Case Study: Breaking the Commodity Barrier, Pg 2

CASE STUDY
Breaking the Commodity Barrier
Continued..

Solution A
S. Rama Iyear,
Chairman & MD, Kvaerner Power Gas India

S. Rama Iyear Hooper Gas India Ltd (HGIL) should concentrate on tonnage plants, which constitutes the high end of the gas market. It is in only in this segment that both volumes and profits are high. Even if the merchant segment offers better sales realisations--which, as I see it, would be more than offset by the attendant costs--the company should, gradually, reduce its presence in the low end of the market, which is characterised by the sales of loose cylinders. A close watch on the Total Delivered Cost (TDC) is crucial to the profitability of the gas business. Since freight is a major cost component, proximity to the customer is an important factor in reducing the TDC.

This, in fact, is one of the reasons why there is a gradual shift in the industrial gases market towards tonnage plants. Of course, the other major reason is technology. Therefore, even if HGIL has the largest share of the merchant segment, Managing Director Harpreet Duggal and his team should not lose sight of the changing business paradigm. The merchant segment is best left to the small-time operators, who have the advantage of being close to the customer.

Instead, HGIL should concentrate on improving its presence in the high-margin segments. To do so, it must focus on the target customer. The national market for industrial gases could be split into 4 geographical zones. Bulk users in sectors like petrochemicals, steel, chemicals, electronics, smelting, and food-processing can be identified by their prime locations. Since gas-generation is a non-core business for these user-industries, they would be reluctant to invest capital in such activities.

Worldwide, user-industries outsource gas through sites located on their premises. So, oxygen mills are separate business entities for steel-manufacturers; they are not an integral part of their value-chain. Although most are owned by the gas companies themselves, some are spun off into joint ventures, where the steel-maker and the gas company have equal stakes. Such a strategy helps both companies. For the gas company, it ensures guaranteed offtake of the finished product, and facilitates quick capacity-expansion. For the end-user, it eliminates the risks associated with capital investments, and helps it get its business focus right.

The Build, Own, & Operate (BOO) mechanism is the best route for HGIL; that is where the profits lie. More importantly, the boo option offers enough scope for relationship-marketing. Also, the assets would lie with the company. The Build, Own, Operate, and Transfer (BOOT) route is less tempting for 2 reasons: the gestation period--typically, 15 to 20 years--is high, and the technology employed is sophisticated. Consequently, obsolescence sets in by the time the unit is ripe for transfer. In the BOO option, the assets stay with the gas company.

Once the prime locations of potential customers are identified, the next step is to actively woo those customers. While HGIL may have lost the Steel India contract on price, what usually clinches a contract is the customised benefits the gas company can offer, and the value-addition it can deliver. This is where HGIL should utilise the brand equity it has built over the years to its advantage. That should provide it an edge. Gas, per se, is undifferentiated, but it is in the promise and the extent of value-addition--which varies from one customer to another--that HGIL should be able to differentiate itself easily.

Since each prime location would have a number of secondary users spread around it, the surplus output could be sold to them in retail lots. In fact, HGIL's interest in the merchant segment should be confined only to this target group. The company could enter into strategic alliances with smaller firms to service this group better. Such an approach would offer new technologies to the end-user. For instance, oxygen can be available on tap for emergency medical operations at rural healthcare centres if HGIL introduces new-generation products. So, tie-ups with small gas firms located close to the areas of consumption are important.

I do not, however, recommend franchising as a growth strategy. It is true that franchising becomes a compelling option for capacity-expansion and business growth in industries where transportation costs are high. But in areas like industrial and medical gases, where technology often provides the cutting-edge over the competition, the move could prove to be counter-productive unless the quality of the end-product is monitored closely. Moreover, HGIL does not have the infrastructure to support such an initiative.

In fact, the only benefit it could get from franchising is the licence fee, which could be 5-6 per cent of sales. But licensing has a downside: the licensee would be under no compulsion to reduce costs. This would make the relationship meaningless unless HGIL is able to monitor the costs of each of its franchisees regularly. Although such an arrangement is likely to consume the management's time and attention, even dilute its business focus, it would be fine as long as the licensee adds value to the end-user.

Ideally, of course, HGIL should divest its healthcare business and stick to its core business: industrial gases. After all, the latter can never be construed to be part of its main business. The volumes in the medical gases business are small in relation to industrial gases. And the costs of the marketing support required to sustain the healthcare business would far outweigh the benefits. In fact, it will be hardly surprising if Hooper Inc. were to decide in favour of selling its healthcare business worldwide just as it did the welding business years ago. Besides, HGIL will be able to attract the right talent only if it concentrates on its core competence.

