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

A Behavioral Model of Strategy

Strategy is unique among all the domains and disciplines of a corporation. As opposed to various other disciplines which are relatively deterministic (such as operations, materials, information technology and quality), corporate strategy tends to be a domain of forecasts and aspirations, with all the imponderables that could emerge in future. This is in spite of the vast body of theories, techniques and tools that have been developed in the strategy domain over the last five decades (reference my blog on “Thought Leadership in Management” in “Strategy Musings” at cbrao2008.blogspot.com).

Strategy development uniquely requires the strategist to predict a future and lay out an execution pathway with commensurate resource deployment to achieve certain goals. The strategist needs to take professional decisions that could handle uncertainty in a successful manner. There are, of course, couple of other disciplines that are governed by certain non-quantifiable factors.  For example, R&D is as much science and technology driven as it is passion and perseverance driven. Safety is more a matter of behavior than a function of science and technology. Even these disciplines, however, do not provide a free play to emotional decision making as strategy does.

This paper argues that intrinsic attitudes of the strategy makers have an overarching influence on the eventual effectiveness of corporate strategies.  Several bold and successful as well as adventurous and unsuccessful actions taken by corporations are more easily explained when they are viewed in a behavioral decision making paradigm.

Strategic adventures

Corporate actions reflect the way the behavioral models of the key strategists pan out in a company.  Actions taken by corporations in recent years to acquire overseas assets at hefty valuations, for example, reflect irrational exuberance of the strategists.  Decisions relating to product range expansion or renewal, capacity expansion or reduction, business diversification or divestments, mergers and acquisitions require significant strategic thinking.  In such crucial strategies, an inappropriate behavioral component could cost the company dearly in terms of time and resources required to recover from any adventurous moves.

Strategic decisions that are taken without evaluating multiple scenarios of opportunities and risks could be suboptimal.  Strategic acquisitions undertaken without requisite due diligence on current business and future prospects could prove costly.  Examples from the national and international industries are pointers.  A premier private sector airline in India which was indeed flying high hit turbulent skies upon a hasty acquisition of another cash strapped airline.  A pioneering low cost airliner gave up the business all too soon when a longer stay would have provided greater value for the low cost model in a recessionary environment.  An operationally efficient diversified automobile manufacturer focusing on fuel efficient vehicles almost went into a tailspin by acquiring an overseas manufacturing infrastructure at a high cost for making ultra-luxury, ultra-expensive fuel guzzling cars.  Conservative outlook of Indian tractor manufacturers and three wheeler manufacturers have narrowed their business options to obsolete designs and products even as mainline automobile companies grew their product range aggressively.  Inadequate due diligence led an Indian pharmaceutical major and a Japanese pharmaceutical giant acquire companies at high cost and lose goodwill.  Inadequate understanding of the dynamics of generics market led several Indian pharmaceutical companies to establish capacities in excess of demand in a vain pursuit of market shares.

Japan’s leading electronics giant lost the innovation edge due to the short term distortions in strategy caused by its movie and music divisions.  A leading printing solutions and computer company of the US is still to extract the full value of a merger with another computer company.  The disastrous acquisition by the Germany’s leading car major of an ailing US automobile corporation is another example of behavior driven strategy gone astray. The world’s leading software company’s ego state refused to recognize the potent threat of the Internet search firm.  Another Internet search firm’s decision to spurn a takeover offer again was a behavioral response that flew against the dynamics of business.

The above examples suggest the need for a model of strategic thinking that optimizes behavioral approaches with classical conceptual and analytical tools of the strategy domain for effective corporate development.

Behavioral model

The basis of the behavioral model of strategy is that a strategist is essentially an individual as well as a professional who has correspondingly certain intrinsic behavioral traits and certain imparted behavioral traits. These traits influence how a strategist views the environmental opportunities and risks as well as how he understands the corporate competencies and capabilities. 

There are four key pairs of human emotions that influence how the individual in a strategist develops the corporate strategy. These are: (i) passion and diffidence, (ii) hope and despair, (iii) confidence and panic and (iv) ego and humility. There are three key pairs of behavioral traits that influence how the professional in a strategist develops the corporate strategy.  These are: (i) deliberative and impulsive, (ii) consultative and individualistic and (iii) deterministic and abstract.

