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8/18/2019 Arvind Mills Re-Evaluating Profitability
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Arvina Mills Re Evaluating Profitability
ByRajeev Khera, under
t
supervision of Professor Murray J. Bryant
It was a typical, tropical June summer afternoon in
western India. The temperatures outside were soar-
ing to 45°C, and in his climate controlled environ-
ment, Mr. Bala, vice-president of operations,
knitwear division, atArvind Mills Limited, had been
thinking hard about a trial order from one of the
world s major ready-to-wear apparel retailers. .The
initial developments leading up to this trial order
had gone smoothly, and the company was confident
that it had more than adequately addressed all the
major concerns of this customer. The continued
communications to and from the customer reflected
this sentiment. In fact, the success of this trial order
was taken as a given, and management was planning
for the large volume of business that would, in all
probability, come their way.The entire deal hinged
upon the premise that the customer would accept
the prices that were going to be quoted on June 22,
1999,the followingMonday.
The importance of the right price was not in
the leastbit underestimated by Bala.He had carefully
Copyright
@ 2 4
Ivey Management Services
monitored each and every elemental cost of raw
materials and process, and had suggested tremen-
dous innovations on aspects that provided a con-
siderable reduction in costs, without compromis-
ing on the quality; delivery schedules; and other
critical metrics. And yet, the numbers he was
looking at today were not globally competitive-a
factborne out of the company s own market study.
Any further reduction in prices would render the
entire business un-profitable.
The choices to be made were stark and diffi-
cult. On the one hand was the option of quoting
the prices that had been worked out by the current
costing system-and lose the business to the com-
petition (mainly China) (see Exhibit 1). The other
option was to accept the business at the price of the
competition (ignore what your own costing is tell-
ing you), ensure continuing revenues and take a hit
on profitability-and hope that in due course, the
company would be able to negotiate better prices
and recover some of the lost profits.
Version: (A) 2009-10-08
8/18/2019 Arvind Mills Re-Evaluating Profitability
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China
Hong Kong China)
India
99
16,889
23,619
4,709
60,000
50,000
40,000
2
§. 30,000
~
20,000
10,000
0
Arvind Mills: Re-Evaluating Profitability
75
995
37,967
35,112
8,468
999
43,121
34,642
10,240
52,206
37,656
11,929
2
53,476
35,660
13,897
1990 1995 1999 2000 2001
Year
1--
China --- Hong Kong China) -f:r- India I
Textile Industry in
India n
Overview
From the day India achieved its independence on
August 15, 1947 after about 200 years of the Brit-
ish Raj), until about 1986-87, the industrial poli-
cies of each successive government were guided by
the principles of socialist form of governance. The
governments enacted a labyrinth of laws, rules
and regulations, ostensibly to promote industrial
growth in a market environment that was pro-
tected to the greatest possible extent from external
competition.
The textiles and clothing industry is the largest
manufaCturing sector in India, accounting for
around four percent of GDP, 20 percent of India s
industrial output and 37 percent of total exports
WTO,1998).Textiles i.e.,yarn, cloth, fabrics and
including substantial segments of weaker sections of
society. Its growth and vitality, therefore, had critical
bearings on the Indian economy at large.
The dominant concerns of government policies
towards the cotton textile industry centered around
import substitution the credo of self-sufficiency).
Exports were considered a marginal outlet for sur-
pluses, protection of existing employment in the
organized big business) sector, support of the decen-
tralized small scale) sector, and protection of the
cotton farmers interests. These pre-occupations were
refleCted in the major government policies for this
sector such as:
.
extensive quota restrictions on vanous
product categories,
strong exit barriers, even for unviable oper-
ations to ensure continued employment),
.
.
8/18/2019 Arvind Mills Re-Evaluating Profitability
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7
CHAPTER :
PRI IN
.
stringent licensing for the organized sector
at the expense of small and medium-scale
manufacturers.
