Evaluate the financial implications of the two options.(sales volumes or increase gross margins.) [1 page]

JMDOilsDecidingonaGrowthStrategy.pdf

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JMD OILS: DECIDING ON A GROWTH STRATEGY Sakhhi Chhabra and Jaydeep Mukherjee wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2015, Management Development Institute Gurgaon and Richard Ivey School of Business Foundation Version: 2015-08-07

Naresh Dhingra, the director of JMD Oils Pvt. Ltd. (JMD Oils), was considering the strategic options to drive the company to the next level of sales and profitability. In the last three years, the business had delivered a top-line compound annual growth rate (CAGR) of 17 per cent and a bottom-line CAGR of 12 per cent (see Exhibit 1). While the growth figures looked impressive, they were mostly due to price increases and natural growth in the demand for edible oils in India. JMD Oils was part of a large family-owned business. It enjoyed cost advantages in production and supply chains for the markets it served. The company did not have a presence in the markets of southern and eastern India, which accounted for 22 per cent and 24 per cent, respectively, of national demand. JMD Oils had three soybean oil brands, but they were not well known brands. To increase the profits of JMD Oils, Dhingra could increase sales volumes or increase gross margins. An increase in sales volumes could be achieved by increasing the geographical footprint, which required setting up additional factories. Increasing the margins required a shift from a dealer-push strategy to a consumer-pull strategy, which could be achieved by brand building. The resources of the company were limited, yet Dhingra was confident of raising the necessary capital through an initial public offering (IPO). To initiate the IPO, he needed to present his plan for investors to evaluate. The business risks and implementation issues related to these two choices were very different, making the decision complicated. Implementation would require considerable hard work. He had to take the best option to make JMD Oils operationally viable and strategically efficient. COMPANY BACKGROUND The JMD Group was founded in 1987 by J.R. Dhingra. His four sons, Krishan, Gulshan, Naresh and Sanjay, worked closely under his supervision after the inception of the business. Initially, the group was an edible oil retailer, then graduated to a distributor, and eventually started marketing its own products in 2000 (sourced through contract manufacturing). After the demise of J.R. Dhingra in 2001, the brothers started acquiring manufacturing facilities. Initially, they acquired loss-making Kwality Dairy, with its manufacturing facilities for milk-based products. In 2004, the group ventured into the production and D

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Page 2 9B15M055 marketing of packaged water and aerated drinks with its H2GO brand. In 2005, it set up an 800-tonnes- per-day refining factory using German technology and machinery. It was located near the port of Kandla in western India. By 2014, the refinery had been augmented to have a capacity of 1,250 tonnes per day with facilities for in-house power generation and the manufacture of packing materials, as well as a fleet of 40 tankers for the transportation of oils. By January 2014, the JMD Group consisted of JMD Oils Pvt. Ltd., Super Veg. Oils Pvt. Ltd., JMD Beverage Pvt. Ltd., JMD Proteins Pvt. Ltd. and Delhi Super Roadways. The group was managed by the brothers jointly, with specific responsibilities delegated to each (see Exhibit 2). The client base for JMD Oils included institutional consumers such as large restaurants, confectionary manufacturers, five-star hotels, hospitals and modern trade organizations like Big Bazaar and Reliance Fresh. The group also catered to more than 150 million retail consumers through a network of 325,000 retail outlets and 3,000 distributors who were served from its 22 depots (see Exhibit 3). It also operated through trade associates. EDIBLE OIL MARKET IN INDIA India’s consumption of edible oil had grown at a CAGR of 4.6 per cent from 11.6 million metric tonnes in 2003–04 to around 17.44 million metric tonnes in 2012–13. It was projected to reach 23.1 million metric tonnes by 2019–20. The growth in consumption was expected to continue unabated due to a rising population and an increase in disposable income among the growing middle class of India. However, the production had shown a decline of 0.6 per cent during the nine-year period from 2003–04 to 2012–13. India was a major importer of edible oil in the world (see Exhibit 4). The pricing in the edible oil market was volatile. It was governed by supply- and demand-side factors like commodity market fluctuations, production estimates, differences in regional consumption patterns, and variations in consumption due to seasonality. Expenditure on edible oil constituted a significant portion of a household’s budget. Palm was the cheapest; it was widely used for commercial purposes and by people who could not afford higher-priced groundnut, cotton, soybean and mustard oils. Indians were prone to coronary heart disease, hypertension and related ailments due to their tradition of using high-cholesterol edible oils for frying. Increased health consciousness drove the consumption of mustard and soybean oils, which were considered healthier than palm oil. Although the consumption of other oils such as rice bran oil and olive oil was insignificant in absolute terms, they were gaining popularity due to their superior health properties. In comparison to the per capita refined oil consumption of 23 kilograms in developed countries, India’s consumption was 14.3 kilograms per annum. Consumption of branded edible oils was at about 31 per cent in urban households and about 9 per cent in rural households, with the national average being 16 per cent. Keeping all factors in mind, such as rising wealth levels, the low diffusion of branded oils and the quality consciousness of Indian consumers, it could be predicted that there would be significant growth potential in the branded oil segment.1 The main drivers for growth in branded oils were India’s urbanization, nuclear family structures, changing food habits, economic growth and emerging middle class. See Exhibit 5 for different consumer

