Global Recession and Indian Response – 4: The Case of Larsen & Toubro Ltd

Global recession hit the world economies badly from mid-2008 onwards. The growth prospects of companies were adversely affected. 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. Companies in the core engineering sector and those who made aggressive overseas investments in the previous years were particularly under severe pressure.

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.  This enquiry also results in an understanding of relevant business models and strategies as a subject of broader academic interest.

In the fourth paper of the series, the author examines how Larsen & Toubro Limited (L&T) fared in 2008-09. The conclusion that emerges from the study of L&T (as from the earlier studies on Maruti Suzuki, India’s leading car manufacturing company and BHEL, India’s leading power and industrial equipment company and Tata Steel, India’s global steel maker – reference the other posts in the author’s blog site “Strategy Musings”) is that Indian companies did acquit themselves rather creditably due to their intrinsic fundamentals and business management skills.  This, in turn, leads us to the interpretation that select Indian companies must set their sights higher and move on to higher trajectories of growth on a global canvas.

Larsen & Toubro – Diversified competencies

Larsen & Toubro Limited is India’s most reputed engineering, manufacturing and construction conglomerate, with highly diversified capabilities. These include (i) engineering design and construction of infrastructure and industrial projects, buildings and townships, (ii) turn-key delivery of projects in the oil & gas, petrochemicals, power and water sectors, (iii) manufacture and supply of critical equipment to several industries, (iv)shipbuilding, (v) transportation projects, (vi) manufacture and supply of power and energy equipment, (vii) defense and space production, (viii) infrastructure development, (ix) information technology and (x) financial services, to name a few. L&T would rank among the world’s largest engineering and construction firms. In terms of the range of products and services offered L&T probably is one of the most diversified, even globally. It has multiple engineering and manufacturing campuses and several subsidiaries, associate companies and offices in India and abroad.

L&T was founded in 1938 by two Danish engineers by Mr Henning Holck-Larsen and Mr Soren Kristian Toubro as a partnership firm. These engineers who came to India as representatives of Danish engineering firm F L Smidth &co., in 1937 were truly visionaries who could foresee the potential India would offer in engineering and construction areas. Their biggest legacy has been the development of L&T as one of India’s most professionally run companies. This professional DNA has undoubtedly contributed to its unmatched growth as the largest engineering and construction conglomerate in India. Like Tata Steel, L&T has been a beacon of India’s enterprising spirit over a century of tumultuous national and international developments. The company has been a pioneer all through its over seven decade long history, always venturing into newly emerging areas, time to time, with full-fledged emphasis, be it energy or shipbuilding, the latest being the foray into nuclear energy.

L&T followed a policy of collaborations and joint ventures to support its diversification strategies. Joint ventures with technological leaders such as Komatsu, Case, Demag, Sargent & Lundy, Chiyoda and Mitsubishi reflected such an approach. The company also followed an aggressive strategy of establishing subsidiaries specifically aimed at certain mega projects or key diversification initiatives.

A model of diversified project engineering

L&T represents a business model which derives growth and sustainability through excellence in engineering. While L&T has no doubt several manufacturing and project execution capabilities, it is its core competence in engineering that enabled the company successfully perform in a number of high technology fields. As with other Indian engineering majors such as Tata Steel and BHEL, the company’s domestic orientation, technological sophistication, execution capability and cost competitiveness enabled it to continuously lead the Indian engineering industry.

L&T’s diversified businesses provided a hedge against recessionary cycles witnessed from time to time, including the global economic crisis of 2008-09. Like other companies oriented towards heavy engineering and infrastructure, L&T drew 80% of its business from India in 2008-09. The Middle East and GCC countries as well as the Far East constituted the major overseas presence, with manufacturing facilities and on-site construction and project activities. More recently, the company has been able to export its products to countries traditionally considered engineering nerve centers – the US, UK, Canada, France and China.

The consolidated turnover of L&T increased by 37.2% in 2008-09 to Rs 414,930 million (USD 8.64 billion; USD 1 = Rs 48). Group companies helped the stand alone revenues increase by 18.3%. Stand-alone turnover of the company, or in other words, L&T’s organic turnover at Rs 350,650 million was 84.5% of the Group’s consolidated turnover.    On a consolidated basis, the Earnings Before Interest, Taxes and Depreciation (EBITDA) was Rs 53,980 million in 2008-09, compared to Rs 39,840 million of 2007-08, representing an increase of  35.5%, even in a year of recession.  Profit before Taxes (PBT) increased by 28.3% to Rs 43,440 million, while Profit after Taxes (PAT) increased by 30.5% to Rs 30,070 million.  On a standalone basis also EBITDA in 2008-09 increased by 33.4% Rs 44,250 million. Standalone PBT registered a growth of 28.4% to Rs 39,400 million in 2008-09 while standalone PAT also grew by 29.1% to Rs 27,090 million. The robust growth in revenues and profits reflects the strength of L&T’s order book and its preferred position as a premier engineering corporation.

