RIL needs to invest more in technology to be competitive. But unrelated businesses, such as telecom and retail, are eating into resources.
The profitability of Reliance Industries (RIL) has been steadily dropping; it posted its third consecutive drop in quarterly profit, with net profits falling over 20 per cent in the last quarter.
One of its shareholders reportedly expressed concern at the recent AGM on the company’s diversification into retail and broadband. RIL Chairman and Managing Director, Mukesh Ambani, replied that diversification was essential for RIL to grow the way it did in the last few decades under Dhirubhai Ambani’s leadership. If not for diversification, RIL would have remained a textiles company, he said.
Fair enough. But the issue relates to where the management should deploy the company’s resources.
Unrelated diversification within the same company exerts pressure on financial and human resources, forcing the company to ration resources across businesses. Respective individual businesses become less competitive, as compared with a focused competitor who allocates larger resources, building stronger competencies.
RIL AND BHARTI
It is interesting to contrast RIL with Bharti’s structuring of its businesses, and the implications these have on corporate diversity. RIL diversified away from core oil and gas business into retail and digital broadband while Bharti, in addition to telecom, has forayed into retail, fresh foods and financial services.
At the outset, it would seem that both the groups are diversified into unrelated areas, away from their respective core businesses. A closer examination of how these diversified businesses are structured provides interesting insights.
RIL, the vertically integrated company (exploration, production, refining, petrochemicals, pumps), diversified into retail (through 91.01 per cent subsidiary company Reliance Retail Ltd) and digital broadband (95 per cent subsidiary company Infotel Broadband Services Ltd); investments made by these subsidiaries in retail and broadband businesses come from RIL’s funds accrued from, or raised from shareholders for its core oil and gas business.
In effect, the funds from the core business will compete for investments in diversified businesses. With accounting standards stipulating consolidation due to majority holding and management control, RIL thus becomes a diversified company with a portfolio of unrelated businesses (oil and gas, retail and broadband).
Contrarily, Bharti Airtel Ltd, a flagship company of Bharti Enterprises, is focused on telecommunication, both directly and through its subsidiaries. Bharti’s foray into retail, is structured through Bharti Retail Limited, directly owned by Bharti Enterprises and has got nothing to do with Bharti Airtel.
Hence shareholders’ monies raised by Bharti Airtel for telecom (and profits from telecom business) will not be deployed in other unrelated business; Bharti Airtel thus becomes a telecom-focused company (and Bharti Retail, a retail-focused company). Other businesses like fresh foods and financial services are similarly structured.
PROFILE OF PORTFOLIOS
The extent to which diversified businesses compete for a share in resources from a ‘common pool’ is aggravated if all the businesses happen to be in ‘high growth’ phase; this is the bigger challenge for RIL.
With energy demand in the West flattening and emerging economies increasing consumption exponentially, driven by China and India, RIL needs significant investment to satisfy this demand.
Its slashing of gas reserves in the KGD6 block by 70 per cent has left specialists gasping. Further, it has been unable to fix the problem of lower output from its fields; all of these point to the fact that RIL needs to acquire a higher level of expertise to support its core business, which will demand more investments. It has started accessing the latest technologies to tackle such geological complexities, such as deep water exploration and non-conventional production from shale formations. These entail substantial capital expenditure; RIL’s joint venture with BP moves it precisely in this direction. More such initiatives are required to gain competitive advantage in all aspects of the ‘core business’ value chain.
Even today, global oil majors including Exxon Mobil and BP, remain vertically integrated in order to control feedstock supply and pricing. In the Indian space, vertical integration becomes more pertinent; ‘downstream’ companies Hindustan Petroleum and Bharat Petroleum are steadily moving ‘upstream’ while ‘upstream’ ONGC and Oil India are moving ‘downstream’.
Natural gas player GAIL moved into petrochemicals. Companies not vertically integrated (Haldia Petro, NOCIL) are finding survival difficult, without this backward linkage. Given these, RIL’s strategy of vertical integration was a masterstroke. Having won and retained shareholders’ confidence for over three decades is no mean achievement. But now, enormous investments in each segment of the value chain are inevitable.
In its refining business (90 per cent of RIL’s revenue) global capacity is moving from West to East, demanding more capital spend. It needs to create the next level of differentiators to enhance gross refining margins (GRN) as competitors, including Essar and Bharat Petroleum, are catching up. Its GRN is reducing over the last two quarters, and return on capital is dropping sharply. Its market capitalisation has been eroded and it recently lost the ‘most valuable company’ status to TCS and ONGC. A ‘war chest’ of financial resources is needed to address these issues.
With these challenges, foraying into businesses like retail, broadband and aerospace, which are undeniably attractive opportunities, can erode its competitive edge in the core business.
Besides, establishing differentiators in the new businesses becomes extremely difficult. For example, RIL’s penetration and market share gain in retail over last six years is modest while focused competitors Bharti Retail, Future group and Aditya Birla have been aggressive.
In digital broadband, Airtel has already launched its 4G services in selected circles, whereas RIL is not yet ready, in spite of being two years since it acquired Infotel. It is true that the macro-economic climate is weak, but is increasing complexity in RIL’s core business and diluted focus showing up?
RIL has remained a model in the Indian capital market as a superior value creator; this does give comfort that it can replicate this success in its diversified businesses as well. However, its current diversified position may warrant the management to take a serious re-look at its strategy.
The management, however, seems confident and recently demonstrated this through announcing one of the largest buy-backs of shares in India’s corporate history.
(The author is a management consultant.)