The Mind Of The Strategist

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Is there a way to reach gas to homes at half the cost of LPG? Is there a way to generate and sell power at Rs 3 a unit? Is there a way to convert gas into diesel? Is there a way to lay an information highway to millions of Indian homes and provide music and video on demand at affordable prices? And then take that model to countries around the world?

Those are some of the questions that are occupying many bright minds in Reliance these days. They symbolise the attempt of India's largest business group to move into the "next orbit", as Dhirubhai Ambani would have put it. They also symbolise the attempt to transform an industrial behemoth into a consumer-facing organisation. It would be foolhardy to expect the journey to be smooth. But as anybody who has watched Reliance all these years would know, it would be even more foolhardy not to take it seriously.

In a long session with Businessworld Editor Tony Joseph and Deputy Editor Indrajit Gupta at the 132-acre Dhirubhai Ambani Knowledge City on the Thane-Belapur Highway, Mukesh Ambani revealed the thinking behind Reliance Phase Next. Excerpts from the interview:

A lot of things have happened in the last one year since you took over. How do you look back at the year?

At a personal level, it has been a very, very difficult year. He (Dhirubhai Ambani) and I were very, very close. You don't realise that one year has gone by just like that.... I feel the momentum has kept going till now. It actually takes over and does not give you time to think about these (things)... We've been brought up in the belief that once you have a goal, you should be focussed on it and not on the obstacles. The day you start focussing on the obstacles, you'll miss the goal. That has actually kept us so busy that we had no time to think. But when sometimes I sit back, yes, I miss him. It is always difficult.

In terms of managing the group, what has the change been like?

I don't think in terms of managing or leading the group and all that. Frankly, there has been a great deal of continuity. Papa had his own operating style. He had a brilliant operating style. He always said, 'I made myself. My success is in the fact that whether I am there or not there, the speed at which I want to move will be there." A lot of people make a big deal out of things. Frankly, there is continuity, there has been no transition. It is the same management team and there lies our strength. When you look at a large company anywhere in the world, when the leadership changes, a lot of things change too. But for us it has been continuity. Whichever way, with or without papa, we would have done exactly the same things.

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If one looks at the investments that you are planning today - in oil retailing, in gas pipelines, in telecom networks and power networks - one can sense the nature of the group is changing in fundamental ways.

It is much more about 'networks' than has been the case so far. How would you define the change?

When we started thinking about it, in the late 90s, when we were nearly through with refining, we were very clear that India has oil and gas and we have to find it. That would be the upstream investment. But given our healthy cash flows, we really had to think of where else we wanted to go and what India needed. Papa in his speech as chairman of Reliance at the 2000 AGM had said: "We see services growing, they are going to form a large part of global GDP and whatever opportunity we get, we will create competencies and invest in the services business with our goal as 2005." That meant five years from then, we had to have meaningful revenues from services. The endgame that we had visualised was to leverage Reliance's existing strengths of large project financing, complex project execution, and the ability to use leading edge technology to deliver value to the average Indian at affordable costs. And to do all this on a scale that would make sense for us.

With that in mind, and taking into account all the developments of the nineties, we quickly came to the conclusion that every household will need energy on an ongoing basis and it will also need information and communication as a service. These would be the two fundamental areas. Energy was our own area; we just added information and communication. We saw growth here. We also saw technology maturing in these areas and deregulation happening at the same time. We were very lucky that we had the appetite to build. The only new competency we had to build was creating value for consumers. The question was, how do we create competency in the company to serve the consumer and, within that, get him a perception of value.

Coming out of that were things like 'Can we be the choice supplier of power?', 'Can we be the choice supplier of gas and gas distribution to individuals?', 'Can we be the choice supplier of diesel, petrol and kerosene?', 'Can we be the choice supplier of data, voice and video communication?' and, at the end of the day, 'Can we also be the mobile data and voice supplier of choice?'. That is how we started off and then opportunities emerged. We really think that there is convergence of these two sectors. This is what we are chasing in what we call our second phase.

Can you explain a little more what you mean by these 'new competencies' that you need to build now?

