Friday, February 27, 2015

The Drug Pipeline Flows Again

For decades, victims of advanced melanoma had few treatment options. Most died within a year from the virulent skin cancer. Now a new generation of biotech treatments—targeting proteins that allow cancer to evade the body’s own defenses—is poised to change that. One new drug, Bristol-Myers Squibb’s Opdivo, boosted one-year survival rates in trials to 73 percent from 42 percent for standard chemotherapy.
There’s one problem with Opdivo: It costs $150,000 a year per patient. It and dozens of other cancer drugs are problematic for insurers and employers who are being asked to foot the bill. More than 30 cancer drugs that hit the market from 2010 to 2014 cost $5,000 a month or more, according to data from Memorial Sloan Kettering Cancer Center in New York. Express Scripts, which administers prescription benefits for 85 million Americans, considers cancer treatment one of its cost control priorities.
A decade after Big Pharma worried that it wouldn’t have enough drugs in the pipeline to maintain the costly research-driven business, the industry is enjoying a rush of expensive breakthrough medicines promising treatment for everything from rare cancers to hepatitis C. That’s put the drug industry at odds with those picking up the tab for medical science’s successes.
The conflict threatens to slow the pace of future discoveries and patients’ access to the drugs. Pharma stocks have dropped when Express Scripts and other pharmacy benefit managers have decided to favor cheaper drugs over pricey ones. Express Scripts ignited a price war in December for hepatitis C drugs when it excluded a new drug from Gilead Sciences that cost more than $1,000 a day from its main list of covered drugs. Instead it favored a competing medicine from AbbVie, which offered significant discounts to get the business. “The costs are just so staggering, the health-care system cannot sustain it,” says Steven Avey, vice president for specialty programs at MedImpact Healthcare Systems, a prescription benefits manager.
Leonard Schleifer, chief executive officer of Regeneron Pharmaceuticals, which is working on a cholesterol-fighting drug, sees it differently. “You are going to stop people from innovating” if coverage is limited to drugs with the lowest prices, he says.

Drug coverage is approaching a breaking point, says Stephen Schondelmeyer, a pharmacist and economist at the University of Minnesota, who’s been following drug prices for decades. “We can cut prices, cut the drugs that are covered, or cut the number of beneficiaries, and none of those are very palatable,” he says. “All mean reduced revenue for the drug companies. We will have to do one or more of those three things at some point in the next five years.”
The 41 new drugs approved in 2014 by the U.S. Food and Drug Administration were the most in 18 years. Nine received expedited treatment as FDA-designated breakthroughs, including Opdivo, Merck’s rival melanoma treatment Keytruda, and two hepatitis C treatments: Gilead Sciences’ Harvoni and AbbVie’s Viekira Pak.
Scientific advances, more investment in biotech, and new FDA expediting policies are increasing the chances of more discoveries. Researchers at IMS Health, which tracks and sells prescription data, say about 30 to 35 drugs a year will come to market through 2018, vs. an average of 25 from 2000 to 2013.
None of the closely watched cardiology drugs that Regeneron, its partner Sanofi, Amgen, and others are working on have gained FDA approval, but they’ve already triggered cost alarms. Known as PCSK9 inhibitors, the drugs aim to mimic the effects of genetic mutations discovered a decade ago that reduce heart disease risk by as much as 88 percent by lowering levels of LDL, the bad cholesterol. In testing, the new inhibitors cut LDL by 60 percent.
CVS Health, the second-biggest drug benefits manager after Express Scripts, said in a blog post on Feb. 17 that some of the drugs are expected to be approved this year and stand to be “the highest selling class of medications in history,” with annual sales as high as $150 billion, equal to about half of all current U.S. drug spending. “We will be attempting to address this with every approach that pharmacy benefit managers use,” says Troyen Brennan, CVS’s chief medical officer. Express Scripts has said it’s considering all the options for how to cover the PCSK9 drugs and hasn’t ruled out restricting coverage to just one of the drugs to get a discount. CVS says they will cost an estimated $7,000 to $12,000 a year, or as much as 60 times more than the generic statins that are typically prescribed to fight cholesterol.
Executives who get too aggressive with pricing risk big stock drops—and their jobs. Sanofi shares fell the most in 15 years on Oct. 28, when it said sales of its diabetes drugs would be little changed this year because it had to cut prices of its Lantus insulin medicine to stay on benefit managers’ lists. CEO Chris Viehbacher, who had clashed with Sanofi’s board over other issues, was ousted the next day.
Express Scripts dropped GlaxoSmithKline’s asthma drug Advair from its main list of covered drugs in 2014 over pricing issues. U.S. sales of the drug fell 25 percent. Advair made it back onto the list this year after Glaxo lowered the price, according to Express Scripts spokesman David Whitrap. Still, sales of Glaxo’s U.S. drugs and vaccines slumped 10 percent in 2014.

So far, the payer backlash isn’t reversing the expensive trend. The average price of more than 5,000 commonly used prescription medicines rose 11 percent last year, a rate 14 times higher than that of U.S. consumer inflation, according to Truveris, a maker of software that analyzes prescription drug prices and benefits. IMS sees prescription spending in the U.S. growing to about $450 billion in 2018, from $329 billion in 2013.
In Europe, drug companies have long had to negotiate drug prices with governments. Since the financial crisis, pressures to keep prices down have increased. The U.K. has a state-run agency that advises its National Health Service on which treatments represent value for money.
“There is a lot of innovation on one hand, but the U.S. market is getting more challenging and more price-competitive,” says David Redfern, chief strategy officer for GlaxoSmithKline. “It’s not only one or two therapy areas; it’s clearly moving out to other therapy areas.” While the total number of applications to the FDA isn’t going up, the medicines the agency reviews “are much more effective than we have seen in the past,” says John Jenkins, director of the FDA’s office of new drugs. Forty-four percent of drugs approved in the last three years are totally new classes of medicines, the agency says, vs. 27 percent from 1987 to 2001.

