financial management of public sector unit (psu) - notes
TRANSCRIPT
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Financial Management of PSUs:
1. What is the nature and scope of finance function in government
companies? What are the special features of financial function in
government companies? mine
Ans : Globalization of Indian economy has made it necessary for Public
Sector Undertakings (PSUs) to be sound in terms of profitability and
earnings per share. For PSUs to be selfsustaining organizations, Financial
Management assumes a lot of significance.
The nature of the finance function is shaped mainly by the structure of the
organization. The nature of finance function of would be more complex for
a multi-product, multi-unit and multi-functional undertaking than that for a
PSU having a simple structure in terms of products and location.
Over the years the organization for finance has been undergoing a shift from
a pure functional and centralized type to decentralized and divisionalized
type of organization.
The finance function in PSUs is becoming more and more inclusive. It has
grown beyond traditional boundaries to newer avenues such as restructuring
and corporate governance.
The scope of the finance function has undergone a great transformation, the
area of focus of the finance function has widened to include other functions
having a bearing upon the management of investments and financing.
The scope of the financial function in PSUs includes:
Projecting cash-flows by providing for risk.
Determining financial resources required to meet the companies
operating program.
Forecasting the amount of requirement
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Developing best plan to obtain external funds.
2. How are investment, financing and dividend decisions organized in
government companies?
Ans:
Investment management :
Investment proposals are examined by various agencies of the government
including a Project Appraisal Division of the Planning Commission, the
Department of Public Enterprises, the Public Investment Board, and the
Cabinet Committee of Economic Affairs.
The limits on capital expenditure and approvals required are :
Upto Rs. 5 crore By the enterprise
Upto Rs. 5-20 crore By the enterprise with integrated financial system
Upto Rs. 20-50 crore To be approved by the administrative ministry
Proposals above Rs. 50 crore By the Project appraisal division, public
investment board and the Cabinet Committee on
external affairs
Financing Decisions:
The Government has been the main provider of equity and long term debt in
PSUs. Internal financing plays an insignificant role as a source of financing.
The financial institutions have provided about 2% of the total long term
investment needs. Foreign equity/loans account for more than 10% of the
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long term investment needs. Differed credits take a lions share of foreign
finance.
Private participation from Indian business and investors is about 11% of the
total long term resources. Many PSUs have raised short term finance
through commercial papers in the post 1990 period.
Dividend payments in PSUs:
In 1988-89, the dividends declared were less than 1% of the paid up capital.
Due to a revised stipulation announced as a part of the New Economic
Policy, these enterprises have to now declare 50% of their profits as
dividends. However in 97-98, the dividends declared were a mere 30% of
the net profit earned by these enterprises.
The percentage increased in the years to follow and 70 % profits are nowdeclared as dividends. It is very heartening to see that over the years the
number of dividend declaring PSUs has increased along with the quantum
of dividends declared.
3. What is the nature of working capital in government companies? What
steps should be taken to improve the effectiveness of working capital
management in government companies?
Ans: The management of working Capital is a vital element in PSUs.
The working capital requirements of PSUs are generally met through
cash credits and advances arranged with the State Bank of India and
other nationalized banks. The amount of outstanding cash
credits/advances drawn by the Central public enterprises (CPSUs) from
Banks and others as on March 31st 2003 was Rs.69,294 crore.
In special cases non-plan loans are also advanced by the central
Government to some enterprises for meeting their working Capital
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requirements. As on March 31st 2003, a total of Rs. 1,815 crore was
outstanding from 51 enterprises as working capital loan from the Central
Government.
Steps that should be taken to improve effectiveness of working Capital
management:
o Current liabilities should be given greater attention as a
component of source of funds.
o Spread of awareness concerning the current techniques to working
capital management.
o Avoid excess buildup of working capital by favourable credit
management.
4. What is performance budgeting? What is Programme Budgeting? What
are their pros and cons?
Ans:
Performance Budgeting (PB):
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It is a system wherein managers are provided with a flexibility to utilize
department or organizations resources as required in return for their
commitment to achieve certain performance results. PB is a system of
planning, budgeting and evaluation that emphasizes the relationship
between money budgeted and results expected.
