Arvina Mills: Re,Evaluating Profitability

By Rajeev Khera, under the supervision of Professor Murray J. Bryant

It was a typical, tropical June summer afternoon in
western India. The temperatures outside were soaring to 45C, and in his climate controlled environment, Mr. Bala, vice-president of operations,
knitwear division, at Arvind Mills Limited, had been
thinking hard about a trial order from one of the
world's major ready-to-wear apparel retailers. .The
initial developments leading up to this trial order
had gone smoothly, and the company was confident
that it had more than adequately addressed all the
major concerns of this customer. The continued
communications to and from the customer reflected
this sentiment. In fact, the success of this trial order
was taken as a given, and management was planning
for the large volume of business that would, in all
probability, come their way. The entire deal hinged
upon the premise that the customer would accept
the prices that were going to be quoted on June 22,
1999,the following Monday.
The importance of the "right" price was not in
the leastbit underestimated by Bala. He had carefully
Copyright

@ 2004,

Ivey Management

Services

monitored each and every elemental cost of raw

materials and process, and had suggested tremendous innovations on aspects that provided a considerable reduction in costs, without compromising on the quality; delivery schedules; and other
critical metrics. And yet, the numbers he was
looking at today were not globally competitive-a
fact borne out of the company's own market study.
Any further reduction in prices would render the
entire business un-profitable.
The choices to be made were stark and difficult. On the one hand was the option of quoting
the prices that had been worked out by the current
costing system-and lose the business to the competition (mainly China) (see Exhibit 1). The other
option was to accept the business at the price of the
competition (ignore what your own costing is telling you), ensure continuing revenues and take a hit
on profitability-and hope that in due course, the
company would be able to negotiate better prices
and recover some of the lost profits.
Version: (A) 2009-10-08

Arvind Mills: Re-Evaluating Profitability

1990
China
Hong Kong (China)
India

1995

1999

2000

2001

16,889 37,967
23,619 35,112

43,121

52,206

53,476

34,642

37,656 35,660
11,929 13,897

4,709

8,468

10,240

175

60,000
50,000
40,000
'2
. 30,000
~

20,000
10,000
0

1990

1995

1-<>- China ---

Textile Industry in

India-An Overview
From the day India achieved its independence on
August 15, 1947 (after about 200 years of the British Raj), until about 1986-87, the industrial policies of each successive government were guided by
the principles of socialist form of governance. The
governments enacted a labyrinth of laws, rules
and regulations, ostensibly to promote industrial
growth in a market environment that was protected to the greatest possible extent from external
competition.
The textiles and clothing industry is the largest
manufaCturing sector in India, accounting for
around four percent of GDP, 20 percent of India's
industrial output and 37 percent of total exports
(WTO, 1998).Textiles(i.e.,yarn, cloth, fabrics and
other products not made into garments) constituted
25 percent ofIndia's total exports, over half of which
consisted of cotton fabrics.l As the second largest

employerafter agriculture,the textileindustry provided direct employment to 35 million people

1999
Year

2000

Hong Kong (China) -f:r-

2001

India

including substantial segments of weaker sections of

society. Its growth and vitality, therefore, had critical
bearings on the Indian economy at large.
The dominant concerns of government policies
towards the cotton textile industry centered around
import substitution (the credo of self-sufficiency).
Exports were considered a marginal outlet for surpluses, protection of existing employment in the
organized (big business) sector, support of the decentralized (small scale) sector, and protection of the
cotton farmers' interests. These pre-occupations were
refleCted in the major government policies for this
sector such as:

.
.
.

extensive quota restrictions on vanous

product categories,
strong exit barriers, even for unviable operations (to ensure continued employment),
general discouragement of automation,
even for exports,
stringent price regulations to ensure the
poorest were able to afford to clothe themselves, and

CHAPTER 6: PRICING

176

stringent licensing for the organized sector

at the expense of small and medium-scale
manufacturers.

