When inflation in India started to get out of hand earlier this year, the first whipping boys of the central government were the cement and steel industries. They were forced to cut or hold down prices, and several measures such as export bans and reduction in import duties were initiated. These steps succeeded to the extent that prices didn’t gallop, but that stability came at the cost of the industry’s bottom line. Share prices of cement companies have slumped and analysts have removed the sector from their most-favored lists.

The 20-million-ton capacity ACC (formerly Associated Cement Companies), once owned by the Tatas and now controlled by Holcim of Switzerland, is the country’s largest cement producer. Holcim also owns Ambuja Cement, which adds 19 million tons to the group’s capacity. Put together, it is the second largest cement producer in India, marginally behind the Aditya Birla group. Holcim’s core business is cement, while the Aditya Birla group straddles various sectors. This makes ACC the leader in its category, and the company’s CEO Sumit Banerjee the de facto spokesman for the industry.

In this interview with India Knowledge at Wharton, Banerjee counters the government’s allegations of cartelization. He also discusses the dynamics of the industry and ACC’s own plans.

India Knowledge at Wharton: Why has the government been targeting the cement industry?

Sumit Banerjee: That question is best addressed to the government. We in the cement industry are surprised. On the one hand, we are constantly feeling the pressure of increased input costs. On the other, we are under pressure to reduce prices.

The average price per 50 kg bag of cement is about $5. This is much cheaper than the rate in Pakistan, Bangladesh, Sri Lanka and Nepal. Raddi (old newspapers sold as scrap) costs 14 cents a kg, while cement costs just 10 cents a kg.

India Knowledge at Wharton: But the cement industry is making very good profits. Doesn’t this point to cartelization?

Banerjee: Cement is a cyclical business where the margins depend upon the demand-supply situation. There are peaks and valleys. You cannot look at the profits of one year in isolation. They should be analyzed over a period of time, say, 10 years. Only then can a correct inference be drawn. Profits may have been at the crest of the cycle in the recent past. But at the present juncture, they are declining due to increased taxes, duties, levies and input costs.

Profits and cartelization are two different things, and it is unfortunate that they are being mixed up. Any company which is in business (and a trustee of the shareholders’ money) has to make profits. In the cement industry, which is highly competitive, there is not much scope for a single firm to make super-profits. This may give rise to allegations of cartelization, but these are ill-founded and motivated by certain user segments.

It is not possible to cartelize an industry that is extremely fragmented with more than 25 large cement producer groups and 20 others with a total capacity of 189 million tons. Besides, India has 365 mini-cement plants with a capacity of 11 million tons.

Being a commodity, there is not much product differentiation in cement. This leads to a small bandwidth of prices and a herd mentality on prices. From 2001 to the end of 2005, supply exceeded demand, which led to cutthroat competition, resulting in lower reinvestment realization. Because of this lower realization, capacity addition slowed down significantly during the period. This resulted in a marginal shortage from 2006 through 2007. Fresh capacity of 23 million tons was added during the last financial year (April 2007-March 2008). This has created the current capacity of 189 million tons.

Cement prices have always been lagging the wholesale price index (which measures inflation). It has caught up only recently. There has been a cost increase of around 33 cents a bag in March 2008 over March 2007, excluding tax increases. The tax increase is more than 40 cents a bag. Fuel, power, freight, excise and sales tax are the main contributors to the cost increase. As against this, the retail price increase has just been 21 cents a bag in this period. This is less than the cost increase. At the current average retail price of $5 a bag, the cement industry earns approximately 75 cents and the government $1.68 through direct and indirect taxes.

India Knowledge at Wharton: If these are the numbers, why are there still accusations of cartelization?

Banerjee: Market leadership, which is a well-accepted principle, is being mixed up with cartelization. As the product is a commodity and does not have any differentiation, whenever the market leader increases prices due to increased cost, others follow as they have the same cost pressure.

India Knowledge at Wharton: What has the government actually done?

Banerjee: The government has imposed a 12% ad valorem duty on MRP (maximum retail price). In absolute terms, the excise duty has gone up by $4.67 a ton. In addition, costs have gone up by 20%, which the government has asked the industry to absorb.

