ACC's Sumit Banerjee: 'Profits and

Cartelization Are
Two Different Things'
Published: August 07, 2008 in India Knowledge@Wharton
When inflation in India started to get out of hand earlier this year, the
first
whipping boys of the central government were the cement and steel
industries. They were forced to cut or hold down prices, and several
measures such as export bans and reduction in import duties were
initiated. These steps succeeded to the extent that prices didn't gallop,
but
that stability came at the cost of the industry's bottom line. Share
prices of
cement companies have slumped and analysts have removed the
sector
from their most-favored lists.
The 20-million-ton capacity ACC (formerly Associated Cement
Companies), once owned by the Tatas and now controlled by Holcim of
Switzerland, is the country's largest cement producer. Holcim also
owns
Ambuja Cement, which adds 19 million tons to the group's capacity.
Put
together, it is the second largest cement producer in India, marginally
behind the Aditya Birla group. Holcim's core business is cement, while
the Aditya Birla group straddles various sectors. This makes ACC the
leader in its category, and the company's CEO Sumit Banerjee the de
facto
spokesman for the industry.
In this interview with India Knowledge@Wharton, Banerjee counters
the government's allegations of
cartelization. He also discusses the dynamics of the industry and ACC's
own plans.
India Knowledge@Wharton: Why has the government been
targeting the cement industry?
Sumit Banerjee: That question is best addressed to the government.
We in the cement industry are
surprised. On the one hand, we are constantly feeling the pressure of
increased input costs. On the other,
we are under pressure to reduce prices.
The average price per 50 kg bag of cement is about $5. This is much
cheaper than the rate in Pakistan,
Bangladesh, Sri Lanka and Nepal. Raddi (old newspapers sold as scrap)
costs 14 cents a kg, while
cement costs just 10 cents a kg.
India Knowledge@Wharton: But the cement industry is making very
good profits. Doesn't this point to
cartelization?
Banerjee: Cement is a cyclical business where the margins depend
upon the demand-supply situation.
There are peaks and valleys. You cannot look at the profits of one year
in isolation. They should be
analyzed over a period of time, say, 10 years. Only then can a correct
inference be drawn. Profits may
have been at the crest of the cycle in the recent past. But at the
present juncture, they are declining due to
increased taxes, duties, levies and input costs.
Profits and cartelization are two different things, and it is unfortunate
that they are being mixed up. Any
company which is in business (and a trustee of the shareholders'
money) has to make profits. In the
cement industry, which is highly competitive, there is not much scope
for a single firm to make
super-profits. This may give rise to allegations of cartelization, but
these are ill-founded and motivated
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by certain user segments.
It is not possible to cartelize an industry that is extremely fragmented
with more than 25 large cement
producer groups and 20 others with a total capacity of 189 million
tons. Besides, India has 365
mini-cement plants with a capacity of 11 million tons.
Being a commodity, there is not much product differentiation in
cement. This leads to a small bandwidth
of prices and a herd mentality on prices. From 2001 to the end of
2005, supply exceeded demand, which
led to cutthroat competition, resulting in lower reinvestment
realization. Because of this lower
realization, capacity addition slowed down significantly during the
period. This resulted in a marginal
shortage from 2006 through 2007. Fresh capacity of 23 million tons
was added during the last financial
year (April 2007-March 2008). This has created the current capacity of
189 million tons.
Cement prices have always been lagging the wholesale price index
(which measures inflation). It has
caught up only recently. There has been a cost increase of around 33
cents a bag in March 2008 over
March 2007, excluding tax increases. The tax increase is more than 40
cents a bag. Fuel, power, freight,
excise and sales tax are the main contributors to the cost increase. As
against this, the retail price increase
has just been 21 cents a bag in this period. This is less than the cost
increase. At the current average retail
price of $5 a bag, the cement industry earns approximately 75 cents
and the government $1.68 through
direct and indirect taxes.
India Knowledge@Wharton: If these are the numbers, why are
there still accusations of cartelization?
Banerjee: Market leadership, which is a well-accepted principle, is
being mixed up with cartelization.
As the product is a commodity and does not have any differentiation,
whenever the market leader
increases prices due to increased cost, others follow as they have the
same cost pressure.
India Knowledge@Wharton: What has the government actually
done?
Banerjee: The government has imposed a 12% ad valorem duty on
MRP (maximum retail price). In
absolute terms, the excise duty has gone up by $4.67 a ton. In
addition, costs have gone up by 20%,
which the government has asked the industry to absorb.