Jenkins cites Cosentyx, a psoriasis drug from Novartis, as an example of how effective new, targeted biotech drugs can be. In human tests, the drug almost completely cleared signs of psoriasis in most patients. The drug, which was recently approved, is likely to be priced similarly to other psoriasis drugs costing $30,000 a year or more, says David Epstein, head of Novartis’s pharmaceuticals unit. But he says he’s prepared for a price war when drugs from Amgen, its partner AstraZeneca, and Eli Lilly hit the market.
In cancer, “it wasn’t that long ago” that the FDA was being asked to approve drugs that shrank tumors in only 10 percent to 15 percent of patients, the FDA’s Jenkins says. “Now we are seeing drugs with a 50 to 60 to 70 percent response rate.” The pricing pressure is aggressive and challenging, according to Glaxo’s Redfern.

“From a scientific standpoint, it has never been a more exciting time,” says Steve Miller, chief medical officer of Express Scripts. “But how are you going to pay for it?”

Thursday, February 26, 2015

Oil Sails From Russia to Asia Faster on Smaller Ships

 With supertankers booked solid carrying cheap crude, smaller vessels are taking advantage of the opportunity by hauling record volumes of Russian oil to Asia.
Aframax ships that ply the route between the Russian port of Kozmino and North Asia in three days, compared with journeys of a month for supertankers from the Middle East, are carrying the most ever East Siberian Pacific Ocean Pipeline oil to China, South Korea and Japan. The demand has pushed ESPO’s price to the highest since July versus benchmark Dubai crude, according to industry consultant KBC Energy Economics.
Oil buyers are hiring 30 percent more Aframax tankers compared with last year’s average, potentially benefiting owners including Mitsubishi Corp., Hin Leong Trading Ltd. and Sinokor Merchant Marine Co. The glut that drove global prices down by about half lifted demand for stockpiling at sea in the biggest vessels, pushing their rates in December to the highest for any month since January 2010, and more than double those for the smaller ships.
“Russia is sending more and more crude to Asia at the expense of Europe, while interest in offshore storage has returned and freight rates have increased,” Ehsan Ul-Haq, a senior market consultant at KBC in Walton-on-Thames, England, said by phone.

ESPO Premium

Stronger demand for Russian crude helped ESPO fetch as much as $3.50 a barrel more than the benchmark Dubai grade for cargoes loading in March, according to data compiled by Bloomberg, up from a $2 premium in January.
A total of 26 cargoes of ESPO crude, or a record 615,000 barrels per day, are scheduled to be shipped in March, according to a loading schedule obtained by Bloomberg. That’s 30 percent more than a monthly average of 20 loadings last year, data show.
An Aframax sailing from Kozmino to Japan’s Chiba port was fixed at a rate of 90 cents a barrel this month, little changed from what it cost in October, according to Seatown Shipbroking Pte.
The price for hiring a supertanker from the Arabian Gulf to Japan surged to a five-year high of $2.38 a barrel in December, compared with $1.34 in June, before the collapse in oil prices began, data compiled by Bloomberg show. The rate has averaged $2.20 this year.
Front-month futures for Brent, the benchmark for more than half the world’s crude, averaged $5.56 a barrel below six-month contracts during January, compared with a $2.77 premium in June, data compiled by Bloomberg show. This market structure, known as contango, may make it worthwhile for traders to store oil and petroleum products to sell later. It was at $3.82 a barrel discount at 12 p.m. Singapore time.

Time Charters

Vitol Group, Koch Industries Inc., Royal Dutch Shell Plc and Trafigura Beheer BV have booked tankers that could be used to store crude at sea for one-year charters, according to reports from shipbrokers including Optima.
As many as 35 tankers were booked for time charters with capacity to store as much as 66 million barrels of oil, according to three shipping reports compiled by Bloomberg on Feb. 7. More than half of the vessels were fully fixed for periods of six months to two years.
Spokesmen at Sinokor Merchant Marine, Hin Leong and Mitsubishi, shipping and trading companies that operate vessels on the Kozmino-to-Northeast Asia route, declined to comment on the tanker market.

Siberian Pipe

Russia built the ESPO pipeline, a 3,000-mile link from the Siberian town of Taishet to Kozmino on its east coast to supply more crude to Asia as demand from traditional markets in Europe slowed. The port loaded its first cargo in 2009, while the pipe was completed in 2012.
“Asia is the only market that is witnessing any increases in oil demand,” said Hong Sung Ki, a commodities analyst at Samsung Futures Inc. in Seoul. “With Russia and OPEC producers both eyeing the Far East, the price war has begun for bigger market share and we’re likely to see more and more of it.”
Russia boosted sales of its crude to China, Japan and South Korea by 25 percent last year, increasing its portion of shipments to 8.7 percent from 7.2 percent in 2013, according to government data compiled by Bloomberg.
The proximity of the Kozmino port to Asia presents ESPO with a benefit versus Middle East crude, which takes about a month to arrive in the Far East.
“For the Russian grade, immediate demand from the regional refiners could be met because of the geographical advantage,” the Korea Petroleum Association, a Seoul-based group that represents the country’s refiners, said in an e-mail. “As a result, we’re seeing the crude getting more and more attention.”