Common characteristics of a Performance budget include:
o Organizations identification of mission goals and objectives.
o Linkage of strategic planning information with the budget.
o Development and integration of performance measures into the
budget.
o Desegregation of expenditures into various broad areas (such aspersonnel, operating expenses and Capital outlays) rather than
more specific line-items.
Advantages of PB are as follows:
PB has more of a policy-making orientation. It connects plans, measures
and budgets.
PB forces departments and policy makers to think about the big picture. PB provides better information about the impact of budget decisions on
people.
It gives the department increased budgetary flexibility and incentives for
generating budget savings.
Disadvantages:
Emphasis on quantity, not quality of the activity being monitored.
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The link between performance measures and resource allocations are
subject to political choices.
Lack of Credible and useful performance information.
Difficulties arising in achieving Consensus on goals and measures.
Programme Budgeting:
Under a program budgeting system, department or agency budget
requests not only include the funding that it would like to receive, but
also the outputs and outcomes they expect to produce as a result of that
funding. The legislature then establishes performance targets fo
outcomes and outputs in the implementing act to the appropriations act.
Department or agencies then report their actual performance in their long
range programme plans and budget requests for the following fiscal year.
Agencies may give incentives for performance that exceeds standards or
disincentives for performance that falls below standards. These
incentives and disincentives can be monetary or non-monetary.
An example of a monetary incentive would be performance bonuses for
employees and managers. An example of a non-monetary incentivewould be an increase in budget flexibility.
Thus by its nature a programme budget focuses on the output services
that the programme provides to its users. It also more readily relates to
overall organizational goals and objectives
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5. What is Zero-Base budgeting? How is it different from traditional
budgeting? What are its merits and demerits?
ANSWER:-
ZBB is a budgeting method for a corporation or government in which all
expenditures must be justified afresh each year & not just in excess of the
previous year. Under ZBB, nothing is considered as sacrosanct. Every time, the
managers are supposed to start from scratch or writing on a clean slate.
ZBB is claimed to be a new technique of planning & decision making. It
reverses the working process of traditional budgeting. In traditional budgeting,
departmental managers need to justify only increase over the previous year
budget. This means what has been already spent is automatically sanctioned.
While in ZBB, no reference is made to the previous level of expenditure. Every
department function is reviewed comprehensively & all expenditures rather
than only increases, are approved. The Zero-base is indifferent to whether the
total budget is increasing or decreasing.
Merits:-
Elimination of obsolete, non-relevant decision packages.
Increased or decreased levels of funding for some decision packages &addition of new decision packages.
ZBB encourages budget participation at the operating level. As a result,
managers & employees become more focused.
The comprehensive resources cost analysis process is a strong internal
planning characteristic of ZBB
ZBB, when properly implemented holds great promise for assisting
personnel of an organization to plan & make decisions about the most
efficient & effective ways to use their available resources to achievetheir defines mission, goals & objectives.
Results in efficient allocation of resources as it is based on needs and
benefits.
Forces and derives managers to think critically in order to find out cost
effective ways to improve operations.
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Useful for service department where the output is difficult to identify.
Increases communication and coordination within the organization.
Managers and employees learn more about the organizations activities
and problems.Demerits:-
Increase in paper work and time consuming.
In certain areas of the organization, it is difficult to define decision units
and decision packages.
It forces the managers to justify every related to expenditure. Sometimes,
certain departments like R&D may be threatened while production
department would benefit.
In the first year, cost of training, paper work and implementation of ZBB
may go up because without its proper understanding, it cannot be
successfully implemented.
Organization may face some resistance from the employees and their
unions.
Difficult to administer and communicate the budgeting because more
managers are involved in the process. Since ZBB threatens certain
positions of the managers and executives, they may play games andpolitics.
6. Explain the steps in the process of zero-base budgeting?
ANSWER:-
The development & implementation of the ZBB model requires managers &
others in the organization to engage in several major planning, analytic &
decision-making processes. These major processes of ZBB include the
following:-
Identification or redefining the mission and goals of the organization.
