Road Map to Success for the Construction Equipment Industry

Road Map to Success for the Construction Equipment Industry With high infrastructure growth expected in India, the earthmoving and construction equipment (ECE) market is estimated to increase by 20 to 25 percent. Road Map to Success for the Construction Equipment Industry 1

Acknowledgments This study was undertaken by A.T. Kearney with support from the Indian Construction Equipment Manufacturers Association (ICEMA). We would like to thank the Excon conference leadership for their overall guidance with this study: Amit Gossain (president of ICEMA and executive vice president of JCB India), Anand Sundaresan (vice president of ICEMA and vice chairman and managing director of Schwing Stetter India), Glenville Da Silva (vice president of Volvo Construction Equipment), P. Ravi Shankar (CEO of Ashok Leyland John Deere Construction Equipment Company), D.K. Vyas (CEO of SREI BNP Paribas), Dinanath Dubhashi (managing director and CEO of L&T Finance), and Pratik Kumar (CEO of Wipro Infrastructure Engineering). We would also like to extend our sincere thanks to various ECE original equipment manufacturers, construction companies, and component suppliers for their valuable insights. Foreword Excon s 2011 study charted a vision for the earthmoving and construction equipment (ECE) industry for 2020, emphasizing its strong long-term potential. Despite the short-term challenges of adverse market conditions, we believe the industry s long-term potential is intact and will unfold over the next few years. Infrastructure growth holds the key to the industry realizing its potential in India. In the 12th Five-Year Plan, the government has earmarked approximately $1 trillion for infrastructure investment. Consequently, infrastructure spending is expected to grow from 7.2 percent of GDP in 2012 to 9 percent by 2017. This is likely to spur the demand for ECE, and if the industry s full potential is realized, the result could be a $16 billion to $21 billion industry by 2020. This significant opportunity raises some important questions: What challenges need to be overcome for the ECE industry to harness this potential? What enablers will help the ECE industry fulfill its potential? What global best practices can help address these challenges, and how effectively can they be used in India? To answer these questions, A.T. Kearney and the Indian Construction Equipment Manufacturers Association (ICEMA) conducted a joint study to identify the industry s challenges and opportunities and assess potential solutions. The findings are presented in this report, which draws on A.T. Kearney s global expertise and the intellectual capital on the industry. Experts across the ECE value chain, the infrastructure industry, and private-sector specialists have also contributed valuable insights. The proceedings of the Excon conference will be released as a companion report, which will draw out the specific recommendations for a variety of stakeholders, including governments, original equipment manufacturers, and construction companies. Amit Gossain, president, Indian Construction Equipment Manufacturers Association Manish Mathur, partner, A.T. Kearney Road Map to Success for the Construction Equipment Industry 2

Contents Overview 2 Demand Drivers for Growth in the Earthmoving and Construction Equipment Industry 12 Transportation Infrastructure: Road and Rails 12 Urban Infrastructure: Urban Centers and Mass Transit 19 Rural Infrastructure: Irrigation and Rural Roads 28 Enablers for Growth in the Earthmoving and Construction Equipment Industry 35 Equipment Financing and Renting 35 Skill Development 39 Construction Equipment Components and Aggregates 41 Road Map to Success for the Construction Equipment Industry 1

Overview A well-developed infrastructure is a foundation for growth in any country, paving the way for a better quality of life and a rapid rise in gross domestic product (GDP), especially for developing countries such as India. However, building infrastructure in a country as diverse and populous as India isn t easy. The country is behind in terms of infrastructure availability when compared with other leading developed and developing countries. For example, India has one of the world s densest road networks (1.42 kilometers per square kilometer of land area compared to 0.66 for the United States and 0.43 for China), but the number of multilane highways (four or more lanes) is quite low (see figure 1). Airports are among the most crowded in the world, highlighting the need for airport infrastructure (see figure 2). India has witnessed rapid urbanization over the past two decades, which has put tremendous strain on urban infrastructure. Access to sanitation is poor despite tremendous strides in the past decade: Just 44 percent of India s population has access to sanitation, while in China and Brazil that number exceeds 80 percent, and in the United States and Malaysia it is 100 percent. Figure 1 India has a shortage of multilane highways Figure 2 India s airports are among the world s most crowded Roads with four or more lanes (km as % of overall road length) ('000s of passengers) 628 12.9% 204 55 8.2% 3.5% 19 23 0.6% United States China Mexico India Mexico Brazil United States India China Source: A.T. Kearney analysis Source: A.T. Kearney analysis All signs point to a country that would be wise to focus on developing its infrastructure. And when it does, demand for earthmoving and construction equipment (ECE) will surge. Growth in a country s ECE fleet is highly correlated to the growth of the construction industry (a proxy for infrastructure growth), with a high correlation coefficient of more than 0.99 (see figure 3 on page 3). In the near future in India, the bulk of construction growth is likely to come from growth in transportation infrastructure (roads, rail, airports, ports), urban infrastructure (mass rail transit systems, water supply and sanitation, urban housing) and rural infrastructure (rural roads, irrigation, rural housing) three important sectors for driving ECE demand. With significant infrastructure growth expected in India, we expect ECE stock to exhibit robust growth in the near future. Road Map to Success for the Construction Equipment Industry 2

Figure 3 When the construction industry grows, equipment stock rises Earthmoving and construction equipment stock (million units) 400 300 200 R 2 = 0.9949 100 0 0 100 200 300 400 Construction ($ billion) Source: A.T. Kearney analysis Earthmoving and Construction Equipment Market Growth The ECE market is expected to grow by a healthy 20 to 25 percent over the next few years to reach 330,000 to 450,000 units sold in 2020, from current levels of about 76,000 units (see figure 4 on page 4). This would imply a $16 billion to $21 billion market, up from today s $3 billion. The sector will continue to be dominated by backhoe loaders (more than 40 percent of total demand), but broad-based growth is expected across products, with each segment expected to see double-digit growth. A rise in the use of concrete will also create demand for concrete equipment in infrastructure and housing projects. Six factors will propel the industry forward: Fundamental growth from end-user industries. Demand will continue to rise as a result of growth in traditional end-user industries, including construction and mining. Higher adoption in traditional applications to speed up projects. Increased use of ECE in previously traditional applications will give rise to new demand in applications such as digging and soil loading, especially in time-sensitive projects. ECE demand from new applications. Demand is also expected to grow in new segments such as agriculture, which have not historically been ECE users because of a lack of access but are slowly adopting ECE. Growing urbanization. Urbanization will drive the demand for construction to meet residential, commercial, and infrastructure development needs. Increased affordability. New players entering the market have made competition stiffer, thereby making ECE more affordable. This will further deepen the markets to cover users with ECE needs and previously low access. Better availability of financing. More financing of ECE and the increased use of rentals will create wider use by encouraging users that don t necessarily want to own equipment. The rental market in particular is expected to pick up in tier 2 and tier 3 towns, where growth will be driven by small contractors doing construction work. Road Map to Success for the Construction Equipment Industry 3

The long-term potential for India s ECE market is significant, but growth is expected to lag behind China by about 10 years. For example, excavator sales in India in 2012 (14,500 units) are on par with sales in China 11 years earlier (12,500 in 2001). Equipment sales grew much faster in China. For example, excavator sales in China grew by about four times between 1999 (6,800 units) and 2004 (28,000 units). In India, sales grew by 2.5 times over the same number of years, starting from a similar base of 5,900 units in 2006. More end-user industries using ECE and a surge in investment in infrastructure in China have propelled ECE market growth at a significantly higher rate than in India. Infrastructure Investment in the 12th Five-Year Plan India s need for infrastructure development is also well supported by the government s intentions as outlined in the 12th Five-Year Plan (FYP). Infrastructure is one of the plan s primary areas for spending, with about $1 trillion (INR 55 lakh crores) earmarked for investment (see figure 5 on page 5). Five sectors account for more than 80 percent of total planned spending: electricity, telecom, roads and bridges, irrigation, and railways, including mass rapid transit systems. Overall, the 11th FYP saw a significant rise in infrastructure investment, with 24 lakh crores invested. This represents an overall increase of 70 percent compared to the 10th FYP. Figure 4 Sales of earthmoving and construction equipment are expected to rise in India (sales in 000 units) CAGR (2012-2020) 20 25% 330 450 12 16 10 15 25 35 Forklift Wheel loaders Mobile cranes 15 20% 22 27% 13 18% 95 120 Crawler excavator 25 30% 160 180 7 8 4 6 14 18 140 190 Backhoe loader 20 25% 35 40 76 2 9 4 15 32 4 9 1 2012 $3 billion 65 75 2 3 7 10 22 24 2016e $7-8 billion 3 4 11 14 40 55 2020e $16-21 billion Batching plants Transit mixers Other 12 17% 12 17% 20 25% Note: Other includes mobile compressors, compaction equipment, asphalt finishers, boring machines, motor graders, skid steerloaders, crawler dozers, mini-excavators, and pavers. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 4

Figure 5 Infrastructure is one of the main spending areas in India s 12th Five-Year Plan (Rs '000 crores) Plan Actual 5,575 About 8.2% of GDP over plan period 1,358 1,433 2,653 2,424 10th Five-Year Plan 11th Five-Year Plan 12th Five-Year Plan Source: A.T. Kearney analysis Although the infrastructure investment fell short of target during the 11th FYP by about 10 percent, the planned investment is now more than double the levels achieved in the 11th FYP. Private investment was higher than projected during the 11th FYP. The shortfall was the result of lowerthan-planned investment by central and state governments, primarily in railways, irrigation, water supply and sanitation, and ports. Overall, infrastructure spending is expected to grow from 7.2 percent of GDP in the 11th FYP to 9 percent by fiscal year 2017 (see figure 6). Private investment in infrastructure is expected to increase from INR 8.8 lakh crores in the 11th FYP to INR 26.8 lakh crores in the 12th FYP, with the last year alone of the 12th FYP period (fiscal year 2017) targeting private investment of Rs 8.7 lakh crores. Figure 6 Infrastructure spending is expected to grow Spending (Rs 000 crores) 11th Five-Year Plan 12th Five-Year Plan Central State Private 2,653 2,424 5,575 1,601 (29%) 997 857 1,589 1,290 (23%) 859 797 680 888 751 251 207 293 887 281 230 377 1,061 315 256 490 1,286 354 283 648 400 314 875 2,684 (48%) Plan Infrastructure spending as % of GDP Actual FY13 7.2% 7.4% FY14 FY15 FY16 FY17 7.6% 7.9% 8.4% 9.0% 12th Five-Year Plan total Note: FY is fiscal year. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 5

More than 80 percent of private-sector spending will continue to focus on four sectors: telecom, electricity, roads and bridges, and renewable energy. Private investment in infrastructure is expected to increase from 37 percent in the 11th FYP to 48 percent in the 12th FYP. This growth is expected to be spurred by private players expected capacity expansion and their ability to provide good quality, timely service while keeping costs low. The target for spending during the 12th FYP is stiff, and there are concerns that government spending may not meet the targets if finances do not improve. Private spending might also remain muted in the near term because of an uncertain business environment. Moreover, there is a significant bunching of overall spending toward the end of the plan s timeframe, with spending in fiscal years 2016 and 2017 accounting for 52 percent of total spending. All of these factors point to a spillover risk of investment targets beyond 2017, especially if there are delays in the first half of the plan s period. Based on past performance, we believe achieving the targets would be a stretch in four sectors: Electricity. Government funding fell short of its goal by 30 percent in the 11th FYP and is expected to double during the 12th FYP. While stretched government finances are a concern, issues about coal availability, land acquisition, and an orderly rehabilitation and relocation might also prove to be barriers. Roads and bridges. Private spending fell short of investment targets by a third during the 11th FYP, primarily because of the slow rate of project awards, funding constraints for road projects, delays caused by land acquisition issues, and environment and forest clearances, among others. Moreover, the 12th FYP envisages a much higher construction target than previous plans and a private-spending target of three times the 11th FYP achievement. Railways and mass rail transit systems (MRTS). The 11th FYP witnessed an investment shortfall of 28 percent, primarily because of low participation from the private sector, where total investment was less than a quarter of what was planned. Compared to 11th FYP investments, private funding is expected to increase by 10 times in the 12th FYP, with similar scale across both railways and MRTS. Irrigation. Irrigation investments are primarily done through states, which were responsible for 90 percent of investments in the 11th FYP. The investment target for states has more than doubled in the 12th FYP, despite a 21 percent shortfall in the 11th FYP. A significant number of projects have spilled over into the 12th FYP, and achieving the target will be a stretch, especially given the poor fiscal situation of some states. Challenges to Achieving Infrastructure Targets The infrastructure investment targets outlined by the government are aggressive and signal a positive intent, which could mean huge potential for India s ECE industry. However, certain challenges will need to be overcome if the industry is to realize that potential. Because the following barriers stretch across multiple sectors, addressing them could lead to a significant pickup in infrastructure activity across the country: Limited long-term funds. Funding for infrastructure is a constraint because of limited public funds, which leads to work-in-progress projects being stalled. Moreover, infrastructure outlay by the central government is spread thin across a large category and number of projects. At the local execution level, local bodies have a low revenue base to work with for urban infrastructure projects. With a lack of innovative funding models and an uncertain business environment, private funding is also constrained. Road Map to Success for the Construction Equipment Industry 6