Saturday, February 21, 2015

The churn in the retail sector

What impact is the fledgling e-commerce industry having on the profit of mainstream retail companies? Here are a few indicators from the last quarter’s corporate results and management commentary. Shoppers Stop Ltd’s like-to-like sales growth last quarter for the Shoppers Stop department stores stood at 0.8%, the lowest for past 12 quarters. Like-to-like sales growth refers to comparable sales growth from stores that have had operations for over a year and does not take into account growth coming due to new stores. A key reason that led to Shoppers Stop’s weak sales performance was the stiff competition from online retailers. Heavy discounts and lots of advertising from the online counterparts spoiled the festival season for brick-and-mortar firms this time around. “One of the big elements that we see clearly is the online sales and the kind of disruption that the online space is bringing to the entire retail field,” said the company in its post-results conference call. Titan Co. Ltd’s watch business, too, faced the heat from online companies. Titan saw a 4% decline in watch volumes during the December quarter. The company maintains that the festival season was damp last quarter. “Of course the Flipkart sale etc., would have drawn out many walk-ins to our consumers,” said Titan in a conference call. The biggest thing was the fact that the consumer was not willing to spiritedly purchase during Dussehra and Diwali, added Titan. Fortunately, the watch business contribution is smaller at about 16% of the earnings before interest and tax (Ebit) in the December quarter and hence it wouldn’t perturb investors as much. Another company that suffered during the quarter was TTK Prestige Ltd, revenue growth for which slowed to 3.9% year-on-year to Rs.384 crore as physical stores have started stocking less. T. T. Jagannathan, chairman from TTK Prestige, said, “We expect revenue growth to halve to 10% in FY15 as customers are shopping more from online channels which is hurting sales at brick-and-mortar stores. The distributors are stocking less and inventory holding has come down to 20 days from 40 days earlier. This is equivalent to 8% of our annual sales and we have lost that much.” Another firm that was adversely impacted during the quarter due to heavy discounting from online sales was Kewal Kiran Clothing Ltd. With the online space growing at a rapid pace, it goes without saying that offline companies will have to look for ways to counter online competition. TTK Prestige is trying to come out with more consumer schemes—discounts and freebies to boost offline sales. Shoppers Stop intends to strengthen its own online infrastructure. It will be important to watch out how the situation evolves over a period of time in the coming quarters, for both online and offline. But the clear moral in this story is that the brick-and-mortar companies can no longer afford to take the new kids on the block casually.


NBFCs to prosper as credit requirement for clean energy projects poised to increase six-fold

The paucity of bank credit for renewable energy projects has made the sector the next growth area for non-banking financial companies such as Tata Capital, L&T Infrastructure Finance and PTC Financial Services.

The lending requirement for solar, wind and other clean energy projects is poised to increase sixfold from Rs 20,000 crore a year currently, if the government's target of adding 20 gigawatts of green power annually is to be met.

Over the past few years, wind and solar energy companies have found it hard to get banks to finance their projects as most of them have supposedly exhausted their lending cap to the power sector. Also, bank loans have turned bad because some power projects were affected by cancellation of coal blocks, scarcity of gas, absence of power purchase agreements and land acquisition hurdles. These limited the availability of bank credit for clean power projects, a gap that NBFCs now seek to fill.

NBFCs to prosper as credit requirement for clean energy projects poised to increase six-fold
India's clean energy capacity, including solar, wind, hydro and biomass, stands at 33 gigawatts. The government aims to install 170 gigawatts by 2022, entailing a fundingrequirement of $200 billion.

Tata Cleantech, the clean-energy lending arm of Tata Capital, is looking to become an infrastructure finance company so that it can source foreign funds for lending to renewable power projects.

"Our exposure at present is Rs 1,000 crore to the renewable sector. In future, we want to play a significant role and want to get involved in setting up of 2 gigawatts of clean energy in 3-5 years.

This could mean 30% of Tata Capital's total infrastructure lending," Tata Cleantech CEO Arijit Bhattacharya told ET. L&T Infrastructure Finance is considering issuing bonds and is awaiting the government's green signal to allow infrastructure debt finance to fund clean energy projects.

"This has been the most attractive area in last 2-3 years, with 50% of our energy exposure to clean energy. In the next one year, 40% of our total lending will be to this sector. Ours is a Rs 20,000-crore-plus balance sheet and this is going to be a big opportunity for us," said L&T Infrastructure Finance CEO G Krishnamurthy.

Although NBFCs charge a higher interest rate on loans than banks, clean energy project developers may still find them an attractive option because they offer faster financial closure.

"Banks take a few months to close a project. But we take only 15 days to communicate to a project developer whether we are going ahead or not and we're able to close it within 30-45 days," said PTC Financial Services MD & CEO RM Malla.

PTC Financial will have almost 50% exposure to renewables at Rs 2,000 crore by the end of this financial year, which the company plans to increase.

"We can arrange funds for, say, a 50-200 megawatt project. But that's not possible for a 1 gigawatt project. Only reason we go to NBFCs is that they are quicker.

However, we need more sources of funding in addition to these," said Vikram Kailas, MD of Mytrah Energy, a wind-energy company. Experts say NBFCs should adapt by structuring loans for longer periods and lowering interest rates.

