Discuss capital and labour productivity in engineering

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Reference no: EM13218420

Companies that attend to productivity and growth simultaneously manage cost reductions very differently from companies that focus on cost cutting alone and they drive growth very differently from companies that are obsessed with growth alone. It is the ability to cook sweet and sour that under grids the remarkable performance of companies likes Intel, GE, ABB and Canon. In the slow growth electrotechnical business, ABB has doubled its revenues from $17 billion to $35 billion, largely by exploiting new opportunities in emerging markets. For example, it has built up a 46,000 employee organization in the Asia Pacific region, almost from scratch. But it has also reduced employment in North America and Western Europe by 54,000 people. It is the hard squeeze in the north and the west that generated the resources to support ABB's massive investments in the east and the south. Everyone knows about the staggering ambition of the Ambanis, which has fuelled Reliance's evolution into the largest private company in India. Reliance has built its spectacular rise on a similar ability to cook sweet and sour. What people may not be equally familiar with is the relentless focus on cost reduction and productivity growth that pervades the company. Reliance's employee cost is 4 per cent of revenues, against 15-20 per cent of its competitors. Its sales and distribution cost, at 3 per cent of revenues, is about a third of global standards. It has continuously pushed down its cost for energy and utilities to 3 per cent of revenues, largely through 100 per cent captive power generation that costs the company 4.5 cents per kilowatt-hour; well below Indian utility costs, and about 30 per cent lower than the global average. Similarly, its capital cost is 25-30 per cent lower than its international peers due to its legendary speed in plant commissioning and its relentless focus on reducing the weighted average cost of capital (WACC) that, at 13 per cent, is the lowest of any major Indian firm.

A Bias for Growth

Comparing major Indian companies in key industries with their global competitors shows that Indian companies are running a major risk. They suffer from a profound bias for growth. There is nothing wrong with this bias, as Reliance has shown. The problem is most look more like Essar than Reliance. While they love the sweet of growth, they are unwilling to face the sour of productivity improvement.

Nowhere is this more amply borne out than in the consumer goods industry where the Indian giant Hindustan Lever has consolidated to grow at over 50 per cent while its labour productivity declined by around 6 per cent per annum in the same period. Its strongest competitor, Nirma, also grew at over 25 per cent per annum in revenues but maintained its labour productivity relatively stable. Unfortunately, however, its return on capital employed (ROCE) suffered by over 17 per cent. In contrast, Coca Cola, worldwide, grew at around 7 per cent, improved its labour productivity by 20 per cent and its return on capital employed by 6.7 per cent. The story is very similar in the information technology sector where Infosys, NIIT and HCL achieve rates of growth of over 50 per cent which compares favorably with the world's best companies that grew at around 30 per cent between 1994-95. NIIT, for example, strongly believes that growth is an impetus in itself. Its focus on growth has helped it double revenues every two years. Sustaining profitability in the face of such expansion is an extremely challenging task. For now, this is a challenge Indian InfoTech companies seem to be losing. The ROCE for three Indian majors fell by 7 per cent annually over 1994-96. At the same time IBM Microsoft and SAP managed to improve this ratio by 17 per cent. There are some exceptions, however. The cement industry, which has focused on productivity rather than on growth, has done very well in this dimension when compared to their global

counterparts. While Mexico's Cemex has grown about three times fast as India's ACC, Indian cement companies have consistently delivered better results, not only on absolute profitability ratios, but also on absolute profitability growth. They show a growth of 24 per cent in return on capital employed while international players show only 8.4 per cent. Labour productivity, which actually fell for most industries over 1994-96, has improved at 2.5 per cent per annum for cement.

The engineering industry also matches up to the performance standards of the best in the world. Companies like Cummins India have always pushed for growth as is evidenced by its 27 per cent rate of growth, but not at the cost of present and future profitability. The company shows a healthy excess of almost 30 per cent over WACC, displaying great future promise. BHEL, the public sector giant, has seen similar success and the share price rose by 25 per cent despite an indecisive sensex. The only note of caution: Indian engineering companies have not been able to improve labour productivity over time, while international engineering companies like ABB, Siemens and Cummins Engines have achieved about 13.5 per cent growth in labour productivity, on an average, in the same period. The pharmaceuticals industry is where the problems seem to be the worst, with growth emphasized at the cost of all other performance. They have been growing at over 22 per cent, while their ROCE fell at 15.9 per cent per annum and labour productivity at 7 per cent. Compare this with some of the best pharmaceutical companies of the world - Glaxo Wellcome, SmithKline Beecham and Pfizer -who have consistently achieved growth of 15-20 per cent, while improving returns on capital employed at about 25 per cent and labour productivity at 8 per cent. Ranbaxy is not an exception; the bias for growth at the cost of labour and capital productivity is also manifest in the performance of other Indian Pharma companies. What makes this even worse is the Indian companies barely manage to cover their cost of capital, while their competitors worldwide such as Glaxo and Pfizer earn an average ROCE of 65 percent. In the Indian textile industry, Arvind Mills was once the shining star. Like Reliance, it had learnt to cook sweet and sour. Between 1994 and 1996, it grew at an average of 30 per cent per annum to become the world's largest denim producer. At the same time, it also operated a tight ship, improving labour productivity by 20 per cent. Despite the excellent performance in the past, there are warning signals for Arvind's future. The excess over the WACC is only 1.5 per cent, implying it barely manages to satisfy its investor's expectations of return and does not really have a surplus to re-invest in the business.

Apparently, investors also think so, for Arvind's stock price has been falling since Q4 1994 despite such excellent results and, at the end of the first quarter of 1998, is less than Rs 70 compared to Rs 170 at the end of 1994. Unfortunately, Arvind's deteriorating financial returns over the last few years is also typical of the Indian textile industry. The top three Indian companies actually showed a decline in their return ratios in contrast to the international majors. Nike, VF Corp and Coats Viyella showed a growth in their returns on capital employed of 6.2 per cent, while the ROCE of Grasim and Coats Viyella (India) fell by almost 2 per cent per annum. Even in absolute returns on assets or on capital employed, Indian companies fare a lot worse. While Indian textile companies just about cover their WACC, their international rivals earn about 8 per cent in excess of their cost of capital.

Questions

1. Is Indian companies running a risk by not giving attention to cost cutting?

2. Discuss whether Indian Consumer goods industry is growing at the cost of future profitability.

3. Discuss capital and labour productivity in engineering context and pharmaceutical industries in India.

4. Is textile industry in India performing better than its global competitors?

Reference no: EM13218420

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