Land acquisition delays. Across infrastructure projects, delays as a result of land not being acquired by the time projects are awarded have affected many projects both before and after they start. For example, land clearance issues have held up the Trivandrum-Tamil Nadu border road project, where no construction has taken place since the tender award in 2010 because of land acquisition delays. Country-wide regulations on land acquisition have been enforced in a non-uniform fashion, causing delays. Even lenders are unwilling to support projects unless clearances are available and 100 percent right of way has been secured. Clearance delays. Delays related to forest and environment clearance are also impacting many infrastructure projects. Clearance policies are often not used objectively, providing different rationale for clearances on different occasions. Not only does this impact the speed of clearances, it also sends uncertain signals to investors and often leads to pullback of investments. For example, the contractor for the Kishangarh-Udaipur-Ahmedabad six-lane highway has terminated the project because environmental clearance failed to materialize. Similarly, a lack of clearance from the state water department has held up the Chennai Port-Maduravoyal road project. Inadequate planning. Current infrastructure plans do not necessarily incorporate an integrated view that encompasses all facets of development, including transportation, housing, and effective land use, to name just a few. For example, there is lack of coordination between central, state, and local agencies for road construction projects, and planning for urban transportation and housing development are often not done concurrently. Because of changes in the ecosystem, the master plans developed for urban development are often outdated by the time they are implemented. There is an urgent need to develop an all-encompassing perspective on infrastructure development planning by incorporating multiple aspects of development, going beyond just the immediate project. Low financial viability. Many infrastructure projects have a low internal rate of return because they are heavy on investment and the revenue stream often does not reflect fair costing. For example, India s MRTS projects have historically provided financial returns of less than 5 percent, although if the positive externalities are taken into account, the returns to the economy are much higher at more than 20 percent. Benefits of any infrastructure project often go way beyond the domain of the project itself. Similarly, projects related to water supply and sanitation often don t provide enough user revenues to even cover operating costs. Because infrastructure projects tend to be multiyear programs, working capital cycles are long, and operators are stretched for margins. Consequently, interest in infrastructure development projects is often low, especially from operators looking to invest in short-term projects with good financial returns. Weak governance. Multiple bodies acting at all levels across central, state, and local governments is a common phenomenon across an array of infrastructure development areas. The fragmented nature of governance not only delays projects, but also conveys conflicting signals to stakeholders. For example, devolution of responsibilities to urban local bodies (ULBs) per the 12th FYP schedule has not been fully implemented by state governments, often leaving very little execution control in the hands of the ULBs. The powers of regulatory bodies at central and state levels overlap at times, creating confusion and procedural delays. Addressing the Challenges of Infrastructure Growth An array of proactive initiatives based on best practices from other nations can help the ECE industry achieve its full potential as India s infrastructure grows. Road Map to Success for the Construction Equipment Industry 7

Improved funding for infrastructure projects. Dedicated debt and equity funds will help to improve funding availability for infrastructure projects. India has already taken some steps in this regard. On the operations side, higher tariffs to at least cover operating costs can be implemented, as has been successfully done with volumetric tariffs for water consumption in the cities of Dharwad, Hubli, and Gulbarga in Karnataka. Taxation for citizens and organizations that benefit from infrastructure projects is another way to raise funds, as France did with its MRTS development projects. Improved funding can also help in higher levels of private participation through build-operate-transfer (BOT) and operation and maintenance (O&M) models. Streamlined land acquisition process. There is a need for uniform policies about compensation, relocation, and rehabilitation for projects that require significant amounts of land. In August 2013, the government showed its strong intent to streamline the process by passing the Land Acquisition, Rehabilitation and Resettlement Bill, although successful implementation on the ground has yet to be seen. Countries such as Malaysia have taken a greenfield master-plan approach to road construction to address the social problems of land acquisition in brownfield projects, which can be applied for select cases in India as well. Legislation currently mandates cabinet approval before leasing, licensing, or transferring government land, which is another opportunity to reduce clearance delays if this legislation is reviewed and not applied in a blanket fashion. Signs point to a country that would be wise to focus on developing its infrastructure. When it does, demand for ECE will surge. Improved procedures for clearances. Environment and forest department clearances determine the fate of many infrastructure projects. A strong rationale for approvals and objective project evaluations can help convey the right signals to contractors and expedite the clearance process. Enhanced planning and contract management. There is an urgent need for a better planning process as part of creating long-term integrated urban development programs. Well-run cities such as Singapore and London create 20-year plans, beginning with detailed socioeconomic forecasts that incorporate elements of future land use, transportation, and housing infrastructure development. On the project execution side, a strong independent regulator can help ensure good contract enforcement and effective project monitoring, thereby keeping the focus on achieving the right project outputs within the defined timelines. The Malaysian Highway Authority, for example, has been able to enforce it successfully for road construction. Effective legal recourse mechanisms can also help ensure that executing parties stick to contract guidelines while delivering the project in a timely and cost-efficient fashion. Adoption of innovative operating and business models. Because infrastructure projects often need to be deployed despite financial hurdles, innovative operating models can help improve cost recovery. For example, cost recovery and collection efficiency for water payments have significantly improved in countries that deploy prepaid water cards, such as South Africa. Another example is farmer associations that adopt participatory irrigation management for irrigation projects. While core irrigation projects may not be financially attractive, having the beneficiary farmer associations in charge of O&M and revenue collection helps improve cost Road Map to Success for the Construction Equipment Industry 8

recovery. Irrigation facilities in Japan are often run through this route. In India, Andhra Pradesh and Gujarat have taken the lead. Financing incentives can also be linked to the extent of cost recovery, as has been implemented in Gujarat. Use of a single regulatory body and local delegation for execution. Creating a regulatory body for individual project categories can help streamline end-to-end coordination. This helps convey a unified stance to project stakeholders and reduces delays that result from questions about jurisdiction. For example, Malaysia s Construction Industry Development Board establishes regulations and legislations for construction. In addition, more autonomy for local bodies in terms of execution freedom and tax revenue collections, with incentives aligned to implementation achievements, can help speed up projects. In Nordic countries, local taxes account for more than half of government spending, with execution responsibility delegated to local municipal bodies. Challenges in the ECE Ecosystem In addition to addressing infrastructure challenges, the ECE industry achieving its full potential will hinge on addressing challenges in three areas of the ECE ecosystem: Financing Original equipment manufacturers (OEMs) in India offer limited financing options, and payment terms for first-time users are often unfavorable. The result is that access to financing prevents many prospective users from buying. Renting is a good option for users with an eye on limiting their large capital expenditures. However, renting penetration in India is much lower (7 to 8 percent) than in other large ECE markets (65 percent in the United States and 35 percent in China) because of a tax regime that makes moving equipment across states unviable. India s secondary market for used equipment is underdeveloped. Recovery is a big challenge for non-bank finance companies, the major providers of ECE financing for whom regulations pertaining to defaulters and bad debts are not very favorable. Availability of skilled manpower As the ECE industry continues to grow, the need for trained operators and mechanics will increase proportionately. Availability of skilled workers is likely to be an issue. Multiple entities from the government, ECE companies, and industry bodies are working to solve the skill gap issue, but coordination among these agencies can be improved. Most construction-equipment users are small players who prefer on-the-job training for operators and mechanics and are unwilling to pay a premium for qualified workers. Specialized courses on construction equipment operations are not a part of vocational training at industrial training institutes because the high cost of equipment makes hands-on training expensive. ECE training institutes run by OEMs tend to be expensive for low-income groups. There is a lack of uniform national guidelines for safety and quality. On-the-ground enforcement is a challenge because of the fragmented nature of the industry. (Small contractors make up about three-fourths of the industry.) Road Map to Success for the Construction Equipment Industry 9

Components There is a high variability in OEM demand owing to market fluctuations, which makes capacity planning difficult for component providers. India is a market where component suppliers tend to focus on items at the lower end of the technology spectrum, while relying on imports for high-tech items. Consequently, there is a gap in terms of technology adoption at the supplier end, where the market demand for higher connectivity and compliance to fuel economy regulations is not met with indigenously manufactured components. Suppliers are also constrained for operating margins because the market is very price and value conscious. Imperatives to Addressing the ECE Ecosystem Challenges An array of initiatives can be taken up and expanded, based on best practices in ECE and adjacent industries, such as automotive. Financing OEMs can take a more active role in improving the availability of financing for buyers. Setting up in-house financing arms or long-term tie-ups with banks and non-banking financial corporations (NBFCs) can also be considered. Financing availability can also be addressed through dealers. For example, some OEMs have been active in this space through exclusive contracts with NBFCs and by launching dealer-run rental operations to improve rental penetration for their equipment. Financing penetration can be further strengthened by reforming laws pertaining to equipment rental and usage. A nationwide general sales tax could help bring uniformity in imposed taxes (for example, as implemented in Australia), rather than the varied indirect taxes currently being collected by individual states. A national ECE registration can also eliminate the need for paying multiple lifetime registrations with regional transport offices, as is the current norm. Buyback schemes and used-equipment exchanges can help deepen the secondary sales market. Atlas Copco, Caterpillar, and Volvo all offer buyback schemes in developed markets. Availability of skilled manpower In developed nations such as the United States, stringent requirements and mandatory qualifications for operators and mechanics ensure that there is a high demand for skilled manpower from the user industry. Better awareness of the benefits of using skilled manpower, along with mandatory qualifications, can also help boost demand in India. Countries such as Australia also ensure availability of funds for training manpower through levies on construction projects, the proceeds of which go to the Construction Training Fund. Dedicated grants and scholarships for manpower training in India can help the long-term sustainability of such programs. Industry-body coordinated training program guidelines can help standardize training requirements, along with periodically evaluating the training needs of the sector and developing plans to address those needs. Global benchmarks can help identify best practices for manpower development. Road Map to Success for the Construction Equipment Industry 10

OEMs can take proactive steps in setting up training avenues through tie-ups with different types of players. Tie-ups with industrial training institutes to provide vocational training have already started. OEMs are also looking at partnership opportunities with professional training companies in collaboration with state governments and are using the support and network of non-governmental organizations to offer subsidized training programs for underprivileged youth. Components OEM-supplier collaborations and risk-sharing contracts have been used in the automotive and aerospace industries and have helped suppliers in capacity planning to meet market demand. For example, Maruti and other automotive OEMs often engage in supplier capability development to raise quality standards. The ECE industry can identify areas for closer collaboration with suppliers to ensure their healthy growth with the industry. OEMs can support suppliers through technological collaboration and help raise R&D standards. R&D establishments can be further set up with industry and government backing to drive indigenous technology. Laws mandating local technology can also help improve technology adoption. This has worked well in the aerospace industry, where adopting the offset clause, which mandates more than 30 percent local sourcing for foreign aerospace contracts, has helped improve technology standards at local suppliers. Focus on indigenization can also help suppliers develop India-centric, cost-competitive offerings with frugal designs tailored to domestic needs. This will go a long way to improve margins for suppliers otherwise constrained by low-cost sourcing from other countries. The Road Ahead Under-penetration for most key aspects of India s infrastructure highlights the need for development. The government has signaled its intent by earmarking $1 trillion for infrastructure in the 12th Five-Year Plan, but restricted sources for funding could delay achieving targets in certain areas. Regardless, the opportunity is huge for ECE players. Reaching this potential will require addressing some tough challenges in the infrastructure sector and resolving issues in the ECE ecosystem. Best practices from other countries can point the way, but India s success will depend on close collaboration among government, industry, and regulatory bodies to ensure the challenges are ironed out in time to realize the vision for the country s infrastructure. In this report, we take a deep look at three vital markets for ECE equipment: transportation, urban infrastructure, and rural infrastructure. We also explore three enablers of ECE industry growth in India: equipment financing, skill development, and the component industry. We look at both the opportunities and the challenges, and we examine some of the best practices in developed and developing nations to find solutions for clearing the obstacles that lie ahead. The sessions will discuss the imperatives and potential solutions to address infrastructuredevelopment constraints to help the ECE industry realize its long-term potential. Focused imperatives and specific recommendations for all stakeholders governments, industry bodies, OEMs, suppliers, and construction companies will be arrived at during the course of the conference and will be published separately as conference proceedings as a companion to this report. Road Map to Success for the Construction Equipment Industry 11

Demand Drivers for Growth in the Earthmoving and Construction Equipment Industry Transportation Infrastructure: Road and Rails India has one of the highest densities of roads in the world, with 1.42 kilometers of road for every square kilometer of land area. However, the country still lacks high-quality roads, including highways with four or more lanes, which offsets the benefits of high road density. Of the total road length of 4.6 million kilometers, 60 percent of the roads are rural (by length). National highways account for only 2 percent of the total length, of which less than a quarter are multilane highways. Figure 7 compares India s road density with other countries and gives a snapshot of length by various road categories in the country. Road construction is one of the most intensive sectors for ECE, which accounts for up to 15 to 20 percent of project costs. With high investments expected to pour into this sector over the next few years, spending on ECE for road projects is also likely to get a boost. If investments planned in the 12th FYP materialize as expected, nearly a quarter of the construction equipment fleet will need to be deployed on an annual basis just to support road construction projects. Planned Investments in the 12th Five-Year Plan The roads sector saw significant investment growth during the 11th FYP. Overall investment grew by 3.5 times compared to the 10th FYP, reaching 4.5 lakh crores. Roads alone accounted for about 20 percent of overall infrastructure investments in the 11th FYP, up from Figure 7 India has a shortage of multilane highways Road density, % of multilane highways (km of length per square km of land) 12.9% 8.2% 3.5% Road length by categories in India (%, million km) 2.3 1% 8% 9% 27% +4% 3.3 2% 7% 6% 26% 4.6 2% 9% 6% 25% 59% 0.66 0.43 0.19 1.42 0.6% 54% 58% United States China Mexico India 1991 2001 2011 Road density National highways Project roads Rural roads Multilane highways as % of overall road length Urban roads State highways and other PWD roads Note: PWD is the Public Works Department. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 12