The behavioral model governing a strategist’s actions is a complex interplay of the individual and the professional traits.

Individual behavioral facets

Fundamentally, a strategist’s role is to grow the company with passion, overcoming all anticipated and unanticipated hurdles. He has to play for the long term, looking beyond the obvious for opportunities and risks. Even as he develops a strategy encompassing and leveraging all the functions he needs to have the passion and perseverance to secure the buy-in of all the functions and ensure their commitment in execution. A strategist who is reluctant to draw up functional strategies and is diffident about securing the functional buy-in is like an engine decoupled from the bogies.

The strategist draws his strategic plans and undertakes course corrections in the context of the business and economic environment that the company faces. Economic volatility and business turbulence need a balanced mind to understand and handle the forces. Professionals whose strategic thinking is only skin deep get carried away by hope, especially in the years of boom and get drowned in despair in times of recession. During the last one year, for example, countless strategists mothballed valuable businesses while in the earlier years they splurged money on ambitious expansion and diversification projects. Strategists who took a balanced view of recession last year and persisted with creative product development activities would be smiling as the recovery gets underway.

The strategist needs to have the ability to handle both opportunities and crises with confidence. Confidence arises from own competencies as well as an understanding of the overall organizational competencies and competencies. Being in a state of eternal preparedness for opportunities and risks, through a continuous focus on developing and evaluating multiple scenarios, helps the strategist remain confident. Being in constant touch with functional performance also helps the strategist understand the potential play in times of growth as well as recession. A strategist who is unprepared with any scenario other than his own is bound to be panic stricken when faced with times of discontinuity.

A strategist’s job is arguably one of the most glamorous jobs in an organization. A responsibility to plan for the organization’s future, proximity to the CEO and the Board and a business practice which requires him to collaborate with the external world could lead to a sense of superiority and infallibility. An obsessive ego could influence the strategist to underestimate competition and land the company into difficulties with excess capacities. Ivory tower planning as a phrase is more a practical reality than an academic idiom in respect of such strategists. At the same time, extreme flexibility to pander to each and every viewpoint may not help the strategic planning process either. Successful strategies, executed with considerable corporate effort, need to be celebrated to reinforce rational risk-taking in the organization. A self-effacing backroom strategist who takes his successes in his silent strides is unlikely to inspire the organization at large.

Professional behavioral facets

It is important for the strategist to be deliberative rather than impulsive.  The domain of strategy involves taking the company successfully into uncharted territories.  It requires that the strategist is fully aware of the various internal and external factors that could support or derail the strategy.  A strategist who chooses appropriate strategies based upon deep deliberation has a much greater of success than one who frames strategies on impulse.  Not only he would have laid out a more enduring strategy, he would also have been prepared with course corrections having considered various alternative scenarios a priory. On the other hand, a strategist who is impulsive, taking decisions on the spur of the moment, can never be a good strategist.  As a matter of fact, impulsive behavior is counter-intuitive to strategic thinking.

A successful strategist would be consultative, rather than individualistic in his approach.  A strategist by virtue of his domain specialization ought to have a high degree of conceptual and analytical skills, acquired through formal education and the very nature of the job.  This by itself cannot be cited by a strategist to act individualistic in his methodology.  A strategist is perhaps like a master craftsman who assembles the several resources available to develop a meaningful program for the future.  The more consultations he has, the more would be the strategic alternatives he would have.

Being deliberative and consultative does not, however, mean that a strategist can be indecisive or flexible.  On the contrary, a strategist needs to be deterministic and quantitative at the end of his deliberative and consultative processes.  Strategies could be abstract and futuristic but it is the challenge of the strategist to convert the abstract concepts into a set of number-driven programs to enable management of the strategic planning process by relevant metrics (see my blog titled “Management by Metrics” in  “Strategy Musings” at cbrao2008.blogspot.com). 

The foregoing leads us to conclude us on an ideal behavioral profile of an effective and successful strategist; that of a deliberative, consultative and deterministic professional who is passionate and never diffident, is not driven unduly by either the hopes or the despairs of the times, and whose confidence and humility are enhanced by his capability.  The CEO and SBU Heads who work closely with the strategist obviously need to share the ideal behavioral profile of the strategist to perform successfully in tandem. A positive behavioral model of strategy would explain why some corporations are more consistently successful than others.

