Snapshot on Indian Logistics Industry

Indian Logistics Industry

ü  Globally, the logistics industry is valued at US$ 3.5 trillion. (Source: CII)

ü  The U.S., which contributes to over 25% of the global industry value, spends close to 9% of its GDP on logistic services.

ü  The Indian Logistics Industry is presently estimated at US$ 90 billion, which is expected grow at around 10-12 % each year. (Source: CII) 

ü  The industry has generated employment for 45 million people in the country  in comparison with the IT and ITeS sector which employs approximately 4.3 million people.

ü  It is  forecast to grow at a  Compound Annual Growth Rate (CAGR) of  approximately 8% over the next three to five years.  (Source: CII) 

Strengths

ü  India’s logistics story is indeed an attractive one, fuelled by factors like a rapidly growing economy, the increase in outsourcing of logistics and a significant government thrust on investment in infrastructure.

ü  Additionally, changes in tax and regulatory policies like the plan to introduce a uniform Goods and Service Tax (‘GST’) to obviate the need for multiple warehousing will lead to a consolidation of the industry.

Weakness

ü  Less economy of scale due to high fragmentation within Industry.

ü  Lack of skilled and knowledgeable manpower

ü  Growth in infrastructure is not sufficient enough to support growth in sector.

Opportunities

ü  Boom in average income of average Indian. 128 million households are expected to have annual income between 2-10 lakh by 2025 as compared to 13 million in 2006.

ü  10% annual growth in Manufacturing Sector

ü  Indian logistics market is likely to cross the $ 200 billion figure by 2020, fueled by the consistent growth of the economy and key industries such as automotive, engineering, pharmaceuticals, and food processing. (Source: 'Yearly Sectoral Analysis: Indian Transportation Logistics')

ü  Emergence of India as IT Super power which will enable logistics companies an IT support of International level.

ü  Presently, Indian logistics industry is highly fragmented and is still evolving, with the top 100 listed players only having a miniscule 2 per cent market share.

ü  Globalization of manufacturing systems  coupled with advancements in technology is compelling companies across verticals to concentrate on their core competencies and avail the cost saving potential of outsourcing.

ü  This is expected to contribute to an increase in the need for integrated logistics solutions, which is the niche, every Third Party Logistics Service (‘3PL Services’) provider is aiming to exploit.

Threats

ü  Supply Chain delays drive up the logistics costs

ü  Fierce competition from not only the established players but majorly from unorganized ones.

Industry Statistics

ü  The Indian logistics market recorded revenues of about $ 82.10 billion in 2010, witnessing a growth of about 9.2 percent over the previous year. (Source: 'Yearly Sectoral Analysis: Indian Transportation Logistics').

ü  Annual logistics cost- 13% of the GDP out of which 4.3% is wasted due to various inefficiencies. (Current GDP=1.38 trillion USD)

ü  Highly Unorganized with organized sector responsible only for 6% of the logistics activity although it is increasing with a rate of 20%.

ü  Share of 3rd Party Logistics only 10%

ü  The total logistics spend (total logistics market size) in India represents around 6.2 percent of the country’s total GDP. However, it represents about 11.6 percent of Services GDP (contribution of the services sector in the total GDP). (Source: The Automotive Horizon)

Political

ü  Over all government spend has increased from USD 10 billion to 30 billion and is expected to rise in near future.

ü  Special economic zones for development of Logistics parks. (Mumbai, Kolkata, Chennai and Hyderabad etc.)

ü  National Highway Development Project

ü  End of indirect tax regime after implementation of GST. Other tax reforms like VAT

ü  The much-awaited implementation of the nationwide uniform Goods and Services Tax (GST) regime, which was scheduled to become effective from April 1, 2010 has been delayed by a year by the Union Government due to non-agreement of several State Governments on the proposed tax revenue sharing model between the Centre and the States. However, since there has been no notable consensus on the issue between the Central and the opposing State Governments, the implementation of GST could be delayed further. On the other hand, market participants related to various industries have been hoping for a faster implementation of the new tax regime, because it is expected to bring in major transparency in tax policies, collections and also significantly reduce the tax burden for companies. Implementation of GST is also expected to revamp the supply chain process and logistics infrastructure for majority companies in each industry.