8 percent in the 10th FYP. The actual investment in roads during the 11th FYP was 10 percent higher than planned, primarily because of an increase in central-government spending on rural road programs (namely the Pradhan Mantri Gram Sadak Yojana) and state investments. The 12th FYP outlays an increase in planned investments by more than 100 percent from the 11th FYP achievements, driven by higher targets across national highways, state highways, and rural roads (see figure 8). The FYP has plans for about 13,000 kilometers of new national highways and 158,000 kilometers of new roads in rural areas. Special packages for developing connectivity to ports and airports and new projects such as developing roads in the Delhi-Mumbai industrial corridor are also a part of the plan. Apart from government spending, private funding has increased from 5 percent in the 10th FYP to 20 percent in the 11th FYP, primarily driven by factors such as 100 percent foreign direct investment in road infrastructure, 10- to 20-year tax breaks during concession periods, and duty exemptions for importing road equipment. The 12th FYP targets about 33 percent of the investment to be fulfilled by the private sector. Railways have continued to be another large focus area for developing transportation infrastructure, with the government investing about Rs 201,000 crores in rail projects during the 11th FYP. However, this was 24 percent lower than planned investments, mainly the result of lower freight traffic growth and revenue losses of Rs 81,000 crores in passenger traffic because of several years of unrevised tariffs. The investment shortfall was further driven by negligible private participation (Rs 9,000 crores against a target of Rs 65,000 crores). Going forward, about Rs 519,000 crores have been earmarked for railways during the 12th FYP, of which about Rs 95,000 crores are targeted for investment in dedicated freight corridors on eastern and western routes. In addition, considerable investments are planned in other transport sectors, namely airports and ports. For ports, the 12th FYP budgets investments worth Rs 198,000 crores, of which around 85 percent is expected to be fulfilled by private players. For airports, the budgeted Figure 8 Investments in India s road network are expected to jump Spending (Rs '000 crores) 914 336 (37%) Central government State Private 412 141 (34%) 453 195 (43%) 274 (30%) 132 (32%) 166 (37%) 139 (34%) 92 (20%) Plan Actual 11th Five-Year Plan 304 (33%) Plan 12th Five-Year Plan Note: Based on 2011 12 prices. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 13

investments are Rs 88,000 crores, of which about Rs 70,000 crores are expected to be private investments through public-private partnerships. Planned investments in ports and airports under the 12th FYP are more than twice what was achieved during the 11th FYP. Challenges for Developing Road Infrastructure While there is much potential for growth, several challenges need to be addressed: Procedural delays for obtaining clearance Several gaps exist in the clearance processes for road projects. According to World Bank reports, these gaps have caused considerable delays for about 70 percent of projects. One of the main reasons for the delays is a lack of country-wide objective procedures and processes for clearances. The existing processes largely depend on the subjective judgment of the individuals making the decisions, leading to procedural inconsistency and delays. Another reason for delays is the existence of multiple state and central agencies for clearance without an independent oversight mechanism. This results in lack of accountability among the agencies and increasing procedural complexity, which leads to clearance delays. For instance, relocating electrical utilities takes about 33 months, telephone utilities 31 months, and water utilities 29 months on average, against a typical target of 18 months planned during the design phase. If deforestation is involved, the delays are even longer, with an average of one to three years to obtain environmental clearances. Other issues such as rigid demands from banks and lenders also cause project delays. Lenders have stringent requirements for upfront clearances and promoter investments before sanctioning loans, which puts severe pressure on contractors and leads to cash-flow issues and even more delays. Land acquisition issues Land acquisition and rehabilitation are major issues for the road construction industry. On average, there has been an overrun of about 10 months from the stipulated 20 months in initial handover of project stretch to constructors because of land acquisition delays. One of the main reasons for problems with land acquisition is a lack of robust upfront acquisition planning by various agencies during the project design phase. Quite often, land acquisition plans are prepared late in the design phase, leading to procedural and clearance delays. There have also been instances of poor investigation during the initial phase, resulting in sudden discovery of utilities that need to be relocated or deforestation that needs to be done before acquisition, leading to execution delays. Another problem is the social issue of relocating affected households and utilities. Delays in relocating households and utilities have created social unrest in various parts of the country. These issues have a severe impact on time lines and cause implementation delays. Poor contract model and execution There are also gaps in the construction contract model and execution capabilities. Issues related to unclear contractual clauses that lead to needless disputes and claims are quite common in the road construction industry. In addition, the lack of stringent output quality checks leads to contractors using low-end equipment or more manual labor to cut costs, resulting in poor process control and inconsistent quality. Even though many contracts specify the type of equipment to be used and desired output expected, the specifications are often not followed because there are no stringent quality checks. Road Map to Success for the Construction Equipment Industry 14

Another issue in the current contract model is the level of uncertainty on project feasibility during tendering stage. The feasibility analysis and detailed project planning is not very evident during the tendering stage, which causes roadblocks and time-line delays. Gaps in contractor skill levels often delay projects. This skills gap leads to poor work planning, resource management, and cash flow management, which adds severe financial stress. This lack of skills and experience has also resulted in contractors inability to put sufficient safety systems in place, causing potential danger to employees and project delays when accidents happen. High costs of funds and poor operating margins Road construction companies face several issues related to costs of funds and operating margins during various project phases. These companies are highly sensitive toward costs of funds because of long working capital cycles and high dependency on external debts and funds. Contractors also face a liquidity crunch because of implementation delays, poor estimates of traffic projections, social issues, and resistance to toll collection, thus making BOT models unviable in certain cases. Finally, rising commodity prices and idling capacities as a result of project delays adversely impact operating margins, putting further financial pressure on contractors. Addressing the Challenges of Developing Road Infrastructure The industry will need to address these challenges to achieve the growth projected in the 12th FYP. While finalizing the key areas of improvement, the Indian construction equipment industry can adopt best practices from other developing countries, including Malaysia and Chile, where there has been significant progress in building high-quality roads through government support and private investments (see sidebar: Central Agency Guides Malaysian Road Construction Industry on page 16). In addition, we can look at successful project-implementation stories from India (see sidebar: Mumbai Pune Expressway a World-Class Highway on page 17). The following activities should be given priority: De-bottlenecking the current clearance process, and addressing governance issues The current environmental clearance process needs to be de-bottlenecked to expedite project clearance and awards. Malaysia is a good example: The government introduced a one-step process for environment and forest clearance, which reduced the days required for construction permits by half. The government also took concrete steps to reduce the number of clearances and time needed to complete standard requirements for a firm wanting to bid for a road contract. It now takes about 30 days for eight clearances for starting a project, compared to India s average of 70 days for 11 to 13 clearances. In addition, India should address governance issues, including the lack of an independent oversight mechanism for supervising projects. To improve governance issues, Malaysia clearly delineated regulatory bodies: the Construction Industry Development Board develops regulations and legislation for the construction process, and the Malaysian Highway Authority (MHA) ensures enforcement capabilities and effective project monitoring mechanisms. They also set up strong IT systems and databases integrating government and other agencies seamlessly to expedite clearance procedures. Similarly, the Gujarat government has taken steps to improve the governance processes. To avoid potential conflicts of interests, the government shifted the planning, management, and oversight role from the Public Works Department and established the Gujarat Industrial Development Board. In addition, the government works to streamline clearance procedures through effective use Road Map to Success for the Construction Equipment Industry 15

of information technology systems and setup. Steps such as establishing e-dhara, a centralized IT database of land records across the state, and an e-procurement facility for improving procurement transparency have significantly improved clearance procedures. The government also implemented an integrated workflow management system for automating functions and clearance procedures, which has helped improve transparency, information retrieval, and collaboration across various government functions, thus expediting clearance procedures. Improving the land acquisition process Indian industry will need to identify concrete steps for improving the current land acquisition and rehabilitation process. In the past, countries such as Malaysia and Chile have successfully tackled land acquisition issues. For instance, in the early 1970s, Malaysia was facing significant social issues for expanding their roads. To address this, the government established the MHA, which developed a master greenfield plan to account for all social uncertainties and eliminate the social problems of land acquisition observed in brownfield projects. In Chile, the government developed a robust project evaluation process from financial, social, and environmental perspectives to identify all potential risks during the planning stage. This ensures that all social risks are identified up front, with clear-cut solutions and time lines identified, thus significantly expediting implementation. Central Agency Guides Malaysian Road Construction Industry In the 1970s, Malaysia saw a spurt in economic growth, which resulted in population growth and more disposable income in major cities. With more people owning cars, federal roads became crowded. Highways were badly needed. The government considered expanding current roads but faced substantial social problems related to acquiring land a problem that eventually led them to drop the idea and focus on greenfield options. A new government agency called the Malaysian Highway Authority (MHA) was created to establish a robust and integrated master highway plan that could account for all social uncertainties. The MHA worked with international design consultants from Japan, Italy, and the United Kingdom to build capacity in project design and implementation. Their first project was to develop the 848-kilometer North-South Toll Expressway. The MHA now acts as a central agency for planning and managing the country s highway programs. The agency divides larger projects into smaller packages and subcontracts to small contractors to develop capabilities across the supply chain. The MHA also ensures enforcement capabilities and effective project monitoring mechanisms for highway projects. The government also developed regulations and de-bottlenecked issues to ensure robust processes and oversight mechanisms in the road construction industry. The Construction Industry Development Board was created to establish construction regulations and legislation. A singlestep process was introduced for environment and forest clearance, which helped cut in half the number of days it takes to get construction permits. Finally, to strengthen processes, the government set up strong IT systems and databases that seamlessly integrate processes across government and other agencies. In addition to regulatory reforms, the government focused on building manpower capacity and capabilities. Mandatory certification and accreditation of all industry personnel and contractors was instituted to ensure skill building and personnel quality. To build financial capability for constructors, the government ensured a smooth cash flow with the Construction Industry Payment and Adjudication Act. It also consistently developed flexible cash support plans in line with the economic scenario. While BOT projects were encouraged during the initial phase of growth, governmentfunded projects were developed during recession periods to ease contractors financial burden. Today, the focus is on creating private finance schemes to cash in on the economic revival and encourage private investments in this sector. Road Map to Success for the Construction Equipment Industry 16

Improving the contract model and contractor skill sets One of the elements of an improved contracting model would be to provide clarity on project feasibility before the tendering process, which significantly improves the probability of timely and cost-efficient completion of projects. For example, Chile s government does a detailed initial analysis of the project, including basic engineering, design, and traffic estimates for the base year, to ascertain feasibility and bring in more certainty on the project s execution. Furthermore, at the time of bidding, the government offers bidders reference designs that are 90 percent complete to reduce planning and construction risks. On the execution side, higher process control needs to be instituted in laying down tolerances for quality norms for roads, and monitored through strict inspections. For instance, in Malaysia, the MHA is responsible for quality control and adherence to contract norms during execution. To keep control of quality, they periodically ask for maintenance and inspection reports and assess the work progress for various projects. They also make site visits, witness quality control tests, and inspect site records to ensure adherence to quality norms. Mumbai Pune Expressway a World-Class Highway During the 7th Five-Year Plan (1985 1990), the Ministry of Surface Transport (MOST) identified the Mumbai Pune corridor as one of the most congested highway corridors in India. To remedy the situation, MOST proposed a new highway system to be developed as a part of the National Expressway System. To take this proposal forward, the government of Maharashtra appointed two external consultants, RITES and Scott Wilson Kirkpatrick, to conduct a technocommercial viability study. Spanning four years, the study established feasibility and developed a blueprint for the expressway, with an estimated cost of Rs 1,146 crores. The government also took steps to improve governance and procedural issues to expedite construction. In 1996, they set up Maharashtra State Road Development Corporation (MSRDC), a central agency for developing, building, and maintaining roads. In March 1997, the government sanctioned the Mumbai Pune Expressway project and handed over responsibility to MSRDC on a BOT basis with permission to collect tolls for 30 years. MSRDC collaborated with the revenue department and various agencies to accelerate land acquisition for constructing the highway. Government support was also instrumental in expediting land acquisition. To de-bottleneck all issues and expedite clearances, the government set up a highpowered steering committee chaired by the MSRDC chief, as a result of which both environmental and forest clearances were obtained by the end of the first year. The vision of MSRDC and the government was to develop a world-class highway between Mumbai and Pune. To have better control of output, MSRDC divided the work into eight subsections and selected constructors for each subsection through a robust tendering process. MSRDC also developed quality specifications on par with international standards and appointed external consultants to supervise the work. Because the project was awarded on a BOT basis to MSRDC, a public limited organization, the company had to acquire initial funds from external agencies to begin construction. To facilitate this, the government provided a guarantee for MSRDC for raising funds through various financial instruments. To improve financial viability, the government allotted an additional 1,030 hectares of land to MSRDC to generate peripheral revenue streams, including a food mall and petrol pump. To improve the financial situation for private contractors, MSRDC took steps such as clearance of running account bill within 10 days, granting advance funds for machinery, and bonuses for early project completion. The construction was completed with an overall expense of Rs 1,630 crores. The world-class, six-lane highway was opened to the public in 2002. Road Map to Success for the Construction Equipment Industry 17

