from the government or industry. The capital expenditure required is enormous and if the intent is to only cater to India, it will not be viable,” says Khurana of Intex.

Clearly, silicon wafer fabrication, which is dominated by Taiwan and China, requires a global export-oriented outlook. “Right now, it is important that mobile phones, tablets, PCs, computers, notebooks start getting manufactured in the country,” says Anwar Shirpurwala, executive director, Manufacturers Association for Information Technology (MAIT). As far as that is concerned, we are pretty much on track, moving up from assembling to manufacturing in a phased manner. For the rest of the component ecosystem to develop, it will take three to five years, but the important first steps have already been taken.