Case Study – Facility Location

Ellora Time's Manufacturing Woes

“We will produce our goods in China and export them to India. It's not possible for us to
run the industry in India.”

- Jaisukh Patel, Export-finance Director, Ellora Time, in January 2001.

ELLORA GOES TO CHINA

In early 2001, Ellora shocked the corporate world by announcing its decision to shift its
manufacturing activities to China. Commenting on the decision, Ellora sources said that
the decision was more out of compulsion than choice. The company claimed that it was
unable to cope with imports from China that competed directly with its products. As
these goods were much cheaper than Ellora's products, the company was facing serious
problems that seemed to threaten its very survival.

Ellora's decision attracted immense media attention because it came at a time when the
Indian manufacturing industry was facing severe competition from cheap Chinese
imports. Experts feared that the future of Indian manufacturing will be very bleak if more
companies began to follow Ellora's example. Since plant location decisions are integral
for a manufacturing concern, China's favorable manufacturing environment seemed all
set to result in an exodus of manufacturers from India.

BACKGROUND NOTE

Established in 1991, Ellora manufactured timepieces under the Orpat brand name. The
overwhelming response to its products encouraged Ellora to manufacture calculators and
telephones as well. These products were also received well by the market and in a short
span of time, Orpat and Ajanta established themselves as good brands. The company
offered over 40 models of Ajanta timepieces including the highly popular
‘devotional'models for both Hindu and Muslim communities.
Orpat calculators were available in 15 different models and were very popular for their
quality and economical price. Telephones were available in around 12 different models.
Ajanta and Orpat enjoyed a 70% marketshare in the timepiece and calculator business
respectively and Orpat telephones held 20% of the market share. For the year 1999-00,
the group recorded a combined turnover of over Rs 2.50 billion

Ellora set up its manufacturing base in the ‘Orpat Industrial Estate'in Morbi with a built-
up area of 15,00,000 sq. ft. and an overall carpet area of 10,00,000 sq.ft.. The estate
housed essential machineries, such as Wafer Sawing Machine, Automatic Coil Winding
Machine, Ultrasonic Ware Bonders, CNC Plastic Injection Molding Machine,
Mould/Dies/Jigs and a full fledged workshop for in-house mould manufacturing as well.
Around 80% of this machinery was imported. By 2001, Ellora was producing around
15,000 calculators, 20,000 timepieces and 8,000 telephone instruments per day.
There were around 1800 workers at the estate with 90% of them being females. Ellora
used 45 trucks for daily dispatch as part of its transportation setup to feed its distribution
network of 25,000 dealers spread across the country. Ellora's products were popular both
in India as well as the export markets because of its manufacturing efficiencies. The
company's overheads were low, which enabled it to price its products very reasonably
and competitively.It had exclusive showrooms in Morbi, Rajkot, Baroda, Surat (all in
Gujarat) and in Mumbai. These outlets were serviced by a network of 150 sales depots
and service stations. According to company sources, Ellora gave prime importance to
R&D and quality. R&D efforts were described by the promoters as “an ongoing process
in which a dedicated team is constantly engaged under the direct supervision of the
directors.

Individual initiative is encouraged at all levels and innovation is sought.” All products
were reportedly made from the finest quality raw material in a dust-proof environment,
which ensured better functioning of electronic goods. There were quality checks at all
stages of the manufacturing process. These initiatives paid off in the form of Ajanta
receiving the ISO 9002 certification. Around 20% of Ellora's output was exported. The
company won many awards for its continual good exports performance, including 9 ECS
awards for Excellence in Exports (Electronics and software sector) in 1991-92, 1992-93
and 1994-95. In 1994, Ellora was honored by the Electronics Department of the
Government of India.In 1996-97 and 1997-98, the company received awards for
‘Excellence in Export Promotion'from the Electronics and Computer Software Export
Promotion Council. In 1997-98, Ellora received a ‘Certificate of Merit'from the Ministry
of Commerce, Government of India for its export performance during that year.

In its initial years, Ellora imported spare parts, raw material and components from Japan,
Taiwan and Korea. However, from 1998, the company began to import these items from
China, which were not only good in quality, but were much cheaper as well. Little did
Ellora know that these very cheap, good quality Chinese imports would soon prove to be
its biggest enemies. Although imports from China had always been trickling in for a long
time, Indian markets were flooded with Chinese imports in the late 1990s.