The Gujarat government has also taken steps to improve road quality. For immediate impact, they strengthened the quality-control process by establishing a separate unit to monitor construction quality. The unit conducts random checks at construction sites and collaborates with laboratories such as Gujarat Engineering Research Institute and other local engineering schools to set up dedicated testing facilities. To develop a sustainable advantage on a long-term basis, the government is promoting a strong quality-assurance culture within the state. As a first step, they have set up facilities to offer quality training to contractors and employees. They have also developed robust IT databases to compile and centralize data on road quality across the state. The databases are expected to provide vital input for developing quality-assurance frameworks that can be deployed effectively in the long run. There is also a pressing need to improve contractors skill sets to have tighter controls of project execution. Malaysia has instituted mandatory certification and accreditation requirements for all industry personnel and contractors to ensure hiring of skilled contractors and discourage non-serious players. These certifications also enabled government agencies to build in quality and safety awareness among contractors, resulting in much more consistency in the quality of the outputs and higher safety measures during execution. Better funding and financial support In India, there is a strong case for improving the financial support of private contractors to address the liquidity crunch and profitability issues. Similar to the current Indian scenario, Mexican contractors in the 1990s had serious cash flow issues as a result of lower-thanexpected cash from tolls after projects were completed. As a long-term solution, Mexico s government used a three-phase support system for contractors. The first two phases involved support through short-term loans from government banks and subsequent refinancing through medium-term infrastructure bonds. Once the construction was completed and traffic stabilized, the final phase kicked in, at which point the government gave the option of attracting foreign investments for refinancing in case the constructor wanted to exit the toll option. Crosssubsidization is also encouraged in Mexico, where private contractors are given permits for operating and maintaining existing roads and use the toll collected from these roads for financing new road construction. In Chile, bids for infrastructure projects include government guarantees for minimum revenues over a concession period. Contracts also allow concessionaires to develop ancillary revenue streams that do not adversely affect the improvement in infrastructure. Finally, the government estimates the traffic post-construction and finalizes the optimal toll amount up front, considering the purchasing power of passengers, thus ensuring a stable cash flow for BOT projects. The Road Ahead With India aiming to significantly increase investments in road projects in the current FYP compared to the previous one, there needs to be comparable spending in support systems and skill levels to realize effective use of the planned investments. While these challenges have been long-standing, examples from other developing countries such as Malaysia, Chile, and Mexico suggest they can be tackled with concerted efforts by government and industry over a short to medium term. This effort would go a long way toward supporting the long-term vision of setting up world-class road infrastructure in the country. Road Map to Success for the Construction Equipment Industry 18

Urban Infrastructure: Urban Centers and Mass Transit Urbanization is one of the strongest indicators of a country s economic growth, modernization, and development. In India, large-scale urbanization over the past decade has resulted in an urban population of nearly 377 million people in 2011 with 53 urban centers (cities with a population of more than one million). However, with an urbanization rate of 30 percent, the country trails several developed and developing economies, including Japan, the United States, Malaysia, and China (see figure 9). This gap presents a huge potential for urban growth. Over the next two decades, at a forecasted compound annual growth rate of 2.4 percent, the urban population could reach 600 million by 2030 2031, according to several global studies. This will result in an urbanization rate of more than 40 percent with 85 to 90 urban centers. Such explosive growth will need to be supported by proportionate expansion in urban services, which will spur demand for construction equipment. Opportunities for Developing Urban Infrastructure Fifty-five percent of urban infrastructure capex is expected to be invested in urban roads, 14 percent in urban transport, and 10 percent each for water supply and sanitation, according to the High Powered Expert Committee (HPEC) at the National Institute of Urban Affairs. Other areas for investment include affordable housing, storm water drainage, traffic support, and street lighting. Urban roads. There is a huge disparity in urban road density between India s cities and other cities around the world. Road density is 9.2 km per square km in Singapore, 9.7 in Curitiba (Brazil), 21.8 in Seoul, and 10 in Johannesburg. There is also a gap among India s different cities. Road density is 19.2 in New Delhi but only 3.8 in Chennai, according to an HPEC report. The existing roads are of poor quality because of a lack of maintenance, space encroachment, and limited road width to provide for footpaths and demarcated lanes. Urban transport. With the growing population in India s cities comes a steep rise in the number of vehicles on the road, which poses environmental risks and causes traffic congestion. According to government statistics, public transportation only accounts for 27 percent of urban transport in India compared with 40 percent for South Africa, South Korea, and Brazil and 49 percent for the Philippines, Venezuela, and Egypt. Hence, ULBs have earmarked Figure 9 India s urbanization rate is much slower than in other countries (% total in 2011) 91% 82% 72% 47% 30% Japan United States Malaysia China India 9 40 3 84 53 Number of urban centers Note: An urban center is a city that has a population of more than one million people. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 19

significant investments for urban transport systems, including metro rail or MRTS, bus rapid transit, monorail, and intelligent transport systems, in accordance with the National Urban Transport Policy. Already, 9 percent of India s urban population (four cities) has access to MRTS among 187 such cities globally. If all the currently planned MRTS projects are executed over the next 20 years, the share of urban population with access to MRTS would be 24 percent (23 cities) still lagging present-day access in the United States (more than 30 percent) and Japan (nearly 53 percent). This implies a tremendous planned and latent demand for infrastructure development and construction equipment. Water supply. The WHO/UNICEF Joint Monitoring Programme estimates that 92 percent of the Indian population has access to improved water sources. However, most of it is groundwater, which is increasingly being contaminated by chemicals such as arsenic and fluoride. A deeper evaluation of the delivery of safe drinking water reveals that only 23 percent of India s total population (48 percent of urban citizens) has access to piped water within premises, compared with other economies such as the United States at 88 percent, China at 68 percent, and Brazil at 92 percent. Sanitation. Only 44 percent of India s population has access to sanitation, compared with 100 percent in the United States and Malaysia, 84 percent in China, and 82 percent in Brazil. Access to sanitation in rural India, at 28 percent, lags other developing countries, including Pakistan (40 percent) and Bangladesh (80 percent). Even within the country, there is wide disparity in sanitation coverage across states (see figure 10). The Total Sanitation Campaign aims to improve sanitation coverage, including fund allocation for toilet construction, minimal subsidies for households, community education, and awareness. Yet statewide disparity exists, primarily because of a lack of reach and low community awareness. Figure 10 Access to sanitation varies widely across India Rural sanitation coverage (% total population) Kerala 94% Punjab 72% West Bengal Maharashtra 44% 49% Andhra Pradesh Karnataka Tamil Nadu Uttar Pradesh Rajasthan Bihar Odisha Madhya Pradesh 35% 32% 27% 23% 20% 19% 15% 14% Jharkhand 8% Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 20

Affordable housing. An absence of decent housing options across cities with growing populations has resulted in slums, where health and living conditions are poor. For a projected slum population of 94.98 million in 2012 (25 percent of the urban population), the Technical Group on the Estimation of Housing Shortage has projected the shortage of dwelling units in urban areas in 2012 to be 18.78 million. By 2030, this is expected to more than double to about 38 million units. For India to reach global standards, the government, local bodies, and the private sector will need to make massive investments in an array of urban services. Planned Investments in the 12th Five-Year Plan Urban infrastructure saw significant growth in investments in the 11th FYP compared to the 10th FYP. Recognizing the continued need to improve urban services, the government has further stepped up investments in the above sectors, particularly in MRTS and water supply and sanitation, from the 11th to the 12th FYP. MRTS. About Rs 124,000 crores have been earmarked for MRTS projects in the 12th FYP much higher than the planned funds allocated in the 11th FYP, despite a lag in actual spending (see figure 11). Increases in planned investments during the 12th FYP to approximately three times the actual investment during the 11th FYP are primarily to support ongoing MRTS projects: Delhi Phase 3 (2016), Chennai (2014), Bangalore Phase 2 (2017), Gurgaon (2013), Mumbai (2014), and Hyderabad (2015). The Gurgaon, Mumbai, and Hyderabad projects are being implemented under a public-private partnership (PPP) model with viability gap funding from the central government. However, actual private investments were lower than planned in the 11th FYP because of a lack of investor confidence. Globally, most cities with metro rail have used public funding because of low financial returns. In India, metro projects are still fairly recent, and PPP-funded projects have yet to demonstrate success. Moreover, existing investments have faced significant delays in acquiring land, securing rights of way, and starting construction. The 12th FYP is expected to be more optimistic for private participation with the potential success of the ongoing PPP-funded projects. Also, to encourage private entities, PPP funding is expected to be given preference for high-density and above-ground construction with faster development and better returns. Figure 11 Spending on India s mass transit system is expected to jump Spending for mass rail transit systems (Rs 000 crores) 124 40 Central government State 72 26 13 33 11th FYP Plan 42 21 15 6 11th FYP Actual 32 52 12th FYP Plan Private Note: FYP is Five-Year Plan. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 21

Water supply and sanitation. Overall investments in water supply and sanitation doubled during the previous plan period to reach 1.2 lakh crores. The 12th FYP aims to achieve universal, 24/7 access to water and sanitation through pending and new projects. The 11th FYP had an investment shortfall of 35 percent, primarily because of a shortfall in state investments after many states were slow to take up program funds during the early part of the mission (see figure 12). Many states are lagging because of insufficient enabling capacity at the state and ULB level. Also, progress on tougher reforms has been slow, requiring more effort and coordination, which has bottlenecked fund usage. This investment shortfall has caused projects that were supposed to be implemented under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) by the end of the 11th FYP to be carried over to the 12th FYP. These pending projects and the implementation of new JNNURM projects have led to a 110 percent increase in 12th FYP investment compared with actual investments in the 11th FYP. In addition to achieving universal, 24/7 access to water and sanitation, the higher allocations also aim to reduce unaccounted water (leakage), attain 100 percent metering of the water supply, and improve reuse of treated sewage for industrial applications. Figure 12 India is pushing for universal access to water and sanitation Spending in water supply and sanitation (Rs 000 crores) 255 Central government 185 98 (38%) State 54 (29%) 121 Private 65 60 124 (67%) 46 (38%) 151 (69%) 75 (62%) 0 6 10th FYP Plan 10th FYP Actual 7 11th FYP Plan 11th FYP Actual 12th FYP Plan Note: FYP is Five-Year Plan. Source: A.T. Kearney analysis Affordable housing. Investment planning for affordable housing has primarily been through JNNURM programs. Amid a growing demand for housing, the number of dwelling units sanctioned under JNNURM in its seven-year mission period (2005 2012) was only 1.6 million units. Despite various efforts, private participation and fund use in this sector continues to be low because of persistent issues, including scarcity of land and a lack of long-term urban planning. The Delhi-Mumbai Industrial Corridor project. In addition to the scheduled investments mentioned above, another major center of infrastructure spending is expected to be the Delhi- Mumbai Industrial Corridor project, which will involve large-scale urban development starting with the creation of seven new smart cities or satellite towns across six states and resulting in up to 24 such urban centers. Inspired by hubs in China and South Korea, these cities will have world-class infrastructure in terms of connectivity, logistics, power, water, and sewerage. The approved project fund amounts to Rs 17,500 crores over the next five years. Because a significant part of these projects is expected to involve PPP funding, it could give a significant boost to the construction equipment industry. Road Map to Success for the Construction Equipment Industry 22

Urban infrastructure is one of the most ECE-intensive sectors. ECE investment in projects such as water supply and MRTS can account for 7 to 10 percent of the project cost. With large investments expected to pour into this sector over the next few years, spending on ECE for urban infrastructure development is also likely to get a boost. However, despite the huge potential for infrastructure growth and planned investments, certain challenges have been slowing the pace of progress. Adopting global and local best practices can help address these challenges so the construction equipment industry can tap into this demand. Challenges in Urban Development Overall urban development and planning faces an array of issues that cut across all of India s major urban services. Poor governance with limited powers and responsibilities with the urban local bodies, along with hurdles in funding and execution, are the main challenges. Lack of ULB empowerment. The basic governance structure and mechanism of urban local bodies is still very fragmented. The devolution of responsibilities to ULBs in accordance with the 12th FYP has not yet been fully implemented by state governments. Multiple institutions, including state governments, parastatal agencies, municipal planning committees, and ULBs, are involved in urban development. For instance, Bangalore has nearly 10 institutions involved in urban development, according to an HPEC study. Insufficient funding for local bodies. Approximately Rs 55 lakh crores is estimated to be required to fund urban development in India over the next 20 years. However, no clear revenue base has been defined for ULBs. Total municipal income forms only 0.9 percent of GDP, compared with 6 percent in South Africa and 7.4 percent in Brazil. Property tax, a major source of municipal tax income, provides a very narrow and inflexible tax base to the local bodies because it is controlled by the state government, with the local government fixing the rate within a suggested band. Additionally, central and state grant schemes are often ad-hoc and do not match the actual fund requirement. On the other hand, ULBs are also unwilling to levy appropriate user charges for services. For example, a 2007 study suggests that 10 out of 25 corporations included in the study recovered less than 10 percent of costs through fees. Lack of integrated planning. There is lack of coordination between central, state, and local initiatives with respect to planning for related areas such as urban transport, land use, and housing. Further, because of the involvement of multiple stakeholders and a lack of long-term vision, master plans are often outdated by the time of implementation. Lack of capacity and expertise. ULBs are in grave need of manpower and technical expertise to carry out their responsibilities. About 4,000 city planners are needed across India, but there are only 3,000 registered. Also, comprehensive databases on urban statistics and performance metrics are still not available. Overcoming the Urban Development Challenges Learning from global and Indian best practices, we have identified four imperatives that can help resolve the above challenges by ensuring the required sponsorship of development activities as well as smooth and successful project implementation. Integrated planning and governance. Developing long-term cascading government plans that integrate all aspects of urban development could help ensure a focused approach. Lessons can Road Map to Success for the Construction Equipment Industry 23