Solution B
P. Ramakrishna,
President (Petrochemicals), Grasim Industries

P. Ramakrishna It is obvious that the turnaround initiated at Hooper Gas India Ltd (HGIL) by Managing Director Harpreet Duggal's predecessor is, by no means, complete. The loss of a Rs 175-crore contract to a competitor is a matter of serious concern. The issue requires the personal intervention of Duggal and his team on a priority basis. Evidently, HGIL's products and services are outpriced in relation to some of its new- and nimble-competitors.

It is also obvious that the company has still not been able to get a grip on the internal costs of its operations. There is little doubt that the company has accumulated flab during its 50 years of existence. A monopoly status has translated into an indifference towards cost management. These are dangerous trends that could place the very survival of the company at stake. The sooner HGIL's management team recognises this, the better.

One of the first steps that Duggal should undertake is a benchmarking exercise vis-à-vis the competition. The purpose should be to pin down the specific areas where HGIL can trim its costs. A number of opportunities for improvement would surface through such an effort. Simultaneously, Duggal should launch a value-engineering exercise within the company. This is best done by setting up a dedicated cross-functional team with a mandate to identify the areas of cost inefficiency.

Power costs, for example, could go haywire in an energy-intensive business like gas-generation. Although the company has been able to cut its labour costs through a Voluntary Retirement Scheme, there is still scope for reduction. In fact, labour productivity could well be HGIL's Achilles' Heel even now. These issues need Duggal's immediate personal attention, not only to bag new sales orders, but also to stay on course. The company should also adopt Enterprise Resource Planning systems to ensure higher returns.

The second area that deserves a close look is HGIL's business portfolio. Disposing off the welding division was a step in the right direction because it did not constitute the company's core business. As far as healthcare is concerned, it does not appear to have much in common with industrial gases. It is, therefore, not the company's core competence. But my personal feeling is that HGIL should not divest its healthcare division; it should focus on the manufacture and marketing of both industrial and medical gases.

My reasoning is based on the fact that the medical gases division may grow exponentially in the future. The healthcare business is still at a nascent stage since government spending on healthcare is extremely low in this country. Public investment in healthcare is likely to go up in the future. So, the demand for related products and services, such as medical gases, will increase. So, HGIL should grow this business, which has the potential to turn into a cash-cow, sooner or later.

The company should not only concentrate on healthcare, but also identify areas for improving customer service through tailor-made and customer-specific packages. The same logic applies to the merchant segment--where HGIL has had a substantial market presence for years--which, today, has become a cash-cow. A 30 per cent share in a Rs 65 crore market-segment is impressive not only because it is the most profitable, but because 2 of its closest competitors have a combined share of just 8 per cent. It is obvious that HGIL is doing better in the merchant segment than in the gas business. The company should, therefore, concentrate on developing it. And, as a leader, HGIL is eminently placed to expand the market as a whole.

As far as the debate about franchising as a growth option is concerned, the choice is clear: HGIL must go in for franchising. In order to be competitive in the open market, it should selectively opt for the franchising route, depending on the location of its plants. This route would help the company close down a number of units that are unviable. A countrywide network would lower transportation costs, ensuring that HGIL retains its profitability as well as marketshare in the merchant segment.

The Build, Operate, and Own (BOO) route will help HGIL tie up some major customers in the captive gas-generation business. All the steel majors, for example, have come to realise that they should outsource their requirements from gas companies, and concentrate on their core competencies. Afterall, HGIL has a distinct edge over its competitors because it has been catering to the steel sector for over 50 years. It is, therefore, better-placed than its competitors to offer customised packages to its clients.

However, the boo option should be examined carefully. A single-customer-based contract for the supply of gas could lead to fluctuations in profitability, depending on the customer's product-cycle. It will be better if the boo option is exercised with only 2 or 3 customers in mind, so that supply swings in one can be evened out by those in the others. Of course, that requires a closer look at the supply logistics. An alternative would be to ensure that a network of feeder-units are developed close to each primary customer.

The reversal of the nitrogen:oxygen ratio in favour of nitrogen could also be an area of consideration; the expertise of Hooper Inc. can be easily utilised in this context. It will help the Indian company to produce nitrogen cost-effectively through state-of-the-art technology. Apart from the existing applications, HGIL should interact with user-industries to establish the process parameters, and develop indigenous applications to facilitate the adoption of gas-based technologies.