Hero Plans to cut unput cost by 5% every year till 2015

In a move that could help save it a targeted Rs. 700 crore in the current fiscal year and more thereafter, India’s largest two-wheeler maker, Hero MotoCorp Ltd, has asked vendors to submit a report suggesting ways to reduce input costs. The move to pare these costs by up to 5% every year for the next three years is expected to increase the Ebitda (earnings before interest, taxes, depreciation and amortization) margins by four percentage points in the next three years. The circular on reducing the cost structure has been issued to Hero’s vendors by Neeraj Mathur, vice-president (strategic sourcing and supply chain management), and B.S. Jolly, general manager (vendor development), on 27 February, with the subject line “Sourcing strategy”. Mint has reviewed the circular. A January Motilal Oswal Securities Ltd report had cited the management as saying it wanted to pare as much as Rs. 1,000 per motorcycle, translating into a saving of about Rs. 700 crore in the current fiscal, which is slightly above the net profit posted in the third quarter of the last fiscal year. Hero will announce earnings for the fourth quarter and full fiscal in May. The company sold 6.2 million units last year, 15% more than the previous year. It is increasing capacity at existing factories to seven million units this fiscal year from 6.4 million, apart from which it’s expected to set up one more plant this year. The savings are expected to rise subsequently as Hero’s volumes are seen expanding in line with the 14% compounded annual growth rate projected till 2015 for the two-wheeler industry by Society of Indian Automobile Manufacturers lobby group. As part of seeking to prune costs in the wake of its break with long-standing partner Honda Motor Co., Hero is also looking to nurture a fresh set of vendors, while also seeking to reduce the number of component suppliers so that parts costs can be brought down. Mint’s Amrit Raj says Hero Motocorp has asked its vendors to submit a report suggesting ways to cut input costs, in a move that analysts say can save almost Rs. 700 cr for the company in the current fiscal “The company has initiated a vendor-rationalization programme. It is in the process of shifting away from Honda-approved vendors,” Jinesh Gandhi and Manasi Verma wrote in the Motilal Oswal report cited above. “However, its first priority would be the quality of the vendors. It will not change the vendors on the cost of quality. The rationalization process will help the company save at least Rs. 1,000 per unit over the next two-three years,” the report said. Under the arrangement with Honda in its erstwhile joint venture, Hero Honda Motors Ltd, Hero had to get the approval of the Japanese firm before appointing a new vendor. In December 2010, the Hero Group and Honda agreed to end their 26-year-old relationship, with the Indian promoters buying the Japanese firm’s 26% stake for Rs. 3,841.83 crore. The vendor strategy is expected to bring Hero’s profitability closer to rival Bajaj Auto Ltd’s, which boasts the maximum Ebitda margins of 20% in the Indian two-wheeler business. “This process will increase its Ebitda margins to above 15% over the next three years,” added the Motilal Oswal analysts. According to analysts’ estimates, Bajaj’s Ebitda margin is estimated at 20.5% for 2011-12, while that of Hero is seen at 15.6%. After adjusting for the quarterly royalty payment of Rs. 220 crore to Honda, Hero’s Ebitda will be 12.3%. The company asked vendors in the February circular to increase capacity. Hero aims to sell in excess of 10 million units a year and achieve $10 billion in annual sales in the five-six years, managing director and CEO Pawan Munjal had said in August. A component manufacturer confirmed the company’s move to increase capacity and rationalize its costs. “We received a circular from the company in March, which asks us to do value analysis or value engineering of our cost structure,” said a Hero vendor who supplies oil pumps to the firm. “In the circular, the company talks about its expansion plans by setting up new plants and promises full support in terms of setting up a vendor base around the plants.” Value analysis is a process that identifies and selects the best-value alternatives for designs, materials, processes and systems. The process seeks to determine whether the cost of any item can be reduced or eliminated without having any impact on quality, effectiveness and customer satisfaction. Hero’s expenditure on raw materials grew 16% to Rs. 4,453 crore in the third quarter of the last fiscal year from a year ago. A 5% reduction in input costs would result in savings of Rs. 223 crore every quarter. To be sure, vendors are not very optimistic that the move will lead to the kind of savings the company has envisaged. “The way raw material prices are going up, it seems a daunting task for us,” said the component supplier cited above, who declined to be identified. “Besides, there has been a demand for wage revision in almost all the companies. That has made the situation even worse.” Hero’s move may not yield the kind of return that it’s looking for, given the current business environment, said Mahantesh Sabarad, senior vice-president (equity and research) at Fortune Equity Brokers (India) Ltd. “Their intent is right, but the target looks ambitious,” he said. “The company needs to understand that the amount of money that may be accrued via value engineering could get offset by increasing raw material prices.” Two detailed questionnaires emailed to Hero on 27 March and 18 April did not elicit any response.