Internet traffic in India grew 74%, 3G usage more than doubled

Mobile Internet usage in India grew by 74 per cent, driven by 3G traffic which more than doubled last year, says a study by Nokia Networks.
“There has been huge growth momentum of data usage in India on wireless networks driven by 3G traffic. The data usage grew by 74 per cent and 3G usage was up by 114 per cent at end of 2014, compared to 2013,” Nokia Networks Vice President and Head of India Region Sandeep Girotra said here.
The 2G mobile Internet usage grew by 41 per cent in 2014, as per Nokia Network’s MBit Index study.
The study is based on data collected from Nokia Network’s reach in Indian telecom network — about 30 per cent in terms of network and 70 per cent as device management business.
In terms of actual quantum, the total mobile Internet traffic grew to 85 petabyte (PB) at the end of 2014 from 49 PB in 2013. 3G usage is estimated to have contributed 52 per cent in the total data consumption.
“On an average a 3G subscriber in India consumed three times more data than a 2G subscriber. 3G is driving the data growth but 2G growth is stabilising. Based on ecosystem, I feel 2G is going to be there in India. Now operators need to further strengthen their 3G network,” Girotra said.
In terms of usage, it is not metros but category A service areas — Maharashtra, Gujarat, Andhra Pradesh, Karnataka and Tamil Nadu — that contributed most to the overall data usage as well as 3G. The 3G usage in these service area increased by 129 per cent in 2014 compared to previous year.
There are eight category B circles that accounted for second highest data consumption at 30 per cent. The 3G usage in these circles grew by 107 per cent. Metros – Delhi, Mumbai and Kolkata – followed category B service areas in terms of data consumption.
“This can be because metros are small compared other category circles. Also people have various means to access Internet apart from mobile,” Girotra said.
He said the factors that impacted data growth were kind of devices available in the market and network coverage.
“In 2014, as per industry study, 258 million devices were shipped in India. Out of this 22 per cent were 3G smartphone, 70 per cent were feature phone, 7 per cent 2G smartphone and 1 per cent 4G,” Girotra said.
Telecom operators, who have 3G spectrum, now cover about entire metro, almost equal to that of 2G network in Category A service area, he said.
“In category B and C service areas, 3G coverage is about 40 per cent and 30 per cent as that of 2G network. Next, we will see 4G data usage also picking up. At present 4G numbers are very small,” Girotra said.

NDA government hits reset on road projects

In a desperate attempt to revive private investment in the roads sector, the government on Wednesday hit the reset button. Not only will investors now be required to contribute only 60% of the project cost, they have also been relieved of the politically sensitive burden of collecting tolls. By derisking the project for developers, the government is seeking to put in place a gamechanger that would revive investor interest in road building. The entry of private sector is key to the government realizing its target for constructing roads. It is estimated that the government requires nearly Rs.2 trillion to fund 20,000km of road construction under the National Highways Development Project over the next four-five years. The roads ministry on Wednesday proposed a new model of highway development—the so-called hybrid annuity model. The new model deviates from the existing models through reallocation of risks in road construction. The new model proposes to cushion developers from the risk of revenue uncertainty arising from inaccurate traffic projections and divide the financial burden between the developer and the government. Under the new model, the developer will have to contribute just 60% of the total project cost while the balance will be invested by the government. The government will collect the toll under this model and pay the developer a biannual annuity for recovering investment and interest costs and fee for operations and maintenance. Under the existing public private partnership model called build-operate-transfer, the developer absorbs most of the risks—financial, operations and maintenance and revenue. “The idea is to provide a transparent, time-bound mechanism to fast-track decision making and anticipating solutions to issues that could arise through a built-in approach so that private sector interest is revived,” Nitin Gadkari, minister of road transport, highways and shipping, said at a Confederation of Indian Industry conference. With this new model, the government is hoping to address several issues like access to finance, inaccurate revenue assessment, delay in clearances and long-drawn dispute resolution mechanisms that have thwarted private sector interest in the roads sector. The ministry failed to get any bids for at least 21 projects worth Rs.27,000 crore between fiscal years 2013 and 2014. “I am very optimistic about the outcome of this new model. It is a practical approach to problem solving and a risk allocation model as appropriate as can be under the circumstances,” said Vinayak Chatterjee, chairman and managing director, Feedback Infra Pvt. Ltd, an infrastructure consultancy. “The key takeaways are that the private sector does not have to take the traffic risk, it apportions risks where they really belong, it is a win-win for all stakeholders and a structure that will allow the sector to attract even long-term financing by improving its creditworthiness. We could see massive resurgence of both private and foreign investment,” he added. The government has, over the last two years, taken several measures like permitting rescheduling of premium commitments of developers, allowing an early exit to developers through the substitution route to free up capital and de-linking of environment and forest clearances, in order to revive investment in the roads sector. With the private sector not responding to these incentives, the government reverted to awarding most road projects under the government-funded model called engineering, procurement and construction. The premium here is the money road developers agree to pay the National Highways Authority of India (NHAI) for building highways and collecting toll from users. However, the ministry of road transport and highways concedes that funding road projects through government money is unsustainable and hopes the hybrid annuity model would mobilize some private capital for road infrastructure. “The major advantages that would emanate from this framework are the reduced initial capital outflow for the authority, which will further allow us to spread our resources in a wider net and govern a larger portfolio of road projects,” said Vijay Chhibber, secretary, ministry of road transport and highways. “This arrangement would also ease the debt servicing for head concessionaires as the quantum of debt required would get reduced,” he said. “So in this framework while the private sector continues to take the construction and O&M (operations and maintenance) risks, unlike with BOT toll projects it is not expected to take traffic risks, which has been suggested is one of the main issues on behalf of the builders’ forum. And I think lastly, we believe it will bring back the lenders into the road sector as toll revenue streams to service the debt will be inbuilt into the framework,” he added. Chhibber said the ministry had identified 13 projects stretching to 1,100km worth Rs.14,442 crore to be awarded under this model as of now. The new model adjusts project cost for inflation at different stages of the project. It also staggers the government equity support in five equal instalments, linking it to physical progress of the project and expenditure incurred by the concessionaire. The concession agreement for the model incorporates a slew of key changes. To avoid delays on account of delayed land acquisition, it raises the government obligation to acquire at least 90% of the land required, along with environment and forest clearances for the same. Earlier, NHAI was required to acquire 80% of the land. It provides for a sharper penalty for delay in fulfilling obligations, either on the part of the government or the concessionaire. It has proposed to raise the penalty for government to 0.2% of the performance security for each day’s delay from 0.1% earlier. For the concessionaire, a similar delay would be charged at 0.3% of the performance security as compared with 0.2% earlier. It also sets one year as the upper time limit for terminating a project if either the government or the developer fails to fulfil obligations that prevent the project from taking off. Interestingly, this model also incentivizes the concessionaire to complete projects ahead of schedule by offering a bonus for early completion. A provision to refinance projects has also been added. Gadkari said that the ministry is open to feedback on this model for the next 15 days, after which it will formally notify the hybrid annuity model.