Key Factors affecting the Indian Logistics Industry

ü  Growth in GDP and trade are the core drivers

ü  Supportive regulatory changes are catalyzing growth by removing inefficiencies

ü  Ongoing infrastructure buildup improves long-term prospects

ü  Containerization gains momentum; specific segments will benefit more

Technological

ü  As of 2010, only about two-thirds of the end users reported to using some form of technology solution to support their logistics functions. These solutions included basic inventory management packages and barcode systems. However, usage of exclusive logistics technologies such as warehouse management systems, transportation management systems and radio frequency identification is significantly low across industries. (Source: CEO, Frost & Sullivan)

ü  India’s logistics technology market is set to grow at 19.8 percent between 2010 and 2015, to cross $ 600 million by 2015. This growth is driven by demand from the thriving logistics, retail and manufacturing sectors, as well as government promotion. However, these technologies are highly expensive, making them unaffordable for majority of logistics service providers and end users, thus limiting the full potential growth of the Indian logistics technology market.  (Source: CEO, Frost & Sullivan)

Recent M&A and Equity Funding transactions in the Industry

ü  The Indian logistics sector is expected to witness a consolidation wave, considering the reviving fortunes of the sector with booming end-user industries. Industry experts report that even private equity and venture capital firms are eyeing a slice of the logistics sector, which saw testing times for the last 12-16 months.

ü  FedEx’s acquisition of AFL Logistics and Transport Corporation of India’s (TCI) 51 percent equity stake acquisition in Infinite Logistics Solutions Pvt Ltd. In 2010 (Source: The Automotive Horizon)

ü  Apart from these, companies such as Toll Global Logistics, Allcargo Global Logistics, and FH Bertling Ltd have been actively seeking to expand their size in India through the inorganic growth mode.

ü   In addition, private equity firms and leading finance organisations have been actively investing in Indian logistics companies. International Finance Corporation (IFC) invested $ 5 million in Snowman Frozen Foods Ltd, a Bangalore-based company that transports, stores, and distributes frozen and chilled foods.

ü  Eredene Capital, a UK-based fund house that invests in logistics projects in India, took 90 percent stake in MJ Logistics, a 3PL cold storage service provider for processed food and retail industries. (Source: The Automotive Horizon)

ü  Recent 5 M&A (Source: Deal Curry, VC Circle)

o   NYK Line acquires stake Tata Martrade International Logistics in 2010 (Port Services)

o   Hitachi Transport Systems acquires stake in Flyjac in 2010 (Transportation)

o   PSA International acquires stake in Chennai Container Terminal in 2010 (Ports)

o   Toll Group acquires stake in BIC Logistics in 2009 (Transportation)

o   Louis Dreyfus Armateurs acquires stake  in ABG LDA Bulk Handing in 2009 (Bulk Cargo Handling)

New Entrants in the Industry

ü  Entry of 3rd party logistics providers

ü  Series of mergers and acquisitions leading to consolidation of industry (DHL acquired Blue Dart, TNT acquired Speedage Express Cargo Service and Fedex bought over Pafex. )

ü  Entry of global giants like Gazeley Broekmen (Wal-Mart's logistics partner), CH Robinson and Kerry logistics.

ü  Entry of large Indian corporate houses like Tata, Reliance and Bharti group.

ü  Expansion through franchisee

Competitive Analysis

ü  The logistics market in India is highly fragmented with several thousands of unorganised participants holding the dominant share of the market. These include unregistered transporters, storage providers and freight-forwarding agents. The leading 3PL service providers in India continue to be those with a strong nationwide

ü  surface transportation services such as TCI, Om Logistics and GATI. Leading international logistics players such as DHL, FedEx and TNT have a strong brand presence in the country, but their market presence is high only in the Express Logistics Services segment. Government-owned units dominate the market in their respective segments - such as Indian Railways and Container Corporation of India (CONCOR) in rail transport; Shipping Corporation of India (SCI) in ocean cargo, Central Warehousing Corporation (CWC) in warehousing.