1 Solvent Extractors’ Association, Overview of Indian Oil Sector, www.seaofindia.com/publcations, accessed October 5, 2014. D

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Page 3 9B15M055 segments in India and Exhibit 6 for projections of the number of households in each segment. The sales of packaged palm, sunflower and soya oils were 17.5 per cent, 70 per cent and 55 per cent, respectively for 2013-14. Most packaged oils were blended with different oils to improve their health and cooking properties or reduce prices. Given the cost and taste preferences of consumers, experts expected palm, soya and mustard oils to dominate the Indian consumption mix (see Exhibit 7). COMPETITION IN SOYBEAN OILS The Indian soybean oil industry was fragmented, with the presence of a large number of players in the organized and unorganized sectors. The organized sector was dominated by brands from large companies with all-India production and distribution footprints like Adani Wilmar Limited, Cargill Foods India, Ruchi Soya and Marico. These companies had diversified product portfolios and multiple manufacturing units, and operated on a pan-India basis. See Exhibit 8 for the soybean oil portfolios of some important national players. The industry also had strong regional players striving to establish their brands. These big regional players were more susceptible to risks, but at the same time enjoyed certain rewards by virtue of their scale. They could withstand margin pressures, commodity price volatility and foreign exchange fluctuations, as they had cheaper access to working capital credit as well as savings in the cost of production. CONSUMER BEHAVIOUR IN SOYBEAN OILS Edible oils accounted for one of the highest monthly cooking-related expenditures for a typical Indian household. The average consumption of a middle-class family comprising three to four members was estimated at four to six litres per month. Consumers were price-sensitive and exhibited low brand loyalty. Taste, quality, health and value for money were the main criteria of brand choice. The target market for soybean oils was urban consumers, specifically 25 to 44-year-old married women, who were educated and concerned about their family’s well-being. Homemakers who read the information given on product labels were the key decision-makers for the family’s food choices. Recommendations made by the retailers had limited appeal to these individuals. In many semi-urban areas, men did the shopping based on the shopping list made by the lady of the house. The aspiring middle class dominated the market opportunities, but their purchasing power was substantially lower in comparison to higher-income groups. This segment mainly consumed soybean oil at the price point of ₹70 to ₹80 per litre.2 Research confirmed that consumers preferred edible oil that did not produce smoke even after being super-heated. Spent oil should retain its colour and flavour for subsequent use. Cooked food should be good even when consumed at a later time. Fried food such as pooris3 should remain soft and fresh for a long time and should retain its essence after being fried.

2 All figures shown are in INR (₹) unless stated otherwise; US$1 = ₹62 as of January 5, 2014. 3 Poori is unleavened deep-fried Indian bread that is commonly consumed for breakfast or as a snack and is usually served with curry. D