The first competency is what I call 'understanding consumer preferences and delivering consumer values'. We as a country do not have many companies that want to face the consumer directly. We appoint an agent who will get a distributor who will have a wholesaler who will have many retailers. By and large, that is how we market. (But) our strategy is that we will not shirk from looking the consumer in the eye. We are not going to give it (the chance) away to dealers, we are not going to give it away to agents, (we will) ensure that customers can see, touch and feel Reliance. That is one set of competency.

The other major competency that we have to build on is managing people as we scale up, as we spread geographically. This will allow us to move from managing 50,000-60,000 people at a few locations to managing 150,000-200,000 people around the country. And if we can manage them in different geographical locations, we will have a basis then to globalise. In the last 18 months, we have put more than 150 Reliance people in the polyester and refining businesses in 20 countries. All of this is teaching us new things and I believe that the best way of learning is by doing. Give us two or three years, and we will be a good, strong consumer-facing organisation.

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Reliance Industries vice-chairman and managing director Anil Ambani is the man leading the charge into the energy sector. A graduate of the Wharton Business School, the extrovert Anil is considered a financial whizkid and the brain behind many of Reliance's innovative money-raising instruments over the last decade like the 100-year bonds. As chairman of Reliance Energy (formerly BSES), he is pushing to make it the biggest power distribution company in india. It already operates in Delhi and Mumbai. The gas strike has opened up a range of new possibilities for him

Telecom has been the first sector where you have tried to become a 'consumer-facing organisation'. What has that experience taught you? In hindsight, did you launch the service before you were ready?

Well...it was an emotional tradeoff (to push for the launch of Reliance Infocomm services on 28 December, the birth anniversary of Dhirubhai Ambani). In hindsight, it was a few months earlier than it should have been, but the emotional energy that it created makes me think it was still the right decision. We were very quick to acknowledge that we needed time to make up. We put our heads down, we worked in the marketplace, we worked on our interconnections and we came back to all our customers and we find that now we are making up for that (lapse)... The culture still is 'let's do new things', it does not matter if we make mistakes, we will correct them, but we will make sure that we won't commit the same mistake again.

Do you still think Infocomm will break even this year?

Yes, if the present trend continues. We are in reasonable shape.

But there could be regulatory surprises - especially if the decision at the telecom disputes authority goes against WLL... (As it indeed did later - Editor.)

We (India) have to get out of this. In the service area, India has really delivered value by delicensing. My favourite story is that of our polyester business. From 1980 to 1990, we struggled, struggled and struggled. By 1990, it was delicensed. By 1996, we had grown 10-12 times bigger. In the 21st century we don't need a licence permit raj. In 1999-2000, we were the highest-cost mobile and fixed line service country in the world. Today we are the lowest-cost service provider. This is what deregulation does to consumers. In a democracy, there will be enough collective wisdom to see that we benefit... I really see that regulation is necessary only for customer protection. It will not be for anything else. Fortunately, in the petroleum sector, we are getting there. In power, we are getting there. In the telecom sector, the intent is there... As I have always said, there will be short-term risks. But if you take a medium- to long-term view, I frankly see zero risk.

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But would the telecom business make economic sense for you if the cost of entry for both WLL and GSM were to be equalised?

What is entry cost? What is the mobile business like? It really means allocation of spectrum. Nothing else. Our entry costs are already high if you look at the cost per Megahertz (MHz) that we are paying. We only get 5 MHz spectrum. If equivalent spectrum is given (to both WLL and GSM operators), then the incremental spectrum will actually be cheaper (for us). Everybody, including the cellular operators, have agreed on unlimited entry. When the government converted the cellular licence fee into a revenue sharing arrangement, it said, 'We are giving you the option of paying revenue share, but we are taking away from you the guarantee that there will be only three licensees. I can bring 10, 20, as many as I want'.

To go back to the idea of networks - if you look at a house today, you will see the power line coming in, the cable line coming in, the telephone line coming in, and perhaps the gas line. And you are probably the only group which has plans for all of these. Is that the way you see the group's future, and are there synergies in looking at things this way?

There are huge amounts of synergy. Up to the home, they all go into the same trench. So there will be capital cost savings. And, obviously, anything that is done at a lower cost in a competitive market benefits the consumer. As we go along, we would like to reduce the capital costs and we are working on how we do it.

The next synergy is in terms of the operating cost. Here, the biggest cost is billing, collection and use of technology. If we can get this cost low, then we can bring these services within the budget of the customer.

