Strategy

Made in India

India may be known more for BPO than manufacturing, but the subcontinent's factories are roaring into life.
M. MahanamaJuly 2, 2008

Bharat Doshi, finance chief of India’s US$6.2
billion Mahindra Group, is ever grateful he
was only 42 years old in 1991. Back then, he
was executive assistant to the managing director
of Mahindra & Mahindra (M&M), the automotive arm of
the Mahindra Group. As such, he spent much of his time in
Delhi’s labyrinthine “Licence Raj,” trying to persuade bureaucrats
to increase the number of tractors and off-road vehicles
his company was allowed to make each year.

Then came India’s liberalization in 1991. Reforms shifted
the country from a planned economy to a market-based system;
the legislature hacked away at stifling regulations; and
India opened its borders to international trade. “My boss at
the time was a brilliant man, but he spent all his life bogged
down in getting approvals,” says Doshi with a sigh. “At least
for me it was only half my life. Since 1991, we have had the
freedom to invest as we want, to embrace new technology, to
set up collaborations and partnerships, to start making new
types of products and to respond to the market. The change
has been incredible.”

It’s also been tough, not just for M&M, but for all manufacturers
in India. As Doshi recalls, “The scrapping of licensing
and the introduction of competition — both with domestic
players and foreign ones — was a complete shock.” By 1993, for
example, Japanese car-maker Suzuki was churning out 122,000
vehicles a year in India with a workforce of 4,000. Mahindra, by
contrast, was producing 73,000 vehicles with a staff of 17,000.

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Today, after years of restructuring and productivity
improvements, Mahindra is not only growing rapidly — its revenue
rose 37 percent last year — but is also expanding globally.
Exports of tractors, light trucks, and sport utility vehicles grew
34 percent last year to nearly 21,000 units.

In many ways, M&M’s recent transformation embodies the
long journey of India’s entire manufacturing sector. Decades
of socialism, closed borders, and self-sufficiency starved firms
of investment and opportunity. Now freed from these shackles
and with the pain of restructuring behind them, India’s manufacturers
are emerging with a vengeance. Many are now world
leaders in productivity — a remarkable change, considering how
staggeringly uncompetitive they were in the early 1990s.

Take Tata Steel, part of India’s Tata Group. During the
decade between 1995 and 2005, Tata Steel halved its workforce,
from 75,000 to 40,000, and doubled its output, from 2.5
million to 5 million metric tons of steel a year. In 1995, the
company consumed 4.5 tons of raw material to produce 1 ton
of steel; today it uses just 3 tons of raw material. In June 2005,
World Steel Dynamics, a U.S.-based industry research group,
gave Tata Steel ten out of ten for its operating costs in a survey
and named it “the best steel company in the world.”

Finance on the Frontline

Along the way, finance at these companies has been a driving
force in key areas. Cost control is one. “For CFOs in Indian
manufacturing, we don’t call for price increases. We spend
70 percent of our time hunting down ways to cut costs,” says
K. Sridharan, CFO of Ashok Leyland, a US$1.7 billion maker
of buses, trucks, and diesel engines. “Cost competitiveness is
absolutely key. It’s suicide to build new capacity on anything
but a foundation of super-efficiency.”

That super-efficiency includes a system Sridharan and his
team developed to pare costs to the bone. Starting with the
simple observation that cost divided by output yields a product’s
per unit cost, Sridharan and his team have used this equation
for a very granular view of its costs. “Using this philosophy
to blow up our cost drivers and understand them is the foundation
of our competitiveness,” he explains.

The philosophy is also a key way to help the company
cope with the escalating material prices hitting manufacturers
around the world, spurring it to find new ways to keep purchasing
costs low. Along with joining forces with other local
car makers to cut bulk deals with suppliers, it’s also scouring
the globe to source components in cheaper markets, including
China. As Sridharan recently told The Times of India,
Ashok Leyland has been steadily increasing its purchases of
components in China over recent years, now totalling a few
million dollars.

