Thursday, September 24, 2009

Global Recession and Indian Response - 2: The Case of Bharat Heavy Electricals Ltd

Global recession has hit the world economies badly. The growth prospects of companies were affected adversely. As companies aimed to survive or remain profitable they instituted severe measures to close down or realign businesses and operations and implement severe cost compression measures. Jobs were lost and savings were wiped out while purchasing power crumbled and customer confidence wilted.

Indian economy too faced the adverse impact of the global recession with reduced GDP growth and heightened liquidity crisis. The fiscal year 2008-09 represented one of the most excruciating years for Corporate India. Different companies, of course, were affected by the economic recession differently and also responded to the evolving situation differently. Yet, the fact remains that the Indian government (like most other governments) remained more solvent and liquid than the corporate sector, and with the Indian government, the government owned public sector undertakings (PSUs) too exhibited a rare resilience.

The author examines in a series of papers as to how different Indian companies withstood the ravages of recession in a more enduring manner than most overseas firms could. In the second paper of the series, the author examines how Bharat Heavy Electricals Limited (BHEL), an engineering PSU in the power and industrial infrastructure sectors fared in 2008-09. The conclusion that emerges from the study of BHEL (as from the earlier study on Maruti Suzuki, India’s leading car manufacturing company – refer is that Indian companies did acquit themselves rather creditably due to their intrinsic fundamentals.  This, in turn, leads to the interpretation that select Indian companies must set their sights higher and move on to higher trajectories of growth rather than be limited by generic climates of euphoria or depression.

BHEL – An engineering giant

BHEL is the largest engineering and manufacturing enterprise in India in the energy related and industrial infrastructure sectors.  BHEL was established as a PSU more than four decades ago ushering in the indigenous heavy electrical equipment industry in India.  BHEL caters to the core sectors of the Indian economy, viz., power generation and transmission, industry, transportation, renewable energy, defense and so on. The company has a wide network of 14 manufacturing sites, 4 power sector regional centers, 8 service centers, 15 regional offices and one subsidiary company.

BHEL’s core competence lies in developing and manufacturing turbine generator sets for different types of power generation, including hydro, thermal and nuclear energy. It has the capabilities to put up total power generation and transmission systems utilizing different types of equipment and technologies.  Other products include boilers, pumps, heat exchangers, electrical machines, valves, heavy castings and forgings, digital control systems, railway traction equipment and renewable energy equipment, to name a few. 

BHEL is a highly domestic oriented company with only 5% of the order book being received from international operations.  Its fortunes are also dovetailed with the power sector, with 78% of the order book being derived from the power sector. Allocations by the governments in the power sector, investments in public and private power projects and the financial health of the state electricity boards influence BHEL’s corporate plan and growth track to a large extent.  

A monolithic business model

BHEL represents a business model which derives stability and growth based on the strong development needs of infrastructure in a growing economy like India. The company’s domestic orientation and infrastructure emphasis has enabled it to withstand the recessionary cycle witnessed in 2008-09.  The turnover of the company increased by 31% in 2008-09 to Rs 280,330 million (USD 5.8 billion; USD 1 = Rs 48) which, in fact, represented a growth rate that was higher than the growth of 14.2% recorded in the boom year of 2007-08.  That said, the profit before tax grew at a more modest pace of 9.5% to Rs 48,490 million in 2008-09, a growth rate which was lower than the 18.6% recorded in 2007-08.  The profit after tax grew by 10.5% to Rs 31,380 million, which again was lower than the growth rate of 18.4% recorded earlier. Pricing pressures were thus evident and could not be managed.

The order book grew at a slower pace of 18.7% in 2008-09 to Rs 596,780 million which represented a far lower growth compared to a 41% growth rate in the order book in 2007-08.  Sundry Debtors increased by 33% to Rs 159,755 million, in line with sales growth. Sundry Debtors as a percentage of sales stood at 61%, same as in the previous year; however, it represents a relatively high percentage.

The company increased its manpower by 4.7% to 45,666 in a year of recession (growth in manpower in the previous year was 3.6%). While pricing pressures and manpower increases no doubt impacted the profitability, an increase in value added per employee was achieved to counteract the recessionary and pricing pressures. The turnover per employee increased by 24.5% to Rs 6.1 million whereas the increase in turnover per employee was only 11.4% in the growth year of 2007-08.

Design and manufacture of equipment and systems for infrastructure and industrial sectors is an investment-intensive endeavor.  In several cases, erection and commissioning activities are an integral part of the contracts.  The fixed assets of the company increased by 60.3% to Rs 26,273 million, reflecting the need to aggressively invest, to be ahead of the customers’ own investment cycle in the infrastructure industry. Only by optimal turnaround of the investments into saleable machinery and systems, can companies such as BHEL can  protect their profitability.  BHEL’s sales to turnover ratio of 11:1 in 2008-09 has been less than the ratio of 13.4:1 achieved in 2007-08.  This probably reflects the impact of fresh investments during the year and the lead time required to turn investments into sales during a recessionary period. A long term, well managed business and financial model is reflected in a zero debt profile and a healthy cash balance of  Rs 103,147 million (an increase of 23%), which in turn helped the company retain a stable financial profile during the recession.

In sum, BHEL presents a profile of a strong monolithic business, and a robust financial model which performed well based on its preeminent position. In addition, the advantage of being a PSU and the vast number of collaborations it has with other PSUs in the power, infrastructure and industry sectors has worked to the advantage of the company.  However, the question would remain whether the company could have positioned itself for a much greater role in the broader energy and infrastructure space in India.  For eg., Larsen & Toubro which is a private corporation in a similar sector has been able to notch up a turnover of USD 8.5 billion in 2008-09.  In terms of business divisions as well as product profile, L&T reflects a more vigorous growth profile. 