These strict policies led to an extremely skewed
development of the Indian textile industry. The
large-scale industries were restrained at the expense
of the small-scale industries that prevented mod-
ernization, quality investments, scale adoption, and
change in product mix from exclusive reliance on
cotton garments to mass clothing items based on
synthetic and man-made fibers. Indian fiscal and
customs policy too discriminated against develop-
ment of synthetic base in India in line with the
government belief that synthetic is for the classes
and cotton is for the masses: As a result, while cot-
ton prices were not allowed to move up (trade
control, and buffer state operations), synthetic
fibers were deliberately priced at uncompetitive
levels (viewed as a luxury fiber for higher income
groups) against cotton.
In its development policies, the state discrimi-
nated against the mill sector in favor of the power-
loom sector, which was perceived as an engine of
growth. This was done through preferential import
and export quotas for the powerloom sector. As a
result, the powerloom sector flourished at the
expense of the other two.
Between 1977and 1986,the powerloom sector
more than doubled its capacity, reaching 800,000
looms, while the mill and handloom sectors lagged
behind. Government controls on scrapping obso-
lete equipment and restrictions on imported
machines resulted in further under-used capacity,
poor productivity, and loss in profitability.
Strong resistance from workers fearing job
losses prevented any technological changes and
internal restructuring in these two state-owned
textile sectors. This led to a loss of competitiveness,
rising operational costs, and a weak and sickly
industrial structure.
The degree of skewing became apparent in
the fact that the Indian textile and clothing indus-
I
consumer. Each contributed not only to the
lengthening of lead times, but also to additional
costs. By the time cotton worth INRlOOreaches
from farmer to the spinning unit, its cost inflated
to INRI48. By the time it reaches the final con-
sumer, it costsINR365.
The spate of broken links, exemptions avail-
able to various segmentssuch as smallscaleindus-
trial units that competewith exciseand duty pay-
ing segment, and disproportionate excise duty
incidence across the chain had become major
impediments to developingcompetitivenessin the
industry.Marketstructuresweredistorted,creating
unhealthycompetitionamong the segmentsthem-
selves,and succeedingin creatinga diversevariety
of vestedintereststhat are (eventoday) opposed to
any reformin the sector.
The global trade in textiles was also regu-
lated to a considerable degree, and access to
markets in the developed countries was not free
of protective tariffs and artificial barriers usually
in terms of quantitive restrictions. From 1974
and up to the end of the UruguayRound in 1994,
textile and clothing quotas werenegotiated bilat-
erallyand governedbythe rules of the multi-fiber
arrangement (MFA).Though this systemhad its
fair share of drawbacks, it did help transfer the
demands from the developed countries like
China and India.
With the Indian industry crying for reforms
to essentially ensure its survival, and sensing a
whiff of the opportunities in the markets abroad,
manufacturers met with the government to
embark on a long-term policy of liberalization
and earning export revenuesbecame a key thrust
area. The years 1986-87marked this key turning
point. The initial forays into the international
market weremade by the first generation, entre-
preneurial apparel (clothing) manufacturers.
Their abilities and resourcefulness brought a
number of international clothing majors such as
Levis,Benetton, Lacoste,and Pierre Cardin to the
Indian stores. Their gains also percolated down-
8/18/2019 Arvind Mills Re-Evaluating Profitability
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The textile industry's restructure was helped
in large measure by the rapid devaluation of the
Indian rupee, and for the most part, it camouflaged
the lack of industry competitiveness and ensured a
steady growth.
The MFA was later replaced by Agreement on
Textiles and Clothing, a more rationalized system
that came into effect in 1995 at the Uruguay round
of General Agreement on Trade and Tariff (GATT),
giving further boosts to exports.
Arvind Mills Limited
With the current revenues at US 550 million,2
Arvind MillsLimited is the flagshipcompany of
LalbhaiGroup (Exhibit2). It was incorporated in
1931to manufacturecotton textiles.Operatingin a
highly regulated and protected market, the com-
pany grew to become one of the leading cotton
manufacturing companiesin the country,produc-
ing conventional suiting fabrics, shirting fabrics,
and sarees(traditional Indian robe).
