Post Recession – The Way ahead

The morbid fear has always been “If US sneezes the world catches cold”. However, the Global meltdown that has impacted the US, Europe and rest of the world seemed not to affect India as much as it was feared. IT and ITES indeed were impacted quite a bit. But most of the other industries and agriculture are seemingly not affected much. Many reasons are proffered to explain this. I believe there are a few reasons that have caused this “so called” immunity from the global melt down.

Prudent Financial Sector:

Indian banks are always accused of being way too conservative and stringent when it comes to helping the industry. This conservatism in a way has helped them not to get committed to a “sub-prime” kind of lending. The loans are generally backed by tangible securities rather than derivatives.

However, the situation is not as rosy as it used to be. Till few years back most of the Indian banks had less than 1% of net NPAs and quite a few of them even had zero net NPAs. They management this is because of the, often complained, conservative lending and also by aggressively making provisions. But of late, there is no zero-net NPA bank in India now. Eighteen of the 39 banks have at least 1% net NPAs, with Development Credit Bank topping the list (3.11%), followed by Indian Overseas Bank (2.52%). When it comes to gross NPAs as a percentage of loans, once again Development Credit Bank is the worst performer (8.69%). Other prominent names in this list are ICICI Bank Ltd (5.06%), Indian Overseas Bank (4.47%), Kotak Mahindra Bank Ltd (3.62%), United Bank of India (3.21%) and State Bank of India (3.05%).
(Source: http://www.livemint.com/2010/05/30221921/The-biggest-worry-for-indian-b.html)


People:

Culturally we are so obsessed with savings. It has both upside and downside to it. Upside is we as a country are rarely short of cash in the system. The downside is it stifles growth. But this cultural bend to save leads to stability which helps to tide over recession. Whereas, in the US the savings is negative; meaning an average American spends tomorrow’s income today. The private capital formation has continued to raise. The pattern of household savings is shifting towards financial assets and thereby raising the available loanable funds in the economy. (RBI Annual report 2009-10)

Culturally, India is a more tolerant society than many others. It is not absolutely true that we are resilient by force not by choice. We are resilient by our cultural roots as well. The basic contented attitude which is still prevalent in the semi-urban and rural India, (which is more than two-thirds of the Indian Population) has definitely a role to play in the recession not affecting us as much as it affected the developed economies. The neo-rich IT/ITES “professionals” were indeed affected more than others within India.



Domestic Consumption:

Manufacturers and service providers in India have sufficient market potential to survive on their own. Though our exports are increasing, a major chunk of our output is consumed within India. The ever increasing middle income group which is about a fourth of the Indian populace spends and saves predominantly within India. So our dependence on the recession hit economies is minimised (other than of course, IT/ITES).
This is another major reason for our scrapping through the recessions with mimimal damage.



Foreign manufacturers and service providers setting up shop to server local as well as export needs

India's FDI flows during the last couple of years has increased to over US$25 billion. The greatest opportunity considered by multinational firms is the market potential within India. In the world competitiveness index, India is ranked 3rd on the market size. (World Competitiveness Report 2007-08: World Economic Forum) There is a significant shift in the attitude of the Indian firms as well. We have also been investing globally in the last decade or so.
However, there is a huge negative aspect to this story. World Competitiveness Report 2007-08 has ranked India as low as 48 out of 131 countries.

Thanks to the sheer market size, we have managed to attract investments. We have fared extremely poorly on the other fronts. On a positive note, there is a huge potential for us to attract more FDI into India, if we manage to do well on the other parameters.

Getting used to recession or Immunity from recession:

We have not overcome the recession, but we have taken the recession in our stride. It is of course, a good attitude. The major reason is the resilient, prudent Indian populace. Being fearless is not “absence of fear” but “overcoming fear”. Similarly getting used to recession is not being recession proof. Systemic immunity from recession and capability to overcome recession is critical to ensure we are not really impacted by future recessions. I believe we have a long way to go. Lack of infrastructure, lack of public spending on education and, corrupt bureaucracy and polity provide a huge hurdle in our journey towards real stability. Our cultural base, especially in Urban India, is definitely getting impacted by the “spend tomorrow’s income today” mindset of the west. Urban India is bordering out of a contented mindset; while the rural India gets steeped in poverty.

In the context of this, I believe that the probable solution lies somewhere in a remote village of Kuthambakkam near Chennai.

