CIRCUIT BREAKER. Don’t cry foul at anti-profiteering measures

The Goods and Services Tax is finally here. One clause of the new tax law that is attracting more than its fair share of brickbats is the anti-profiteering clause.

To ensure that firms do not quietly pocket the tax or cost savings from GST on their products or services, the Government has proposed to set up a national-level anti-profiteering authority (APA) with State-level arms, to look into consumer complaints and industry data on selling prices.

Critics of the APA argue that this signals a return to the bad old days of ‘Inspector Raj’. They contend that the Government should leave it to market forces to decide selling prices, rather than bully firms and micro-manage their pricing decisions. But if the APA idea is draconian, expecting that market forces will make Indian firms willingly share their profits with consumers is utopian.

Empirical evidence from India Inc and the structure of domestic consumer markets, both suggest that the Centre’s fears about GST savings not reaching the consumer in full, are well-founded.

Analysts tracking the Indian corporate sector will tell you that listed companies in India’s consumer-facing sectors have always enjoyed high pricing power. When raw material prices or tax rates in the economy fall, listed firms are usually able to retain a good portion of this windfall to line their employees’ or shareholders’ pockets. When costs rise, they usually share the burden with consumers. Elevated inflation rates in India have also made consumers rather fatalistic about perpetually rising MRPs.

A study of the annual financial data for over 2,800 listed non-financial companies put out by RBI since 2014, provides evidence of India Inc’s pricing behaviour.

In the last four years, global commodity prices have gone from boom to bust, unleashing substantial raw material savings for listed firms. Thus, after consistent increase until FY13, between FY13 and FY14, listed firms saw their raw material costs to sales ratio fall sharply from 56.3 per cent to 53.9 per cent. Had they passed on the savings entirely to consumers, their operating profit margins would have remained flat. But in practice, they expanded from 12.8 to 13.6 per cent, an indication of pricing power.

As the commodity meltdown gathered steam in FY16, India Inc reaped even higher savings. The raw material to sales ratio fell from 53.9 per cent in FY15 to 49 per cent in FY16. But operating profit margins again expanded from 13.6 to 15.2 per cent. In both years, firms also saw a rise in staff costs and overheads, suggesting that the cost savings were either retained in profits or spent, with only residual amounts passed on to consumers. The curious thing is that the firms decided not to take steeper price cuts, despite a weak demand environment.

Yes, these aggregate numbers are bound to mask divergent trends at the firm level. Some sectors and firms, faced with the windfall, may have tightened their belts and taken price cuts. But the big picture clearly tells us that, left to its own devices, India Inc likes to choose higher profits over price sacrifices that can pep up volumes.

But given that India is a liberalised market economy, why doesn’t competition nudge some firms to rock the boat when costs fall, and start a price war? Well, the answer is that across most big consumer sectors in India, there is no perfect competition in the textbook sense. While there are a number of players in the fray, it is just two or three who hold dominant shares and call the shots on pricing.

Take the FMCG category, which is believed to be highly competitive. In detergents, the top three players (HUL, P&G, Nirma) command over 60 per cent share of the market. In soaps, the top player (HUL) commands nearly a 50 per cent share. In toothpastes, the top two players (Colgate and HUL) sit tight on 75 per cent. While challengers such as Patanjali do crop up from time to time, they usually find it hard to chip away at those market shares, given the high marketing spends and entrenched distribution of the leading players.

It’s a similar story with big-ticket consumer items such as cars and two-wheelers. In FY17, Maruti Suzuki accounted for 47 per cent of all passenger vehicles sold with Hyundai a distant second (16 per cent). Hero Motocorp (51 per cent share) and Bajaj Auto (18 per cent) have a stranglehold on the motorcycle market. In most big-ticket consumer appliances, the top two players straddle nearly half of the market.

Services, you would think, are more amenable to competitive forces. But consider telecom. Even with the advent of the aggressive Reliance Jio which has bagged a 6 per cent share, the market is divided up neatly between the top three players – Bharti Airtel (24 per cent), Vodafone (18 per cent) and Idea (17 per cent). In airlines, IndiGo commands now a 41 per cent share of all domestic traffic, followed by Jet Airways at 15 per cent. Consolidation is set to further cement these shares. While smaller rivals in these sectors do try to compete on prices, the survival rate of newbie entrants is not high, given the deep pockets required to scale up and sustain operations.

If sheer scale and distribution reach act as natural entry barriers in some consumer sectors, convoluted regulations keep new entrants at bay in others. The promising telecom sector has seen hardly any new entrants in recent years, save for the 800-pound gorilla Reliance Industries, because of the exceptionally high costs of acquiring pan-India spectrum and licences.

Or take banking, where despite fragmented market shares and dozens of private and public sector banks, price competition is absent. Deposit rates and lending rates across banks move in tandem, with the latter actually subject to a formula decided by RBI. RBI’s frugality with granting universal bank licences in recent years has strengthened the hands of older players.

In some sectors, the Government itself is the villain of the piece, with legacy benefits granted to public sector giants allowing them to keep private rivals at bay – LIC and the public sector general insurers are a case in point. In services, the high switching costs of migrating from one provider to another also ties consumers to older brands.

With so many entry barriers protecting older players, and the market muscle they continue to enjoy, it should come as no surprise that Indian consumers have little say in the prices they pay for most goods or services. The weak enforcement of consumer protection laws adds to their plight, as fighting unfair trade practices or usurious pricing can entail high outlays and long delays.

Given this backdrop, the anxiety that an anti-profiteering authority will bully big firms and put them out of business is somewhat overdone. In fact, the APA may have its task cut out in unearthing firm-level data to make out a tenable case against the entrenched players.

If the APA lets the big fish go scot-free and nets smaller firms alone (they are already feeling the squeeze from GST), that will lead to even less competition.

All this suggests that, rather than rely on a new regulator to force firms to toe the line on GST, the Centre would be better off embarking on a much bigger project. It should task the Competition Commission of India with conducting a detailed, time-bound study of the entry barriers impeding competition in India’s key sectors. It should then go about systematically dismantling them.

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