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Gita Piramal & late Sumantra Ghoshal |
March 17, 2005
London-based Ispat International (now Mittal Steel) and its founder Lakshmi Niwas Mittal recently became the world's biggest steel maker, and has been named by Forbes magazine as the world's third richest man.
How does Mittal transform poor performing steel mills into power-packed profit centers?
We bring to you an inside account written by written Gita Piramal and late Prof Sumantra Ghoshal. Sumantra Ghoshal was a leading management guru. Gita Piramal is managing editor, The Smart Manager. The two also co-authored a book: Managing Radical Change.
Acquisitions is one of the three major routes for business expansion, the other two being organic growth and strategic alliances.
But why choose acquisition as a growth strategy? When is this strategy more appropriate? And, if you have chosen this strategy, what are the main do's and don'ts for managing it well?
While not quite an Indian company -- incorporated in Holland and headquartered in London -- Ispat International N.V. (now called Mittal Steel) is Indian in both its spirit and management. In less that a decade, Lakshmi Niwas Mittal has spectacularly expanded the company from a wire rod manufacturer in Indonesia to the largest steel producer in the world, largely through an acquisitive strategy.
In 1992, Mittal acquired a Mexican steel mill. From this case study, it is possible to distil some simple lessons about how to manage acquisitive growth.
There are, of course, some variations depending on the nature of the industry, the history of the acquiring company, and the specific circumstances of each individual acquisition case. But, overall, there is a certain commonality in the pre- and the post-acquisition phases.
The story of Ispat Mexicana (Imexa)
Lakshmi Niwas Mittal's (widely referred to as 'LN' both inside and outside the company) faith in DRI (direct reduced iron) technology governed his choice of acquisitions. He believed in its future long before others.
"This has spelt success for so many of my plants," he says. Starting in Indonesia in 1976, he bought mini steel mills using the DRI route in various countries and turned them around. Eventually in January 1995 Mittal acquired Hamburg Stahlwerke, the originator of DRI technology on which almost all LN's plants depend.
According to Peter F Marcus, director of Paine Webber: "Lakshmi Mittal championed the practice of mini mills becoming integrated producers through the use of scrap alternatives."
This faith created 'the only true global steel company,' according to the Financial Times, and Mittal's reputation as a doctor of sick steel mills. In 1991, this reputation brought the Mexican government knocking at his door.
In the early 1980s, the Mexican government decided to build a new steel mill -- Sicartsa II -- adjacent to its existing Sicartsa facility located in Lazaro Cardenas.
They invested $2.2 billion in a state-of-the-art facility, which included a pelletizer plant to produce iron pellets from ore, the first DRI plant in the world using the HyL III technology, electric arc furnaces, casters to roll molten steel into flat slabs and a mill to convert these slabs into plates to produce pipes for the then-booming oil industry.
Before the factory was completed, however, the end of the oil boom coincided with a faltering economy which forced Mexico to devalue the peso. The government curtailed investment in the planned pelletizer plant, which forced Sicartsa management to source high cost iron pellets on the open market.
The government also abandoned the planned plate mill, forcing the plant to sell steel slabs -- an intermediate product -- rather than finished steel plates. Three years after opening, the plant operated well below its capacity of two million tons per year and incurred significant operating losses.
Mexican government officials publicly blamed the management and employees of the factory for the losses, and decided to privatize both Sicartsa factories in 1991. Based on Ispat's reputation for turning around Iscoot, a steel mill in Trinidad, the Mexican government invited Ispat to join two other steel companies in bidding for Sicartsa.
The pre-acquisition negotiation process
- The team: Mittal sent a due diligence team consisting of twenty managers representing all line and staff functions chosen from Ispat's Trinidad and Indonesian plants and instructed them to develop plans to turn around the plant.
Mittal also explained that some members of the due diligence team would have an opportunity to remain in Mexico if Ispat acquired the facility. There were no merchant bankers.
The team was divided into sub-units to look at specific are as such as finance, marketing, management and costs. Each team had to make specific recommendations.
"These had to be solid and do-able as the person making the recommendation could easily be called upon to implement it," said one manager. "This eliminates consultants and their ivory tower analyses. After this process, targets are fixed and LN largely steps out of the picture."
Each team's report provided a valuable check on the other's to eliminate biases and oversight.