Probable Solution: Kuthuambakkam – Model Village:
(http://www.modelvillageindia.org.in and http://www.goodnewsindia.com/index.php/Magazine/story/elango-kuthambakkam)

Kuthambakkam was like any other village of India – caste divides, abject poverty, illicit liquor and full of grievances, drunken brawls, wife beating and wails of women and children. An educated local lad R Elango, a chemical engineer by qualification, quit his job with government sector, decided to change it all. His attempts, along with his friends, to change the face of the village by forming youth clubs, wall posters with reformist messages, organising study groups, giving special tuitions and various other in-adequate reforms bore little result. Unlike many of us, he realised that reforms can be effective and sustainable only if it done through the formal governmental process but through harmonising the local passion. He threw his hat in the ring and became the President of the Kuthambakkam Village Panchayat.

World over we talk about “inclusive growth”. Kuthambakkam has become a model village for inclusive growth under the stewardship of Mr Elango.

He started using the local populace for building roads, culverts, drains and housing colonies using locally available material. Thereby a major portion of the Government funds for the village development was used for the villagers’ development. Officials backed his approach of cutting out contractors and employing locals instead. As he created jobs, liquor menace receded. He had always paid above the market average and most revolutionarily, precisely the same for women.
He mastered the Governmental promulgations for Village development and availed of every scheme for the village. "There are enough well meaning schemes announced by the Government. It is up to the local leadership to go and get them," he says. He has been an efficient conduit between his people and available opportunities.

The concept of Kuthambakkam model village is getting replicated in many villages in the last few years thanks to the evangelical enthusiasm of Mr. Elango and his motivated team.

He has been evolving an economic theory of village clusters. In simple terms about seven or eight villages form a free trade zone. They identify and produce goods and services without overlap. They consume each other's produce. And the money stays back and gets invested in human development.

Elango is optimistic for India. He says, "… the system will come up with the necessary resistance,… There are successful, honest Panchayat Presidents. We have begun to network and stay connected. This number will only increase. I am sure similar is the case in other States. I am starting a Panchayat Academy to teach the Presidents their powers and villages' entitlement. All these will rouse people's expectations. There is an emerging force not visible to the media and most people. It is at work changing India from below. This force cannot be stemmed."

In a recent conference, Mr. Elango opined, “What recession! If there is recession in US or Europe, Kuthambakkam will not be affected. Even if there is recession in India, Kuthambakkam will not be affected” (TiE Enterprising India Summit March 2011)

I believe this is the way forward for India to replicate more and more models using grassroots democracy. A model that is inclusive, generates self sufficient village clusters, providing housing for all, water management, hygiene and a perfect environment for harmonising the passion of the local populace.

Flavour of the season – a tale of aborted initiatives

I vaguely remember a definition of long sentence. “A long sentence is one, which starts slowly, uncertain of its terminus, and after the initial hesitancies it gathers momentum, meanders for a while and when it becomes apparent that the movement is not towards any specific destination, but towards a darkness, far darker than any known tunnel, dungeon or abyss, then that long sentence will come to an abrupt halt with the black head of the full stop on the paper like this.”
There is a variation to this definition when companies undertake initiatives. They don’t start slowly, but with lot of fanfare. There are initial resistances not necessarily hesitancies. It does gather momentum but meanders for a while. Then it another initiative crops up and this initiative drops off.

There are many reasons for this endemic malaise.

Desperate measures:

Initiatives are triggered by the desperation to address a current problem. It may not be even a problem but a symptom. We end up selecting the wrong tool, try out to fit the “so called” problem. The solution naturally fails and the initiative gets dropped. The cat has tried out piping hot milk and refuses to take the milk again even if required. We end up blaming the tool (first of all calling an initiative as a tool itself is blasphemous), blame the consultants, or worse blame the employees.

Fashion statement:

The boss attends a conference, picks up some idea about a few new “tools”. If everyone is trying this out there is something about this tool. Everyone is doing six sigma, kaizen, lean, reengineering (the fad of early 90s) so we should. We tryout a few baby steps, call an auditor to certify that I’ve arrived and blow it up in every forum. “We have been following 5S for last 8 years” (repeating 1s and 2 s five times is not 5s). Just before the 5S auditor arrives, 1S and 2S is undertaken on a feverish pitch, stopping production.