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Page 4 9B15M055 THE VALUE CHAIN OF JMD OILS Supply Chain Soybean oil in its crude form was the second-most traded oil in international markets after palm oil. The two traded forms of the commodity were degummed (crude) and refined soya oils. About 85 per cent of the soybean produce in the world was crushed, and byproducts of soybeans were derived.4 The demand for soybeans was mostly for soya oil and soya meal. Even though India was one of the major producers of soybeans after the United States, Brazil, Argentina and China, soybean oil was imported in significant quantities (about 45–50 per cent) due to heavy demand. The price of soybeans in the Indian market was volatile, as it depended on the prices in the international market. The commodity markets in Indore and Mumbai were looked upon for price references. Production The cost of a soybean refinery project with an annual installed capacity of 1,200 tonnes per day (equivalent to 0.3 million metric tonnes of seed processing) is given in Exhibit 9. Such units could process soybeans as well as mustard seeds for the purpose of extracting oil and also had facilities for manufacturing cottonseed oil through oil-expelling machines when the factory was operational for more than 300 days. The internal rate of return was estimated at 15 to 16 per cent and the cost of capital was 10 per cent per annum. The project’s commissioning time was around 18 months, after purchasing the land. Location played a major role when setting up a refinery, as the logistics cost was a major component in the pricing of edible oils. The oil production cost of JMD Oils is given in Exhibit 10. In order to expand the market and target new areas, outsourcing production was common, whereby a refinery close to the target market was given a production contract. In this case, the cost of production remained exactly the same as the ex-factory cost of the manufacturer, after including the factory margins and taxes. Sometimes, the companies giving contracts to refineries preferred providing the raw material (in the form of degummed soya oil).This increased the cost of the end product, as additional logistics costs were involved in the transport of raw materials, but in return it assured the quality of output. Distribution The business was distribution-driven; marketers purchased or hired depots to improve market coverage and distribution reach. In this case, either the company could keep its own employees or outsource the management of the depot by keeping a consignee or commission agent. This agent took care of all the statutory requirements and the management of the depot. Usually the commission charged was ₹400 per metric tonne. JMD Oils had structured logistics as a distinct business segment. The distribution network was a strong competency for the company. Since the inception of the business in 1987, it had been involved in the distribution of major oil brands and hence knew the exact market arrangements in terms of margins offered and the number of distributors required to serve markets optimally. It had played a major role in

4 Soybeans, after crushing and solvent extraction, yield 17 to18 per cent soybean oil and 82 to 83 per cent soya meal. About 85 per cent of the global soybean production is crushed. There were no imports of soybeans into India, as it was more feasible to import oil. Soybean oil was traded at the Chicago Board of Trade in contracts of 60,000 pounds at a time. Source: Solvent Extractors’ Association. D

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Page 5 9B15M055 developing and maintaining relations with different customers in the supply chain and had a large distribution network. It sold through three different mechanisms — tanker customers, institutions and retail channels — and the relative share was in the ratio of 1:2:3. There were large customers who purchased tanker loads; the price offered to them was at the rate of the ex-factory price. For institutions such as hotels, restaurants and caterers, modern trade and wholesale markets, the price offered was the ex- factory price plus 1.5 per cent, however, different levels of credits were offered. The retail business was conducted at discounts on the maximum retail price and the margins could be higher or lower, depending on the intensity of competition (see Exhibit 11). Marketing JMD Oils marketed its soybean oils under three brands — Vital, Good Health and Priya. But these brands did not have strong brand recognition and thus operated like any other commodity business, with low gross margins. The company did not involve itself in any extensive branding activity. Competitors, who enjoyed a stronger brand pull, were able to charge premium prices as well as offer lower discounts to channel partners. In order to fetch premiums in a highly competitive market, it was important for JMD Oils to establish a strong brand name (see Exhibit 12). Brand building was not expected to have any effect on the margins for tanker and institutional sales. CHOICES FACING DHINGRA Dhingra could invest in improving the cost efficiency of the supply chain, be a low-cost producer and expand the distribution network to the territories of east and south India. The advantage of this model was that the company had a reasonable amount of experience in such activities. There was lesser risk of loss, as the investment would be in setting up factories, which were tangible and could be resold. He was confident that he would be able to build a 1,200-tonnes-per-day plant and make it operational in one and a half years. He expected to start selling 30 per cent of the capacity in the second year and 75 per cent of the capacity in the third year. Although he could increase the business volume and overall sales, this strategy would not increase the profitability of the business. The other option was to invest in brand building. The problem with this strategy was that the asset being built was intangible in nature and there was no certainty as to the outcome. Such activity was expected to be time-consuming at best and Dhingra could expect to reach the gross margins of the top brands in the next three years only (40 per cent in the first year, 75 per cent in the second year and full impact in the third year). Brand equity could be increased by only 30 per cent, but it could also be increased by 50 per cent or 100 per cent, and all three possibilities were equally likely. However, in the long run, it could deliver on business value, volume, profits and profitability, as the business volume could be extended with contract manufacturing. Dhingra was not sure what the right strategy was for JMD Oils and how that strategy would be viewed by the investing public. He needed a strategy that enjoyed the confidence of investors and brought the best results for JMD Oils in the long run.