And Ashok Leyland’s cost-consciousness stretches beyond
its own factories. In 2006, when one of
its suppliers began struggling to produce
the fuel tanks used in its trucks,
Ashok Leyland weighed up whether
it should simply throw money at the
problem by launching a capex program
to help the supplier. Instead, the vehicle
maker decided to send its supply chain
team onto the vendor’s shop floor, and
subsequently identified a series of fast,
incremental measures it could take
to improve plant capacity. One measure
involved tweaking processes that
reduced machine downtime; another
was to change remuneration so that it
was linked to productivity. Machine
downtime tumbled, as did maintenance
costs. What’s more, individual productivity
improved 40 percent from the
previous year and production doubled
to 65 tanks a day, enabling Ashok Leyland
to increase its vehicle roll-out by
45 percent.

Having achieved new levels of efficiency,
Ashok Leyland is now confidently
stepping onto the global stage.
Exports are growing and the firm is making
acquisitions overseas — including a
2006 deal in the Czech Republic. It has
taken this a step further with an arguably
bolder move — its planned acquisition
of French car-parts company Valeo,
announced earlier this year. “Our system
for identifying and improving our cost
drivers underpins our M&A strategy because we can see clearly
how we might add value to the manufacturing processes at a
target company,” explains Sridharan.

Many other manufacturers have followed a similar journey.
At M&M, for example, Doshi — CFO since 1992 — has instilled a new culture that emphasizes production driven by market
demand rather than quotas decided by the country’s plethora
of labor unions. “In the early days, we could shut off the
electricity in our factories half-way through a night shift and
nobody would complain,” he recalls. “The workers had built
their quota of engines for the night and were all sleeping.”

Overstretched

Beyond shop floors, however, CFOs cite a more vexing challenge
that’s largely outside of their control. According to a
recent report from the International Monetary Fund, the
country’s overstretched infrastructure is shaving one percentage
point off its GDP growth every year. Ports and airports are
straining at capacity, roads are congested, and electricity supply
is patchy and falls well short of demand. On average, companies
report power outages 85 days a year.

Such constraints, of course, create real headaches for
manufacturers. At M&M, for example, Doshi tells how all factories
have to build standby diesel generators to make up for
power shortfalls. That raises both investment cost and the cost
of diesel-generated power, which is 11 rupees (26 US cents)
per unit compared with 3.7 rupees (9 US cents) for a unit of
grid-connected power. Equally, because ports and roads are so
stretched, M&M’s suppliers are often forced to keep as much
as a month’s inventory on hand to make sure that production
lines don’t grind to a halt.

Another oft-cited challenge involves workforce management.
Relative to other emerging economies in the region, labor
productivity in India has historically been low, partly because
of inflexible laws that make it tough to lay off workers or hire
part-time workers to meet seasonal demand. Furthermore,
unions are particularly strong in India, making it relatively easy
for workers to vent their displeasure about company decisions
and take industrial action in a way that hasn’t been possible in
countries like China.

“The rigid labor policies of the government get in the way
of our cost competitiveness,” laments
Ashok Leyland’s Sridharan. “We have
a five-year rolling plan and at no point
in that plan can I assume any staff
redundancies. In all our initiatives, we
have to build our strategies around this
constraint.”

The silver lining is that many Indian
firms have been growing at such a pace
that excess workers have been easily
re-absorbed into other parts of their
companies. While unions rail against
workers being forced to accept different
jobs than what they initially signed
on for, such complaints are much less
prevalent today than they were in
the 1990s, when Indian manufacturing
went through its most extensive
restructuring.

A further challenge — among CFOs
of both local and foreign manufacturers —
has been the tax environment.
The country’s complex transfer-pricing
regime, in particular, draws heavy
fire from Coen Reuvers, CFO of Philips
India, part of the US$42 billion Dutch
electronics and lighting group that
set up its first factory in India some
70 years ago. As he explains, “Often
the authorities initially assume that
the local profit on inter-company
exports is four or five times higher
than the corporate global assessment.
And when the tax authorities contest
corporate tax assessments in court —
which they do frequently — the cases
take years to resolve.”