These strict policies led to an extremely skewed

development of the Indian textile industry. The
large-scale industries were restrained at the expense
of the small-scale industries that prevented modernization, quality investments, scale adoption, and
change in product mix from exclusive reliance on
cotton garments to mass clothing items based on
synthetic and man-made fibers. Indian fiscal and
customs policy too discriminated against development of synthetic base in India in line with the
government belief that "synthetic is for the classes
and cotton is for the masses:' As a result, while cotton prices were not allowed to move up (trade
control, and buffer state operations), synthetic
fibers were deliberately priced at uncompetitive
levels (viewed as a luxury fiber for higher income
groups) against cotton.
In its development policies, the state discriminated against the mill sector in favor of the powerloom sector, which was perceived as an engine of
growth. This was done through preferential import
and export quotas for the powerloom sector. As a
result, the powerloom sector flourished at the
expense of the other two.
Between 1977 and 1986,the powerloom sector
more than doubled its capacity, reaching 800,000
looms, while the mill and handloom sectors lagged
behind. Government controls on scrapping obsolete equipment and restrictions on imported
machines resulted in further under-used capacity,
poor productivity, and loss in profitability.
Strong resistance from workers fearing job
losses prevented any technological changes and
internal restructuring in these two state-owned
textile sectors. This led to a loss of competitiveness,
rising operational costs, and a weak and sickly
industrial structure.
The degree of skewing became apparent in
the fact that the Indian textile and clothing industries had one of the longest and most complex
supply chains in the world, with as many as 15
intermediaries between the farmer and the final

consumer. Each contributed not only to the

lengthening of lead times, but also to additional
costs. By the time cotton worth INRlOOreaches
from farmer to the spinning unit, its cost inflated
to INRI48. By the time it reaches the final consumer, it costs INR365.
The spate of broken links, exemptions available to various segmentssuch as smallscaleindustrial units that compete with exciseand duty paying segment, and disproportionate excise duty
incidence across the chain had become major
impediments to developingcompetitivenessin the
industry.Marketstructures weredistorted, creating
unhealthy competition among the segmentsthemselves,and succeedingin creating a diversevariety
of vestedintereststhat are (eventoday) opposed to
any reform in the sector.
The global trade in textiles was also regulated to a considerable degree, and access to
markets in the developed countries was not free
of protective tariffs and artificial barriers usually
in terms of quantitive restrictions. From 1974
and up to the end of the Uruguay Round in 1994,
textile and clothing quotas were negotiated bilaterallyand governed by the rules of the multi-fiber
arrangement (MFA).Though this system had its
fair share of drawbacks, it did help transfer the
demands from the developed countries like
China and India.
With the Indian industry crying for reforms
to essentially ensure its survival, and sensing a
whiff of the opportunities in the markets abroad,
manufacturers met with the government to
embark on a long-term policy of liberalization
and earning export revenuesbecame a key thrust
area. The years 1986-87 marked this key turning
point. The initial forays into the international
market were made by the first generation, entrepreneurial apparel (clothing) manufacturers.
Their abilities and resourcefulness brought a
number of international clothing majors such as
Levis,Benetton, Lacoste,and Pierre Cardin to the
Indian stores. Their gains also percolated downstream, and the large-scale manufacturers began
making huge capital investment to maximize
potential gains.

Arvind Mills: Re-Evaluating Profitability

The textile industry's restructure was helped
in large measure by the rapid devaluation of the
Indian rupee, and for the most part, it camouflaged
the lack of industry competitiveness and ensured a
steady growth.
The MFA was later replaced by Agreement on
Textiles and Clothing, a more rationalized system
that came into effect in 1995 at the Uruguay round
of General Agreement on Trade and Tariff (GATT),
giving further boosts to exports.