Organization, a key driver

As a company enhances its scale and scope, the design of organization plays an important role in strengthening the business foundations and also in opening up new avenues for future growth.  BHEL’s organization structure, despite its wide range of products and vast spread of customers, does not seem to follow any specific organizational design.  The design does not reflect principles of product commodity segmentation, geographical segmentation or domain specialization in any discrete or synergistic fashion.  Apparently the evolutionary course of the organization has solidified into a highly cross-wired network of overlapping facilities, products and services.  

It may be noted that several of BHEL’s plants were set up with multiple overseas collaborations and reflect diverse ethos.  A review of the organization and key responsibilities suggest that the company is organized in a typical departmental organization manner rather than in terms of product or domain specializations.  In addition, it is surprising that a behemoth like BHEL has at present a Chairman & Managing Director with only a 6 month tenure as the appointment period.  BHEL has in the past contributed such stalwart-leaders as Sri V Krishnamurthy and Sri S V S Raghavan to the Indian industry. It should not be difficult to carve out a stable and high profile leadership team from the vast talent pool that the company has.

The key to BHEL’s future growth would seem to lie in a complete reorganization of its business and operations in terms of a product-market matrix structure, which would enable required autonomy, empowerment as well as responsibility to drive growth across several product-market segments, each of which has significant growth potential in its own right.  It would perhaps be ideal to segment the business drivers in terms of key sectors such as power, transmission, industry, transportation, oil and gas, renewable energy and so on.

Alongside, a reorganization of operations based on manufacturing flow and product specialization would strengthen product-market delivery. Given the fact that common products serve multiple industries (albeit with customization), an integrated asset back-end and a diversified business front-end would be a powerful organizational driver.  As an alternative to the matrix structure, however, an SBU structure whereby each business sector is treated as a standalone vertical can also be considered.

In redesigning its business model and reorganizing its value chain, BHEL can perhaps pick a leaf out of Maruti Suzuki, which in spite of being a joint sector undertaking with government participation, until a few years ago, operated with an efficient business and operational structure from the very inception.

Maruti was one of the few public sector corporations which succeeded with an integrated operational excellence model. The Japanese parentage has helped the company to implement the famous Japanese automobile management systems from the very beginning. Maruti was a pioneer in India in terms of a massive vendor development system covering both tier-I and tier-II, and even tier-III vendors. This has helped the company create a contiguous vendor eco-system and implement a just-in-time inventory system, customized to Indian scenario. In terms of manufacturing too, Maruti Suzuki adopted well the parent’s practices of balancing high throughput and high product variety. An end-to-end optimized supply channel drives Maruti’s business efficiencies.

A robust financial strategy well supported by a strong product-market strategy and an efficient supply chain strategy provided Maruti with strong fundamentals and the capability to withstand the severe recessionary climate. Maruti’s example illustrates that an integrated operational framework that is strategically designed and assiduously reinforced over the years helps companies withstand turbulent times.  Japanese management philosophy is reflected in the uniqueness of operations of engineering giants in Japan such as Chiyoda, Toyo and Hitachi as well.  BHEL could profitably also adopt some of the value chain management concepts from Maruti or any other Japanese engineering giant.

Traction for an electrifying future

The product range that BHEL leads the industry in not only generates energy but also contributes to consumption of energy in a significant manner.  Research and development in the fields of new materials and technologies which leave a low carbon footprint would not only provides significant cost saving to BHEL as well as its customers but also contributes to the global environment in a positive manner.  Surface coatings and nanotechnology can contribute substantially to the efficiency of its basic products.  In addition,  BHEL would need to diversify in a big way into alternative energy, digitization and robotics as new growth drivers.

BHEL spent a sum of Rs 127.4 million in 2008-09 on R&D, constituting 2.5% of the total turnover.  Most of the R&D investments have been channeled towards enhancing the efficiency and operating life of its products. To enable BHEL  fulfill a new technological mission, R&D expenditure would need to be significantly upgraded to achieve requisite and newer state-of-the-art competencies.

While BHEL has, no doubt, achieved self-sufficiency in terms of technology, the company should not be averse to bringing in newer technologies and products through collaborations in a more proactive manner.  Technologies for bullet trains, nuclear energy, space exploration, oil exploration, geo-thermal exploration, energy recycling are a few of the domains where collaborations could provide a new drive into the future.

Technology would be one prime area of change; equally important would be a strategic plan that sets 5-10-15 year perspectives for quantum leaps based on development of technologies, their deployment into businesses and generation of resources to execute successive transformation of businesses.

Leadership in Indian PSUs is notable for its virtually selfless service which is reflected in highly endowed managers and leaders working their heart out for compensation packages that are mere fractions of their private sector counterparts. It is unbelievable but true that the Chairman and Managing Director of BHEL draws a remuneration of just Rs 1.63 million per annum, a level any front line manager easily exceeds in an information technology company in India. The shareholders of BHEL, of which the Government of India holds the dominant majority at 68%, must ponder if the current scale of responsibilities and future scope of business development do not deserve a more motivating and equitable pay structure.  

With a renewed R&D focus, new technology perspective, multi-stage strategic plan and a well-rewarded and empowered leadership, BHEL can drive itself, and the Indian infrastructure sector, into a new electrifying future.

Posted by Dr CB Rao on September 24, 2009

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