This was because in 1999, the Indian government removed restrictions on import of
electronic goods. Thus, clocks, telephones and calculators from China, exactly the same
range of products Ellora had built its empire upon, were suddenly available in abundance.
The difference was that they were much cheaper compared to Ajanta or Orpat products in
the same categories.In spite of the fact that the Patels did not have to pay interest to any
lenders, had the most popular brand in the industry and owned a good marketing and
distribution network, they realized that they were not in a position to compete with
Chinese goods in the Indian market. More importantly, they were afraid of the fact that
Chinese goods will sooner or later affect their export markets as well.

To demonstrate the effect of the Chinese influx on its operations, Ellora cited the
example of the hardships being faced by its calculator business. Orpat was the only major
player in India for calculators. According to company sources, while the demand for
calculators went up from 20 million in the mid 1990s to 40 million in early 2000, the
company's production had gone down from 6-7 million to 2-2.5 million during the same
period.

Its market share touched an abysmal low of 5% from 70%. This was because
approximately 90% of the calculators used in India were imported. And a majority were
either smuggled goods or were imported and assembled in India. In case of imports, the
goods were under-invoiced and thus saved a substantial amount by evading custom and
excise duties. In addition, the importer did not have to pay central sales tax and local
taxes. These calculators were sold in the grey market. Eventually, the cost of such
calculators worked out 30-40% cheaper than of those manufactured by organized sector
players like Orpat. The problems were further compounded when imports came in via
Nepal. Under the South Asian Association for Regional Cooperation (SAARC) Rupee
Trade Area (RTA) arrangement, India allowed imports from Nepal at concessional duty
rates.

Chinese companies began to use this low duty facility by routing their goods through
Nepal. The problem aggravated because it was difficult to monitor the country of origin
of the goods most of the times. According to the Indian regulatory setup, while spare part
imports were charged a duty of 5%, raw material imports are charged a duty of 25%.
Thus, it did not make sense for manufacturers like Ellora to import raw material at all.

Therefore, Ellora began to import parts from China, assemble them at its Morbi plant and
sell them. It stopped purchasing raw material from the local market, which resulted in
many transporters, drivers and cleaners losing their jobs. While a few years ago, Ellora
employed around 15,000 workers, by early 2001, the company had onl about 5,000
employees. Commenting on the company's sorry state of affairs, Jaisukh Patel (Patel)
said, “Chinese traders have almost ruined our market. We too are shifting to China now
because of the attractive incentives given to manufacturers there. If we don't do that, we
will not be able to compete in the global market and be wiped out.” He further added,
“We have leased a building with 300,000 sq. ft. floor space in Shenzhen. Our machinery
– worth Rs 3 billion – will be moved in phases to China. In the first phase, we will shift
about one-third of it. Six months later, we will shift all our machinery.”

Analysts however commented that Ellora's decision to shift to China was completely
logical. China had emerged as a low-cost producer that could beat any country in the
world, with the promise of cheap labour, high productivity and attractive government
subsidies. There were a host of other factors that made China a lucrative manufacturing
destination for corporates across the globe (Refer Exhibit I for major factors influencing
plant location decisions)

WHY CHINA?

Many manufacturing units in India had to close shop because they could not withstand
competition from the extremely cheap Chinese imports. A leading manufacturer of fans,
Ortem, closed its manufacturing unit in Delhi after it decided to rely on imports. Many
other companies including consumer electronics major BPL had to either cut back
production or sell at prices below the cost of production. Leading tire manufacturers
Ceat and JK Tyres were forced to offer bigger discounts to their dealers, as Chinese tires
were around 25% cheaper than Indian radials. Besides these, chemicals, textiles including
synthetics and silk, ready-made garments, steel and rubber products were the other
industries, whose business was affected by imports from China.

Explaining the benefits of manufacturing in China, Patel said that the Chinese policy
framework encouraged export promotion. It had subsidies for export production, cheaper
power and labor costs, a highly regimented labor pool, fewer public holidays and low
costs of finance, which are some of the major positive features of the Chinese economy.
The tax structure and infrastructural facilities are much better and manufacturer-friendly
in China than India. China has a large number of production units manufacturing raw
material, spare parts and components. Hence there is no need for importing these things
unlike in India, where most companies either import or start a small unit to ensure regular
supply of raw material and components. This puts pressure on the company's
manufacturing efficiencies as well as finances. Many factories in China operate on a
‘zero-inventory'basis which means the raw material arrives in the morning and the
finished product leaves the factory in the evening. This was reportedly almost impossible
to duplicate in India, with a typical factory owner having to stock almost three months of
inventory.

