Indian Flour Mill by Institute for Competitiveness

This case has been authored by Professor Amit Kapoor and has received the Ruth Greene Memorial Award from North American Case Research Organization. You can contact Professor Amit Kapoor at amit@amitkapoor.com

Indian Flour Mill “In 1982 when we were making our decision to invest in a flour milling enterprise we thought that India being an agriculture economy, with growing population would always have a great opportunity in food. No industry could really match its growth and profitability potential. The world over food has been one of the most profitable industries and most of global food giants that have emerged have fundamentally been wheat millers. The most profitable and largest companies in the world are also food companies like Nestle, Kraft General Food, Cargill etc.” (See Exhibit 1 for Map of India) This is what Vinod Kumar (Managing Partner) said who was in an extremely pensive mood, as the unit was not performing well and it was getting more and tougher to stay overboard. The company had come a long way since 1997 wherein it had record profits that the ownership had always expected after being in this business (Exhibit 2 and 3). However, the last few years had been very miserable in terms of performance for the company as there were huge losses and 1 capital was eroding at a very fast pace. In the financial year of 2000 – 2001 the company 2 suffered a loss of Rupees 4 million . This problem was further compounded, as there were certain changes in the environment such as the entry of giants as Hindustan Levers, Cargill etc. The industry was also suffering from overcapacities, unpredictable supply of wheat, and unpredictability of prices. With eroding capital there were certain tough decisions at hand Kumar had to take. He was not very sure as to how these forces would affect industry and the company. Kumar scheduled to meet his business partners in about two weeks time from now scheduled to make a presentation on possibly the best course of action for the firm.

Industry Background This industry can be categorized into two sectors – the organized sector comprising Roller Flour Mills involved in commercial milling operations and unorganized sector consisting of 3 mainly Chakkis . In 1950, there were 54,000 Chakkis in India producing about 5 million tones of wheat products; today the number is expected to be more than 2.8 million Chakkis producing 4 more than 35 million tones of wheat products, primarily Atta . 5

Around 800 large Flour Mills in the country convert about 10.5 Million Tons of wheat into wheat products i.e., Coarse Flour, Flour, Semolina, Bran & Wheat Germ. The installed capacity of Flour Mills is more than 21 Million Metric Tons (Exhibit 4). Roller Flour Milling sector processes around 12 – 15 per cent of the total wheat consumed in the country, the balance being processed 6 through Stone Chakkis. A major part of the flour milling industry is in the small-scale sector . Started almost a century ago the Roller Flour Filling industry is one of the oldest established industries in the country. The majority of units have an average installed capacity of 70 tons per day and only around 10 per cent of the mills are above the capacity of 120 Tons per day. The flour milling industry in India has grown to become over the years the largest organized sector for utilization of wheat in the country. The number of mills has more than doubled from 454 1

Financial year in India is from April through March US$ 1 = About Rupees 47 3 Small Flour Mills based on stone grinding technology 4 Coarse Flour 5 Capacity greater than 70 tons per day 6 Any manufacturing venture with investment of upto Rs.10 million in plant and machinery is defined as small scale venture of India. 2

Case - Indian Flour Mill

in 1985 to 812 in 1997. Added in it are another 100 units that are about to start operations. This has made the competition intense and capacity utilization to a level of 40 percent. 7

The location of the industry is not only in the wheat belt but well spread across the country (Exhibit 5). Karnataka, which is one of the farthest states from the wheat belt, houses nearly 8 per cent of the Flour Mills in the country. The largest concentration of Flour Mills in the country is in the states of Uttar Pradesh, Punjab and Haryana. The flour milling industry is highly working capital intensive. Moreover, it is a low margin â&#x20AC;&#x201C; low value addition business. The operations are in very price sensitive wherein even a slight upward movement prices attracts government intervention. The economic policy after 1991 led to a number of foreign collaborations and units to come up in this sector such as Godrej Pillsbury, Cargill, Hindustan Levers etc.

The History Flour Milling Industry has seen several policy led ups and downs. Broadly we can divide the growth of the industry into three phases: Viz. licensed regime, deregulated period and post liberalization era. Prior to 1986 the Industry was highly regulated. To start a flour-milling unit a license was required. With improvement in wheat production the industry was delicensed / deregulated. After 1986 it was possible for the millers to procure wheat directly from the market. After 1991, with the begining of the liberalization process, the Industry entered a new era wherein the competition was to be with large conglomerates including a few global companies. Situation prior to the 1986 deregulation Before 1986, entire wheat both domestic and imported supplied to the mills was only from 8 Food Corporation of India (FCI) . The millers did not have the choice over the type and quality of wheat received. The wheat given was named as Fair Average Quality (FAQ) i.e., wheat that was fit for human consumption. The price of the wheat was fixed by the FCI with little regard for quality or type of wheat. The millers were not allowed to purchase wheat in excess of the daily licensed capacity. There were restrictions on storing wheat at the mills location. The wheat Roller Milling industry was governed by special regulations under the Industries Development and Regulation Act. Reserved for the small scale sector, even wheat Roller Flour Milling units were required to obtain two licenses under this Act if they were employing 50 or more than 50 workers. Though the mills were privately owned they could not be built or operated without the prior approval and license from the Food Corporation of India. The policy of the government did not allow setting up a mill with more than 60 tons capacity per day. The Food Corporation of India dictated the location of the mill in effect as it only gave licenses for new milling capacity where it felt there was a need. The products made at the flour mill were picked up by Food Corporation of India which paid a fixed price for these products (Cost of Wheat + Milling Margin). The Food Corporation of India was solely responsible for distribution and sale of wheat flour to bakers, consumers or other end users. There was no link between the consumers and the individual millers. The quality specifications for flour were those established by the Pure Food Standards. They were quite strict with respect to sanitary and nutritional standards but quite loose with respect to end use quality. Millers could go to jail for selling flour that did not meet standards, yet it was usually impossible to do so given the poor quality of the wheat that was being supplied for