be learned from Singapore and London, which create 20-year plans that start with vision and socioeconomic forecasts, and incorporate land use, transportation, and housing and other services with detailed project sequencing and financing plans. A more immediate action point could be speedy devolution of responsibilities to local governments in keeping with the 12th FYP. Instituting a governance mechanism in which parastatal agencies either report to or partner with ULBs could further streamline planning and execution. For India to reach global standards, the government, local bodies, and the private sector will need to make massive investments in an array of urban services. High private participation. Encouraging PPP could be a huge boost to fund availability for urban infrastructure. Currently, only 2 percent of urban infrastructure projects are being planned or implemented under the PPP route, compared with 40 to 50 percent in sectors such as ports and roads. Private spending could be promoted with increased participation of foreign companies as there are only a few Indian players with the necessary financial and technical capabilities. The types of PPP operating models prevalent in India are BOT, performancebased management and maintenance contracts (incentives linked to efficiency improvement), and modified design-build contracts. Outside India, contractual arrangements that combine private operation with public financing of investment appear to be the most sustainable option. Another successful model has been using a private operator to establish a corporatized public utility. For example, the management contract for Johannesburg water was initially awarded to an experienced international operator. The goal was to establish a viable, corporatized public water utility by leveraging the expertise of an experienced private operator for a number of years. The various revenue models could be toll-based, revenue sharing, outsourcing of O&M, or incentive based. Fiscal autonomy for local bodies. Delegating tax revenue powers to ULBs could give them fiscal autonomy. Alternatively, a system of formula-based sharing of taxes can be established between central, state, and local governments. Several countries have instituted such mechanisms and have demonstrated its benefits. For instance, local governments in the United States and Canada have complete autonomy in selecting a tax base as long as there is no interference with interstate commerce. In Denmark and Sweden, local taxes account for nearly half of local government spending. In South Africa, local governments can set property tax rates and user fees and are legally guaranteed a share of national revenue as an equalization grant. Performance grants could also be offered to ULBs based on the extent of reforms implemented to encourage execution. Developing a municipal bond market along the same lines as South Africa, Hungary, Russia, and Mexico could also help provide greater financial flexibility to local bodies. Capability building. Empowering local bodies to hire private-sector experts in urban planning and management could help incorporate innovative technologies and processes to execute ongoing and planned urban development projects. Using geographic information systems mapping and e-governance technologies can help when creating databases for effective planning and monitoring. Select cities in India are already successfully using GPS technologies: Road Map to Success for the Construction Equipment Industry 24

Surat and Indore use GPS to track and monitor bus services, and Hyderabad uses GPRS to monitor solid waste management and street lighting. Challenges for MRTS Projects In addition to the overarching issues in urban infrastructure planning and execution across all sectors, two broad challenges are causing bottlenecks for MRTS projects: Low financial viability. In view of the large number of capital-intensive projects planned across 19 cities, the current budgetary support outlaid is insufficient to cover all projects. And although metro projects in India have generated an economic rate of return of 22 to 23 percent, the financial rate of return has been only 3.5 percent. Often, revenues from metro projects in India are insufficient to recover capital or O&M expenses. For example, O&M cost recovery was only 48 percent for Delhi Metro Rail Corporation in 2011 while MRTS in Hong Kong, Tokyo, and Singapore have 100 percent recovery. This is because projected traffic is often overestimated during project evaluation, as is the case in Delhi Metro, where actual ridership was only half of the forecast numbers in 2011. Low revenue generation would be even more pertinent to metro rails built in low population areas such as Chandigarh or cities with cheaper alternate modes of transport, such as bus service in Kolkata. On the other hand, projects are also restricted from increasing fares because it could negatively impact ridership. Delays in execution. The lack of government support in land acquisition and other activities has resulted in execution delays for many of the completed and ongoing MRTS projects. Metro projects in most cities, including Mumbai, Bangalore, and Hyderabad, have been delayed by land acquisition that was not completed before the project began. Delay in support activities such as shifting of underground utilities, alternate traffic route planning, and environmental clearances have also hampered projects, including the Mumbai Metro Phase 2 project. Further delays have been the result of inefficient planning, as in the case of the Bangalore metro project, which was delayed by a decade because of indecision about the terms of the concession agreement. The project eventually moved to a public-funded model. Other technical and political challenges have also played a role in derailing projects. The exclusive use of indigenous technologies without assistance from experienced foreign consultants has caused some of the technical snags of the Kolkata Metro. Also, budgetary support for the Kolkata Metro expansion was cut down with changes in the railway ministry. Overcoming the MRTS Challenges Successful MRTS projects across the globe suggest that using sources of funding beyond government allocations and ensuring sufficient project empowerment and advanced planning can help projects in India overcome these challenges. Innovative funding. Taxes for citizens and organizations benefiting from the project, such as a payroll tax for large organizations within the MRTS area or a transport surcharge for properties in the vicinity, could help substantially bridge the funding gaps. France has successfully implemented such payroll taxes, and the Bangalore Metro Phase 2 has incorporated a surcharge for properties whose valuations have increased as a result of the MRTS line. Taxes could be levied for environmentally unsustainable transport, such as owning a vehicle and using petrol and diesel. Advertising and commercial development of land around stations could also generate revenue. Private participation in capital funding could be a significant contributor to MRTS projects, not just in India but globally. Worldwide, nearly 90 percent of cities with metro rail used public funding. However, there are exceptions: In Hong Kong, the state-owned MTR Corporation was Road Map to Success for the Construction Equipment Industry 25

publicly listed in 2000 with an IPO of 23 percent shares and is currently involved in the construction and operation of metro projects in Hong Kong, China, and Australia. Another exception is Tokyo, which also has a privately owned and operated metro. Even contracting out O&M to private players with strict service-level agreements can help improve efficiency and control costs. In 1997, the Rio de Janeiro metro operations were contracted to a private company for 20 years. The project has since reported an increase in ridership and a drop in costs. Effective project management. As a first step, project execution teams could look for potential land acquisition challenges well before a project begins. Early stages of project assessment could include planning alternate traffic routes, shifting utilities, and relocation. Access to advanced technology involving design, coach manufacturing, and training support from successful MRTS models in developed countries could improve project quality and execution timelines. Incorporating tight cost control including capital expenditures, labor, and energy costs in financial planning and execution could also help improve returns. The Delhi Metro Rail Corporation is a good example of effective project management (see sidebar: Delhi Metro Project Complete Three Years Ahead of Schedule). Water Supply and Sanitation Challenges Water supply and sanitation have also faced several financial and operational challenges: Low coverage. Only 48 percent of India s urban population has access to a piped water supply, according to a UNICEF report, and this drops even further to 19 percent for the urban poor. Delhi Metro Project Complete Three Years Ahead of Schedule Delhi Metro is the world s 13th largest metro, with 142 stations and six lines with a total length of 189.63 km. Built and operated by Delhi Metro Rail Corporation (DMRC), construction started in 1998. The first phase, expected to take 10 years, was operational in 2005 in just seven years. The project s success can be attributed to effective project management in several areas: Avoiding political interference. The government promised the DMRC complete autonomy on all major matters, with financial powers vested in the managing director. Preventing land acquisition challenges from disrupting the project. The Delhi Metro Railway (Operations and Maintenance) Act of 2002 superseded local municipal laws and barred lower courts from issuing stay orders. A legal team was formed to handle land acquisition cases, and timely temporary accommodations were built for relocated people. Planning for potential hurdles. Utility diversion was coordinated with concerned utility bodies and completed long before work on each section began. Alternate traffic arrangements such as road widening, new road construction, and traffic rerouting were planned well ahead in collaboration with the Indian Institute of Technology Delhi. Best-in-class technology. DMRC employees were trained under the Hong Kong Metro Rail Transit Corporation. A global bidding program was adopted for consultancy that resulted in project participation by multinational engineering firms from Japan, Australia, France, Germany, Korea, Portugal, Spain, and Sweden. Coach manufacturing technology was also transferred from a South Korean firm to Bharat Earth Movers Limited for manufacturing the metro cars for DMRC. Cost control. Labor costs were controlled by employing just 45 people per kilometer of track. (Kolkata Metro had three times as many people.) Energy costs were controlled by sourcing power at low rates through an agreement with Delhi Transco Ltd. Transparency and accountability. Contractor payments were made on time with minimal corruption, which encouraged contractors to support project activities and helped speed up timelines. Employees were held accountable for their responsibilities and deadlines, and delays were frequently and strictly reviewed. Road Map to Success for the Construction Equipment Industry 26

Even for cities with access to water, the average hours per day of water service is abysmally low at 1.5 for Chennai, 2.5 for Bangalore, 4 for Mumbai, and 5 for Delhi, compared with 19 for Asia Pacific. With respect to sanitation facilities, 80 percent of the urban population has access, but that number drops to 47 percent for the urban poor. This compares poorly against more than 70 percent coverage of urban sanitation facilities in Cambodia, Brazil, and Morocco. Also, the percentage of sewage treated across cities in India varies from as low as 4 percent in class 1 cities of Rajasthan to 61 percent in Delhi. Low cost recovery. O&M cost recovery for water supply varies from as low as 11 percent in Haryana to 68 percent in Maharashtra. The primary reason is non-revenue water, which is estimated to be between 40 and 70 percent because of physical and commercial losses, compared with 15 percent in developed countries. Losses are usually in the form of leaks, unauthorized connections, and billing and collection inefficiencies. (Only about 24 percent of connections are metered.) Another reason is the unscientific method of determining the water tariff. For instance, Ahmedabad charges a flat 30 percent of property tax as an annual water tariff, as per the Ministry of Urban Development. Delhi follows a two-part tariff model (fixed plus volumetric), but the volumetric rate of Rs 2.0 per kiloliter is less than even the cost of servicing, which is Rs 2.3 to 4.9 per kiloliter. Irrigation and rural roads will be essential for improving India s agriculture sector and providing connectivity to more than half of the country s population. Low service quality. The intermittent water supply has led to higher risks of water contamination. Also, the release of untreated water into water bodies is resulting in source contamination, which is further worsened by a lack of monitoring mechanisms and reliable databases for planning. Overcoming the Water Supply and Sanitation Challenges Improving private participation, revising tariffs, and making collection more efficient, as demonstrated by some model water supply and sanitation systems in India and abroad, has the potential to improve the quality of service across India. Improving private participation. As with most infrastructure projects, private sponsorship could help improve project viability and quality. A funding gap of Rs 16,500 crores (23.5 percent) for the urban water supply in the 11th FYP points to the need for private investment for better coverage and regular maintenance. PPP models have been successfully implemented in water supply and sanitation in France, Brazil, and a few other Latin American countries. Two modes of PPP funding are worth considering: Management contracts, which are performance contracts, can be awarded with coverage, quality, and operating targets for the private company while investment responsibility remains with the public body. Most water supply and sanitation projects in France are operated this way. Privatized water supply and sanitation initiated in Brazil in 1996 now caters to 10 out of 26 states and has resulted in lower average non-revenue water for private utilities than for state or municipal utilities. In India, performance Road Map to Success for the Construction Equipment Industry 27

contract-based operation of water distribution by a private player has resulted in 24/7 supply in three cities in Karnataka. Concession contracts, in which the private operator contributes to capital costs and operates the asset for a fixed period to recover costs, have been successfully used at a water treatment plant in Khandwa, Madhya Pradesh. Revising tariffs. Utilities could consider raising tariffs to cover costs (operations, capital, and depreciation) with targeted subsidies for low-income groups. For example, in Brazil, water supply and sanitation tariffs are higher than in neighboring countries, and the rates are periodically revised to account for inflation. This has encouraged private players to participate. Given India s erratic ways of determining tariffs, moving from fixed tariffs (mostly based on plot size or property tax rates) to volumetric tariffs could be beneficial. For example, in Ludhiana, households with plot sizes of 50 to 125 square yards, which consume nearly 30 kiloliters of water per month, are exempted from tariffs. Volumetric tariffs with subsidies for low-income groups could prove to be a more scientific approach with better cost recovery, as shown by cities in Brazil and in three cities in Karnataka. Making collection more efficient. Stringent penalties for illegal connections and unpaid bills have been successful in Indore, Bangalore, and Hyderabad. Prepaid meters installed for every household and commercial center with a water supply have also improved collections. Higher revenues could come from new service connections, identifying illegal users, billing unbilled services, and replacing faulty meters. Several countries have already put such a system in place, including the United Kingdom, Brazil, Egypt, South Africa, Kenya, Uganda, Curacao, Nigeria, Tanzania, Swaziland, Sudan, Malawi, and Namibia. Manila, with a privatized utility, and Singapore, which has outsourced billing and collection to a private player, have seen a steep rise in revenues with 100 percent billing and metering. Building a World-Class Urban Infrastructure With the impending explosive growth in India s urban population over the next two decades and the current state of urban services, infrastructure investment opportunities will grow, and demand for construction equipment will rise. Planned investments in two sectors, MRTS and water supply and sanitation, seek to bridge this gap to some extent. However, challenges in funding availability, project execution, and poor service quality can inhibit success. Creating a world-class urban infrastructure in India will require stakeholders to draw from best practices that encourage private participation, streamline urban planning, improve project management, and ensure better cost recovery. Rural Infrastructure: Irrigation and Rural Roads Rural infrastructure is essential for India s agricultural sector and the livelihood of more than 800 million people. Agriculture provides an income for half of the country s population and commands a steady share of its economy approximately 14 percent of economic output. Developing the rural infrastructure, especially irrigation and roads, is crucial not only to sustain the population s livelihood but also to improve mobility and connectivity. Irrigation: Feeding an Economic Resource The development of irrigation infrastructure has been sluggish over the past decade or so, with irrigation penetration increased minimally from 36 percent in 2001 to 40 percent in 2009. The use of canals as a source of irrigation has declined, while groundwater usage continues Road Map to Success for the Construction Equipment Industry 28

