CHAPTER 5 COST OPTIMIZATION THROUGH VALUE ADDITION IN CONSUMER PRODUCT SECTOR COMPANIES IN INDIA: AN ANALYSIS 134
5.1. Introduction Companies across the globe have started adopting Cost Optimization strategies such as shared services, application of IT in functional areas, supply chain management, benchmarking of costs etc. Now it has been the realization to the companies that it is not a onetime effort but it is continuous effort. Cost Optimization will focus to bring a sustainable cost benefit to the companies concerned. In the year 2011, Booz & Co. has conducted survey and found that 75 percent of companies have adopted Cost Optimization strategies to manage and survive economic crises. The survey revealed that companies have recognized the importance of Cost Optimization in creating or adding value. Therefore this chapter is organized to present on analysis to know whether Cost Optimization exists in terms of value addition in consumer product sector companies in India. In the contemporary world there are value adding measures such as Economic Value Added (EVA), Market Value Added (MVA), Cash Value Added (CVA), Shareholders Value Added (SVA) etc., Instead of focusing our attention on input side of Cost Optimization we focus on output side. As per this cost has become input and Value Addition may be Economic Value Added (EVA) and Market Value Added (MVA) have become output. Accordingly a study is presented to know whether companies in the consumer product sector have experienced Cost Optimization in terms of Economic Value Added (EVA) and Market Value Added (MVA). 135
As a matter of fact Economic Value Added is better system than Return on Capital Employed (ROCE), Return on Equity, Earnings per Share, Net Profit Margin, and Operating Profit Margin to measure the efficiency of a firm in creating a Value. Economic Value Added is excess of Net Operating Profit after Tax (NOPAT) over Cost of Capital. Economic Value Added (EVA) can be calculated as follows: EVA = NOPAT - (TCE x WACC) Where, NOPAT = Net operating profit after tax TCE = Total capital employed WACC = Weighted average cost of capital While calculation of NOPAT, the non-operating items like dividend/ interest on securities invested outside the business, nonoperating expenses etc. will not be considered. The total capital employed is the sum of shareholders funds as well as loan funds. But this does not include investments outside the business. In determining WACC, cost of debt is taken as after tax cost and cost of equity is measured on basis of Capital Asset Pricing Method (CAPM). CAPM is traditionally used by founders of Economic Value Added. Under CAPM, Cost of Equity (K e ) is given by the following. K e = R f + b i (R m R f ) Where, 136
R f = Risk free return R m = Expected market rate of return i = Risk coefficient of particular investment Economic Value Added (EVA) is expressed in terms of rupee figure and as a percentage i.e. EVA measure the absolute rupee value of wealth created. EVA calculation removes the distinction between the providers of capital because the total capital employed in the business is taken, whether provided by shareholder or creditors. The EVA figure measures the value added after the claims or expectation of each of the group of capital providers have been met. Cost Optimization in normal course understood that the maximization of profit without sacrificing or compromising quality of products produced or services rendered which is to be a continuous in character. Ultimately this exercise lead to Value Addition in terms of EVA and MVA. follows. Therefore in this chapter Cost Optimization is construed as Cost Optimization is said to a exist only when proportionate change in value addition is more than the proportionate change in cost incurred. On the other hand, cost is not said to be optimum (suboptimum) only when proportionate change in value addition is less than the proportionate change in cost. This line of thinking can be applied even to material cost, Labour cost, Administrative cost and financial cost and EVA. Optimity or suboptimity of each element of cost with EVA can be known. Hence result of our study for 137
