By Ranjit Pandit

To prosper in this millennium, India Inc. will need to redefine the basis on which it chooses to compete. Our recent research in corporate finance and strategy shows that, across industries, short-term (5-year) earnings account for only about 25 per cent of a company's total market value. The rest is based on expected earnings growth beyond the short term. In other words, to defend and increase their market value, companies must prove that they can grow profitably. This is not a new idea. But what is new is that companies have to compete and grow in a world so transformed that it is critical to comprehend the new basis for competition.

What has driven this transformation? Three global forces-the liberalisation of trade, the integration of capital markets, and the blinding pace of technological innovation-are revolutionising the way business is done. These have had 2 major consequences: they have opened up almost all of the world's economies to competition. And they have increased the importance of intangibles such as brands and intellectual property in determining the success of a business.

Economic liberalisation has gained momentum, and its impact at various levels is now being assimilated. What we need to comprehend is the significance for Indian companies of the other 2 forces: the integration of India's capital markets with the global capital markets, and the continual decline in interaction costs due to rapid advances in technology. India's integration with the global market has been driven primarily by significant foreign portfolio investment. This has forced Indian companies to contend with one fact: today, capital rushes across borders in search of the most promising business opportunities. Companies that fail to deliver returns will fail to attract capital, and will be starved of the resources for growth.

This is not all they have to contend with. Today, companies must also create growth in an environment in which technological innovation is continually overthrowing old business models. A key element in this change is the declining costs of interaction. Interactions occur within firms, between firms, and all the way through markets to the end-consumer. An analysis by McKinsey shows that nearly 36 per cent of Indian labour content is made up of economic interactions.

Historically, because interaction was expensive, companies chose to vertically integrate rather than outsource; to centralise rather than decentralise. Customers chose to limit their transactions in search of goods and services. Today, however, greater connectivity and cheaper modes of communication have made interaction costs negligible. Together with liberalisation and the integration of capital markets, this has redefined the formula for business success.

Today, businesses no longer need to be integrated, and companies are being forced to focus on those parts of the business system in which they have a distinctive advantage. Physical assets, a primary element in the old formula, are now a necessary-but no longer sufficient-ingredient of success. Intangible capital such as brands, relationships, and skills have become the pre-eminent drivers of value because they can be extensively leveraged in today's connected world.

If corporate India wants to compete-and win-in this scenario, it must promise nothing less than world-class value. Can it do so? At present, almost half of India's Top 100 companies are unable to earn their cost of capital. The challenge for Indian companies, thus, is to earn the right to grow by achieving superior performance, selling any unrelated and under-performing business, and building investor-confidence by earning healthy returns and demonstrating sound corporate governance.

Once this hurdle has been crossed, companies must concentrate on the larger imperative: discovering and developing capabilities that will ensure strong, long-term growth. Companies must develop a view of the likely end-games in their industry, and look to building new capabilities that can position them as winners. These are operational skills, growth-enabling skills, privileged assets, and special relationships.

Operational skills refer to a company's ability to outdo its competitors in activities critical to success in its industry. Examples are R&D, superior product-design, low-cost manufacturing, and distribution. Hindustan Lever, India's leading FMCG player, has built its position on the basis of excellent skills in brand-management, logistics and supply chain-management, and low-cost manufacturing of large-volume products. However, simply strengthening and refining operational skills will not ensure long-term growth.

Growth-enabling skills such as financing, acquisition and post-merger management, capital-management, and risk management provide immense capacity for growth. In contrast to operational skills, which tend to be specific to a company's business, these skills are transferable from one market to another. Enron is a prime example. It leveraged its superior skills in risk-management and deal-structuring to grow from a gas and pipeline company into a gas- and derivatives products-trading company. Recently, it entered waste-water management, an industry in which it can further leverage its growth-enabling skills.

Privileged assets are physical or intangible assets that confer competitive advantage while simultaneously being hard to replicate. Examples are infrastructure, distribution networks, intellectual property, brands and reputation, and customer information. Ranbaxy is building the intellectual property to develop new molecules and delivery-systems to build a sustainable position once India recognises product patents.

Special relationships can provide access to new markets and supplement an organisation's capabilities. Alliances with service-providers, like car-rental firms, travel agents, and tour operators, allow airlines to provide hassle-free travel to both business and leisure travellers. Relationships with other firms such as consumer product companies or restaurants allow them to offer customers access to products they prize.

Do companies have to build all 4 capabilities? Not necessarily. Instead, they must identify and build capabilities in which they can be distinctive. Other capabilities can be outsourced. We will see a world no longer constrained or protected by geographic or other barriers. Companies, like individuals, must make the most of this opportunity, remembering that, more than ever before, the future will belong to the capable and the strong.

Ranjit Pandit is the Managing Director (India) of McKinsey & Co.

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