ANALYSIS. What Bhushan Steel tells us about ‘strategy’

After being in the black all these years, Bhushan Steel’s finances are awash in red with the company reporting a net loss of ₹141.6 crore for the quarter ending June 30, 2014. Its stock has no takers with the order book at the National Stock Exchange at close of trading on Wednesday showing only sellers to the tune of 3.15 lakh shares in the ₹169 price range with absolutely no buyers at any price. It couldn’t get any worse.

The company’s predicament is an occasion for reiterating some well-recognised principles in strategic management.

The first lesson. When a company embarks on a new venture, the project may promise mouth-watering returns. But the key question to be asked is this: If that venture fails, would it drag the company’s present business down along with it? If the answer is a ‘Yes’, then no matter how rosy the financial projection appears to be, the project had better be shelved. At one level, it may appear to be a case of plain common sense, but it is at the core of managerial caution about excessive leverage.

Here is a company that has been a successful secondary steel producer (cold rolled steel coils from primary metal) for a number of years. It chooses to embark on a massive expansion which would see it enter into mining for iron ore and coal, produce ingots of steel from such ore and further expand capacity in the manufacture of value-added steel products. In other words, it was taking an investment bet four times its size and when things began to go wrong (delays or hiccups of one kind or the other are an ever present danger to even the best conceived of projects) in the new venture, the company’s existing financials couldn’t cope with the fallout.

The second insight is this. Every business is in possession of some ‘managerial bandwidth’ at any given point of time and however much one seeks to augment it, there is always a risk of mismatch between the bandwidth that the expanded scope of the business now requires and what the management can bring to bear on the operations at any given point of time.

It is not just about how much time the managing director or the senior management can devote to attending to the challenges that a new project throws up. But the entire organisation has to equip itself with the skills needed to handle the new business environment. After all, an ability to produce and market special grade steel successfully does not automatically confer the ability to handle the challenges of extracting iron ore or reducing such ore into billets of steel. This leads automatically to the third lesson, namely, that backward integration is not always a sure shot winner as commonly assumed. A Reliance Industries could have transformed itself successfully from a business of producing synthetic yarn to going all the way back in the value chain to exploration for crude petroleum and natural gas. Even they had certain favourable regulatory-cum-policy environment which sheltered them from adverse business conditions in the initial years, which was very crucial.

But granting that a company is able to successfully impound the value available for capture from an earlier stage in the total value chain of a product, there is an additional danger. That brings us to the fourth lesson in strategy. The further one goes back in the value chain of a product, the greater the likelihood of it being a commodity business. This is not bad per se. For instance, the Saudi Arabian oil major Aramco is an extremely profitable business although it operates in the commodity business of oil.

As a general rule, the higher up the value chain one operates in, the easier it is to command a premium in the market place for the output. But it becomes a great deal harder to do so when all that company has to offer, for instance, is a basic metal, such as a steel ingot that is clearly shorn of any special attribute warranting a premium price.

The general slowdown in the global economy and more particularly, the excess capacity for steel production in China has meant that steel prices have fallen off their dizzy heights reached in 2008. The cost of capital already locked into in an investment project may enjoy no countervailing relief. A sharp downtrend in end product prices coupled with high cost of capital contracted in an era when everything was on an upswing, is a double whammy that project promoters may find it difficult to extricate their businesses from.

Quite apart from the risk of diffused managerial attention that a massive investment project entails, it gets further enhanced, at least in the Indian context, when it involves projects of mineral extraction such as coal or iron ore. That is the fifth lesson that the tortuous progress of Bhushan Steel’s clutch of new projects offers. The normal execution risks inherent in a project get further accentuated by political and regulatory factors.

While these may be eventually overcome, the adverse financial consequences of delayed commissioning may bankrupt a business sooner than a promoter’s ability to clear the regulatory hurdles.