consumer product sector companies such as Asian Paints Ltd, Colgate Palmolive (India) Ltd, Dabur India Ltd, Godrej Consumer Products Ltd, HUL Ltd, ITC Ltd, Marico Ltd, Nestle India Ltd, Tata Coffee Ltd, and Tata Global Beverages Ltd. are presented for analysis in the following pages. Table: 5. 1 showing Total Cost and EVA of select consumer product sector companies YEAR APL CPIL DIL GCPL HUL COST EVA COST EVA COST EVA COST EVA COST EVA 2009-10 4465 748 1542 414 2325 393 904 127 14991 2109 2010-11 5602 759 1794 394 2728 457 1016 245 17348 2306 2011-12 7071 931 2158 445 3158 447 1969 430 18696 2690 2012-13 7600 1019 2484 496 3569 579 2488 587 21837 3773 2013-14 8717 1133 2942 539 4057 648 3068 494 23710 3830 Average 6691 918 2184 457 3167 504 1889 376 19316 2941 Source: Annual Report of Respective Companies. YEAR ITCL MIL NIL TCL TGBL COST EVA COST EVA COST EVA COST EVA COST EVA 2009-10 11492 3648 1680 200 5089 824 266 20 1530 333 2010-11 12804 4835 2078 286 5994 969 329 51 1690 141 2011-12 14903 8366 2602 319 6601 1041 401 70 1813 288 2012-13 17887 10670 3017 387 7048 1081 476 89 2126 230 2013-14 19175 8801 3099 546 6048 1208 543 101 2404 404 Average 15252 7264 2495 347 6356 1024 403 66 1912 279 Source: Annual Report of Respective Companies. 138
By looking at the table no 5.1 it is so clear that average Economic Value Added (EVA) by consumer product sector companies in India is ranging from Rs. 66 crores to RS.7264 crores for the study period. Keen observation of the table provides an information that the EVA by respective companies is not uniform. Some companies have better performance in creating value and some others have low performance in adding value. No companies of the select pack have destroyed the value. Each and every company of consumer product sector have added value over the study period. When we look at average value addition to prove a point that the best performance ITCL and HUL have highest value addition over the others. Whereas the least added value was to Tata Coffee and Tata Global Beverages Ltd respectively. When we look at average total cost incurred composing of material cost, Labour cost and Administration cost was more in case of ITCL and HUL whereas less in case of Tata coffee and Godrej consumer products. The average total cost range for the study period is Rs. 403 crores to Rs.15,252 crores. And cost fluctuation exists. Therefore in order to see whether the Cost Optimization exists or not in consumer product sector companies an average increment in Economic Value Added (EVA) is compared with average increment in total cost. The table for the same is given below. 139
Table: 5. 2 showing Increment in Cost and IEVA of select consumer product sector companies YEAR 2009-10 APL CPIL DIL GCPL HUL ICOST IEVA ICOST IEVA ICOST IEVA ICOST IEVA ICOST IEVA 2010-11 25 1 16-5 17 16 12 92 15 9 2011-12 26 23 20 13 15-2 93 76 7 16 2012-13 7 9 15 12 13 29 26 36 16 40 2013-14 14 11 18 9 13 12 23-16 8 2 Average 18 11 17 7 14 14 38 47 12 17 Source: Annual Report of Respective Companies. YEAR ITCL MIL NIL TCL TGBL ICOST IEVA ICOST IEVA ICOST IEVA ICOST IEVA ICOST IEVA 2009-10 2010-11 11 33 23 43 17 18 23 157 10-58 2011-12 16 73 25 12 10 8 21 39 7 104 2012-13 20 27 15 21 6 4 18 27 17-20 2013-14 7-17 2 41 0 12 14 14 13 75 Average 13 29 16 29 8 10.5 19 59 12 25 Source: Annual Report of Respective Companies. Table No. 5.2 reveals that the average increment in cost for the study period of consumer product sector companies in India in ranging from 08 percent to 38 percent. Whereas range for the Economic Value Added (EVA) increment is ranging from 7 percent to 59 percent. The net result from our study is that ITCL, HUL, Nestle India Ltd, Tata Coffee, Tata Global Beverages Ltd, Godrej consumer products Ltd and Marico Ltd company respectively have achieved Cost Optimity in adding EVA to their organizations. But 140
Colgate Palmolive (India) Ltd, Asian Paints Ltd and Dabur India Ltd have not achieved the Cost Optimity in adding value. However these company have added value not in more proportionate to total cost incurred. Therefore we inferred that Cost Optimity has not taken place in these companies. A similar attempt is made to know about Cost Optimization in term of Market Value Added (MVA) is comparing of the study period. Table: 5. 3 showing total cost and MVA of select consumer product sector companies Year APL CPIL DIL GCPL HUL COST MVA COST MVA COST MVA COST MVA COST MVA 2009-10 4465 12553 1542 5176 2325 2537 904 3012 14991 29902 2010-11 5602 10984 1794 5987 2728 5105 1016 3766 17348 38488 2011-12 7071 18734 2158 9545 3158 6717 1969 8318 18696 50023 2012-13 7600 2004 2484 8306 3569 8965 2488 10043 21837 54818 2013-14 8717 26917 2942 9517 4057 12336 3068 11679 23710 47995 Average 6691 14239 2184 7706 3167 7132 1889 7364 19316 44245 Source: Annual Report of Respective Companies. Year ITCL MIL NIL TCL TGBL COST MVA COST MVA COST MVA COST MVA COST MVA 2009-10 11492 42815 1680 2676 5089 12734 266 333 1530 319 2010-11 12804 101433 2078 3247 5994 13799 329 520 1690 3319 2011-12 14903 147939 2602 4937 6601 16671 401 978 1813 6014 2012-13 17887 169503 3017 5565 7048 17808 476 686 2126 5962 2013-14 19175 189560 3099 7410 6048 20298 543 626 2404 5573 Average 15252 130258 2495 4767 6356 16262 403 629 1912 4237 Source: Annual Report of Respective Companies. 141