Patel revealed that he had to invest around Rs 300-400 million worth in raw material
stock. As against this, a Chinese factory of equal capacity needed an investment of just
Rs 60-70 million. Even after willing to invest so much in piling up raw material, factories
in India faced many hardships because of erratic delivery schedules on part of the
suppliers, delays in raw material imports being cleared by the ports and legal hassles with
the customs, excise and sales tax officials. According to Patel, the corruption level was
also much lower in China. He said, “Electricity costs Rs 2 per unit in China, less than half
of what I pay in India. The supply is faultless. Exporters get around 19-27% cent
subsidies and free trade zones are easy to set up. The ports clear goods speedily.”

Manufacturers also found that finance was easily available in China as against India
where arranging finance was an extremely difficult, complicated and costly process.
Banks such as the China Industrial Bank and China Agriculture Bank not only sanction
loans without much formalities, interest rates are as low as 5.5%. As against this, loans in
India cost around 14-15%. Most importantly, factory owners have to deal with a number
of government departments to get their factories operational. These include the
authorities looking after the Factory Act, the labour department, sales tax, customs,
excise, income tax, pollution control board, the RBI, central and state ministries,
licensing authorities, the RTO, supply department, clerks of revenue office, collector and
the district industry center, to name a few.
THE CHINA STORY

Due to the favorable manufacturing environment, China's growth rate was almost double
that of India's during the period 1980-2000. China's export volumes were easily
five times those of India's and around 40% of these exports were products of
multinational companies operating in China. It was widely accepted that Chinese
firms were often ‘ready to try illegal methods to capture a market.' Chinese firms
reportedly did not hesitate to use smuggling routes and loopholes in India's legal
system. Explaining the rationale for this, T K Bhaumik, Senior Adviser (Policy),
CII, said, “The philosophy of a Chinese manufacturer is simple. It won't claim to
sell you the best quality product, but it will charge you a tenth of the price offered
by others. Maximization of sales is more important for a Chinese manufacturer than
profit maximization.” According to analysts, despite the fact that Indian
manufacturers were continually protesting against the dumping of goods by China,
the Finance and Commerce Ministries seemed to be rather lax about the issue.

Since China was not a part of the WTO, there was no transparency in its accounting
systems. Thus, it was very difficult to ascertain the input costs and claim that Chinese
exports amount to dumping. In 2001, the government finally initiated anti-dumping
investigations against Chinese toys, sport goods and batteries, in response to the protests.
Government agencies confiscated Chinese goods and the finance ministry unilaterally
imposed higher import duties if the certificate of origin of the goods was China. It was
also made mandatory for 131 imported products to strictly follow the BIS[4]
specifications and packing instructions including the printer's name, prices and other such
details, before they were sold in India.

By the end of 2001, Ellora had set up a production base on two acres of land at Ningbo,
in Southern China. In addition, it added a separate production line at the Morbi plant.
These new capacities were established after the company decided to diversify into the
home appliances business. The 200-worker factory in China produced mechanical parts
for home appliances. The range of home appliances products includes hair dryers, house
heaters, water heaters, water dispensers, electric fans, electric irons, emergency lamps,
blenders, toasters, electric kettles, washing machines, air coolers and vacuum cleaners.
These products were to be marketed under the Orpat brand name.

According to analysts, Ellora seemed all set to make a success out of the home appliances
business. According to Ellora Director A O Patel, “Diversification into calculators,
telephones, toys and now home appliances is basically a balancing act to offset the trend
of clock production volumes outstripping demand.Our entry into the home appliances
product segment aims at increasing demand by making available products of Japanese
quality at Chinese prices.” Meanwhile, the ‘feared exodus'of Indian manufacturers to
China had somehow not taken effect even by mid 2002. This fact however did not negate
the fact that India needed to put in place a host of measures to sustain its manufacturing
industry.
According to Patel, India needed to reform its labor laws, the customs duty structure,
increase the accountability of government employees and strengthen its anti-corruption
laws. Until these changes were put in place, it would perhaps be difficult to stop
manufacturers from relocating their plants.

