The inside story of how Hero Honda split in 2010, and the Hero was re-born soon after, Ravi Sud, Senior Vice President and CFO of Hero MotoCorp, speaks to CFO Connect

Who knew in 1984, when Hero Group and Honda Motors signed a JV agreement to form Hero Honda that this infant will become the world’s largest two-wheeler company by 2001. But when this happened it increased the aspirations of the Indian partner to export its two-wheelers, and develop the products in-house with its own R&D. This was the main reason for the dissolution of this enormously successful JV. However, when Honda sold out to its partner, it did so amicably, recognising

that the Indian partner was responsible for creating the brand equity that Honda enjoyed in India. This holds lessons for other JVs that will eventually split when the in-terests of the partners cease to align. Here we present the inside story of the split and the birth of Hero MotoCorp, its plans and aspirations, and how it expects to continue to hold its number one position without Honda’s powerful name and technology. Ravi Sud, Senior Vice President and CFO of Hero MotoCorp, speaks to IMA India.

the Hero Re-born

26 cFoConnECt may 2012

What compelling reasons forced Hero Motor Corporation and Honda to part ways?

Let me begin by giving a little background on the Joint Venture. In 1984, Honda formed two JVs; one was to manufacture motorcycles with the Hero Group and the other was with Kinetic Honda to manufacture scooters. Honda sold its stake in Ki-netic Honda in 1997 and about a year later decided to set up its own scooter manufacturing subsidiary. At that time Press Note 1 was in force, which made it mandatory for it take a No Objection Certificate (NOC) from its existing JV partner, that is, Hero Honda. The NOC was given with the understand-ing that Honda will not manufacture motorcycles whereas Hero Honda will not make scooters for five years. Honda kept its commitment, despite the fact that scooters was a declining market at that time. To Honda’s credit, it grew and transformed the market and today, they have about 55-60 per cent share of this market.

The other agreement that was made at that time was to set up a model committee comprising a representative each from Hero Honda, Honda, and from Honda’s newly formed Indian subsidiary Honda Motorcycles and Scooters India Private Limited (HMSI). The third agreement was that Honda would manufacture the products based on the individual specifications of both companies.

The conflict arose when HSMI decided in 2010 to launch a 110cc motorcycle, the segment that formed over 70 per cent of Hero Honda’s sales. Honda dis-missed Hero Honda’s apprehensions that HSMI’s motorcycle will become a direct competitor to its largest selling bikes – Passion and Splendor.

What were the main reasons for parting?There were really three constraints on Hero

Honda which it had shared with Honda in 2008. The first was the issue of exports. According to the shareholder’s agreement signed in 1984, the joint venture was only for domestic production and consumption. Who would have thought then that one day, this company will become the world’s biggest player in the motorcycle segment? For 11 years starting 2001, Hero Honda has been the world’s largest, with volumes growing from 1 mil-lion to 6.2 million in 2011-12. The agreement was subsequently, modified to allow exports of limited products to a few countries, namely Sri Lanka, Bangladesh, Nepal, and Columbia.

However, in 2008, when the issue of exporting the Indian JV’s products to other countries came up, Honda said that Hero Honda will have to compete on its own since it could not influence its subsidiaries abroad to import the JV’s products. Honda’s subsidiaries are run very independently and decide which countries they want to source their products from. This was a bitter pill to swal-

low for Hero Honda. The second contentious issue was that of board

representation. Of the four Honda representatives on the board, one executive director was the head of Honda in India, to whom HSMI reported, and the other located in Bangkok, represented Honda’s two-wheeler business in Asia. The other two were nominated by Honda. As directors on the board of Hero Honda all of them had access to its plans and strategies, while Hero Honda had access to none of Honda’s plans. This, Hero Honda had felt amounted to a conflict of interests.

The third issue was related to Hero Honda want-ing to do its own independent R&D and manufac-turing its own products. When it asked Honda to be allowed to do so, subject to approval from the head office in Japan, Honda’s response was ‘R&D is like its heart and it can’t give its heart to anyone’.

Did you make a mistake in agreeing to some of the clauses at the time of signing the JV?

As I said, in 1984 who would have thought that the business that started with equity of Rs 16 crore, of which Honda contributed only Rs 4 crore, will become the world’s largest two-wheeler company? Similarly, who could have imagined that the export market will have opened up in 30 years, the way it has? Every partner in the JV has some objectives, which determine the terms of the agreement. How-ever, not everyone parts as amicably as Hero Group and Honda did.

Did Honda want to buy out the Indian promoters?Honda already had a substantial entity in India

- it reported a sales volume of 1.7 million last year and should hit 2.4 million this year – over which it exercised 100 per cent control. Besides, it would have found the JV expensive to acquire where it had only 26 per cent share.

