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CASE STUDY The Case Of Contract Manufacturing
A living company. That was how K. Narayanaswamy, the fit-at-55 CEO of Tarang Limited, liked to describe the organisation he headed. ''Look at us,'' he would point out to anyone who cared to listen, ''and look at the way we have managed to re-configure our business over the years to survive and succeed.'' Only, circa 1998, with Tarang in all sorts of trouble, and the only way out requiring the company to restrict its activities, he was having to use these words more often. And their credibility was wearing thin. He was right. Tarang did have the resilience of a living company. It had started off in 1972 as a trading firm, which imported refrigerators, air-conditioners, machine-tools, chemicals, and capital goods-and just about anything it thought profitable-and sold them at margins in excess of 25 per cent. These profits, though huge, were not sustainable since the companies whose products it imported were bound to enter the Indian market. To tackle this eventuality, Tarang focused on building a distribution and service network as well as becoming a manufacturer in its own right. As the then-CEO, Vallabh Desai, who retired in 1990 to make way for Narayanaswamy, put it: ''We have to build a network of external relationships and a set of internal competencies, which will serve as entry-barriers to those planning to invade our territory.'' So, Tarang spent most of the 1980s converting itself into a typical manufacturing company. At a sprawling industrial estate on the outskirts of Delhi, the company began making machine-tools, textile-machinery, air-conditioners, and refrigerators, with an investment of Rs 370 crore that came from the company's reserves and, in part, from a public issue. It adopted a divisional structure, creating 4 around its 4 product-lines, and a fifth for trading (in electrical, industrial, and medico-electronic equipment as well as light engineering products). Machine-tools and textile-machinery, Desai soon realised, were businesses whose fortunes depended on those of their user-industries. However, the other 2 divisions offered him an opportunity to build economies of scale and brand equity. By successfully bidding for large projects-domestic as well as international-Tarang acquired, over the years, a critical understanding of what worked and what didn't in these markets. And this gave the company an edge over its competitors in both the refrigeration and air-conditioning industries. When Narayanaswamy took over as CEO, the refrigeration and air-conditioning businesses accounted for 60 per cent of the company's turnover; trading, 20 per cent; and its other businesses, 20 per cent. And the company's brands had become synonymous with refrigerators-with a 21 per cent share, Tarang was the second-largest player in the market-and central air-conditioners (marketshare: 45 per cent). However, not only were the company's machine-tools and textile-machinery divisions not contributing to its revenues, they were eroding its bottomline. Narayanaswamy's first initiative was to recommend to the company's board of directors that they sell off the 2 divisions. The board demurred, but agreed, albeit reluctantly, to hire the services of Richardson & Co., a global consulting firm, to identify the company's key strengths (what C.K. Prahalad and Gary Hamel were to later term core competencies). In fact, Tarang's core competencies in 1998 were identical to the key strengths identified by Richardson in 1991: LOW WORKING CAPITAL REQUIREMENTS. Tarang's major line of business-projects in refrigeration and air-conditioning-were funded by client-advances rather than bank-finances. In fact, less than 5 per cent of the company's working capital requirements came from bank financing. Tarang managed this by breaking, in consultation with its clients, each of its projects into phases, completing each one on time, and following up on collections promptly. Its expertise in projects, in turn, gave the company an edge over its competitors, whose emphasis on unitary products and ducted systems forced them to borrow funds to finance their operations. PROJECT ENGINEERING SKILLS. Tarang's competitors couldn't match its range of capabilities in terms of Engineering, Procurement, and Construction (EPC) skills, products, technologies, and after-sales service. So pleased were its customers that referrals accounted for more than 50 per cent of the company's new business every year. TECHNICAL TALENT. With 650 engineers and 1,200 technical support-staff in 1998, the company had the largest concentration of technical specialists in the country. TRADING. Tarang's trading division, which marketed products sourced from 65 companies overseas, had created a distribution-network of more than 2,000 dealers. Richardson's advice was based on an understanding of these strengths: stick to projects-driven businesses, and sell off the machine-tools and textile-machinery ones. Much to Narayanaswamy's surprise-after all, he had suggested the same thing 2 years ago-the board, eventually, accepted these recommendations. Tarang's problems began with liberalisation. Like many companies, it had been carried away by reports that the Indian middle-class numbered 250 million and so, had expected the market for, inter alia, white goods to boom. Thus, instead of investing the proceeds from divesting in the machine-tools and textile-machinery businesses into its core activity-projects-the company used them to fuel the expansion of its refrigerator and air-conditioner manufacturing-capacities, and strengthen its distribution network. Both were capital-intensive, as Tarang soon discovered, and part of the revenues from the profitable projects business was diverted to fund what was expected to be a money-spinner. Its existing economies of scale and a low-cost structure helped Tarang hold its own against the transnationals that entered the market even as its own facilities were being expanded. But, by end-1995, when they had been completed, Tarang's dreams too had turned sour. The problem was the market; the middle-class did not number 250 million. That, by itself, would not have hurt the company. But the capital cost involved in expanding its facilities ended up fattening the fixed-cost component of Tarang's fabled cost-structure. Suddenly, it wasn't that low-cost a company any more. Expectedly, capacity-utilisation plummeted-to an all-time-low of 25 per cent in 1996-97. And that distorted the cost-structure even more. The result: a loss-the first ever in the company's history-of Rs 15 