December 2006
Management

By Sujit Mundul

Reality says that the traditional ratio analysis does not always distinguish in a clear and consistent manner between the successful, likely-to-survive unit and the one heading for reorganisation or bankruptcy. Researchers and analysts have sought for years for some method to spot winners and losers well in advance. The technique of "Z" scoring, developed by Edward Altman, is one offering.

It consists of reducing the financial data of a company to a single number, the sum of a series of ratios each multiplied by a co-efficient, the idea being that the higher the total, the less risky the company.

A score in excess of 3 is said to indicate a safe company and one below 1.8, is a likely candidate for bankruptcy.

To evaluate this formula as an analytical tool we need to know something about how it was devised. It was not the product of anyone's particular opinion as to the importance of any given ratio in corporate analysis. What Altman did was to take a large population of companies, and put their accounts of several years into a computer. Some of the companies in the sample were "good", that is, companies which had gone on to obvious prosperity, the rest "bad", entities which had subsequently filed for bankruptcy, or reorganisation or negotiated major debt rescheduling with their bankers. The computer was programmed to calculate dozens of ratios for each company in the sample, and armed with this data, Altman proceeded then to devise a statistical test that separated the "good" from the "bad".

His aim was to come up with a formula which would identify potential "bad" at the earliest moment, if possible at least two or three years before the crisis occurred.

The underlying belief in this statistical approach was that there are certain mathematical features commonly found in the accounts of "bad" companies and the more extreme the incidence of these features in a set of accounts, the more likely the company is to fail. Care had to be taken in devising the Z score to ensure that each of the ratios measured something different and that no two ratios were closely co-related, since there is no point in including two separate ratios that essentially measure the same phenomenon. This consideration in part explains the rather peculiar selection of ratios included in the formula.

Looking at the actual components of the formula, one is not surprised to see that low working capital, retained profits, current operating profits and asset turnover were all found to be crucial indicators (ratios a, b, c, e), and ratio d is curious only in that, in measuring leverage, Altman found that the market's evaluation of the equity of a company was a better number than the book value of the equity.

In the process of evaluating the effectiveness of Altman's formula as a bankruptcy predictor, it has been observed that for US manufacturing companies, the model still works more than adequately. Supporters of this technique claim that potential bankruptcies can be spotted as far ahead as five years in some cases. However, it should be kept in mind that as Altman's sample companies were all US manufacturers, one can hardly expect the formula to work accurately for companies outside that category, and that there are evidences to that extent.

A company's financial statements owe a good deal in their structure and shape to the underlying nature of business as well as to the accounting conventions prevalent in the country of domicile. It is reasonably expected that in the UK, Altman's model would work up to an extent, but probably not as well as it does for US manufacturers. The model does not work for service or financial companies. High leverage, for example, is dangerous in a manufacturing company but may be essential (within reason) for a finance company or a bank.

Since Altman's celebrated model first appeared, a lot of work (including significant refinements by him) has been done, much of it in the UK, to produce better predictive models and adapted to categories of company other than US manufacturers. Nevertheless, it is extremely difficult to suggest one universal "Z" scoring formula. As a consequence, most other "Z" scores remain commercial secrets.

It is now well recognised that the "Z" score will be a factor in a commercial decision, to be weighed along with other data, given due weight but not allowed to assume disproportionate importance.

(Mundul is the CEO of Standard Chartered Bank Nepal Ltd.)

OM in Noodles Biz

Assessing how operations management ( OM) is practiced in the Nepali instant noodles companies.

Concepts like just in time (JIT), six sigma and lean production are still very rarely practiced in Nepali companies. When questioned about the feasibility of implementing such concepts in Nepal, G.P. Shah, CEO of the Chaudhary Group and Rabindra Man Shrestha, the previous CEO of Himalayan Snacks and Noodles (who recently joined Continental Trading Enterprises Pvt. Ltd. as its MD), agree that in the noodles industry, even though some modern concepts are practiced, a lot more could be done.

Implementing the JIT concept means employing ideas like implicit control mechanism, collective decision making, holistic concern for employees, human capital investments etc., but almost all of these ideas are still alien to Nepali companies. Implementing these concepts also means total process reengineering: making drastic changes in organisational cultures and strategies, a time consuming as well as an expensive exercise for Nepali companies.

Operations management ( OM) started gaining serious attention in Nepal as a core organisational competency only since the mid-80s when significant changes were felt imperative in the manufacturing sector after the start of the liberalisation of economic policies. In this relatively short span of time since then, Nepali companies haven't been able to adopt many of the modern management concepts that were developed in foreign institutions. But there have been some improvements in quantitative as well as qualitative terms. Although the Nepali manufacturing sector is still far behind the level attained by this sector in developed countries, it has definitely grown to become more complex in recent years. Dealing in a steadily globalising and competitive market, Nepali managers know that the concept of operations management is a powerful weapon.

Even though he admits that Nepali companies aren't able to follow modern concepts in managing operations, Shah says his company is prepared for competition from multinationals. "Our processes and products are at par with international standards. That is why we have been able to market our products in different countries like Bhutan, India, Hong Kong, Qatar, Saudi Arabia and the UK." Shah also claims that his company's instant noodles brand Wai Wai has always focused on operations management like marketing and finance. "Operational excellence has been one of our core competencies," says he.