While the order book for L&T continued to increase from Rs 420,190 million to            Rs 516,210 million, the growth rate reduced from 37.3% to 22.9%. While L&T is a conglomerate in its own right, Engineering & Construction business at Rs 279,430 million still contributes an overwhelming 82% of the total turnover. Electricals & Electronics and Machinery & Industrial Products divisions contribute 8% and 7% respectively to total business. Other divisions contribute only 3%. It is, however, interesting that Engineering & Construction business and Electrical & Electronics have  lower EBITDA margins of 12.8 and 12.5 respectively, compared to EBITDA margin 19.4% enjoyed by Machinery & Industrial Products division. Other businesses, in the aggregate, have contributed to a steady decline in EBITDA margins from 9.4% in    2005-06 to 6.1% in 2008-09. However, in terms of dependence on different industrial sectors the company is better balanced, with infrastructure contributing 39%, power 26%, process 16%, hydrocarbons 12% and others 8% to the order book.

L&T’s business seems to be characterized by a long collection cycle and high levels of sundry debtors. Sundry debtors at Rs 100,550 million were sharply higher by 36.5% on a standalone basis.  Consolidated sundry debtors increased at an even higher rate of 41.4% to Rs 116,435 million, reflecting the impact of recession. On a standalone basis, sundry debtors as a percentage of turnover was at 29% both the years. On a consolidated basis too the percentage was 28% in both the years. The collection practices did not seem to have been adversely affected although one may surmise the growth in turnover was supported by increase in sundry debtors. The high level of sundry debtors, even as a characteristic feature of the engineering and infrastructure business, is a matter of concern.

Careful expenditure management apparently helped L&T weather the storm of recession. Major expenditure heads stayed flat in 2008-09 as compared to 2007-08. L&T’s business is manpower and engineering talent intensive. Notwithstanding the recession, the company resorted to a net addition of 5,416 employees to take the manpower strength to 37,357 to meet long term growth needs. Staff expenses at Rs 19,980 million were higher by 30% due to additions as well as salary increases. However, staff expenses as a percentage of sales declined marginally to 5.8% in 2008-09, compared to 6% in 2007-08. Sales & administration expenses as a percentage of sales stood flat at 6%.

L&T’s core businesses are asset intensive. Standalone fixed assets increased by 42% to Rs 50,538 million while consolidated fixed assets increased by 173% to Rs 82,637 million. Fixed asset turnover ratio declined from a high of 11.1 in 2005-06 to a low of 7.7 in 2008-09. As the company operates in the engineering and construction field high quality and performance of its machinery and equipment are a vital component of project delivery and safety. Notwithstanding this, the need to manage assets better even as the company diversifies and expands its business is evident.

Overall, despite the recessionary conditions affecting its core customer segments of infrastructure and industry, and the high levels of debtors, the company generated an operating cash profit of Rs 14,970 million. However, despite cash accrual from the divestment of ready mix concrete business which boosted cash position by Rs 12,210 million and additional borrowings of Rs 25,580 million, the closing cash position dropped by 20% to Rs 7,753 million due to higher level of investing activities. Apparently, the business suffered the impact of tight liquidity conditions.

Organizational alchemy as a strategic driver

L&T’s phenomenal growth has been driven by a unique professional alchemy in the organization. There are few parallels in India of a company which, without the anchor and driving force of either government ownership or private family ownership, could reach the status of a massive conglomerate. L&T’s identification with professional national ethos has been so strong that a move in the past by the Reliance group to acquire a stake in the company had to be aborted due to a public outcry. L&T’s unique organizational alchemy is explained by four factors: total professionalism with growth oriented organization, engineering excellence as a core competence,  technical and managerial band-width across the group, and strong collateral competencies in IT and financial services.

