L&T's Naik: Not one to rest on laurels, the CMD is focussing on cutting costs and improving margins in the construction group within a two-year time frame

The façade of Larsen & Toubro (L&T) house, a stately brownstone mansion in Ballard Estate, Mumbai's colonial era business district, conforms to the architectural style of its neighbours-they were all designed by the same architect (one George Wittet) in the European Renaissance style to ensure uniformity. It's more than just passing trivia to note that most of the other corporate headquarters in the district remain family-run businesses to this day. But more on that later...

Inside the building, the dimensions of the hallways (and the foghorns of ships anchored in the neighbouring docks) are like a step back in time. One barely has time to soak in the sight of polished teakwood and cane boardroom chairs when A.M. Naik, 63, Chairman and Managing Director of l&t, strides in, shattering the genteel, old world ambience with his here and now aggression.

This reporter has to field a volley of questions on the hows, whats, wheres and whys of the Business Today Best Managed Companies survey, before attempting a few of her own. Naik is an old l&t hand who's been there, done that, and most importantly, believes in straddling the here and now as well. Having joined the company as a junior engineer some 40 years ago, he has risen through the ranks.

Seamlessly rolling l&t's past, its future strategies and the odds that the management has had to battle over the years into one comprehensive low-down on the company, Naik spells out clearly where l&t is coming from and where it is headed. "You are probably too young to even conceive of what the license era was like. Who got what licenses and how policies were framed all depended on the maliks of Indian businesses; we were just professionals with next to no clout. I remember we wanted to make boilers, turbines, offshore platforms and earth moving machinery... every licence application was rejected under public sector opposition. It makes me unhappy when I think where l&t could have been if...," he reflects.

That pretty much sums up how l&t is genetically different from its neighbours in Ballard Estate, almost all of whom are controlled by business families. But why the fuss about licences today? Simple! The company lost the opportunity to gain expertise and scale up operations in crucial business segments.

Leadership @L&T: (Front row L to R) M.V. Kotwal, Sr. VP (Heavy Engineering); Y.M. Deosthalee, Director & CFO; A.M. Naik, CMD; K.V. Rangaswami, Sr. VP (Construction); and J.P. Nayak, Director & President (Operations). Back row (L to R) K. Venkataramanan, Director & President (Operations); V.K. Magapu, Director & Sr. VP (IT & Technology Services); and R.N. Mukhija, Director & Sr. VP (Operations)

When Naik took over as Chairman in 1999, he had his task cut out-l&t was a lumbering giant with no less than 65-odd businesses across 12 verticals. It was growing steadily and had an excellent dividend record, but its share price had remained range-bound at Rs 170-180 levels for almost a decade. "Yes, we 'Made The Things That Made India Proud' and were the 'Builders to the Nation' and all that, but our share price didn't reflect this. Much of our growth had come in the earlier protected environment, but we had to learn to survive in a competitive environment-where someone is butchering someone else all the time," says Naik.

The management set about the task of changing the l&t mindset, particularly on the issue of shareholder value. This led to the company's first Vision Statement in 1999 (see Best Practice). "Everyone was required to look at value creation. It could be operational excellence, better use of working capital or even looking at new geographies-the efficacy of any new idea was (and is) measured using the return on capital employed (roce) and debt-equity parameters. Over the last three years, the roce has gone up markedly and debt is down from 1.07 times equity to 0.3 times equity in the same period," says Y.M. Deosthalee, cfo, l&t.

But how much of these financial gains are related to the demerger of l&t's Rs 2,600-crore cement division? "It didn't have much effect on the debt-equity ratio since cement was never a huge user of working capital. We were down to 74 per cent (debt-equity) even before the demerger," explains Deosthalee.

The company is not resting on its laurels. "Effective costs need to be brought down to a level where they are half a percentage point lower than the competition's. To do this, we are looking at costs across materials, overheads and labour," says Naik, adding: "This year, we have launched a two-year programme to bring down costs and improve the margin in the construction group from 6-6.5 per cent to 8 per cent. The goal is clear: I don't want only growth; I want profitable growth; I want return on capital."

L&T has also launched an extensive business rationalisation process that will kick off with the unveiling of the company's next strategic plan next month. This will involve the sale of businesses in the Rs 50-100-crore range and the acquisition of others that complement its core competence. About 65 businesses will come under the microscope. "It will be a continuous portfolio review. You will hear something on this rationalisation every second or third month," says Naik.