But Shrestha has something different to say about Himalayan Snacks, the producer of the Mayos brand of instant noodles. "We never segregated functional areas. We treated marketing and finance as parts of operations management. To us, operational excellence meant excellence in all the core areas and not just in the manufacturing side alone. We had a holistic view towards operations management," he says.

About six years ago, the intense competition between Wai Wai and Mayos to promote their products led to aggressive advertising schemes from both companies. The aftermath of this promotional drive has proved astoundingly good for both as it has helped to expand the instant noodles market as a whole. Shrestha and Shah both claim that these days many households in Nepal have been consuming noodles as standard lunch while, until six years ago, it was considered only as a snack. Also, the production capacities of these companies have increased significantly since then. For example, with four noodle plants situated at Nawalparasi, the Chaudhary Group now has the capacity to produce 30,000 cartons of Wai Wai and other snacks per day while 2PM has the capacity to produce 20,000 cartons. Wai-Wai is soon going to be produced in Uttaranchal in India, as well. It is already being produced from a Sikkimese plant under contractual manufacturing for over a year now. "But we don't manufacture noodles without market research as our production totally depends on research. That is why Wai Wai employs a separate unit for market research," claims Shah.

All Nepali noodle companies employ the same type of equipment (an important aspect of operations management) in their factories. Most of the equipment is imported from Japan as they are very efficient. "There have been breakdowns in machineries but seldom have our operations been halted due to this," say both Shah and Shrestha. Normally preventive maintenance is practiced in-house to pre-empt major breakdowns. If a major breakdown does occur, then Japanese technicians visit the factories to repair the equipment.

Facility location and layout planning are also given due importance in the operations management of noodle factories. The layout systems of most of the noodle factories in Nepal are 'product layouts'. In this system, different machines are placed along the product flow line and they perform various operations on raw materials in a fixed sequence to manufacture the final product.

"We don't establish our factories in isolation. We take into account all the factors that influence our business activities. Tax considerations, proximity to customers, raw material sources and potential for future expansion are the four basic considerations that we look at while establishing factories," says Shah. He also maintains that Wai Wai has nearly doubled its labour efficiency since it began to focus on systems that minimise the material handling time and built layout designs based on optimum utilisation of floor space. "We have also given due consideration to the safety of our workers in our designs," says Shah, "That is why Wai Wai has not faced any labour disturbances."

"We had excelled in the safety factor," says Rabindra Shrestha. "Our labour efficiency was also attributable to a good layout system design. None of our workers complained about the quality of their work life. We provided good working conditions for them. The lighting systems in the factories were well balanced. Similarly, we focused on safety measures as well. Emergency exits and fire extinguishers were placed for the safety of the workers."

As for inventory management, every noodle company follows the standard Economic Order Quantity (EOQ) concept. EOQ follows a formula to find the ideal quantity of goods to be ordered to minimise the total annual cost of inventory and modern technological advancement has played a pivotal role in its development. Managers now use various behavioural and statistical modelling and scientific techniques for cost effectiveness. "With the help of software like Oracle, SAP R\3, and QAD Mfg/pro, important issues like minimising transportation costs and allocating optimum resources can easily be calculated," says Shah. Material requirement planning and other important data are also computed through software.

Because of the uncertain nature of the Nepali business environment, noodle manufacturing companies have to be prepared for sudden adversities and manage their inventory with extreme cautiousness. "A certain percentage of the noodles we manufactured were kept as stock to prepare for emergencies like Nepal bandhs or other major unannounced close downs of factories or businesses. Recently the factory was closed for a month due to external factors but our products still reached the customers. There was never a shortage of our products in the market even in difficult situations," recalls Shrestha.

Quality is seen as the backbone of operations management and both companies give it due importance. "This was the only area from where our customers could see us, especially when the products reached places way beyond our national borders," says Shrestha. "We always gave the topmost priority to quality."

Shah is also confident about Wai Wai's quality. "We are the first ISO certified noodles company in Nepal. So, we don't have to give any explanation about the emphasis we place on quality," he says. "People have been loyal to us on this ground alone. We have never compromised our quality and we never will," claims Shah. He says that a good product is the result of intelligent efforts and an organisation must perform a series of tasks, each in perfection, to achieve the desired quality. "We keep a close eye on the quality of materials, manpower and machines to get our target standard. Any output that falls below the standard will not go on to the distribution department. There has been a separate quality control department to scrutinise the manufacturing activities. So far, we have never heard of defected Wai Wai products in the market and this has been a great achievement for us," adds he.

However, even though people in the noodle industry are confident of success in the future, they have to be careful. The basis of G.P. Shah's claim that his company is ready for multinationals relies only on the strong brand name that Wai-Wai has developed into. In reality however, competing with other organisations through operational efficiency means more than just creating a brand. Therefore, even if some elements of operations management are already practiced in the noodles industry in Nepal, this is not enough. With Nepal liberalising its trade policies and attracting foreign investment, foreign players may enter the Nepali market anytime. If they arrive, multinational companies, with their modern technology and managerial efficiency, can drive the domestic industries to doom.