Posted by Dr CB Rao on September 29, 2009

Global Recession and Indian Response - 3: The Case of Tata Steel Limited

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 third paper of the series, the author examines how Tata Steel Limited (Tata Steel), fared in 2008-09. The conclusion that emerges from the study of Tata Steel (as from the earlier studies on Maruti Suzuki, India’s leading car manufacturing company and BHEL, India’s leading power and industrial equipment company – refer the other posts in this blog) 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.

Tata Steel – A pioneering venture

Tata Steel Limited, Asia’s first integrated private sector company, is the world’s second most geographically diversified steel producer with major operations in India, Europe, South East Asia and rest of the world.  Listed as a Fortune 500 company with an annual crude steel capacity of around 31 million tones, the company has manufacturing units in 26 countries and a strong presence in 50 European and Asian markets.  Tata Steel India is the first integrated steel company in the world, outside of Japan, to be awarded the coveted Deming Application Prize 2008 for excellence in Total Quality Management.

Tata Steel was established as a private sector enterprise by the renowned nationalist and industrialist Mr Jamsetji Tata 102 years ago, laying the basic foundations of an engineering industry in the British occupied India.  The Company was a beacon of India’s enterprising spirit over a century of tumultuous national and international developments. Tata Steel caters to the core sectors of the Indian economy, viz., construction, automobiles, industry, defense and so on with its wide range of products. Tata Steel’s core competence lies in developing and manufacturing a wide range of steel products, steel tubes, bearings, wires and rods.  Tata Steel was a pioneer in developing high quality sheet steel and high precision steel tubes required for the new generation of automobiles in India. 

An exceptional chapter was written in Tata Steel’s century old history when in 2007 it acquired the Anglo-Dutch steel giant Corus Group Plc (Corus) for USD 12.11 billion in a landmark deal that placed India Inc in the global map. With the acquisition of Corus, Tata Steel’s capabilities extended to more value added products including those catering to European and American automobile and aerospace industries.

Prior to Corus acquisition in 2007, Tata Steel was a predominantly domestic oriented company with a production capacity of 7 MTPA.  With the integration of Corus, the capacity jumped up by 23 MTPA, making the Group the fifth largest steel producer in the world.  Current capacity stands at 31 MTPA.  Tata Steel also owns Jharia coal fields which meet the coal requirements of Tata Steel India.

A global business and operations model

Tata Steel represents a business model which derives sustainability through cost efficiency and growth through globalization.  The company’s domestic orientation, technological sophistication and cost leadership enabled it to continuously lead the Indian steel industry and withstand the recessionary cycles witnessed from time to time, including the global economic crisis of 2008-09.  With the Corus acquisition, in terms of capital deployment and sales the company is well-balanced.  Capital employed and revenues by geographies for Tata Steel, in that order are - India: 28% and 17%, UK:  32% and 34%, EU excluding UK: 26% and 30%, SE Asia: 12% and 12%, and Rest of the World: 3% and 6%.

The turnover of the Tata Steel Group increased by 12% in 2008-09 to Rs 1,473,290 million (USD 30.7 billion; USD 1 = Rs 48). Acquisition of Corus contributed to the significantly enhanced turnover profile of the company.  Stand-alone turnover of the company, Tata Steel India, at Rs 246,240 million was just 16.6% of the Group’s consolidated turnover.  That said, globalization, and in particular the expensive Corus acquisition, took a significant toll on the profitability of the company.  On a standalone basis, the Earnings Before Interest, Taxes and Depreciation (EBITDA) was Rs 90,980 million in 2008-09, compared to Rs 80,810 million of 2007-08, representing an increase of 12.6%, even in a year of recession.  Profit before Taxes (PBT) increased by 10.3% to Rs 73,156 million, while Profit after Taxes (PAT) increased by 11% to Rs 52017 million.  On a consolidated basis, however, EBITDA in 2008-09 was flat at Rs 176,103 million compared to Rs 177,105 million in 2007-08.  Consolidated PBT registered a sharp fall of 59% to Rs 67, 432 million in 2008-09 while consolidated PAT also plummeted by 40% to Rs 49,509 million.