How was the money raised and the capital share transfer structured, and how were the private equity people convinced to provide the funding?

This was not really in my domain but I can

coVeR Story

In 2008, when the issue of exporting the Indian JV’s products to other countries came up, Honda said that Hero Honda will have to compete on its own since it could not influence its subsidiaries abroad to import the JV’s products

may 2012 cFoConnECt 27

coVeR Storyshare a few things with you. There were two teams that negotiated independently with Honda. One was from the shareholders’ side and one from the company’s side. I represented the company. My main interest was to protect the company and the minority shareholders. Let me tell you honestly, I have no access to the deal that the shareholders had with Honda, nor did I need to know. There were a series of discussions between the promoters and seven PE partners who also asked that the top management be present at the meeting, so that they can get an understanding of the company. They met me, and the heads of marketing, operations, and HR / Strategy functions. Following this meeting, what transpired between them and Honda, and at what price they had agreed to take the shares, I do not know.

How was the parting with Honda?When we parted, Honda could have told us

that since the deal was over, it will not share any new technology with us, though we could continue to use the existing technology. However, Honda realised that we could not compete without a continuous flow of new products and technology during the 24 to 42 months it takes to bring out a new product from scratch. It agreed to provide us the products that were being developed for the joint venture at the time of the split. These products were not to be shared with its own subsidiary. People ask me why did Honda sell its shares at Rs 740, when the market price was about Rs 1480. This is how

the long term 26-year relationship has panned out.Honda’s gesture reflected its appreciation for

the fact that it was this joint venture that built the Honda brand in India over 26 years of a win-win relationship. This sort of appreciation you will not receive from an Anglo-Saxon partner. For example, a US company will, one fine day, say let us shake hands, it is over. You keep on using whatever technology I have shared, but from now on, do you own R&D.

Honda’s parting gestures told us that it appre-ciated us and it would have liked to continue its relationship with us, except that we had ambitions to go global and build our own products. And the fact that through its directors, Honda had access to all our strategies, even though they assured us that strategic information was not shared.

What have you learned from Honda? We have got tremendous learning from work-

ing with Honda in many areas – the way they conducted meetings, standard operating processes, and processes. Our effort will be to continue these practices. I will not hesitate in saying that if we are responsible for establishing their brand, they have given us a lot as well.

Now that you have dropped Honda’s name from your brand, do you think that a domestically generated brand will be strong competition in the export markets?

We started the campaign to establish our new brand on August 15, and I think it has been very successful. During a visit to Pehelgam in Srinagar, some of my colleagues wanted to visit a golf course. But the caddy there would not allow us entry with-out any ID proof, so I handed him my Hero Honda card. But he rejected it saying that it had the old name whereas the new name of the company was Hero Motocorp. I then gave him my new card and he accepted it. We are in the process of building the new brand which is the Hero Motorcorp brand, through an emotive TV advertisement which talks of 1 billion heroes and a hero in each one of us.

What role did the board play?Hero Honda had a very large board. As per the

shareholder agreement, the Indian promoters and Honda had four directors each on the board. Since we had an executive chairman, we needed half the board to be independent. Therefore, the board had 16 members, comprising eight independent direc-tors, four Honda representatives, and four Indian representatives.

Around the time that we began to raise our three contentious issues with Honda in 2008-2009, we also sensitised the board, and the audit com-mittee actively discussed the matter as well. The

28 cFoConnECt may 2012

coVeR Storyindependent directors played a very active role in questioning Honda as to why the company cannot grow further and why does it have to always be dependent on Honda. When Honda said that it could not give us the three things that we wanted, the independent directors strongly advised that Hero Honda should go to the next growth phase, independent of Honda.

Wasn’t there even one member who said that this is a risk for the minority shareholder?

A majority of the independent directors felt this, particularly the chairman of the audit committee and an independent director who is still on our board. Their view was that it will be in the interest of the company to go to the next level, even though there were risks in going alone. As far as the risk to the minority shareholder is concerned, we can’t eliminate it, but we can mitigate it through our actions and strategies.

Are you facing any distribution challenges after removing the Honda brand name?

Our parting agreement with Honda is that we have the right to retain the Hero Honda name on our products as well as at our distribution outlets, till March 2014. However, we thought that it was in our interest to work immediately on strengthening the new brand. So effective August 15, 2011, the branding and name changed in all the dealership and showrooms. This is being complemented by very strong advertising. The next step is to change the brand name on the product. From March-end, 2012, we have started changing the branding on products to Hero, which will be completed in six months.

How did you handle the employee morale issue? Did you have a non-poaching agreement with Honda?

