Small manufacturing firms in the informal sector have the potential to contribute to structural transformation, but their capacities vis-à-vis formal firms are not well-understood. To address this, we create a novel unit-level dataset combining Annual Survey of Industries data for registered (formal) factories with the National Sample Survey data on unincorporated (informal) enterprises. We show that differences in observed characteristics, such as capital and labour inputs, location and gender composition of the workforce, account for a major part of the productivity difference between formal and informal units. Unobservables, such as local geography, managerial or entrepreneurial ability and labour quality (skills), account for around 25% of the productivity gap.