We measure value for the consumer differently from the way it is done in the West. We think of per capita income. Our per capita income will grow over a period of time, but right now if you want to reach 200 million households, you are stuck with an income level of about $600. And if you say you want to reach only 50 million or 100 million households, then also the income level does not go beyond $600-700. Then the judgement you have to make is how much money an average household at that income level is likely to spend on energy and how much on information. That is the purchasing power. Our challenge is to match things so that I get a return and I get my customers to use my services. We have to think outside the box to find solutions here.

Then, as per capita income goes up, we will take a share of those incomes. If today we look at the US, AT&T is rolling out video, data and voice services - $99.9 for video service, $48 for all-you-can-eat fixed line services, and if you add up all these and other services, it comes to about $180 per month. They are growing very well and they can then look at their capital and operating costs on the basis of those revenues. But at $180 per month, my market will shrink to 5 million, 2 million or 1 million consumers and that is not interesting enough for me. Our challenge is continuously to marry these things. To that extent, when we bring in synergies, it helps us in bringing down the costs to the consumer.

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And you see this mostly as a technology problem?

It is a capital-productivity-execution problem. It is a full business model, a unique business model that we are trying to develop ourselves.

Our view of the world is that there are 6 billion people living in it. Take out the 1.5 billion who are in the developed world and there are 4.5 billion left who have got such low purchasing power that the Western world does not even think they are worth chasing. But if we can demonstrate our capabilities, we will have this global market for information-communication.

That is quite similar to what Prof. C.K. Prahalad has been talking about for some time: the market opportunity at the bottom of the pyramid.

Absolutely. I will go one step beyond and say, out of these 4.5 billion, China is something that we are trying our best to understand. Frankly, they do not have the burden of accurate accounting. It is so difficult to understand what these guys are doing. So remove a billion people out of that. You still have a 3.5-billion-people market in Africa, Latin America, the Middle East and other parts of Asia. So if we are able to 'crack the code', and say that, yes, now we have a product for people who have got per capita incomes of $600-700, then we can leverage our information-communication solutions in the second half of this decade. In energy, maybe we could look at selective, niche infrastructure. Otherwise, energy infrastructure has been very well developed since 1910. So this really is our aspiration.

In energy in India, there has been some movement in liberalising the power sector with a new Electricity Act being put in place. But as Enron has shown, unless we see substantial reduction in the cost of producing and distributing power from private plants, the problem wouldn't go away, would it?

Conceptually, the policy direction is right... Let's talk about pricing. Our view of the future is that if we look at the next 20 years, India is blessed with low-cost fuel - gas. With this availability of gas, if you take the average value of the rupee at 45 or 50 to a dollar, then you should arrive at a cost of between Rs 2.20 and Rs 3 per unit of power (from new gas-based plants). Frankly, Rs 2.50 per unit is our assessment.

So, if I look at the next five years, we have got a great opportunity because of the increasing productivity of power equipment, because of gas finds in India, and because of deregulation. We now have got a real chance to fix our power sector.

What is the next step for Reliance in power?

Our next step is we will look at entry into distribution. We will integrate the whole balance sheet. Basically Reliance Energy (formerly BSES) will be our power distribution centre. We are open to all options. We can look at taking over existing distribution systems or we can look at brand new distribution systems, whichever gives us and the consumer more value. You have to evaluate the options case-by-case, city-by-city. If you are getting a 50-year-old network that has no chance of working, you are better off building the next generation network straightaway.

Below is a picture that symbolises the traditional strength of Reliance: big project execution. It is an oil rig that is being used by the company's oil & gas exploration & production operations.

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Are you still waiting for the regulatory environment to clear up?

I think the regulatory environment will clear up, what we are really waiting for is movement in the states. We anticipate that the big thrust will happen only after the elections.

Is it your intention to use the gas you have discovered mostly for power generation?

We think India has got large quantities of gas. We can't just be relying on one use for it. Basically the largest market for gas anywhere in the world is power generation. That makes sense for us also because of our service strategy. Next is petrochemicals, where it will give us a large advantage in terms of coming on a par in with our friends in Iran, Iraq and everywhere. Until now, we had been working with a tremendous disadvantage in feedstock cost.