Overzealous consultants:

Tarka Sastra (science of dialectics, logic and reasoning) proposes “nahi ninda nyay” to support one’s theory. Glorify your view, but that doesn’t mean that the other view is flawed. But unfortunately, in business consultancy, is “evam ninda nyay”; ridicule the other methodologies to glorify your methodology.
With plethora of consultants carrying one or two methodologies in hand reminds me of the village fair I used to attend in my child hood. In one corner, a guy sells “Activity Based Costing – take this and have clarity on costs” ; another vendor next to him yells “SAP is the way to manage your data and have clarity on not only costs but also all your business processes”. Go further down the aisle, you will find two guys sitting next to next selling Balanced Score Card and EVA. “Unless you link your people to your strategy map you can’t have a successful business (BSC)” or “Unless you measure the bottom-line impact of your individual divisions you can’t align the goal (EVA). Then you have a horde of disparate vendors selling Kaizen, 5S, 6 Sigma, Lean Six Sigma. Disparate, as they claim that that their way of doing it is the right way and the only way. “I’ve been trained at Motorola itself on 6 Sigma”; “I got trained under a Sensei from Japan”. Normally you also find a guy selling an “amulet”, claiming that if you don’t take it, you’ll face dire consequences. Similarly, a few consultants sell Theory of Constraints, claiming that to be the cure all of all ailments; and worse, if you don’t adopt it you’ll be in real trouble. Then you have the evangelical Lean consultants supposed to look at the holistic view of business, but rarely so.
In this melee, the hapless business man is confused and ends up taking that initiative proffered by the most convincing seller.

Myopic view of the initiative:

Every methodology focuses on one key theme. “If the only tool you have is a hammer, you tend to see every problem as a nail”. – Abraham Maslow (1908-70). Maslow’s observation was spot on. It is not uncommon to see people claiming “if you follow ‘XYZ’ methodology everything is taken care of”. Replace XYZ with any initiative you undertake.

For example, 5S’s focus is to bring in stability that will enable the other improvement initiatives. TPM’s aim is to improve the reliability and availability of the equipment. Six Sigma addresses process capability. Activity Based Costing is a cost measurement mechanism trying to articulate the resource consumption more scientifically.

Lack of preparedness of the organisation:

We take up initiatives, without understanding our preparedness for the same. ERP implementation is a classic case. Organisations without any great culture of data capture end up wasting their time and resources, hoping it’ll ease up all the problems they face. Shop floor is in a mess, but I claim to follow Six Sigma. Six Sigma calls for a lot of data gathering and analysis. If I don’t have a great deal of data gathering in my gemba, I can’t have a great Six Sigma initiative.

Viewing an initiative as a tool:

Every initiative has prerequisites and preparedness; needs champions to take it forward and ultimately should become part of the performance measure. Instead perceiving an initiative as a tool will only lead to short term focus of benefits of the tools and not the long term focus of sustainable improvement.

Conclusion:

Purpose of any business is to create value for the customer. We need to align what we do to the purpose, i.e. the process has to be in sync with the purpose. We need people to align the process to purpose and are to be aligned to the purpose and process. We need initiatives and methods to ensure that this alignment is as seamless as possible. Only then we can prosper. Choosing the method, therefore, is the first critical step. Find the purpose of the method, the method follows.

Sources of Causes Of Cost

Dukh mein sumiran sab kare
Sukh mein kare na koi
Jo sukh mein sumiran kare
To dukh kahe ka hoi.

Kabir

We all remember God when we are beset by grief,
none of us remember Him in our good times.
Had we remembered Him in our good times,
why should the days of grief have come!

With due apologies Kabir if I may rewrite the Doha for the business -

Loss mein Cost Cutting sab kare,
Growth mein kare na koi
Jo growth mein Cost Management kare,
to loss kahe ka hoi…


Normal practice, if the company is not doing well, is to demand every employee to cut cost by 15%. It is akin to telling each employee, “take 15% lesser food”, or “Restrict the number of words in your report to 85% of the intended length”. What many of us call as cost control is nothing more than expense control. We list the expenses appearing in the Profit and Loss Account, take percentage of the expenses on Sales and set “aspirational” targets to reduce the expenses. Expenses appearing in the Profit and Loss accounts are only the symptoms of the management decisions we take. The impact of our decisions impact Revenue, Cost and Investment.

Addressing Costs calls for addressing the causes of cost. Addressing Expenses is to cut the expenses without understanding the impacting factor of the cost. For example, we take material cost as a percentage of sales and compare across periods. Then we attempt to reduce the material cost in isolation by forcing the purchase in-charge to look for alternative sources. Without any concern for the impact on the delayed material delivery, adverse impact on conversion cost and material losses and adverse impact on the post sales utilisation by the customer, the purchase in-charge end up cutting the material purchase price. Material cost might have changed from the previous accounting period due to myriad reasons, which includes, change in material prices, change in product mix, change in input mix, changes in material wastages and operating practices. If an increase happens, we tend to put the blame on factors beyond our influence and control (global meltdown); otherwise, we take the credit for our superior operating practices. Either way, we sweep the reasons for variation under a singular major cause.