The disparity in the demand profiles of different global markets was evident in terms of Tata Steel’s performance.  The Indian steel division reported an increase of 10% in finished steel production and sales during 2008-09 to 5.231 MTPA while the European finished steel production in 2008-09 dropped by 20% to 16 MTPA.  Sundry debtors at  Rs 6359.8 million were higher by 17% on a standalone basis.  As a percentage of sales, however, the standalone sundry debtors as a percentage of turnover declined marginally from 2.7% in 2007-08 to 2.6%, reflecting the company’s prudent sales and collection policies.  On a consolidated basis too, management of sales and collections reflected prudential principles even in a year of recession.  Consolidated sundry debtors, in fact, declined by 30% to Rs 130,316 million and as a percentage to consolidated sales declined sharply from 14.2% in 2007-08 to 8.8% in 2008-09.  The domestic collection practices were more robust than those of the overseas operations but the progressive discipline that was witnessed in 2008-09 would augur well for the future.

The standalone manpower costs of Tata Steel India increased by a whopping 26.9%, from Rs 18,160 million to Rs 23,060 million in 2008-09.  The consolidated manpower costs, however, increased at a lower rate of 6.4% from, Rs 169,000 million to Rs 179, 750 million, reflecting cost cuts in the overseas operations.  On a standalone basis, turnover to employee ratio (on rupee base) was 10.5 in 2008-09, compared to 10.8 in 2007-08.  This stable turnover to employee cost ratio, despite the 27% increase in employee costs, reflects the high degree of efficiencies achieved in the Indian operations in terms of non-employee costs and also improvements in conversion efficiencies. On a consolidated basis, the value added ratio was 8.2 in 2008-09, compared to 7.8 in 2007-08.  These marginal improvements reflect an effort to optimize employee costs and conversion efficiencies on a global basis.

Manufacture of steel and value added steel products for automobile, infrastructure and industrial sectors is an investment-intensive endeavor. The need for ensuring raw material security through ownership of mines puts an additional pressure.    The fixed assets of the company increased by 8% during 2008-09 to Rs 453,056 million, reflecting a continued asset augmentation policy.  Substantial portion of the fixed assets represent overseas assets in 2:1 ratio (overseas : domestic).  Sales to assets ratio of the standalone operations was 1.7:1 while that of overseas operations was 4:1.  It would appear that the domestic assets need to be sweated much more through enhanced operations on a stand-alone basis. This insight, coupled with the geographical distribution of capital employed and revenue generated brought out earlier, appears contrarian to the general perception that Tata Steel’s domestic operations are one of the lowest cost operations, globally.  New investments in green field and brown field projects in India which have potential to add capacity and turnover and enhance input security could change the profile favorably in future.

The acquisition logic and challenge

Tata Steel’s acquisition driven strategy to leapfrog into global steel arena is a path- breaking one for the Indian industry. After taking 100 years to reach a 7 MTPA capacity, Tata Steel in one sweep quadrupled capacity and derived 65% of its sales from Europe. Tata Steel became the fifth largest producer of steel in the world, up from fifty-sixth position.  Access to some sophisticated technologies and products has also been part of the bargain. The potential benefits of the Corus deal were widely appreciated. Most experts were of the opinion that the acquisition did make strategic sense. Some analysts had doubts about the outcome and effects on Tata Steel’s performance.  They pointed out that Corus’ EBIDTA (earning before interest, tax depreciation and amortization) at 8 % was much lower than that of Tata Steel which was at 30% in the financial year 2006-07.  Whether the price paid of USD 12.1 billion was worth the leap into the Top 5 global league is a matter that will be answered by the company’s performance in a few years. The comment from the chairman of Tata Steel and a few opinions from some industry experts are instructive.

Commenting on the acquisition, Mr Ratan Tata, chairman, Tata & Sons, said, “Together (with Corus), we are a well balanced company, strategically well placed to compete at the leading edge of a rapidly changing global steel industry.”

