Thursday, April 10, 2008

State-Owned Enterprises: Performance Matters, Not Ownership

Shyam Ponappa / January 05, 2006

PSU reforms should be on systematic changes for results, not on ownership

PSU Profits

There is a tendency now to worship the private sector. Mention PSUs, and the impressions are “loss-making” and “inefficient”. So it is surprising to find the most profitable companies in India are PSUs (FY04). The table gives the top tier ranked by net profit in FY04 in the BS1000 and the Forbes Global 2000 with their return on capital employed (RoCE):

Red = Private Sector

Eight of the top 10 were PSUs, with seven having over 15 per cent RoCE. The exception is a bank, where the criterion is return on assets. Some may demur that administered markets skew PSU profits. While this is true, and the RoCE is not a life-cycle criterion like net present value, the fact is these entities show good returns on capital. What’s more, their performance could possibly be much better. There are, however, plenty of loss-making PSUs wasting resources, but that’s another matter [Business Standard, December 1, 2005: “How to read a PSU”, Sunil Jain (review of PK Basu’s Saving the Crown Jewels)].

Performance & Ownership

Focusing on the profit makers and the ownership conundrum, one would think our long-term interests are best served by maximising profits with due care for our people, their well-being, and our environment. Yet, much effort and time centre on privatising government-owned companies. The effort, presumably, should be to strengthen productive enterprises. Enterprise ownership is relevant only in four senses:

(a) It is in the public interest for enterprises to share profits with their stakeholders, comprising investors, employees, owners/employees of support facilities, or “ambient” society [reasons after (c) below].

(b) It is in the public interest for the government, too, to share in the profits, for use in infrastructure and governance. There is no particular virtue in taxes compared with a share of profits; in fact, the latter works better, because it does not distort prices. We should therefore concentrate on end-uses—results—and not sources, for evaluating material benefits and social impact (e.g. balancing growth with environmental protection, or development with displacement).

(c) The third aspect relates to performance, current or potential. Government interference in India often degrades performance, so taking government out of management is clearly in our interest. But we must also recognise that major undertakings elsewhere succeed when government and business collaborate. In the bastions of capitalism, the US and Britain, private enterprises in energy, industry (aerospace, armaments, and heavy engineering), and services (banking and insurance, not to mention the subtle backing such as nationals staying at their “home-brand” hotels) benefit greatly from government support. In India too, recall that supportive regulations—enabling communications, a favourable tax policy—nurtured the IT sector.

(d) The fourth also relates to performance, arising from special contributions by a strategic partner. Such partnerships often require an ownership stake.

The crucial requirement of most enterprises is to generate legitimate profits, operating in the long-term interests of all stakeholders, which includes society beyond the shareholders, employees and management. This may be contested now in India, where privatisation is considered the silver bullet. However, as with passive smoking or polluting industries, we need only recall that enterprises functioning in a regulatory-cum-social environment collectively result in enterprise performance as well as the total impact on society, to accept that enterprises affect all stakeholders, not just shareholders.

Human Resources

Once capital and land are available, the ultimate resource is people. Our PSUs have prime human resources: trained and skilled engineers and managers with expertise. If you doubt this, think of the PSU alumni who contributed to the achievements of Mittal Steel, Reliance, and international and domestic banks, e.g. HDFC, started by HT Parekh, who once headed ICICI. It must have been difficult, but it was possible.

Commercial Logic

There is compelling logic for vertical integration in sectors like energy, and for public-private partnerships, e.g. Boeing, Airbus, and Embraer. Energy security is accepted in the real world of assertive national interests, non-free trade, and material transaction costs, although academics might question it (Business Standard, December 15, 2005: “The race for oil”, Deepak Lal). There are also commercial considerations of size and capital access, opportunities of scale or buying power, and the ability to fully hedge long and short positions that provides competitive advantages (“Vertical Integration in Gas and Power: Necessity or Distraction?” Public Utilities Fortnightly, April 15, 2002, by Dan Gabaldon and Joe Quoyeser, after the Enron debacle:; “Welfare Effects of Vertical Integration in Energy Distribution”, Mark Lijesen, Netherlands Bureau for Economic Policy Analysis, at So, there are reasons not to privatise simply to rearrange ownership, just as blanket opposition to diluting government stakes is misplaced. We should all hold our dogmatic biases—the Left, Socialists, private sector votaries—and focus instead on ends in the public interest, and performance (how to get there).

Likewise, we can shoot for sectors like shipbuilding, turbines, or aircraft only with government backing, e.g. as Brazil’s Embraer has proven.

Strengthening PSUs

How can we strengthen good PSUs? Start from first principles:

- Redefine objectives, shelve logorrhoeic ideological debates on “disinvestment”.

- Build systems around aims and how to achieve them, using informed, multidisciplinary teams and project management, e.g., integrating energy PSUs. How else can they compete with Reliance or Shell? Reservations on integration seem premised on containing government interference, as against advocating disaggregated, stand-alone enterprises. They do not seem to reflect the requisite domain knowledge (to paraphrase Deming: best efforts bring improvement only when guided by knowledge; else they only dig deeper the pit we are in) on financial or commercial aspects.

- Induct strategic partners as our private sector would, e.g. no running airlines/airports by the seat-of-the-pants, nor awards for the lowest bid.

- Formulate strategies from multidisciplinary perspectives, instead of just aping free-market ideas, e.g., where scale economies operate (see Business Standard, August 4, 2005: “Competition, open skies ... and bust?”).

- Get government out of the management of enterprises (BSNL, ONGC, airlines).

- Get rid of administered pricing; use other less distorting methods, even taxes and rebates.

Any dogmatic approach will be damaging in the long run. Ownership is not the issue; setting up proper systems and performing well are.

Shyam Ponappa

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