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Unshackling infrastructure industry

image December 14, 2015

Infrastructure industry in India at crossroads

The World Economic Forum ranked India 71 out of 144 countries in the 2014 global competitiveness index. The Forum cited poor infrastructure as one of the major reasons for this low rank. It is loud and clear that if India aspires to be a key global player on the economic front, it has to take up infrastructure development on a war footing. Improving infrastructure has been a major challenge for India. Many projects (worth almost Rs.18 lakh crores) initiated in the last few years have been are stalled. Chronic delays have worsened working capital crises that infrastructure companies face. Working capital cycles are among the longest in the world; Cash flow statements show high debt and low returns1. According to the finance ministry’s mid-year report, private sector infrastructure companies across the board are deep in debt. Therefore, even if the incumbent government initiates new projects or expedites approval, the situation for many of these companies will continue to be dire. They may not be able to source the resources to undertake these projects. Many do not even have earnings to cover interest payments for their current debt. Moreover, the banking sector is increasingly unable to or unwilling to lend more money to this sector2.

Working capital crisis in companies

Infrastructure companies need large amounts of working capital. Hence the high debt. Even companies who excel (who have managed to have positive working capital) use 30-80% of their debt to finance working capital which is high because receivables and inventory are high. This is characteristic of the Infrastructure industry in India . It is also true that, in the recent years, the quantum of receivables (and the money stuck in it) has been growing, as an analysis of the major infrastructure companies reveals. (Refer to figure 1).


On the face of it, it looks like this liquidity crisis they face is beyond the control of the infrastructure companies. The truth, however, is that some of these woes are self-inflicted. Companies continue to favor conventional project management styles even though these may not be ideal for curtailing wastage of working capital.

Working capital situation of infrastructure companies goes through predictable swings during the quarters of the year. These movements are linked to how the companies recognize turnover. Skewed sales every quarter-end and greater sales skew at the end of the last quarter of the year lead to skewed working capital requirements throughout the year. The working capital situation deteriorates dramatically in the first quarter of every year for most companies (Figure 2).


The phenomenon of last quarter (or year-end) sales spike is well documented. What is less known is that there are spikes in turnover booked at the end of each quarter as well (Figure 3).


Each spike in sales is followed by a spike in working capital and debt. This is because while sales has been booked, and receivables have ballooned, no real money has accrued in the system from operations. It is expected that the contractor will receive payment after a credit period post billing to client. This payment maybe delayed when there are errors or gaps in documentation. The practice of batching customer billing further increases the risk of payment delays as mistakes in few bills can lead to entire batch of receivables being held up. This is more so during quarter end where focus is on internal turnover booking rather than customer billing. While the contractors may cry “delay from client end”, a substantial portion of the responsibility for this delay in realizing receivables actually lies with the companies and the way they operate.

The turnover bias

The sales spikes and the corresponding working capital spikes is a consequence of “turnover bias” in a company’s approach to project management. Turnover bias comes in when a company manipulates information or material/execution flow to meet quarter-end or year-end numbers (usually to meet targets) in its financial statements. Such practices are rampant in most infrastructure companies, be they ‘execution-intensive’ or ‘material-intensive’. The turnover bias manifests itself in ‘material-intensive’ projects when managers choose to supply high value items to project sites in order to meet quarter-end numbers. To do this, multiple work fronts are opened in the project so that more and more high value material can be supplied and booked as sales. Since supply is usually focused on select items, the full kit of material required to complete a logical work stretch becomes available only in fits and spurts. So, worker gangs move on, and have to keep moving back and forth multiple times to complete work. This mode of project management creates a vicious loop of wastage of time and capacity leading to delays and increased site expenses for the project (Figure 4). This is the same for erection-intensive projects. Here too turnover bias prompts the contractor to pick the highest billable jobs first. He/she opens many work fronts to harvest more such opportunities. In the absence of supervisory bandwidth to simultaneously complete all these, the project is inevitably delayed.

Over time, clients have come to recognize these patterns in project management. Many have now skewed the payment terms towards erection and project closure. Yet, most turnover-biased infrastructure companies continue their project management practice of “cherry-picking” material to meet turnover targets of quarter-end and year-end. Most of the turnover is already booked by the end of the year. The opportunity to cherry-pick reduces dramatically and hence, there is a dip in turnover in the first quarter. Companies go back to cherry-picking to meet their ambitious numbers.


The problem aggravates when recession sets in; the working capital cycle spirals out of control. New projects become scarce so do advances which could have been used to bank roll ongoing projects. At the same time, many open projects are at their tail end or near-closure. A crisis-like situation arises. Money is not available to book significant turnover, even the ability to cherry-pick is gone. Cash-starved and hard-pressed to meet increasing working capital requirements, companies are forced to source expensive short-term debt. Over time, this style of project management drives these companies into a vicious, out-of-control loop of inevitably delayed projects. They find themselves up against angry clients, ever increasing working capital requirement, and debt (Figure 5). Thus, the companies (already working on wafer-thin margins), have to contend with write-offs, cost overruns, erosion of profit margin, and late delivery penalties.


The way out

To break out of this vicious loop companies need to embrace the flow principles of project management. They need to focus on rapid execution and project closure. The flow principles can be implemented using the following rules

a) Implement a Pull system, where material movement is based on execution speed.
b) Remove value targets in purchase and focus on full-kit (the complete assortment required for execution).
c) Limit the number of simultaneously open sites (limit work in progress) within a project based on availability of supervisors. Strict rules for opening sites linked to site closures have to be enforced. One should be started in only when one is fully completed.
d) Resolve issues obstructing flow by implementing a strong system of active daily management.

These flow rules ensure that management attention is on closures. These processes in project management can successfully lower lead-time. Low lead-time inevitably leads to increased rate of turnover. The need to manipulate material or information movement to book sales goes away. The usual skew of sales turnover during quarter-end and year-end is broken as each project is managed to meet its promised lead-time and due date. The working capital requirements and its variability also drop.

This new style of project management which focusses on flow (execution and speedy closure of projects) not only guarantees timely and within-budget completion of projects, it also ensures that working capital is not locked up needlessly. Organizations implementing the flow principles have been able to increase the working capital turns many folds. In the process, they have also succeeded in freeing up 30-40% of their working capital. Extrapolating this to the industry as a whole, we see that Rs. 30,000 crores – Rs. 40,000 crores (almost 40% of the total debt of the industry) can be released by simply changing the approach to project management. The impact would be availability of significant cash for investment in new projects and other avenues of growth. This would benefit not just the industry but the country as well.


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