Northern part of India comprising the states of Punjab, Haryana and Uttar Pradesh The agency that exacts this levy and, in general, executes GOI food policies is the Food Corporation of India, established by Parliament in 1965 under the Food Corporation Act 1964. 8

Case - Indian Flour Mill

milling. Due to their restrictive policies the trade led had a flourishing black market for both wheat and flour. 1986: Deregulation Since 1986-87 all the restrictions on establishment of new Roller Flour Mills or expansion in the capacity of existing units were removed, including reservation of the industry to the small scale sector. No license is now required for manufacture of wheat products. There are no controls on price and distribution of wheat products. The mills are free to obtain their requirements of wheat from any source and sell to anyone. The Main effect of deregulation was that the market for domestic wheat was opened for free trade. The millers were allowed to buy wheat from the farmer or through the private grain trader. The Food Corporation of India reoriented its strategy towards food security, which made these changes possible. Food Corporation of India reduced its procurement to a level designed to cover its strategic food reserve (Buffer stock of Wheat). The government distributed subsidized food through its Public Distribution System (PDS) that targeted the low-income families rather than the rich ones. The import of wheat however, was not open. Food Corporation of India was the sole agency, which could import wheat in the shortage years and later distribute amongst the masses under the PDS. There was no change in the ownership pattern of the mills. It continued to be in the small-scale sector after deregulation. Though licensing was still required but it became a lot easier for the entrepreneur to obtain them. It became possible to have larger capacity mills i.e., beyond the 60 tons per day, the maximum capacity set prior to deregulation. The existing millers were allowed to expand their capacity and entrepreneur could decide the location of the mill. The Food Corporation of India was no longer in the flour business. The millers were free to operate as per the market dictate. For the first time in decades they had to face customer and push the demand for their products. The price of flour was decided / negotiated between the buyer and seller and hence was influenced by the demand and supply situation and as well by the quality of the product. One of the positive changes that took place after deregulation was that freedom to the millers to decide on the quality of wheat brought by him. It was no longer the question of fair average quality wheat as sold by Food Corporation of India. It became easier for the miller to control the quality of the product and meet standards of end products as stated by the Pure Food Standards. The net effect of the deregulation was manifested in terms of free market competition amongst the millers. A miller could no longer depend on the government income built into the old system. Food Corporation of India did not dictate the selling price of the product but it was decided by the prevailing demand and supply situation. The black marketing in the end products stopped, as the product was available in abundance. The most important change was the power that rested with the consumer. He could decide on the product he wanted to buy. The trade certainly moved from seller‟s market to buyer‟s market. The consumer became the key to survival. The essence of the change was that “If you could not satisfy the customer, you could go broke “. 1991: Liberalization The millers have achieved prominence from a trading community to an industrial community only in the last two decades. This industry was relatively traditional and served a small share of the nations population by mainly grinding wheat provided to it by the government. But in

Case - Indian Flour Mill

the last ten to fifteen years flour consumption and production has exploded. Along with the increase in production and consumption the country‟s domestic wheat production as also the milling capacity has increased considerably. The situation now is very different for the industry that has worked under licenses, quotas and controls. The raw material supply & prices were regulated and the quality was not the major concern as it was the supplies market. Moreover the distribution was also limited and there were limits on everything including how much raw material and finished goods stock can be stored. It was a happy scenario as the number of the firms was limited, making sure that everyone made money due to the restricted competition. The scenario today has become even more unusual with the government easing restrictions on foreign players setting up production units in India and that too without any restriction. Although the present milling capacity is estimated to be around 21.8 million tonnes, only around 11 million tones of wheat is being milled by the Roller Flour Mills. This is due to the fact that most of the mills do not operate even at 50 per cent of their rated capacities. Regulators Role in the Open Market The Government of India authorizes Food Corporation of India to offload wheat in the open market for sale to trade and industry during lean season either to work as a price stabilization effort in times of shortages or to offload surplus wheat stocks. This policy has been in vogue on more or less regular basis since industry‟s liberalization of 1986. From October 1993 it has been virtually on a continuous basis. Prior to industry‟s liberalization, the State Governments depending upon the milling expenses and extraction percentages fixed the price of wheat products. From 1986, only the price of wheat was fixed and there was no price fixation of products. Whenever the Government offered wheat for sale the same was sold by tender / auction. From November 1993, FCI started selling wheat on fixed prices from month to month or effective whenever changed. The prices fixed were on state wise basis from November 93 to October 95. From November 95, the prices were changed from state basis to 34 center basis. This was done to bring it in conformity with the open market trends in a free market competitive environment economy and to reduce the subsidy burden on the Government. Between November 1995 – March 1997, the period till, which the practice continued, the center wise pricing was made to conform to the open market price mechanism. The price at Chandigarh was Rs. 490 per quintal whereas in Trivandrum it was Rs. 790 per quintal. The policy was discontinued with effect st from 1 April 1997 and it was reverted back to the November 1993 situation. In 2000 the Government fixed the APL issue price for wheat at Rs. 900. The Government suddenly announced the lowering of Issue prices from Rs. 900 to Rs.750 and subsequently to Rs. 682 in the month of July 2000.