Figure 13 Groundwater is the main source for irrigation in India Irrigation sources (%, million hectares) +1% 57 27% 61 28% 63 26% Canals Tanks, tube wells, and other wells Other sources 66% 63% 64% 8% 2001 10% 2005 9% 2009 160 158 157 Total arable land Source: A.T. Kearney analysis to increase (see figure 13 ). In fact, in 2010, a United Nations World Water Development report placed India at the top of its list of groundwater-abstracting countries. Rain feeds 60 percent of arable land that has no access to other irrigation sources. Though India s arable land area of 157 million hectares is the second largest after the United States, arable land has steadily been decreasing because of mounting pressure to exploit large tracts of land for infrastructure and industrial development. Compared with other developing nations, India has a much lower penetration of canal irrigation with just 12 percent of total arable land irrigated by canals versus Pakistan s 20 percent and Indonesia s 34 percent. Such a large amount of arable land presents India with an economic resource, but it has not been adequately nurtured. A renewed focus on durable irrigation infrastructure and more investment can move the country s agriculture sector forward. Planned investments in irrigation in the 12th Five-Year Plan During the 11th FYP, 243,000 crores were invested in irrigation infrastructure, a 103 percent increase in investment in irrigation infrastructure over the 10th FYP. However, in the 11th FYP, the central and state governments both missed their investment targets by 56 and 21 percent respectively. Overall, there was a 25 percent investment shortfall from the intended target because of poor project preparation, execution, and implementation. Project funds are then spread across longer periods of time 30 to 40 years without completion whereas the normal timeline for medium and major projects is five to 10 years and 15 to 20 years respectively. There was a spillover of 553 projects from the 10th FYP to the 11th FYP, with more than 50 percent of these projects initiated by state governments without the approval of the Planning Commission, making them ineligible for central government assistance. The 11th FYP set an ambitious target of irrigating 16 million hectares, but only 10.5 million hectares was achieved. The shortfall occurred primarily because of project delays, driven by investment shortfalls and poor project planning. As a result, 327 projects spilled over to the 12th Road Map to Success for the Construction Equipment Industry 29

FYP. And of that 10.5 million hectares, only 2.7 million hectares were used because of faulty project designs, poor lining and de-silting, substandard maintenance, low water discharge, and insufficient and inefficient water distribution. Major and medium irrigation projects (MMI), which cover more than 2,000 hectares, fared far worse than minor irrigation projects (MI), which cover fewer than 2,000 hectares. MMI projects had a utilization rate that was half of minor projects at 22 percent. To fast-track the implementation of ongoing MMI projects, the Accelerated Irrigation Benefits Program (AIBP) was launched in 1996. The program has been successful: 54,251 crores have been deployed, and the hectares added for MMI projects in each FYP have doubled since the program began. AIBP has infused much-needed capital into the irrigation sector. However, the program s focus is limited to creating potential rather than using it. Efforts to improve usage are therefore imperative. As India aims to increase agricultural output to improve its food security and become an even larger player in the global grain trade, there is an urgent need to improve its irrigation infrastructure. A 107 percent increase over actual investment in the 11th FYP has been targeted to increase irrigation potential, reduce the widening gap between potential created and eventually used, and fund projects carried over from the 11th FYP along with new projects (see figure 14). The 11th FYP proposes spending 504,000 crores for developing irrigation infrastructure, with 92 percent coming from states and the remainder from the central government. Although the target seems aggressive at first glance, it s not unattainable: a 103 percent increase in investment was achieved between the 10th and 11th FYP. Nonetheless, the Land Acquisition Bill, passed by parliament in 2013, may cause complications in efforts to expedite the acquisition of land in rural areas for the purpose of irrigation development. Irrigation is one of the most intensive sectors for ECE, accounting for up to 12 to 15 percent of the project cost. With large investments expected to pour into this sector over the next few years, spending on ECE for irrigation projects is also likely to get a boost. Rural Roads: Connecting Citizens Developing India s rural roads can provide mobility and connectivity for more than 800 million people living in rural areas. Improving connectivity can reduce the alienation of rural India from urban India, increase economic opportunities for rural dwellers, and establish greater permeation of health and educational facilities. Significant progress was made in building rural roads during the 11th FYP, with new road construction and habitat connectivity doubling during the period, compared to the completion achieved by the end of the 10th FYP (see figure 15 on page 31). Figure 14 India plans to invest more in irrigation Irrigation spending (Rs 000 crores) 111 120 323 243 504 Plan Actual 10th FYP 11th FYP 12th FYP Note: FYP is Five-Year Plan. Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 30

Figure 15 India has increased the number of rural roads and connected homes Rural roads (km of road, number of habitats) New roads Road upgrades Habitats 209,570 140,930 84,414 113,610 57,173 41,678 95,960 83,757 42,736 Compared with 10th FYP During 11th FYP Total Compared with 10th FYP During 11th FYP Total Compared with 10th FYP During 11th FYP Total Note: FYP is Five-Year Plan. Source: A.T. Kearney analysis Since the 2000 inception of Pradhan Mantri Gram Sadak Yojana (PMGSY), the central government s plan to provide good roads to isolated villages, 84,414 habitations have been connected by roads measuring 350,500 km, of which 209,570 km of new roads have been built and 140,930 km have been upgraded. This translates to more than half of PMGSY s goals being completed. However, achieving goals varies widely across states: The top three Tamil Nadu, Gujarat, and Uttar Pradesh have achieved 80 percent of their habitat connections target. The bottom three Orissa, Bihar, and Uttarakhand have achieved less than 32 percent of their goals. Emphasizing the development of rural infrastructure will prove to be a catalyst to India s goal of maintaining an average GDP growth rate of 8 percent and improving the well-being of millions of underprivileged and rural citizens. Planned investments in rural roads in the 12th FYP Although rural road development is a state subject, the National Rural Roads Development Agency has helped reach goals by applying a nationwide set of operating procedures, including quality assurance and monitoring. The 12th FYP proposes spending Rs 126,491 crores on rural roads, which is on par with the total sanctioned amount for PMGSY since inception (see figure 16). Figure 16 Investments in rural roads are expected to continue Spending on rural roads (Rs crores) 127,786 91,498 126,491 Plan Actual Till 11th FYP 12th FYP Source: A.T. Kearney analysis Road Map to Success for the Construction Equipment Industry 31

The investment is expected to result in the construction of 158,000 km of new roads and upgrades for 84,181 km of existing roads in rural areas. Challenges in Developing the Rural Infrastructure Developing and planning India s rural infrastructure faces four primary challenges: Inadequate public funding. State governments carry the burden of financing irrigation projects. In the 12th FYP, states are meant to undertake 92 percent of the investment. However, many states suffer from deteriorating financial positions, which will limit their ability to invest in irrigation. Compounding this problem, irrigation projects are frequently delayed, which causes elongation and spillover of costs. For instance, of the 583 projects earmarked for the 12th FYP, 327 are spillovers from the previous period. And estimates show that medium and major irrigation projects had average cost overruns of 325 and 1,382 percent respectively. Inefficient execution. Various design, environmental, and governmental inefficiencies and regulations create a system of inefficient project execution. In 2013, irrigation engineers constructing the multi-crore Polampalli reservoir realized that designs were faulty eight years into construction. Similarly, the bureaucratic quagmire of environmental clearances is holding back numerous projects. The Maharashtra Forest Department announced in 2013 that 76 of 90 irrigation projects were delayed because of non-compliance of environmental regulations; others were pending approval. The Land Acquisition Bill may further affect the conversion time, project financing schedules, and feasibility of large-scale infrastructure projects. Operational barriers. The biggest operational hurdle is state governments regulation of water rates. Since the 1960s, the ratio of water receipts and working expenses has dropped steadily because of the policy of maintaining subsidized rates for end consumers. Most states have left water prices unchanged for 20 years. For example, Uttar Pradesh, India s most populous state, last raised its rates in 1995. However, O&M and administrative costs have gone up, which has resulted in big deficits and less money available for maintenance. The results: aging infrastructure and poor asset quality. On average, water charges only cover 10 to 12 percent of total operating expenses. O&M expenses alone can be as high as 30 to 35 percent of total operating costs. Moreover, managing an irrigation facility can be difficult. Poor water delivery service, driven by a lack of farmer participation in project planning and management and a lack of accountability on behalf of operators, is a hurdle that must be overcome. Compounding this situation, there is widespread underuse of created irrigation potential, which has consistently deteriorated over the past 50 years. The 11th FYP had a usage of 26 percent, despite the created potential being the second highest across all FYPs. Implementation challenges. Although the PMGSY program has met with success, several obstacles are blocking growth. Issues include inadequate institutional capacity because of limited availability of qualified technical personnel, limitations to contracting capacity and budgeting as a result of low government finances in some states, and land availability, especially in densely populated areas and areas with difficult terrain. Overcoming Rural Infrastructure Challenges Learning from global and Indian best practices, several imperatives can address the challenges of developing rural infrastructure. Private-sector participation. Because the percentage of government funds allocated for irrigation has been steadily dwindling, involving the private sector in funding large-scale projects Road Map to Success for the Construction Equipment Industry 32

is crucial. Private players can infuse capital into projects and improve the operational efficiency of a facility, thus leading to improved use, shorter break-even time frames, and better water availability. Globally, the use of PPPs to improve the efficiency and financial viability of irrigation projects is gaining acceptance. Morocco s Guerdane project is the world s first PPP in irrigation. The project involves construction, co-financing, and managing the network with the concessionaire maintaining this responsibility for 30 years. Similar models have been carried out elsewhere: Brazil s Pontal Irrigation Project is a PPP in which responsibilities for construction, operation, and maintenance lie with the private player. India s state governments will have to reconsider water pricing norms to make the investment opportunity attractive for private players. Participatory irrigation management. In participatory irrigation management (PIM), farmers operate and manage the irrigation system. This model entrusts the responsibility of key management operations to a water user association (WUA) that executes various activities, including maintenance, equitable distribution of water, gauging water demand, collecting water charges, resolving disputes between recipients and members of the WUA, and monitoring the flow of water. The rationale behind PIM is that the farmers have the most to gain from the irrigation system and thus will govern the system in the most beneficial way. PIM shifts certain powers from state government irrigation departments to farmers or farmer associations. Andhra Pradesh and Gujarat have already successfully implemented PIM, and many other states are in the process of initiating pilots that put beneficiary WUAs in charge of O&M and revenue collection. In Andhra Pradesh, water taxes help finance associations. In fiscal year 2009, WUAs in Andhra Pradesh collected Rs 474 crores in revenue, against a total of 150 crores for O&M. Water efficiency usage improved by 15 percent. Gujarat has adopted a different financing model, using incentives based on the extent of revenue recovery. Although PIM can improve an irrigation system s operation and distribution, the legal and regulatory framework must also be improved to better serve WUAs. To make PIM more viable, several factors must be addressed: enacting clear-cut regulations for water charges, strengthening of memorandums of understanding between WUAs and irrigation departments, specifically with regard to the availability and supply of water, improving financial viability, and offering technical training to help farmers associations manage the irrigation system. Building institutional capacity. Institutions are the backbone of successful infrastructure development. Institutional shortcomings in India s irrigation exist across the value chain, from planning and execution to management and maintenance. In the project planning phase, state irrigation departments are encouraged to abide by investment clearance guidelines set by the Planning Commission before beginning construction on irrigation projects to streamline project planning, ensure adequate funding, and adhere to timelines. The huge disparity between the total volume of water expected and what actually materializes is another major issue. Because of overambitious expectations, faulty design, and faster-than-projected siltation, among other issues, the total water available can be far less than anticipated. To combat this issue, external, non-partisan agencies should play a part in project planning to provide transparency and offer a second opinion about an irrigation system s potential. Problems related to project execution are intrinsically linked to shortfalls in the planning phase. To prevent delays, the central government has suggested linking schedule adherence with the annual allocation of resources to state governments, thus creating an incentive for completing projects on time. The Planning Commission has also recommended that projects be evaluated on the basis of optimum water use by external agencies, with AIBP grants awarded on the basis Road Map to Success for the Construction Equipment Industry 33

of these evaluations. Increased cooperation between government programs and agencies is highly encouraged. The AIBP and the Command Area Development Program (CADP) can play a central role in bridging the gap between creating and using irrigation potential. While AIBP focuses on creating irrigation potential, CADP focuses on improving the use of irrigation through methods such as encouraging fair distribution of water, training farmers and other individuals in best practices, advising on cropping patterns, and the on-farm development of field canals, channels, and land leveling. However, CADP s work is frequently not completed and has fallen by the wayside in recent years, which negatively affects utilization. Better links between CADP and AIBP are needed with synchronized time lines and schedules. Regulatory frameworks and institutions for PIM need to be put in place to adequately manage and maintain irrigation systems. So far, 15 of 28 states have passed PIM acts, and numerous WUAs have been formed. However, very few have been given the power to manage the system. WUAs need technical, financial, and human resources support to bolster their ability to manage an irrigation system and make them a viable option. Close coordination between CADP and WUAs is essential. Additional support for WUAs can come from state-level water and land management institutes, training and research establishments, and non-government organizations to strengthen WUAs irrigation management and implement best practices. Innovative cost-recovery options. The subsidized water rates scheme in most states in India has had a negative effect on the long-term viability of irrigation facilities lower receipts and increasing costs dissuade investments. A more effective system of using water fees to cover O&M fees and improving financial viability should be considered. Innovative pricing mechanisms such as area-based pricing, which levies a fixed charge based on the area to be irrigated, or volumetric pricing, which promotes better water usage by end users, are already being put into action. There are two approaches to volumetric pricing: Block pricing sets a price for a base amount of water enough to support a farm family at a subsidized price with higher charges for additional blocks. Two-part changes combine volumetric pricing with a fixed admission charge. Volumetric pricing with automated charge collection using prepaid cards has been successful in Shandong in China, and Brazil and Chile have adopted innovative models for trading water in localized markets to help realize fair value for water. Efficient irrigation techniques. Modern irrigation techniques such as drip irrigation can improve the efficiency of irrigation systems, especially in India s water-scarce areas. Drip irrigation has been adopted on a mass scale in the United States, Australia, Brazil, and Egypt. Adoption is beginning to pick up in India as well, with drip penetration being highest in Maharashtra, which accounts for 60 percent of India s drip-irrigated land. Laying the Groundwork Irrigation and rural roads will be essential for improving India s agriculture sector and providing connectivity to more than half of the country s population. Vast challenges surrounding inadequate funding, poor project planning and execution, operational issues, and a culture of mismanagement and neglect need to be surmounted to quickly develop the rural infrastructure. Streamlining public and private investment, improving project management, using modern operational techniques, and improving institutional capability can help ensure that rural infrastructure development does not get left behind as the country moves forward. Road Map to Success for the Construction Equipment Industry 34

