Business Portfolio Planning at Roland Construction Company Limited

Background

India won independence in the August of 1947 and adopted parliamentary democracy to become the biggest democracy in the world. The nation has since gained in status from a third world nation to a country of growing economic power. However, India continues to face some serious challenges, one of which is non-availability of adequate infrastructure—transport, power, real estate, water and sanitation, etc. In 2002, the central government took serious steps to resolve this issue of poor infrastructure and made sustained efforts to build the infrastructure of the country. In the year 2012, the total investment in infrastructure—housing, roads, ports, rail transport, airport development and water supply amounted to about 12 per cent of the country’s gross domestic profit (GDP). One activity common to all types of infrastructure is construction.

The share of construction in different sectors of infrastructure is shown in Table 1 (Annexure). Thus, the construction activity in India is the major contributor to the economic growth of the country. It has a multiplier effect of five, that is, one unit of expenditure in this sector has the potential of generating income that is five times the expenditure. It is also the second largest employer of manpower in the country. The 12th Five-Year Plan (2012–17) has a very ambitious target of investing about USD 1 trillion in infrastructure and construction which forms a substantial portion of the investment. About 50 per cent of the construction revenue comes from infrastructure and the remaining 50 per cent comes from real estate that comprises residential, commercial and industrial buildings. Construction sector has contributed to about 8 per cent to the country’s GDP for the five financial years—2006 to 2010 (Working group on construction sector 2011).

The construction sector in India consists of about 120,000 standalone contractors, 25,000 small (employees less than 200), 500 medium (200–500 employees) and 250 large sized contracting firms (employees more than 500). The construction sector has some very formidable contracting firms such as Larsen and Toubro, Hindustan Construction Company, GVK, GMR, Gammon India, Reliance Infrastructure, Shapoorji Pallonji Company Ltd, Simplex Infrastructure and Roland Construction Company Ltd to name only a few. The Indian construction industry is relatively large in comparison to its peers; however, the sector is dominated by a handful of large players who by themselves possess the expertise to execute several mega projects that are required (Business Monitor India 2012).

Roland Construction Company Limited

The Roland Construction Company Limited (RCCL) is a company listed on the Bombay Stock Exchange and also on the National Stock Exchange. Although it is a public listed company, the founding family has a majority shareholding and manages the firm. It has been in existence for the last 78 years and has a consistent track record of profits. It outperforms all its competitors on every attribute of financial performance including reserves. It has interests in roads, railways, power plants, ports and airports. It has executed projects both under the EPC model as well as PPP model. Currently its annual revenue is INR 40 billion and net profit of INR 8 billion for the year 2012–13. Its cumulative annual growth rate is 21 per cent in revenue earned and about 23 per cent in net profits for the last ten years. It has already completed a large number of challenging and prestigious projects within and outside the country. RCCL is a firm known for its capability to execute projects as well as for financial prudence. It seriously and routinely attempts to execute its projects with lower capital base so as to improve its profitability. It negotiates well and drives a hard bargain with all its subcontractors and vendors. Due to its strong financial position, it bargains with its bankers too. Thus, for its size, RCCL enjoys impressive cost efficiencies. RCCL is divided into four verticals—Roads, Railways, Power and Industrial Construction. Industrial Construction was the latest addition to its business portfolio in 2011. Road and power verticals each contribute 30 per cent of its revenue while railway constitutes 38 per cent and industrial construction contributes just 2 per cent of its revenue.

RCCL does its best to close the project by the due date. It uses its expertise in planning and scheduling to meticulously plan projects and execute its plans. This enables RCCL to avoid cost escalation and also establish its name. This objective is achieved with the least number of people on project sites. It strongly believes in adding to the skills of its functional managers as a means to enhance productivity. To achieve this end, it sends its people for trainings periodically to different institutes within the country. It has good tie-ups with internationally known players who provide RCCL with the latest technology and has thus successfully supplemented its expertise in planning and execution with the technology. Its ability to quickly mobilize equipment and resources is remarkable. According to the norms of the Indian construction industry, construction activities are outsourced to subcontractors. However, RCCL has a large equipment base for its construction activities. This equipment is maintained and serviced by a specialized department, thus increasing the equipment uptime and making them more cost efficient. RCCL hires its manpower very carefully and gives importance to its retention. It hires people after a rigorous process. The HR personnel are continuously identifying the training needs of its manpower and providing them with adequate training. They have developed and stabilized systems to evaluate the effectiveness of the training provided to its personnel. Training is provided in the managerial as well as technical areas.