Credit Default swaps

CDS is a very popular hedging instrument against credit counter party risks. However off late this instrument has lost some shine in the western markets after the recent financial melt down. In India RBI feels that this
instrument will prop up the shallow Bond market and hence permitted it, albeit with a lot of precautions and that too as an OTS product. Let us now look in to the proposed new product and understand its utility and
limitations.
It is a financial derivative contract which allows one party (Protection Buyer) to transfer, for a premium, the credit risk (losses due to Credit Events) of a reference obligation (Underlying loans, Bonds etc.), to another party (Protection Seller) without transferring its ownership. It is an off balance sheet financial instrument.
The credit events may cover Bankruptcy, Failure to pay, Obligation acceleration etc. However, the original credit relationships are neither changed nor newly established due to a CDS transaction.

RBI Guidelines on CDSIn view of the complexities involved in the valuation, accounting, and risk management aspects of
credit derivatives RBI has decided to initially allow only plain vanilla credit default swaps.

Advantages of CDS
1. Hedging the credit risk: Gains from CDS offset losses on an investment which arise due to an adverse credit event.
2. Investment to earn profits. CDS is transfer of credit risk in lieu of the credit spread in the form of premium. In case of no credit event, the CDS premium received is the profit to the market maker. It makes leverage possible and helps those with high funding costs.
3. Increase investors’ interest in corporate bonds and help development of the corporate bond market in India.
4. Trading profits. The CDS premium reflects the present value of the expected loss on a default risky asset. It increases or decreases with the shift in credit quality of the underlying reference entity or/and
obligation. Hence CDS can be used to take a view on both the deterioration and improvement in the credit quality of the reference obligation and earn trading profits.
5. Relief to capital charge. When credit risk gets hedged with a CDS contract, the credit risk capital is freed to support fresh credit exposure case of Banks, financial institutios and NBFCs etc., The exposure
level is reduced for protection buyer. For protection seller it becomes his credit obligation.
6. Exposure Management:
v CDS helps in transferring exposures from one counterparty to another.
v To release credit exposure limits to a counterparty;
v To reduce concentrations by shedding exposures to a counter-party (without affecting the
relationship with the borrower since there is no transfer of title of the asset) or to a sector;
v To assume exposures to a counter-party or to a sector to diversify risks or to fill gaps in credit quality spectrum

CDS PRODUCT FEATURES:ü The CDS contract outlines potential exchange of payments between the two parties in which at least
one leg of the cash flow (payout) is linked to the “performance” or “credit event” of a specified
Reference Entity/ Asset.
ü At the minimum, the contract specifies
ü Reference Entity: Issuer of bond/Lender
ü Reference Asset: The bonds/loans for which credit protection is bought or sold
ü Credit Event: The credit service/ quality related event that triggers claim for compensation.
ü Notional Amount: The amount for which the protection is bought or sold
ü Premium: The present value of the expected loss on a default risky asset
ü Term of Contract: The tenure for which the protection is bought or sold.

CDS INTERNATIONAL MARKET OVERVIEW• The total CDS outstanding trades have declined from 36,098 to 29,878 billion USD from H1-2009 to
H2-2010.
• The share of CDS in total Global OTC derivatives contracts outstanding has declined from 6.07% in H1-2009 to 4.97% in H1-2010.

CDS FOR INDIAN MARKETS – PRODUCT DESIGN:
Eligible Participants
v Users: Entities permitted to buy credit protection (buy CDS contracts) only to hedge the underlying credit risk on corporate bonds.
v Market Makers: Entities permitted to quote both buy and/or sell CDS spreads. They would be permitted to buy protection without having the underlying bond.

Exiting CDS transactions by usersv Users cannot exit their bought positions by entering into an offsetting sale contract.
v User can exit their bought position by either unwinding the contract with the original counterparty or, in the event of sale of the underlying bond, by assigning (novating) the CDS protection, to the purchaser of the underlying bond (the “transferee”) subject to consent of the original
protection seller (the “remaining party”).

Credit Eventsv Bankruptcy, Failure to pay, Repudiation/moratorium, Obligation acceleration, Obligation default,
Restructuring approved BIFR/CDR mechanism and corporate bond restructuring.

Determination Committee (DC)v The DC shall be formed by the market participants and FIMMDA and shall deliberate and resolve CDS related issues such as Credit Events, CDS Auctions etc.

