Role of Value Creation in the Indian Industry
Background: The Indian economy is widely believed to have moved into its next phase of sustainable growth rate of 8-10%.The last five years have seen an unprecedented value creation in Indian stock markets.Aim: This study focuses an analytical valuation perspective of various privileged companies in India.
Methods: The data set for the study was collected from the CMIE prowess database.The five industry sectors were chosen for the study. Results: While rapid stock market growth is widely ascribed to a global liquidity glut and re-rating of Indian stocks, our analysis shows that outstanding performance in business fundamentals — sales and profit — growth has been the predominant driver of this spectacular value creation in India.
Conclusion: These findings have major implications for any preventative or intervention strategies. INTRODUCTION To create sustainable, long-term shareholder value, it is important to explicitly establish an appropriate shareholder value target.It can be argued that value creation is the ultimate measure of performance for a manager. Companies must establish priorities based on value creation; gearing planning, performance measurement and incentive compensation systems towards shareholder value and communicating with investors in terms of value creation. The ability to manage value is an essential part of developing sound corporate and business strategies–strategies that create value for shareholders. A study by (Richard et al. 2000) observed that companies in today’s superheated economies are in a race to discover the underlying code of value creation.
That is they are trying to find out the greatest amount of assets-tangible and intangible-create the greatest amounts of economic value and to avoid those combinations that destroy it. Value creation The term “value creation’ can be a misnomer, but for procurement professionals it is simple: delivering additional value to the bottom line through new methods. The difficulty only lies in drawing that value out of the plethora of intangible drivers that you have to deal with.Non-financial factors like innovation, people and ideas are difficult to quantify, rarely acknowledged in accounting methods and not adequately measured, managed or reported on by organisations. However, these are some of the critical sources of value that can be utilised by companies to improve their competitive advantage. ANALYTICAL VALUATION PRESPECTIVE: 1. Potential of the Automobile industry The automobile industry in India happens to be the ninth largest in the world.
Following Japan, South Korea and Thailand, in 2009, India emerged as the fourth largest exporter of automobiles.Several Indian automobile manufacturers have spread their operations globally as well, asking for more investments in the Indian automobile sector by the MNCs. In 2008, Hyundai Motors alone exported 240,000 cars made in India. Nissan Motors plans to export 250,000 vehicles manufactured in its India plant by 2011. Similar plans are for General Motors. 2. Communication – Value-Added Services Market As per a research conducted by Stanford University, Indian mobile value-added services (MVAS) are expected to reach USD 2.
74 bn by the FY2010.To benefit from the emerging MVAS market in India, Reliance Communications and Bharti Airtel Limited are all set to introduce online cellular phone applications in Indian retail stores. While Bharti Airtel will offer around 1,250 applications, Reliance Communications’ applications will soon be accessible to its GSM customsers by Feb 2010. 3. Success of Indian software companies There are a number of reasons why the software companies in India have been so successful. Besides the Indian software companies, a number of multinational giants have also plunged into the India IT market.India is the hub of cheap and skilled software professionals, which are available in abundance.
It helps the software companies to develop cost-effective business solutions for their clients. As a result, Indian software companies can place their products and services in the global market in the most competitive rate. This is the reason why India has been a favorite destination for outsourcing as well. Many multinational IT giants also have their offshore development centers in India. some of the top Indian software companies can be listed as: •Tata Consultancy Services •Wipro Limited •Infosys HCL Technologies •Tech Mahindra •Patni Computer Systems •i-flex Solutions •MphasiS •L&T Infotech •IBM India 4. IT Outsourcing in India As per NASSCOM, IT exports in business process outsourcing (BPO) services attained revenues of US$ 48 billion in FY 2008-09 and accounted for more than 77% of the entire software and services income. Over the years India has been the most favorable outsourcing hub for firm on a lookout to offshore their IT operations.
The factors behind India being a preferred destination are its reasonably priced labor, favorable business ambiance and availability of expert workforce.Considering its escalating growth, IBM has plans to increase its business process outsourcing (BPO) functions in India besides employing 5,000 workforces to assist its growth. 5. Pharmaceutical Industry Industry Trends •The pharma industry generally grows at about 1. 5-1. 6 times the Gross Domestic Product growth •Globally, India ranks third in terms of manufacturing pharma products by volume •The Indian pharmaceutical industry is expected to grow at a rate of 9. 9 % till 2010 and after that 9.
5 % till 2015 There are several national and international pharmaceutical companies that operate in India.Most of the country’s requirements for pharmaceutical products are met by these companies. Some of them are briefly described below: •Ranbaxy Laboratories Limited is the biggest pharmaceutical manufacturing company in India. The company is ranked at the 8th position among the global generic . Ranbaxy Laboratories 2009-2010 Q3 Net Profit Results showed a profit of Rs 116. 6 crore as compared to Rs 394. 5 crore deficit, recorded during the corresponding period last fiscal.