90% of Indian brands to spend 15% of promo budget on social media: EY

Companies and brands have significantly increased theirspends even as they find it challenging to measure the effectiveness of their social media engagements according to EY’s second annual Social Media Marketing India Trends Study.

About 90 per cent of organisations reached out to in this study are planning to spend as much as 15 per cent of their annual exclusively on social media, up from 78 per cent organisations in 2013.

Digital and social media presence is a key element in the marketing mix of most brands.

About 23 per cent respondents stated that their social media budgets were in excess of Rs 1 million per annum and 14 per cent of the brands spent Rs 1-2 crore on social media in 2014.

There was a decline in the number of brands that spent in excess of Rs 2 crore from 17.1 per cent in 2013 to 14.3 per cent in 2014 indicating that brands are exceedingly cautious on the returns and are optimising spends.

As integrated campaigns are reckoned as effective, being able to correctly attribute leads, attain conversions and returns to channels, campaigns and devices will determine how budgets are allocated going forward.

The study analyses how Indian marketers and organisations have been using the various social media platforms and how they go about tracking the performance of their social media initiatives. Brands across industries have realised the significance of social media and its peculiar demands, said the report.

In 2013, the study also found out that Social media is being increasingly used for thought leadership and internal communications, recruitment, and in addition to marketing.

About 35 per cent of the organisations said that they use social media for thought leadership and around 27 per cent said they use the medium for CSR.

Increasingly the HR department is leveraging social media for internal employee outreach through unique platforms.

Dinesh Mishra, Partner and Customer Practice Leader (India), Advisory services, EY, said: “Through this study we reached out to India’s top social and digital savvy brands from the third quarter of 2014 to January 2015. It is our observation that while brands have invested financially and in processes, there is a need for holistic customer engagement and strong community building strategies through the use of social media. That, in my mind, will strengthen the brand and allow for innovative and meaningful interactions between communities, as well as between the company and the community.”

“About 32 per cent of digital-savvy brands in India depend on the internal core team for strategy but the average team strength is small varying from 1-3 people.

Given the mass reach and quick response time in social media, ownership plays a critical role in success. Every organisation irrespective of size must focus on developing capabilities and creating a strong internal governance framework,” he added.