The team's due diligence revealed a factory plagued by technical problems, running at 20% of capacity, producing low quality slabs and manned by a dispirited workforce. The Ispat team was impressed, however, by the recent vintage of the assets, a young workforce with an average age of 27 years, and the supporting infrastructure.
The team recommended bidding for the plant, and developed a turn around plan.
- The bid: Ispat proposed acquiring all the Sicartsa II factory's assets and liabilities, excluding contingent environmental liabilities.
Ispat also bid for 50% equity stakes in several of the businesses that supported the Sicartsa II plant, including PMT, a producer of welded pipes, Pena Colorada, which provided the factory with iron pellets and Sersiin, which managed the deep water port facilities and distributed electricity. It took eight months to sew up the contract.
Ispat proposed a total consideration of $220 million, consisting of $25 million in cash and $19 million n in ten year bonds (at 15% interest) issued by the Mexican government and secured by a warrant for 49% of Imexsa (not Ispat) equity. Of the cash component, $5 million was a loan from Trinidad and $20mn came from LN's personal resources.
Ispat's bid outlined the company's five-year plan for improving Sicartsa's operations, and included a commitment to invest an additional $350mn, with a $50mn penalty if the company failed to follow through on its promised capital spending.
Ispat's proposal also included a clause capping the number of employees it would lay off at 100 of the 1,050 workers. Impressed by the business plan, the Mexican government selected Ispat's bid. Ten members of the due diligence team remained in Mexico to run various departments, including Dr Johannes Sittard the former head of Iscoot, who served as the managing director of Imexsa from 1991 to 1993.
The post-acquisition integration process
- Stopping the bleeding: Ispat took control of Imexsa on January 1st 1992 in the midst of a global recession in the steel industry, and had to briefly shut down the furnaces because there were no orders for the steel and no place to store the finished slabs.
Despite the shut-down, Imexsa laid off only seventy people -- thirty fewer than the agreed-upon limit -- and ultimately hired an additional 270 employees.
The $220 million consideration which Ispat had committed to more than halved almost instantly. The plate mill which had been lying abandoned -- still packed in crates -- was shipped to a Korean company.
"Our focus is slabs and we didn't need the plate mill," RR Mehta, Imexsa's executive director told Business India. The deal brought in $135 million -- much of this went towards upgrading facilities.
Mittal recalled his first steps at Imexsa: "In Mexico we did what we do with every business . . . we sat down with management of the acquired company to discuss various options for improvement and we developed the business plan. We sat down with each of the departments to understand their problems and viewpoints and gave our input based on international experience and our due diligence."
"Together we set very aggressive targets because we don't benchmark companies based on local standards, but on international standards. If the management of the acquired company is willing to commit to these targets, they stay. If they have any problems following our business plan and vision, they go. The Imexsa managers stayed," he added.
Production Planning Manager Oscar Vasquez recalled his first meeting with Mittal: "In our first meeting, we presented two alternative production plans, one for 600,000 tons -- it was conservative and based on our past experience -- and another plan for 1.2 million tons. Mr Mittal saw both and said, 'forget the small plan, just let me know what you need to implement the second plan.' We expressed concern that we might not find a market for the additional slabs, but Mr Mittal said, 'You will have the volume because I'm going to take care of that for you'."
Mittal used Ispat Indo's sales network to identify Asian customers for Imexsa's slabs, including a contract for 400,000 tons per year with a Taiwanese steel manufacturer. Although these orders provided low margins, they allowed Imexsa to increase capacity utilization while improving quality to win more profitable business.
Imexsa also reduced costs by switching to suppliers willing to match the lowest costs provided at Ispat's Trinidad and Indonesia plants.
The next step was to quickly develop cost-consciousness and discipline among the Imexsa management team. Jai K Saraf, Ispat International's finance director, and Sittard instituted a daily meeting of the heads of each department in the plant, which began after the day shift ended at 5:00 p.m. and generally ran until 9:00 or 10:00 at night.
The team evaluated the previous day's cost, volume, productivity and quality performance, discussed the current day's results, and agreed on detailed targets by department for the following day.
Om Mandhana, purchase director, described the purpose of the daily meeting: "The idea of the daily meeting was to cut red tape. You got together all of the people involved to talk through any issues, and as a means of coordinating and resolving day to day problems. The idea was to take a decision then and there rather than refer to committees."
Raul Torres, melt shop director, recalled his first impressions of the meetings: "Before Ispat bought the plant, the boss just told us how we should do things, but the daily meetings were nothing like that. Dr Sittard asked a lot of detailed technical questions to force us to think through problems to their root causes."