Then there is the multiplicity of
indirect taxes levelled by both the federal
and state governments. “If you’re
moving goods across the country,
sales taxes can be repeatedly charged
by each individual state the goods pass
through,” says Reuvers. “You have to
be smart about your logistics, using a network of depots to
reduce the tax burden.”

Add up all these constraints and India should seem less
than enticing for manufacturers. And yet, manufacturing output
is climbing and investment in new production capacity is
gathering pace, from foreign and local players alike. Similarly,
exports are growing, at an average annual rate of 19.2 percent
since 2000.

The biggest spur has been India’s dynamic economy. With
growth that has averaged more than 8 percent for the past five
years, per capita income levels are climbing and stimulating
domestic demand for manufactured goods. Sales of passenger
cars, for example, have doubled in the past six years to 1.1 million
in 2007. Meanwhile, India has become a hot-house of ideas
for taking products created in the West and re-tooling them
for emerging markets, where consumers have much lower disposable
incomes and conditions — such as India’s poor-quality
roads — are vastly different from developed markets.

Manufacturers’ engineers are also developing products
at a lower cost than in the West. After Renault and M&M
announced a joint venture a year ago to manufacture the Logan
car for the Indian market, Carlos Ghosn, CEO of the French car
maker, enthusiastically announced that engineers at Renault’s
Indian partner figured out how to reduce the new model’s production
cost by 15 percent.

According to Reuvers, this process — known as “frugal
engineering” — is a prime attraction for manufacturers wanting
to get a foothold in developing countries. “Emerging markets
are where the growth is today and we need to have products
that are suitable for these markets,” he explains. “India is a wonderful place to develop these products.” For its part, Philips has
been acquiring healthcare companies that can design and build
medical equipment at a cost suitable for emerging markets.

Meanwhile, the deepening supplier base for many industries
in India is adding significant support for manufacturers
aiming to serve the growing local market. ABB, the US$45
billion Swiss-Swedish engineering group, has 14 factories in
India making products for the power sector, and motors and
robots for industrial automation. ABB’s policy is to manufacture
locally all over the world, and in India it makes 90 percent
of the firm’s 1,000 or so products on the ground. For 10 of
those product lines, India is a “global center,” taking the lead in
design and manufacture, and exporting to other countries. As
K. Rajagopal, CFO of ABB’s US$1 billion Indian operation, sees
it, manufacturing in India is benefiting from a local supplier
base that “has been improving gradually for at least 10 years
now, but in the last five years we’ve seen a real surge.”

And because the supply networks feeding manufacturers
are improving, new industrial clusters are developing. Take
Sriperumbudur, a town that’s part of an emerging manufacturing
corridor connecting Chennai with Bangalore. The
likes of Nokia, Samsung, Motorola, Dell, and Flextronics are
all investing heavily there, creating an ever more integrated
ecosystem for electronics manufacturing.
And it’s not just technology companies.
Ford, BMW, and Hyundai are
also expanding their car manufacturing
around Sriperumbudur, as are French
glass-maker Saint Gobain and U.S. ball
bearing manufacturer Timken.

Then there are the burgeoning special
economic zones being developed
right across the country, offering tax
breaks to exporters, not to mention
pockets of first-rate power, roads, and
other infrastructure. The proportion of
India’s exports originating from SEZs
has more than doubled today from
nearly 5 percent in 2005, when the government
formalized its SEZ policy. (See “Moving to the SEZs” at the end of this article.)

Adding more interest to India’s manufacturing
story, the Indian government
is starting to address many of the country’s
traditional problems. The government’s
current five-year plan, which runs
to 2012, calls for US$500 billion of infrastructure
spending, 70 percent of which it expects to come from
the private sector. To that end, it has rolled out more robust
and innovative policies governing public-private partnerships.
The response has been impressive. In 2007, funds investing in
Indian infrastructure raised US$4.7 billion of capital compared
with US$600 million in 2006.