Defence equipment business has companies interested like never before

The government’s Make in India programme, the belief it will spend far more aggressively than its predecessors on upgrading the country’s armed forces in terms of equipment, and growing opportunities presented by offsets are encouraging well-heeled conglomerates to venture into the defence equipment business. On Wednesday, at the Aero India 2015 exhibition and conference in Bengaluru, Bharat Forge Ltd and Anil Ambani’s Reliance Group detailed their foray in the defence equipment manufacturing space, joining the Tata Group, Reliance Industries Ltd (RIL), Larsen and Toubro Ltd (L&T), the Godrej group and the Mahindra Group that have been in the business for some time. For over 15 years, India has tried to interest its private sector in the business and while it has succeeded in doing so to some extent, domestic defence manufacturing is dominated by defence public-sector undertakings (DPSU) and the Ordnance Factories Board (OFB), which together have an 80-90% share. Such efforts are finally coming to fruition now because of three reasons. The first is the pressing need to modernize India’s armed forces. “A vast percentage of our equipment is of the 1970s and 80s vintage and have reached their end of life status,” said Amber Dubey, partner and India head of aerospace and defence at consultancy firm KPMG. “Our technology gap with China is increasing by the day and needs to be arrested and reversed as a national priority.” According to KPMG India, the defence ministry expects the defence budget to grow at a compounded annual growth rate of 8% to touch $64 billion in the financial year 2020. The growth will primarily be driven by capital expenditure—the component of the defence budget used for creation of assets and expenditure on procurement of new equipment. India will see a total defence budget allocation of $620 billion between financial year 2014 and 2022 of which 50% will be on capital expenditure, according to a report released by the industry lobby the Federation of Indian Chambers of Commerce and Industry (Ficci) and financial services company Centrum Capital Ltd this month. The annual opportunity for Indian companies—both state-owned and private—is expected to reach $41 billion by financial year 2022 and $168 billion cumulatively, it said. The second is the government’s ambitious Make in India campaign aimed at attracting foreign companies to invest in India’s manufacturing sector. The local manufacture of defence equipment is at the heart of the Make In India programme, Prime Minister Narendra Modi said at the inauguration of Aero India 2015 on Wednesday. Thecountry imports nearly 60% of its defence equipment, spending tens of billions of dollars, he added. “There are studies that show that even a 20 to 25% reduction in imports could directly create an additional 100,000 to 120,000 highly skilled jobs in India. If we could raise the percentage of domestic procurement from 40% to 70% in the next five years, we would double the output in our defence industry,” Modi said. He said it will be no longer enough to buy equipment and simply assemble in India. “India’s frugal but sophisticated manufacturing and engineering services sectors can help reduce costs. India can also be a base for export to third countries,especially because of India’s growing defence partnerships in Asia and beyond,” Modi added. The third reason is offsets—a policy that requires any foreign arms manufacturer securing an order worth more than Rs.300 crore from India to source components worth 30% of the value of the order from India. The offsets opportunity is expected to be worth $15 billion within the next 10-15 years, assuming that several proposed purchases are completed on time, according to KPMG. It could be worth much more. The minimum opportunity for domestic entities is $75 billion, given the 30% offset requirement, Edelweiss Securities Ltd said in a July 2014 report. On Wednesday, Modi said that the government is reforming defence procurement policies and procedures. “There will be a clear preference for equipment manufactured in India. Our procurement procedures will ensure simplicity, accountability and speedy decision-making,” he said. The government has raised the permitted level of foreign direct investment in the defence sector to 49%. “This can go higher, if the project brings state-of-the-art technology. We have permitted investments up to 24% by foreign institutional investments. And there is no longer a need to have a single Indian investor with at least a 51% stake,” Modi said. Industrial licensing requirements have been eliminated for a number of items. Where it is needed, the process has been simplified, he said. The results can already be seen, said one executive. Srinivasan Dwarakanath, chief executive officer of Airbus India, said a clutch of private companies, including conglomerates, are entering the aerospace and defence sector. “Five years ago, there were only defence PSUs but now there are many private companies. This is mainly because there are several defence and aerospace development programmes dedicated to India. For that, you need private companies with deep pockets,” Dwarakanath said. On Wednesday, Anil Ambani’s Reliance Infrastructure Ltd said it has formed three wholly owned subsidiaries—Reliance Defence Systems Pvt. Ltd, Reliance Defence Technologies Pvt. Ltd and Reliance Defence and Aerospace Pvt. Ltd—to pursue growth opportunities in the defence sector. The companies plan to start by manufacturing naval utility and army utility helicopters. So why are these private companies entering aerospace and defence? Reliance Industries Ltd (RIL), controlled by Mukesh Ambani, set up two defence subsidiaries—Reliance Aerospace Technologies Pvt. Ltd and Reliance Security Solutions Ltd—in 2011. The company will enter the defence space by investing and signing new deals with global original equipment manufacturers (OEMs) primarily towards offset arrangement of defence equipment, the Edelweiss report said. RIL recently signed an agreement with French defence firm Dassault Aviation SA. The company has also signed agreements with Raytheon Co. and The Boeing Co. of the US and Siemens AG of Germany for homeland security systems. Mahindra Group launched Mahindra Defense Systems division in 2000 and spun this off as a separate company in July 2012. The company makes artillery systems and armoured vehicles and hopes to increase revenue to $430 million by FY16E from the current $51 million. The Tata Group expects revenue of around Rs.2,500 crore, or more than $400 million, from its defence and aerospace business in the year to 31 March. Tata Sons Ltd said the current order book size of Tata Group in the sector is more than Rs.10,000 crore. Mukund Rajan, a member of the group executive council and brand custodian of Tata Sons, said that in financial year 2014, the group invested more than Rs.320 crore in the defence and aerospace sector. Bharat Forge, a part of the Kalyani Group, is looking at setting up manufacturing plants for artillery guns, anti-tank missiles, armoured vehicles and aerospace components and Larsen and Toubro Ltd (L&T) is aiming to build submarines. Bharat Forge chairman and managing director Baba Kalyani said the company will set up four manufacturing plants in India this year. “It’s time now for action,” Kalyani said on Wednesday. The Godrej Group plans to focus on developing niche manufacturing capabilities in building engines, providing maintenance, repair and overhaul services, and supplying replaceable components known as line-replaceable units. Kalyani Group will form a joint venture with Israel’s Rafael Advanced Defence Systems Ltd to develop and manufacture high-technology systems for the defence sector. Their joint venture company will include a wide range of technologies and systems, like missile technology, remote weapon systems and advanced armour solutions. Kalyani will hold 51% of the stake in the company while Rafael will hold 49%. “We believe in the vision of Make in India and our proposed joint venture with Rafael is a step in this direction,” Kalyani said in a statement on Thursday. “As part of our global strategy, we form alliances to develop military applications based on our proprietary technologies and in Kalyani Group we see a lot of synergy and opportunities for growth in new markets and especially in India which is strategic market for us,” said Brigadier General (Retires ), Itzhak Gat, chairman, Rafael. Dubey of KPMG said companies will need to choose the technology, scale, alliances and business model with care, or risk a sour experience. “Defence manufacturing is a long gestation but profitable business, provided one can be humble and patient,” he added.