Mr Vivek Gupta, Managing Director, AT Kearney (India) said, “The financials for this deal (require) high performance levels, perfect post-deal execution and sustained high steel prices.  It is a risky game and will be okay for Tata as long as the economy is growing and no major bumps occur.  If (these bumps) do occur, they can become a challenge, and I am reminded of the high leverage days of the mid-1980s.”

Mr S Mukherji, Managing Director, ICICI Securities said, “Indian steel companies are on a consolidation mode.  The Tata-Corus deal has set many records.  So far, the only $1 billion-plus deal was done by ONGC, and it’s the first milestone for India Inc, with the Tata deal crossing $10 billion mark.  It’s a landmark deal since an Indian company has taken over an international company three times its size.”

Stressing on the synergies that could arise from this acquisition, Phanish Puram, Professor of Strategic and International Management, London Business School said, “The Tata-Corus deal is different because it links low-cost Indian production and raw materials and growth markets to high-margin markets and high technology in the West.”

On the face of it, the multi-pronged strategy adopted by the company to integrate global assets, enhance raw material security, expand the low cost manufacturing base in India and diversify into logistics could take the company into an era of superior cost and supply chain dynamics. The company is setting up new green field projects in Orissa, Chhattisgarh and Jharkhand states, which are rich in natural resources.  In addition, the company has shown remarkable openness to form 50:50 joint ventures with other domestic and global corporations.  BlueScope Steel, Australia (for coated steel and building products), Larsen & Toubro, India (for deep water port in Orissa), NYK Line, Japan (for shipping bulk cargo), Riversdale Mining, Australia (for coking coal), co-investment with Vale, Nippon Steel, JFE and POSCO (for coal mining in Australia), SAIL, India (for acquisition of coal blocks), New Millennium Capital, Canada (for iron ore) and Al Bahaja Group, Oman (for limestone) are some of the joint venture partners.  These multi-pronged initiatives should strengthen Tata Steel significantly in the years to come.

Six strategic drivers

The success of Tata Steel’s acquisition strategy depends on six primary components: cultural exchange, capital structure stabilization, asset integration, value chain optimization, cost leadership and technological differentiation.  These are also essential to cope with the pressure caused by the acquisition in a period of intense global recession.  The leadership of Tata Steel, headed by Mr Ratan Tata, chairman and Mr B Muthuraman, managing director acted with alacrity from the date of acquisition to put in place a framework that meets the six strategic criteria. 

In one of the first acts, post-Corus acquisition, Tata Steel’s leadership team was expanded to include senior leaders from the Corus group.  The leadership team of Tata Steel continuously engaged the Corus team during the pre- and post-/acquisition phases to ensure mutual acceptance and cultural integration.  To smoothen the integration process, a 3-member Group Corporate Centre and a 6 member Group Corporate Function Team was created with representation from Tata Steel Europe (erstwhile Corus).  The senior management team was also expanded to a total of 23, including 5 senior representatives from Tata Steel Europe.  The integration of decision making and operational review and allotment of key functions such as Group strategy to erstwhile Corus executives helped in smoother cultural and corporate integration.  The two Corus executives were also a part of the five member team which constantly interacted with various stakeholders to address their concerns about the recessionary environment and Tata Steel’s response to the crisis and strategy.  Whether the representation for Tata Steel Europe in the leadership team is adequate or additional skills need to be leveraged could be debated further.

The second critical concern relates to capital structure stabilization.  The equity and debt resources had to be significantly expanded (with more debt than equity) to fund and manage the Corus acquisition.  The gross debt in the Tata Steel Group rose dramatically to USD 10.54 billion in March 2008 essentially because of the Corus acquisition while it increased further to USD 11.78 billion by end March 2009 to fund the growth projects in India and to provide adequate liquidity buffer in the recessionary times.  During 2008-09, the debt instruments were restructured for better terms and the foreign currency term debt in Tata Steel India was hedged into rupees to manage payment pressures and exchange volatility respectively.  The debt-equity ratio which increased from a low of 0.06 in 2005-06 to 1.99 in 2007-08 was contained at 1.65 in 2008-09.  Considering that the company operated at similar high debt-equity levels in the past but managed to improve the situation to a zero debt level eventually, one may expect the company to be successful once again, provided a few other concerns are effectively addressed, as below.