Yes, we have a non-poaching clause, unless the employee joins some other place before joining Honda. For morale boosting the key was commu-nication. We announced the split on December 16, 2010 at 4 pm, and from that moment on, we held a series of meetings that day and over the next couple of days just to ensure that the news of the split went out correctly and in the right manner. I headed the communication committee that also included the heads of IT and PR and we planned it minute by minute. On December 16, the board meeting was held at 2.30 pm, and at 3.16 pm the MD went live on PCs of employees, dealers, and vendors. Then between 4.00-5.30 pm we held a press conference, and at 6.30 we met key vendors at the Taj Mahal hotel. The next day on December 17, there was a meeting with 200 dealers, and on December 21, 222 vendors attended a briefing.

What steps have you taken to beef up your R&D? We have a transition period of three-and-a-half

years and we intend to use it well and be ready at the end of it. Over the last one year, the number of engineers in our R&D has increased from 175 to about 280. Second, we have hired advisors and con-sultants who are modifying the existing products. Third, we are working with some design houses in Japan and other parts of the world for new prod-uct development. Fourth, the engine is the heart of our products and we have tied up with world leader Erik Buell who designs high-end bikes go-ing up from 250 cc to modify existing engines and develop new platforms. We are targeting FY14 to have our own products from our R&D. There are newer entrants coming in like Harley Davidson and this is why Erik Buell makes sense for us as it is very futuristic and it is promising us our first product in 2014.

What have been your competitive strengths?In this market we always have to think ahead.

In 2008-09, the market tanked but we did well because we invested in developing the rural mar-kets. Today, just under half our sales come from that segment.

During a slowdown, usually, advertising re-ceives the biggest cut and the pace of new product introduction slows down. However, we kept on launching new products and refreshing existing products to keep the customer interest alive. When the markets bounced back, we had a disproportion-ate growth. We have also continued to invest in increasing our distribution channel from just 2000 in 2006 to around 5000 now. The key is to do some-thing that differentiates you from competition.

What is the vision for the company post the split?Our vision is that by FY 16, we should be a 10

million volume company, of which 10 per cent should come from exports. Today, exports is negligible.

And what are the challenges in achieving this vision?

If I have to focus on what are our red flags or risk areas, there are many, but the following are the

The next step is to change the brand name on the product. From March-end, 2012, we have started changing the branding on products to Hero, which will be completed in six months

may 2012 cFoConnECt 29

most challenging in my view. First, is the transition of our brand from Hero Honda to Hero MotoCorp. Our assessment after the first six months is that it has happened very successfully. The next challenge is to successfully change the name on the bikes. The challenge is how can I stop a dealer of a competitor telling a customer that the bike is not Honda, and the quality has gone down? We are partly mitigat-ing the risk by launching new Hero products in September. We also launched a new unisex Hero scooter a couple of months ago. Third, the success in this industry lies in continuously launching products, including refreshed existing products modified by R&D. If a company cannot deliver it, then it risks failure. Fourth, one of the main reasons for the split revolved around exports and to my mind, after listening to analysts and consultants, it will not be an easy job. In any market that we enter, we will be anywhere from the fourth to the sixth player as the big boys - TVS, Bajaj, the Japanese, and the Chinese brands – are already present there. Fifth, is managing our costs. Many people have commented that with Honda gone, we will save on material costs. I feel that at best, we can save only 3 per cent, which works out to Rs 1250. But in trying to get this saving we may compromise on three things that we are known for - quality, durability, and after sales. Just to save Rs 10, if we replace a component in our brand, I wonder what the impact of this will be on our reputation.

How successful have you been in addressing these challenges?

We have completed more than one year of trans-formation and in the first year our sales volume

coVeR Storygrew by 20 per cent. In the previous year, we were well ahead of the industry and our market share went up. We could not source technology from anyone other than Honda, so we could not even set up a separate company to export.

What progress have you made on the exports front? Have you launched your new brand iden-tify abroad?

Rebranding in the overseas markets will happen only when we start our exports. I feel we have to manage the environment in our own country, and then see how to manage outside. Doing business is to manage the environment. For exports we have shortlisted markets, and have started appointing or recruiting distributors. The next step will be to arrive at an arrangement with the distributors, and to decide whether to ship completely built units (CBUs), or set up an assembly plant. Before we com-mence our operations overseas, branding will also have to be done. There may be some rub-off from Hero Cycles, which we export to about 75 countries, but they are two separate products. Right now we are 98 per cent focussed on the domestic market. The only advantage of being late in the game is that you can avoid the mistakes of others and we want to make sure that even if we are late by another six months, at least we do not make any mistakes.

