Overall production cost has gone up by 10-12% - PHD Chamber Survey

Industry located in North India finds that its overall production costs have gone up by 10-12% owing to a phenomenal rise in costs of raw materials, oil, power, transport, interest burden and administration.  The escalating input prices are adversely affecting corporate margins and operating performance of companies and in the process making a huge dent on India’s image as a producer of low cost goods.

These are the findings of the recent survey undertaken by PHD Chamber on cost escalation in industry in the Northern region carried out for units located in Punjab, Haryana, Delhi, Madhya Pradesh, Rajasthan, Himachal Pradesh, Uttarakhand and UP.

Industry feels that the uncertainty in the global market arising out of commodity and fuel prices, has worked its way to adversely affect the production costs in industry.  What is more, the manufacturing sector has been hit the most with a majority of those surveyed reporting a surge in raw material prices, which is emerging as the biggest threat to industry.

The PHD survey reveals that almost all respondents, around 90% of the units, have witnessed a rise of over 10% in their raw material costs.  A further break-up shows that a significant majority, around 39%, finds that the raw material costs have surged beyond 50% in the last one year.  It is only a small minority, around 7%, which have been relatively unaffected by the spiraling commodity and raw material prices.

Another serious problem confronting industry is the sharp escalation in fuel and energy bill.  This is contributing, in a big way, towards undermining utility finances and pushing up the operating costs of companies.  Not surprisingly, a sizeable majority of the respondents (around 50%) find their energy costs going up by between 10-30% over the last year which could add up to 5% of the production cost.  This is particularly affecting units which operate on low margins and are unable to raise product prices in response to cost pressures.  Nevertheless, around 46% have not being much impacted by hike in energy prices.

Continuing with its downbeat prognosis, the results polled show that it is not only spiraling material and fuel costs but also manpower costs that industry has had to deal with.  It is feared that a 60% of industry finds that expenditure on employees has gone up by about 10-30% in the current fiscal and is of major concern to units as their reputation has been built around low wage costs. The rise in employee salaries without corresponding rise in their skill sets would put corporates behind major competitor countries while exporting in the overseas market. 

However, there is an equally significant majority for whom employee cost has been contained within the range of 0-10%.

Apart from the above heads of expenditure, India Inc. is also feeling the pinch on account of high transport costs, rising outward freight charges and spiraling administrative expenditure.  Industry also finds that high excise duty structure, which constitutes a significant portion of production costs, and high sales tax and other levies in certain items which make products uncompetitive in the international market.

An increase in interest costs has been cited as yet another major deterrent in business.  The survey shows that interest costs could add up to around 30% of production costs for those accessing outside sources of finance.  However, the overall impact of a hike in interest rate on production costs is not much as many companies are utilizing internal resources to fund their working capital needs.

According to the PHD survey, the respondents find it hard to raise output prices at the present juncture because of the elastic nature of demand. The situation today is that if companies pass on all costs to the end consumer, it will affect demand and if not, it affects operating margins.  The survey shows that it is only a handful of companies surveyed, around 11%, which are able to fully pass on the rise in input cost to the end-consumers.  A whopping 35% felt that the prevailing demand conditions were not conducive to a rise in output price.  However, around 54% said that they have been able to partially raise product prices to off-set the pressure on costs.

The good news is that the hike in fuel and commodity prices have induced firms to be more energy and cost efficient which have helped them to sustain their profitability to a significant extent.  Reports indicate that companies have already started adopting belt tightening measures to adapt to the changing market conditions.  According to the PHD survey, companies have started cutting down on travel, costs, deferred hiring decisions and experimented with ‘work from home’ to beat costs.  Besides corporates are also assiduously adopting energy saving devices such as implementing heat recovery systems, changing raw mix designs, installation of latest gas analyses for process control, switching over from captive power and to grid power, using alternate fuels CFL for lighting, staggering peak load in the works, initiating water conservation, air compression use of waste heat utilization and power saving devices etc. to conserve resources and bring about energy efficiency.

Some methods to save overall costs in industry include:

• Inventory control
• Reduction in overheads
• Adopting lean manufacturing – identifying bottlenecks and other impediments in the path of lean production, initiating six sigma measures to control costs, effecting line balancing / flow design / layout changes to save time and cost.
• Reduction of raw material cost by value engineering and by development of alternative vendors.
• Augmenting R & D and finding technology solutions to offset the rise in major raw material costs.

Commenting on the rising costs in industry, companies feel that the government should have responded to signals emanating from the global economy and gradually raised fuel prices as this would have made it easier for companies to absorb cost instead of creating an environment of uncertainty in the economy.

Respondents felt that the recent price hike of inputs would definitely have an adverse impact on profitability.  In fact, around 50% of respondents polled perceived that their net revenues would decline by 10% by the end of this fiscal.  Around 38% anticipated their profits to go down by 11-30% while a small minority envisaged a fall in profits beyond 50%.  This is despite the cost cutting measures initiated by industry to stay lean.

Under the circumstances industry feels that there is also a compelling need to revisit prevailing policies in order to reinvigorate the industry and improve the investment climate in the region.  In this context, the respondents have suggested that efforts be made to ensure provision of better infrastructure facilities like roads, rail, airports, ICD, water sewerage and power. 

Secondly, the regulatory and fiscal burden on industry should be reduced by allowing higher depreciation on capital goods.  Furthermore, rationalization of excise duty on inputs, removal FBT and all special cess and duties and streamlining procedures should be given priority attention.  Skill development and reduction in cost of credit as also sustained efforts to bring down inflation to 6-8% were the other suggestions made by units to address the problem of cost escalation in industry.