The third important concern is with reference to asset integration.  With Corus acquisition, the assets of Corus accounted for more than thrice the asset base of the original Tata Steel.  Clearly therefore integration of asset base, with implications in terms of paring down of overlapping assets and divesting obsolete assets and building up of required, niche assets in a major challenge.  While several actions were underway at Corus from 2003 to optimize assets, the economic crisis and the acquisition provided a major push to implement a much more aggressive asset restructuring at Corus plants.  Closure of 4 plants, mothballing of 2 plants out of the 15 plants of Corus group was a primary action.  In addition, enhancement of efficiencies and reduction of overheads were taken up at each unit to enhance asset competitiveness.

The fourth plank of the strategy relates to value chain integration.  One of the premises of Corus acquisition was that Tata Steel India would be in a position to provide low cost, high quality crude steel to Tata Steel Europe for conversion into value added products.  This would emerge from a global product-market portfolio plan and integrated supply chain management.  This apart, ensuring raw material security is an essential component of strategy from risk management and value chain perspectives.  Raw material self-sufficiency of the Group reduced to 25% of the requirements post Corus acquisition.  While the current plans envisage enhancement in material sufficiency to 50%, a more aggressive mining and minerals strategy could be required to ensure value chain economics and achieve requisite production assurance.  In addition, tighter integration of the various overseas ventures in the end-product space would be essential for more optimal matching of production and sales profiles across the globe.

Cost leadership is the fifth essential requirement for Tata Steel to enhance its global competitiveness.  Focusing essentially on the high cost, high asset European operations, the Group has taken up “Weathering the Storm” and “Fit for the Future” programs to ensure cost competitiveness in an environment of changed realities.  These comprise a host of measures for asset restructuring, manpower rationalization, overhead review and efficiency enhancement.  Together these programs are believed to have resulted in more than USD 1.2 billion in cash savings to the group during the year.  Durable increases in cost economics would, however, occur only when technology driven cost savings are achieved.  These would relate to better quality of input raw materials, better combustion and conversion efficiencies, energy-efficient operations, reduction of carbon footprint and tighter inventory control through global supply chain management.  Initiatives of continuous improvement in shop floor, logistics and commercial operations need to be combined with break-through initiatives in process and product technologies, for which a more comprehensive plan probably needs to be still developed.

While Tata Steel could be seen have already covered a significant ground on the above five issues, the strategy on the sixth dimension of technological differentiation is still somewhat abstract.  The technological equity enjoyed by Tata Steel’s products relate to their robust specifications and high quality with reasonable costing, together providing considerable value to the customer.  This, however, cannot be the same as a clear technological differentiation in terms of first-in-class products for the market place.  Tata Steel spends only Rs 415.9 million on R&D, which account for just 0.17% of the company’s total turnover.  Clearly, Tata Steel needs to take a quantum jump in R&D expenditure to undertake fundamental research in new material technologies, new coating technologies, nano-functional materials and fluids and material characterization technologies (to name a few areas) in order to ensure a truly differentiated technological position.

In addition, industry specific research needs to be undertaken to dovetail or even proactively lead product development in other industries through first-in-class or best-in-class steel technologies.  Achieving technological leadership through enhanced R&D effort and commitment of requisite resources is a strategic lever that must be put in place by Tata Steel as soon as possible. 

In sum, Tata Steel has accomplished an incredible feat by catapulting itself into the global steel arena as a Top 5 steel producer through the Corus acquisition.  The sustainability of this strategy has been tested by the global economic recession that hit the steel industry suddenly and adversely in 2008.  It is clear that Tata Steel’s strategic initiatives for cultural integration, capital stabilization, asset integration, value chain optimization and cost leadership are firmly in place and have helped the company weather the storm.  Reinforcement of these strategic initiatives with the sixth essential component of technological differentiation based on higher R&D effort would help Tata Steel achieve an unassailable position in the global steel industry.

Posted by Dr CB Rao on September 26, 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 cbrao2008.blogspot.com) 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

Global Recession and Indian Response - 1: The Case of Maruti Suzuki

The 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 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. 

