Diversification Dreams: Will Bharat Forge Become India's Newest Conglomerate?

: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4443)

Diversification Dreams: Will Bharat Forge Become India's Newest

Conglomerate?
Published in India Knowledge@Wharton

When France's Alstom and India's Bharat Forge

announced a new Rs. 24 billion (US$520 million)
joint venture in December, the news was easy to
overlook. After all, joint ventures are formed all
the time. But theirs -- to co-manufacture 5,000
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megawatt (MW) power-generation equipment --

was unusual: Though Alstom is a world-leading power generator, Bharat Forge is a specialist in a
completely different field, having spent nearly 50 years churning out crankshafts, axles and the like for
big names in the auto sector.
If the top executive of the Pune-based company -- the world's number-two auto forging supplier by
annual sales -- has his way, Bharat Forge will have a hand in many more deals in energy as well as a
range of other high-growth sectors, from aerospace and railways to oil and gas. By 2012, "I want us to be
a conglomerate making industrial equipment and capital goods," says Baba Kalyani, the 60-year-old
chairman and managing director of the Kalyani group's flagship company. His reason is clear: The
company needs to break its long dependence on the highly cyclical auto sector, which he says has
"restricted creativity" and hampered its growth prospects.
Kalyani's determination to change the revenue mix at Bharat Forge isn't without risks. "It's a difficult
game to pull off," says Rajesh Chakrabarti, professor of finance at Hyderabad's Indian School of
Business. "It is tough to leverage competitive strengths in unrelated sectors."
"Diversification is always risky, but firms seek opportunities to grow," says Saikat Chaudhuri, professor
of management at Wharton. "The point is, [Bharat Forge] wants to be a huge forging company, and it
wants to be number one or number two in many sectors, not just in one. If you look at the large
multinationals, they're like that, too."
The Bigger, the Better?
Indeed, Bharat Forge's desire for diversification certainly isn't unique among multinationals, particularly
in India. Mumbai-based Tata Group, for instance, is involved in everything from power, autos and IT to
chemicals, engineering and telecoms, while Aditya Birla Group, also based in Mumbai, includes metals,
retail, IT, telecoms and power. They are joined by Mahindra & Mahindra, Reliance and ITC on the
growing roster of India's conglomerates. "Indian groups like to have a presence across sectors," says
Harish H.V., a partner at the Bangalore office of Grant Thornton, an accounting and consulting firm.
"They like a balanced portfolio to hedge their risks when they are looking for scale."
Though Bharat Forge first began talking publicly about diversifying in 2005, the plan really didn't get
under way until recently, with new joint ventures as well as the opening of plants dedicated to non-auto
forging. Now, if all goes according to Kalyani's timetable, Bharat Forge's non-auto business, which
accounted for slightly more than 20% of the company's revenues in the last fiscal year ended March 31,
2009, will grow to 40% of revenues by 2012 and 75% by 2015.
Yet Bharat Forge's diversification is arguably different than those of India's established conglomerates in
one important way: It is driven by necessity -- and even more so because the economic downturn that
began in 2008 has pummeled the auto sector. According to Bharat Forge, the order books of original
equipment manufacturers around the world contracted between 40% and 70% over the past year as car
sales plunged and top customers, like General Motors and Chrysler, hit a wall. "It is hard to make money

