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Posted by on in Management

The old saying “When the going gets tough the tough get going” is probably most apt to describe the current situation that most organizations are facing!  There is pressure all around – strong evidence of slowing down of the economy, inflation -prices  of key raw materials are going up, interest rates are going up all of which are clear pointers that margins are going to be under enormous pressure.  It would not be possible to increase prices under these circumstances or even maybe suicidal!

In an extremely challenging and competitive environment, like this, it is impossible to pass on all increases in costs to customers. The fact is that the customers have become very discerning with greater choices and more importantly availability of information. In such a situation if a company is desirous of increasing or retaining customers, it may even have to do it by reducing its prices without compromising on its profitability. It then becomes imperative for them to target all costs that do not add value to its products. 

It is here that companies should focus on a great opportunity to focus on “Cost of Quality”.  Like the term quality itself, the term “Cost of Quality” is used loosely and not entirely in the right context.  The term “Cost of Quality” refers to the summation of all costs associated with not delivering product or service in accordance with the requirements. These requirements can be regulatory, customer specifications or even internal.

Many organizations while monitoring performance do not measure this in its entirety effectively losing a great opportunity to manage costs.  It is estimated that in a typical organization the cost of quality would in be region of 30% of its sales, if not higher, while ideally the number should be less than half of it. The problem is that there is really no validated data but past experience does tend to point towards these numbers.

There is management quote that says that “What is measured gets managed”. A focused assessment of cost of quality will have an impact not only on the profitability of the company but on the quantum of resources that a company would require.  It could reduce the inventory requirements, make the collections more efficient and probably even impact the fixed assets acquisition.  Interest rates being high the lower the capital employed the better it would be.

There are four broad parameters under which “Cost of Quality” has to be measured under two categories.  The categories are “Cost of Non-conformance” and “Cost of Conformance”. Costs of Non-conformance include costs associated with internal failures & external failures. Conformance costs include costs of appraisal and costs of prevention.  To elaborate, internal failures would include costs associated with wastages & scrap, rework, breakdowns etc and external failures would include warranty claims, costs associated with addressing customer complaints, litigation costs etc.  Appraisal costs would include all costs associated with inspecting goods and services to ensure that they meet the specifications.  Preventive costs are costs associated with establishing good systems, training costs etc. In the ultimate analysis the first three costs namely internal failures, external failures and appraisal costs have to be brought down.  Preventive costs are proactive measures and it is the only cost that is permitted to go up though its incremental growth has to be continuously brought down.

It is strongly recommend that all costs are monitored using the four M approach – Men, Machines, Materials and Methods.  This captures all the elements of costs barring financial costs though even that is done indirectly.  The various parameters of costs of quality can be monitored under the above four heads and it would be possible to get a fairly reasonable picture of what the targets should be.  Every organization tends to have some low hanging fruits and that can easily be initial target. 

For prioritizing the target the ABC analysis of costs would be best approach where “A” items could account for about 65% of total costs, “B” 25% and “C” 10%. Invariably material and labour costs account for a significant part of the costs and that would be best starting point. It has been observed that revisiting the bill of material and checking out the ideal material consumption norms is very effective. It is critical to get back to basics and use the zero base approach where you have to justify expenditure from the first rupee. Better material specifications, choosing the right vendor are all integral part of the exercise.  We must remember that when are sourcing goods and services we not buying just products but capabilities.  Coming to manpower costs, much higher in the context of service industries, good job definitions, recruitment policies go a long way in reducing costs.

The cost of quality can also be used judiciously by companies to compensate employees as a part of their variable pay component.  This will make the employees also part of the process of cost management.

In addition to constantly monitoring cost of quality it is critical to monitor capacity utilizations. Capacity utilization monitoring helps to take dynamic pricing decisions to ensure that organizational activity is maintained at a healthy level. Again the primary metric would have to change depending on the industry, why a typical manufacturing company would monitor the capacity determining equipment a service company should be monitoring the utilization levels of the manpower. For example in a situation when the capacity utilization low it may be good idea to price a product or service below full cost recovery. That would ensure atleast partial recovery of fixed costs. From a metric perspective, it would be good idea to monitor “Overall Equipment Effectiveness” as it considers all the aspects namely availability, efficiency and quality. Best in class measures of OEE would be anything in excess of 85%.

Management of cost of quality is definitely the right route to cost optimization and strongly recommended even in good times!

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The scourge of “Bad Loans” have been occupying a fair amount of space in not only the news headlines but in most financial discussions.  As that was not really enough, the recent arrest of a “Start-up” entrepreneur for failing to pay his debts to the vendor accentuated the discussions a lot ore. The objective of this article is not to analyse the reasons for any but to examine the way forward given the fact that bad loans are integral part of business as much as failure or problems part of the entrepreneurial journey as some business plans are bound to go wrong.  Neither, within acceptable limits, are a stigma and warrants a rational approach to find a long term sustainable solution.

