ABC LIMITED: LUMP-SUM TURNKEY PROJECTS

On 10th September 2015, Mr. Pradeep Shukla, MD & CEO of ABC Limited was in a serious
discussion with Mr. Deepak Sharma, Business Head – Gas Compressor Division (GCD) on
the market share of Gas Compressors. Mr. Sharma was worried about the stagnant market
share and pointed out that the adoption of the LSTK (Lump-sum Turn Key) business model
will enhance the market share. However, Mr. Shukla was concerned about the level of ABC’s
experience and manpower proficiency in LSTK business model in comparison to the existing
market players. Mr. Sharma argued however that delaying the entry into this new business
model may hamper the growth of the business and strongly recommended initiating the
implementation of this model at the earliest. After the discussion, Mr. Shukla was brooding
over the challenges in the implementation and impact of this strategy on business growth.

ABC Limited

ABC Limited has three divisions and decided to venture into a new market segment for
business development focusing on the aggressive growth plan. ABC – having the in-house
technology and expertise in manufacturing compressors for gas applications and
understanding the excessive demand for this product in the market – has an advantage to enter
the new market segment (gas compressor). ABC invested INR 20 crores of its revenue for the
new business line. Therefore, Gas Compressor Division (GCD) became the fourth business
unit in the organization since 2005. Need for the gas compressor in the market for the last 30
years is growing exponentially. Having the expertise to make gas compressors coupled with
the growing market aligns with the ABC’s strategy of aggressive business growth. GCD
manufactures gas compressors for various applications for industries like Compressed Natural
Gas (CNG), biogas and oil and gas, etc. GCD is also in the business of spare parts sales and
after-market service.

The major focus of the GCD business is on its main product i.e. CNG compressors. GCD also
caters to non-CNG applications for the oil and gas sector. Over the last ten years, GCD has
captured a significant market share with a business turnover of INR 200 crores as of 2014.
The overall turnover of the GCD distributions is as follows: 70% revenue comes from CNG
compressor business, 20% revenue comes from the oil and gas sector and 10% comes from
spare part sales. This growth of GCD till 2014 is four times since its inception in 2005.

Most of the countries in the world are eager to reduce their dependence on crude oil. They
want to switch the fuel required for production units, vehicles, power plants to natural gas
from crude oil and make the economies gas-based for the pollution-free environment. Natural
gas is available in most countries and it is economical for production and does not require
refining before use, which is similar to crude oil. Therefore, the focus of the GCD is more on
the CNG compressor business as there are and will be more opportunities in domestic as well
as in the international market, contributing towards environmental stability.

Oil and Gas Industry

The oil and gas sector is among the core industries in India and plays a major role in
influencing decision making for all the other important sections of the economy. India’s
economic growth is closely related to its energy demand; therefore, the need for oil and gas is
projected to grow more, thereby making the sector quite conducive for investment.

Having the opportunity for business expansion, ABC entered this new market segment
through its GCD. Being in this industry for a decade has given its own challenges and
learnings to strategize the business survival and growth. While GCD focuses majorly on CNG
compressors, the non-CNG compressor requirement seeks attention as there is a huge demand
for it in the Oil and Gas sector. The statistical analysis predicts around 30% annual demand
for gas compressors in this sector.

GCD’s Challenges and Opportunities

With rising demand, many new entrants are willing to enter into this market. However, major
key competitors in the market, who have captured the larger segment, have given tough
competition for newcomers creating a situation to figure out their survival. GCD buys the
compressors for non-CNG applications from Europe and USA to address the customer needs
which is beyond the production capacity of its organization. Whereas the key competitors of
the GCD have suppliers who manufacture gas compressors of the same capacity within India.
This scenario creates a cut-throat competition for business survival in terms of costing.

GCD eventually shall face challenges in the CNG compressor business due to the entry of
new players. These new players compete with existing players like GCD through low cost and
short delivery time, which causes the existing customers to shift. This may lead to reduction in
market share of GCD - CNG compressor business in the coming years.

To address this pressure on the GCD business, ABC management strategizes a way to survive
in the gas compressor business by entering into the new segment of Lump-sum Turnkey
(LSTK) projects for the business growth and competing with the existing competitors by
adding significant value proposition of one-stop solution for all requirements to its customers.
This creates indirect competition to the suppliers in this segment.

LSTK Industry Background

Lump-Sum Turnkey (LSTK) business model is in the market for several decades. This
business model reflects operations like a supply of types of machinery, involving civil and
electrical work, installation and commissioning of supplied machinery on-site for production
of oil and gas, waste water management, power generation, etc.

Dilemma

Mr. Sharma and Mr. Shukla had discussions on various challenges the company might face
while executing LSTK projects like - competition from the existing players in the market for
many years, capital investment, funds flow, financing from financial institutions for
completing the work, resources, and infrastructure available. GCD also needs to recruit
manpower with the required proficiency and may face challenges in completing LSTK
projects with no experience in this field so far. Being the pioneer in this segment, with the
existing competitors working on application engineering, accurate costing, competitive
bidding, order booking, and project execution requires much higher proficiency in terms of
competency and skills in comparison to the existing players in the market, who have made
their presence significant and branded their services.

After the detailed discussion between Mr. Sharma and Mr. Shukla on the pros and cons of
venturing into LSTK projects, considering following key factors:
· Capital investment and revenue
· Proportional growth over the next three years

Mr. Sharma is focusing on the existing competent companies and targeting the market share
of 40% in LSTK business over the next three years upon entering. The market captured by
existing players is shown in Exhibit 1.

If GCD achieves this, then there will be a year-on-year growth in the ABC sales figure by
20%. Mr. Shukla is ready to fund GCD by allocating a one-time investment of 1% of last
year's sales of ABC in order to have additional manpower (skills like project execution, cost
estimation, marketing, etc.) and infrastructure needed to run LSTK projects (see Exhibit 2).

Mr. Sharma and Mr. Shukla are equally considering the payment terms in the LSTK projects
which require a longer duration for payment receivables on pro-rata basis based on the project
progress in comparison to other projects handled by GCD. This situation raises the need of
funding the project operations from financial institutions, becoming one of the key factors for
the decision making to run the projects successfully ensuring the business growth.
Additionally, 35% subcontracting with the local service providers to support project execution
at the site will also be required.

Case questions:

1. Should ABC venture into LSTK business segment? Explain with reasons.
2. To what extent ABC should consider funding from external financial institutions to
reduce the interest amount and expense efficiently?
3. How should GCD manage its operations around payments made on pro-rata basis?
4. Upon entering the market, what should be the strategy and ways of operating the
LSTK projects to capture the market share of 40% over the next three years?
Exhibit 1: Market share of existing players in LSTK business.

Name of the existing player Market share % Market Value (INR)

TPL 50 300

KPL 30 180

HOL 20 120

Total market value of LSTK business in FY 2014-15: INR 600 Crore

Exhibit 2: Financial details of ABC Limited for FY 2014-15 (In INR)

Revenue 600 Crore

Expenses 480 Crore

Profit before tax 120 Crore