On its pricing strategy and incentives to dealers…This company’s philosophy of doing business

is slightly different; every associate becomes a part of the company and we take moral responsibility for their profitability. Of course, if an associate commits fraud, it is a different matter. So people feel connected and engaged with the company. As a result, from December 2010, when the split happened to January 2012, only two dealers have left us.

At the top, what was the relationship and how did it influence the final outcome of the company?

Honda is very hierarchical and accessing its President is very difficult, but access to the Asia Pac head, who holds the rank of the senior MD, is 100 per cent. Communication at the operations’ level, such as, at the CFO’s and marketing level is very high. I am sure the Asia Pac head had taken the blessings of the President or some Executive Committee that Honda has, before saying yes, to the separation.

What makes for a successful JV in your view?I will say there are three or four principles that

can make or break a JV. First, the Indian promoter has to be willing to accept the JV partner as an equal. Second, the JV partner should have an adequate say in the operations of the company.

30 cFoConnECt may 2012

coVeR StoryThird, the foreign partner should have adequate representation on the board and must have a say in the way it functions. In my experience the Indian partners just expect the foreign partner representa-tive to just have a good life and leave the running of the company to local promoters. Ultimately, this is what creates frustration and then it all begins to unravel.

You have to not just be fair, but also be perceived to be fair by the JV partner. Whenever the operat-ing team made an important decision, say price increase, we first informed the Joint Managing Director, who was from Honda, and then the MD. This assured Honda that its interest in the company is being protected.

What is the CFO’s ‘dharma’ in a JV, based on your experience?

The CFO has to be totally non-partisan and has to look after the interest of both the sets of promoters. There were many instances when the Asia-Pacific head was in one room, and the Indian shareholder in another, and I, as CFO mediated between them. The Japanese representatives always felt that I was non-partisan and I did not take sides with any party.

For example, Honda had four directors on the board, who could not attend the meetings. I advised Honda to have an alternate director who would at-tend the meetings. Just before the deal, I asked the Joint MD, who was a Japanese to tell Honda to ask for a dividend before the deal since Hero Honda was cash rich. The response from Tokyo was that it did not need cash, and that they are Samurai fighters and will generate their own cash. You have to come across as fair and you will gain people’s trust. When there are two parties, you have to find middle ground.

Also, one has to be always correct. On December 16, 2010 when the separation was announced an Aberdeen representative in Singapore, which held over 9.5 per cent stake in the company, called and said that Aberdeen did not wish to be an insider. I told him I will share with him only what is already in the public domain. Today, it owns =12.0 per cent of the company.

On bankers and lenders’ consent to Hero post-split, and who is the winner 15 months after the split, Hero or Honda?

We are cash surplus so we did not need any-one’s consent. If you are talking of our promoters, they have taken independent ratings from Crisil on companies that they wanted to raise money in. They raised money for the short term, and in the meantime, they brought in private equity players and retired most of the debt. It has been absolutely win-win for both parties.

How has the labour conditions been at your plants?

The Gurgaon-Manesar belt is seeing a lot of labour problems, but our company is not affected. The labour issues also boil down to how well do you communicate with your people, and how fair you are? For example, the minimum wage is Rs 5000, but we pay our contractor much higher. I think the last problem that we faced was in April 2006, when some contract labourers stopped working. The fact is that the differential between a permanent and a contractual labourer in our industry, is very high.

What will be biggest challenges for you as CFO over the next few years?

The biggest challenge will be to allocate re-sources. There is unprecedented demand for capital for initiatives ranging from R&D, spare parts ca-pacity enhancement, developing exports markets, manufacturing capacity expansion, tying up with technology vendors and re-branding, among oth-ers. We are working with each function head to understand what is his wish-list, what is essential and what can be deferred. Though Hero Honda is a cash-surplus company, the need to raise money cannot be ruled out.

I suspect that these costs will put pressure on our profitability as initiatives such as R&D and exports do not yield results immediately. To offset these pressures, our focus will be on costs, particularly through value engineering. We now have flexibility to change our vendors and re-negotiate prices with them. It is showing results.

What have been your key achievements as CFO of Hero Honda?

I think my biggest contribution was to convince the board and management to pursue market share in 2006-07 when the pricing war started in the mar-ket putting pressure on margins of every player. My argument was that if you lose market share, it will be very difficult to win it back. I said even if we sacrificed the bottom line for three to four quarters, it will be worthwhile. I have been proven right by later developments. My biggest satisfaction is that I have seen the company grow from less than half a million, to nearly 7 million now, and that I have played a role in it.

My biggest satisfaction is that I have seen the company grow from less than half a million, to nearly 7 million now, and that I have played a role in it

may 2012 cFoConnECt 31