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Identification of the organizations Decision Units and Decision
Packages.
Ranking of decision packages based on cost-benefit or qualitative
criteria.
Fixing a cut-off point for funding.
Acceptance and allocation of resources.
Budget execution.
Monitoring and Evaluation.
7. What is a Memorandum of Understanding (MoU)? How is it structured?
How does it help in performance improvement and measurement?
ANSWER:-
MoU is supposed to be a freely negotiated document between the government,
acting as a owner, & a specific PSU. It is also supposed to clearly specify the
intentions, obligations & mutual responsibilities of both parties to the MoU. If
either of the two conditions is violated, the effectiveness of the MoU as an
instrument of performance improvement is bound to be affected.
The basic philosophy guiding the MoU is to create an understanding between
the government & the PUSs about the accountability of the latter to the former& the autonomy the former would provide to the latter in the task of achieving
the objectives for which the PSUs were set up. It was expected that such an
agreement would minimize the reference that the PSUs were expected to make
to the government, on the one hand, & the control that the government would
exercise on the PSUs to ensure their effective performance, on the other.
The MoU makes an attempt to move the management of PSUs from
management by controls & procedures to the management by results &
objectives.
Objectives of MoU system:
1. Measure the performance of the PSUs taking into account the
complexities effusing social & financial objectives & translating them
into measurable parameters.
2. Ensure simultaneous increase in autonomy as well as accountability.
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3. Set up new institution & administrative & personnel.
4. Replace multiply principles with multiple objectives with clarity in
goals & objectives.
Structure of MoU
The MoU is not merely a document, it is the way of life or a management
system. This is tool for performance improvement incorporates within its fold
three sub-system, namely, performance information system, performance
evaluation system, & performance incentive system.
Performance evaluation in MoU involves five steps. First three steps are taken
at the beginning of he year & the last two steps are taken at the end of the year.
Beginning of the year
Step 1: CRITERIA SELECTION: - In this first step, one has to choose
appropriate set of criteria to be included in the MoU. The criteria included in
the MoU should mearsure only those aspects of the managerial performance
which are under managers control.
Performance criteria must be selected carefully & not arbitrarily. These should
be based on the enterprises corporate plan that looks at three to five years in
the future. They must also be consistent with plan & budgetary goals of the
government.
MoU is an instrument that measures the performance of the manager & not thatof the enterprises. While selecting performance criteria this must be kept in
mind and only those parameters that judge managerial performance should be
selected.
Step 2:- CRITERIA WEIGHT SELECTION:- For running an enterprise
successfully a Chief Executive has to undertake a number of tasks. However,
not all the tasks are of equal importance. A smart Chief Executive therefore,
priorities his tasks based on his perception of relative importance of different
activities in hand.
In the interest of clarity of purpose it is necessary that from long list of things to
do, the manager must be told what are the relative priorities so that he can
allocate his time more effectively in achieving those priorities.
Step 3:- CRITERIA VALUE SELECTION:-To understand on needs to
distinguish between criteria & criteria value. Now, kilometers per liter in a
criterion to measure efficiency of motor vehicles, however, 10 kilometer/liter
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may be excellent for a truck bit it is very bad for a scooter. This value of 10
kilometer/liter is a criteria value. It is a value, which distinguish various levels
of performance. The MoU is rated on a 5-point scale, where 1 represents
excellent performance & 5 represents poor performance.
This indeed is very heart of the MoU philosophy. Once you have specified theobjectives for the managers you should not interfere in the operation & wait till
the end of the year for them to deliver the goods.
The selection of criterion value should be carried out through a participative
process. Experience suggests that without a participative approach, targets tend
to take the form of formal directives which are often overtly accepted &
covertly resisted. These targets should be easy to understand & well defined.
The sources of information which could assist in setting criterion values
include:
The original objectives at the project formulation stage.
Comparisons with similar undertakings of other selected developed &
developing countries.
Comparisons with the performance of the same firm in the previous
years.