The Market for Products Around eighty per cent of the total Roller Flour Mill / Chakki output is consumed directly by the household sector for preparation of various types of India breads and other dishes. The balance output is consumed by the secondary and tertiary sector, which produce bakery and confectionery products (breads, biscuits and other products), pasta products (macaroni, spaghetti etc.) breakfast foods and other instant foods (See Exhibit 6 for Prices of Products at Various Locations). Maida (Flour) Bread & Biscuits manufacturers, households, Sweet makers, confectioners, protein rich food manufacturers primarily use Maida. All these customers, to make these products, require

Case - Indian Flour Mill

flour with different characteristics. While an automatic bakery plant may make bread out of poor quality flour yet the smaller baker may not be able to make good bread out of the same. Different end users need different qualities of flour produced from different varieties of wheat classified as hard and soft wheat. These varieties are available but not segregated in the 9 market. The bread manufacturer is looking for flour with high protein content , high water 10 absorption , gas production capacity of flour and gas retaining capacity of flour to make dough of uniform consistency. The biscuit manufacturer is looking for flour, which has greater extensibility but lower resistance to make biscuits. The confectioners are looking for low ash, low gluten flour to make fluffy products. Cereal based breakfast food manufacturers / protein rich food manufacturers desire to have high protein flour with lesser starch damage. The household consumer / restaurant user goes to the retailer and buys flour available on the shelf. Suji / Rawa / Cheroti (Semolina) Semolina, Suji & Rawa are all names of the same item, Suji, in general is bold Semolina where as Rawa is fine / medium Semolina. The Consumer profile is similar to that of flour i.e., industrial, for pasta manufacturing or in the quick food manufacturing units. Pasta product manufacturing units have preference for semolina of hard wheat where as the other end-users can do with semolina of any wheat. The household consumer is primarily in south where Suji is used as a regular raw material for making breakfast items like Idli, Dosa that has a large per capita consumption. The consumer in north consumes Rawa primarily on festive occasions to make sweet items, the favorite being Halwa. Whole Wheat Flour / Coarse Flour (Atta) Atta is primarily consumed in North India by all sections of society at least twice a day, if not more, to make chapattis. It primarily has a household usage and the people prefer to get the wheat floured in the Chakkis to get the consistent quality they want to have. These customers are served by a large number of milling units springing up in the country, specializing in producing whole meal Atta and not venturing into other products. Bran Bran is used as cattle feed and its consumer profile is similar to that of flour and Semolina i.e., traders who specialize in direct sales to local dairies, both big and small. The variations in bran prices are dependent on alternative sources of cattle feed availability in the region and the price.

The Wheat Market Wheat Growing Regions Wheat is grown primarily in five states of the country. These states contribute to the extent of 90 % of the total wheat grown in the country. The wheat grown in these states are taken as Fair Average Quality (FAQ) and no efforts are taken to segregate wheat according to its core characteristics. The wheat is purchased as is by the Governmental Agencies, end consumer and Flour Millers. Single largest purchaser of wheat is the Food Corporation of India which procures wheat to the extent of 15 million tons.

Gluten quantity and quality Depends on starch damage that happens during the processing of wheat

Case - Indian Flour Mill

Indian Wheat Production – Top 5 States State 5 Year* Average Production Uttar Pradesh 35% Punjab 21% Haryana 12% Madhya Pradesh 11% Rajasthan 8% * Years 1994 - 1998

Pricing of Wheat During the third five-year plan (1961-62 to 1965-66) the Government of India formulated its food policy. One of the objectives was to ensure a reasonable minimum support price that will encourage the farmer to adopt improved methods of cultivation for increasing production and to ensure that consumer prices do not rise unduly. As an outcome of this in 1965, Agricultural Price commission (APC) was setup with presumably long-term goals in view. The APC (presently Commission for Agriculture Cost and Pricing (CACP)) is an advisory body and all the decisionmaking powers rest unquestionably with the Government. The APC was entrusted with the responsibility of evolving a balanced and integrated price structure “in the perspective of the overall needs of the economy and with due regards to the interests of the producers and the consumers”. The terms of reference to the Commission refer not only to the need for price incentives for promoting agricultural growth but also to the need to ensure rational utilization of land, other production resources and to the likely effect of price policy on the rest of the economy, particularly on the cost of living, industrial cost structure etc. Support Support price may be regarded as an offer price at which the Government is willing to buy any amount of grain from the farmers in years of good harvest when, in the absence of the support operation, the market price may fall below the cost of production. A logical corollary to the concept of the “minimum support price” is that of maximum or ceiling price the rational for which lies in two factors. First, protecting from losses in years of abundance through purchase by the Government at minimum prices. Second, a maximum price would imply protection of consumer‟s interests in years of crop failure. Thus there seem to be two notions, one of price control within a certain range and the other of support to farm incomes along with some degree of protection of non-farm incomes The other issue before the Government is of achieving procurement targets to ensure sufficient food stocks. Procurement of grain becomes increasingly difficult under conditions of scarcity, local or global. It implies that procurement price has to remain close to market price at all the times. The CACP recommended in 1998 that there shouldn‟t be any increase in the price of wheat for next 3 years but the prices were increased by the central Government due to the political compulsions prevailing in the country. Minimum Support Price of Wheat Year 1991 – 92 1992 – 93 1993 – 94 1994 – 95

MSP in Rupees 225.00 275.00 330.00 350.00

Case - Indian Flour Mill

1995 – 96 1996 – 97 1997 – 98 1998 – 99 1999 – 00 2000 – 01 2001 – 02

360.00 380.00 475.00 510.00 550.00 580.00 610.00

Source: Roller Flour Millers Federation of India

Central Issue Price Food Corporation of India distributes food grains to poor under several government programs e.g. Targeted Public Distribution System (TPDS), the Jawahar Rozgar Yojna (JRY, a food for work Program), nutrition / feeding programs, schedule castes, schedule tribes and backward class hostels, below poverty line food processing units, mid – day meals program and the World Food Program projects.