Sakhhi Chhabra (Fellow Programme in Management student) and Jaydeep Mukherjee (faculty member) are from MDI Gurgaon. D o

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EXHIBIT 1: KEY FINANCIAL INDICATORS OF JMD OILS (IN ₹ MILLION)

Particulars Year ended 31/03/2011

Year ended 31/03/2012

Year ended 31/03/2013

Sales 13,279.4 15,092.6 17,968.1 Operating profit before finance cost, depreciation and tax

664.7 717.9 768.6

Finance cost 402.6 431.6 482.8 Profit after tax 155.6 165.3 194.4

Source: JMD Oils balance sheets.

EXHIBIT 2: GROWTH OF JMD OILS

1987 Started the edible oils business as a small department store and oil distribution unit in a Delhi residential colony.

1988 Beginning with the distributorship of Kabra Agro Industries for JMD’s soybean oil, it got the distributorship of the Gujarat Cooperative Oilseeds Growers’ Federation.

1989– 1996

Multiplied its distributorship network of major oil brands, e.g., Vital- SM Dyechem; Dalda Refined Oil-Hindustan Lever Limited; Sundrop, Crystal - Agro Tech Limited; Sohna- Markfed; Saffola- Marico Industries Limited.

1997 Diversified into the business of manufacturing and marketing dairy products and acquired an INDANA brand franchise.

1999 JMD Group commenced importing crude oil and subcontracted the refining process, after the oil reforms in 1999, when the government increased the tax.

2000 Business established a strong dealership network of 650 dealers. 2000– 2001

Launched its own brands called Lite (palm triolein oil) and Good Health (soybean oil). Acquired famous edible oil brand Vital from SM Dyechem, which was earlier owned by Britannia.

2004 Group diversified and set up a plant for packaged drinking water and aerated drinks under the brand name H2GO.

2005 Set up an oil refinery with a capacity of 800 tonnes per day near the port of Kandla, in the Kutch District of Gujarat.

2008 Company gave up the distributorship of all brands it was working for and concentrated on diversifying its network of operations. The group also manufactured salt by the name of Good Health, laundry soap, club soda and cola drinks.

2013 Its distribution footprint was seen all across the country with various stock-points catering to more than 3,000 distributors, 60 super stockists and 22 depots, numerous brokers and other trade associates. Its consumer reach was more than 150 million Indians.

Source: Created by authors from company documents.

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EXHIBIT 3: NETWORK FOR JMD OILS PVT. LTD.

Source: JMD Oils’ balance sheet.

EXHIBIT 4: EDIBLE OIL DEMAND AND IMPORT PROJECTION

2013 2015 2020* Indian Population (in Billions) 1.22 1.25 1.32 Total Demand (MMT) 17.30 19.00 23.10 Domestic Supply (MMT) 6.8 8.0 9.2 Imports (MMT) 10.5 11.0 13.9+

*Projected. Note: MMT stands for million metric tonnes. Source: Solvent Extractors’ Association.

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EXHIBIT 5: INDIAN CONSUMER CLASSES BASED ON INCOME

Consumer Class

Characteristics

Rich and Affluent

(Globals)

Less than 2% of Indian households. Mainly work in metros as senior employees or professional managers for multinational corporations, governments or private businesses, or entrepreneurs. Live in moderate-sized houses or apartments and own cars, computers with broadband Internet accessibility, televisions, and other appliances similar to their Western counterparts. Large disposable incomes. The geographic spread and smallness of the group makes them difficult for retailers to target, except through television media channels.

Middle Class

(Strivers and

Seekers)

Just under 19% of Indian households. Mainly graduates who are now middle-level managers or owners of small and medium-sized enterprises. Live in apartments and own appliances and electronics such as televisions, refrigerators, washing machines, computers, scooters/motorcycles, small cars, telephones, etc. Enjoy shopping in modern retail outlets and are relatively well informed about the quality and pricing of international products due to overseas travel and media exposure. Ready to try new products. Moderate disposable income, discerning buyers.

Aspiring Middle Class

39% of Indian households. Occupations include shop workers, drivers and farmers. Live in small flats. Some own refrigerators and televisions. All have mobile telephones. Very price-conscious and shop in traditional retail outlets (known as Kirana merchants) who extend credit facilities.

