India’s electronics industry is booming, but it’s hard to reach for Sri Lankan manufacturers without deep domestic value chains

Tos Lanka, a $50 million export revenue circuit maker – Sri Lanka’s largest electronics company and one of the many ‘pockets of excellence’ in South Asia, according to the World Bank – is struggling both to fend off stiff global competition and to take its business to the next level of growth.

Merrick Gooneratne, Tos Lanka’s executive director, can’t hide his pessimism when he talks about the future of his company.

Gooneratne’s electronics assembly plant was the first such facility at the Biyagama Export Processing Zone in the late 1990s. Assembling circuits for electric guitar tuners gained traction after Japan’s Toslec invested Rs220 million incorporating its wholly owned subsidiary Tos Lanka in 1995. Gooneratne stuck around to manage the firm.

Toslec Japan is a manufacturer and supplier of electronic components for industries from consumer electronics to aerospace. Following its beginnings assembling circuits for its parent, Tos Lanka diversified its products and acquired new customers. Gooneratne is unsatisfied with Tos Lanka’s average annual seven percent topline growth because the firm hasn’t risen fast enough up the value chain, nor has the business scaled. The ubiquity of electronics, fragmented production and the ease with which global tech firms relocate production facilities to low-cost destinations enabled developing countries to benefit from the global electronics boom since the 1970s. The global electronics trade has been growing 5.9% annually since 2008, and reached $1.4 trillion in 2012. Electronics is a driver of innovation and productivity, linking countries to fast growing industries through their ability to join supply chains. In the 1990s, Sri Lanka enjoyed the same advantages that made East Asia a popular production destination for electronics: low labour costs, skilled workers and the availability of management talent. However, progress was limited.

The nature of the global electronics industry was an opportunity for Tos Lanka, despite there not being any other similar firms located here. However, Tos Lanka’s pioneering venture isolated the company in Sri Lanka, as electronics component makers and consumer electronics manufacturers didn’t set up facilities here, deterred by Sri Lanka’s small domestic market, limited access to global markets and the war. The industry thrived in South East Asia because global electronics manufacturers and their suppliers were able to set up production and assembling plants, forming clusters within easy access to ports and cities. Clustering brought down logistics costs, reduced imports and increased local value addition, and allowed for more seamless technology transfers. Tos Lanka did not have any of these advantages. Gooneratne sees new opportunities emerging across India and wants a small piece of the action.

“We’re aggressively pursuing opportunities in India, especially in the south where the electronics industry is estimated at $50 billion,” Gooneratne says. However, he faces a frustrating challenge. Tos Lanka is restricted from exporting to India as it fails to meet the minimum value addition requirement.

Electronics exports to India must have a 35% value addition to qualify for tariff concessions, he says, and Tos Lanka doesn’t make the cut. “A Japanese investor was once willing to partner us on a product for export to India. They pulled out at the last minute because the value addition was below 35%,” he says. Tos Lanka imports all its inputs: The circuit boards and components such as diodes, transistors and resistors are all shipped by its clients for assembling and testing. Tos Lanka’s value addition averages 20%, and Gooneratne is not satisfied with this. Had Tos Lanka been able to source its inputs locally, it could have achieved the 35% value addition in needs to export to India. It can make up for this by scaling the business or moving up the value chain for higher-margin products.

In many ways, Tos Lanka is still stuck in the 1990s: It still assembles tuners for guitars that have since gone out of production. “There are a few people who still hold on to these old instruments as collectibles or for sentimental value, so we still make the tuners for them,” he says. This line of business is small, but it encapsulates Tos Lanka’s struggle to scale and move up the value chain.

The company has lost a few opportunities as well. Japanese electronics giant Hitachi intended contracting Tos Lanka to assemble florescent lamps here, but shelved the deal after discovering that Sri Lanka’s retail market was too small. “This was back in the day when florescent lighting was a big deal. Hitachi’s representatives told us that just one of our production lines could meet the entire market’s demand in five days,” Gooneratne says.

