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CASE STUDY Breaking the Commodity Barrier "I was quite disturbed by the resignation of my CEO, Mangesh Rai. I wondered whether we would be able to sustain the remarkable turnaround that he had achieved single-handedly. Cost-management was clearly his forte. Had he continued, we would have all been called the Neutron Jacks of the industry because of our downsizing exercises. I remember what Mangesh had told me once: `Lean is fine, but we need to make the customer the centre of our universe. After all, industrial gases is a commodity business; product differentiation is going to be tomorrow's competitive advantage.' It was with that understanding that I have hired Harpreet Duggal, a marketing and operations professional, as his successor. For an outsider, he has a good understanding of our business. I wonder whether he will be able to convince my senior managers about the need for developing new product applications, modernising our plants, and, crucially, improving customer service. And will my team repose the same faith in the new leader as it did in his predecessor?" A thoughtful Anirudh Desai, Executive Vice-Chairman, Hooper Gas India, was envisioning a new era for his company on the eve of its Executive Committee Meeting. Kvaerner Powergas' S. Rama Iyer and Grasim Industries' P. Ramakrishnan chalk out a path for the new CEO. A BT Case Study. OCCASION: Weekly Meeting of Hooper Gas India
Ltd's (HGIL) Executive Committee Anirudh Desai: Good morning, gentlemen. What I have to say will disturb you. I have just learnt that our company has lost the bid for setting up an on-site air-separation unit for the public sector enterprise, Steel India. The contract, valued at Rs 175 crore, has been won by PristineAir, a global gas major, which has been in the country for less than 6 months. Surprisingly, we lost the bid on price I am sorry for unsettling you, but I have some good news too. Let me welcome Harpreet Duggal, who has just joined us today as our new managing director. He will replace Mangesh Rai, who resigned last week; after managing our remarkable turnaround between 1991 and 1995. Harpreet has had a distinguished track-record in the fast-moving consumer goods industry in both marketing as well as operations. His 15-year-long career has been largely spent with a transnational. So, he understands the dynamics of the relationship between a parent and its subsidiary rather well. During my last few meetings with him, he has constantly talked about the need to add value to the customer, especially in a commodity business like ours. I am sure we will benefit from his expertise Harpreet Duggal: Thank you, Mr Desai. I have been watching HGIL's progress for some time now. I am aware that the company--the undisputed market-leader in industrial gases for 5 decades--has had some problems since 1985, when the industry was deregulated. Faced with stiff price competition from low-cost operators, HGIL's fortunes have declined Suryakanth Rao: But the company is now back on an even keel. Our profitability did hit a record low of Rs 25 lakh on sales of Rs 168.36 crore in 1989-90. The net margins that year, in other words, were a bare 0.14 per cent. However, our half-yearly profits for the period ending September, 1996, stood at Rs 32.32 crore, yielding a margin of 15.80 per cent. Our reserves have almost trebled: from Rs 19 crore in 1991-92 to Rs 53 crore in 1995-96. Another positive indication is HGIL's scrip-price, which, till recently, quoted at Rs 38. It is now ruling at Rs 70 Duggal: Still, my mandate, as I understand, is two-fold: consolidating the impressive gains from the turnaround, and preparing the company to withstand global competition. I think we first need to identify our priorities. So, I would appreciate a brief on the company's history, its turnaround, and its prospects. That will enable us to look at issues in their right perspective Arun Nagarkar: Allow me to provide the update. We manufacture various types of industrial and medical gases--such as oxygen, nitrogen, and argon--with a capacity of 400 tonnes per day in 16 locations across the country. We are a subsidiary of the Connecticut (US)-based $58-billion (Rs 2,43,600 crore) Hooper Gas Inc., which has had a 49 per cent stake in HGIL since 1948. Being the first full-fledged gas company to be set up in India, HGIL had a headstart that helped it retain its market-leadership for decades. We had a 45 per cent share of the industrial gases market in 1985, which has now come down to 25 per cent. We still have the largest marketshare--our nearest competitor has only a 15 per cent share--but that is hardly any consolation. The gradual erosion of our leadership is a matter of grave concern Desai: We are facing a number of threats: the government has allowed foreign direct investment in the gas sector, and a number of transnationals are now eyeing the