Arvind Mills: Re-Evaluating Profitability
Cashing in on its technical skillsand mana-
gerial capabilities, Arvind Mills undertook its
first expansion to manufacture denim. In 1986,
the company started to look for textiles that had
global demand, high margins, high entry level
barriers, (either of technology, expertise or
set-up costs) and, very importantly, low fashion
volatility. The company wanted to focus on fab-
ric that would never goout of style. Fromwithin
the possible products, denim proved to be most
suitable. From 1987 (at annual production
levels of three million meters), within 10 years,
Arvind Mills expanded to become the world's
third largestproducer of denim cloth at 120mil-
lion meters.
In 1993,a studyof sevencountriesfound that
the price of cotton yarn per kilo was cheapestin
Indiaat 2.79,comparedto 3.30in Brazil, 4.19in
Japan,and 3.10in Thailand.Thiswasthe resultof
overalllabor and rawmaterial costsbeingcheaper
in India. .
Spurred on by the successesin the denim
industry, Arvind Mills undertook substantial
Sales by Market Rs. in Crores
1997-98
1854
1998-99
1999-00
2000-01
18 Months
2400
2000
1600
1200
800
400
0
1996-97
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8
CHAPTER
PRICING
Sales and Operating Income
Rs. In Crores
1877
~
200
100
0
-100
-200
-300
-400
-500
-600
1996-97
1997-98
1998-99
1999-00
2000-01
18 Months
Profit Before Tax Rs. in Crores
133
109
-499
1997-98
1998-99
1999-00
2000-01
18 months
ourceCompanyiles
Conversion:
I Crore= 10million
US I = INR36
investmentsof millions of dollars into manufac-
turing other textilefabricsas:
.
knitted fabric 120million;and
apparel.
2100
1800
1500
1200
900
600
300
0
1996-97
8/18/2019 Arvind Mills Re-Evaluating Profitability
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had other business interests in related and
non-related industries. One of the group s compa-
nies, Atul Limited ( 130 million), manufactured
chemicals and intermediaries for the textile, paper,
and leather industries. Another, Amtrex Appliances
Limited,manufactured and marketed household air
conditioners and had joint ventures with Hitachi
(Japan) and Fedders (United States).
Market Dynamics Increase
Toward Complexity
The fashion and textile market worldwide had wit-
nessed an immense transformation since 1990.
Moving from constant, non-volatile fashion trends,
major retailers, working with textile designers in
the fashion centers of the world, continually added
complexity to the products theytetailed in terms of
fabric color, composition, structure and styling of
the garments. The customer therefore was no lon-
ger buying out from the inventory they associated
with the manufacturers and the very initial stages
in the process of fabric manufacture. Tough com-
petition placed further pressures on the lead time
to market and development cycles; in fact, the
entire end-to-end logistics of the value chain was
bearing the pressures of such transformations.
Arvind Mills expansion kept pace with the
increasing complexity of the marketplace. The process
of manufacturing denim was relativelysimple. It had
Arvind Mills: Re-Evaluating Profitability
79
fewer variables, a less complex product mix and rela-
tivelyeasylogistics in terms of process and workflow
(seeExhibit 3). The company was able to successfully
exploit the economies of scale, (thereby reducing per
unit overhead), the low price of cotton, and the power
in its supply chain. The growth was therefore relatively
smooth, controlled, and predictable. But the early
gains were being eroded due mainly to the increasein
cotton prices that more than doubled between March
1989and March 1993.Also,the worldwide demand in
denim reached a plateau, and the margins were being
squeezed out.
The product structure, the product mix, and the
logistics involved in the manufacturing processes the
other divisionswere, however,much more involved.
The apparel retailers and designers looked to
fabrics other than denim that offered more possi-
bilities in terms of color and structure to manufac-
ture trousers. Bo~tom weights became the next
logical step forward. Whereas the manufacturing
processes remained essentially similar, the logistics
had to address many more variations, production
run switches, different lot sizes, etc.
A recent addition to the range of fabric and
clothing came in the form of knitwear. The technol-
ogy,equipment, processes, material inputs, product
mix, and logistics were entirely different from those
currently followed to manufacture woven fabrics
such as denim, shirting or bottom weights.
