i) Restructuring and Rationalising
The first task which has been substantially accomplished is the rationalisation and restructuring of your Company's portfolio of businesses and investments. The decision to exit from the Financial Services and Edible Oils businesses was based on the need to focus on such businesses where the Company possessed a credible track record, and where it had the relative capacity to strengthen and nurture core capabilities over time to sustain a leadership position in the Indian global market of tomorrow. A careful analysis made it readily evident that ITC was not well positioned to add long term value in these areas. In fact, persisting with these businesses over the years had caused a substantial drain of corporate energy and shareholder value. A hard-nosed, determined and responsible exit was the only answer. As the Directors' Report makes explicit, in the case of Classic Finance it involved an outlay of nearly Rs. 800 crores of cash, closely on the heels of the pre-deposit of Rs. 350 crores relating to the excise case for the period 1983-87, completed in the preceding year. The task, required to be accomplished during the most turbulent period of your Company's history, was indeed daunting. This seemingly impossible feat was accomplished by generating internal resources through an unprecedented doubling of operating cash flows in the preceding year, supplemented by an additional Rs. 240 crores last year on the one hand, and mobilising long term loan finance on the other.
Such sacrifice, decisive action and capability displayed by your Company enabled the assets of these businesses to be placed in the hands of two international players of repute, namely ICICI and ConAgra, paving the way for their productive utilisation. The financial collapse of Classic Finance would have caused distress and panic among lakhs of deposit holders, which would have neither been in the interest of your Company nor in the national interest. You are aware of these occurrences as we had concluded this task with your knowledge and approval in keeping with the standards of transparency expected of your Company.
I would like to register a handsome tribute to you, the shareholders, for your ready comprehension and co-operation in putting this unsavoury history behind us. What needs to be carried forward are the lessons on how not to conduct a business, and the principles of trusteeship for which managements are accountable. The lessons learnt are also manifest in the code of governance that is being actively refined, which I shall address later.
ii) Strategic Focus and Challenges
The businesses that remain in your Company's portfolio are those where ITC has had a credible track record over long periods of time, ranging from twenty five to around a hundred years. These are also the businesses that present abundant opportunities for growth in line with the growth of the Indian economy. More importantly, these are the businesses that can be infused with core capabilities through modernisation, scaling up, and nurturing human skills. These businesses are already at a stage that provides a platform from where strategic positioning can be accomplished for sustainable global competitiveness over the medium to long term. Strategies are already in place for inculcating internationally benchmarked operating standards, marketing orientation and the related processes to exploit the special insight into the Indian market that arises from being close to the consumer. Consumer loyalty flows from the speed and efficiency with which an organisation adapts and innovates in satisfying his/her needs. Competitive advantage therefore is derived from anticipating the future and encouraging strategic thinking capabilities in the organisation.
As stated last year, the portfolio of ITC's businesses now comprises Tobacco and Cigarettes, Hotels and Tourism, Packaging and Printing, and Paperboard. It continues to be our objective to find a capable international partner for the specialty paper business of Tribeni Tissues division, as the future success of this business, in large measure, would depend upon proprietary technology more readily available with international players. We continue to encourage Exports, not only to earn valuable foreign exchange needed by the country, but also to interact with global markets to facilitate benchmarking and sighting future opportunities. The Real Estate acquired I the process of disengaging from Classic Finance can be a valuable asset, redeemable at a profit over a period of time. We are also exploring opportunities presented by the Retailing business, that can draw upon and combine the strengths of your Company's trademarks and the services knowledge accumulated whilst growing the Hotels business.
Each of your Company's businesses is in a different phase of development requiring distinctive focus and level of investment for the transition from a position of dominance in the regulated market of yesteryear, to a position of leadership in the highly competitive markets of tomorrow. Whilst possessing a conglomerate profile, the businesses are structured such that executive management can take place in a focused manner appropriate to the dynamics of each industry. Any buyer-supplier relationship in these businesses occurs in a policy framework that provides freedom to the buyer to access the most appropriate from the general market. The in-house supplier has to earn the custom through competitively superior quality and cost. To the extent that one business is a supplier to another, it creates an opportunity for building unique strengths through closeness of interaction and common purpose.