•Dr. Reddy’s Laboratories manufactures and markets a wide range of pharmaceuticals both in India and abroad.Dr. Reddy’s Q1 FY10 result shows the revenues of the company at Rs. 18,189 million which is up by 21%. •Cipla is an Indian pharmaceutical company renowned for the manufacture of low cost anti AIDS drugs. For the financial year 2008-09 the company registered an increase of 22% in sales and other income over the previous year.
•Nicholas Piramal is the second largest pharmaceutical healthcare company in India.•Zydus Cadila also known as Cadila Healthcare is an Indian pharmaceutical company located in Gujarat. The company’s 1QFY2010 results show the net sales at Rs880. cr which is higher than the estimated Rs773cr. The net profit was Rs124. 8cr which was increase of 39%; the increase was on account of higher sales and improvement in the OPM. RESEARCH METHODOLOGY The data set for the study was collected from the CMIE prowess database.
The following five industry sectors were chosen for the study. * Telecommunication, Information technology, Automobiles, Software, pharmaceutical industries. Besides primary data, the research using secondary data that gathers by internal and external data from the sample of the study.The data also can be obtain from web sites, pamphlets, books, magazines, bulletin, newspaper cutting, published journal, government publication and case study. The data collection and analysis paves way for the recommendation ad conclusion of the study that reveals some important findings regarding the strategy and corporate structure. RESULTS: While rapid stock market growth is widely ascribed to a global liquidity glut and re-rating of Indian stocks, our analysis shows that outstanding performance in business fundamentals — sales and profit — growth has been the predominant driver of this spectacular value creation in India.Automobile industry The figures show that the automobile sector in India has been growing robustly.
The market shares of the different types of vehicles will clearly depict the demand pattern in this sector. Domestic Market Share for 2008-09 Passenger Vehicles15. 96% Commercial Vehicles 3. 95% Three Wheelers 3. 6% Two Wheelers 76. 49% Communication industry With the influx of new telecom giants in Indian market, the investments are likely to gain immense momentum: •Investment of USD 6 bn by Vodafone Essar for the next 3 fiscal years in order to expand its list of cellular phone subscribers to 100 million against the existing 40 million. By 2010, Reliance Communications (RCom) is expecting to increase the total number of telecom towers by constructing 56,596 telecom towers and attaining the preset target of 100,000.
•Telenor, Norway based telecom giant has purchased 7% of shares in Unitech Wireless and now possesses 67. 25% by bringing in an investment of USD 431. 70 million •Indian government owned telecom player, BSNL will invest USD1. 17 billion in its WiMax scheme •A proposal of foreign direct investment worth USD 660. million by Federal Agency for State Property Management of the Russian Federation has been recently approved by the Indian government. The Agency would be acquiring 20% stake in Sistema-Shyam after bringing in the investment. •A USD 1 billion investment will be brought in by Tata Teleservices in its newly introduced GSM facility Tata DoCoMo.
IT Outsourcing In the next few years, the industry is all set to witness some multi-million dollar agreements namely: •A 5 year agreement between HCL Technologies and News Corp for administering its information centers and IT services in UK.As per the industry analysts, the pact is estimated to be in the range of US$ 200-US$ 250 million •US$ 50 million agreement between HCL Technologies and Meggitt, UK-based security apparatus manufacturer, for offering engineering facilities. •Global giant Walmart has short listed there Indian IT dealers namely Cognizant Technology Solutions, UST Global and Infosys Technologies for a contract worth US$ 600 million. Pharmaceutical Industry India’s Domestic Pharmaceutical Market (12 Months Ended January 2009) CompanySize ($ Billion)Market Share (%)Growth Rate (%)Total Pharma Market6. 9100. 09. 9 Cipla.
365. 313. 4 Ranbaxy. 345. 011. 5 Glaxo Smithkline. 294.
3-1. 2 Piramal Healthcare. 273. 911. 7 Zydus Cadila. 243. 66.
8 Source: ORG IMS CREATION OF STRATEGIES AND ITS PROBLEM a)Successful Value-Creation Strategies Real value creation—and long-term growth and profitability—occurs when companies develop a continuous stream of products and services that offer unique and compelling benefits to a chosen set of customers. This means that to maintain industry leadership, a company must establish a sustainable process of value creation.Some of the major themes that underlie successful value creation strategies in the information economy are: • Product and process innovation • Detailed, real-time understanding of changing needs of well-defined customer segments (frequently database enabled) • Leveraging emerging technologies in existing markets (particularly information technology) • Leveraging technology or regulatory changes to create new markets • Reconfiguring company and industry value chains • Creating win/win partnerships with customers, employees, and suppliers.Pragmatic Idealism and Value Creation If value-focused behavior is idealistic, then the most pragmatic way to manage a company is with idealism. Such pragmatic idealism rejects the fragmented conception of “us versus them,” and embraces an integrated, systems view of business that recognizes the interdependence of all players in the value-creation process. Here is a pair of principles for managing with this systems view of business: • Think first about creating the most value, then think about capturing part of that value as profit. Think of the value of a product or service as being what the customer would pay for that product or service if he had perfect information, such as knowledge of the total life-cycle costs and benefits associated with the purchase.