Professional judgment by third parties.
Professional judgment at the ministry level.
Professional judgment at the enterprise level.
At the end of the year
Step 4:- PERFORMANCE VALUATION:- The forth step is taken in the end of
the year, when we look at the achievement of PSUs & compare them with the
criteria values & determine the scores. This is the final step in the performance
evaluation exercise cannot be mechanical procedure. The value of the
composite scores will also lie between 1 & 5. If management has done
excellent in all fonts including in the MoU, they will get a score of 1.
It measures the ability of the enterprise to its own commitments.
Step 5:- PERFORMANCE REWARD:- While performance evaluation of PSUs
provide a measures of the degree of achievement of the objectives set out,
evaluation by itself does not lead to improvement of performance. Unless
performance evaluation is coupled with a system of rewards & penalties &
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utilized as a means for that purpose, it provides no motivation to the PSUs for
improving their performance. A transparent system of rewards & punishment is
thus a corollary to the introduction of an objective performance evaluation
system of the PSUs. Thus a performance rewards scheme constitutes an
essential complement of MoU system.
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Financial Management of Sick Units :
1. What are the causes of industrial sickness?
Definition of sickness:-
The Companies Act ,2002 defines a sick company as one,
i. which has accumulated losses in any financial year equal to 50% or more
of its average net worth during four years immediately preceding the
financial year in question or
ii. which has failed to repay its debts within any three consecutive quarters
on demand for repayment by its creditors.
Causes of sickness:-
The sickness in any industry can be caused by various reasons which
can be categorized or because of
i. unfavourable external environment
ii. Managerial deficiency
Unfavourable external environment-
The firm may cause the sickness because of unfavourable
external environment. External environment is the environment
which affected the functioning of the firm and the control of these
factors is not in hand of any industry.
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Following are some factors which cause the sickness.
a. Shortage of inputs like power or basic raw material
b. Change in government policies
c. Development of new technologyd. Sudden decline in orders from the government
e. Change in customer preferences
f. Natural calamities
g. Adverse international development
Managerial deficiency
These deficiencies can be classified as per the function like
Production , finance , marketing, human resource.
Under these function there are some other reason because of
which the industry face the problem of sickness
Production;-
a. Improper location
b. wrong technology
c. uneconomic plant size
d. unsuitable plant & machinery
e. poor quality control
d. poor R&D
f. poor maintenance
Finance: Finance is the lifeblood of business. It links and passes through all areas of a
business unit. The problem areas may be because of,
1.
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The promoters might have chosen a project which is beyond their
financial capacity. This often happens due to over ambitious approach of
entrepreneurs. A bigger project needs a bigger investment and
accordingly a higher promoters contribution in absolute terms. If the
promoters are not able to mobilize their contribution, with the sole idea
of implementing the project, they often resort to borrowings, invariably
at higher interest rates with the hope of clearing the high cost borrowings
once the project takes off
2. Funding a project with a higher debt component than that it can safety
bear is another reason for sickness, since such projects will not be able to
service the high interest charges.
3. Using short term funds for acquiring fixed assets is an area of concern.
This will put the liquidity position of the business in strain when the
short term obligations become due for repayment.
4. Improper inventory management policy will lead to holding huge stock
of finished products, late realization of debts from sundry debtors, lack
of proper planning to pay to creditors of raw materials, etc., which willall have telling effects on the operation of a business unit.
Marketing;
a. Inaccurate demand projection
b. Improper product-mix
c. Wrong product positioning
d. Irrational price structure
e. Inadequate sales promotion
f. High distribution cost
g. Poor customer service
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Human resource
a. Ineffective leadership
b. Inadequate human resource
c. Poor organization design
d. Insufficient training
e. Irrational compensation
2. List the symptoms which might indicate that sickness lies ahead.
As the sickness in any industry does not occur overnight, but develops
gradually over time. Any sick industry shows some common symptoms.