India's economy: A chance to fly

EMERGING markets used to be a beacon of hope in the world economy, but now they are more often a source of gloom. China’s economy is slowing. Brazil is mired in stagflation. Russia is in recession, battered by Western sanctions and the slump in the oil price; South Africa is plagued by inefficiency and corruption. Amid the disappointment one big emerging market stands out: India.
If India could only take wing it would become the global economy’s high-flyer—but to do so it must shed the legacy of counter-productive policy. That task falls to Arun Jaitley, the finance minister, who on February 28th will present the first full budget of a government elected with a mandate to slash red tape and boost growth. In July 1991 a landmark budget opened the economy to trade, foreign capital and competition. India today needs something equally momentous.
India possesses untold promise. Its people are entrepreneurial and roughly half of the 1.25 billion population is under 25 years old. It is poor, so has lots of scope for catch-up growth: GDP per person (at purchasing-power parity) was $5,500 in 2013, compared with $11,900 in China and $15,000 in Brazil. The economy has been balkanised by local taxes levied at state borders, but cross-party support for a national goods-and-services tax could create a true common market. The potential is there; the question has always been whether it can be unleashed.
Optimists point out that GDP grew by 7.5% year on year in the fourth quarter of 2014, outpacing even China. But a single number that plenty think fishy is the least of the reasons to get excited. Far more important is that the economy seems to be on an increasingly stable footing (see article). Inflation has fallen by half after floating above 10% for years. The current-account deficit has shrunk; the rupee is firm; the stockmarket has boomed; and the slump in commodity prices is a blessing for a country that imports four-fifths of its oil. When the IMF cut its forecasts for the world economy, it largely spared India.
The real reason for hope is the prospect of more reforms. Last May Narendra Modi’s Bharatiya Janata Party won a huge election victory on a promise of a better-run economy. His government spent its early months putting a rocket up a sluggish civil service and on other useful groundwork. But the true test of its reformist credentials will be Mr Jaitley’s budget.
The easy part will be to lock in India’s good fortune, with fiscal and monetary discipline. In addition India’s public-sector banks need capital and, since the state cannot put up the money, the minister must persuade potential shareholders that they will be run at arm’s length from politicians.
If India is to thrive, it needs bold reforms and political courage to match. The tried-and-tested development strategy is to move people from penurious farm jobs to more productive work with better pay. China’s rise was built on export-led manufacturing. The scope to follow that model is limited. Supply-chain trade growth has slowed, and manufacturing is becoming less labour-intensive as a result of technology. Yet India could manage better than it does now. It has a world-class IT-services industry, which remains too skill-intensive and too small to absorb the 90m-115m often ill-educated youngsters entering the job market in the next decade. The country’s best hope is a mixed approach, expanding its participation in global markets in both industry and services. To achieve this Mr Jaitley must focus on three inputs: land, power and labour.
Jumbo on the runway
All are politically sensitive and none more so than land purchases. In China the state would just requisition the land, and let farmers go hang. But India has veered too far the other way. A long-standing plan to build a second international airport in Mumbai is on ice. An act passed in the dying months of the previous government made things worse by calling for rich compensation to landowners, a social-impact study for biggish projects and the approval of at least 70% of landholders before a purchase can go ahead. Mr Modi has used his executive powers to do away with the consent clause for vital investments. It is a temporary fix; Mr Modi needs to make it permanent and to win that political battle he needs to show that prime locations do not go to cronies, but to projects that create jobs.
Power, or rather the shortage of it, also stops India soaring. According to one survey half of all manufacturers suffered power cuts lasting five hours each week. Inefficiency is rampant throughout the power network, stretching from Coal India, a state monopoly, to electricity distributors. The first auctions of coal-mining licences to power, steel and cement companies, which began this week, are a step forward. More effort will be needed to open distribution to competition. Regulators are cowed by politicians into capping electricity prices below the cost of supply—though people will pay up and leave the politicians alone if they know that the supply is reliable.
The third big area ripe for reform is India’s baffling array of state and national labour laws. Compliance is a nightmare. Many of the laws date to the 1940s: one provides for the type and number of spittoons in a factory. Another says an enterprise with more than 100 workers needs government permission to scale back or close. Many Indian businesses stay small in order to remain beyond the reach of the laws. Big firms use temporary workers to avoid them. Less than 15% of Indian workers have legal job security. Mr Jaitley can sidestep the difficult politics of curbing privileges by establishing a new, simpler labour contract that gives basic protection to workers but makes lay-offs less costly to firms. It would apply only to new hires; the small proportion of existing workers with gold-star protections would keep them.
Adversity has in the past been the spur to radical change in India. The 1991 budget was in response to a balance-of-payments crisis. The danger is that, with inflation falling and India enjoying a boost from cheaper energy, the country’s leaders duck the tough reforms needed for lasting success. That would be a huge mistake. Mr Modi and Mr Jaitley have a rare chance to turbocharge an Indian take-off. They must not waste it.
(Source: The Economist)

Friday, February 20, 2015

Software is steering auto industry


Here is a quiz: with which big three auto companies has Google partnered to build a self-driving car? If you guessed FordGeneral Motors and Fiat Chrysler, you are wrong. The correct answer is Bosch, Continental and Delphi, three of the industry’s global suppliers.
It is an easy error to make. Although much of the technology that guides and controls cars is built by suppliers, even the biggest of them is little known outside the industry. The balance of power, and most of the market value, lies with the “original equipment manufacturers” that assemble vehicles and sell them to consumers.

But competition is intensifying as Google and Apple enter the market. Google is testing a self-driving car that uses Bosch sensors. No one knows precisely what Apple is doing, but it is employing several hundred people on a project called Titan. Along with Elon Musk’s Tesla, Silicon Valley companies are challenging Detroit.
The challenge is not merely external. As software and communications become as integral to a new generation of vehicles as hardware, the tradition of OEMs being able to control and squeeze their suppliers is shifting. There is a revolution from below.
This revolution makes it possible for a technology group to be a car company, as Tesla has shown. It may even be possible to thrive without being either an OEM or a supplier — the idea that Google is exploring. As with computers and mobile phones, they could own technology and license software, rather than shaping metal.
Marc Andreessen, the venture capitalist, proclaimed in 2011: “Software is eating the world.” Software is starting to steer the car industry — to redirect the way in which it has been organised since Henry Ford and Alfred Sloan of General Motors placed assembly companies at its heart.
The role of global suppliers — companies such as Bosch and Continental of Germany and Denso of Japan — has been growing for some years. They invest heavily in research and development on electronics and automation, and have higher margins than OEMs. Bosch’s mobility division employs 34,000 engineers, of which about a third work in software..
When cars were mechanical, the companies that assembled them from thousands of parts wielded more power than their myriad small suppliers, even though they were heavily outnumbered. Four-fifths of the jobs in the industry in Tennessee, for example, are still provided by suppliers.
As cars turn electronic, the suppliers are building a bigger proportion of each one. The cost of the electronic parts in the average vehicle will rise from 20 per cent in 2004 to 40 per cent this year, according to Boston Consulting Group. A premium class car now contains 100 microprocessors and runs on 100m lines of software code.
The move towards automated, even self-driving, cars takes this further. Instead of vehicle assembly, design and marketing — the traditional specialisms of OEMs — software, electronics and automation are in the lead.
To a software engineer, this makes a car look like a computer — a networked device founded on software and applications that can be designed in California, built from modules made by suppliers, and snapped together in contract factories. Apple’s executives are said already to have visited Magna Steyr, the Austrian contract assembler.
Google is taking this approach, testing its prototype self-driving car around its headquarters in Mountain View, California. It believes the industry’s slow-and-steady approach — using computers to help the driver at the wheel rather than replace him or her — is insufficiently radical, and it wants to take a bolder leap into the future.
Its business model is also revolutionary. Even if it succeeds, it will probably not build its own cars. Instead, it would license the technology to car companies and suppliers as the operating platform for their self-driving vehicles. The obvious parallel is Android, the mobile operating software that Google licenses to phone manufacturers in return for installing Google services.
For suppliers, this is a fine idea. Not only is Google supporting their research — they can sell the technology they develop to others — but self-driving cars are full of costly, high-margin devices. For auto companies, however, it is a flashing amber light.
When the same thing happened in computers — the essence of the machine became its operating software and core components — the profits went to Microsoft and Intel, and manufacturers suffered. Samsung is discovering how fragile a business making Android mobile devices can be.
The OEMs could yet escape the trap. Xavier Mosquet, a senior BCG partner, argues that companies such as Ford have multibillion-dollar R&D budgets and could turn electronics and software into specialities if they decided they had to. They did the same with engine-making in the past.
They must accelerate, though. Until now, they could rely on suppliers’ loyalty, no matter how hard they squeezed, but this may change. Bosch and Continental already supply 40 per cent of vehicle electronics, according to Semicast, a research group.
One day, the industry’s big three may be different companies, doing quite different things.