He is excited about an ongoing government project to digitalise television broadcasting here with a $120 million loan from Japan. “It’s a big opportunity for electronics manufacturers, but we’re only looking for a small share because of our size,” he says. An aura of pessimism escapes Gooneratne when he talks about Tos Lanka’s future. “Electronics are everywhere, and the advent of the Internet of Things (IOT) will make it even more so. Tos Lanka can cater to the requirements of an IOT world. We can make products for smart companies, smart cities and smart health. But we’re cautious about the outlook for growth,” he says. Twenty years since Tos Lanka was incorporated, the World Bank held the company as a glowing example of how companies in South Asia excel under difficult conditions in a 2017 report on export industries: ‘The electronics export company was one of the many ‘pockets of excellence’ in the region, investing in people and R&D to create opportunities in a highly competitive global market,’ the report said, but Gooneratne knows it’s a slow process.

“Electronics are everywhere, and the advent of the Internet of Things (IOT) will make it even more so”

Tos Lanka has not been able to come close to the success achieved by the apparel sector, which has evolved from piecing fabric to make clothes into Sri Lanka’s most sophisticated and innovative industry holding its own in an intensely competitive global market and investing in production facilities in Asia and Africa. The clothing industry imports most of its inputs, but is making up for it with innovation, cost controls and process improvements so it can deliver speed and move up the value chain.

Neither is Tos Lanka any closer to achieving the successes of some of its peers. Lanka Harness, a $40 million export revenue company ($10 million less than Tos Lanka) making automobile safety devices, will double its size and acquire its Japanese parent company later in 2017. Like Tos Lanka, the company imports all its inputs for assembling, but its relentless drive to move up the value chain gives Lanka Harness an average value addition of 55%, more than twice that of Tos Lanka.

Tos Lanka has stumbled along since it began operations assembling circuits for its parent company Toslec Japan. It was a profitable business as long as labour costs were low. Eventually, freight costs began to overtake labour costs, and assembling for the parent became unfeasible because it could not offer competitive prices by sourcing inputs locally. Although the company cannot compete with manufacturers elsewhere who enjoy scale, its small size had its advantages. Tos Lanka found a ready market securing long-term contracts from buyers looking for small quantities. Chinese and Indian manufacturers don’t tolerate small orders, but there is still demand for small quantities, Gooneratne explains. “I can’t say if that was our strategy; it just happened,” he says.

Today, 50% of its export revenue comes from Germany, Norway and Canada. Its circuit boards go into a range of products like automobiles, aircraft, computers, televisions, clinical equipment, guitar tuners and wrist watches. Its reputation for quality garnered additional revenue streams like testing electronic circuits made elsewhere in the world.

However, the value addition remains low at 20%. Tos Lanka needs new clients with products that give higher value addition. Typically, these would be circuits requiring a high level of human skill to assemble, enabling Tos Lanka to factor rising wage costs into prices that customers are willing to absorb.

Tos Lanka is investing in R&D capabilities, and training is crucial to rising up the value chain and manufacturing higher value-added products. Toslec Japan does open a few doors for its Sri Lankan subsidiary in terms of acquiring new customers. It also invests in R&D. But for Gooneratne, this is not enough. “Sri Lanka lacks a robust R&D culture that we can draw from. Academics at universities are living in a world of their own, and their R&D outcomes are not relevant to the practical world of manufacturing,” he complains. “There is enough talent, but I cannot afford them.”

The electronic components manufacturer has managed a few R&D partnerships with global companies, Gooneratne says. Tos Lanka is developing clinical devices including fertility incubators in collaboration with a German company with significant value addition. The company is also looking at the possibility of assembling consumer electronics like television sets and refrigerators. “We have the capability here to do these,” he says.

However, without scale or access to cheaper inputs, gains from R&D will be limited. Tos Lanka’s R&D team once developed an energy-saving street lamp, which never went into production because the Chinese had cheaper product options. Gooneratne gives three reasons why Tos Lanka hasn’t grown as fast as he would have liked. First, is the 35% value addition hurdle to exporting electronics components to India. “We’re supportive of free trade with India, but the government needs to negotiate harder to ease restrictions on rules of origin,” Gooneratne says.