Indian market. Some of them are already here: Air Products Inc. of the US has tied up with Industrial Oxygen; Lifeline Gases of Malaysia has an alliance with Shangrila Gases; PristineAir GmbH of Germany has acquired a stake in Bharat Gas; and Air Liquide of France, ags of Sweden, and Nippon Gas of Japan are all here in some form or the other. And many more are likely to gain a foothold, sooner rather than later Nagarkar: Getting back to what I was saying, 1985 was a watershed year. That was the first time HGIL faced competition in its 40 years of market dominance. The deregulation of the industrial gases industry led to the flooding of the market; as many as 200 small gas units quickly set up shop. While these units could not, of course, measure up to us in terms of product quality, they fared better because of their proximity to the customer. The customer gained too since transportation accounts for more than 50 per cent of the product costs in our business HGIL failed to read the market signals. Between 1985 and 1990, our profits after tax nose-dived from Rs 4.06 crore to Rs 25 lakh. Worse, we were almost 20 years behind in terms of technology. Used as we were to a monopoly, we did not pay adequate attention to technology-upgradation nor did we develop a market focus. The company had set up plants in places like Guwahati and Kanpur, which increased our transportation costs. And, to top it all, the company was over-staffed; personnel expenses accounted for more than 20 per cent of HGIL's sales. And our fixed costs were close to 25 per cent, further squeezing our margins. It was during these troubled times that Hooper Inc. lost interest in India, and was keen on selling off its stake in HGIL. That, definitely, had a demoralising effect on our operations Girish Rangan: The situation was too bad to be addressed by short-term measures. We had to overhaul our entire operations. Accordingly, we re-examined our business portfolio. Between 1950 and 1980, welding products was an important Strategic Business Unit, accounting for about 35 per cent of the turnover. Worldwide, welding was a crucial business for the Hooper Group as well. However, in the early 1980s, the group decided to sell off the welding business as it did not classify as its core business, which included gas and gas-related products, healthcare equipment, and vacuum technology. Hooper Inc. was, thus, selling off its welding ventures one by one in the UK, the US, and Australia. So, our decision to rightsize was helped by our parent's initiative to get the right business focus. Following this strategy, HGIL sold off its welding division to Pelmel India, a subsidiary of the Stockholm-based Pelmel--the world's largest welding company--in December, 1992. This was necessary not only because of its irrelevance to HGIL's core business, but also because huge investments in technology were required to make the business profitable. For instance, Pelmel pumped in about Rs 30 crore immediately after the acquisition to modernise the plant; we couldn't have afforded that. One key strategy we adopted during the 1980s to improve our operating efficiency was the pruning of our workforce. We had no choice but to make the organisation lean. Our survival depended largely on our ability to reduce our huge wage-costs. But we had 2 major problems: a trade union that opposed manpower reduction, and a traditional managerial mindset that did not favour change Himanshu Roy: Bottomline management finally got our attention over all the other organisational issues. So, in 1989, we embarked on a Voluntary Retirement Scheme (VRS) at Hooper Inc.'s insistence, which, after we divested the welding division, was beginning to show interest in our re-organisation. Our target was to reduce the workforce from 5,200 to about 1,500 by 1995. The numbers involved made it one of the most drastic flab-cutting exercises in the country. The challenge was all the more daunting as the company was always known to be a benevolent employer. The message, however, was unambiguous: HGIL had to shrink before it could show signs of growth. Fortunately, the VRS didn't run into rough weather mainly because of the generous compensation package it offered. HGIL ensured that even the lowest-paid worker got an exit package of Rs 2.25 lakh. The impact on the bottomline was immediate: wage costs, which stood at 21.30 per cent of sales in 1989, dropped to 15 per cent in 1991. It stands at 11 per cent today, but we should, ideally, bring it down to 8 per cent. Incidentally, the industry norm is 3 per cent. Of course, the sale of the welding business also benefited HGIL since 1,600 employees went off the company's rolls in 1991 in one fell swoop Rao: In fact, HGIL's cost-containment drive involved not only downsizing, but also the reduction of administrative expenses, energy consumption, and raw material costs. The process was all-embracing as we were in