By looking at the table no 5.3 it is noticed that, average Market Value Added (MVA) by consumer product sector companies in India is ranging from Rs. 629 crores to RS.130258 crores for the study period. Intensive observation of the table provides an information that the MVA by respective companies is not uniform though these companies belong to consumer product sector industry. In the sense, though the nature of business is almost similar, no uniform value addition is taken place for the cost incurred. Some companies have better performance in creating value and some others have low performance in adding value. No companies of the select pack have destroyed the value. Each and every company of consumer product sector have added value over the study period. When we look at average value addition to prove a point that the best performance with observed in case of during the study period. Highest Market Value Addition has happened to ITCL and HUL others. Whereas the least addition was to Tata Coffee and Tata Global Beverages Ltd respectively. When we look at average total cost incurred composing of material cost, Labour cost and Administration cost was more in case of ITCL and HUL whereas less in case of Tata coffee and Godrej consumer products. The average total cost range for the study period is Rs. 403 crores to Rs.15,252 crores. Cost and Value addition fluctuation was observed for the companies. Therefore in order to see whether the Cost Optimization exists or not in consumer product sector companies an average increment in Market Value Added (MVA) is compared with average increment in total cost. The table for the same is as follows. 142
Table: 5. 4 showing Increment in cost and Increment in MVA of select consumer product sector companies YEAR 2009-10 APL CPIL DIL GCPL HUL ICOST IMVA ICOST IMVA ICOST IMVA ICOST IMVA ICOST IMVA 2010-11 25-13 16 16 17 102 12 26 15 29 2011-12 26 71 20 60 15 32 93 121 7 30 2012-13 7-90 15-13 13 34 26 21 16 10 2013-14 14 1243 18 15 13 38 23 17 8-13 Average 18 304 17 19.5 14 51.5 38 46 12 14 Source: Calculated figures from the respective tables. Year 2009-10 ITCL MIL NIL TCL TGBL ICOST IMVA ICOST IMVA ICOST IMVA ICOST IMVA ICOST IMVA 2010-11 11 137 23 22 17 9 23 57 10 940 2011-12 16 46 25 53 10 21 21 88 7 82 2012-13 20 15 15 13 6 7 18-30 17-1 2013-14 7 12 2 34 0 14 14-9 13-7 Average 13 52.5 16 30.5 8 13 19 26.5 12 253.5 Source: Calculated figures from the respective tables. Table No. 5.4 reveals that the average increment in cost(aic) for the study period of consumer product sector companies in India was ranging from 08 percent to 38 percent. Whereas range for the Market Value Added (MVA) increment is ranging from 13 percent to 304 percent. The net result from our study is that Cost Optimization is not achieved uniformally for all the companies. It has been seen that out of all the companies, only some have achieved Cost Optimity and some have not achieved cost optimity. Therefore Asian Paints Ltd, Tata Global Beverages Ltd, ITCL, Dabur India Ltd, Godrej consumer products Ltd, Marico Ltd 143
companies respectively have achieved Cost Optimity in adding MVA to their organizations. But Nestle India Ltd, HUL, Tata Coffee, and Colgate Palmolive (India) Ltd have not achieved the Cost Optimity in adding value. In case of HUL an exception is seen that HUL has achieved cost optimity in Adding Economic Value. But in Market Value Addition, cost optimity is not seen. However this company have added value not in more proportion to total cost incurred. In order to see whether there exist a relationship between Cost and Value addition, a co-efficient of correlation(r) is calculated and presented for the analysis in following table. Table No. 5.5. Relationship between Total Cost and Economic Value Added (EVA) of select consumer product sector companies in India For the study period Sl. Co-efficient of correlation Name of CPS Companies No. between Total cost and EVA (r) 01 APL 0.97 02 CPIL 0.95 03 DIL 0.95 04 GCPL 0.89 05 HUL 0.97 06 ITCL 0.89 07 MIL 0.89 08 NIL 0.94 09 TCL 0.98 10 TGBL 0.42 Source: Calculated figures from the respective tables. Table no. 5.5. brings a fact that Economic Value Added (EVA) of select consumer Product sector companies in India for the study is positively related to Economic Value Added (EVA). Hence company increase or decrease in cost will definitely lead to is that increase or 144