In an environment of accelerating change—in which long-term partnerships and joint ventures must be built on mutual trust, in which employees must be committed to provide superior service and drive ongoing innovation, in which customers have access to more and more information—a course of pragmatic idealism and value creation is not only possible, it is increasingly the only viable approach. )Flawed Measures Of Value creation Fortunately, many smart managers take steps to de-emphasize the management roles of accounting measures of performance to keep the focus on value creation. This article first clarifies the problem—the reasons accounting performance measures are often not good indicators of value creation—and then describes four main alternatives managers can use. This low correlation should not come as a surprise. Many things affect accounting profits but not economic values, and vice versa: 1.While value is future-oriented, accounting profit measures focus on the past. Future revenues, and most future expenses, are not anticipated.
2. Accounting systems are transactions-oriented. Although fair value accounting attempts to capture changes in the value of certain assets recorded on the balance sheet, many changes in value are not captured in profit figures. 3. Accounting profit measures are highly dependent on the choice of measurement method. Multiple measurement methods are often available to account for identical economic events. 4.
Accounting measurement rules are conservatively biased. They are slow to recognize gains and revenues but quick to recognize expenses and losses. 5. Accounting rules ignore some economic values and value changes that cannot be measured accurately and objectively with conventional accounting measures. Prime examples are investments designed to create “intangible” assets. 6. Accounting profit measures ignore the cost of equity capital, which is usually much more significant than the cost of debt capital.
7. Accounting profit measures ignore risk and changes in risk.Companies that have not changed the pattern or timing of their expected future cash flows but have made the cash flows more certain (less risky) have increased their economic value. This value change is not reflected in accounting profits. Approaches for the addressing problem To address the problems that can be caused by using GAAP performance measures, managers can use any or all of four basic alternatives: 1. Market measures. One obvious way to avoid the inherent problems of accounting performance measures is to focus on market indicators of value creation.
In the end, market values determine what returns shareholders earn on their investments. Emphasizing these market measures of success in incentive plans has an obvious appeal because executives, and often other employees, benefit only when the shareholders do. But for several important reasons, market measures are not a cure-all. Market valuations might not reflect the company’s true intrinsic value because the market does not have access to all the private information available to managers. 2. Improved, non-GAAP profit measures. Choose “better” profit measures, many of which use measurement rules that are inconsistent with GAAP.
Indeed, many companies, and especially those in service and high-tech industries, are now placing attention, even primary attention, on non- GAAP measures such as free cash flow, EBITDA, economic profit, or various forms of “pro forma” profit measures that exclude line items that management deems to be unusual, non-recurring or uncontrollable. Some research has focused on whether these non-GAAP measures, provide better indications of value creation than GAAP measures. Studies in broad samples of companies and in specific industries suggest they do. 3. Extensions of the measurement window. In most companies, performance reviews and incentive contracts are based on one-year and shorter measurement periods. But some companies extend the measurement window for some purposes, particularly the awarding of incentives.
The most common measurement window for this form of long-term incentive plan is three years, but some companies use periods of up to six years. Long-term incentives have their drawbacks. It is difficult to set properly challenging performance targets for periods covering three to six years into a future that could be significantly affected by many macroeconomic and competitive factors.Profit measured in a three- or five-year period is still far from being perfectly correlated with value changes; one large sample study found the correlation in even a five-year measurement window to be only 0. 57. 4. Combinations of measures.
In most settings, the main problems with the profit measures are that they are short-term oriented and backward-looking. A reasonable option, then, is to supplement the profit measures with some other measures that are more long-term oriented and forward-looking.Many of these so-called “leading indicators” or “performance drivers” are non-financial measures, such as customer satisfaction, product quality or R&D productivity. At the extreme, a company can decide that nonfinancial indicators are virtually all that is important and ignore the accounting measures almost entirely. CONCLUSION The path to value creation requires that economic profits be earned. In order to ensure that economic profits are being earned, the same type of capital budgeting analysis used to evaluate new investments must be applied to the existing assets and operations of the going concern business.This process is vital not only to forming a coherent strategy for the future, but to prioritizing management resources as well.
Value creation is a never-ending cycle. It begins with modeling business operations, prioritizing areas for more detailed investigation, identifying opportunities for improvement, implementing the changes required to maximize success and the measurement and revision that starts the process over again and allows management to stay abreast of company and market changes.