Addressing Costs call for an uncluttered thinking process of understanding the root cause of the cost and focus on that. Uncluttered thinking can happen if we have a clarity on the sources of causes.

Four sources of causes:

In my opinion there are four sources of causes for cost. I classify them as Economic factors, Design, Operational and Attitudinal.



“Economic factors” are price level changes, Government policies and social issues and are generally factors beyond our control and influence.

“Design” includes, design of product, process, supply chain structure and organisation structure. These factors are normally within our influence and control.

“Operational” is fulfilment of design. It is influenced by the Economic factors and design. These factors are normally within influence and control.

“Attitudinal” is the way people react to a situation and the culture of the organisation. It is also influenced by the design of organisation structure. These factors may or may not be within influence.


Economic Factors:
This is the favourite “Pass-The-Buck” for any cost increase. “Why have the costs gone up?” “Input prices have gone up”; “Our suppliers are in a monopoly market”. “Wages have gone up”. “Government has changed the rules”. “The Green Lobby is creating lot of problems”. We need to isolate the Economic Factors first. Addressing these factors call for a more strategic focus than by a simplistic operational focus.

The following is an inclusive list of economic factors:

1) Changes in price level Prices are influenced by many factors, both and macro and micro economic. Macro economic factors are like demand supply gaps, speculation of commodity prices, cost of living index going up leading to labour cost changes. The impact of these on the bottom line is to be isolated before doing any comparison of costs across periods. Otherwise, this will vitiate the sense of direction. Addressing these causes is to be at a strategic level of freezing the sources for longer duration. However, the flip side is when the prices fall. Micro economic factors of an individual firm impacting the prices due to their monopoly position in the market, Union level wage agreements, normal trend being followed within the company for salary increase (this drives the attitude) are again to be addressed at a strategic level. Developing alternative sources (design), relook at the practices within the organisation for salary hikes, relook at the agreements are some ways of influencing these causes. Costs going up due this factor are normally not a worry, if it impacts all the players and the product we deal is a necessity for the customer. We palm off the cost impact to the customers. However, if it impacts only our firm, then we are in trouble. Design plays a crucial role here, if we can create a modular design to change the dependence on any one input and thereby minimise the impact. Or Design of our supply chain, where we integrate with the upstream sources (Holding the mining rights and thereby minimise the price level changes)

2) Government policies: Changes to tax structures, money market policies, restrictions and removal of restrictions on import play a huge role in causing our costs. For example, our design of supply chain is influenced not only distances and nearness to sources, but also speculation on introduction of GST. These again, in the ultimate analysis, will impact the whole industry and not only a specific firm. However, it will certainly impact differently, if the different players are in different impact zones like an SEZ or FTZ. Even if competing within the domestic competition may not impact differently, if a firm has to compete globally or with global competition internally, then it plays a huge role on the cost structure.

3) Triple Bottom Line Requirement: Global concern for measuring firm’s performance based on People, Planet and Profit makes the environment and society a non-negotiable necessary condition for survival of the business. Firms are expected to avoid exploitation and spend on creating a carbon credit as they grow. It certainly impacts the costs internally for the firm. However, over a period of time, it hopefully, will impact all the firms. So long as a few vested interests get away with exploitation, this will only be a lip service. What ever may be, the impact of focusing on TBL will certainly impact the internal cost, mostly adverse. But, I think it is worth it.


Design:

Design can create or destroy. More than 90% of the costs are committed by the time we go for the detailed design (of the product, process, and supply chain or organisation structure). Trying to reduce the cost after the “damage” is done is more like catching the bull by the tail. Once committed, you have to address the design to achieve significant cost impact.

1) Design of the Product: Product Design plays a huge role in the life cycle cost of the product and the process. Any attempt to reduce the cost after the design is complete can have only a limited impact. For example, in the case of material costs, after prices, design has the greatest impact on the cost. If I can design a component out, then the resultant effect on the cost is significant. Methodologies like Target Costing (in conjunction with Value Engineering and QFD) can help the firm to design out tomorrow’s cost through today’s design.

2) Design of the Process: Design of the product plays a significant role in the design of the process as well. Still Process design independent of the product design, impacts the operations cost significantly. Out dated technology, unreliable process due to faulty process design, inappropriate processes are capable of playing havoc with the cost structure.

