Defence shipyards' profit limits raised - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Wednesday 5 December 2007

Defence shipyards' profit limits raised

(Part 4 of a 5-part series on shipbuilding)

by Ajai Shukla
Mazagon Docks Limited, Mumbai
Business Standard, 6th Dec 07

For decades, the three public sector shipyards under India’s Ministry of Defence (MoD) have laboured to meet India’s warship requirements in facilities that gradually withered away due to a shortage of capital for modernisation. Profits for the three --- Mazagon Docks Limited (MDL) in Mumbai, Garden Reach Shipbuilders and Engineers (GRSE) in Kolkata, and Goa Shipyards Ltd (GSL) --- have been pegged at a fixed rate of 7.5% on the vessels they construct.

Whatever little modernisation has been implemented was funded through the warship building projects that the shipyards were allotted. Mazagon Docks, for example, is currently upgrading facilities with Rs 423 crores, which was budgeted within three ongoing projects at the shipyard: the Project 15 Kolkata class destroyers, Project 17 Shivalik class frigates, and the Scorpene submarine project. These funds, naturally, came with tight conditions on where they could be spent, leaving little to the discretion of the yard management.

That, however, is about to change. The MoD has sanctioned the raising of profits from 7.5% to 10% of turnover. A high-powered committee headed by the Secretary, Defence Finance, proposed this raise; the Secretary Defence Production and the navy’s Controller of Warship Production and Acquisition were also a part of the committee. The Defence Minister has okayed the proposal and the MoD will be issuing formal orders soon.

Secretary of Defence Production, Mr KP Singh, told Business Standard, “There is no hold up, and the Defence Minister has approved the increase. The drafting of the order is taking time because we want to study the previous orders properly.”

The increased flow of funds will provide the defence shipyards with a greater ability to manage their own modernisation. In 2005-2006, MDL made a net profit of Rs 60 crores; that rose to Rs 168 crores in 2006-07. Now, with the profit margin being enhanced to 10% on what will be a higher turnover this year, MDL could get as much as Rs 200-225 crores next year for its own modernisation schemes. Since GRSE and GSL are smaller yards, their profits rises will be correspondingly smaller.

The shipyards say that accruals through profits make for more stable and predictable modernisation than funds being sanctioned through warship building projects. Vice Admiral SKK Krishnan, Chairman MDL says, “We need to modernise the shipyard on a regular basis. Instead of Rs 423 crores through three projects, it would have been better to get Rs 40-50 crores annually for ten years.

The increase in shipyard profits will come primarily from the naval budget. With the three Kolkata class destroyers costing about Rs 2800 crores each, the 2.5% raise in profits would translate into a hefty Rs 210 crore rise in the cost of such a project. The navy, therefore, has insisted that profits will be increased only if the shipyard meets strict conditions, such as cutting down on ordering time and reducing the wastage of steel.

Admiral Krishnan explains that, “A cost-audit department of the MoD identified about ten different attributes that affected the cost of shipbuilding. In each one we said, this is our current figure over the last two years, and this is how we will improve our efficiency. Linkages were laid down between improving upon our efficiency, and our profit margin. So now we can claim more than 10% profits if we can match up to those expectations.”

The navy, for now, has accepted the shipyards’ contention that paying more for its indigenously produced warships will translate into modern shipyards that will cut down the cost of ships in the long term. Vice Admiral Birinder Randhawa, until last week the navy’s Controller of Warships Production and Acquisition says that all the infrastructure built so far through previous warship building projects will be considered Phase I of the shipyards’ modernisation plan. The modular shipbuilding facilities that the three MoD yards are now going to implement, with a global partner who is being selected, will form Phase II of the modernisation.

(Next: Part 5: Piecemeal orders: shipyards cry for long-term planning)

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