Enablers for Growth in the Earthmoving and Construction Equipment Industry Equipment Financing and Renting As with any product that requires a large one-time capital expense, financing is a good way for the construction equipment industry to spark demand and acquire new customers. In 2011, India s ECE financing industry was valued at Rs 23,000 crores. Financing accounts for about 80 percent of the equipment purchased. For imported machinery, it s even higher, with 90 percent of equipment purchased being financed. Over the next few years, the ECE financing industry is expected to grow by a compound annual growth rate of about 22 percent (see figure 17). Most financing is through loans, with leasing as a distant second option (see sidebar: Financing Models in India). About 80 percent of ECE users that opt to finance are micro, small, and medium-sized enterprises. With ticket sizes varying from Rs 20 lakh for a backhoe loader purchased by an individual user to Rs 20 crores for a construction firm s bulk equipment purchase, the variety of players offering equipment financing has grown. The competitive landscape now consists of banks such as HDFC Bank and Kotak Mahindra Group, NBFCs such as Srei Infrastructure Finance and Magma Fincorp, leasing companies such as ORYX India and Srei BNP Paribas, external commercial lenders, and cross-border leasing firms. Figure 17 Construction equipment financing in India is expected to grow Equipment financing in India (Rs 000 crores) +22% 23 2011 46 2014e 62 2016e Source: A.T. Kearney analysis Financing Models in India Loans are mainly provided by banks and non-banking financial companies. Similar to vehicle loans, a margin is paid up front, and monthly payments are made over three to five years. Leases are gaining popularity because of tax benefits. There are two options: In a financial lease, the asset is transferred to the lessee at the end of the leasing period. In an operating lease, the asset is returned to the lessor. Only 3 percent of leases are operating leases because financial firms often can t maintain the equipment. Suppliers and buyers credit is often used for imported equipment because of its high cost, mostly financed by Indian and overseas banks. A rent-to-own transaction allows users to pay a rental fee (a percentage of the machine s price) at periodic intervals with the option to buy at the end of a specified period. End-to-end solution providers are financing firms that help with acquiring, training for, maintaining, and buying back used equipment. Road Map to Success for the Construction Equipment Industry 35

NBFCs handle 75 to 80 percent of ECE financing. Large players are expected to continue to dominate, thanks to the growing ticket size of construction-firm purchases and the continued dependence on imports, which require large banks to settle the transaction. The Rental Financing Market Globally, rental is a well-established, preferred way to finance because it is simple and costeffective. However, India s rental ECE market is underdeveloped compared with other developed and emerging economies (see figure 18). India s market is highly fragmented with organized players such as Quippo Rentals and Sanghvi Movers accounting for only 30 percent of the market. The unorganized sector consists of about 10,000 players, each with small fleets of two to 50 machines. These players typically offer equipment only from Indian manufacturers and don t have any dedicated maintenance team. Figure 18 India s market for renting construction equipment has room to grow Earthmoving and construction equipment rental penetration rate 80% 65% 35% 30% 12% 7 8% Japan United States China Brazil Russia India Source: A.T. Kearney analysis The limited presence of large organized players is restricting the growth of rental financing. Hence the rental market is expected to grow at a compound annual growth rate of just 15 to 20 percent by 2015. Given the industry s narrow focus today and the tremendous opportunities for growth, better access to financing will help broaden the market. Challenges of Equipment Financing To improve access to equipment financing in India, four challenges need to be addressed: Lack of easy access. Most OEMs lack in-house financing arms and engage in short-term tie-ups with banks or NBFCs. First-time users, although forming about 30 percent of the customer base, face high-margin money requirements of 20 to 25 percent, compared with just 5 to 10 percent for repeat customers, which dampens equipment demand. Also, the payback period for firsttime users is shorter, resulting in the payback amount being higher than the depreciation. Challenges in collection. Most finance users are micro, small, and medium-sized enterprises that depend on third-party payments, which can lead to collection delays and defaults. As a result, the average number of days of sale outstanding can reach 150 for organized rental players. Further, most of the financing business is handled by NBFCs, which face significant recovery challenges because of a lack of adequate regulatory support. For example, NBFCs do not get tax benefits on Road Map to Success for the Construction Equipment Industry 36

provisions for bad loans; banks and financial institutions do. In addition, NBFCs are not under the purview of the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, which empowers banks, financial institutions, and housing finance companies to move against defaulters. NBFCs also lack access to debt recovery tribunals for collecting dues. Unfavorable regulations. Indirect taxation on construction equipment in India is 21 to 38 percent, higher than France and Germany s 20 percent and Indonesia s 12 to 17 percent, according to a Confederation of Indian Industry (CII) report. Further, lease transactions are subject to dual taxation: a value-added tax (VAT) and a service tax. An array of entry taxes and lifetime Regional Transport Office (RTO) taxes imposed by various states make moving construction equipment between states unviable. In addition, the 15 percent depreciation rate for construction equipment assets (compared with 30 percent for commercial vehicles) is too low compared to the falling asset life as a result of rapid technological progress and equipment obsolescence. Moreover, for interest paid to NBFCs on loans for equipment financing, tax is deducted at the source, which is not the case with banks. In addition, external commercial borrowing as a source of funds is available only when purchasing imported equipment; it is not available for domestic equipment. Low rental penetration. There are a limited number of organized players with large rental fleets because players lack the capital to expand. Organized players also face huge pricing competition from the unorganized segment, where players are involved in off-the-book cash transactions and can therefore offer much lower rates. Used equipment and the secondary sales market are also highly underdeveloped in India because of an absence of established trading platforms and a lack of buyback schemes from OEMs. Existing sparse secondary trades are based on non-standardized transaction prices. Another factor inhibiting rental usage is tender prerequisites, which often require the contractor to demonstrate equipment ownership. Above all, ownership still remains the preferred option for Indian users. Overcome the Challenges of Equipment Financing Best practices from OEMs and financing players around the world indicate that four imperatives can help India overcome the challenges of equipment financing and renting: OEM-supported financing. OEMs could establish in-house financing arms or forge long-term relationships with banks or NBFCs that can reach small contractors. Some OEMs in India already have exclusive contracts with NBFCs, but much more could be done: First-time users could be offered buyback schemes or a co-borrowing option to give them easy access and better financing terms. OEMs such as Atlas Copco (a Swedish manufacturer) and some large financing players in the United States offer equipment buyback as part of their financing options. Large global OEMs also offer financial leases with an option to buy the equipment and return it at the end of the lease. OEMs could also collaborate with third parties or other OEMs to provide channels for equipment exchanges. Uniform tax regulations. Standardized tax laws across states can significantly boost equipment purchases, rentals, and resale. National registration of construction equipment could eliminate the need to pay multiple lifetime RTO taxes. Also, recognizing equipment as either a good or a service could streamline the imposition of either a VAT or a service tax, eliminating the dual taxation. Implementing a general sales tax (GST) could create a degree of uniformity, as in Australia, where the federal government levies a GST. (No further taxes are charged by the state government.) In addition, the depreciation rate could be increased from 15 percent to 25 or 30 percent, similar to that for commercial vehicles, as proposed by the CII for all plants and machinery. Road Map to Success for the Construction Equipment Industry 37

More efficient collections. Telematics systems with GPS services can be used to track equipment and improve collections. Global OEMs provide such systems with their equipment, and some of these offerings are now being launched in India. Providing further policy support to NBFCs for payment collection, regulations could also empower NBFCs to move against defaulters and claim tax benefits against bad loans, as banks do. Availability of skilled manpower for construction equipment is already becoming an issue in India. Developing an ecosystem for the rental business. Creating equipment safety and environmental regulations on par with the global construction equipment industry, along with training skilled manpower for construction equipment, will enable large organized rental players to improve their value proposition against the cost-competitiveness of smaller unorganized players. This will help attract more customers to larger rental players and improve rental penetration. In the developed economies of the United States, Japan, and Europe, large rental players offer the latest equipment with an average fleet age of only two to four years, and they ensure that the equipment complies with regulations. They also provide lower maintenance costs and offer operators from a pool of qualified manpower. Consequently, customers prefer to rent from organized, established players. OEMs could also enter the rental space, as has already started in India, either with dealer-run rental operations that offer new and used equipment or independent franchise-run rental operations. Tapping into the Potential The low penetration of equipment rental or other financing options in India, apart from loan-based purchases, indicates a latent demand for construction equipment that has yet to materialize because of a lack of easy financing. Current and potential customers will be encouraged to buy equipment if there is direct access to numerous viable financing options that are based on their needs. However, the current lack of uniform financial regulations, collection inefficiencies, and the absence of several large organized rental players are major challenges for equipment financing. If OEMs, organized financing players, and the government all contribute to an ecosystem that encourages easy purchasing or renting, flexible payments, and convenient disposal of construction equipment after use, the demand for construction equipment will rise at a much higher rate than expected. Greater availability of financing can support the penetration of ECE in India, and help the market tap into a larger latent demand from fringe players that, because of a lack of access, are not already participating. Improvement of regulatory norms for financing can also help boost NBFCs role in overall financing and help reach customers in different parts of India. Growth of organized rental players can boost the rental industry and help boost the underdeveloped secondary sales market. Better rental availability also frees up the need for capital equipment purchases for small players and increases participation in the industry. Organized rental players can offer the latesttechnology equipment, with trained operators and mechanics, which can also support project execution. Overall, many benefits can be attained through improved penetration of ECE financing. Road Map to Success for the Construction Equipment Industry 38

Skill Development Skilled manpower is an essential factor to ensure safe and efficient operations of construction equipment. In India, the demand for skilled workers was approximately 800,000 people in 2011, and an additional 2 to 2.5 million will be required to manage the fleet by 2020 if the industry s projected growth materializes (see figure 19). Figure 19 India needs skilled workers for construction equipment Fleet size and manpower required (million) +16% 3.0-3.5 Fleet size Manpower 0.3 0.8 1.3 1.5 2011 2020e Note: Manpower includes operators and maintenance personnel. Source: A.T. Kearney analysis Availability of skilled manpower for construction equipment is already becoming an issue in India, with a potential shortage of around 20 percent anticipated by 2015. In the short run, unskilled labor is expected to bridge the gap. However, this can create issues for safety, operational efficiency, and the life of the equipment. If the industry grows as predicted, the gap could widen to 30 percent by 2020, given the growing fleet size and safety requirements that will require using trained manpower. There will also be a demand for workers with specific skills to operate specialized equipment. Steps must be taken now to address the lack of skilled manpower. Challenges to Skill Development To bridge this manpower gap, the construction equipment industry will need to address four challenges: Limited pull from the user industry. In the construction and mining industries, 75 percent of firms are owned by small employers and contractors that own fewer than 15 pieces of equipment. Most of these small-scale players prefer hiring unskilled labor, opting to minimize labor-related expenses by providing on-the-job training rather than employing qualified operators. In such an environment, qualified workers find it difficult to get compensation that matches their skills, often moving abroad to places such as the Middle East, where they have more options with better pay. This trend will further widen India s gap for skilled workers. Lack of coordination among stakeholders. There is a lack of coordination among government agencies, OEMs, and construction companies for creating skill development programs. This has resulted in significant duplication in allocating resources and a lack of standardization for Road Map to Success for the Construction Equipment Industry 39

training programs across the industry. For example, the government has 17 departments that provide different formal and informal vocational education training programs. In addition, some construction companies have independently established training schools for their own operators and customer staff. Lack of access to affordable training. Several issues are deterring easy access to affordable training programs for construction equipment operations. For instance, India s industrial training institutes offer one of the most standardized and affordable modes of technical and vocational training. However, there are no specialized courses to train operators for construction equipment such as cranes, backhoes, and excavators. Additionally, no private schools or agencies offer practical training similar to automotive driving schools because of the high cost of the equipment and a lack of available qualified trainers. Finally, there are few construction equipment training institutes run by OEMs or construction companies, and the ones that do exist are often unaffordable for low-income groups. For example, a three-month crane-operator course offered by one of the leading construction companies costs Rs 35,000 per person, which is expensive for those with a low income. Lack of quality guidelines. The industry lacks quality guidelines and mandatory certification requirements for employees. The government does not have mandatory requirements about quality and safety standards for industry personnel. For instance, the only qualification needed to operate mobile cranes and excavators in India is a heavy-vehicle license. As a result, companies can hire less-skilled personnel, which can lead to productivity and safety issues. Overcoming the Challenges of Skill Development The industry would be wise to address the skill gap by tackling these challenges on a mediumto long-term basis. The construction industry is taking some steps already, but several more imperatives could have a positive impact: Demand driven by the user industry. Developed nations such as the United States have stringent requirements and mandatory qualifications for construction equipment operators to ensure that the industry employs skilled workers. For example, loader, bulldozer, and crane operators are legally required to have special licenses in most U.S. states. As India s industry matures, using trained manpower can improve both productivity and safety records, which in turn will lead to recruiting more trained manpower for operations and maintenance. An awareness of the benefits of using trained manpower will need to permeate India s user industry. Grants and scholarships. Establishing dedicated grants and scholarships can improve the affordability of quality training and boost enrollment for training programs. This has been highly successful worldwide. In Australia, the construction equipment industry established the Construction Training Fund, which uses levies on construction projects (0.2 percent of value) to support students who want vocational training. The Canadian government s Canada Job Grant matches federal, provincial, and employer contributions to fund vocational training. Establishing such grants and scholarships in India is possible, but the mode of financing them needs to be finalized with long-term sustainability in mind. Training program guidelines coordinated by an industry body. A sector skill council for the construction equipment industry, promoted by CE industry bodies, is crucial. This body would serve two primary objectives: to identify the skill-development needs of the sector and develop a plan to address those needs. The skill council would also plan to use global benchmarking to identify best practices around the world to help build a robust skill development plan for India. Road Map to Success for the Construction Equipment Industry 40