177

Cashing in on its technical skills and managerial capabilities, Arvind Mills undertook its
first expansion to manufacture denim. In 1986,
the company started to look for textiles that had
global demand, high margins, high entry level
barriers, (either of technology, expertise or
set-up costs) and, very importantly, low "fashion
volatility."The company wanted to focus on fabric that would never go out of style. From within
the possible products, denim proved to be most
suitable. From 1987 (at annual production
levels of three million meters), within 10 years,
Arvind Mills expanded to become the world's
third largest producer of denim cloth at 120million meters.
In 1993,a study of sevencountries found that
the price of cotton yarn per kilo was cheapest in
India at $2.79,compared to $3.30in Brazil,$4.19in
Japan,and $3.10in Thailand.Thiswasthe resultof
overalllabor and raw material costs being cheaper
in India.
Spurred on by the successes in the denim
industry, Arvind Mills undertook substantial

Arvind Mills Limited

With the current revenues at US$550 million,2
Arvind Mills Limited is the flagship company of
Lalbhai Group (Exhibit 2). It was incorporated in
1931to manufacturecotton textiles.Operatingin a
highly regulated and protected market, the company grew to become one of the leading cotton
manufacturing companiesin the country, producing conventional suiting fabrics, shirting fabrics,
and sarees (traditional Indian robe).

Sales by Market (Rs. in Crores)

2400
2000

1854

1600
1200
800
400
0
1996-97

1997-98

I~

Do~estic

1998-99

Exports

1999-00

-+-

Total

2000-01
(18 Months)

I
(Continued)

178

CHAPTER 6: PRICING

Sales and Operating Income

(Rs. In Crores)

2100

1877

1800
1500
1200
900
600
300
0
1996-97

1997-98

1998-99

1999-00

2000-01
(18 Months)

Profit Before Tax (Rs. in Crores)

200
100
0

133

109

-100
-200
-300
-400

-499

-500
-600
1996-97

1997-98

1998-99

1999-00

2000-01
(18 months)

Source:Companyfiles.
Conversion:
I Crore= 10million
US$I = INR36

investments of millions of dollars into manufacturing other textilefabricsas:

.
.

bottom weights (fabrics used to make

trousers) $275million;
shirting (fabrics used to make shirts)
$100million;

.
.

knitted fabric $120million; and

apparel.

The company organized itself along these

product lines and imaginativelynamed the respective divisionsas bottom weights,shirting, knit and
apparel division. Apart from these, the company

Arvind Mills: Re-Evaluating Profitability

had other

business

interests

in related

and

non-related industries. One of the group's companies, Atul Limited ($130 million), manufactured
chemicals and intermediaries for the textile, paper,
and leather industries. Another, Amtrex Appliances
Limited, manufactured and marketed household air
conditioners and had joint ventures with Hitachi
(Japan) and Fedders (United States).

Market Dynamics-Increase
Toward Complexity
The fashion and textile market worldwide had witnessed an immense transformation since 1990.
Moving from constant, non-volatile fashion trends,
major retailers, working with textile designers in
the fashion centers of the world, continually added
complexity to the products theytetailed in terms of
fabric color, composition, structure and styling of
the garments. The customer therefore was no longer buying out from the inventory they associated
with the manufacturers and the very initial stages
in the process of fabric manufacture. Tough competition placed further pressures on the lead time
to market and development cycles; in fact, the
entire end-to-end logistics of the value chain was
bearing the pressures of such transformations.
Arvind Mills' expansion kept pace with the
increasing complexity of the marketplace. The process
of manufacturing denim was relatively simple. It had

fewer variables, a less complex product mix and relatively easy logistics in terms of process and workflow
(see Exhibit 3). The company was able to successfully
exploit the economies of scale, (thereby reducing per
unit overhead), the low price of cotton, and the power
in its supply chain. The growth was therefore relatively
smooth, controlled, and predictable. But the early
gains were being eroded due mainly to the increase in
cotton prices that more than doubled between March
1989and March 1993.Also,the worldwide demand in
denim reached a plateau, and the margins were being
squeezed out.
The product structure, the product mix, and the
logistics involved in the manufacturing processes the
other divisions were, however, much more involved.
The apparel retailers and designers looked to
fabrics other than denim that offered more possibilities in terms of color and structure to manufacture trousers. Bo~tom weights became the next
logical step forward. Whereas the manufacturing
processes remained essentially similar, the logistics
had to address many more variations, production
run switches, different lot sizes, etc.
A recent addition to the range of fabric and
clothing came in the form of knitwear. The technology, equipment, processes, material inputs, product
mix, and logistics were entirely different from those
currently followed to manufacture woven fabrics
such as denim, shirting or bottom weights.
The fabrics came in both tubular and open
widths, in single knits as jersey, pique, textures,

(Primarily
indigo/white)

Customer

Dyeing

Processing

Source:Companyfiles.