His second complaint is about the education system churning out youth averse to manufacturing jobs. Inadequate infrastructure, mainly around logistics and housing for workers, is the third. Youth in the Western Province tend to shun factory jobs, so Gooneratne recruited workers from rural areas. “We provided accommodation for as many as we could, but housing was a challenge, especially if they had families,” he says. He set up production facilities in Kegalle, in the central hills and in Mullaitivu in the North so workers didn’t have to leave their hometowns. But this created another problem for the company. “It was a nightmare. We had to transport inputs and the finished products by train, and these were handled with the same care given to sacks of vegetables and fruits—they were thrown about. We lost a lot of money.” He tried again in Jaffna, intending to train 100 youth. But no one was interested in a factory job; the youth there have higher expectations.

Tos Lanka’s challenges are not unique to the company, but common to South Asia’s electronics industry, as documented in a 2017 World Bank report titled ‘South Asia’s Turn: Policies to Boost Competitiveness and Create the Next Export Powerhouse’.

According to the World Bank, the rise of China, Malaysia, Singapore, Taiwan, Thailand and, more recently, Vietnam is closely linked to the global electronics boom. During 1970-90, electronics was the biggest industry in terms of output and exports in Singapore and Taiwan.

“The electronics industry has played an important role in the development trajectory of most East Asian economies. However, South Asia has not been able to achieve this, although the potential remains substantial,” the World Bank says. India’s per capita electronics exports to the world is just $0.30 and Sri Lanka is at $0.20, far behind Vietnam at $147 and China’s $253. The report identifies a few common problems preventing the development of supply chain clusters that would have made electronics exports more competitive. Policy inconsistency was one of them. Bangladesh dragged its feet for 15 years to finalise a land deal, which would have seen Samsung invest $1.25 billion in a factory employing 50,000 people; but Samsung invested in Vietnam instead, along with 76 suppliers who also invested in facilities there. In India, import duties were lower for finished electronics goods than inputs, discouraging local production. Domestic production meets only a third of Indian consumption and less than 50% for electronics components; the shares are likely to decline further, according to Indian manufacturers. The Indian electronics market is dominated by imports from China, the World Bank paper notes.

The World Bank estimates that India’s electronics industry will grow 24% annually to $400 billion by 2020 (nearly four times Sri Lanka’s total export earnings for 2015)

But India is also making gains by realigning policy, attracting the attention of many global tech firms. Foxconn is investing $5 billion to set up R&D and manufacturing facilities there. The Taiwan-based firm manufactures a host of devices for Apple, Amazon, Motorola and Sony. It also announced plans to invest $20 billion with Japanese SoftBank Group in India’s solar sector, and of a possible joint venture with India’s Adani Group to make iPhones and iPads. Foxconn is planning to establish around 12 plants across India, employing a million people. Samsung is investing nearly $2 billion to double production capacity in India, and several of its suppliers have located there. For Gooneratne, the success of Tos Lanka now depends on its ability to link with India’s electronics sector.

India used to be an important market for Sri Lankan electronics exports, followed by the EU, the US and Japan, and we benefitted from the free trade agreement that came into effect in 2000. But the honeymoon was short. India negotiated trade pacts with several other countries and Sri Lanka lost its tariff advantages, now enjoyed by everyone else.

Electronic component exports fell from a $120 million peak in 2000 to under $25 million in 2013, while final electronics products fell from a near $60 million peak in 2002 to less than $5 million in 2013, according to the World Bank. Sri Lanka failed to compete. Gooneratne knows his company is vulnerable to competition, especially against companies that enjoy advantages of scale, when he admits “What we do here is not rocket science.” Its strength is its adherence to global standards for quality. “We’re so good, we even conduct testing of electronic components made elsewhere.”

If Gooneratne succeeds in getting a foothold in India, Tos Lanka will be pitted against a growing list of Indian and global manufacturers. Competition will be intense and brutal. But that’s where Tos Lanka has to go.

The World Bank estimates that India’s electronics industry will grow 24% annually to $400 billion by 2020 (nearly four times Sri Lanka’s total export earnings for 2015). “Tos Lanka’s future is only in India,” Gooneratne says. He is desperate now, after trying unsuccessfully for years, to enter the Indian market. “The government must intervene, they must negotiate harder,” he says. “I can’t scale the business or retain talented staff with a value addition of 20%.”