Other Regulatory Requirementsv User (except FII) & market-maker shall be resident entities
v CDS contract shall be denominated and settled in INR
v No CDS on securities with original maturity up to one year
v CDS contract must be irrevocable.
v dealing in any structured financial product with CDS as one of the components shall not be permitted

SETTLEMENT METHODOLOGIESFor transactions involving users, physical settlement is mandatory. For other transactions, any of three settlement methods (physical, cash and auction), may be opted
v Physical settlement:
It is delivery of reference asset to the protection seller in exchange of the Par value plus accrued Interest (Computed with reference to the Notional Value).
v Cash settlement
Protection seller pays the difference of Par value including accrued Interest (Computed with reference to the Notional Value) minus its market value at the time of credit event as determined by a pre-agreed
dealer poll mechanism. The calculation agent plays an important role in the process of settlement.

Cash SettlementThe Reference Asset will normally retain some value after a credit event has triggered settlement of the
contract. The recovery value is normally determined within 3 months after the credit event, by a dealer poll or auction.

DocumentationFIMMDA shall devise a Master Agreement for Indian CDS.
The standardization of CDS contracts shall be achieved in terms of coupon, coupon payment dates, etc. as put in place by FIMMDA in consultation with the market participants.

• Pricing & Valuationü Market participants shall Mark to Market (MTM) the CDS contracts on a daily basis with methods
validated by external validators periodically. FIMMDA published daily CDS curve shall be used for valuation.
ü If a proprietary model results in a more conservative valuation, the market participant can use that too.

ISSUES GOING FORWARD
• Exiting CDS trades
v Guideline 2.6.2 of RBI circular: The users would be given a maximum grace period of ten business days from the date of sale of the underlying bond to unwind the CDS position.
v Guideline 2.6.3 of RBI circular: In the case of unwinding of the CDS contract, the original counterparty (protection seller) is required to ensure that the protection buyer has the underlying at the
time of unwinding.
Ideally, at the time of unwinding the CDS buyer need to have the underlying securities i.e sale of bond should be only after unwinding of CDS.
(BOTH ARE CONTRADICTORY TO EACH OTHER)
• Collateralisation and MarginingThe regulator has sought to achieve standardisation in the OTC CDS trades, but has left open the margining policy to be decided by each participant individually. Although an efficient market ensures the parity, it may prove as a hindrance in taking off for the product.
• Pricing & Valuation
v The intrinsic value of the CDS is a function of probability of occurrence of credit events & losses associated with it. Mapping the probability of unique credit events require extensive & reliable data
which is a challenge. The rating agency’s accuracy would be instrumental in determining ‘no arbitrage prices’.

AccountingThe user has to replace its credit exposure to the reference entity by the protection seller. Accounting methods will need to evolve keeping an eye on following complications:
v How the exposure reduction would be accounted when the funds still remain due from the reference entity?
v Exposure to the protection seller is Non Fund Based & Contingent in nature. How it would replace a fund based exposure in books?

Exposure assessmentRegulator has sought for daily credit exposure monitoring for reckoning various prudential limits.
Daily credit exposure monitoring on account of loans is a big challenge.

ValuationValuation of unlisted/unrated/SPV issued instruments is a big challenge subjected to absence of secondary market and two way quotes.

Credit EventRBI has identified “Restructuring approved under (BIFR)” as a credit event. However approval may sometimes take 2-3 years. It means that compensation would be triggered after approval whereas the
premium would be required to be paid for the intervening period. It seems a grey area as premium payment seems unfair when credit quality has already deteriorated. Getting referred to BIFR should be sufficient enough to be considered as a credit event.
Determination Committee (DC)

The market participants in the DC having vested interests may lead to a problem of moral hazard.
To conclude, although the CDS is an excellent hedging derivative product introduced in the Indian market, because of the above complexities, it may take some time by the players and market makers to properly develop a market for the same.

This article has been published in the Dec 2011 magazine of KSCAA. The Author is a senior banker and is currently working as General Manager with Punjab National Bank, Head Office, Delhi. Author can be reached at krammohanpnb@gmail.com.

Change management in a firm

A practicing Chartered Accountant is not only a professional filled with knowledge on tax, audit, accounts, IFRS etc but also is an entrepreneur who sets up an organization early in his age, employees people, services clients and manages everything single handedly (of course, unless there is a partnership or a team of managers involved).

