Strategy: Oil on the boil

With less than two years to go before the oil sector is decontrolled, India's state-owned giants are moving to consolidate their positions.

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Six months ago, the Indian Oil Corporation (IOC) spent Rs 1.5 crore on upgrading its outlet (called Top Gear) at Warden Road in Mumbai. The outlet, besides peddling petrol and diesel, boasts an Akbarally's Convenio (a convenience store), a HSBC ATM counter, an automatic car wash, a snacks corner, and even an art gallery-all of which accept credit cards. That's not all. At Top Gear, customers can pay their phone bills, and will be able to surf the internet or buy medicines.

None of this would have been conceivable as recently as the mid-90s. With the retail market protected by government regulations and marketshares monitored by a Sales Plan Entitlement policy, the state-owned oil monoliths had little incentive to think up ways of luring consumers to their outlets.

Today, the three oil giants are in a tearing hurry to acquire a customer-friendly face, it's because come April 1, 2002 (perhaps even earlier), the oil sector will be decontrolled. In one swoop, the government will fell most of the protective barriers. Instead of adhering to a basic, pre-determined price, companies will be free to sell at whatever prices they deem fit; the restrictions on the number of outlets will be gone too; and instead of engaging one another in a pseudo-competitive battle, the three companies will have to deal with global majors such as Shell, Exxon, and BP (formerly British Petroleum).

What's made the threat more real is the fact that last month the government relaxed the investment rules for petro marketers. Instead of making a Rs 2,000-crore investment in refining or exploration, new players will be allowed to invest an equivalent amount in downstream facilities such as terminals, pipelines, and storage tanks. Besides, the decision to divest 33.6 per cent stake in the state-owned IBP has raised hopes among the foreign companies. Notes K. Mukundan, Vice-President (India Business Development-Gas & Power), BP: ''The excitement has to do with the fact that the deregulation is happening faster than expected.''

Few doubt what the unrestrained entry of market-savvy transnationals would mean. Sure, there are huge entry barriers. Together, the three Indian companies run 17,435 outlets all over the country. They are vertically integrated and their huge refineries are well depreciated. Replicating just the front end of, say, BPCL, could cost a foreign major Rs 2,244 crore in investment. Building matching infrastructure will be difficult too. Take a look at IOC's infrastructure: a 6,453-km long product-and-crude pipeline, 188 terminals and depots, 92 aviation fuel stations, and 59 LPG bottling plants. At the retail level, it has 7,252 gas stations, 3,430 kerosene/light diesel oil dealers, and 3,251 LPG distributors in 1,531 towns, and serves more than 23 million customers. Yet, the bastions of the Indian giants are not impregnable.

Consider this: six years ago, when the Anglo-Dutch oil major, Shell, re-entered India after a gap of 18 years, it took up six gas stations on lease from its erstwhile company, Bharat Petroleum Corporation Ltd. (BPCL). Spending around Rs 2 crore per outlet, Shell turned those greasy vendors into upmarket retail stores that sold not just petrol and diesel, but also cola, magazines, chocolates, and a whole host of other packed eatables. Within months of starting business anew, the six gas stations posted a four-fold jump in sales. Admits S. Sundararajan, 58, CEO, BPCL: ''The greatest challenge is to improve our understanding of our customers.''

As a first step, the companies are restructuring their sprawling operations into Strategic Business Units (SBUs) with the help of external consultants. For instance, BPCL, which roped in Innovation Associates (an arm of Arthur D. Little), has split itself into six SBUs to improve focus, cut layers, and tighten control over its retail centres. IOC (advised by PricewaterhouseCoopers) and HPCL (Arthur Andersen) have moved identically, although their pace may be different from BPCL's. Says Gokul Chaudhri, Senior Manager, Arthur Andersen: ''(All of them) are trying to widen their infrastructure network and deepen penetration.''

The Shell experience drove home the point that the purchase experience had to be superior, even if it was just oil that customers were buying. Ergo, IOC, BPCL, and HPCL are spending anywhere between Rs 1 crore and Rs 2 crore on doing up their metropolitan outlets. Even in smaller towns, they are spending Rs 60-75 lakh on modernising their gas stations. That apart, Jubilee Outlets-mooted in 1997, to coincide with India's 50th year of Independence-are being set up at a cost of Rs 2-3 crore. Jubilee Outlets include a convenience store, a car servicing station, a car wash, a motel, a restaurant, and telecommunication services.

There are two reasons why the companies believe these initiatives will help. For one, in a free market, profit margins at the retail end will be higher than those at the refining end. In the US, for example, a retailer makes a profit of $5.7 per barrel, compared to the refiner's $2.7. In India, however, controlled prices have kept marketing margins lower at $1.33 per barrel (refiners make $2.5 per barrel).