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sales plunged and top customers, like General Motors and Chrysler, hit a wall. "It is hard to make money
in an industry if all your customers are losing money, [because the tendency is] to squeeze suppliers to get
savings," notes Nirmalya Kumar, professor of marketing at London Business School, who recently wrote
about Bharat Forge in India's Global Powerhouses: How They Are Taking on the World.
As Kalyani recalls, "The Americans pulled the rug from under all of us." Up until then, he says, Bharat
Forge was "a company looking only for growth and didn't even consider the flip side." As it now knows,
the flip side isn't pretty -- in fiscal 2009, profit before taxes plummeted 60% year on year to Rs. 1.6
billion (US$34.7 million) on net sales of Rs. 47.7 billion (US$373 million). Cash flow, meanwhile, fell
from about Rs. 4 billion (US$87 million) to Rs. 1.6 billion (US$34.7 million).
The start of fiscal year 2010 has shown only slightly more promise. In the second quarter ended in
September, net sales declined 37% year on year to Rs. 4.3 billion (US$93.5 million) but were up 19%
from the previous quarter, thanks in large part to the company's domestic commercial vehicles business.
Domestic sales increased 29% quarter on quarter (though were down 17% year on year) to Rs. 2.8 billion
(US$ 61 million), while exports in the quarter remained "muted" at Rs. 1.5 billion (US$33 million),
according to an analyst note published in October from Mumbai-basedIDFC-SSKI Securities.
Kalyani acknowledges that the downturn has put Bharat Forge's diversification plan under pressure, but
he adds that the company has been using the past year to clean up internal weaknesses that prevent it from
diversifying efficiently. "You have to use the downturn to reduce costs and change processes," he notes.
To that end, the company has been squeezing working capital, improving inventory management and
removing operational bottlenecks to increase the productivity of its 6,500 employees worldwide.
Engineers have begun using lightweight material to redesign crankshafts, reducing costs by 10%. To help
save energy costs, a batch of crankshafts is now forged every 36 seconds, compared with 48 seconds
earlier. Management, meanwhile, has taken salary cuts, and staff on the shop floor are doubling up on
duties.
Global 'De-Risking'
Bharat Forge has faced similar trouble before. For years, nearly all of its revenues came from India. So
when the domestic auto sector began skidding in the mid-1990s, the company went overseas with a
vengeance, ramping up its exports and its international deal making. At the time, "we started by
geographically 'de-risking,'" says Kalyani. It helped that the global forging industry was fragmented with
many small players, making it easier for Bharat Forge to acquire companies outside India and build
market share.
Since 2000, the company has spent nearly US$100 million buying firms in Europe and the U.S. The
acquisition spree included Federal Forge in the U.S., Imatra Kilsta in Sweden, Scottish Stampings in
Scotland, and Carl Dan Peddinghaus and CDP Aluminiumtechnik in Germany. Three years ago, Bharat
Forge also gained access to the world's largest auto market by acquiring a majority stake in China's FAW
Corporation in Changchun. These acquisitions have been a key to the firm's "dual shore strategy,"
according to Kalyani -- that is, supplying components to clients from two plants, one in India and another
closer to clients to help control costs.
Today, operations in Europe contribute to more than 40% of overall company revenues, and the U.S.
operations contribute 27%. Without the international acquisitions, Kalyani notes, it would have been
"tough" to grow the company's market share and maintain an industry-leading position.
Now, the question is whether Bharat Forge canachieve in other sectors what it has in auto parts. It already
has two new dedicated plants to manufacture parts for customers in other sectors -- in Pune and Baramati
-- which Kalyani is confident "will help us get more business." But as experts note, new distribution and
sales channels, not to mention technical knowledge, also need Bharat Forge's attention.
As Arvind Mahajan, executive director and head of business advisory at KPMG in Mumbai, notes, there
is a "huge potential" in each of the company's new businesses. "But it all depends on how well and how
quickly Bharat Forge can master the new capabilities and get the right technology," he adds.
Others are equally cautious. "One starts on the basis of: Don't diversify; stick to what you do best," says