The company's largest business is the Engineering & Construction (e&c) Division, which comprises construction, e&c projects and heavy engineering and contributes 83 per cent to l&t's Rs 11,000-crore turnover. The Electrical & Electronics (e&e) Division accounts for 10 per cent of sales. Others (including infotech) make up the remaining 7 per cent. "Currently, the mix at the e&c Division-which includes both manufacturing and projects-is skewed in favour of the latter. We plan to plan to rejig this portfolio to get a more even balance; in the next four-five years we are looking to earn a greater proportion of our revenues from it, e-engineering and embedded software services," says Deosthalee.

There are sound business and financial reasons for this. Turnkey projects, typically, introduce an element of volatility into earnings, given that they involve time and cost management by the company. This, coupled with global competition, means that maintaining margins-rather than the more desirable growth of margins-can itself become a challenge. Thus, the growing emphasis on services! Deosthalee expects this initiative to "increase margins by 1-1.5 per cent across the company" in the next four-five years.

The bigger picture is also very much in place. "By the end of this period (four-five years), 60 per cent of sales should come from turnkey projects and construction compared to 70 per cent now, 25 per cent should come from manufacturing-which includes the e&e Division-up from 16-17 per cent now, and the balance from it, engineering and embedded software against their current contribution of 4-5 per cent," he informs.

BEST PRACTICE

Global foray: Acrylonitrile reactors made by L&T are headed for a plant in China Larsen & Toubro went on a value creation drive in 1999. A massive interactive process involving 7,500 people generated the company's first vision statement. Value creation was at the core of the philosophy and was defined differently for different constituents of the "value tree"-and ranged from operational excellence, to better use of working capital or even tapping new geographies. "We involved people down to the supervisor level in this process so they understood exactly how they could make a difference," says Y.M. Deosthalee, cfo, l&t. The results are already visible: Strict monitoring of working capital has resulted in a doubling of the asset-turnover ratio in the last four-five years. l&t has been climbing steadily up the value chain-from fabrication and construction projects to engineering and project management. It is now gunning for a presence in technology-intensive projects to differentiate itself from scores of smaller players that take up construction and fabrication jobs. "We focus on quality growth and outsource jobs that don't require major engineering talent to smaller companies," says K. Venkataramanan, President (Operations), l&t. The company has also adopted a crucial de-risking strategy through geographical diversification. "Our revenues had remained stagnant between 1998 and 2001. The overall investment level in the country was low and we had to compete with international majors in the domestic market; so we embarked on a strategy to create a global footprint, thus insulating ourselves against the vagaries of the Indian market," says Deosthalee. L&T is making an aggressive foray into the international markets, particularly in the manufacturing space. Its heavy engineering division's order book has grown 55 per cent in the last year alone and its Hazira Works was recognised as a "Most Valuable Supplier" by Fluor Daniel, a major US-based EPC contractor.

The company is also climbing up the value chain within the e&c business. Explains K. Venkataramanan, President (Operations), l&t: "There is an increasing degree of complexity (in skill sets) as you move up from construction and fabrication into engineering, project management and technology-based projects. And as India enters a massive growth phase, we are moving away from the construction and fabrication orbit into engineering and project management."

His answer should pacify investors who are growing concerned over margins. "The company needs to differentiate itself from others. In construction, there are at least 15-20 smaller players who can execute the large projects l&t does," says an analyst with a domestic brokerage firm.

In the last five years, it has aggressively moved into the West Asian construction and turnkey project market. "The strategy has been to treat West Asia as an extension of India. In construction and turnkey projects, we have a presence in seven West Asian nations, Bangladesh, Nepal and Sri Lanka," says Naik, adding that he expects to have an l&t House in Abu Dhabi within the next two years. In addition, the company has bagged heavy engineering orders worth Rs 275 crore from the us in the last 10 months alone. China is another focus market. l&t will open an office in Beijing this May. "We have already sold high tech equipment worth Rs 700 crore in China and I am targeting Rs 500 crore sales there this year," says Naik. This global foray is beginning to pay off: Five years ago, international sales contributed next to nothing to the company's turnover; they now account for about 17 per cent of revenues. The goal is to step this up to 25 per cent by 2009-10.

Overseas turnkey and construction projects could mean lower margins for the time being, but "they will improve as we establish more beachheads", assures Venkata-ramanan. He adds, "The important thing is to guard our turf in India. Global companies are entering India and China. There will be qualitative changes in requirements as massive infrastructure projects are launched. We have begun to prepare for that scale. Even now, we are the only Indian company operating in several of the niches we occupy; the others are all multinationals. In that sense, you could call us the 'national champions'."

National champion it may be, but it still faces some major risks and challenges. Key among them will be the ability to attract the best talent and manage the attrition of top performers. Also, the sizes of most of its businesses are still quite small by world standards. This raises questions about their global competitiveness.

How it addresses these issues will decide if the "national champion" can go on to become a world beater. For now, investors can rest assured that its domestic turf is reasonably well protected.