Accidents are cheap and safety expensive

There was a blast in the Tarapur unit of Aarti Drugs Limited at the Tarapur MIDC yesterday. Five young people lost their lives. It seems these young people were screaming with pain for 2 - 3 hours before giving up the struggle.

http://timesofindia.indiatimes.com/city/mumbai/5-dead-as-reactor-blast-brings-building-down/articleshow/19137728.cms

This is not the first incident of an accident at Aarti Drugs Limited. As recent as October 2012 a major boiler blast in the Dombivali unit of Aarti Industries had led to three people being hospitalised and more than 125 others treated for vomiting, burning eyes and breathing problems. Coming back to Tarapur, this is just one of the many incidents which have been reported from Tarapur MIDC. In December 2012 a reactor blast in Sunrise Process Equipment had led to injury of four people. In September 2011 a hydrogen sulphide gas leakage at the Sequent Scientific plant at Tarapur had caused death of 4 employees.

Tarapur is not a town secluded from the mainstream. It is less than 100 kms away from Mumbai and has the Atomic Power station. The industrial town also boasts of organisations like Tarapur Management Association (TMA) and Tarapur Industries Manufacturers' Association (TIMA). Such frequent accidents do not show these organisations, factory owners and professionals working in Tarapur in a positive light. 


Why is it that the accident rate is so high in the Tarapur MIDC and also a few select companies like Aarti Industries? The only possible reason is that it is cheaper to manage accidents and more expensive to prevent them.

The low probability factor

Human minds are known to ignore all risks that have a very low probability of occurrence. That is why people avoid wearing helmets and seat belts. Even though the impact of a traffic accident is high, possibly death, the extremely low probability makes the human mind think - it can't happen to me. This is precisely why these firms, their owners and the senior professionals have a lax attitude towards accidents.

What they fail to understand is that a series of low risk situations would lead to a high risk probability. For example, assume that one process has a probability of failure as 1%. If five such processes are kept in a series, the cumulative probability of failure would be higher than 60%. This is a very simple probability calculation and I do not think that the firm owners are oblivious of this fact.

Accident prevention is a mindset. It starts with not tolerating even the slightest deviation from the operating norms. Equipments have to be maintained as per some fixed processes. Piping and valves have to be changed routinely. People working in the plants have to be trained continuously for safety procedures. But, all these activities are very expensive. It is probably easier to 'manage' a boiler inspector rather than shut the firm and have a honest boiler inspection. Same could be the case with pollution inspectors who are generally 'considerate'. As it is, it very rare for a business owner to get jailed for such acts of wilful murder.

Is it Tarapur and Aarti alone?
Of course not. The lax attitude towards industrial safety seems universal in India. A major automobile OEM has different safety standards for its own and contract employees. It is rare to see a worker on scaffolding in industries and around new constructions wearing safety belts. There are many offices in Mumbai where adequate fire protection  measures are avoided and extinguishers even when present are past the due date.

May be, the government authorities who are responsible to monitor and the business owners who are responsible to provide have both enough incentives to not do their jobs. At such times it is the professionals and professional organisations (like TMA and TIMA) who are responsible towards highlighting lax procedures and forcing firms to implement safety procedures. Businesses surely have to run to create profits and every action of businesses would be directed towards creating higher returns. However, human life should be above all such calculations. It might be okay to work around excise, transport and all such officials. But, anything that could even have the smallest probability of impact on human life must be non negotiable. 

Disclaimer
There of course will be some exceptions. I am sure that some plants in Tarapur and such industrial clusters have a very elaborate safety mechanism. But at the same time, there would possibly be a large number who would consider safety as an unnecessary burden. The article is directed towards these firms.

I do not have data of accident rates at other locations and I consider even a single occurance of such accidents as an untoleratable act.