Issue Price of Wheat Year

MSP (in rupees)

Issue Price * (in rupees)

1991 – 92 1992 – 93 1993 – 94 1994 – 95 1995 – 96 1996 – 97 1997 – 98 1998 – 99 1999 – 00 2000 – 01 2001 – 02

225.0 275.0 330.0 350.0 360.0 380.0 475.0 510.0 550.0 580.0 610.0

280.0 280.0 330.0 402.0 402.0 402.0 250.0 250.0 250.0 415.0 -

The APL Price for the Year 1997 – 98 was Rs.450 and for 1998 – 99 was Rs.650. Source: Compiled from Economic Surveys of 1992 to 1999.

The TPDS, which is upon the most important operation of the FCI, was launched closer to in 1997 with the intention of improving upon the operations of old PDS. It segregates Below Poverty Line (BPL) and Above Poverty Line (APL) households. The APL prices are intended to be closer to the market prices, with unrestricted access. The APL prices and the BPL prices are the same across the country and the wheat is procured by the flour mills in the non growing states through the Governmental agency at the declared price. The Sale and Distribution of Wheat FCI implements the rice and wheat price support program through its procurement operations. It also handles, stores and distributes rice and wheat for the Targeted Public Distribution System and other Government of India (GOI) food programs and stabilizes domestic food grain prices through buffer stock operations, open market sales and external trade. State Civil Supplies Departments and other State procurement and distribution agencies assist FCI in their tasks. GOI covers the difference between FCI‟s selling price (called the issue price) and its procurement price plus costs of handling, storage etc. through a central food subsidy. Whether public or private, wheat marketing follows identical parallel trading arrangements, with the private sector handling from 30 to 50 percent of the grain that is traded.

Case - Indian Flour Mill

The rest moves through the public channel – FCI and other state agencies. Purchases by private traders and FCI agents take place in “regulated” wholesale markets and other trading centers. Farmers who sell voluntarily to FCI receive pre announced uniform procurement prices i.e., the minimum support price. FCI‟s wheat is then distributed to the consumers without further processing through fair price shops and other government programs at below market prices. Most private-sector wheat is also directly sold to consumers for subsequent custom milling at neighborhood Chakkis (small scale traditional grinding units), although private flour mills take a smaller but increasing share. Once milled, flour is sold to wheat product manufacturers (e.g. Bakeries, and biscuit manufacturers) or to wholesalers for domestic distribution through retailers to consumers). Freight Equalization / Subsidy The government doesn‟t give a direct subsidy to the flourmills. To regulate the price across the country beyond the Public Distribution System (PDS) the government regulates the price of wheat through FCI and keeping a uniform sale price across the country, which translates into an in built freight subsidy for the millers. In the process flour millers in wheat belt are not able to exploit the advantage they possess being nearer to the source of principal raw material. (See Exhibit 7 for freight of Wheat from Panchkula to Various Locations) Purchase Tax and Other Procurement Expenses on Wheat Although several Government Ministries oversee the functioning of the food grain marketing system, the Ministry of Food and Consumer Affairs (MOF) has the primary responsibility for managing the food economy. It is charged with the formulation and implementation of national polices on procurement, movement, distribution and stocking of food grains, provision of storage facilities for the food grains strategic reserves and control over external trade of food grains. The MOF oversees the operations of the FCI. The Ministry of Food Processing Industries facilitates the rice and wheat milling industries, while the Department of Rural Development of the Ministry of Rural Areas and Development, works with state governments in fostering the growth and development of regulated markets system through State Agricultural Marketing Boards levying market fees, and Rural Development Fund. These levies vary from state to state. These taxes are payable once the flour miller is purchasing wheat for processing in the unit but in case a farmer wants to take the wheat out of the state he is not to pay any of these taxes and Cess to the Government. The commission to the Pucca Arthiya and Kuchha Arthiya are also decided by the stricture from the Government (Exhibit 8). Taxes on Wheat Declared by State Governments Punjab Haryana Delhi Chandigarh Purchase / Product Tax 4% 4% 0% 2% Market fee 2% 2% 1% 1% Rural Development Fund 2% 2% 0% 0% Pucca Arthiya Commission 1% 1% 1% 1% Kuchha Arthiya Commission 2.5% 2.5% 2% 2.5% Mandi Expenses 1% 1% 1% 1% Infrastructure Cess 1% 0% 0% 0% Total 13.5% 12.5% 5% 7.5%

UP 4% 2% 0% 1% 2% 1% 0% 10%

Source: Roller Flour Millers Federation of India

Substantial levels of taxes are levied on industry at the procurement stage Punjab and Haryana impose the highest levels of taxes on wheat amongst the North Indian States. The flour milling industry provides a value addition to the extent of 10 per cent on final products.

Case - Indian Flour Mill

The Changing Situation Signing of WTO It is becoming more and more clear that India cannot remain insulated from the upheavels in the world market. Having signed the General Agreement on Trade and Tariffs (GATT) and becoming the member of the World Trade Organization (WTO) India has made it clear its resolve to get integrated the world economic structure by 2003. There are certain issues that arise under the WTO regime, the most pertinant being the effect of Sanitary Provisions, Wheat Prices and Product Specifications. Prices of Indian Wheat Vs US Wheat at Mumbai Port (Prices in Rupees) Year

US Wheat

Indian Wheat

1991 – 92 1992 – 93 1993 – 94 1994 – 95 1995 – 96 1996 – 97 1997 – 98 1998 – 99 1999 – 00 2000 – 01