The government has also imposed an export ban on cement (which
has been partially lifted). This is a
knee-jerk reaction. Some 90% of this cement is produced in coastal
Gujarat. Because of infrastructural
constraints, it cannot be transported to other parts of the country. This
means that the cement that cannot
be exported cannot be sold. Pakistani cement, meanwhile, is being
allowed into the country without any
import tax.
There is another important issue. Indian companies have contractual
obligations with foreign importers.
Such export bans make India less reliable in the international
community.
India Knowledge@Wharton: What impact will the government's
moves have on capacity building and
investment?
Banerjee: If the industry does not get returns that can be reinvested,
some of the future capacity
additions may come under scrutiny.
Until 2012, cement companies have placed orders for 140 million tons
of additional capacity. We
estimate that 32 million tons will come up in calendar year 2008, 80
million tons by 2009, and 111
million tons by 2010. This will lead to much higher supply than demand
and put further pressure on
prices. This, coupled with policy inconsistencies, may reduce
investment in creating cement capacity.
People may prefer to wait and watch. Investment in building cement
capacity may go down.
But, in terms of volume sales, India is one of the fastest growing
markets in the world. At the same time,
its per capita consumption at 150 kg per annum is lower than even the
400 kg in Vietnam and Thailand.
In the U.S., it is as high as 800 kg. In places where there is a
development boom, such as Dubai and the
Emirates, it is a whopping 4,000 kg. The fear is that when
infrastructure building in India moves into top
gear -- we expect per capita consumption to double to 300 kg in 10
years -- the capacities may be
inadequate. Today, cement consumption is about 65% in sectors like
house building. But infrastructure
sector consumption will go up.
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sector consumption will go up.
India Knowledge@Wharton: What about the cost of creating
capacity?
Banerjee: Inflation affects capital expenditure (capex) too. Our lower
margin means that we have less
money to put into building for the future. In just two or three years, the
capex for creating one ton of
cement capacity in India has moved up from $100 to $200.
India Knowledge@Wharton: What are your plans for ACC, which has
a tradition of being a
slow-moving giant?
Banerjee: The giant is not somnolent any more. If you look at our
financial results in the past decade,
you will notice a definite upward trend. I do not necessarily need to set
a fresh agenda. The past two
years have, in fact, shown an all-time best performance. So, most of
the agenda is already set.
I have some dreams of my own for this organization. For instance, I
want us to be a benchmark in
internal communications. We should be able to reach out to every
employee of this organization and
rejuvenate a strong sense of accountability and performance
orientation. That will help us all be more
committed and responsive to work and results. I want us to be
recognized in the area of sustainable
development. I want us to be a learning organization. But, above all,
we as a team are deeply committed
to retaining our number one position in the cement industry in India. It
is not going to be easy.
India Knowledge@Wharton: What do you see as your principal
challenges?
Banerjee: The first challenge the industry has to face is to meet the
growing demands for cement from
the economy. This means we have to keep pace with economic growth
and install additional capacities.
Project implementation, planning and completion all become critical
factors. We are facing difficulties in
procurement of certain machinery which can lead to delays.
Availability of skilled manpower is another
challenge. The cement industry now has to attract and retain talent,
while facing competition for skilled
manpower from other manufacturing sectors.
Energy poses a looming threat. Most of our plants are self-reliant as far
as power consumption is
concerned but sourcing thermal energy will become increasingly
difficult in the future. We are,
therefore, carefully creating our long-term strategy for coal to mitigate
sourcing and cost-related risks.
Besides, we need to bring about substantial improvements in
distribution costs and alternate modes of
distribution. Our existing methods of distribution, particularly
transportation, are quite dated and not
necessarily globally competitive.
India Knowledge@Wharton: What are Holcim's plans for India?
Banerjee: India accounts for 17% of Holcim's global revenues, though
it would be slightly lower in
terms of profits. Holcim controls 24% of the market. It is planning to
invest $2 billion to increase
capacity from 39 million tons today to 55 million tons by 2010. Holcim
has already invested $3.5 billion
in India.
The company is also increasing its stake in ACC and Ambuja Cement
through the creeping acquisition
route. (Under Indian law, promoters are allowed to increase their
stakes by buying up to 5% of their
shares every year without having to make an open offer to the public.)
India Knowledge@Wharton: What difference has Holcim made to
ACC?
Banerjee: Holcim has a successful global presence in 70 countries. It
is made up of people from many
countries, including Asians. The association with Holcim has opened
ACC's mind to the world.
India Knowledge@Wharton: Thank you for your time.
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