Question of Scale in Indian retail

An issue very close to my heart has brought me back to blogging. It also gives me an opportunity to say - "I had told you this". It was the news in the Economic Times dated 19th March, regarding Office Depot and Staples putting a halt to their India plans.

http://economictimes.indiatimes.com/news/news-by-industry/services/retail/office-depot-staples-concede-fight-to-kiranas-pack-up-retail-plans/articleshow/19055125.cms

 It is very clear that the large format retailers have a significant overhead and would need a huge scale to be able to sustain their business model. The MD's salary for Shoppers Stop is around 0.15% of the total revenue. For Walmart, this percent is 0.000045%. Well there are lots of difference between WalMart and Shoppers Stop, but the differences in the proportion mentioned above are too large to be ignored. (WalMart does not reveal the salary expenses and based on newspaper reports the remuneration for Mike Duke has been assumed to be 20 million USD). To put this into perspective roughly one third the gross margins (not profits) of one Shoppers Stop store are expnesed in paying the MD's remuneration. With only 53 stores this is way too much money spent on one person. (The expenses of Shoppers Stop considered for Gross Margin inclde the COGS and the employee costs)


According to a report, 90% of Americans have a WalMart within 15 minutes of their house. It is only with this huge scale and the superlative use of technology that WalMart makes the money that it does. For a population around 2 million, Dubai has six super stores of Carrefour. Thus there is one Carrefour for every three hundred thirty three thousand (333,000) people. Mumbai metropolitan area which is about the same size as Dubai and a population of around 20 million has six Big Bazaar stores. This makes it around one Big Bazaar store for 3.3million people.

Again, it is debatable if Mumbai and Dubai can be compared. The idea here is to indicate the stark difference and the lack of scale among Indian retailers. Overheads like salaries, IT expenses, etc are not very linear to the scale of Operations. Shoppers Stop is not even 0.1% of the size of Walmart in terms of revenue, but the compensation to the Shoppers Stop MD is around 3% of the WalMart CEO compensation.

Unless these large retailers in India plan for scale, it will be impossible for them to sustain. They have to have planned growth that has a significant multiplier effect to the number of stores. Shoppers Stop has managed 53 stores in 20 years, and in ten years Big Bazaar has managed 214 stores. That they still have such a small footprint does not seem right. Walmart has 3000 stores in the US. Even Toys "R" Us has around 875 stores in the US. Tesco has 471 super stores in UK which is 80% of the size of Maharashtra. In all formats combined Tesco has almost 3000 stores in the UK. France, which is just around twice the size of Maharashtra has 1200 super and hyper markets of Carrefour. Across formats the number of stores is more than 5500. An Asian country like Taiwan, which is around 12% of the size of Maharashtra has 70 Carrefour stores.

It is clear here that scale is an essential component for survival in organised retail. And, this scale is more about the stores in the same retail format than across formats Given this common knowledge the behaviour of Indian retailers is surprising. McDonald's India has managed to create around 250 restaurants in 15 years and now they plan to double the number in West and South India in the next two years.The message here is that it is okay to have a lower number of outlets now, but without a significant increase in capacity the survival of the organised retail market in India is questionable. 

Is it really the Kirana?

Foreign FDI has been blocked in multi brand retail on the pretext of protecting the small kirana (mom and pop) stores. Sometimes I wonder if this is the real reason. I strongly believe that the restriction is actually to help the large Indian organised retailers. They are the ones to be first affected by the direct entry of Wal-Marts and Tescos of the world in retailing.

The typical design of the large foreign retailers is that they have a very strong but investment intensive back end. In order to get good returns from their investments, the stores have to be necessarily large formats. In addition, in one given market there have to be a high number of stores.

The high lease rates in urban areas of India make it impossible for retailers to have many large stores inside the city. The Wal-Mart model of having the store outside the city would be difficult given the traffic and road infrastructure bottlenecks. In rural areas the scale of operations is generally very low. Indians typically do not have a spend oriented culture like the Americans. So, it would be difficult for a retailer to set up and sustain a large store in a Tier 3 city.

The kirana stores in India have created a very low cost selling model. A pan shop could sustain itself at a monthly profit of around Rs. 5000 only. This number could be much lower in rural areas. This was not the case in the USA. These players can never be threatened by the foreign retailers. The existing so called organised retailers in India would probably have the most to lose.

Indian organised retailers are still in an experimentation mode. They hastily set up the front end and are now trying to make the back end work. Most have poor systems. Some companies have closed down and most of the rest are not making money. They have tried to copy the IT systems in foreign retail as this can be easily bought. But, the human systems and discipline needed are sadly missing.

By getting the government of India to form rules banning the foreign retailers, the organised players seem to be creating space for themselves. Foreign companies wanting to enter India would be forced to tie with the existing Indian players. It clearly seems that the rule has been created in the first place to benefit these large Indian retail players.