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Richard Whittington, professor of strategic management at Oxford University's Said Business School in
the U.K. "The conventional wisdom is not to diversify, because you're starting from behind." But he and
others note that under certain conditions, diversification is a wise move.
For Bharat Forge, there are two main reasons why diversification can work, experts point out. The first
has to do with the sectors that it has chosen to enter. Unlike auto making, these sectors are growing
rapidly and are crying out for investments, not to mention suppliers. Electrical power is a case in point. At
the company's annual meeting in June, Kalyani announced that the company wants to help India become
energy self-sufficient in the next five to seven years. That's a tall order, given that close to one third of the
country's population of 1.2 billion (and increasing) does not have access to electricity, and that GDP is
expected to grow at around 8% for several more years. But that's good news for the likes of Bharat Forge.
Another reason is that Bharat Forge is using joint ventures -- such as the one with Alstom -- to get a
toehold in new sectors and gain the technical know-how it lacks. Last June, for example, the company
joined forces with India's top power generation company -- National Thermal Power Corp. -- to set up a
greenfield facility to make castings, forgings, fittings and high pressure pipes for the power sector and
others.
For international joint venture partners, it's not just Bharat Forge's metallurgical expertise that makes it so
attractive. The company's Indian roots are also helpful, particularly in sectors such as nuclear energy,
which is in the process of being opened up to private-sector firms for development. France's Areva, the
world's largest supplier of nuclear reactors, is another new Bharat Forge partner. As part of one
agreement, Bharat Forge will soon be making nuclear forgings at an industrial complex in India, and in
another, the two companies will jointly manufacture pressurized heavy water reactors in a Rs. 1 billion
(US$22 million) investment, according to a report in October by business news site Livemint.com.
Meanwhile, U.S. companies -- which require permission from their government before entering into deals
to develop nuclear energy in other countries -- are laying the groundwork for their entry into India.
TendersInfo, an India-based research and consulting firm, reports that GE-Hitachi, for example, has plans
for a 10,000 MW nuclear power plant in India and is in talks with a number of Indian companies,
including Bharat Forge, to manufacture equipment for the plants.
Yet despite the growing array of prospects, a number of factors can derail Bharat Forge's diversification
plans. For one thing, Said's Whittington warns that the company will have to learn how to run a
diversified venture, which can "distract management time." A big challenge will be to revamp existing
systems so that they meet the needs of a larger, and potentially very different, company. Sales and
marketing strategies need overhauling, as do supply chains, distribution channels and all kinds of
processes that will keep the company running while it undergoes change.
"If you define your culture very much by the market that you have, the customers you have, even the
sector you're in, and you start to diversify, it gets much harder in terms of how, say, sales and marketing
adapt," Chaudhuri notes. "I don't think that's the case at Bharat Forge," which sees itself first and
foremost as a forging company, he adds.
Filling the Gaps
But is Bharat Forge putting its hard-earned global lead in auto forging at risk as it pursues new sectors? "I
don't think Bharat Forge is throwing away its lead in auto parts but just trying to balance the group's
fortunes as the auto industry is a very cyclical industry," says Kumar of London Business School.
Kumar and other observers generally give Kalyani's decision to diversify the thumbs up, but with caveats.
"Bharat Forge will retain its strength in auto parts but by diversifying will hopefully be able to smooth
earnings and revenues better across business cycles," he says. "Whether it is able to gain leadership
positions in the new industries is, of course, open to debate."
Chaudhuri agrees. "For [Bharat Forge] to go into railways and other sectors makes a lot of sense, as long
as it sticks to its capabilities." The company is essentially following the lead of firms in other troubled
sectors, he adds. IT services firms, for example, "have realized, especially after this financial crisis, that
they were much too dependent on the U.S. market and on financial services. They're all saying, 'We'd like
to be stronger in other areas as well.' That doesn't mean they want to sacrifice their strong positions."

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Diversification Dreams: Will Bharat Forge Become India's Newest Conglomerate?: India Knowledge@Wharton
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Indeed, the company isn't forsaking its old auto relationships: Kalyani is working closely with global auto
makers that are developing new engine platforms. Besides, a huge domestic auto market is emerging as
India becomes the global small car hub for companies ranging from Toyota and Ford to Volkswagen and
Chevrolet.
Even as he is reshaping Bharat Forge, Kalyani is already laying the groundwork for newer markets. South
America, Brazil and Russia will be his new turf soon. "Patience has never been my virtue. But I will be
better prepared to handle a downturn next time," he says.

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