293 392 420 442 700 594 610 559 607 575

344 411 481 514 512 541 661 713 782 830

The Competition Being typically small scale, the flour millers in general tend to focus on branded processing and meeting the regional demand. The local players try to compete in the market through lower prices by undercutting each other. The prices are also reduced due evasion of tax by a few unethical businessmen. They rarely pay agriculture and procurement taxes. The Government of India initiated the Liberalization process to exploit resources the country has to the fullest and create wealth and move towards the status of a developed nation. Taking advantage of the liberalization policies multinationals started investing in the country through Portfolio Investments or forming joint ventures. Sensing the opportunity in this segment many large players have also entered the market including two Multinationals Viz. Hindustan Lever Limited (a subsidiary of Unilever), which has introduced „Kissan Annapoorna‟ brand of coarse flour & salt and Godrej Pillsbury with their brand of Pillsbury – Chakki Fresh Atta. The Indian companies include DCW Home Products (marketing Atta and other food products under the brand name of „Captain Cook‟) and NEPC Agro (marketing under the brand name of „Trupthi‟). Now, several other international majors and large Indian corporate are expected to follow suit. The strategy of most of the large companies is that they concentrate only on marketing only and help the producers (existing Flour Millers) to revamp their facilities and maintain quality. They have also gone up-stream to help the farmer use better seeds and adopt better farming practices. They are also focusing on development of large distribution network and relying heavily on advertisements to make their presence felt in the market. They are also ensuring off the shelf availability of products even if they have to incur some losses. (Exhibit 9)

Case - Indian Flour Mill

Changing Food Habits Two things disposable are driving changes in food consumption patterns. First, the most important, is the rise in disposable incomes and increasing internationalization and convergence of food habits. With rising incomes, what is considered good food comes to accommodate greater diversity? It is expected that in the next twenty years, the convergence in peopleâ&#x20AC;&#x;s consumption patterns is likely to be even more rapid because of their factors.. This change is predictable as it maps the change or the evolution pattern that has been evident in over twenty countries. Studies show that countries go through a distinct food consumption evolutionary pattern. In the first stage the focus is on obtaining basic dietary inputs, the second stage focuses on improving and building basic food, before moving on to the third stage of adding premium food to the diet. It can be seen that all these stages of food consumption evolution are simultaneously apparent in a nation such as India. As some upper income segments of the population move from Basic to Premium, others in lower income groups may well be moving from Subsistence to Basic. It is the Basic segment that is expected to be central with large population moving into the middleincome segment. The Retailing Revolution The growth in the packaged flour and wheat based foods / health foods would make in roads into the households. These would be driven by three factors. The first of these factors and the one that drives all the others is the rise in disposable incomes. The second factor that is expected to cause a shift towards packaged products is the increasing value many Indian households put on time. Currently over 90 per cent of the wheat consumed in India is eaten as Roti and other forms of bread. Consequenced, bread making consumes many hours a week. Consumers buy the wheat grain, sieve it to remove impurities, and then take it to be milled at the local stone mill or Chakki. This process, which was the only way of assuring a consistent quality of flour until recently, is labor intensive and time consuming. Perpetuating this system is becoming increasingly difficult in the larger towns due to changing lifestyles. These changes, typified by the increasing numbers of nuclear families with working women, ensure that time is being perceived as a scarce resource. This trend, coupled with increasing disposable incomes of such families, changing food habits combine to catalyze the demand for packaged branded wheat products. The third factor driving the growth of packaged wheat products is the increasing demand for improved quality and hygiene. The hygiene levels and quality of locally procured grain and of the local Chakkis leaves much to be desired. Both local organized players and large-scale players are beginning to educate the consumer about these issues. The Bakery Industry (Bread and Biscuit) The industry was regulated by the Government in 1977 â&#x20AC;&#x201C; 78 and was reserved for the small-scale industry sector that restricted the entry of large producers. The small and unorganized sector had shared the growth in the industry till 1997 when the sector was dereserved. In 1998 the market for bread, biscuits and cake was estimated at 3 million tons. In 1998, 80 percent of the bread and 60 percent of biscuit were manufactured in the unorganized sector. The market for bread is estimated to be growing at 7 percent per annum and that for biscuits and cakes at entry of the 10 percent per annum. The bakery products market is expected to be 6 million tons with the entry of the organized sector.

Case - Indian Flour Mill 10

The Firm The roots to the venture lie in the year of 1980, when Vinod Kumar shifted to 11 Panchkula , Haryana where eventually the unit was set up after leaving his job with the Reserve Bank of India. An expert in the area of corporate finance he set the ball rolling for setting up of the unit in middle 1979. The unit was completed in 1981 but commenced commercial production in 1982, due to the licensing problems. The unit was state of the art, using indigenous technology and having a capacity of 30 tons per day. The operations at this time were fairly simple. The firm got wheat from Food Corporation of India and was paid a milling margin for the processing it at the mill. The unit kept abreast with the changes in the environment and increased its capacity to 120 tons per day with the deregulation of the industry in 1986. With a view of reaping benefits of the market economy the management thought that the global integration of the Indian economy will present a great opportunity in terms of better purchasing power, changing lifestyles and better demand for products in the global market. The management also thought that, with the advent of open economy, the market forces would compel the farmer to segregate wheat in terms of their quality and the industry would graduate towards being more customers oriented. Keeping all these in view the unit started taking certain strategic steps which they felt would give them an edge in a competitive but a dynamic market. Differentiation The firm tried to focus its energies on differentiating their product offering. The strategy was focused towards the industrial segment wherein a certain quality of flour was guaranteed. The unit started focusing on being the best in the region for giving flour to the bakery units. This gave the unit acceptance in the bakery industry and a few majors like Britannia, Bakemanâ&#x20AC;&#x;s, Harvest Gold, Seetha Foods started buying from the unit, for the quality that it produced. In the industry where there is no segregation of wheat at the farm level in terms of quality or breed. It took a lot of effort on the part of Indian Flour Mill to find the right blend for the manufacture of their flour with a consistent the quality. The mill had a team of 6 people who were constantly in touch with the market trying to know about the quality coming into the wholesale markets (mandis) and testing it for its suitability for manufacturing the quality of flour promised. New Product Introduction With increasing awareness levels of the consumer and changing demand pattern there were introduced into the market. New products like Wheat Germ and Wheat based Breakfast Cereals had been introduced. The company in collaboration with Micronutrient Initiative of Canada started manufacturing and selling fortified Atta. With the changing attitude of the consumer the company thought it as an appropriate step to introduce Maida and Suji in consumer packs. The various products introduced were pre mixes and 3 types of Suji each catering to a specific end use namely Rava for making Upma, Suji for making Idlis and Cheroti for making Halwa. Developing Distribution Network The company understood the importance of distribution and went on to increase its reach in the market. The company had harnessed around 1500 retail outlets in the states of Punjab, Haryana and the Cities of Delhi and Chandigarh. 11