The author examines in a series of papers, the first of which is this paper, as to how Maruti Suzuki, India’s leading automobile manufacturer responded to the situation.

Maruti Suzuki – the small car titan

Maruti Suzuki India Limited (Maruti Suzuki) requires no introduction. Maruti Suzuki was set up on 14th December 1983, in collaboration with Suzuki Motor Corporation, Japan, which was an innovator in small car technology. Maruti Suzuki revolutionized the Indian automobile industry with its small cars and vans, and provided unprecedented choice to the Indian automobile user, consistently from the 1980s. Set up to produce 100,000 cars a year the company grew by leaps and bounds to reach a production capacity of a million cars a year by 2009. Maruti has become an icon of India’s industrial capability with four plants, nineteen related companies, several hundred dealers, vendors, service entities and business associates.

Despite the entry of several global automobile majors into India and the foray by India’s own leading truck and bus maker, Tata Motors, into the car sector, Maruti continues to hold an impressive market share of  55% in cars and vans. The company has sold over 7 million cars cumulatively and despite the domestic orientation exported over 500,000 cars cumulatively.

Like every other company, Maruti Suzuki was buffeted by the adverse economic developments of 2008 and 2009. Recession hits automobile markets rather instantly and intensively, with sharp curtailment of automobile finance and postponement of automobile purchases by individuals and institutions. The car industry did register a healthy growth of 15% in physical sales during Q1 of FY09 but saw the growth plummet to 0.5% in Q2 and then to a negative growth of 15.5% in Q3. The growth recovered to 1.6% in Q4. In the overall for the year, it was creditable that Maruti’s vehicle sales increased by 1.6% to 792,167 and the total income increased by 14.3% to Rs 214,538 million (USD 4.47 billion; USD 1 = Rs 48).

Yet, given the growth impetus that existed in the company, total expenditure increased faster by 17.6% to Rs 187,610 million,  Earnings before interest, depreciation, tax and amortizations (EBIDTA) reduced by 22.3% to Rs 24,333 million, Profit before tax (PBT) reduced by 33.1% to Rs 16,758 million and  Profit after tax (PAT) reduced by 29.6% to Rs 12,187 million. Three other critical parameters of performance showed interesting trends. Inventories declined by 13.1% to Rs 9,023 million and sundry debtors understandably increased by 40.2% to Rs 9,189 million.

Fixed assets increased by 22.3% to Rs 49,321 million, given the significant capacity creation that was effected. Given that around 75% of the company’s components are outsourced working capital management plays a key role. It is significant that the company’s inventory turnover ratio increased significantly increased from 15.7 in FY08 to 16.7 in FY09 while the average receivables holding period increased only marginally from 12.2 days in FY09 to 12.4 days in FY09.

Sound finances and robust strategies

The manner in which Maruti Suzuki withstood the recession underlines the fact that a cumulative set of virtuous strategies can help a company withstand the volatility of economy and the vicissitudes of business. Being virtually debt free and enjoying healthy cash balances (Rs 44,907 million), the company’s ability to fund growth from internal generations has laid a solid financial foundation for operational resilience. The company consistently followed prudent financial policies whether relating to dealer incentives or vendor payments which helped the company to build strengths in these two vital stake holders. In addition, continuous efforts at cost cutting and productivity improvement, even in good times, helped the company make reasonable profits despite the higher commodity prices and a weaker rupee. The company recorded complete capacity utilization and provided full employment to its workforce despite the recession.

Maruti Suzuki’s strength lies in its emphasis on product-market equity. Continuous expansion of product range (8 new models in 40 months; a new car and a new engine in the year of recession), focus on product quality, service infrastructure and customer connectivity. Maruti’s products continuously rank high in J D Power surveys on excellence in automotive performance as well as in customer satisfaction. The company’s continuously expanding distribution network of 681 sales outlets spread over 454 cities and towns, 315 pre-owned car outlets in 181 cities and towns, and 2767 service workshops across 1314 cities and towns remains the bulwark of a foresighted marketing strategy that the company steadfastly pursued. A network of over 50 driving schools further reinforces customer connectivity.

Maruti is perhaps one of the leading companies with an integrated operational excellence model. The Japanese parentage has, no doubt, 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.