Professional management

Professional management has been a great legacy left behind by the two Danish founders of the company. Henning Holck-Larsen, the co-founder of L&T laid the foundations of a humanistic and nationalistic corporation when he said: “If you want to belong to a country that is becoming a nation, you have to keep the economy growing by creating jobs. And you can only do that by investing in tomorrow, and tomorrow is made by people.”  He also believed that no deal and business could be made unless the customer was completely satisfied with the products, services and after-sales attention. The company as a result laid an enormous emphasis on quality and commitment of the workforce to make a significant contribution to the company’s success.

Today, as a conglomerate, L&T is one of the few Indian corporations which has given  whole time board level directorial responsibility to each of the leaders driving the core businesses of the company. The L&T board has seven whole-time directors for each of the seven businesses ofEngineering & Construction Projects, Machinery & Industrial Products, Electricals & Electronics, Construction, IT & Technology Services, and Heavy Engineering, Finance and Human Resources. These seven directors, led by the chairman & managing director, Mr A M Naik constitute the visible and focused executive leadership team of the company. Together with eight independent, non-executive directors, the sixteen member board of directors provides the fusion of strategic thinking and operational clarity that a conglomerate needs. L&T’s board is also one of the few boards in India that meets almost with a monthly frequency.

Engineering excellence

L&T, from the inception, saw engineering as the bridge between aspiration and achievement. From recruitment processes to business development, the company aimed to integrate engineering as the key driver of growth. L&T always nurtured two major passions. One was to play consistently the role of a resource institution for as many technologies as could be brought within the reach of its engineers. The second was to participate in the crucial core areas of India's development. Company managers were required to constantly examine opportunities, and bid for them, so that L&T could step in with the requisite product or technology. Almost as soon as a need arose, L&T had the capability to meet it. When the needs of Indian industry changed, L&T kept pace by staying at the vanguard of technological development.

The 'climate of excellence' that L&T employees enthuse about is the result of the precepts and practices of the company's founders. Under the professional management structure put in place by Mr Holck-Larsen, and carried over with equal commitment by all the successors, L&T engineers enjoy an unparalleled degree of freedom and the opportunity to seek out challenges. The results are evident - L&T engineers have scripted some of the most spectacular success stories in Indian industry. To nurture the design engineering capabilities the company set up a Knowledge City to deepen and widen L&T’s capabilities in an array of high technology industries.

Significantly, L&T has all along been a private-sector 'partner' to several national endeavors. It manufactured rocket motor casings for India's first foray into space and subsequently, remained closely associated with the country's space program. L&T has also held the Indian flag high, providing indigenous engineering expertise for critical defense projects. Other national missions for which L&T either supplied vital equipment or offered critical construction services include the 'White Revolution' and the nuclear power program. Much of what L&T produced were the first of their kind for India, whether it is India's first indigenous hydro-cracker reactor - a critical equipment for refineries or customized electrical switchgear for India’s unique farm and industrial conditions. The familiar L&T logo has come to represent an insignia of engineering excellence, robust quality and customer service on an array of high-technology products. 

Technical and managerial band-width

L&T derives its growth because of the vast engineering and managerial talent that the company has built over the years. L&T is one of the few companies in India which laid emphasis on grassroots talent management as an essential corporate credo. Its graduate and post-graduate engineering training programs and its annual recruitment contact programs with India’s leading engineering institutes such as the Indian Institutes of Technology and National Institutes of Technology have been a nearly five-decade old path-breaking practice. Not surprisingly, L&T is widely recognized as a crucible of engineering talent in India.

L&T has also a company-wide endeavor covering thousands of managers to enable them to hone their abilities in people management, and translate those skills into effective leadership and motivation. To ensure quality and depth of leadership, L&T has linked the leadership process with consistency of performance. Select employees are also sent to premier business schools and management institutes to gain experience and knowledge through their advanced management programs. In addition, the SBU type organization structure with multiple product divisions and several group companies provides the requisite channels for leadership development linked to opportunities as well as technological and managerial performance.

That said, management of the company’s vast network of group companies poses no easy challenge. As on March 31, 2009 L&T had 97 subsidiaries, 22 associate companies and 15 joint ventures in its fold. The typical nature of infrastructure and construction space which requires creation of special purpose vehicles (SPVs) based on build-operate-transfer (BOT) or build-operate-own (BOO) concepts makes a large number of subsidiaries an inescapable reality. The company’s ability to manage the vast network of group companies, several of them international operating companies, is therefore noteworthy.