Within its portfolios, RCCL competes with about six firms. These six firms have been in existence for a long time, are profitable and have multiple verticals. In terms of market share (number of projects) in the four verticals, RCCL ranks second in the railway sector and third in the road and power sectors. In case of industrial construction, it is at the fifth position. There are, however, a few firms which have come into existence in the last twelve years which have a revenue growth rate of more than 35 per cent annually.

Despite the achievements discussed, the Chief Managing Director of RCCL strongly feels that they have not grown as much as they should have and he therefore, seriously wants to have a re-look at the portfolio. He has a feeling that the importance given to railways might have to be revisited. He has also decided to close down the company’s industrial construction business since the organization’s relative position in that sector is weak and the experience of doing business in this sector does not particularly encourage him to continue doing industrial construction. Further, the industrial construction business consists of clients who are loyal to their contractors and rarely switch over to a new contractor. This makes getting business from new clients in this sector difficult. Financial position of RCCL is sound enough to fund the entry into new sectors. He is also seriously looking at entering into seaport and/or airport construction. He is aware that RCCL has to clear the pre-qualification requirements stated by the clients in the port and airport sectors. He has therefore had an initial dialogue with different firms that have expertise in construction, operations and maintenance of ports and airports in order to form a consortium for bidding for port and airport sectors. These discussions have been very encouraging. The CMD decides to hand over the task of revisiting the portfolio and entry into new sectors to the newly formed Corporate Planning Team consisting of three members of RCCL and led by Deepak Joshi, an alumnus of a prestigious business school.

Business Environmental Appraisal

The 12th Five-Year Plan offers a massive opportunity for the construction sector. However, there are also challenges faced by various sectors of infrastructure. These include shortage of labour, difficulties and delays in obtaining land and environmental clearances, intense competitive pressure, high inflation, rising costs, non-availability of finance from financial institutions, terrorist attacks especially on projects in deep forests and delays in receipt of payments from clients. The democratic system of governance and the existence of multiple political parties have often times caused delays in decision-making by the government. The social structure in the country is also changing; there is increased urbanization, joint family system has converted to nuclear family system, more and more women are completing higher education and taking up jobs and household incomes are on the rise to name a few. Currently the economic situation of the country though not delicate is definitely a cause of concern. The GDP growth has slowed to 5.0 per cent (as against 9.4 per cent a few years back), inflation is beyond control, interest rates are high, Indian currency is depreciating and liquidity is poor. A lot of reforms in the areas of finance, law, procedures/clearance/approvals for projects are expected to make the situation conducive to infrastructure project businesses. The central government is making an effort to contain the inflation; however, there is no success on the horizon. According to the World Bank’s Doing Business Survey, India ranks a lowly 132nd in the overall ‘ease of doing business’ category, out of 183 countries (Business Monitor India 2012).

Roads

India has one of the largest road networks in the world. The roads are broadly divided into four; national highways, state highways, district roads and village roads. Construction and maintenance of roads is carried out with the help of four agencies (Ministry of Shipping, Road Transport and Highways, 2007). The National Highways Authority of India (NHAI) is responsible for the national highways. The Public Works Department (PWD) of the state governments or the governments of the union territories are responsible for the state highways. Border Roads Organization (BRO) is responsible for national highways on the difficult terrain and national border of the country. A Road Vision 2021 prepared by the Department of Road Transport and Highways, proposes a total national highway network of about 80,000 km by the end of the year 2021. The national highways constitute 2 per cent of the total length of roads, and supports about 40 per cent of the total traffic in the country (Ministry of Shipping, Road Transport and Highways, 2011). State highways connect the national highways to important towns, tourist places and ports. Their total length stands at about 130,000 km at present. Major district roads run within the district connecting areas of production to markets, rural areas to the district headquarters and to state highways and national highways. Their length is estimated at around 300,000 km and carry medium to heavy traffic. State highways and major district roads carry about 40 per cent of the total road traffic, although they constitute only about 13 per cent of the total road length. State highways serve as a link between rural and urban areas and contribute to rural economy as well as industrial growth (Working Group on Roads 2011). Today the demand for roads exceeds the supply. Vision 2021 formulated by the Department of Road Transport & Highways envisages the network to include expressways, four-lane roads, better pavements, bypasses, bridges, etc., for a length of about 71,500 km. The monetary requirements for this would amount to INR 800 billion. The 12th Five-Year Plan includes road projects such as 1,000 km road under the tribal sub plan at an investment of INR 50 billion, Delhi–Mumbai industrial corridor, development of state roads in Jammu and Kashmir to the tune of 700 km at an investment of INR 7 billion, connectivity for about fifty minor ports which involves 1,000 km of road at an investment of INR 50 billion and connectivity for twenty-four airports involving INR 18 billion.