The government has also imposed an export ban on cement (which has been partially lifted). This is a knee-jerk reaction. Some 90% of this cement is produced in coastal Gujarat. Because of infrastructural constraints, it cannot be transported to other parts of the country. This means that the cement that cannot be exported cannot be sold. Pakistani cement, meanwhile, is being allowed into the country without any import tax.

There is another important issue. Indian companies have contractual obligations with foreign importers. Such export bans make India less reliable in the international community.

India Knowledge at Wharton: What impact will the government’s moves have on capacity building and investment?

Banerjee: If the industry does not get returns that can be reinvested, some of the future capacity additions may come under scrutiny.

Until 2012, cement companies have placed orders for 140 million tons of additional capacity. We estimate that 32 million tons will come up in calendar year 2008, 80 million tons by 2009, and 111 million tons by 2010. This will lead to much higher supply than demand and put further pressure on prices. This, coupled with policy inconsistencies, may reduce investment in creating cement capacity. People may prefer to wait and watch. Investment in building cement capacity may go down.

But, in terms of volume sales, India is one of the fastest growing markets in the world. At the same time, its per capita consumption at 150 kg per annum is lower than even the 400 kg in Vietnam and Thailand. In the U.S., it is as high as 800 kg. In places where there is a development boom, such as Dubai and the Emirates, it is a whopping 4,000 kg. The fear is that when infrastructure building in India moves into top gear — we expect per capita consumption to double to 300 kg in 10 years — the capacities may be inadequate. Today, cement consumption is about 65% in sectors like house building. But infrastructure sector consumption will go up.

India Knowledge at Wharton: What about the cost of creating capacity?

Banerjee: Inflation affects capital expenditure (capex) too. Our lower margin means that we have less money to put into building for the future. In just two or three years, the capex for creating one ton of cement capacity in India has moved up from $100 to $200.

India Knowledge at Wharton: What are your plans for ACC, which has a tradition of being a slow-moving giant?

Banerjee: The giant is not somnolent any more. If you look at our financial results in the past decade, you will notice a definite upward trend. I do not necessarily need to set a fresh agenda. The past two years have, in fact, shown an all-time best performance. So, most of the agenda is already set.

I have some dreams of my own for this organization. For instance, I want us to be a benchmark in internal communications. We should be able to reach out to every employee of this organization and rejuvenate a strong sense of accountability and performance orientation. That will help us all be more committed and responsive to work and results. I want us to be recognized in the area of sustainable development. I want us to be a learning organization. But, above all, we as a team are deeply committed to retaining our number one position in the cement industry in India. It is not going to be easy.

India Knowledge at Wharton: What do you see as your principal challenges?

Banerjee: The first challenge the industry has to face is to meet the growing demands for cement from the economy. This means we have to keep pace with economic growth and install additional capacities. Project implementation, planning and completion all become critical factors. We are facing difficulties in procurement of certain machinery which can lead to delays. Availability of skilled manpower is another challenge. The cement industry now has to attract and retain talent, while facing competition for skilled manpower from other manufacturing sectors.

Energy poses a looming threat. Most of our plants are self-reliant as far as power consumption is concerned but sourcing thermal energy will become increasingly difficult in the future. We are, therefore, carefully creating our long-term strategy for coal to mitigate sourcing and cost-related risks. Besides, we need to bring about substantial improvements in distribution costs and alternate modes of distribution. Our existing methods of distribution, particularly transportation, are quite dated and not necessarily globally competitive.

India Knowledge at Wharton: What are Holcim’s plans for India?

Banerjee: India accounts for 17% of Holcim’s global revenues, though it would be slightly lower in terms of profits. Holcim controls 24% of the market. It is planning to invest $2 billion to increase capacity from 39 million tons today to 55 million tons by 2010. Holcim has already invested $3.5 billion in India.

The company is also increasing its stake in ACC and Ambuja Cement through the creeping acquisition route. (Under Indian law, promoters are allowed to increase their stakes by buying up to 5% of their shares every year without having to make an open offer to the public.)

India Knowledge at Wharton: What difference has Holcim made to ACC?

Banerjee: Holcim has a successful global presence in 70 countries. It is made up of people from many countries, including Asians. The association with Holcim has opened ACC’s mind to the world.

India Knowledge at Wharton: Thank you for your time.