The third use is for home consumption and cooking. That is a large area. That is something we are working extremely hard on, to try and get the economics right. If we do, the cost to the consumer relative to LPG will halve in a single shot. And it will also free the government of LPG subsidy.

But compared to power or petrochemicals, the demand for natural gas from the domestic sector would be quite low, wouldn't it?

Absolutely right. Today, in India, gas at home is used only for cooking. But think about this - this is where we would like to experiment with technology - using gas for refrigeration. One of the primary uses of fuel anywhere in the world is for heating or ventilation. And ventilation is the sophisticated name for air-conditioning; HVAC is what we call it now. In India, the fuel used for HVAC is zero. If we build a fuel distribution infrastructure, I am sure there will be further developments and the cost will be low relative to power. It looks impossible today, but in the next two years it will be in the realm of possibility. If that happens, we are all trying to figure out what the Indian market can be. It can be large, given our conditions. If you make air-conditioning cheap, lots of people might want it. From our point of view, I am better off relying on 10 million customers who pay me every day rather than on three power plants.

Within the group, we are doing a lot of pioneering work on gas. For example, we are looking at converting gas into liquid kerosene, diesel, and gasoline. A few other companies like Shell in Indonesia have also been working on this, but there are issues of capital costs, catalyst cost and conversion efficiency. We are putting a group together. We see long-term potential here because the world is going in for cleaner fuels. If I look at the next 20 years, you would want zero-sulphur diesel, and the same with gasoline. What am I doing today? I am taking crude oil, running it through the whole Jamnagar refinery (with Rs 25,000 crore of investment), where it goes through all kinds of chemical and biological processes to try and get for you fuel with 0.05% sulphur content. That increases your capital costs and your operating costs. If you think about it, I take crude from the ground, I put in $5 billion and at the end of the day I get 30 million tonnes of crude and 60 million tonnes of distillate products. Now if I have gas, I can bring it to the shore, put a large GTL (gas to liquid) plant - today, conceptually, the capital cost should be around $3 billion - and come up with high-yield, absolutely pure kerosene, gasoline and diesel since gas by nature has no impurity. These are three products the world will need. Everything else is just gas, we will always find other uses for it.

But the challenge is to get the right kind of catalyst and to get the economics right. Now it is the domain of one or two players in the world, but we are working on it. If we succeed, then this would be a huge opportunity and gas will not become a burden to you. Qatar has large amounts of gas. Iran has large amounts of gas. If we cannot use the gas, there would be no benefit. Like, if we just invest in making LNG and then transporting it, we think it will be capital-inefficient. So this is what we are going to push for - all the four options. And LNG will always remain another option.

The picture below is the face of the new "consumer-facing organisation" that Mukesh Ambani wants to build. It is a Reliance Telecom centre which ensures that the problems of its subscribers get solved as quickly as possible

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How long will it be before you start delivering the gas?

We will deliver the first commercial gas to the shore in 2006. There will be some initial pipeline.

It is not a long gestation period...

It is, but you lay it first to the nearest market. Say, you bring it to Andhra Pradesh and supply to all the power plants in Andhra Pradesh, then you grow step-by-step, year-by-year.

When you look at the group today, there are two concerns that come up. One is about telecom, which you addressed. The other is that the margins in the old-line business are falling. How do you respond?

See our bottomline results.

No, we can see that your profits are going up, but I am talking about margins.

The very simple answer is that any financial concern should only become a concern when you see the bottomline. If you look at our bottom line quarter-by-quarter, year-by-year, what we can say is that we will not disappoint you. If you look at medium term, we think that in all the businesses that we are in, it is not as if we have finished with growth - whether it is polyester, plastics or refining. Upstream oil and gas have not even started. India is very deficient in energy. So there could be profitable growth there maybe for the next 20 years. Look at the refining business; India's demand-supply parity is comfortable if I just look at fundamentals. And if I look at per capita consumption, we have a long way to go even if you want to reach 33% of the world per capita figure. If you look at the total number of cars that are coming into the system, the purchasing power, the next 10 years will be a reasonable growth period for the refining business in India. The same is true of plastics and polyester. They may not yield the 25% growth that they did in the eighties and nineties, but we still feel that they are in the low double-digit group, which is good.