crore. Narayanaswamy responded quickly to the challenge. Total Cost Management became the guiding principle for all activities, costs were pruned mercilessly, and Tarang re-focused around its basic strength: projects. Operating efficiencies, and a focus on the denominator saw the company back in the black in 1997-98. But the quantum of profits was small, and Narayanaswamy knew that he could be back in the red if the slightest thing went wrong. If there was a millstone around Tarang's neck, it was its state-of-the-art manufacturing-facility. The only way in which the company could write off the capital charge (per unit) was to produce and sell to capacity till 2003. That was unrealistic. Selling 100,000 refrigerators and air-conditioners year after year wouldn't be easy. It was around this time that Narayanaswamy was approached by a global refrigerator-manufacturer, looking at the Indian company as a contract-manufacturer, which offered to book its capacity of 100,000 refrigerators a year for the next 5 years. Narayanaswamy immediately realised he couldn't get a better offer. However, becoming a contract-manufacturer required Tarang to take some hard decisions. At one level, the company would have to stop making refrigerators under its brandname. It was difficult to pin-point the financial implications of this move, but it meant a loss of face and a dilution of the company's brand equity. It could even affect the company's prospects in the refrigeration-projects business. At another, Tarang would have to lay off the team involved in marketing refrigerators. Most of the employees were executives, and the company did not foresee any labour-problems, but the thought of suddenly asking 320 people to find other jobs was not a pleasant one for Narayanaswamy. Like most managers faced with tough decisions, Narayanaswamy called in a consulting firm. Richardson & Co., which had already worked with the company, was the natural choice. The Firm wasted no time in coming up with its recommendations; it was familiar with corporate India's recession-induced crises. RECOMMENDATION 1. Tarang should not let go of the contract-manufacturing opportunity, especially since the arrangement was a long-term one. Richardson's managing partner, the avuncular 47-year-old Rohit Jha, pooh-poohed Narayanswamy's fears: ''You have to let people go. Your decisions have to be based on what is good for the business.'' But he had no answer when Tarang's cfo, Manubhai Patel, a 35-year-old whiz-kid from the Wharton Business School, pointed out the disadvantage of such an arrangement: ''Five years down the line, the transnational could terminate the contract and offer to buy us out. And we may have no option but to sell out.'' This set Narayanaswamy thinking: if that happened, Tarang would have to either find another company to supply to-or re-enter the market under its own brandname. Both would not be easy. RECOMMENDATION 2. Tarang should leverage its skills in the projects side of the air-conditioning business to enter the room air-conditioning market. This was a good move since the market for room air-conditioners was nascent-a penetration-level of less than 1 per cent-and was expected to grow at 40 per cent per annum. Besides, the household nature of this product meant that the company could accommodate most of the people from its refrigerator marketing team in a newly-created cell that would look after sales to this segment. RECOMMENDATION 3. Tarang should re-focus its energies on projects. ''We are already doing it,'' whispered Patel to Narayanaswamy. ''Why are we paying them Rs 5 crore to tell us what we know?'' RECOMMENDATION 4. But the consulting firm had saved its best for last. Jha looked around the room, and paused dramatically, before outlining it: ''Yours is a business in which technology is not the differentiating factor. What differentiates the winners from the also-rans is after-sales services. Tarang has acquired skills in servicing capital-equipment cost-effectively. It can become a gateway for global heavy equipment suppliers. And the products you sell are only one component of your business and one link in your relationship with the customer. Our studies indicate that the margins in the services business are 60 per cent higher than in the products business.'' ''Let me sum up,'' said Jha. ''We think contract-manufacturing is a good idea. Your returns are guaranteed, and Tarang will be spared the marketing expenditure that is only bound to rise over the years as deep-pocketed transnationals enter the market. We also think you should seriously consider becoming a services-provider. Tarang's expertise in projects can easily be extended to cover this area. Services constitute close to three-quarters of every mature economy. I think Tarang should jump at the chance of moving into that area at this stage of the evolution of the Indian economy.'' Jha's statement caught Narayanaswamy's attention. ''Can we really do this?'' he asked himself, as he walked Jha to the door. A month later, each Tarang employee received a personal letter from Narayanaswamy. After outlining the constraints that were forcing Tarang to re-create itself, he presented his vision of the company's future: ''Where do I see us 5 years from now? We will no longer be making products for ourselves, but will execute contract-jobs for companies we view as competitors today. We will focus on the services node of the value-chain. There is a flip side, though. We may lose our historical identity. Several skills will become redundant. Several people may become redundant. It will be gut-wrenching. The bright side is that Tarang will re-invent itself as a value-driven company. It will stay on top of circumstances instead of being overwhelmed by them...'' |
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SYNOPSIS:
Tarang had managed to re-invent itself twice before. But the third time was proving
to be difficult. Competition was hotting up in the markets where the company operated. And
climbing production and marketing costs in its refrigerators and air-conditioners business
threatened to overwhelm even the ever-profitable projects business of the company. CEO K.
Narayanaswamy believed contract-manufacturing was the way out of these troubles; that, and
an emphasis on the services node of the value chain. But he was worried about the negative
fall-out-and there was sufficient-of becoming a contract-manufacturer. Thermax Babcock
Wilcox's G. Trivedi, Microsoft India's M. Ganesh, Centre For Change Management's R.L.
Bhatia, and PricewaterhouseCoopers' S. Tugnait debate Tarang's course of action. A BT Case
Study. 