The COVID 19 Lockdown and the Indian manufacturing industry – effects and recovery
Prof. R. Jayaraman, Operations & SCM at Bhavan's SPJIMR (S.P. Jain Institute of Management and Research) speaks about the current situation and way forward.
The ongoing lockdown has put a lot of strain on the manufacturing industry, which contributes almost 20% of the GDP. Of this, 50% is contributed by the auto industry. Even prior to the lockdown, the auto industry was not in a great shape, with sales down by more than 15% and production cuts of the order of 5 to 10% or more. In the unorganised industry, the situation was much worse, as the uncertainty would impact smaller organisations with lesser retentive power, due to their lower profitability. This is somewhat similar to the ‘root beer game’ effect in Operations Management parlance, where an event in the market can lead to highly amplified response from the suppliers, leading to short term overproduction and medium term discount sales. Choking of distribution channels due to this effect are not unknown and goods tend to get offloaded at lower prices, providing volume support, but hitting the profit and profitability.
Manufacturing industry has been hit in many ways due to the Corona effect. To begin with, lower production, due to lower offtake. This takes a little longer to manifest itself, as, some distributors, sensing an opportunity to earn profits in a developing shortage situation, tend to carry on with the sales, but with an extended schedule of deferred payments. Longer credit days are given by the producer, who is keen on continuing with operations, before a complete shutdown. More and more employees stop coming in to work, due to government directives, thereby reducing the scale of operations, with consequent effect on quality, cost and production volumes. Over a period, this adversely affects the turnover, which slows down to a trickle. The uncertainties in the logistics leads to a cascading effect, transporters struggle to not only place vehicles for loading, they also are under pressure to adjust their quotes for carrying goods, as they also face lower attendance, with their operational risks increasing steeply. The slower rate of banking operations, shorter working hours, jammed and overloaded communications lines lead to delayed money transactions, thereby elevating monetary risks. The suppliers to large producers start feeling the pinch, and start to disengage, and play safe, in order to protect their interests, because their capacity to bear risks is much lower than their big customers. Finally, due to all these interruptions, the end user also starts postponing non-essential purchases, and disengages from the consuming processes, by postponing their demands.
Given the fact that the major manufacturing industries have a PAT to Sales turn over ratios (profitability ratio) in the high single or the low double digits, let us examine the effect of the Corona virus on the monetary situation of manufacturing companies in the organised sector. For example, let us consider a company earning a PAT over Sales of 12% per annum, which is 1% per month. Of course this assumes a regular profit flow, unlike in the case of seasonal industries, like automobiles to umbrellas, which earn a large percentage of their profits during the prime seasons. Of the 1%, if we assume that, due to the Corona effect, the company starts losing money, and that, during a two-month period covering 15 days on either side of the lockdown period of one month, the overall loss could be 2%+. Lets say, this is 3%. To recover and comeback to normal, it may take, say, two months. Thus, the Corona effect has adversely affected the profitability of the company to the extent of about 30% of its annual profit. When we say 30%, we take into account two effects – one, the numerator, which is the profit, and two, the denominator, the sales turnover. The ‘sales compensation’ effect can happen soon after the lockdown is lifted, which means deferred sales are now catered to, and hence, the overall sales for the year could be the same or a little less than the previous year – point to note, growth is ZERO. Hence, a company should strategically plan to at least save its sales, and, at the last resort, grow revenues. Having said that, what about the profit. Here is where the story of each company could differ. And herein lies the proverbial rub.
Those companies which have been operating with excellent operational parameters, like, high quality, high productivity, well trained workmen, well maintained machines, etc., will take off faster than the others. Thus, for well managed companies, the period after lockdown could be an opportunity, while, for others, it could be an uphill struggle. During the lockdown period, good companies must develop recovery plans, while the not so good ones will develop survival plans.
Coming back to the profitability picture, companies will have to work to recover about 3 to 4 % of their PAT/ Sales. Which could be done by three types of strategies.
Cost reduction strategy: if a company’s labour cost is about 20 % of its sales, then, if employees take a paycut for the rest of the year, of say, 10% on an average with senior employees taking a higher percentage, then the cost reduction on this account alone will increase the profitability by 0.2% per annum. However, if they take a paycut of an average 30%, then the 0.2% will go upto 0.6% per annum. This is no doubt, a major sacrifice, but the option could be job losses.
Higher revenue strategy: Increase in revenues is possible in cases where pent up sales will materialise, provided, companies are able to supply goods. Clearly, those companies which have kept their supply chain pipelines active, will benefit, and they can recover some of their sales. This will also be affected by how the competition is gearing up, and, hence, excellent companies can use this opportunity. This could contribute to another 0.5% to 1% of the PAT/ Sales ratio.
New products strategy: This is a direct outcome of the Corona effect, which will last for at least one more year, if not more. Certain goods, especially related to healthcare, are likely to show high demand, and this could lead to a cascading effect, through stimulating demand in related products, and a psychological effect which leads to a general demand pick-up. This is a niche play, to begin with, it can lead to medium and long term strategic changes in the product mix, and, in the one year term, could help the companies recover about 0.5%.
Overall, the balance period of the financial year, of 2020 – 2021, is likely to be difficult, but manufacturing companies can salvage their positions and build for the future.