a hurry to shed the indifference to costs that a monopoly had bred. For instance, the power bills in the welding division accounted for 65 per cent of the production costs although the industry norm was just about 40 per cent. With the successful initiation of the VRS and a new business focus, we began to address the other weak link in HGIL's value chain: technology. With the Rs 35 crore generated by the sell-out of the welding division in our kitty, we went in for technological upgradation, building information-processing facilities and modernising our manufacturing. These initiatives helped slash our power consumption by 25 per cent. We have modernised our old, high-pressure, air-separation plants; we now have low-pressure plants at all our on-site locations. They consume 40 per cent less power and are responsible for bringing down costs. Now, 75 per cent of our capacity is based on on-site tonnage technology. In the next 4 years, we hope to reach the 90-per cent level, which will slash costs further and make us globally competitive Desai: A company which was fat, flat-footed, and on the verge of making losses has now become a lean, fast-moving, profit-making company. The recovery wasn't easy and, by no means, painless. Our efforts haven't gone unnoticed at the head-office. In 1993, Hooper Inc., expressed its interest in raising its stake to 51 per cent. It was a clear vindication of our turnaround. That investment of Rs 27 crore helped us reduce our debt burden and interest payouts. This was crucial as HGIL's debt-equity ratio had risen to 1.51:1. Which was gradually restored to the comfortable level of 0.4:1 in 1994. As its prodigal child improved, the parent returned to integrate it with the Hooper family worldwide Rao: As 1996 draws to a close, HGIL needs to consolidate its gains after one of the most difficult turnarounds in corporate India, and embark on a journey of growth. We must link the new growth phase with the long-term trends in the gas industry. Take, for example, the nitrogen-oxygen ratio in the developed economies, which stands at 80:20. In India, the ratio is just the reverse. But, in future, it is definitely going to change in favour of nitrogen, which we must factor into our strategic plans. The industries that use nitrogen heavily--such as petrochemicals, food-processing, chemicals, and electronics--are all set to grow exponentially. We must address those needs. In the medium term, however, there will be a spurt in the demand for oxygen, fuelled by the growth in the steel and the construction sectors. Essentially, our target industries should be steel, petrochemicals, and chemicals Duggal: I think we should also identify the drivers for corporate growth. These are cost competitiveness, quality, and consumer satisfaction. The best approach, perhaps, is to enter into strategic alliances with each of our end-users. We should step up our interaction with the user-industries to establish the process parameters, and develop indigenous applications for gas-based technologies. But isn't the merchant segment (the open-market sale of gas cylinders) the most profitable business in the industry? Rao: It was--until the industry was delicensed. Now, we could have a head-on collision with the small-scale sector. Developing the merchant segment--which supplies 10 per cent of the gas requirements in the country--is a time-consuming process. It is a cash-cow, worth about Rs 65 crore. We have a 30 per cent share, and 2 of our nearest competitors put together do not have more than an 8 per cent share. I think we should focus on tonnage plants for growth and expansion Duggal: Given the fact that transportation costs are high in this business, and smaller companies are giving us a run for our money based on their proximity to the customer, I think the best growth option could be the franchise route Desai: Franchising is not a popular approach in our business although it makes eminent commercial sense. Since the technology is sophisticated, it is not easily accessible to smaller units with low economies of scale. Perhaps we should forge strategic alliances with smaller units to develop the merchant segment. That will also help us to close down some of our unviable operating sites Duggal: I believe there is a major shift in sourcing. Users have, so far, procured gases through cylinders or small pipelines while large companies have set up captive capacities. Today, many companies are sourcing gases through the Build, Own, and Operate (boo) route, dismantling their captive gas-generation facilities. I believe that the boo route is the best growth alternative. Desai: That is, indeed, the best way to expand. For instance, 2 months ago, we secured an order from Swadeshi Steel Ltd (SSL) to set up a 1,300 tonne-per-day (TPD) plant at Bhilai on a boo basis. SSL would consume 1,100 tpd of nitrogen and oxygen, and HGIL would be free to market the balance. Such an approach helps cut the total delivery cost Duggal: I think HGIL's POA should revolve around the following:
Desai: Let me reiterate that HGIL is, primarily, a gas company. We should remain so. Industrial gases must continue to be our mainstay. But, simultaneously, it makes sense to be present in multiple segments. The steel majors will gradually stick to their core competence--steel manufacture--and leave the manufacture of gases to companies like ours. After all, it is better for them to outsource their gas requirements. We have a distinct edge over our competitors because we have been catering to the steel sector for more than 50 years. But we should also broaden the scope of our applications to a range of sectors like petrochemicals, electronics, foods Duggal: An important area for consideration, in the light of what Mr Desai mentioned just now, is whether we should divest the healthcare segment of our business. That business would be more compatible with a healthcare company than with a gas company. Like some of our end-users, gas companies worldwide too are acquiring sharper business focus Rao: We have, in fact, received feelers from several healthcare firms in the country. We should be able to generate about Rs 40 crore if we sell this business. Interestingly, several gas majors worldwide are retaining their healthcare businesses. Hooper Inc., for instance, has made no efforts so far to divest its business. In fact, it has just introduced a new anaesthesiser with advanced safety measures; it is also negotiating a tie-up in Europe to market a range of medical electronic products. As you may be aware, medical electronics is a nascent segment in our country. Of course, it makes strategic sense for our healthcare division to be part of a larger and integrated healthcare business. But I don't think there are definitive answers here Duggal: I think all that sums up our business priorities Desai: There is something important that I would like to share with all of you. I got the feeling during my visit to Connecticut last week that Hooper Inc. was keen on raising its shareholding in HGIL to 74 per cent. But in a world of fast-moving changes, nothing is certain. If our parent does take a bigger bite, it would mean that that additional investments of, say, $200 million (Rs 840 crore) would flow into our company. Naturally, HGIL can introduce new products, set up new projects, and improve its distribution network. Rao: This is an encouraging development Rangan: Hooper Inc. supplies total gas-based technologies and solutions for the chemicals, petrochemicals, and refining sectors. All 3 segments have a lot of potential here. I think we should concentrate less on the steel business, which is, at present, going through a lean patch, and focus more on refineries. By using our patented technologies for sulphur recovery, for example, we can demonstrate how they can dramatically improve their productivity. Food preservation and processing is another area where nitrogen can be used effectively Duggal: Nagarkar mentioned earlier how HGIL had set up plants at unviable locations like Guwahati and Kanpur. Since they had hiked our transportation costs, we decided to close them down. I think we need to examine the financial viability of each of our 16 plants. As you are aware, the bulk of the new investments in petrochemicals are taking place in the East and the West. I think we should relocate our plants in those regions. We have 6 plants in the South, where hardly any investments are taking place in our growth sectors. It would be pure pragmatism to leave that market. I think the objective of today's discussion is to figure out our priorities for tomorrow instead of assessing our challenges today. The relocations would be justified if we take a strategic decision to reduce our overall business interests in the merchant segment. We should display no growth ambitions in the low-value commodity segments, but look for specialised applications in various sectors. That should help us to retain our plant in Bangalore, and close down the other 5 units in South India Desai: Gentlemen, thank you. Let us meet again next week to discuss these issues. How should HGIL consolidate its position in the face of the growing threat from the global gas majors? What should its core business be? Should it divest its healthcare business just like its welding division? Should it concentrate on the high end of the market or develop the merchant segment? Is franchising a growth alternative? How can HGIL control its Total Delivered Cost in a business where transportation costs are high? Should it pursue the boo option to improve its profitability? Is boo an effective option to create assets and expand capacity? Or should the company opt for the Build, Operate, Own, & Transfer (boot) route? Does HGIL really have a future strategy? |
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