Town next to Chandigarh, the capital of the state of Haryana

Case - Indian Flour Mill 11

Capacity Expansion After its success in the financial year of 1996 â&#x20AC;&#x201C; 97 the company thought of going into the expansion of its capacity. The capacity was increased from about 120 tons per day to 185 tons per day. This was done keeping in view the booming market and acceptance of the core product Maida by the industrial user and being branded as the best manufacturer of flour in the country.

The Future The time to decide was very less hence Kumar thought of taking help from the report that was prepared by its Research Bureau (Exhibit 10) in 1998. The Bureau was later closed down due to huge losses the firm incurred. Kumar was extremely worried as to what his decision should be and how he should approach to analyze the problem as saw the sun going down on a gloomy day and maybe for the future of the firm. He was looking at the possibilities of closure of the firm, relocating the plant, enter new markets as the South Indian market or continue to lobby with the Government. He wasnâ&#x20AC;&#x;t too sure what was in store for him in the future.

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Exhibit 1 Map of India

Case - Indian Flour Mill 13

Exhibit 2 Balance Sheet of Indian Flour Mill (in Rupees) 1996*

1997*

1998*

1999*

2000*

Capital Reserves Secured Loans Unsecured Loans Current Liabilities and Provisions

709460 1085274 11841072 1923935 1531186

8968863 1085274 13335142 1505203 2579971

1787927 1085274 11557242 2578250 2215287

2262699 1085274 7141428 2605250 2017370

2496601 1085274 9424272 2977536 2071423

Total

17090928

27474453

19223981

15112021

18055105

2370505 332402 5201965 8187363 734429 264263

4892899 332402 5990389 12177693 3518291 562779

5301764 332402 7005822 5181438 792717 609836

4202634 332402 5876637 3431654 804491 464202

3973314 332402 4241304 8341504 840310 326272

17090928

27474453

19223981

15112021

18055105

Capital and Liabilities

Properties and Assets Fixed Assets Investments Inventory Receivables Deposits and Advances Cash and Bank Balance Total

The figures are for year ending March 31, 19XX

Case - Indian Flour Mill 14

Exhibit 3 Income and Expenditure Statement for Indian Flour Mill (in Rupees) 1996

1997

1998

1999

2000

112117714

226827397

102477933

87386457

92846834

Manufacturing Expenses** Administrative and Selling Interest and Bank Charges Depreciation

104281537 4320921 2170230 393880

207881294 5497317 3157992 865913

97059161 3500656 2305461 756333

81558857 2822562 2307582 640074

87215132 3129646 1738638 603711

Total Expenditure

111166568

217402516

103621611

87329075

92687127

951146

9424881

-1143678

57382

159707

Income Sales*

Expenditure

Profit / Loss for the Year

The statement is for the period of one year with year ending March 31, 19XX. The profit of loss is transferred to the balance sheet and its effect is on the Capital Account. If the figures for two years donâ&#x20AC;&#x;t match that is because partners might have invested or divested money from the firm.

* The Sales figures includes sales from other sources, which include sales of assets, packing material etc. Other Income

269574

277956

488426

888938

325386

73403026

80323051

**Manufacturing Expenses include the cost of wheat consumed during the year Raw Material Consumed

94131771

188238178

88049715

Case - Indian Flour Mill 15

Exhibit 4 Number and Capacity of Flour Mills Year

Number

Yearly Capacity (Million Tons)

1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

202 206 211 218 221 232 232 232 232 232 232 232 234 306 310 365 426 454 464 496 557 580 605 623 702 710 750 774 800 812

4.53 5.13 5.41 5.50 5.68 5.95 5.95 5.95 5.95 5.95 5.95 5.95 5.95 7.41 7.49 7.85 8.59 8.91 8.99 9.80 10.21 10.39 11.00 12.89 16.00 16.00 17.72 19.10 21.00 21.80

Source: Roller Flour Millers Federation of India

Case - Indian Flour Mill 16

Exhibit 5 Number of Roller Flour Mills in Different States State

Number of Mills

Andhra Pradesh Assam Bihar Chandigarh Delhi Goa Gujrat Haryana Himachal Pradesh Jammu and Kashmir Karnataka Kerela Madhya Pradesh Maharashtra Manipur Meghalaya Nagaland Orissa Pondicherry Punjab Rajasthan Sikkim Tamil Nadu Tripura Uttar Pradesh West Bengal

58 40 58 5 18 2 34 47 15 19 60 27 42 63 1 2 4 19 3 46 10 3 60 2 125 49

Total

812 Source: Roller Flour Millers Federation of India

Exhibit 6 Price of Wheat and Wheat Products as on May 18, 2001 at various locations

Wheat Maida Suji Atta Bran

Panchkula 650 650 660 620 500

Delhi 580 640 660 570 500

Bangalore 682 1000 1050 NA NA

The wheat price is for one quintal (100 Kgs) whereas the selling price of products is for 90 Kgs. The wheat procured contains foreign particles to the extent of 5 â&#x20AC;&#x201C; 8 percent