decrease in value addition. But the point have is value addition should have more change that change in cost. If it has less change than cost brings cost suboptimity. Therefore companies should remember that the proper management of cost either with reference to materials or with reference to labour or overall cost of operations and capital should be there so that Cost Optimization can be achieved. Management cost may include cost control, cost reduction or both. The practice management must become cultured discipline. If this happens respective company can become a great company. In all the cause of companies selected for the study have positive correlation with ranging from 0.42 to 0.98. Table no. 5.6. Relationship between Total Cost and Market Value Added (MVA) of select consumer product sector companies in India For the study period Sl. No. Name of CPS Companies Co-efficient correlation between Total cost and MVA (r) 01 APL 0.38 02 CPIL 0.85 03 DIL 0.99 04 GCPL 0.99 05 HUL 0.81 06 ITCL 0.95 07 MIL 0.95 08 NIL 0.92 09 TCL 0.49 10 TGBL 0.74 Source: Calculated figures from the respective tables. 145
Table No. 5.6 presents a fact that Market Value Added (MVA) of select consumer Product sector companies in India for the study is positively related to Market Value Added (MVA). Hence company more or less in cost will definitely lead to is that increase or decrease in value addition. But the position of the value addition should have more change that change in cost. If it has less change than cost brings cost suboptimity. Therefore companies should remember that the suitable management of cost either with reference to materials or with reference to labour or overall cost of operations and capital should be there so that Cost Optimization can be achieved. Management cost may include cost control, cost reduction or both. The practice management must become cultured discipline. If this happens respective company can become a great company. In all the grounds of companies selected for the study have positive correlation with ranging from 0.38 to 0.99. 146
Table: 5. 5 Correlation between selected consumer product sector companies in India total cost and EVA of the study period. Sl. No. Company Total Cost EVA 1 ITC 76261.05 36319.79 2 HUL 96582.68 14707.51 3 NESTLE 31780.39 5122.8 4 TATA COFFEE 2015.89 331.52 5 TATA GLOBAL BEVERAGES 9563.12 1397.17 6 COLGATE PALMOLIVE 10920.98 2290.07 7 ASIAN PAINTS 33456.06 4591.53 8 DABUR 15838.5 2524.18 9 GODREJ CONSUMER PRODUCTS 9445.51 1883.18 10 MARICO 12476.36 1738.09 Source: Annual reports of respective companies. Graph: 5.1 Total Cost and Economic Value Added of select consumer product sector companies in India of the study period 147
Table: 5. 6 correlation between Total cost and MVA of select consumer product sector companies in India for the study period. Sl. No. Company Total Cost MVA 1 ITC 76261.05 651291.71 2 HUL 96582.68 221226.95 3 NESTLE 31780.39 81310.47 4 TATA COFFEE 2015.89 3144.11 5 TATA GLOBAL BEVERAGES 9563.12 21187.04 6 COLGATE PALMOLIVE 10920.98 38531.91 7 ASIAN PAINTS 33456.06 71194.05 8 DABUR 15838.5 35660.48 9 GODREJ CONSUMER PRODUCTS 9445.51 36817.961 10 MARICO 12476.36 23835.37 Source: Annual reports of respective companies. Graph: 5.2 Total Cost and Market Value Added of select consumer product sector companies in India of the study period. 148
5.2. Conclusion In conclude all companies in the industry are aspiring for value creation in terms of Economic Value Added (EVA), Market Value Added (MVA), some companies are adding value, few companies are adding value with minimization of cost without sacrificing or compromising the quality of the product produced or services rendered. Such companies can become great companies. Rest of the companies can either be good or bad companies. Hence increase in value with minimization of cost should become a cultured discipline of the respective companies to attain the cost optimity. 149