At a time when the global manufacturing sector is undergoing a structural transformation, India must retool its factories for a digitally-driven future if it wants to fulfil its ambition of becoming a manufacturing powerhouse.

India lost out during the manufacturing revolution of the late 20th century. This period saw the emergence of global supply chains and witnessed the rise of China as the ‘factory to the world’, generating jobs for hundreds of millions of its people. The transformation of global supply chains was driven by better information flows and greater visibility enabled by the growth of the Internet. Consequently, large pools of low-cost labour in developing countries became productively deployed on factory floors, making products for the world. In September 2014, the National Democratic Alliance government launched Make in India as a landmark policy to turbocharge the manufacturing sector and seize back the lost opportunity.

Make in India is underpinned by three key thrust areas: (1) procedural simplification to ensure ease of doing business; (2) infrastructure development including fast forwarding the delivery of industrial corridors; and (3) opening up new sectors for growth, for instance, allowing foreign direct investment (FDI) in defence and railways. The project also focuses on growth in labour-intensive sectors such as textiles with a competent incentive package to attract production capacity moving from China. Since Make in India was launched, a lot of progress has been made. India has moved up on the ease of doing business rankings, with individual states becoming more aware and competitive in the wake of rankings being made transparent. Infrastructure build-out has gathered momentum, the productivity of clogged, government-owned ports has improved impressively, and FDI in manufacturing has increased considerably.

These ‘foundational elements’ are critical to the growth of the sector. Without them, India is not even in the game, and faces ‘missing the manufacturing and job creation bus’ once again. However, these thrust areas represent the late 20th century manufacturing paradigm. A new paradigm that is in tune with the digital 21st century is fast emerging, driven by Industry 4.0 (I 4.0), which is a collection of nine cyber-physical and data technologies.

I 4.0 is the fourth manufacturing revolution since the maiden one triggered by the development of the steam engine. The second revolution, driven by electricity, led to rapid mass production in the second half of the 19th century, once again transforming the industry. Subsequently, the third revolution began in the 1970s and 1980s with the growth of the Internet. This phase saw the deconstruction of value chains and outsourcing of production, with low labour cost destinations like China and Thailand emerging as manufacturing powerhouses.

What does I 4.0 stand for? Simply put, it is a set of key digital and technological mega-trends transforming the manufacturing workplace the world over. There are nine sub-parts to I 4.0.

The fourth manufacturing revolution will redefine production in the digital 21st century. To be a part of the new revolution, manufacturing growth and creation of new jobs in India have to go beyond the industrial parks housing large-scale, labour-intensive plants from the 20th century. The challenge for India is daunting, as this new wave of the digitization of manufacturing is coinciding with a period of sluggish global economic growth, with little sign of revival in the near future. In fact, the global merchandise trade as a percentage of global GDP has been stagnant at 24% since 2010.

The new paradigm will be characterized by three key structural shifts in manufacturing.

First, I 4.0 is fundamentally altering the cost economics of manufacturing and competitiveness of countries. This shift erodes India’s big advantage of a large pool of low-cost labour, as the trade-off between labour and automation swings in the favour of the latter. BCG research indicates that the price of industrial robots is expected to come down by 25% over the next decade, with a 5% performance improvement year on year, accelerating the pace of adoption of robotic automation.

The changed economics of manufacturing also erodes the advantage of large-scale plants in low labour cost countries and makes low-scale plants that are closer to the market more competitive. For example, Adidas recently announced that it was bringing back some of its production from China to Germany as advances in robotics made it cost effective to do so. The company is also planning to build smaller plants in its major markets over the medium term, thereby cutting lengthy shipping times and enabling faster delivery to customers.

Robots in this new paradigm are not just the automatic welding bots that have been used for decades in the automobile assembly line. They are more trainable and have a very high artificial intelligence (AI) coefficient. Baxter is a cost-effective robot – available for $25,000 – that can be trained in no time by simply moving its arm through a work-cycle. And within a minute, the robot can be transformed to perform any desired activity.

The second structural shift is the growth of global digital services driven by I 4.0 technologies. These services are becoming growth and profit drivers for manufacturing companies. For example, the aeronautical industry detects and solves problems in aircraft engines flying all over the world through digital remote sensing technology. The technology enables them to harness massive amounts of real-time data collected from the millions of embedded sensors in the engines. In 2013, services constituted 23% of the total exports from the Organization for Economic Co-operation and Development (OECD) countries, up from just 17% in 1980, reflecting the growth of these revenue streams for global companies. GE is building a completely new business of digital services with the launch of Predix, the world’s first industrial operations system and platform. Predix connects industrial assets, and collects and analyses data to deliver real-time insights for optimizing industrial infrastructure and operations.

The major implication for India is that digital services render boundaries between countries and labour cost advantage irrelevant. The availability of skills and capabilities will be the key factors driving manufacturing location decisions going forward.