COMPARING CHINESE & INDIAN MANUFACTURING ENVIRONMENTS

Labour Issues
• 24 hours shift – Industries in China are allowed to operate all 24 hours. This
drastically brings down the investment in plant & machinery. In India, production
units cannot operate after 7 p.m. We can, therefore, take only 1/3 of production, in
comparison to China. Obviously, it adds to the cost of production in India.
• Overtime basis – In India, workers have to paid double wages for overtime. In
China, there are no such provisions. Hence, the cost of labour in China is less than
that in India. The workers'work in China is based on the output target and not on the
number of hours.
• Work culture – In China, workers are highly disciplined and are committed to
work. In India, the work culture leaves ample scope for improvement. There is a
need for Indian workers to be more disciplined and committed. Chinese workers are
15–17% more productive than Indian workers.
• Labour Laws – In China, labour laws are not restrictive. Industrial units are
permitted to dismiss a worker, if his productivity is not up to the mark. Whereas in
India, in an industrial unit, a person cannot be dismissed easily. In India, even if a
factory is closed, workers cannot be discharged.
• Minimum wages – In China, there are no laws related to minimum wages, a
worker is given his salary according to his performance. Whereas in India, a worker
has to be paid the minimum salary irrespective of the work done by him.
• Trade Unions – There are no trade unions in China. Therefore, there are no
strikes/agitations on behalf of workers. This has benefited the workers, in terms of
higher wages due to increased productivity.

Cost of Production
There are many industrial units in China that are manufacturing all types of raw
material and components/parts. This means good quality inputs are available at very
competitive prices. This leads to low cost of production. Whereas in India, in
segments such as clocks and calculators, the end product manufacturer has to opt for
integration, which is not his core competence, which means higher capital
investment, increased wastages and higher cost of production.

Working Capital Requirements

In China, most production units run on the basis of just in time inventory. All inputs
such as raw material and components are received by the production units, only on
the day of production and finished goods are dispatched from the units the same day.
Whereas in India, inventory carrying cost is very high, since producers have to risk
raw material for at least two to three months.

Problems of Supply Chain

In India, suppliers do not maintain delivery schedule, because they are not
 disciplined. Besides, the delivery schedule cannot be maintained because of labour
problems, strike by transporters, or due to power problems. Whereas in China,
suppliers are given the time and date of delivery and the production units receive the
input on time.

Export & Import

China's import procedure is very simple, which leads to faster clearance of
consignments. Goods imported are cleared within 24 hours with the Customs and
Ports working continuously for all 365 days in a year. In India, due to the complex
procedures, consignments take a long time at the clearance stage. In India, the
Customs and Ports work for about 250 days, leading to delays and resulting in huge
inventories

Government subsidy
In China, the government provides 19-27% subsidy for export. Further, the import of
inputs for export purposes are duty free. A large area has been declared as a ‘free
zone.'

Duty structure
In India, there are several anomalies in the duty structure. Customs duty on raw
material/components/parts is higher than the duty on finished products. Excise duty
is required to be paid in retail by local industries, while excise duty on imported
goods is paid on the invoiced price. The burden of sales tax, octroi, etc. and also
income tax is very high, which add to the cost.

Infrastructure
The quality of roads in China is very good. Therefore, material can be transported
from one place to another place very quickly. While in India, the roads are in a very
bad condition, leading to delay in transportation. For example, for a distance of 800
km between Bombay and Rajkot it takes two to three days to get the material. In
China, the distance of 800 km can be covered in 10 hours. The communication
system in China is very reliable and cheaper than India. In China, there are no power
failures and good quality electric energy is available at around Rs 2/ per unit. While
in India, the quality of electric energy is poor, there are frequent breakdowns and the
cost is Rs 4/- per unit.

QUESTIONS FOR DISCUSSION:

Q1. Why do you think Ellora was forced to decide in favor of setting up a factory in
China despite the fact that it had been doing rather well both in the domestic and
export markets. Do you think the company can maintain its success rate in the
future with the new international manufacturing initiative?
Q2. Evaluate the differences between the manufacturing environments and
regulatory frameworks of India and China. What are the reasons behind the huge
cost differential between the products of the two countries?
Q3. What is the likely impact of the ‘Chinese threat'on the Indian manufacturing
industry? Discuss the options available to the government and the industry.
Q4. Discuss the factors that led to the relocation of Tata’s “Nano” to Gujarat .