From my experience, I clearly understand managing work or meeting deadline is never a problem for us, the biggest challenge is people management. People management involves both employee management and client management. These two are universal management issues in any business, starting from a tea stall to the biggest of the organizations.

A busy entrepreneur with clients to handle, work load to manage, cash flows to manage, generally, the last thought on his / her mind would be to notice low productivity from the employees and the most difficult to handle would be resistance to change. Generally, in such a scenario, most expected reaction would be to leave it in as in where in status and proceed with business work and decisions. Most common trend is things never improve if left without any action, either remains same or worsens. But, we are all used to accepting everything the way it is.

But, back in 1950s, Kurt Lewin didn’t feel that changing people’s mind is so very difficult. He simply compared changing people’s mind as changing the shape of an ice block. Even something as hard as ice could easily be changed to a different form through a simple three step process, unfreeze the current shape, change the shape and freeze it again. That’s human mind as well, rather, most of us could be easily compared to Lewin’s theory. Like the statement goes, Change is the only thing constant!

Let us understand this concept with a small case study.

Mr X was running as a sole proprietorship, a CA firm, X & Co., for nearly 12 years and had slowly but gradually set up a client base contributing to around INR 75 Lakhs of revenue per annum with around 30 employees. All was going well, clients were happy, employees busy and the proprietor was earning his share of success and money. A frozen and stable situation! With everything set in an auto mode, proprietor decides to increase his business and size to move on to the next level, but he also realizes that he will need fresh minds with a different skill sets to compliment his capability, use his existing resources and generate new revenues and move towards expansion. Now Mr X decides to induct people of different skills set who could gel well and suit his organization. He finds Mr Y and Mr Z suitable to handle the new roles and services X & Co. could probably get into.

Well so far so good! Changes start evolving and get noticed with new partners’ walking by one and all. A fine strong smile on the face of Mr X on the welcoming day slowly diminishes into an insecure smile and a mind full of ifs and buts. The employees are used to taking final orders from Mr X only so why now take orders from Mr Y and Mr Z. That marks the beginning of resistance to change. Continuous exchange of complaints, cribbing, low morale, high egos and the list goes on. The biggest problem to handle would be when so called less qualified but excellent manager with good experience, an asset to the firm till now threatens to resign due to his unacceptability of change. His fear would be loss of his close position with the top man of the firm.

Now what? Either break the partnership, which will be quite unfair to the newly joined partners or now modify the partnership agreement and have everyone to report to the Managing Partner, that will be forceful, hence not very ethical.

Before we see whether Mr Lewin’s management theory applies here, we need to understand what will motivate the employees. For that, let throw some light on Herzberg’s theory of motivation and Maslow’s hierarchy of needs. Herzberg, a psychologist, proposed a theory about job factors that motivate employees. Maslow, a behavioral scientist and contemporary of Herzberg's, developed a theory about the rank and satisfaction of various human needs and how people pursue these needs.

As per Herzberg’s two dimensional paradigm, factors affecting people’s attitude about work can be classified either as motivators/satisfiers or hygiene factors/dissatisfiers. Motivators would include determiners of job satisfaction: achievement, recognition, the work itself, responsibility, and advancement, they are associated with long-term positive effects in job performance while the hygiene factors (dissatisfiers) consistently produced only short-term changes in job attitudes and performance, which quickly fell back to its previous level.

Next, quick understanding of Maslow’s hierarchy of needs would also help to find out a solution to the existing problem. He says first need for any human would be Physiological (Thirst, sex, hunger), next he would be naturally concerned about Safety (Security, stability, protection), third level of need would be Love and Belongingness (To escape loneliness, love and be loved, and gain a sense of belonging), on achieving the first three needs, a person looks for Esteem (Self-respect, the respect others) and Self-actualization (To fulfill one's potentialities).

Now, going back to our case, if looked at from the Maslow’s hierarchy of needs, quite evidently, our professional force would not be worried about the first three needs. The thought nerve making trouble is the human need for esteem and self actualization.

Naturally, we got to start bottoms up!

