Cost's a fortune

A cost control exercise helped M&M's farm equipment division halve its break-even point

V S Parthasarathy

Executives at Mahindra & Mahindra's (M&M's) farm equipment sector still reserve a special mention for the year 2001.

It's obviously not because the Indian tractor industry was hit by a downturn in that year and sales slid by 13 per cent. Or for the fact that market leader M&M suffered even more "" a 30 per cent decline in sales.

The year was special because the farm equipment division of M&M still managed to make a profit. And what saved the day, or year, for M&M was not the fact that its exports increased by 77 per cent.

Instead it was a cost-control exercise that was initiated in the previous year. The vision in 2000: shave costs out of the system in such a manner that the break-even point of sales is lowered by 50 per cent.

The rationale: the company would stay in the black even if its sales projection went below target by as much as 50 per cent.

The objective was in tune with M&M's desire to become the world's largest tractor manufacturer (it is currently number four). But before achieving that pole position, the company had to first attain cost leadership.

In a strange way, the following year's slow-down helped. "When the market for tractors collapsed in 2001, we had to speed up the process of change drastically," says V S Parthasarathy, vice president, business planning and international operations, farm equipment sector, M&M.

Three years down the line, the company seems to have emerged stronger from this initiative. This is despite the industry declining till the previous fiscal.

In the last financial year, with a market share of 27 per cent and a revenue share of 30 per cent, the company claims that it had an industry profit share of 70 per cent.

In fiscal 2003, when sales had dropped by 22 per cent for the industry, M&M's profit share was 110 per cent (it was the only company that made a profit).

The starting point for M&M's cost-cutting initiative sounded deceptively simple: to be the best in industry on labour and overhead costs, marketing costs, working capital and inventory.

The company could draw encouragement from the fact that on at least one parameter, inventory, M&M was already better than tractor industry standards.

For instance, when average inventory holding levels were in the range of 90 to 120 days, M&M held a 40- to 50-day inventory, though this is still considered high.

To look at the best-in-class across industries, M&M started a project called North Star in which cost leaders from different industries defined the benchmark that M&M could strive to meet.

For instance, DHL was to be the chosen one for supply chain practices, while the company looked at Toyota for managing material costs and controlling inventory. For sales processes, Japanese office automation company, Ricoh, was the benchmark.

For operational efficiency, the company benchmarked against a global trading major that earned gross margins (that is, sales minus cost of sales/sales) of just 7 per cent, which is considered low in a business that earns between 8 and 14 per cent.

What saved this company was that costs were just 4 per cent of sales. This tight control over expenses helped the global major boost its profitability despite lower margins.

Likewise, the task for M&M was to target sales, general and administration costs at less than 4 per cent. And M&M was nowhere close to that number with a cost structure running into double digits.

"The aim was to increase PAT from TPA (profit after tax from top priority actions)," says Parthasarathy.

To ensure that no cost was left unattacked, M&M looked at every cost with a toothcomb. To start with, the fixed component was divided into two heads, fixed committed and fixed controllable.

For instance, while employee wages were left untouched in the grid of fixed committed, cost heads like advertising and travel expenses were pushed into the new grid of fixed yet controllable.

The next step was to set up teams that would attack costs from all sides. Material cost, which accounted for 60 per cent of total costs, was the largest cost head.

To lower material costs, the company appointed 12 teams to tackle each aspect of the cost. Each cost unit had a champion who reported the progress on each project to the management in the monthly meetings.

"To single out costs we looked three layers down from basic cost elements to sub-elements," says Parthasarathy. For instance, marketing costs were broken into advertising, promotion, dealer incentives and so on.

Each cost was captured in the system and assigned targets. Soon the number of cost elements in the organisation went up from 100-odd cost elements, to cost heads in excess of 400.

Even as cost heads went up, negotiating with suppliers was just one part of the cost-cutting exercise. Take material costs as an example.