Although demand seems very encouraging, there are problems associated with this sector. These include lopsided contractual terms and conditions favouring the client, land acquisition, environmental clearances, other multiple regulatory clearances, right of way, cost overruns, competition and availability of funds. An earlier established practice in India was to offer Engineering, Procurement and Construction (EPC) contracts to contractors that aim to construct the roads according to requirements of the client. The funds were provided by the client. This practice was later discouraged and a new Public Private Participation (PPP) model was introduced. There are two types of PPP models—annuity based and toll based. Under the annuity based model, the government offers to provide land and funds to the contractor. The contractor who needs the least funding support is usually awarded the contract. Under the toll based model, the government provides land to the developer who arranges for the funds, constructs roads and collects toll from the users of the roads. The contractor also pays a pre-decided premium to the client. Thus the contractor who offers to pay the highest premium gets the contract. A document called concession agreement is signed between the successful bidder and the client. The successful bidder is then referred to as the concessionaire. In the past few years, there has been a substantial increase in the number of contractors because the barriers for entry into road construction are few. The sector witnessed tough competition during 2010–11 and 2011–12. The bidders bid very aggressively (either offered a higher premium or quoted a lower price) in order to get the contract. There was yet another reason for high premium offers from bidders—the then favourable economic situation in the country. The GDP was around 8 per cent and the growth of sales of commercial vehicles was around 20 per cent, thus promising higher traffic and higher toll generation. Each bidder estimated the revenue generation by way of toll collection and offered the premium payable to NHAI. The premium offered by each bidder is shown in Table 3 (Annexure). The subsequent slowing down of the economy and the aggressive bidding created serious issues for the sector (Das 2013a). The toll collection was very low and nowhere near the estimates resulting into financial problems for the concessionaires. In case of roads under construction, the delays in environmental clearances delayed the projects and caused cost escalation resulting in slowing down project execution. The concessionaires started demanding compensation for the same (Das 2013b). Costs also escalated due to inflation. All this made the banks very cautious, resulting in a decline in the available funds for this sector (Das 2013a). As a result, some concessionaires abandoned the projects halfway.

The National Highway Builder’s Federation suggested to the NHAI to first secure clearances and only then invite bids so that there would be no stoppage of work and no cost escalations due to the same (Kumar 2013). Some concessionaires began appealing to NHAI to modify the concession agreement so that they are required to pay lower amounts to NHAI in the initial years of the concession period and pay higher amounts later, thus resolving the financial problems of the concessionaires (Das 2013c). Many contracting firms have appealed to the ministry and the NHAI to rework the PPP models so that a sustainable stream of revenue may be assured.

It is not that the NHAI and the central government are unaware of the issues. Efforts have been made to overcome these hassles and complete the construction according to schedule. In order to cut delays due to environmental and forest clearances, the highway ministry proposed the idea of doing away with the permission required by road developers to cut trees planted on the sides of the roads by NHAI (Das 2013b). Another idea attempted to improve the funding situation—loans offered to this sector by the banks are considered unsecured loans; the ministry proposed to consider these loans as secured loans (Sapre 2013). This would enable the bankers to lend more to the road developers, thereby reducing the problem of non-availability of funds to a major extent. NHAI is also inclined to the request of the concessionaires to pay lower premiums to NHAI in the initial years and pay more in the later years so as to overcome the financial difficulties of the concessionaires. However, this needs approval from different ministries and even if the approvals come, they may be late. In order to ease out the situation of cutthroat competition, NHAI developed stringent technical and financial requirements for the eligibility of contractors, thereby weeding out low-cost, low quality, small-size bidders and making way for serious, large and quality conscious bidders. The Ministry of Highways has in fact decided to resort back to the EPC model considering the poor response of bidders for projects under the PPP model.