179

Weaving

Stock

180

CHAPTER 6: PRICING

pointells, fleece, French terry, jacquards in solids,

feeds, and automatics, and in double knits such as
interlocks, needle-outs, ottomans, thermals, pointells, textures, reversible, jacquards, ribs in solids,
feeds and automatic collars, plains, and jacquards
(see Exhibit 4). These fabrics had applications
from casuals to formals, from active wear to sleepwear for men, women, children, and infants.
With so much variation and range, the one thing
that stood out was the immense necessity to understand and manage all specificationspertaining to each
and every order from the customer, and more importantly the need to have fast and clear communications
with the customers across the world. Arvind Mills,
sensingthis need, set up a high-tech design center.The
centre was networked globallywith designers to create
corpus of the finest international design. That linked
the designing facilityto a "pilot mill;' and the designs
created on-screen were duplicated on fabric in a matter of hours. This ensured that the customer got an
exclusive,world-class design in a very short time. This
process not only helped shorten design-to-market

lead-time; it also allowed the retailers and designers to

watch the trends closely and design and launch the
products close to the start of a season.

The potential order that Bala was looking at

was as follows:

.
.

Twelveshades (five dark, three medium,

and four light colors)
Overallquantity
Total = 180EoQ
1 EoQ = 350kgs
=> total kgs=
63,000kgs

6 EoQ Icolor
0

Medium

0 D"k
sh'de&-l
shades-2.5
0

Lightshades-

EoQ
I colo,
6.25EoQIcolor
0 Rejectionrate-30/0 (overall)
0 Program anticipated in peak season
Installed capacity = 3,500kgs/day(in three
eight hour shifts)
Therefore total program books about 20 days
worth of production; very lucrative

IIB_Cotton, Polyester/Cotton Blends,

different staple lengths

Different counts (fineness of yarn)

Customer inputs,
communications,
feedback

Different colors: Black, navy, khakis,

greens, olives (all custom-dyed)

Different structures: jersey, pique,

jacquards, pointells, etc.

Different finishes (stain proof,

anti-crease, etc.)

Arvind Mills: Re-Evaluating Profitability

.
.

Targetprice =250-275/kg
Probability of this order
through = 0.80

mind, was to propose a system of costing an order

that was more reflective of the current business
process (see Exhibit 5), and then re-evaluate the

comlllg

quote to be sent to the buyer. He asked the process

managers to work out different scenarios using SAP,
and come up with the numbers (see Exhibit 6).

So and So was confident that the company

could meet the target price.The centralissue,to his

Cost flow (existing) that mimicked

the current process flow

Cost flow as per the actual process

Communication

flow

Overheads
Product development costs

...
..

181

Communication
costs
Common Utilities
Support costs

Machinecosts
Capacity
Utilization/Efficiency

Were totaled and added / kg

of material delivered straight
to the bottom line

Capacity utilization/efficiency worked out.

Efficient schedules were profitable.

..

Overheads

Common utilities
Support costs
Were totalled and
added / kg of material
delivered straight to
the bottom line

.
.
..

EOO defined
SAP used to calculate planned costs

Calculate variances
Less lumped overheads which reduces
cross subsidizations
More accurate analyses on costs

(Continued)

'"

..
182

CHAPTER 6: PRICING

Direct labor

Rsj 2/kg

Product

Rs6/kg

RsIS/kg

Overheads

Rs30 - 40/kg

Arvind Mills: Re-Evaluating Profitability

CASEQUESTIONS
1. Whatpricing

ShouldArvindMillsresortto competition-based
Whyorwhynot?
Areanydiscounting
tacticsavailableto
whynot?
Shouldthemarketing
management
teamatArvindMillsattem
products
beingoffered,
themethods
of production,
andthedQlivery
systems?
program
affectthesechanges?

183