Now suddenly there is a talk about relaxing the rule. Nothing has changed for the small kirana owner. But all the large format foreign retailers have already been subdued to partnerships with large Indian firms – this includes Wal-Mart, Tesco, Woolworths, etc. Having done this, and needing more investments, it seems that the large Indian players are now getting the government to allow more direct investment in multi brand retail.

of Margins, Profits and Collaboration

A manufacturer needs a retail store to sell its products. And, a retail store needs a good agile manufacturer. While this is common knowledge, supply chain practice tends to suggest otherwise. Look at this article in Economic Times:

http://lite.epaper.timesofindia.com/mobile.aspx?article=yes&pageid=1&sectid=edid=&edlabel=ETD&mydateHid=11-03-2011&pubname=Economic+Times+-+Delhi&edname=&articleid=Ar00100&publabel=ET

The Electronic retailers want the manufacturers to raise the margins by 4% from the current 8 -10%. The manufacturers say that the organised retailers give them a lower throughput than the smaller mom and pop stores and hence they can't increase the margins for modern trade.

Gross margin is defined as the buying cost subtracted from the selling price. For all practical purpose, this number is very different from profits. A high margin product can be a net loss product and a super low margin product can be a profitable item.

There is the issue of overheads here. Traders who work on volume products on low margins strive to keep overheads low. This way they can ensure good profits even with gross margins of around 2 - 5% only. For some MNCs on the other hand, profits are not even 10% of the gross margins. MNCs have an expensive bureaucracy to support and pay salaries to. Point that I am trying to make is that increasing margins is not the only way to make more profits.

A vendor who is unreliable would need lot of followups. This follow up is done by a buyer, and this buyer gets her salary from the buying organisation. So, a low cost vendor might actually be a loss making proposition. A bad quality product or a wrong shipment can surely be returned to a vendor. The vendor may also give a 100% credit note against the returns. But, the time lost in creating this return journey is a cost to the buyer. Similarly, a customer who demands frequent deliveries or who keeps changing order commitments is surely more expensive than a customer who lifts material in higher quantity, has lesser frequency of replenishment and also who give stable orders.

Instead of haggling on margins, the electronic manufacturers and the retailers could sit together and analyse these very cost drivers. In a truly modern sense, the modern trade must give up the aggressive postures and come to the negotiating table. Together with the manufacturers, maybe they could work out arrangements of last mile delivery to the consumers homes or offer special after sales service deals.

Same for manufacturing companies. An electronics company has significantly greater efforts in selling to smaller stores than large format chain retailers. Pan country buying decisions are probably made from one office for large format retailers. For smaller mom and pop stores, every small store would need a sales executive from the manufacturing firm visiting every week. The savings in sales effort costs would easily more than make up for the lower throughout in the organised retail.

The key would be for one party to demonstrate maturity and initiate the process. This is not a zero sum game where one firm has to lose for the other to win. There are numerous cost drivers besides the basic price. There can be a truly win win solution here. It is not a fight of the retailer versus the manufacturer. It is actually a relay race where both players have to work together to capture and satisfy the end customer.

Not all customers are equal. Some customers are extremely expensive to serve. Profit for a company is not the direct price of the product minus the cost. There are many overhead expenses. And these overhead expenses are not shared uniformly over every customer.

For a trucking firm, a customer with uniform orders is less expensive to serve than one with sporadic requirements. Few large orders are easier to pick and dispatch rather than many small orders. For an automobile dealership, a flexible customer who buys the vehicle available in the showroom is more profitable than a customer who takes a long time to decide or one who needs a specific configuration.

In spite of this knowledge in most cases we generally charge the same price to all customers. The differential supply chain cost is rarely considered. While in cases there may be some differential in the price, it is rarely calculated from the cost of actually serving a customer. Marketing segments customers according to channels, need of service, etc. Costing segregates costs of every resource and every product. No function looks at cost of serving customers and then creating differential pricing.

Meru cabs is a provider for taxi services in Mumbai, Delhi and a few other Indian cities. Customers who book cabs by using a call centre are billed a convenience charge of Rs. 50 extra. Customers who book online are spared of this cost. The Rs. 50 is clearly an approximate cost for the additional services the customer uses.

Every business needs to think about this idea. By creating differential pricing, businesses can actually direct customers towards specific services. If a customer knows that by placing orders in a certain manner he may get a better rate, the customer might change her behaviour.