Those are :
a. Delay in payment to supplier:
When the company faces the problem of sickness the company fail to
pay to its suppliers on time. As a result they always ask for the
extension to pay the amount.
b. Irregularity in the bank account;
The sick unit may fail to keep the regularity in the bank account
which can be the sign of sickness.
c. Delay in payment to bank or financial institutions
As the sick unit ask for the time to supplier for the payment the same
way it can ask for bank or financial institutions for increase the limit
of credit.
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d. Frequent request to banks for additional credit
In addition to delay in the payment to supplier and bank the sick unit
might ask for the additional credit to meet its obligations.
e. Inability to take trade risk
f. Extension of accounting period
g. Low turnover of assets
h. Decline in prices of shares;
The prices of the sick unit or industry face the problem of reducing
the share prices over a period of time
i. Excessive turnover of personnel
j. Accumulation of inventories
3. Discuss the univariate analysis for predicting industrial sickness.
Univariate analysis aims to predict sickness on the basis of a singlefinancial ratio. Though many financial ratios were used by analysts for
predicting sickness, there was no consensus as to what the most
appropriate ratio is for the prediction of sickness. Such a situation
prevailed till William H.Beaver published
his study on univariate analysis in the year 1966. Beaver examined the
predicative
power of 30 different financial ratios by choosing a sample of 79 firms that had
become sick and 79 firms that were healthy for the same period of time. The
sample was so chosen that for each failed (sick) firm, a healthy firm operating
in the same industry and having comparative size was included in the sample
set. For both the set of samples of 79 firms each, Beaver examined the
behaviour of 30 different financial ratios during the period of 5 years prior to
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the failure. The main finding of Beaver was that the ratio that is most useful in
predicting impending sickness is the ratio of cash flow to total debt, since this
ratio showed the minimum error in his prediction.
4. Discuss briefly how multivariate analysis may be employed for
predicting industrial sickness.
Univariate analysis examines the predictive power of individual financial
ratios. The joint effect of more than one financial ratio in predicting sickness is
not studied in univariate analysis. Multivariate analysis, on the other hand, aims
to predict industrial sickness by studying the combined influence of several
financial ratios.
Altman. E.I.presented his model of multivariate analysis for predicting
industrial sickness in the year 1966. In his model, Altman combined several
financial ratios into a single index. He named this index as Z-score. His
analysis was based on a statistical procedure known as multiple discriminate
analysis (MDA). Altman studied a sample of 33 bankrupt firms along with a
paired sample of 33 non-bankrupt firms. He examined 22 financial ratios to
identify their combined influence on sickness and selected five ratios, which in
his opinion jointly possess the maximum power to predict bankruptcy.
Altman derived a discriminant function (Z) that contains five financial ratios.
The discriminant function derived by Altman is as under:
Z = 1.20x1 + 1.40x2 + 3.30x3 + 0.60x4 + 0.999x5
Where,
Z = discriminant score
x1 = (working capital) (total assets)
x2 = (retained earnings) (total assets)
x3 = (earnings before interest and tax) (total assets)
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x4 = (market value of equity) (book value of total debt)
x5 = (sales) (total assets)
A cut-off point for the Z score was determined by Altman in such a way that
it minimized the
overlap between bankrupt and non-bankrupt groups. Altman found that a cut
off value of 2.675 for
Z minimized the possibility of misclassification. Thus, as per Altmans
analysis, firms with Z
score less than 2.675 are prone to become bankrupt and firms with Z score
more than 2.675 are
free from the threat of bankruptcy.
4. What aspects should be covered in viability study?
Ans :
Revival of a sick unit
When an industrial unit is identified as sick, a viability study should be
conducted to assess whether the unit can be revived within a reasonable period.
If the viability study suggests that the unit can be rehabilitated, a suitable plan
must be undertaken, if the study indicates that the unit is better dead than alive
steps are taken to liquidate it.