The first thing that drives business is growth. The second thing that drives business is competitiveness. In each one of our businesses, we are passionate about competitiveness. At the end of the day, we have a track record where we have outperformed others in virtually every parameter of competitiveness.

This will drive our overall margins. If you look at principles, this is what drives your margins. What happened in Infocomm? Look at our capital productivity. Look at the growth. This market will be growing at 25-30% compounded for the next 15-20 years. Right now it is growing even faster. But over a period of time, it will grow at this rate.

Given growth, given our stress on capital and operational productivity... For us, business is all about operating margins.

V.V. Bhat, head of HR

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But there does seem to be a fall in return on capital employed. Could it be that you are in investment mode today, and it will take time for those investments to pay off? If so, how long will it take?

Let us look at these numbers... oh, this is the impact of the merger (of Reliance Industries and Reliance Petroleum). What you are doing is you are taking capital employed in an Rs 25,000-crore asset which is one year old and merging it with a Rs 25,000-crore asset which is 10 years old. Then you are going to see that. But if you think about it fundamentally, that if I employ so much of capital, what am I getting in terms of return on capital employed vis-à-vis my peers, vis-à-vis my last year's growth, on a continuous basis - international peers, domestic peers, and sectorwise in terms of how many sectors are getting a return on capital employed, even cumulatively, of 12.5 or 13% - you will see our numbers are better.

We think that both our return on net worth and capital employed are very robust. In fact, we have outperformed the industry year-on-year. Your question is relevant to what happened in the nineties. In the nineties, when we built the refinery, Reliance's cash flow was Rs 5,000 crore. It may not be accurate, but I am quoting that to give you an appreciation of the issues. And at Rs 5,000 crore, we said, okay, we will invest Rs 25,000 crore. So there was debt capital that came in. Because of that, you had incremental debt cost which you had to write off. So your overall return on capital went down until you brought in returns from that deficit. That happens particularly when you have large capital-intensive businesses not built out of your own cash flows.

We are now moving into a very different situation. Frankly, our issue now is that if I look at the Reliance group as a whole, our cash accruals are - again I am giving you ranges - Rs 11,000 crore-14,000 crore without Infocomm. And in the first year of Infocomm, which is 2004-05, if you take into account all the group companies, cash accruals will effectively be Rs 19,000 crore-23,0000 crore.

If I now look at the cumulative cash accruals in 2004-05, 2005-06 and 2006-07, I have got Rs 75,000 crore. This is stable cash flow. For me, investing that Rs 75,000 crore is the challenge. What we are doing is pretty much investing only what we earn. We would never again have a situation where we do what we did earlier for leapfrog growth. When we did the refinery, we played a major game of doubling Reliance in a three-year time frame.

When you do that, all your financial indicators come below line and they stay there until that investment pays off. If it does not pay off, then you are in trouble. Now we are saying, fine, this is it; we are investing our own money. If you look, Infocomm has zero external debt. It is literally like Reliance's debt, Reliance as a group. That is the strength of Reliance now. These days when we do capital allocation, it is allocation out of our own money and not that much out of borrowed money. The challenge of return on capital employed will remain because whatever money I earn, I am also accountable to earning money on it for you again. If I earn Rs 10,000 crore, I cannot say that I have earned 10,000 crore...

Unless you return the money...

But I will never see any parameters then, because whatever I earned last year, I have not added a huge interest cost on it to depress my return on net worth or my return on capital employed. As long as I make sure that I do not take Rs 10,000 crore and lock it up for five years, I am okay. One of our key emphases will always be on fast turnaround of capital. We are doing this very consciously. Infocomm is the fastest in the world in terms of turnaround. We expect to have cash break-even or even profit in the shortest possible time since we put in money. That is the name of the game. This is again simple old baniya principle; no rocket science.

Subodh Sapra, head of the polyester business

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RANJU SARKAR

Where Reliance sees itself:

Retailing

When Reliance's 1,500 spanking new gasoline stations open in April 2004, it isn't just market leader Indian Oil Corporation that may need to sit up and take notice; dhaba owners may also need to.