A successful conglomerate needs also to know the prudential limits for technological expansion. In 2003, L&T’s cement business accounted for more than a quarter of L&T’s turnover, but it was still proving to be a drain on resources that could otherwise have gone into growing the core businesses. By divesting its cement business the company demonstrated its ability to take strategic decisions that are in the long term interests. The decision helped the company re-sharpen its focus on engineering and achieve a better utilization of its technical and managerial band-width.

Technical band-width can be, and should be developed at the grassroots level. L&T’s electrical engineering division, for example, implements the Hitori Yatai Seisan or the Single Workman Station concept. Employees are challenged to take complete responsibility for a product instead of letting them work on individual components. Ever since L&T introduced the concept, productivity has reportedly increased, as the employee began to have a sense of ownership for the final product. In the industrial products sector, L&T’s Heavy Engineering Division is focusing on improving manufacturing operations through automation, TPM, Six Sigma and IT- enabled re-engineering.

In addition, L&T has demonstrated its expertise in collaborating with leaders in global engineering industry through joint ventures and associate companies. These include some of the world’s best names such as Sargent & Lundy of USA (for power plant engineering solutions), Chiyoda of Japan (for hydrocarbon engineering solutions), Mitsubishi Heavy Industries of Japan (for power plant equipment), Ramboll of Denmark (for transportation engineering solutions), Komatsu of Japan (for earth moving equipment), Case Equipment of US (for road laying machinery) and Demag of Germany (for plastic machinery). These collaborations and corporate structures enabled L&T strengthen its value chain across verticals, both horizontally and vertically.

Infotech and financial forays

The fourth unique differentiator for L&T has been its foray into information technology and financial services industries. Mainstream engineering or manufacturing companies do not have a particularly notable  track record of venturing into these fields and succeeding in them. It is to the credit of L&T that the company has not only leveraged information technology and finance to enhance its own operational performance but also let them flourish as independent businesses in their own right.

L&T Infotech Limited (LTIL) is a Rs 19,750 million IT company (consolidated IT revenues of Rs 20,810 million), offering both onsite and offsite services in the areas of application maintenance and development, enterprise resource planning, data warehousing, business intelligence, testing and IT infrastructure management. In terms of verticals, manufacturing accounted for 41% of turnover, followed by insurance at 18%, energy & petrochemicals at 16%, product engineering services at 12% and banking & financial services at 12%. In terms of geographies, US contributed 67% (down from 74% in 2007-08), Europe 13%, Asia Pacific 9% and Africa/MEA 4%. LTIL’s reasonable scale and diversified verticals and geographies reflect the value that are more typical of a mainstream IT company, which is indeed creditable. It is perhaps unfortunate that L&T suddenly turned conservative and failed to make a winning bid for Satyam Computer Services Ltd (since taken over by Tech Mahindra) in 2009. A successful bid would have made LTIL the fourth largest IT company in India.

In the field of financial services, L&T has four entities. L&T Capital Holdings Limited (LTCHL), L&T Finance Limited (LTFL), L&T Infrastructure Finance Company Limited (LTIFC) and L&T Capital Company Limited (LTCCL) are the entities; the first one being the holding company for the balance three. LTFL has become a premier non-banking finance company while LTCCL has become a leading portfolio manager and mutual fund operator. LTIFC is focused on financing of infrastructure projects. Reflecting L&T’s corporate social responsibility it has forayed into rural microfinance as well. All have been profitable despite the tough economic conditions.  

 L&T: India’s GE?

L&T has certainly excelled as few other companies could do in the engineering and construction space in India. With a sustained emphasis on engineering excellence and an unwavering commitment to values of professional management L&T became a leader. There are many areas which offer new and exciting opportunities for L&T in future. Aerospace, space research, defense equipment, medical equipment, consumer products, bullet trains, consumer finance, robotics and nanotechnology could be new areas of bountiful opportunity in India.

By re-jigging its corporate and business structure, and forging new collaborations with respective industrial and technological leaders in these new domains, L&T can leapfrog the development space. As a first step, L&T must significantly increase its R&D expenditure from the current Rs 802 million, representing a measly 0.2% of turnover to a globally effective level. A combination of stepped up indigenous technological effort and induction of requisite cutting edge technologies is essential to fast-track L&T into the next trajectory of multi-faceted technological excellence. With a clear strategic vision, L&T can become India’s own General Electric, contributing to nation’s development in an even more pervasive manner.

Posted by Dr CB Rao on October 3, 2009