Having laid before you the policy framework and the nature of your Company's strategic thinking, I would like to touch upon the challenges inherent in repositioning these businesses for sustainable competitiveness. Apart from core capabilities required to generate superior value for the consumer, in most areas of economic activity, size would play an increasingly significant role. The largest corporations in India are tiny in the international context. You might know that no Indian private sector corporation features in the Top 500 Companies of the world. Besides the benefits of size, large corporations entering the Indian market are able to take a long term investment view, because they can service their shareholders from their established bases in other markets. In comparison, Indian business houses like your Company, do not enjoy such an advantage. Strategic moves will therefore require larger investments, gestation periods would be longer, and staying power and commitment to a business would be severely tested. Those who overcome these challenges would be handsomely rewarded, albeit over a longer time dimension. It is imperative to shed preoccupation with maximisation of tactical results and focus on investing in technologies and capabilities for tomorrow. A wholesome balance will have to be struck for profits and cash flows over three time horizons, namely, short, medium and long terms. As stated last year, I would like to re-emphasise that such an approach may not be adequate by itself, without a nurturing Economic Policy framework.
In today's dynamic environment, the only constant is change. Each of your Company's businesses would need to adapt to such change continuously. It would be the endeavour of your Board to keep the portfolio of businesses under periodic review. We would not hesitate to invite a partner, or even to exit a business, if it is concluded that our capabilities cannot match competitive forces in a reasonable time span. Each of the businesses that remains in your Company's portfolio, therefore, would have to subserve the abiding purpose of generating value. I will now share with you some of the salient features of your Company's businesses to update your understanding.
ii) Strategic Focus and Challenges
(1) Tobacco and Cigarettes
Consumer aspirations in India are progressively globalising, following the media and information revolution, and increased international travel. However, as a result of prolonged punitive taxation on cigarettes, fewer than 15% of India's 200 million tobacco consumers are able to afford cigarettes. yet, these 15% contribute more than 90% of Government revenue from the tobacco sector. Indeed, India would probably be the only country in the world where 85% of tobacco users are virtually outside the tax net. It is now a well established principle that sustainable tax buoyancy can be realised only from an expanding tax base. The twin impact of moderation in tax rates and the aspiration of consumers to upgrade tobacco consumption can multiply the size of this industry manifold, which in turn will provide a much larger tax base to yield the resources to invest in social infrastructure. It is not so widely known that nearly 85% of value addition in the cigarette industry accrues to the Exchequer at the local, state, and central levels. Any moderation in the rates of tax will create a multiplier effect, the greatest beneficiary of which will be the rural sector.
India is the third largest producer of tobacco in the world. Yet, its share of international tobacco trade is modest. Upgradation of tobacco consumption would provide the farmers with a larger and more secure domestic base for growing tobacco for export. The current level of foreign exchange earnings of around Rs 950 crores could be multiplied many times over.
The three major strategic thrusts of your Company are:
a) Focus on crop development to enhance quality and farm productivity. Your Company has nurtured a pool of trained manpower for this purpose. Investments of Rs. 375 crores have been planned for leaf processing plants and modern storage facilities to improve quality, reduce waste and enhance productivity.
b) Modernisation of cigarette plants by inducting contemporary technology, involving investments to the tune of Rs. 900 crores over the next five years. A new, greenfield, state-of-the-art factory is being established outside Bengaluru to match globally benchmarked standards.
c) Brands at the upper end of the market are being strengthened in anticipation of consumer aspirations. This is an important area of investment as it takes several years to build sustainable brand equity.
(2) Hotels and Tourism
Travel and tourism is already the largest industry in the world. It earns over US$ 3,700 billion in revenues and continues to grow rapidly. This sector provides the highest potential for generating employment per unit of investment and has a very large multiplier impact on the economy. Moreover, this sector generated nearly US$ 3 billion in foreign exchange earnings for India last year, at a time when tourist arrivals were a fraction of their potential. If India's share of world tourism grows from the current 0.3% to 1%, it will call for investments in the range of Rs. 20,000 crores to Rs. 50,000 crores depending on the mix of tourist arrivals, in the accommodation sector alone, indicative of the size of opportunity.
The Welcomgroup chain, operated and marketed by your Company's subsidiary, ITC Hotels Ltd., is already well established. It services the upmarket business and leisure segments and is the revenue leader in most locations where it operates. In order to exploit the growth opportunity, aggressive investments of around Rs. 1200 crores have been planned over the next five years in partnerships among your Company, ITC Hotels Ltd. and other independent investors. It is expected that these investments will bring handsome rewards over the medium to long term.
(3) Packaging and Printing
India is yet to witness a consumer revolution. Growing incomes would give rise to a higher standard of living that will create an increasing demand for sophisticated packaging. The Packaging and Printing division of your Company is the largest converter of paperboard into high quality printed packaging. It is a dominant supplier to the cigarette and liquor industries in India. The quality of packaging for these two sectors is internationally benchmarked, which has given rise to opportunities in the export market and a growing presence in the high value segments of food and personal care products. The challenge before your Company is to position this business as the premier supplier of creative packaging solutions. Expansion opportunities are being explored towards this objective.