3) Design of the Supply Chain: My customer wants directly online delivery. Therefore, I need to keep stock nearer to the customer. This is essentially a supply chain design driving the cost structure. Creating Supplier clusters, cross docking, milk run design, choice of the channel of distribution and sourcing, etc., all play a major role in the cost structure.

4) Design of the Organisation Structure: For men may come and men may go, But I go on for ever. (The Brook by Tennyson) Similarly, men may come and men may go, but the Organisation Structure goes on for ever. Many firms still follow the pyramidal organisation structure created by DuPont plc in early 20th century. Organisations may be divided as functional or SBU or matrix or flat as it is called for minimal levels of hierarchy. The structure drives the communication channel, drives the decision making process and ultimately the cost as well.

Operational:

This is the favourite “Scapegoat” for any cost increase. “Guys! Cut the cost everywhere; we need to tighten our belt”. Operations can only control cost can’t reduce or manage cost beyond the boundaries given by Economic factors and Design. Operations can fulfil and destroy can’t create. Design can create a far greater damage. But, operation’s inconsistencies, strains and penchant for creating waste all make a heady cocktail of cost increase. The three Ms – Muda, Mura and Muri emerge out of operation’s inefficiencies.

1) Wastes – Muda Defects, Overproduction, Waiting, Transportation, Inventory, Movement and Extra-processing, the seven wastes identified by Taichi Ohno, who propounded the Toyota Production System are essentially triggered at the operations level. Though the structure of the supply chain, process and product do influence this, these seven wastes can emerge independent of the design. Lean thinking principle of aligning the process to the purpose (customer value) and thereby focusing on the Six out of Seven zeros (Zero Defect, Zero Lot size, Zero Lead Time, Zero Breakdown, Zero Handling and Zero Setups) can minimse the Mudas.

2) Inconsistency – Mura Variability in processes, surges and inconsistencies force us to have capacity more than what is actually required. We need to commit resources, men, machine and inventory to minimise the shock of the variability. Hence the cost has a tendency to increase. Focusing on the Seventh Zero (Zero Surging) and thereby improving the process capability is critical for minimising Mura. Six Sigma focuses on this.

3) Strain - Muri Strenuous processes, postures, movements, strain on machines, men and other resources are the third M of the infamous three Ms of Muda, Mura and Muri. Many of the quality initiatives focus primarily on the operational stability. Operation’s major role is to ensure stability.

Attitudinal:

After all organisations are so called as they are made up of people. People behave in the way their performance is measured. For example, I believe that selling price is not driven by the competition or customer or cost; it is driven by the month end pressures of the sales man to achieve the target. We incur costs because there are budgets. We stretch our project completion time to accommodate the padding we have done during planning.

1) Outdated Performance Measures

Purpose of a performance measure is to implement strategy and validate strategy. Strategy has to be in sync with the changed environment. If there is a change in environment, we tend to believe it to be temporary. This leads to a delay in formulating a strategy to meet the changing needs. We need to adapt our performance measure to fulfil the Strategy. Strategy is for the future, but delayed with reference to the changing environment; where as performance measurement is for the past delaying to adapt to the strategy. There is an in-built anachronism among change in environment, change in strategy and change in performance measure.

2) Short term focus

Performance measures tend to focus on short term achievement of targets. Even a CEO’s shelf life is not more than three years. “Who cares what’ll happen to my successor; I need to cover my back (called as CYA syndrome)” (We follow the same attitude with our environment as well).”Let me focus on reducing the purchase price; cycle time reduction is not my area of concern (called as Not In My Back Yard Syndrome NIMBY). This leads to locally optimising the cost but the overall cost may tend to increase.

3) Fulfilling a budget through reprimand

“I have the budget; I need to exhaust the budget.” This is especially true in the case of Discretionary cost – A cost triggered at the discretion of the management, like Research, Sales Promotion, Training, CSR, etc. In these cases, a budget based on a percentage of sales target is given to the functional heads. If the budget is not exhausted, they may get a cut in the next year. We often find a high surge in these expenses in the last three months of the year.

Conclusion

Profit is a mind relaxant. We tend to splurge when we do well, but get to stingy levels when we do badly. To consistently address cost a cost aware culture is critical. We need to realise that cost is an effect and not a cause. Addressing the effect, by taking one-off initiatives rarely deliver, sustainable and significant cost advantage. We need to address the sources of the causes of costs. We find that in many firms Cost Ownership is unclear. Sustainable cost advantage emerges out of Tackling, Taming, Tracking and Trapping the cost. This can be done only by scientifically addressing the causes.