Typically road contracts as compared to other contracts like ports or airports have a shorter gestation period. Further, some segments of a road are very populous and some segments are not. Thus, roads can be constructed in a segmental fashion and revenue generation by way of toll collection is possible. This will not be possible in case of airport or port construction, wherein revenue generation is possible only after the project is fully completed. Regulatory clearances required for road projects as compared to airport and port projects are easier to obtain. However, there is a possibility of Maoist attack on the road projects if they happen to pass through deep forests. The severity of land acquisition problem is next only to that in case of airports.

Port

India has a 7,500 km long coastline with more than 200 ports. A noteworthy feature of performance of India’s port traffic during the years 2002–08 in particular has been its much higher growth compared to corresponding growth in world seaborne traffic. The 12th Five-Year Plan has targeted a total capacity of major and minor ports to reach 2289.04 million tons. However, nothing much has changed so far as the coastal shipping is concerned.

About 60 per cent of the total domestic cargo is carried by road and 30 per cent by rail suggesting that only 10 per cent of the domestic cargo is carried by coastal shipping. Petroleum, coal and cement constitute a major part of the cargo; very little general and container cargo is moved by coastal shipping. There are various reasons for this—regulatory, facilities and finance. Coastal vessels are governed by the same norms applicable to ocean going vessels, thereby making coastal shipping expensive. The Indian ports charge a higher tariff to the shippers; there is also a capacity constraint at the ports. Ocean going vessels get berth on priority whereas coastal vehicles have to wait for a few days to get a berth (Kurup 2013). Lack of long-term source of finance to buy coastal vessels is also a stumbling block in the growth of coastal shipping. The government is trying to solve these issues. It is proposing to develop disused minor ports exclusively for coastal shipping. However, this would only solve part of the problem. Cargo has to be moved from ports to its destination by road/rail. This connectivity is missing.

The Government of India has undertaken an ambitious drive to augment the port infrastructure in the country. National Maritime Development Programme (NMDP) has identified as many as 276 projects for capacity augmentation and modernization in thirteen major ports. Eighty-two of these projects have been completed so far, while the work in ninety-eight others is in progress. However, around sixty-six projects, including the container terminal project at Chennai port, are still in planning or tendering stage. The rest thirty projects were dropped due to various reasons (Simhan 2012).

Projects were stuck at pre-bidding stage for reasons such as lack of clarity on bidding and qualification criteria, litigations and re-bidding. Even post award progress was far from satisfactory in many cases due to problems in getting approvals, land acquisition and environmental clearances. For example, in the financial year 2011–12 only three projects were awarded as against the targeted twenty-three. In the financial year 2012–13, against the initial target of forty-two projects, only three have been awarded to date. In some cases, the aggressive bidding resulted in unrealistic revenue sharing models jeopardizing the project viability. Industry analysts believed that the success of PPP model in a project depended on factors such as commitment, capabilities and contribution of all participants, including government agencies. Multiple ports in states like Gujarat, Tamil Nadu and Andhra Pradesh that had adopted PPP model for capacity enhancement and operations management, helped achieve impressive growth within a short period. Similarly, there were instances where multiple PPP projects suffered due to lack of commitment by the participants (Simhan 2012). Terminal projects at Jawaharlal Nehru port, Chennai port and Ennore ports have passed through rough weather. The projects began with an inordinate four year delay in the award of the contract. Each terminal had specific problems. Jawaharlal Nehru port suffered from aggressive bidding by contractors; the successful bidder offered to share very high revenue with the client. The slowdown in the import–export trade and set up of new terminals in the state of Gujarat made this revenue sharing unrealistic. The successful bidder, therefore, did not sign the concession agreement. In the case of Ennore project, the problem was with the concessionaire. The concessionaire could not arrange the necessary funds for financial closure. In the case of Chennai port project, the problem was competition. Larsen and Toubro’s Kattupalli port and Krishnapattinam port are in the close vicinity of Ennore port. This made the Ennore port project unattractive to bidders (Simhan 2013a). Firms that want to build and operate ports need mandatory security clearances from external affairs, defense and home ministries for every project. The Ministry of Shipping raised concerns about the delays in getting clearances and took steps to streamline the process for security clearances by December 2012.