ITC Bhadrachalam Paparboards Ltd. (ITC BPL) was promoted by your Company about 25 years ago. It dominated the paperboard segment of the industry in the regulated environment of yesteryear. The opening up of the economy since 1991 led to a rapid diminution in customs tariffs from 250% in the 1980s to 20% by 1995. On the other hand, progressive sophistication of the consumer goods industry is rapidly transforming the nature of demand towards high quality coated paperboards. This is a capital intensive industry. The transition from a restricted and regulated environment to a globalised environment requiring internationally benchmarked technology and products is a challenging one, involving substantial outlay and the attendant gestation. This task has become particularly onerous for ITC BPL, as the recently completed expansion and modernisation of its mill at an outlay of Rs. 675 crores, has coincided with a deep supply-demand adversity, intensifying price competition. On stabilisation, the mill is expected to deliver international standards of quality and cost. Such a dimension of capital intensive transition requires financial strength, staying power and determination to succeed. Such initiatives alone are not sufficient to secure the long term competitive standing of the paper industry in India. A supportive policy framework relating to fibre and farm forestry is vital.
Under the circumstances, ITC BPL has approached your Company for an additional outlay of Rs. 150 Crores through a mix of equity and preference capital. This proposal is before you today. Subject to your approval, and various other approvals as may be necessary, your Company's share capital together with its wholly owned investment subsidiaries, will stand enhanced from 37% to 51%. I would like to emphasise that the very scale of this project would serve as a major entry barrier for competitors. Your Board recommends this investment. In time, it is expected that ITC BPL would dominate the paperboard segment in the Indian global market.
Finally, I would like to deal with the subject I touched upon earlier, namely, that of corporate governance.
Corporate governance refers to the structure, systems and processes in a corporation, that are considered most appropriate to enhance its wealth generating capacity. Since business organisations have to match up to both societal expectations and stakeholder aspirations, codes of corporate governance in different parts of the world vary. Despite differences in form, the fundamental objectives of all codes are broadly similar. Equally, the type of business, the state of its evolution, and the nature of its activity would also influence the form of governance.
The Board of your Company bears the principal responsibility for fashioning a governance code appropriate to your Company. It is also charged with the responsibility of subjecting the code to a periodic review to keep it refurbished and contemporary. Over the last two years, your Board has evolved and adopted such a governance code and is now engaged in the process of refining it. ITC is a multi-business Company that needs to combine the governance requirements of each of its businesses and yet reflect a unity of purpose for the Company as a whole.
Decision making within your Company has been broadly divided among three levels. The Board of Directors of your Company at the apex, as trustee of shareholders, bears the responsibility of strategic supervision of the Company, apart from fulfilling statutory obligations. Its composition is a balanced mix of executive and non-executive directors, with the non-executive directors constituting a fair majority. The major responsibilities of the Board, namely audit, senior management succession and appointments to the Board, related remuneration, and legal and safety compliance are discharged on the recommendations of specific sub-committees of the Board constituted for such purposes. The constitution of these sub-committees is displayed in your Company's Report and Accounts. With the exception of the Nominations Committee, where I serve as the Chairman, membership of all aforesaid sub-committees is confined to non-executive directors as a measure of transparency. Over the last two years, these sub-committees have met regularly and have contributed significantly to the effective functioning of the governance code. In addition, the Board carries the responsibility of approving the strategic plans of your Company.
The strategic management of your Company is delegated to the Corporate management Committee (CMC), comprising the wholetime directors and some members of senior management. This committee is charges with the responsibility of reviewing progress of the strategic business plans of your Company and has appropriate delegated authority related to deployment of resources. The executive management of each business division is vested with a Divisional Executive Committee (DEC) headed by a Chief Executive. Each DEC is responsible for and totally focused on the management of its assigned business.
Through this three-tiered interlinked governance process, a wholesome balance has been created between the need for focus and executive freedom, and the need for supervision, control, and checks and balances. Each executive director is responsible for a group of business/corporate functions, apart from engaging in strategic management and supervision of the Company as a whole.
The formalised governance code prescribes the highest ethical standards in the conduct of your Company's business. I, as the Chairman of your Board, am deeply cognisant of my responsibilities in setting a personal example so that the governance code is internalised within the organisation and becomes part of its culture. In the ultimate analysis, there can be no substitute for the enlightened self regulation that is expected of every member of the organisation.