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Unit 8: Laws of Production

double revenues every two years. Sustaining profitability in the face of such expansion is Notes
an extremely challenging task.
For now, this is a challenge Indian infotech companies seem to be losing. The ROCE for
three Indian majors fell by 7 per cent annually over 1994-96. At the same time IBM Microsoft
and SAP managed to improve this ratio by 17 per cent.
There are some exceptions, however. The cement industry, which has focused on
productivity rather than on growth, has done very well in this dimension when compared
to their global counterparts. While Mexico’s Cemex has grown about three times fast as
India’s ACC, Indian cement companies have consistently delivered better results, not only

on absolute profitability ratios, but also on absolute profitability growth. They show a

growth of 24 per cent in return on capital employed while international players show only
8.4 per cent. Labour productivity, which actually fell for most industries over 1994-96, has
improved at 2.5 per cent per annum for cement.
The engineering industry also matches up to the performance standards of the best in the
world. Companies like Cummins India has always pushed for growth as is evidenced by
its 27 per cent rate of growth, but not at the cost of present and future profi tability. The
company shows a healthy excess of almost 30 per cent over WACC, displaying great future
promise.

BHEL, the public sector giant, has seen similar success and the share price rose by 25 per cent
despite an indecisive sensex. The only note of caution: Indian engineering companies have
not been able to improve labour productivity over time, while international engineering
companies like ABB, Siemens and Cummins Engines have achieved about 13.5 per cent
growth in labour productivity, on an average, in the same period.

The pharmaceuticals industry is where the problems seem to be the worst, with growth
emphasised at the cost of all other performance. They have been growing at over 22 per cent,
while their ROCE fell at 15.9 per cent per annum and labour productivity at 7 per cent.
Compare this with some of the best pharmaceutical companies of the world – Glaxo

Wellcome, SmithKline Beecham and Pfizer –who have consistently achieved growth of
15-20 per cent, while improving returns on capital employed at about 25 per cent and
labour productivity at 8 per cent. Ranbaxy is not an exception; the bias for growth at the
cost of labour and capital productivity is also manifest in the performance of other Indian
pharma companies. What makes this even worse is the Indian companies barely manage
to cover their cost of capital, while their competitors worldwide such as Glaxo and Pfi zer
earn an average ROCE of 65 per cent.
In the Indian textile industry, Arvind Mills was once the shining star. Like Reliance, it
had learnt to cook sweet and sour. Between 1994 and 1996, it grew at an average of 30 per
cent per annum to become the world’s largest denim producer. At the same time, it also
operated a tight ship, improving labour productivity by 20 per cent.
Despite the excellent performance in the past, there are warning signals for Arvind’s
future. The excess over the WACC is only 1.5 per cent, implying it barely manages to
satisfy its investors expectations of return and does not really have a surplus to re-invest in
the business. Apparently, investors also think so, for Arvind’s stock price has been falling
since Q4 1994 despite such excellent results and, at the end of the fi rst quarter of 1998, is
less than ` 70 compared to ` 170 at the end of 1994.

Unfortunately, Arvind’s deteriorating financial returns over the last few years is also
typical of the Indian textile industry. The top three Indian companies actually showed
a decline in their return ratios in contrast to the international majors. Nike, VF Corp and
Coats Viyella showed a growth in their returns on capital employed of 6.2 per cent, while
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