The Cabinet Committee on Infrastructure recently approved the proposal for delegation of enhanced financial powers to the shipping ministry for PPP projects in-line with National Highways Development Programme projects in the road sector. As a result, only PPP port projects costing over INR 5 billion will require an approval of the Cabinet Committee on Infrastructure. Earlier, the cutoff level was INR 3 billion. Eighteen out of twenty-five projects targeted for award in the financial year 2012–13, were under INR 5 billion (Simhan 2013b). Hopefully, the new decision will accelerate the pace of work of the port development projects. The shipping ministry has decided to introduce a new tariff regime that will allow the investors in port development to fix market-linked tariffs (P.K. Sinha 2013). This move is likely to attract investments in port development. Further, the shipping ministry is proposing to grant 50 per cent of the total capital dredging costs incurred by ports for providing deeper drafts required by larger vessels (Das 2013d) as the trend favours larger vessels since they lower the unit cost of transportation. Further, competition between contractors in building the ports is less severe as compared to competition between road contractors. There is also a potential of overseas port construction and operation business; for example, Jawaharlal Nehru Port and Kandla Port are in talks with Iranian government to construct a port at Chabahar in Iran (Sinha and Das 2013).

However, in India, certain problems, such as, delays in tendering, upfront tariff fixation, litigation by losing bidders, environmental clearances, land acquisition, dredging and connectivity, still persist. Moreover a typical port project involves longer gestation period as compared to a road project. Revenue generation is possible only after the project is completed. Land acquisition problem is not as serious as in case of roads or airports and risk of terrorist attacks is not as serious as it is in the case of rail or road projects that pass through thick forests. The competition between contractors is less severe as compared to competition between road contractors (EquityMaster.com 2012).

Airport

Indian aviation market is the ninth largest aviation market in the world (Ministry of Civil Aviation 2006). Scheduled air services are available to/from eighty-two airports with seventy-two foreign airlines operating to/from various destinations. After the opening up of the airport sector to private participation, six airports have been built and are operational under the PPP model. Passenger terminal capacity in all airports put together is expected to be about 370 million by 2017. Cargo growth presently being witnessed will necessitate investment in specialized cargo terminal and equipment. Looking at the potential, a few airlines have shown interest in starting or expanding operations in India (Menon 2013).

Growth in the passenger and cargo traffic requires significant investments for construction of new airports, expansion and modernization of existing airports, improvement in connecting infrastructure (road, metro, sea link, and so on) and better airspace management. A typical big airport project consists of city-side facilities, air-side facilities, air space, terminal building and runway. Since it is difficult to get parties that are good at all the above segments, the Government of India allowed for a consortium to bid and execute airport projects. This consortium must have one firm that has expertise in operating the airports; the rest of the members are generally EPC contractors, financial institutions and the lead contractor.

In a meeting held in June 2013 and chaired by the prime minister to fix targets for infrastructure projects, it was decided that fifty-one airports will be constructed in small cities and towns in different states of the country (Sinha, Shishir 2013). These airports will be low-cost, basic and small. It is perceived that airports in big cities where economic activity levels are high with many business travellers are more lucrative for airport operators while those in the small cities may not be that attractive as their revenue generation potential may be low. Thus, it would be easier to attract bidders to construct and operate airports in big cities on a PPP model. A few industry insiders do have apprehensions about the interest of developers in smaller airports. In bigger cities however, where airports are situated far away from the main city, there is a need of speedy connectivity between the airport and the main city. In smaller cities, the problem of land acquisition may not be as grave as in case of big cities. Cost of Aviation Turbine Fuel (ATF) greatly impacts the cost of air operations. This assumes importance as there are other modes of travel such as rail and road which attract travellers on account of low price. In the airport construction sector too, competition between contractors is less severe as compared to competition between road contractors (EquityMaster.com 2012).