If one team was involved in vendor rationalisation, the other looked at increasing the commonality of parts between different products. The results were soon achieved.

For instance, the number of vendors dropped from 300 to 220. This meant that even in a lean year, when there was a 20 to 30 per cent drop in sales, the vendor would not suffer a drop in volumes.

This is because the vendors who remained in the company register would get the incremental business, which otherwise was given to the vendors who went out of the system.

Another benefit of the cost exercise was in increasing the commonality of parts, which has increased from 50 per cent earlier to 60 per cent at present.

For instance, the company used to have 10 types of stickers bearing the model names for tractors, which was rationalised to three. A similar exercise was repeated to even parts like sockets for head- or tail-lamps and bulbs.

To lock in savings, the company took away all cost-heads that had been optimised out of the radar. This meant that a cost control issue would never re-occur under the same cost head.

M&M also focused on location-based cost improvements by deriving benefits from economies of scale. For instance, previously, Rudrapur, in Uttaranchal, was just a satellite plant that the company used only for assembling around 12,000 tractors every year.

In the last nine months, the Rudrapur facility has been scaled up to manufacture 25,000 to 30,000 units from scratch.

To ensure that the initiative stayed on course, 200 managers from across functions met every month and discussed progress on projects and jointly resolved bottlenecks.

"Because of the joint meetings the possibility of one team creating a bottleneck for another was eliminated," says Parthasarathy. To improve margins further, M&M turned its attention to product portfolio optimisation.

The portfolio was bifurcated into best-seller grades and the rest. All marketing initiatives would then be focused on promoting the best sellers.

At present, the company claims that 60 per cent of its products are in the top grade. Two years ago, only 45 per cent had made it to the top grade.

Industry worst practices were also weeded out. During the tractor industry slump in 2001, dealers tended to offer customers longer periods of credit.

This in turn affected the credit cycle of manufacturers, as a result of which the industry had 120 to 150 days of debtors (credits given to dealers) "" M&M had debtors of 90 days. To overcome this hassle, M&M stopped the practice of providing unsecured credit to farmers.

Instead, it initiated tie-ups for tractor financing with banks like Vysya Bank. At present, banks like SBI offer specific programmes for tractors. Due to these initiatives, the company could crash working capital to 30 days in 2003.

To ensure that employees remained focused on the cost control exercise, it was linked to evaluating employee performance based on their contribution.

But as Parthasarathy points out, for the North Star initiative, which was to exceed industry standards, the aim was to subdue the fear of failure.

This was important, because North Star made the management set unrealistic targets. For instance, the company looked at launching a new product within nine months. However, this was a tall task, considering that the average time taken to develop new product was 30 to 36 months.

As six months passed, the company could feel a sense of disappointment within the task force simply because things were not moving.

"If targets become unrealistic then disappointment sets in. This helped us understand how to set realistic targets," says Parthasarathy.

He claims that the exercise was, however, not futile. M&M managed to reduce the time-to-market of new products by 20 per cent and increase first time hits (getting it right the first time) drastically.

To learn from failure, the company had a debottlenecking exercise focused on what went wrong in the earlier plan.

At present, M&M has managed to cut inventory from 40 to 50 days to 22 to 23 days. The aim is to get to four to five days soon for work-in-progress and raw materials.

The company is also exploring global sourcing options from China, for which it recently signed a joint venture with Jiangling Motor Company Group of China.

M&M has also taken to lean manufacturing (which literally means manufacturing without too much waste, using parts that are interchangeable, facilitating better worker and management co-ordination and so on). Parthasarathy says that 30 per cent of the programmes in lean manufacturing have already been implemented.

Overall, M&M expects a 20 per cent turnover from global sales in a three-year time frame. Today it stands at 10 per cent.

However, the tractor manufacturer is still oscillating between the number three and number four slot in the global hierarchy. Will cost efficiency help M&M take the escalator to the top spot?