The fabrics came in both tubular and open
widths, in single knits as jersey, pique, textures,
(Primarily
indigo/white)
yeing
ustomer
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8
CHAPTER PRI IN
pointells, fleece, French terry, jacquards in solids,
feeds, and automatics, and in double knits such as
interlocks, needle-outs, ottomans, thermals, poin-
tells, textures, reversible, jacquards, ribs in solids,
feeds and automatic collars, plains, and jacquards
(see Exhibit 4). These fabrics had applications
from casuals to formals, from active wear to sleep-
wear for men, women, children, and infants.
With somuch variation and range,the one thing
that stood out was the immense necessity to under-
stand and manage all specificationspertaining to each
and everyorder from the customer, and more impor-
tantly the need to havefastand clear communications
with the customers across the world. Arvind Mills,
sensingthisneed, setup a high-tech designcenter.The
centrewasnetworked globallywith designersto create
corpus of the finest international design. That linked
the designing facilityto a pilot mill;' and the designs
created on-screen wereduplicated on fabric in a mat-
ter of hours. This ensured that the customer got an
exclusive,world-classdesignin a very short time. This
process not only helped shorten design-to-market
IIB_-
lead-time; it also allowed the retailers and designers to
watch the trends closely and design and launch the
products close to the start of a season.
The potential order that Balawas looking at
was as follows:
Customer inputs,
communications,
feedback
Cotton, Polyester/Cotton Blends,
different staple lengths
Different counts fineness of yarn
Different colors: Black, navy, khakis,
greens, olives all custom-dyed
Different structures: jersey, pique,
jacquards, pointells, etc.
Different finishes stain proof,
anti-crease,
etc.)
f
.
Twelveshades (five dark, three medium,
and four light colors)
.
Overallquantity
0 D k sh'de -l
Total
=
180EoQ
6EoQ Icolor
1EoQ=350kgs
0 Medium
=> total kgs=
shades-2.5
63,000kgs
EoQI colo,
J
Lightshades-
6.25EoQIcolor
0 Rejectionrate-30/0 (overall)
0 Programanticipated in peakseason
.
Installed capacity = 3,500kgs/day(in three
eight hour shifts)
.
Therefore total program books about 20 days
worth of production; very lucrative
8/18/2019 Arvind Mills Re-Evaluating Profitability
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.
Targetprice
=
250-275/kg
Probability of this order
through
=
0.80
.
Arvind Mills: Re-Evaluating Profitability
comlllg
mind, was to propose a system of costing an order
that was more reflective of the current business
process see Exhibit 5 , and then re-evaluate the
quote to be sent to the buyer. He asked the process
managers to work out different scenarios using SAP,
and come up with the numbers see Exhibit 6 .
o nd o was confident that the company
couldmeet the targetprice.The centralissue,to his
Cost flow existing that mimicked
the current process flow
Overheads
.
Productdevelopment costs
. Communicationosts
.
CommonUtilities
. Support costs
. Machinecosts
.
Capacity
Utilization/Efficiency
Were totaled and added / kg
of material delivered straight
to the bottom line
Cost flow as per the actual process flow
I Communication I
+
Capacity utilization/efficiency worked out.
Efficient schedules were profitable.
Overheads
.
Commonutilities
.
Support
costs
ere tot lled and
added / kg of material
delivered straight to
the bottom line
.
EOO defined
.
SAP used to calculate planned costs
. Calculatevariances
. Less lumpedoverheads whichreduces
cross subsidizations
8/18/2019 Arvind Mills Re-Evaluating Profitability
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8
CHAPTER PRICING
..
Rs 2/kg
irect labor
Produ
Overheads
Rs6/kg
RsIS/kg
Rs30- 40/kg
-
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Arvind Mills Re Evaluating Profitability
8
CASEQUESTIONS
1. Whatpricing
ShouldArvindMillsresorto competition based
Whyorwhynot?
Areanydiscountingacticsavailableo
whynot?
ShouldhemarketingmanagementeamatArvindMillsattem
productseingoffered hemethodsfproduction ndthedQliveryystems?
programffectthesechanges?