Deprived 40% of Indian households. Mainly farmers in rural areas. No proper housing but a few own televisions and mobile phones. Frequent visits to traditional markets and neighbourhood stores that provide credit facilities. Very low disposable income.

Source: “The Bird of Gold: The Rise of India’s Consumer Market,” report by McKinsey Quarterly, www.mckinsey.com/insights/asia-pacific/the_bird_of_gold, accessed October 5, 2014.

EXHIBIT 6: NUMBER OF HOUSEHOLDS BY ANNUAL INCOME BRACKET, IN MILLIONS

Year 2005 2015 2025 Globals 1.2 3.3 9.5 Strivers 2.4 5.5 33.1 Seekers 10.9 55.1 94.9 Aspirers 91.3 106 93.1 Deprived 101.1 74.1 49.9

* Strivers and Seekers are considered to be middle class. Source: “The Bird of Gold: The Rise of India’s Consumer Market,” report by McKinsey Quarterly, www.mckinsey.com/insights/asia-pacific/the_bird_of_gold, accessed October 5, 2014.

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EXHIBIT 7: PRICE OF OILS

Note: Rs=INR=₹. Source: Created by authors through a market survey conducted on August 2014.

EXHIBIT 8: SOYBEAN OIL PORTFOLIOS

Company Brand Adani Wilmar Limited Fortune, Fortune Plus

Agro Tech SundropNutrilite

Cargill Foods NatureFresh Acti-Lite, Gemini

Marico Saffola

Ruchi Soya Mahakosh, Nutrela

JMD Oils Vital, Good Health Source: Created by authors.

EXHIBIT 9: PROJECT COST FOR 1,200-TONNES-PER-DAY SOYBEAN REFINERY

Particulars Amount (in ₹ millions) Land 175 Building 420 Plant and machinery 1115 Pre-operative expenses 55 Misc. fixed assets/furniture fixtures 55 Margin money for working capital 600 Contingencies 90 Total 2,510

Note: ₹1,500 million was expected to be used in the first year and the rest in the second year, though money from the IPO would be realized immediately. Source: Created by authors based on interviews of company executive and past investments. D

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EXHIBIT 10: PRODUCTION COSTS AT JMD OILS

Soybean oil price per MT in US$ 983 Exchange rate for conversion of US$ to ₹ ₹62 Total cost for soybean per MT in ₹ 60,946 Landing cost of soybean at the port per kg 61 Inbound logistics cost in ₹ per kg 0.8 Refining cost in ₹ per kg 5 Packaging cost in ₹ per kg 4 Total refined oil cost in ₹ per kg 70.8 1-L pouch that can be made out of 1 kg 1.1 Cost of 1-L pouch in ₹ 64.36 Factory overheads in ₹ per L 1 Freight in ₹ per L 4 Excise duty exempted, hence excise duty per L 0 Factory margin in ₹ per L 3 Total cost of 1 L soybean oil in ₹ 72.36 Value-added tax @ 5% in ₹ 3.62 Total cost of 1 L soybean oil (ex-factory price) in ₹ 75.98

Note: MT =metric tonne; kg = kilogram; L = litre. Source: Created by authors based on interviews of company executive and CEO.

EXHIBIT 11: RETAIL PRICING STRUCTURE

Brands Vital

Good Health

Fortune Sundrop Nature Fresh

Acti-Lite

Saffola Maha- kosh Nutrilite Active

Company JMD Oils JMD Oils

Adani Wilmar

Agro Tech Cargill Foods

Marico Ruchi Soya

Maximum retail price 115 110 110 99 132 125 125 Price offered to consumer 80 80 80 97.5 98 99 73

Retailer margin 2.6 2.2 2.5 2 2 2 1.5 Retailer landed cost 77.4 77.8 77.5 95.5 96 96 71.5

Source: Created by authors based on interviews of company executive and CEO.

EXHIBIT 12: MEDIA SPEND REQUIRED FOR BRAND BUILDING (IN ₹ MILLIONS)

Year 1 Year 2 Year 3 Total developmental expenses 20 10 10 TV 700 500 400 Press 20 20 20 Radio 1 1 2 Outdoor 2 2 3 Others (cinema/Internet/digital/etc.) 2 2 3 In-store promoter activity 10 5 5 Total media spends 735 530 433 Merchandising 10 10 10 Branch expenses 10 10 10 Market research 10 10 10 Total marketing costs 781 604 507

Source: Created by authors based on interviews of company executive and CEO. D

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