And the list of projects being taken on by the private sector
grows longer by the day. In June, Vedanta, a U.K. mining and
metals group, announced plans to invest US$10 billion over
the next four years in a network of power plants with a generating
capacity of 10,000 megawatts. Danish shipping giant AP
Moller Maersk is in the midst of expanding Pipavav, India’s
first private port.

Sridharan of Ashok Leyland believes Indian politicians have
gained a new level of maturity by recognizing the importance of
infrastructure development. “Policies are now surviving from
one government to the next; we aren’t seeing reverses,” he notes.
The speed of progress may slow down or speed up, but the direction
is consistent. Equally, he adds, “India has begun to embrace
a ‘user pays’ culture. In the past, everyone expected everything
to be free — health, roads, education, power. Now there is much
greater acceptance of paying for things like road tolls, which
makes infrastructure development much more feasible. A lot of
the developers are making very good money.”

It all points to a promising future for manufacturing in
India. And for Mahindra’s Doshi, it makes for far more pleasant
trips to the country’s capital. “In the past, I visited Delhi to
negotiate approvals. These days it’s only ever to give lectures on
how successful liberalization has been,” he chuckles.

M. Mahanama is a frequent contributor to CFO Asia.

Chemicals and Car Parts

As India’s economy powers ahead, some types of manufacturing in the country will
fare better than others, predicts Ramesh Mangaleswaran, a partner at McKinsey in
Mumbai and head of the consultancy’s manufacturing practice in India. In this respect, he believes India’s engineering and innovation skills are critical. “The firms doing really well in Indian manufacturing are those making products that are medium-volume,
high-variety types of goods, which require a high degree of skill and engineering,” such as specialty chemicals, pharmaceuticals, and car components, he says. “China, by contrast, has done very well in items where there are much larger volumes and less variety in the production.”

But what will happen now that China has said it wants to move away from manufacturing low-end, low-value goods and target the same types of higher-value products that are doing so well in India? Mangaleswaran doesn’t see a conflict. “For me it’s not about China versus India,” he says. “Both economies are growing rapidly and creating huge demand, so both will need strong manufacturing. And firms will want to diversify anyway by having production in both countries.”

As for labor-intensive products, such as shoes, garments, plastic toys, and bicycles, he believes that India will succeed in building manufacturing for the domestic market in these areas but will struggle as a significant exporter. “My sense is that India has missed the boat for these types of
goods,” he says. Countries such as
Bangladesh and Vietnam are more
likely to be the natural inheritors of
such industries as they move out of
China. That said, for high-end garments
that require greater skills,
low production runs and extensive
product variability, India may
do well. — M.M.

A Say on Pay

India has become famous for its wage-inflation troubles — particularly in IT and software development. But, says Tulsi Tanti, CEO of Suzlon, a US$3.2 billion
maker of wind turbines, labor costs in other parts of the economy aren’t as troublesome. Wages in engineering and manufacturing haven’t risen as much. “Talent is a constraint in India, and salaries are rising, but the investments being made in education today will alleviate the pressures in the medium-term,” he predicts.

What’s more, adds Tanti, because India graduates 400,000 engineers every year,
and because they work more cheaply than their peers in the West, “The cost of innovation in India is cheaper than anywhere else.”

K. Rajagopal, CFO of India for Swiss-Swedish company ABB, agrees that India’s
cost competitiveness has many years to run. “Salaries are rising, it is true,” he concedes, “but wages are equal to just 6 percent of our revenues in India. In Europe, they’re equal to 30 percent of revenues.”

At India’s automotive giant Mahindra & Mahindra, the firm’s CFO, Bharat Doshi,
recalls how, during a conversation with a foreign partner, his firm realized how inexpensively it had designed its new Scorpio jeep, launched in India in 2002. M&M had spent just one eleventh of what it would have cost to do it in the United States. M&M has since set up a business line where its engineers can be hired on an outsourced basis by other manufacturers. — M.M.

To date, China has built its growth through manufacturing; India has done so through services.
Share of India's exports produced in Special Economic Zones (%)

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