It is against this backdrop that the Insolvency and Bankruptcy Code 2016 that has become law, partially, in December 2016 needs to welcomed, or if one is permitted to say so, with an open mind to ensure that every effort made that it succeeds.  It may not be out of place for one to immediately draw comparisons or evaluate the efficacy of this new law against the ones like “Recovery of Debts and Bankruptcy Act, 1993 (more known for the Debt Recovery Tribunals) ; Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002 (SARFAESI!) or Sick Industrial Companies (Special Provisions) Act 1985 (remember BIFR) not to speak of the archaic & vintage laws like the Presidency Towns Insolvency Act 1909 and Provincial Towns Insolvency Act 1920! There are more, in terms of circulars issued by RBI, for those who want to question this one, Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR) and Scheme for Sustainable Structuring of Stressed Assets (S4A).

Concept of Golden Hour

Problems in business are akin, sometimes, to grave health issues or an accident where the “Golden Hour” assumes immense significance.  A time that could determine if the patient survives. Business is no different too.  We need to give that chance to survive. Not all businesses turn irretrievably bad in a short time. Even the worst cases can become sustainable if pivoted at the right time.

The Insolvency and Bankruptcy Code 2016 (IBC) has rightly placed the emphasis on the revival of the enterprise by bringing in a structure that facilitates it.  A company that has defaulted can be referred to the Adjudicating Authority for evolving a Resolution Plan.  The application can be preferred by either Creditor, Financial or Operational or the company/members/directors/partner/proprietor immediately on a default. 

Time Bound Process

One of the most positive aspects of the Code is the fact that it is time bound.  A resolution plan for the turnaround has to be finalised and approved with 180 days, with a provision for a one time extension of 90 days.  If the various parties are unable to find a sustainable resolution, the defaulting enterprise is sent for automatic liquidation/bankruptcy.  The time bound process should definitely not only reduce the agony of all but also ensure better realisations on the assets which are currently a pathetic twenties in terms of percentage of recoveries. This does not take into consideration the good money being spent in perpetual hope of a turnaround.


 

Shift of Power

Another major change from erstwhile practice on dealing with debts in default is shift of power from the debtor to the creditor. Law has finally recognised that the promoters control on the enterprise is not a divine power.  When the application for resolution is accepted by the adjudicating authority a Resolution Professional, interim for the first 30 days, is appointed who essentially takes over the entire management of the enterprise.  This includes assets and business where the powers of the directors/partners/proprietors stands suspended and is exercised by the Resolution Professional.  The powers, and therefore accountability, of the Resolution Professional are quite comprehensive and also facilitates symmetry of information between enterprise & its creditors. This is quite relevant in the context of determining the state of affairs of the enterprise.  The powers of the Resolution Professional is not absolute as those powers are exercised based on the decision of the Committee of Creditors (CoC) comprising primarily of the Financial Creditors, only in the absence of whom the Operational Creditors, representatives of the workman and employees.  All decisions, including the Resolution Plan, have to be approved by 75%, in value terms, of the CoC. The Resolution Professional is vested with the responsibility of executing the decision of the CoC. 

One question that is bound to inevitably crop up is about the Resolution Professional.  The whole resolution process comes under the aegis of the Insolvency and Bankruptcy Board of India a statutory body that has been created under the Act that has been empowered to ensure proper conduct of the resolution process.  Another issue relates to the ability of the Resolution Professional to manage the affairs of the enterprise whilst under resolution process.  The challenge here is on the understanding.  The Resolution Professional is expected to engage with other professionals, including domain experts, in the management of affairs of the enterprise during the period.

Moving Forward

Going forward the IBC is going to be the single point resolution process for financial defaults.  The authority for adjudication being vested with the National Company Law Tribunal (NCLT) for Companies & Limited Liability Partnerships and Debt Recovery Tribunal for Partnerships Firms and Individuals.  In the case of individuals who have offered personal guarantees in respect of corporate/LLP loans, the jurisdiction will lie with the NCLT.

One of other key aspects that warrants closer review from the banks is that the IBC should not be viewed from a limited perspective of another law to deal with the NPAs.  IBC may not be able to achieve what the others have not except that the liquidation/bankruptcy proceedings will be initiated at the expiry of the resolution period!  IBC should be used as an opportunity to deal with enterprises that are showing early stress.  Dealing with them at that stage would give greater elbow to all the stakeholders rather than allow the ship to run aground when the only option would be to send it to the ship breaking yard.

A collateral to the comprehensive and time based resolution mechanism would also bring a greater buoyancy to the corporate debt market that would help not only corporates to raise monies would give investors an investible opportunity.

In the final analysis, it quite possible that we may still be confronted with a couple of sticky issues but those should not be allowed to stand in way of ensuring the success of the Code.  Structured, well calibrated system for exits are integral part of the entrepreneurial ecosystem and this could well be one of key cogs in the wheel.

R Venkatakrishnan  FCA rvk@rvkassociates.com

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