"If we were consuming too much steel in the electric arc furnaces, for instance, Dr Sittard would ask: 'Why are you consuming this amount of steel? Is there leakage? Why do you have this amount of leakage? Are you losing steel in the slag? How do you plan to improve this? Is that the cheapest way in the world? Who does this best in the world? Can we adopt their technology?'"
"We had open and sometimes heated discussions, but once we agreed on the right thing to do, it was easy to get Dr Sittard's approval and any resources you needed to make it happen. But you had to commit to improvements -- how much you were going to achieve and by when, and the entire team monitored how you did against the promised target."
"And Dr Sittard was always asking for higher targets -- he always kept the pressure on us to increase volume and quality and cut costs."
Imexsa's existing cost accounting system reported only aggregate production costs on a monthly basis, and was first available three weeks after the previous month ended. One of the first things the new management team did was to implement Ispat's daily reporting system which provided overall figures for each day's operations by the next morning.
Led by Saraf, Imexsa's accounting department began collecting detailed volume, cost, quality and productivity data for each step in the production process on a daily basis.
Initially, Imexsa's accountants collected these data themselves every day, and analysed it by hand. To monitor raw material usage, for example, the accountants asked warehouse workers to track the volume of materials leaving the storeroom each day.
As the discipline steeped in, kudos flowed back. A JP Morgan report hailed Imexsa as the lowest-cost slab producer in the world, while Credit Suisse First Boston reported, 'At Imexsa, Ispat makes Nucor's cost position look almost amateurish.'
Imexsa could land a slab in the middle of American at $35 a ton below Nucor's cash cost of production of $210 a ton. And Nucor founder Kenneth Iverson acknowledged, "Ispat comes in and runs the operations very well. They control costs very very closely."
In 1992 -- the first year under Ispat ownership -- Imexsa increased shipments from 528,000 tons to 929,000 tons, decreased the cash cost per ton produced from $253 to $178, and earned a small profit.
From 1992 to 1998 Imexsa increased annual steel shipments from 929,000 tons to over 3mn tons, and improved productivity from 2.62 to 0.97 man-hours per ton.
Antonio Gonzales, the Pelletizing Plant Supervisor observed, "There is no feeling of having finished the turnaround . . . we keep resetting the targets, and now we are aiming for 4 million tons per year -- that's double our rated capacity."
In 1997, MRR Nair joined Imexsa as managing director from the Steel Authority of India, the seventh largest steel company in the world, where he had served as chairman and CEO and had been awarded the Best CEO in India award.
Nair cited four mechanisms for maintaining constant improvement at Imexsa -- i.e. daily meetings and reports, quality programmes, global integration and stretch goals.
- 01. Daily meeting and daily report: The daily meeting, now held each morning for one or two hours, continued to play a pivotal role at Imexsa. A typical meeting (in March 1998) was attended by representatives from each of the departments, most of whom wore the khaki Imexsa uniform.
A few of the managers however wore red Imexsa jackets awarded to recognize achievement of ambitious goals, such as increasing one of the DRI facility's production nearly 50% above its rated capacity.
On several occasions during the meeting, participants jokingly asked whether their targets were ambitious enough to earn a jacket. Nair guided the meeting with a series of questions, inquiring about the results of previous experiments to improve performance, asking what level of performance was budgeted for the following month, and probing why targets were not higher.
Nair left the room for extended periods on two occasions during the meeting, but the discussion continued with the members of the different departments discussing targets and experiments among themselves.
The participants frequently referred to the daily report which provided detailed data on cost, productivity, volume and quality for each of the departments.
- 02. Quality programmes: In 1998, Imexsa used standard quality tools, such as ISO methods, to describe existing processes. Imexsa's quality efforts won numerous international awards and earned it the British Standards Institute's prestigious Company Wide Recognition, one of only two steel companies in the world so honoured (Iscoot was the other).
More importantly, Imexsa's quality initiatives helped the company upgrade its products to serve more demanding customers.
Imexsa enhanced its product mix from 97% low grade steel sold into construction applications in 1992 to 47% of slabs sold for demanding automotive and coated plate applications in 1997.
Despite Imexsa's success, Quality Director Rafael Mendoza wanted more:
"Traditional quality programmes such as ISO 9000 provide excellent statistical tools for documenting your current processes, but they are not as useful in accelerating continuous improvement. For this we introduced benchmarking, Top 10s and internal agreements."