Organizing for core competencies 

A forward looking organization innovates in organization design to ensure core competencies for a sustainable future. A competent board that comprises the representatives of Suzuki, the parent, the full time executive directors of Maruti Suzuki and eminent retired CEOs of leading Indian companies as independent directors brings scholastic vision to the company. A business and operations team well honed in the Japanese management techniques provides business and operational efficiency.

Simplicity in organizational design leads to focus, empowerment, responsibility and accountability, and results in superior performance. The latest Maruti organization design comprises five verticals: marketing & sales business vertical, production business vertical, supply chain business vertical, engineering business vertical and administration business vertical. Each is headed by two managing executive officers, one of whom is also a board member. Together with the MD & CEO they constitute the core leadership team. This unique system has enhanced decision speed, execution agility and business performance in the company.

Each business vertical has its task cut out. The marketing & sales business vertical has the task of strengthening the sales and service infrastructure, increasing the reach to rural markets on one hand, and entering relatively untapped urban segments such as taxi and institutional markets on the other. The production business vertical has the task of enhancing manufacturing standards to higher and more exacting levels.  Reducing line change set-up time, which was reduced from 7 days to current 1.5 days, to even lower levels is a key factor for manufacturing flexibility. Balancing automation and human intervention is a particularly relevant factor.

The supply chain business vertical has a major task in terms of enhancing localization and upgrading quality continuously. The engineering business vertical has perhaps the most exacting task of building a total engineering capability to develop new models with granular cost points. The administration business vertical which provides corporate services has the tasks of enhancing human resources base, leveraging information technology, framing financial framework and assuring corporate governance. The combined set of objectives of these five business verticals constitutes Maruti’s quest for future, which Maruti calls as quest unlimited.

Sufficient for today and superior for future?

There is no doubt that by charting through the recessionary waters successfully Maruti Suzuki has demonstrated its strengths and capabilities. These have been a result of the typical hands-on Japanese approach of focusing on fundamentals and continuously enhancing competitiveness through kaizen. Maruti Suzuki brought a new wave of world class industrialization to India, long before the economy was liberalized in the 1990s. Should Maruti Suzuki be content with retaining its exemplar role or play a pioneering role once again? Is Maruti conceptualizing the necessary strategies and building the enabling competencies for such a breakthrough iconic role again? Will Suzuki’s tight ownership and management offer an opportunity or pose a constraint in such an endeavor?

Industrial scenario in India is significantly different from what existed in the early 1980s when Maruti Suzuki entered the country. At that time Maruti with the technological  backing of Suzuki and a creative leadership team led a technological and business revolution in the automobile industry, virtually single handed. Today, however, industrial competencies are resident in a much wider spectrum of companies and the competitive dynamics are far more complex. Launch of an indigenously designed micro car, Nano, by the very Indian Tata Motors reflects the maturing of skills in the Indian industry.

Maruti’s FY09 Annual Report discusses the enhanced design and engineering competencies the company now has. There is no evidence, however, in the report that the company is geared to design and develop a whole new automobile by itself. Maruti’s R&D expenditure at 0.42% of the sales turnover is hardly sufficient to design and launch a new car. While it is commendable that the engineering talent base has been virtually doubled to 730 people in just one year (FY09) and would be increased to 1000 people by 2011, the potential to further harness Indian engineering talent to design new cars and vans needs to be more comprehensively leveraged. Higher levels of capital and revenue expenditure in the R&D domain are called for.

Clearly, India is emerging as a global hub for small car production, an initiative ironically is being led by Hyundai Motor, which never believed in small cars until it entered India. In contrast Suzuki Motor was a pioneer in small car design and manufacture for decades. Perhaps, Maruti Suzuki India Limited and Suzuki Motor Corporation need to develop a new global strategic plan for small car design and manufacture for global needs. The plan could also focus on the van segment which could lead a new revolution in intra-city movement of goods and passengers.

It is clear that a focused business model with technological strengths and management efficiencies has assured market and financial leadership for Maruti Suzuki, even in the toughest of the times. Strong fundamentals should therefore continue to ensure a vibrant future for the company.

Posted by Dr CB Rao on September 21, 2009