More importantly, though, adding services will help the oil companies build new non-fuel businesses around their outlets. Already, the Jubilee Outlets are said to be selling 1,000-1,500 kilolitres per month, compared to the 48 kilolitres that a highway station sells. (Globally, non-fuel business accounts for a substantial chunk of the margins.) Once retail prices are deregulated, managing dealers will become a critical issue. Today, dealers have a straightforward brief: sell as much fuel as you can. Tomorrow, besides volumes, price will be an issue. Different dealers will have to adopt different prices, depending on how the Shell or IOC dealer is pricing his own fuel. At least initially, a price war could erupt. Agrees Vidyadhar Ginde, Oil Analyst, HSBC Securities: ''Companies will try to undercut each other to generate volume and corner marketshare, since it's marketshare that will count.''

In such a scenario, keeping a finger on the pulse of the market will become critical. Post restructuring, the three Indian companies expect to be more nimble in responding to market changes. Points out Sundararajan of BPCL: ''The organisational structure influences the behaviour of the person. If employees have to ascertain and satisfy customer needs, we need to change our structure.'' Under the old system, a sales officer at BPCL, IOC, or HPCL, would cater to different types of customers (typically, 30 retail outlets, 12 LPG distributors, six kerosene dealers, and 10 bulk consumers). The diffused customer base did not help him get a clear insight into the needs of any one particular customer.

Now, both IOC and HPCL have regrouped their marketing operations under four SBUs. IOC has done away with 44 divisional and four regional offices, and instead operates through 14 state offices. Each of these is headed by a general manager, who has the power to offer discounts to bulk customers. Something like that would have been unthinkable just a few years ago.

BPCL, whose restructuring is almost two years old now, has split its homogenous divisional offices (each of which catered to all kinds of customers) into six different business groups-one asset-based SBU in refining, and five other markets-facing SBUs in retail, LPG, lubricants, aviation-fuel, and bulk business, with each focusing on specific needs of different customers. And support functions like hr, information systems, finance, engineering and project management have been centralised.

That apart, all three PSUs are focusing on getting control over sales-critical outlets, since that would be the first area where the transnational oil companies would want to hit them. Almost six out of every 10 outlets are either owned by the dealer or are on long-term lease. More than half of BPCL's and HPCL's sites are already under the companies' control, and IOC now controls 30 per cent of its outlets compared to 17 per cent three years ago. Says P. Sugavanam, Director (Finance), IOC: ''It's important that we bring them into our fold.''

To complement the restructuring, the oil majors are streamling processes and information flow by implementing Enterprise Resource Planning (ERP). Analysts feel that this will allow the companies to reduce inventory costs, plan production, and manage distribution better. BPCL has already begun tracking the supplies to bulk customers. Points out Sandeep Biswas, Senior Manager, Andersen Consulting: ''They have to get their costing system in place; they will have to find out what it costs them to get a product to an outlet.'' For, a wrong calculation in the context of small price differential and huge volumes could hit their bottomlines.

Even as the hi-profile battles are fought on the front end, crude sourcing and refining will become more critical than ever before. Thanks to a government-mooted restructuring, all the three companies will get additional capacities by acquiring refineries. While the pricing of these acquisitions has not yet been decided by the finance ministry, there is little doubt that new capacities will help. Here's why: there's a huge shortfall in the refining capacities. For instance, IOC's refining capacity last year was 32.42 million tonnes, but it sold 48.79 million tonnes. HPCL's retail sales of 18.86 million tonnes was nearly 10 million tonnes more than its refining capacity. Only HPCL is a product-surplus company.

The profitability of a refinery depends on the complexity factor (the ability to process a wide variety of crude) and the ability to produce a wide range of products. Oil majors have been trying to reduce crude costs and optimise the product mix by adding secondary processing units like hydrocrackers, catalytic crackers, and cookers. The idea is to use cheaper crude and make more light distillates (like petrol, diesel, and kerosene). IOC, for example, plans to increase its distillates-yield from an average of 72 per cent today to 80 per cent by 2002.

The oil majors also are benchmarking their operations against their global peers, and trying to learn the tricks of the international crude trade. Currently, IOC is the sole canalising agency for importing crude under the watchful eyes of the Oil Co-ordination Committee. But decontrol will allow the others to import crude independently, and leverage their specific strengths to strike bargains. Says S.P. Gupta, Director (Finance), HPCL: ''I can have economy and quality in crude purchase and avoid inventory build up.''

There's another problem with centralised buying that decontrol will partly solve. Everytime India enters the international market, prices are jacked up. But separate buying would allow companies to plan their inventory properly, and possibly stock up when the prices are down. Given that millions of barrels of crude are bought each year, the savings could be enormous. Gupta estimates that even a 5 per cent bargain on a barrel price of $30 will save his company Rs 500 crore annually.

Given the overwhelming advantages that the oil PSUs have over their new competitors, any immediate threat to their position is virtually ruled out. Agrees Arthur Andersen's Chaudhri: ''April 1, 2002 may be a significant date, but it may take many years for the market to mature.'' That's a breather India's oil majors can do with.