Viability study
It generally covers the following:-
Market Analysis
Market share behavior over the past few years
Growth rate of total market
Emergence of competition
Production/Technical Analysis
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Technological capability of the firm
Plant condition
Supply of raw material
Finance
Liquidity position
Leverage analysis
Personnel organization
Human Resource
Leadership
Environment
Supply of raw material
Availability of power, fuel and water
The viability study may suggest one of the following:
a. The unit can be revived by adopting one or more of the following
measures; debt restructuring, infusion of funds, correction of functional
deficiencies, replacement of existing management because of its
incompetence.
b. The unit is not potentially viable- this essentially implies that thebenefits expected from remedial measures are less than the cost of such
remedial measures.
5. What are the unusual components of the revival programme?
Ans :
Revival Programme
Usually involves:-
Settlement with creditors
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A sick unit is not able to honour its commitments to its creditors. To alleviate
its financial distress, a settlement scheme has to be worked out which may
involve one or more of the following: rescheduling of principal and interest
payment; waiver of interest; conversion of debt to equity; payment of arrears in
installments.
Provision of Additional Capital
Typically a revival programme entails provision of additional capital. This may
be required for modernization and repair of plant and machinery, for purchase
of balancing equipments, for sustaining a new marketing drive, and for
enhanced working capital needed to support a higher level of operations. The
additional capital has to be provided on concessional terms, at least for the
initial years, so that the financial burden on the unit is not high.
Divestment and Disposal
The revival programme may involve divestment of unprofitable plants and
operations and disposal of slow moving and obsolete stocks. The thrust of these
actions should be to strengthen the liquidity of the unit and facilitate
reallocation of resources for enhancing the profitability of the unit.
Reformulation of product market strategy
Many a business failures can be traced to an ill-conceived product market
strategy. For reviving a sick unit, its product market strategy may have to be
significantly reformulated to improve the prospects of its profitable recovery.
Modernization of plant and machinery
In order to improve manufacturing efficiency, plant and machinery may have to
be modernized, renovated and repaired. This may be essential for attaining
certain cost standards and quality norms for competing effectively in the
market place.
Reduction in manpower
Generally, sick firms tend to be over-staffed. The revival programme must seek
to reduce superfluous manpower. Remember an old managerial saw: The
leaner the organization, the greater are its chances of survival.
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Strict control over costs
A profitable organization can afford wastefulness and laxity in its expenditures.
A zero base review of all the discretionary expenses may be undertaken to
eliminate programmes and activities which are a drain on the finances of the
firm.
Streamlining of operations
Manufacturing, purchasing and selling operations have to be meticulously
examined so that they can be streamlined. Value engineering, standardization,
cost benefit analysis, and other approaches should be exploited fully to improve
the efficiency of the operations.
workers participation
workers participation in management enhances employee commitment,
motivation, and morale. Further, the suggestions offered by the workers result
in improvements that lead to higher manufacturing efficiency and productivity.
A sick unit which is being revived, can perhaps benefit even more from
workers participation in management.
Change of management
A change in management may be necessary where the present management is
dishonest. It has been observed that a new chief executive, who is competentand committed can often bring about dramatic results.
6. Discuss the common ingredients of corporate turnaround.
Ans :
A turnaround situation represents an unusual phase in the life history of a
firm and requires a very different approach to management as comparedto a normal situation.
The key elements found commonly found in turnarounds are:
A change in the top management.
A substantial involvement of top management in day to day operations.
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An emphasis on projects that have a quick payoff.
Opportunistic action, improvisation, crisis management, and short term
expediency.
Turnaround Story
TVS Suzuki
It started operations in 1987-88 on an optimistic note. However its performance
deteriorated in the following three years. While it still made profits in 1988-89,
it incurred losses in 1990-90. By early 1991 the situation was pretty bad
because of intense competition in the marketplace.
With the determination to fight competition and improve performance, the
company took a series of steps.
A six month, week by week, cost reduction drive focused on raw
material cost, manpower cost and non value added expenditures, this led
to a drop of 30% in operating costs.
A massive exercise in value engineering undertaken in tandem with
Suzuki, this resulted in a saving of Rs 10 million pm.
A product improvement strategy to introduce a new model every few
years, to build market share.
A renewed marketing drive backed by a higher advertising outlay and a
new marketing and vendor policy.