Railway

Indian Railway is the fourth-largest railway network in the world in terms of route kilometres. However, considering the requirements of the economy and size of the country, the existing railway network has been inadequate. Currently, a large quantum of work is under implementation and would need about INR 2.25 trillion for completion. The Twelfth Plan targets to enhance rail share in freight traffic by at least 2 per cent. The investment earmarked in the 12th Five-Year Plan is INR 5.19 trillion. The Eastern and Western Dedicated Freight Corridors would be completed during the Twelfth Plan period and planning for other DFCs—North–South, East–South, East–West and South–West may be firmed up during the same period (Planning Commission 2013). The ministry of railways has also shortlisted six different routes for conducting pre-feasibility studies for development of high speed rail corridors. Subject to satisfactory reports these or some of these would be taken up for implementation. Indian Railways too has planned to follow the PPP route for all its projects. Besides there is an initiative from a state like Gujarat to form a special purpose vehicle (SPV) to develop a rail network to connect industrial hubs with important railway stations. This connectivity will facilitate faster and smoother movement of goods and also utilize cost effective transportation, such as railways (Bureau 2013: 17).

Rail is also not free from problems. The speed of progress is too slow. Consider the case of two routes under the East West Corridor in the state of Chhattisgarh cleared by the central government. The memorandum of understanding (MoU) was signed between Indian Railways Construction Company (IRCON), South Eastern Coalfields Limited and Government of Chhattisgarh to manufacture two Special Purpose Vehicles (SPV) for implementation of the rail projects. The MoU was signed in February 2012. The approval from the central government was inordinately delayed and took one year to come (Sanyal 2013). The work of survey, marking and finalization of alignment is yet to be completed. This will be followed by land acquisition. Land acquisition has proven to be the toughest part in the implementation of the projects. Some railway routes will pass through forests and wildlife sanctuaries; environmental and forest clearances for such routes will be very tedious and time consuming. Problems of some sort or the other exist in almost all the projects. Even the Deputy Chairman of the Planning Commission is of the opinion that the Railways have a huge task at hand. The backlog of sanctioned projects worth INR 2 trillion and the scant internal resources with the railways make it difficult for Indian Railways to fully fund all the projects.

Power

Financial year 2011–12 saw a very high capacity addition of about 19,000 MW of power. Power still remains to be in focus due to a large supply–demand gap with demand far exceeding the supply. According to Mr B.K. Chaturvedi, member of the Planning Commission of India, investment in the power sector in the 12th Five-Year Plan would be about INR 13.5 trillion and would drive the investment in the infrastructure sector. The government has taken several steps to promote investments in the power sector. Many state owned establishments and independent power producers have decided to expand their existing facilities or start new ones.

Despite acute requirement of power, power project construction is slow due to multiple reasons. The shortage and pricing of coal is one such reason. Historically, coal pricing in India was based on heat value and was therefore lower compared to international prices. Now however, the price will be based on gross calorific value as per global standards. India has now shifted from its existing pricing based on the useful heat value to gross calorific value (Planning Commission 2013). With this change, the price of coal in India will increase from its current levels and is a major cause of worry for thermal power plants. The gas price is also likely to increase making electricity generation by the gas route also expensive. Environmental clearances which are mandatory take significant time to acquire. Margins have been squeezed due to rising costs as a result of inflation. Another issue is problems in land acquisition. So far only 70 per cent of the target set in the 11th Five-Year Plan could be achieved. In the 12th plan, it is expected that 80,000–100,000 MW of capacity addition should take place. In a meeting of the Prime Minister’s Project Monitoring Group held in July 2013, the group cleared eleven power projects with a total investment of INR 520 billion (Sen and Saikia 2013). These projects were stuck due to lack of fuel-supply arrangements or environmental clearances. These will now be sorted out by the ministries concerned. Fuel linkages and environmental clearances should be acquired over a period of 5–10 years and committed efforts are required to put this sector on track.

Joshi and his team have a tough task ahead. He thought about the exercise and outlined the approach while appraising the business environment surrounding the different verticals, drew a SWOT analysis and zeroed-in on the analytical models to be used for business portfolio planning and entry into the new business. He will then use the best suited model for decision-making and make appropriate recommendations to his demanding CMD.