With a uniform pricing policy, good customers may feel cheated. In spite of being low cost customers they pay as much as other customers. There is a definite danger of such customers changing vendors. In the end, the business will be saddled with high proportion of high cost customers.

Differential pricing can be created on the basis of various basis. It can be the number of orders, quantity per order, consistency of business, number of delivery locations, number of product variants asked for, etc. Every business will have its own dynamics and the pricing has to be configured accordingly. The aim is to reward good customers and also to motivate other customers to migrate to better relationship pattern. Of course, the ultimate aim is to make doing business easier and more profitable.

measure outcomes or the means?

Reading an article on the HBR site triggered many nascent thoughts. The article argues that some CEO decisions are based on the fact that their compensation is solely linked to the share price of the firm. You can view the article here- http://hbr.org/2010/06/column-you-are-what-you-measure/ar/1

Share price is the outcome of the current and the expected future performance of a firm. This, also only in an ideal situation where there is no price manipulation. The current and the future expected performance comes from a series of decisions. The decisions could be about sources of funds, types of markets, manufacturing facilities, etc. So, the share price is essentially an outcome of a series of decisions.

About 50 years back process control ideas rocked the manufacturing industry. Instead of accepting or rejecting a product at the end of manufacturing cycle, effort was focused on ensuring the right set up, right tools, right trained operators, etc. to ensure a correct product. Process control advocated strengthening the process to ensure good products. The focus of measurements were process parameters and not end product features.

Till the product reaches the end of the line, it is subjected to significant additional work. In this sense, the finished product is more expensive than the raw material. When significant amount of finished products are found to be defective it causes high rework cost. In some cases managers dilute the quality guidelines to ensure the product is accepted. In still some other cases, sometimes, managers cheat to show that the products are as per norm. This is because with the end of pipe measurement, the cost and stake of having a rejected product is just too high.

This is what precisely happens in one number outcome based measurements. CEOs would do almost anything to ensure that this number stays up. Such measurements are the root of many corporate scams. The process shifts from ensuring good processes to ensuring good results. Just like in a shop floor, good results can rarely come from weak processes.

The people to blame in most such cases are those who set and reward on the basis of such measures. It is definitely easy to use the stock price for CEO incentive, but it is definitely not a good measure. For one, it is merely a measure of outcome and not about the method or process strength in the organisation. Two, the stock price is a lagging indicator. The price goes down after the performance is reported as poor. In some cases it could be too late to affect an improvement. Three, it is not very difficult to manipulate stock price movement over a short term without a change or performance. This incentives short term behaviour among executives who might want to cash in and move out.

This idea is not limited to CEO measurement alone. It can easily be expanded to measure every professional in every area. The key is to measure the means of doing work. Good outcome is a function of good means and vice versa is not necessarily true.

Is being Green a luxury?

The CEO of a logistics group related to a major retailing company thundered that "green" was not something they could afford. Right now they want to set the supply chain right and think of being green at a later stage. He further added that being green was a branding exercise which his company did not need at this stage.

The young CEO created two divisions - right supply chain and green supply chain and his speech clearly indicated that these were different. I guess the CEO is not alone in having these views. To a good extent we academicians and a few consultants are responsible for propagating green as a mechanism of adding an extra cost to be more environment friendly.

http://www.sustainable-supplychain.com/Sustainability_is_Free___The_Case_for_Sustaina.pdf

The article above cites the example of quality movement. Earlier, the basic idea of 'cost' of quality was prevalent. Quality was something that would be checked for after the product was made. It was about inspection and segregating good and bad products. Today, the term is 'cost of poor quality'. Quality is built in at every stage and includes product design, maintenance, and every function in the organisation. The major change was to have quality in every process to have a good quality product.

Has this increased the 'cost' for firms? In certain areas, may be yes. But overall, the yields have gone up, the rejections reduced and the customers more satisfied. This shift was not overnight and it happened over a long span of time. Some companies are in fact discovering this fact in the last few years only.

It is same with green and sustainability issues. Today, being green means installing a good effluent treatment plant or using expensive technology to emit less carbon. This is very similar to the end of the pipe quality concept followed earlier. With time, I am sure the young CEO and his brethren will realise the difference. Every individual has to work in a way to avoid wastage and every process has to be green. Its just a matter of time for sustainability to be a compulsion to do business.