The esteem level involves the feelings of importance which needs to come from within (self-esteem) and from other people who believe we are important. While, self-actualization is full realization of our own potential. Fortunately or unfortunately, today world is clearly witnessing a strong tug of war between education and experience. Is better experienced one superior or more qualified one? Well, neither. It is just two sides of the same coin and unless both of them are embossed well, it is always incomplete.

But, our gentlemen offering resignation on the arrival of newcomers clearly shows lack of both the motivators of esteem and self actualization. First step to manage the firm wide resistance to change would be to start with preventing any resignations, as the true definition of “Organization” is “A social unit of people, systematically structured and managed to meet a need or to pursue collective goals on a continuing basis”.

Before that, the change management theory could be implemented positively in an organization only if the management is ready for the change. In the case being discussed, if Mr X himself is insecure not sure of whether the initiated change was a correct decision and has similar confusion thoughts, then, inevitably the new partnership / joint working agreement will fail. But, if Mr X believes in his decision to expand and intends to work towards controlling the frictions due to change then, Mr Lewin Kurt’s theory along with other motivational theories could be applied.

Assuming, Mr X is interested in the change and strongly believes in its benefit, we proceed to analyse the case. Mr X should talk to the new partners / senior professionals on the needs of implementing change management principles within the organization. He will need their support and patience for the success of the process. Clear organization and hierarchy structure, definition of job responsibilities and roles and reward / recognition system for performance must be laid down.

For it to be acceptable and successful, Change should be gradual. Once clear systems are defined, the next step would be to encourage team working and performance measures. Of course, performance measures should not be such that it motivates one and de-motivates others. The Performance measures should reward the performers and motivate others to perform. Such a system would avoid unnecessary resignations being rendered, as it would address the human needs of esteem and self actualization.

These policy changes, system implementation and focus on motivation factors mark the stage of unfreezing the prevailing situation in the Company. This first stage of change involves preparing the organization to accept that change is necessary, which involves break down the existing status quo before you can build up a new way of operating.

Sending compelling message to change will never help, it will lead to further resistance and reluctance towards change. In the stage of unfreezing the existing ways and thoughts, Mr X will need to challenge the beliefs, values, attitudes, and behaviors that currently define it. It will be necessary to explain in a convincing manner the needs and benefits of change, lest shaking the very foundations of the organization.  This first part of the change process is usually the most difficult and stressful. When you start cutting down the “way things are done”, you put everyone and everything off balance. You may evoke strong reactions in people, and that’s exactly what needs to done.  By forcing the organization to re-examine its core, you effectively create a (controlled) crisis, which in turn can build a strong motivation to seek out a new equilibrium. Without this motivation, you won’t get the buy-in and participation necessary to effect any meaningful change.

Once Mr X succeeds in familiarizing his team to uncertainty, he will next to lead them in the direction of resolving issues of uncertainty. This will be the stage of Change. With an intention to resolve the problem, people look forward to move in a direction which the management believes and acts positive in.

It is definitely a time taking process for people to embrace the new direction and participate proactively in the change. In order to accept the change and contribute to making the change successful, people need to understand how the changes will benefit them. Not everyone will fall in line just because the change is necessary and will benefit the company. Mr X will still face the issues of resignations and low productivity but most of the work force is expected to fall in line. Time and communication are the two keys to success for the changes to occur. People need time to understand the changes and they also need to feel highly connected to the organization throughout the transition period.

Once, Mr X finds positive work life back in the organization, it will be time for him to move the firm on the third level, Refreeze Level. The outward signs of the refreeze are a stable organization chart, consistent job descriptions, and so on, the skeleton for which should have been drawn in stage 1 but fully implemented in stage 3. The refreeze stage also needs to help people and the organization internalize or institutionalize the changes. This means making sure that the changes are used all the time; and that they are incorporated into everyday business. With a new sense of stability, employees feel confident and comfortable with the new ways of working.

As part of the Refreezing process, Mr X needs to make sure that success of the change is celebrated constantly– this helps people to find closure, thanks them for enduring a painful time, and helps them believe that future change will be successful.

By CA. Aparna RamMohan

This article has been published in the Dec 2011 publication of KSCAA. The author of the article is a Chartered Accountant, Chartered Management Accountant (UK) and an Investment Banking professional. The author could be reached at caaparnasridhar@gmail.com.