Case - Indian Flour Mill 17

Exhibit 7 Cost of Transporting Wheat and Wheat Products from Panchkula as on May 18, 2001 City Delhi Mumbai Calcutta Bangalore Trivandrum

Price / Cost (In Rupees) 30 120 120 230 300

Exhibit 8 Structure of Indian Wheat Trade

Located At

Farmer Farm

Kuchha Arthiya Village

Pucca Arthiya Main Mandis

Broker Towns

Role

Grow Crop

Agent

Consolidates produce of local farmers Often finances farmer and settles crop against dues

Consolidates stocks of Kuchha Arthiya

Links Pucca Arthiya Gets information from all Mandis

2.5 per cent Interest (> 36 per cent per annum)

1 per cent

Margins

1 per cent

Exhibit 9 Cargill in Milling Sector Internationally, Cargill is one of the largest processors of food grains with integrated operations. In India, Cargill had a small beginning with sunflower seeds near Bangalore. This was a part of the arrangement with ITC Agro â&#x20AC;&#x201C;Tech to whom the sunflowers were to be sold for producing oil. There were major agitations against the company due to the promised yields not coming through. In some odd cases the Indian farmers agitated against the prices of the seeds. In wheat milling sector, it started with a 300 tons per day plant at Ghaziabad, near Delhi, for processing wheat. As soon as the 300 ton per day plant was operational, the work started on another 500 ton per day plant on the same location with the single objective of feeding the Delhi market and becoming the most cost effective producer of the same. Another strategic plant was put into place to take the villages nearby under its umbrella, and start educating them about better techniques of farming as also providing them with better seeds. The objective is to simply take them into confidence so that they sell the produce back to Cargill for processing. This would help Cargill maintain a strict vigil on quality of the wheat milled in its mills and fetch a better price in the market. Internationally, Cargill operates only in the bulk institutional market and not in the retail market. The same strategy is being followed in India, and this explains its entry near the biggest flour market of India, Delhi. Simultaneously it started building up large storage silos for wheat and wheat products so that it can store enough supplies for one to two months. This coincided with the Government allowing the companies to set up their own storage spaces for the storage of food grain. Overall, more than Rs.15 crores have already been invested into the development of the mills.

Case - Indian Flour Mill 18

Exhibit 10 The Research Bureauâ&#x20AC;&#x;s Report The Food Sector in Developed Nations Successful food companies around the world are typically very large. Indeed they are often amongst the largest of companies. In stark contrast to rest of the world, Indiaâ&#x20AC;&#x;s food companies are very small despite India being a giant in food production. This is clearly reflected in the industry structure. Over 75% of food players in India are in the small scale or unorganized sector, the remaining 25%, which the government classified as the large-scale player, are again quite small by international standards. The th average size of top 20 Indian food companies is $ 125 million, i.e., 1/80 of the US Average. The largest th food companies in India have revenue of only $600 million, less than 1/30 of Cargill. The second way that the Indian food chain differs from those in more developed economies is in terms of the presence of range of different players, all of whom help drive the process of integration and reduction of inefficiencies. These players include large retailers, branded processors, commodity processors, transportation companies, co-operative, and agricultural input manufacturers. Indian food chain, by contrast, reveals that some of the classes of companies are either nascent or altogether missing. The classes that are missing or in the nascent stage of development include large scale commodity processors, large-scale retailers and seed companies. Commodity Processors are an important part of most developed food chains, these are companies that produce high volumes low value added commodity products such as wheat flour, edible oils, and processed and frozen meat products, they tend to be amongst the largest food companies in most developed nations and are rapidly emerging in less developed countries. Large commodity processors, because they handle very high volumes (e.g. Millions of tones of grains), Invest in infrastructure and system that have wide spread impact on the development of food chain. In India commodity processors are nascent. Large commodity processors dominate developed food chains. The most pertinent examples being that of Cargill and ADM in wheat milling, Con Agra in vegetables, oils and meat processing, Tyson and Gold Kist in fruit juices and Hudson in poultry processing in United States. Commodity processors are also playing an important role in less developed countries like Brazil, Thailand and Indonesia. Thailand is well known for its large poultry producing companies, Indonesia has some of the worlds largest wheat processors like Bogasari flourmills and Indofood, which in recent years have invested in ships, docks, Storage silos and automated wheat mills. In contrast, India has few large commodity processors today. In India even wheat, which in most countries is a sector that is normally dominated by large commodity processors, has only a handful of players with revenues of over $10 million.

Technology does not Impact Scale and Cost Structure Roller Flour Milling technology linking with cost structure may vary upto a minimum economic size capacity of around 80 tons per day capacity. Beyond this capacity level, the technology has very minor flow variations from plant to plant. By virtue of wheat quality parameters, from different streams, the milling industry can cater to individual end use. The upgradation of capacities has been done either by replicating the units or by expanding by adding similar machines with additional equipments in the process. The expanding capacities however did reduce the costs very marginally, if located with same premises, in terms of fixed cost contribution. The direct costs were not affected by such expansions since major contributor to direct costs was energy consumed for processing wheat products. Besides this, manual operations of loading, unloading, bagging etc. still continue and their costs do not change downwards with increasing production. The Roller Flour Milling Directory indicates that the daily capacities all across the country have been from 50 tons per day to 250 MTS per day in a single occasion. The millers also confirmed that the technology remains the same but plants sourced from different sources indicate different energy consumption. Plants sourced from the same source even though varying in size have more or less uniform energy consumption basis, hence operating costs remain the same. The plants are sourced indigenously and imported from erstwhile Soviet block countries and Europe. Increasing interest burden because of additional costs one has to bear on imported plants neutralizes the power savings achieved by sourcing it from foreign sources. The cost of erecting a same size plant through imported machinery was 8 times that of the indigenous plant.