Reliance aims to be a one-stop shop for truckers. So not only will they get to refuel, they will also get lunch from a menu that caters to regional tastes. "Right now, for example, south Indian drivers are forced to cook their own food when they drive in the North," says P.M.S. Prasad, president (petroleum and aromatics business), Reliance. Besides a safe parking berth and food, these 2-3 acre gas stations will provide rest rooms, maybe a bath, a place to watch a movie and a assistance in case of a breakdown. The focus on truck traffic will help mop up diesel volumes. For the rest - car owners and two wheeler owners - Reliance plans to develop specific value propositions. It will bid aggressively for HPCL, but in case it fails, the blueprint is ready for its own rollout.

Inside Reliance, oil retailing is being seen as just the start of a much larger retail play and there's one global company that has caught everyone's fancy: Wal-Mart. While the details are still not in place, Reliance plans to use its interface with customers in oil, power and telecom to create a retail business. "There will be a day when your Reliance phone becomes your credit card through which you pay your electricity, telephone and fuel bills. And you shop in a Reliance kind of mart," says a senior executive. That, of course, is in the future. Now, talks are on for creating alliances with hypermarket chains. Interestingly, Reliance Capital has already picked up a stake in Pantaloon Retail.

So keep watching this space.

P.M.S. Prasad, head of the petroleum business

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You have to do this year-on-year, consistently.

It is basically the job of a particular business to do that on an ongoing basis. We have now virtually eliminated the risk of performance. The risk that you carry is not that. My existing businesses are very transparent. By 2004-05, Infocomm will also become very transparent. So you will know every quarter what is the balance sheet, what we are adding, what is the usage, all the stuff that you try and guess and work out on the back of an envelope! That mystery will go away - as in the case of my plastics business or refining business. At all points in time, we will have our Rs 20,000 crore that we are reinvesting and the challenge will be this: how do I bring our reinvestment time to 18-12 months, or how do I transparently make money on my financial assets and match that up?

To go back to a point you made earlier, the challenge also appears to be in devising new business concepts that will deliver the target rate of return.

Absolutely. And investing in some growth areas. The whole portfolio allocation and risk management question. But as I said earlier, that phase of Reliance Industries will never come when we do again what we did in the mid-nineties. It is unlikely that we are now going to say that let us put in Rs 100,000 crore. Those kinds of opportunities also don't exist - there is a physical limitation.

Can we get an idea of how you would roughly work out your investments in the next three or four years for different sectors?

Our capital allocation model really works with every business. Every business has the first opportunity to reinvest in the existing business provided they deliver 20%. We encourage every business to find opportunities. Our view is that every business leadership has to have enough backlog to reinvest in existing businesses to get whatever is our target rate of return. And if you can't find opportunities there, find opportunities elsewhere. Today we have got enough backlog for pretty much every business to reinvest in their areas. We actually had to cut off (the allocation) when we wanted to invest in Infocomm. Suppose we want to invest Rs 10,000 crore. So all of you guys have to take a haircut of Rs 2,000 crore-3,000 crore. I take it and so you will reinvest only 80%. Basically that is how we work.

How do you make sure that these different investment plans fit together well, for the group as a whole?

That is my job; to integrate the whole thing and figure out what final risk we take. At the end of the day, it is really like saying, 'Okay, I am very confident of this'. A few of us like myself, Anil, seven or eight of us, will say, 'We also think it is okay, now you go and run with this, if you want any help you come back to us, otherwise you move on'. Whatever new things we do, whether it is in life sciences, or in Infocomm, or in something else tomorrow, we will still do it the same way. For large risks, like in Infocomm, we ourselves take the ownership, then build it and float it. In other cases we say, fine, this is what we think is the total amount of capital required, and these are your target returns. Surely, you don't meet all your target returns all the time. Now we are very good at looking at these risks on a quarterly basis and then forming teams to help each other.

Have you already started pulling out of Infocomm in terms of your own personal involvement?

Yes, very much. I am five or six months behind. My goal was to get out by 30 September. But I think I will get there by the end of the year, down to 50%.

What are you turning your attention to?

Children. (Laughter) Right now, my official line is children.

During the Infocomm launch, Anil was not there. There was a lot of comment about that. What is your response?

We have perfect understanding. For us, it is really the goals that matter. Many times, I have not been there at board meetings or AGMs, and I think people make too much out of it. Our culture is, as papa always used to say, kaam is more important than formalities. For us the end result is most important.

[harsh 1]

these guys are great !!!