The third structural shift driving the new manufacturing paradigm is the growth of digital trading platforms. These platforms are transforming global supply chains, further blurring boundaries between countries and making traditional country-based business models redundant. Today, goods worth $700 billion are traded through Alibaba and Amazon. In effect, these global market platforms and their associated supply and delivery systems are replacing the complex supply chains that were a common feature of the first three phases of globalization. Even small companies, therefore, find it much easier to compete in a global market today. For example, a few years ago, a Chinese mobile phone company entered India by leveraging one such platform, and did so more quickly and with much less investment than one of its competitors. It is quite possible that Alibaba founder Jack Ma may in the future propose building a global e-commerce platform that enables small and medium enterprises (SMEs) to directly market to customers and source from suppliers all over the world. This would eliminate the need for businesses to set up independent supply chains.

These structural shifts will not just transform competitive rules and supply chain operations. They will impact entire industries such as logistics and even international banks that have built significant businesses funding global trade.

To be a part of the new paradigm, India needs a Make in India 2.0 policy framework that will allow it to build relevant capabilities and competitiveness, creating jobs for the 12 million young people that enter the job market every year. To deliver effective results, the policy framework must be based on a four-pronged strategy.

First, we must continue our increased focus on labour-intensive sectors to successfully create jobs. Between 2008 and 2013, 80% of production growth and 40% of export growth have been in non-labour intensive sectors such as metals, chemicals and plastics. We have a big window of opportunity in textiles as production capacity moves from manufacturing behemoth China as the wages there increase. The Indian government has already responded to this opportunity by introducing an innovative policy with many firsts, including allowing fixed-term employment. However, we can do more, including tying up market access with a free-trade agreement (FTA) with the European Union (EU).

In the textile industry, we could encourage manufacturers to build ‘future-ready’ facilities that combine the labour cost advantage with new-age digital technologies like robotics. To make this happen, the Technology Upgradation Fund, a policy for the textile industry aimed at incentivizing capital formation with a technology bias, could be revised with specific focus on I 4.0 investments.

Second, we need a renewed policy focus on the SME sector to be prepared for the growth of smaller plants in the new paradigm. India has had an SME policy for a long time and is perhaps one of the few countries with a specific ministry for the segment. Despite this, the fact remains that companies with annualized sales of over Rs1,000 crore are growing, while SMEs are not. Credit extended to SMEs as a proportion of total corporate lending is also shrinking. To drive positive change, we need to rethink our SME strategy for the new manufacturing paradigm, with a 21st century mindset. We can take inspiration from many countries that are doing so. For example, Singapore announced an industry transformation package of S$4.5 billion to help companies, especially SMEs, become ‘future-ready’ by building their I 4.0 technology capabilities.

The third effective Make in India 2.0 strategy should be to grow digital services. Globally, trade in digital-enabled services is growing faster than trade in goods and traditional services. Cheaper and smarter sensors are enabling the Internet of Things (IoT), while 3D printing is allowing remote production of spare parts. These advances are shifting the potential life cycle value from equipment manufacturers to service providers. Large software companies are well placed to provide these services across a range of industries. However, we need to build the requisite digital ecosystem and invest in newer technologies such as sensors, 3D printing and cloud networks.

Nasscom recently said that India is looking to capture 20% of the IoT market, which is projected to be $300 billion by 2020.This is just the starting point. As the value and ambit of digital services grows, we need to leverage the advantage we have built in IT eS globally. However, estimates suggest India is facing a critical talent shortfall in areas such as cybersecurity and Big Data analytics. Reorienting our skilling initiatives towards building the requisite skill sets to win a share of the global digital services pie will be critical.

Finally, large-scale sectors such as automotive that are further along the I 4.0 adoption curve have to be encouraged to make prominent investments in technology, and build capabilities to manage ‘robot workers’. As tasks involving humans become increasingly more complex, the capacity of workers to master new skills and the availability of programming talent will become key drivers of competitiveness.

One of the strategies under discussion in several countries is to build ‘I 4.0 Immersion Centers’ in a public-private partnership model to help companies accelerate their learning process. Immersion centres bring all the nine I 4.0 technologies in a working plant to demonstrate how the plant of the 21st century will look like. The industry also needs to take full ownership of leveraging I 4.0, learning from global leaders like Bosch which is already producing key parts in a semi-automated way. The engineering and electronics major produces disc valves at 30% lower production time and cost using I 4.0 technologies in its Hamburg factory.

The global manufacturing sector is undergoing a massive structural transformation. Make in India 2.0 must enable us to retool our manufacturing for the digitally driven future. India has time to get it right this time – every new manufacturing technology in the past took about several decades to mature. We missed the bus when low-cost manufacturing took off in 1990. Hopefully, we will emerge winners now, as the digital revolution takes off over the next few decades.

Arun Bruce is partner and director, and Arindam Bhattacharya is senior partner and director at BCG. The views expressed here are those of the authors.