For operational excellence, an organisation must be able to either increase or equal its operational margin with that of its competitors. This requires a good supply chain management, inventory management and quality control systems. All these become more complex when the competitors are global giants. This means more brand extensions, more product innovation, allocation of more funds to R&D, a larger variety of products and better quality checks; all achieved with more cost effectiveness. One of the challenges after the arrival of multinationals will also come in the form of poaching of efficient employees. Therefore, excelling in OM means more than just excelling in the transformation process. Despite the difficulty of implementing JIT and other concepts in Nepal, domestic companies need to start practicing these principles right away to be prepared for the future. The sooner they do so, the safer they are likely to be.

(Bibek Subedi & Manish Bikram Shah)

SPORTS
A Managerial Court-Card

By Santosh Poudyal

Sports, rarely taken in to consideration in Nepali organisations, have many implications in the work life. Inter and intra organisational sports-events conducted regularly can recharge employees' batteries. The enthusiasm and energy created by sports encourages employees to bring similar excitement in their work too. Let's look at the effects that sports could have on different organisational domains:

Team building:

Just because a team is assigned for a project, its success is not ensured. Of course, the idea of forming a team is to make two and two into five, but this objective is fulfilled only in a few cases. Sports give valuable insight into how to form the best team and make it effective. Sports teams vividly exhibit such ideas as constructive conflict, high social and task cohesion among members, common interest in the team's objective, removal of duplication of work and sharing the same goals and beliefs. One does not need to be a management guru to say that these are some mandatory factors that determine the effectiveness of a team. Periodic sport-events among employees can help develop these traits in the organisational team.

Setting goals and strategies:

While playing games, individuals are filled with the passion to win. Since the games are played among the employees, winning becomes a matter of pride in the organisation. If a team loses a game, they have to come up with better ideas and strategies to win the next one in a short span of time. This allows individuals to quickly adapt to changing situations, reshuffle roles and form alternative goals and strategies by assessing the other team members' skills.

A tool for internal assessment:

A balanced organisation is one that has members with skills which complement each others'. Strengths and weaknesses of an individual will change as the statistics of work-experience and training increase in his account. Sports can be one of the tools to unearth the hidden talent in the employees as well as to remove the rotten apples. Individuals are more prone to reflect their internal characters in a natural environment while playing games than in the more formal work place. It also provides a chance to the individual to introspect and remove some misconceptions about himself, such as the feeling of being overqualified or underqualified.

Sports and conflict:

Sports teach people how to handle conflicts. The word conflict has a negative connotation but constructive conflict is always very good for team work. Post-play analysis can help employees learn organisational and team work skills. They will clearly see the adverse effects on the end result from things like blaming others for failure, taking the entire credit individually, forcing others to follow a certain idea and beating around the bush by neglecting the focus on the critical issue.

Make the workplace fun:

Sports help to create an ambience in the organisation such that, whenever employees think of the office, they think about fun activities instead of pressure and repetitive and hard work. Managers can cultivate fun in the workplace by holding frequent contests, celebrations, and team-building activities. By encouraging mini timeouts in between office hours and utilising that period for fun activities like solving puzzles, Halma, Chinese-checkers etc., can help to clear the cobwebs developed by heavy work loads. Hence, sports can help organisations undergo a metamorphosis in terms of productivity.

Stress buster:

An organisation needs to keep abreast of the competitive market place, and increasingly more pressure is being felt by employees. Both individual and organisational pressures, stress, tiredness, burnout and other array of factors can pile up in employees and reduce their productivity. Sports can help reduce this. By focusing on the court-card, the managers can turn the market game in their organisation's favour.

Employee-employer relations

Including sports events at the beginning of the recruitment process can work as the ice breaker for new-comers. It also helps in addressing grievances which can brew up among employees or between employees and the management at different times. Another problem frequently experienced in the workplace is the generation gap between old and new employees. Sporting events help to bridge this gap, if it exists.

Employee recognition:

Sports can be taken as another scale to recognise employees. A "best employee/ team" from the sports category can be selected and pictures can be placed on the company's bulletin boards. Picture of the most successful team, media clippings etc. can also be placed. This gives recognition to employees and hence increases their level of satisfaction.

Create loyalty:

Last but not the least, sports help bind the group by acting as a glue among employees. During intra organisations sports, employees become department or branch loyal, while during inter organisational sports events, they become loyal to the organisation. This helps increase in-group cohesiveness, a factor that keeps the team focused and determined.

How to keep employees happy and motivated in today's pressure-cooker work environment has become a vital issue that employers are experiencing today. From venting out grievances to creating loyalty to the organisation, sports have limitless possibilities in the business world. A periodic mix up of sports in the business schedule helps employees to gain a competitive edge. There may be many appealing tools to handle such situations but sports can be a "court card" in the managers' hands that help them make the pessimists see the silver lining.

(Poudyal is pursuing his MBA in Delhi University)