Microsoft CEO Satya Nadella Looks to a Future Beyond Windows

“Our industry does not respect tradition. It only respects innovation,” Satya Nadella said in February 2014 when he was appointed chief executive officer of Microsoft. After 39 years, the company Bill Gates co-founded had come to be perceived as an out-of-touch behemoth that relied too much on its Windows operating system and failed to move into new markets, like mobile. Key products such as Microsoft Office—the suite of applications that includes Word and Excel—had been designed around Windows, with only parts converted to work on Apple’s iOS and Google’s Android systems. Nadella’s accession would be a chance to reorient the company, getting it to introduce products that looked outside Windows and to develop new business models.
Nadella has aggressively pursued this course. Since December, Microsoft has bought two small companies that focus on mobile productivity apps for iOS and Android phones and tablets. To appeal to younger users, the company last September purchased Mojang, maker of the popular Minecraft video game, for $2.5 billion, and it’s adding features to Windows such as 3D holograms that users view through a headset and control with hand gestures. The newest version of Microsoft’s Power BI (business intelligence) product—a dashboard for data analysis—was released in January, first for iOS systems. “Microsoft hasn’t really shown any sort of vision like this in a long, long time,” Michael Silver, an analyst at Gartner and longtime Microsoft watcher, said in January when it unveiled the holograms. “All it took was replacing the senior management.”
In Nadella’s first year, Microsoft stock rose 14 percent, and sales increased 12 percent. The new CEO, unlike his predecessor Steve Ballmer, is popular with investors, venture capitalists, and startups. Even employees like Nadella, surprising for a chief executive who signed off on the largest layoffs in Microsoft’s history—18,000 job cuts were announced last July. Staff say they appreciate Nadella’s strategy shifts and attempts to make the company leaner and less bureaucratic.
The big issue Nadella faces is how to generate more revenue with new software and features, such as cloud subscriptions and free apps replacing pricey Windows and Office licenses. Revenue is projected to increase 8.6 percent, to $94.3 billion, this fiscal year, slowing from last year’s double-digit growth, according to data compiled by Bloomberg. “He’s hit all the low-hanging fruit—that said, these things were not easy to do,” says Brad Silverberg, a venture capitalist and former Microsoft executive.
“Where there are execution issues, we will address them,” Nadella said on a conference call in January. “Where there are macroeconomic issues, we will weather them.” Microsoft declined to make Nadella available for an interview.
Windows, which once dominated computing and ran on more than 90 percent of computing devices, now runs on 11 percent of computers and gadgets, according to a report from Sanford C. Bernstein. Nadella and Windows chief Terry Myerson are looking at ways to update the software.
Nadella uses the Power BI dashboard to track and compile huge amounts of information on product usage and financial performance to see what works and what doesn’t, says James Phillips, general manager of the product. Nadella also measures and coordinates executive performance with metrics from the dashboard. “Satya has been leading the charge for everyone in the company to be more data-oriented,” says Chief Strategy Officer Mark Penn.
Microsoft’s quarterly earnings report in January highlights the hurdles Nadella faces. While cloud software sales to businesses more than doubled in the quarter that ended Dec. 31, sales of traditional Office and Windows software to companies fell short of analysts’ estimates. Windows sales to personal computer makers who put the program on their machines dropped 13 percent. In total, profit declined 11 percent from the previous year, to $5.86 billion, while sales rose 8 percent, to $26.5 billion.
Revenue is being hurt by fluctuating currencies, while the Chinese government is investigating Microsoft over alleged anticompetitive practices and seeking to end purchases of its software. The government of Russian President Vladimir Putin says it wants to reduce reliance on Microsoft.
Internally, Nadella and his executives make the point whenever they can that the day could come when new and younger generations of computer and software users might not use its products. At one board meeting last year, Windows chief Myerson showed a slide with pictures of students using Apple Macs and iPads, according to Microsoft spokesman Peter Wootton.
In 2014, Nadella told employees at a town hall that they should skip meetings if they don’t really need to be there. And he’s advised workers to come to him directly if they feel the bureaucracy is stifling. “The organization knows it’s go-time,” says Phillips. “There are changes in the market we need to respond to.”
Nadella’s also changed the way engineering teams are structured, eliminating testers to speed up software releases and adding data scientists and designers to the teams. He’s looking at cutting some middle managers to make decisions faster and to eliminate layers of bureaucracy, Wootton says.
Eli Lilly Chief Technology Officer Mike Meadows says Microsoft is more open and listening to what customers need. He was glad to see the company demonstrate its products on iPads at Microsoft’s chief information officer conference last fall—Lilly’s 20,000 salespeople use Apple tablets, Meadows says. “They’re starting to demonstrate more understanding of reality,” he says. “They would say, ‘We were going in this direction already,’ but Satya lit a fire.”