In benchmarking operating processes, quality team members looked at best practices within the Ispat network, the steel industry as a whole and also identified and studied related processes at global leaders such as Ericsson and General Electric.
When Imexsa management wanted to improve cafeteria service during the busy lunch hour, for example, a quality team studied the restaurant in a busy soccer stadium renowned for serving large quantities of excellent food quickly during half time.
Imexsa would only work with customers and technology suppliers who agreed to openly share information on new technological developments and applications, and in turn agreed to open their plants for benchmarking.
Mendoza was not worried that Imexsa would surrender competitive advantage by allowing other companies to benchmark the plant:
"In the steel industry these days, all companies have access to good ideas through customers, suppliers and consultants. The difference is who can implement them successfully."
In the Top 10 programme, each department identified projects to either cut costs or improve quality, quantified each project's financial impact (in US dollars per year), and rank ordered the projects from one to ten based on their bottomline impact.
Each project was assigned to a project owner charged with selecting a multi-disciplinary team to quantify the benefits of the project, develop an action plan and monitor progress against agreed process milestones.
In Mendoza's view, the Top 10 programme introduced a consistent discipline in translating proposed projects into financial results and allowed each department to prioritize its own projects for improvement.
In 1996 Imexsa initiated a systematic program for making internal service agreements between Imexsa's departments and monitoring service delivery levels against these agreements.
The head of the department receiving a service would meet once a year with each internal supplier to articulate their key requirements and agree on targets and concrete measures of service delivery. Before agreeing to target service levels, a service provider could request any prerequisites necessary to guarantee delivery.
The maintenance department might agree to provide preventive maintenance on time, for instance, provided that they were notified at least one week in advance of the scheduled downtime.
The head of the department providing the service was responsible for monitoring performance on a daily basis and reporting to the head of the internal customer on a monthly basis, who would sign off on the performance evaluation.
If a service provider repeatedly failed to meet goals, the failure would be elevated for discussion in the daily meeting, but this had occurred only once in the programme's first two years.
In 1998 Imexsa had 140 internal service agreements across 28 production and service departments and sub-departments in the plant. 70% of the agreements fulfilled 100% of the requirements, 11% of the agreements met between 95% and 99%, with the remainder fulfilling less than 95%. These internal agreements yielded significant improvements in operations.
- 03. Knowledge integration programme: The Knowledge Integration Program (KIP) was an Ispat corporate initiative designed by Mittal to "keep stirring the whole organisation."
A few representatives from each operating and staff function (twelve in total) at each Ispat plant would meet twice each year. These KIP meetings lasted two to four days, and rotated among the plants in the Ispat network.
Prior to the meeting, the department heads would send their suggestions for discussion topics to Ispat group headquarters in London, where the agenda would be set and then distributed to each of the participants in advance.
During the meeting, the participants would review their performance against targets, including major accomplishments and disappointments, discuss common technical problems, update each other on developments in their plant and commit to future targets. The participants also communicated between KIP meetings, as Torres described:
"If I have a question, I don't have to wait until the next KIP meeting. I can make a phone call or send an email to Canada or Trinidad. I probably exchange at least one email every week with them."
- 04. Stretch goals: Each department in Imexsa committed to annual targets for production volume, productivity and costs, and presented their plan for achieving these goals. The process was based on a firm philosophy of Ispat.
As described by Nair, "Senior managers should ask the departments what they plan to do, rather than telling them what to do."
At the same time, however, it was not a laissez fair. Nair and his team asked a lot of questions on the plans that were presented. "You achieved this level last year, why can't you do it again? They can achieve the level at another factory, what prevents you from doing the same? What can we do to help you achieve more?"
At the end of such discussions, while the targets were very demanding, they were owned by the departments instead of being perceived as coerced from above.
As Raul Torres described: "I feel the need to constantly improve performance every day, but its not forced on me by management. I'm not fighting against somebody else's budgets -- I agreed to the goal, and the best way to reach a goal is not with a big gun to your head. I set stretch goals because I want Imexsa to win."
"At first, I wanted Imexsa to be the best steel plant in Lazaro Cardenas, then the best steel plant in Mexico, but now I ask 'why can't we be the best steel plant in the world?' We always wanted to be the best, but we couldn't because the old management put up too many limitations."
Design: Rahil Shaikh
Published with the kind permission of The Smart Manager, India's first world class management magazine, available bi-monthly.