Case - Indian Flour Mill 19

Growth Patterns in Developed Nations The growth of the industry in various developed nations have followed quite a similar path. They have moved from a highly regulated industry environment to a liberalized one, large number of players to consolidated world level players, changing ownership patterns i.e., from entrepreneurial startups to professionally managed firms and from small players to integrated food companies. The US Wheat Industry. The industry in US moved from a highly fragmented to one which is highly consolidated and profitable. There were distinct phases in the growth of the industry wherein it has gone on to become the most efficient setups in the world. The wheat value chain is a benchmark for efficiency in the grain processing industry around the world. The Industry has grown to have players who have become conglomerates. There was also the buildup of integrated food firms i.e., firms that operate along the complete value chain i.e., agricultural inputs, agricultural production, procurement and processing. The industry went through a cyclical process of growth that saw the firms following a similar pattern and emerging as large players. The pattern followed by the industry was movement from fragmented, to growing and a mature industry. The strategies followed by the firms were well timed and consisted of efforts to consolidate by mergers and takeovers, integrating along the value chains, entering global markets and building infrastructure to reduce wastage levels. An interesting point comes out that in USA there has been a significant change in the demand pattern. This had been led by the changing consumption patterns of the consumers. There has been an explosion in the demand of pasta in some ethnic communities and now the demand is rising for Tortillas Mexican Chapattis and variety breads is rising. The Canadian Wheat Industry. The industry attracted a lot of attention and in a short period of time and it started suffering from Chronic over capacities. This made the competition intense and was primarily dominated by the strategy of undercutting prices and hence suffering huge losses, which accounted to the closure of a number of mills due to sickness. There was a major shakeout in the industry as there were large-scale takeovers, which transformed the companies from single unit enterprises to multi unit enterprises with units situated at various locations in the country. There was a major shift in the kind of people who managed the flourmills, the management drifted from entrepreneurs to professional managers. In the past the flour millers were having a short-term perspective, till the time there were entrepreneurs who became the major players in the industry. With the advent of conglomerates taking over the businesses it became more of long-term orientation in planning. The industry is in the mature stage of the life cycle and the competition between the players is on gaining the market share. The Australian Wheat Industry. The Australian Milling Industry has grown like in any other developed nation. There were 137 units in 1956, which have come down to 37 in 1998. The Average milling capacity has also increased from 2.5 tons flour per hour to 8 tons of flour per hour. The consolidation over a period of over 40 years has helped in reducing the spare capacity and increasing the efficiencies in the flour milling industry. Today 100 per cent of the flour mills in Australia are privately owned and 90 per cent of the trade is controlled by 3 companies. The 37 flour mills in the country extract 1.8 million tons of flour per year over the grinding of 2.35 million tons of wheat per year. The average mill size in Australia is 750 tons per day that is very close the world average of 850 tons per day. Another feature of the Australian Industry is that there is a clear-cut segmentation of the market. The flour is consumed in distinct categories which can be divided into segments as to be used for Bread, Gluten, Pastry Cookies, Biscuits, Domestic and Premixes, Food Manufacturers and Pasta. A distinctive but similar pattern emerges in the Australian industry that it went from large number of players to a market controlled by 3 players and emergence of niche segments which cater to different demands of consumer and this has been made possible through a well managed infrastructure.

Case - Indian Flour Mill 20

Performance Analysis of Flour Mills in Various Indian Locations 1992

1993

1994

1995

1996

1997

Indian Flour Mill Cost of Wheat at Mill Milling Costs of wheat Financial Costs Revenue Realized by Miller

287.78 30.82 10.51 324.33

321.45 44.26 12.00 384.69

358.89 49.09 9.68 415.25

386.48 51.09 11.40 453.00

410.80 48.87 10.84 471.50

425.74 51.54 9.53 492.29

Ahmedabad Flour Mill Cost of Wheat at Mill Milling Costs of wheat Financial Costs Revenue Realized by Miller

285.69 27.31 10.57 329.37

340.21 29.5 10.2 393.78

388.02 28.63 10.19 451.28

413.88 38.1 6.48 471.51

437.63 38.76 5.68 488.21

437.14 35.95 5.28 488.21

Bangalore Flour Mill Cost of Wheat at Mill Milling Costs of wheat Financial Costs Revenue Realized by Miller

331.65 23.85 8.46 377.97

416.76 22.47 6.03 455.12

457.71 27.24 8.94 514.45

466.94 30.55 9.19 520.32

466.83 41.1 9.8 591.79

553.03 50.26 6.23 583.74

Calcutta Flour Mill Cost of Wheat at Mill Milling Costs of wheat Financial Costs Revenue Realized by Miller

297.41 34.16 2.09 336.9

396.54 49.64 3.01 461.18

412.18 32.05 2.01 455.95

442.66 35.15 1.93 482.12

460.62 36.49 3.49 505.55

499.44 36.31 2.77 541.44

The figures are for year ending March 31, 19XX. All calculations are in Rupees and for One Quintal (100 Kgs) of Wheat

The production pattern generally followed by the mills is 60 % Flour, 20 – 22 % Coarse Flour and 18 – 20 percent Bran. The production of Semolina can be upto the extent of 18 % but the demand is fairly regional or cyclical. The nature of demand is cyclical in North and peaks up during the festival season that is during the months of October and November whereas the demand for Semolina in South is fairly regular as it forms a part of their daily diet. Wheat Germ is a miniscule part of the production about 4 – 5 Kgs per ton of wheat milled and is sold at a premium and is generally used by the pharmaceutical companies or as breakfast food in North India. Flour fetches the best price after Germ, Atta is sold at the price that is very near to the prevailing price of wheat and Bran is generally the lowest in price.

Case - Indian Flour Mill 21