The skill council would aim to work with private and government agencies to devise an industrybased curriculum, set training standards, offer quality vocational training, and provide industryendorsed certification for training agencies. A construction sector skill council would also aim to formulate accreditation guidelines for heavy-equipment operators in line with the U.S. National Center for Construction Education and Research, a joint industry-academia body that provides standard curriculum and accreditation guidelines for vocational training in construction. Establishing the construction sector skill council would be a good first step for developing a pool of skilled labor, but its effectiveness should be periodically assessed and course corrections done to achieve the long-term goals. Training partnerships between OEMs and other players. OEM-level collaborations and tie-ups with industry bodies could help provide affordable vocational training for aspiring employees. There is already some movement on this front with some Indian OEMs working with industrial training institutes to offer training for in-house operators. Similar partnerships are in place between some OEMs and professional training companies in collaboration with state governments. Another option OEMs are exploring is using the support and network of non-government organizations to offer free or subsidized operator training for India s underprivileged youth. Although there is some movement from OEMs to improve the training infrastructure, many more such initiatives will be needed to close the skills gap. Filling the Talent Pool The construction equipment industry would be wise to take proactive steps to ensure that the lack of skilled manpower does not become a bottleneck to industry growth a few years down the line. A lack of demand from the user industry often causes trained manpower to migrate to other industries or other countries. Also, better coordination is needed among various stakeholders: government departments, OEMs, and the user industry. Forming the construction sector skill council will be the right step forward in skill development for Indian operators, but setting up grants and scholarships can also help make programs more affordable. Uniform guidelines and policies for training and hiring programs are also needed. Taking these steps will give the industry access to a larger pool of operators who have consistent, high-quality skills. Operating and maintaining construction equipment requires an advanced skill set, especially for specialized equipment. Deploying more skilled manpower (operators and mechanics) would not only ensure safer use of equipment, but also improve the life of the equipment through regular maintenance and proper usage. The total cost of ownership will drop, and the resale value will rise, which will increase secondary sales in India. Overall, many benefits can be attained by improving the availability and deployment of skilled manpower for using construction equipment. Construction Equipment Components and Aggregates Components and aggregates enable rapid growth for the ECE industry. In India, the industry is expected to expand by 20 to 25 percent in the next decade, thanks to rising demand from the construction and mining industries and a growing number of traditional applications using ECE. Flourishing markets for domestic construction equipment, after-market sales, and exports will cause a spike in demand for construction equipment components and aggregates. Road Map to Success for the Construction Equipment Industry 41

Trends Causing the Market to Expand Several trends are behind the rising demand for construction equipment components: Growth in the domestic construction equipment industry. India s ECE industry is expected to grow at an annual rate of 20 to 25 percent over the next five to seven years. To take full advantage of this boom, many OEMs are planning to add capacity, and global OEMs are ramping up their presence and investments in the country. Robust growth is expected in components used in backhoe loaders, crawler excavators, and wheel loaders, which are often used in large-scale infrastructure projects. Increasing demand for after-sales service. Spare-parts sales are expected to grow in tandem with the overall ECE industry and will be boosted by a growing, under-penetrated after-sales market. Currently, after-sales revenue contributes a low percentage of total sales for ECE OEMs in India: just 2 percent compared to the global average of 7 to 8 percent. Going forward, ECE OEMs are expected to further enhance their after-sales service offerings to tap into a market opportunity that could reach $0.5 billion by 2015. Greater potential for exports. Robust growth is expected in export demand for engineering services and components and aggregates manufactured in India and sold to emerging markets. Three factors are causing this shift: The availability of cheap, highly skilled engineering and design services in India High cost competitiveness because of the scale of production in manufacturing basic powertrain systems, including transmission components and downsized engines The development of product solutions, rather than just designs, to meet the market demand for better connectivity and remote performance monitoring Challenges to the Industry s Growth The Indian ECE components and aggregates industry is on the verge of fast growth, but significant challenges could prevent players from effectively tapping into the market s opportunities. These will need to be addressed to realize the full potential of the components business. Fluctuations in OEM demand for components and aggregates. Varying demand from OEMs can have a significant impact on components suppliers, which sell most of their products to OEMs. Because they rely little on after-market sales, their business is intrinsically linked to the orders placed by OEMs. Because of heightened OEM demand between 2005 and 2011, suppliers invested in more capacity. But now, demand remains low as a result of adverse market conditions, and suppliers are suffering from a demand shock. The problem is further compounded by the fragmented supplier landscape. Numerous low-sophistication product manufacturers and vendors supply customized components to some OEMs rather than standardized offerings. As the industry picks up pace to grow by four to five times in the coming decade, OEMs and suppliers that coordinate to ramp up capacity will be better able to fulfill demand. Planning for spares distribution. The supply chain for spares distribution is often not geared toward providing a very wide reach or catering to the full potential of spare-parts sales. Moreover, a fresh look at the spare-parts pricing model could help, especially if it is more in line with market expectations for specific components. New pricing can help increase the consumption of spares, which are not being consumed in very high numbers. Road Map to Success for the Construction Equipment Industry 42

Gaps in adopting technology. End users of construction equipment in India are demanding more-sophisticated products to meet their needs. However, domestic ECE vendors and suppliers are facing a technology gap between what the market wants and what vendors can offer. For instance, the market has already started demanding products with enhanced connectivity and electronic systems. But production of ECE with technologies such as telematics, GPS, electronic control systems, and real-time remote performance monitoring equipment is at a nascent stage. Suppliers will have to quickly adapt to meet the growing demand from end users. From a regulatory standpoint, greater emphasis is being placed on greener vehicles with lower carbon dioxide emissions and better fuel economy. In addition to the latest technologies, suppliers will have to incorporate more technologies compliant with Bharat Stage IV emission standards and other advanced fuel-efficient technologies. Stiff margin pressure. Vendors in the domestic ECE industry are often under stiff margin pressures for an array of reasons: Emphasis on price. Indian consumers are more price conscious than global players. Price versus value is the primary concern for 70 to 80 percent of Indian customers, compared to 40 to 50 percent of customers in the United States and 60 to 70 percent in China. Dependence on imports. Currently, 50 to 55 percent of components are imported. This is expected to go down to 25 percent by 2017, but high-tech components will largely continue to be imported. Price inflation of raw materials. Prices of materials such as steel and crude oil drain margins because vendors have a limited ability to pass price increases on to customers. Overcoming the Challenges Best practices from OEMs across the world and examples from adjacent industries such as automotive can help guide solutions for India s components and aggregates industry. OEM support for suppliers capacity planning. OEMs could follow the example of the automotive industry, where players such as Maruti and Hyundai have worked with parts suppliers to develop and coordinate order schedules, capacities, and demand forecasting. Closer collaboration of OEMs with suppliers can mitigate risks such as volume fluctuations, improve component customization, and help leverage one another s expertise. Communicating about OEM plans to add capacity will benefit suppliers by allowing them to plan their production schedules in a volatile demand environment and better manage their inventory. Furthermore, establishing supplier parks with shared facilities can substantially minimize incremental capital expenditure requirements. OEM support is especially beneficial to small suppliers, which form the bulk of the market but often struggle to withstand sharp swings in demand. OEM investment in developing suppliers capabilities. OEMs and suppliers can take up joint development exercises, including state-of-the art manufacturing capabilities, training and skills development, and quality monitoring and compliance. R&D enhancement and technology indigenization. Establishing R&D centers focused on product innovation and indigenization could help improve product availability and quality and make India s players more competitive compared to foreign suppliers. Technological collaboration across the value chain spearheaded by industry, research institutions, and industry bodies can drive market-centric innovation. Road Map to Success for the Construction Equipment Industry 43

Increased cost competitiveness. Taking into account the highly price-conscious Indian customer, component suppliers would be wise to lower costs while maintaining their product quality. Developing India-centric product offerings with tailored, frugal designs with an eye on cost optimization could be highly beneficial in the long run. OEMs could also give suppliers more flexibility for value-engineered product designs. More local control over product designs at the OEM end and more supplier involvement at an earlier phase of the design process can also help. At the same time, localizing sourcing and manufacturing of components is a good way to lower costs. Following the example of industries such as defense with compulsory offset clauses, regulatory bodies can mandate that OEMs locally source a certain percentage of components. This would not only encourage component suppliers to localize, but would also help build capabilities in the Indian components industry. The Route to Success The ECE components and aggregates industry is likely to experience a growth spurt in line with the ECE industry over the next five to seven years, thanks to growth in both domestic business and exports. However, the components industry will need to collaborate very closely with OEMs in areas such as capacity planning, technology adoption, and indigenization of manufacturing to ensure tandem growth. Adopting best practices for supplier development from adjacent industries, such as the auto industry, can help guide solutions. A robust supply chain for components and aggregates, closely coordinated with OEMs, can help improve capacity planning, which in turn can help reduce variability of demand and improve inventory control in the supply chain. More R&D focus and indigenization can also help to build local competence, in turn improving the export competitiveness of supplies. Lastly, sustaining component suppliers through improved cost competitiveness is vital to the equipment industry. Overall, a robust components and aggregates supply base can be a strong catalyst for growth in the ECE industry. Authors Manish Mathur, partner, New Delhi manish.mathur@atkearney.com Shiv Shivaraman, partner, Mumbai Mayank Bansal, principal, New Delhi mayank.bansal@atkearney.com Anshuman Sinha, consultant, Mumbai anshuman.sinha@atkearney.com The authors wish to thank Shiva Datwani, Sreejith Edamana, and Tamanna Padhi for their valuable contributions to this paper. Road Map to Success for the Construction Equipment Industry 44

Further Reading A.T. Kearney has published several papers and reports of relevance to this sector: Frugal Re-engineering: Innovatively Cutting Product Costs As rising commodity prices and other factors squeeze manufacturers, frugal re-engineering can cut costs and improve margins. Ramping Up Supplier Capacity in Volatile Times Still stinging from the recession, many suppliers remain averse to risk. How can manufacturers get suppliers to add capacity to help meet demand? By reducing the risks and sharing the rewards. Creating Competitive Advantage Through Supply Chain: Insights on India An A.T. Kearney study for the Council of Supply Chain Management Professionals (CSCMP), India Buckle Up: Six Driving Forces in Manufacturing to Take On Now From Adam Smith s division of labor to the Industrial Revolution and the 1990s high-tech boom, manufacturing shifts with periodic waves of disruptive change. Scenario-Based Strategic Planning in Times of Tumultuous Change Complexity and volatility are creating unprecedented challenges for today s leaders. Scenario planning, properly executed, provides the tools for making strategic decisions and taking speedy corrective action. How to Become a Procurement Champion What is the secret to building a prosperous, value-driven procurement organization? A holistic procurement transformation (HPT), and the right balance between your business and your people. Capex Projects in Developing Markets Developing countries offer a wealth of attractive investment opportunities. They also hold pitfalls for the unwary. Leading companies have devised capex management strategies to mitigate the risk. Road Map to Success for the Construction Equipment Industry 45

About A.T. Kearney A.T. Kearney is a global team of forward-thinking partners that delivers immediate impact and growing advantage for its clients. We are passionate problem solvers who excel in collaborating across borders to co-create and realize elegantly simple, practical, and sustainable results. Since 1926, we have been trusted advisors on the most mission-critical issues to the world s leading organizations across all major industries and service sectors. A.T. Kearney has 58 offices located in major business centers across 40 countries. About CII The Confederation of Indian Industry (CII) is a non-government, not-for-profit, industryled, and industry-managed organization, playing a proactive role in India s development process. Founded more than 118 years ago, India s premier business association has more than 7,100 members, from the private and public sectors, including subject matter experts and multinational corporations, and an indirect membership of more than 90,000 enterprises from around 257 national and regional sectoral industry bodies. CII works to create and sustain an environment conducive to the development of India, partnering industry, government, and civil society through advisory and consultative processes. With 63 offices, including nine Centres of Excellence, in India, and seven overseas offices in Australia, China, Egypt, France, Singapore, the United Kingdom, and United States, and institutional partnerships with 224 counterpart organizations in 90 countries, CII serves as a reference point for Indian industry and the international business community. About ICEMA Founded in 1949 as Tractor and Allied Equipment Manufacturers and Importers Association Ltd., the association started with 10 Indian member companies, primarily manufacturers and importers of tractors and earthmoving and allied equipment. In 1986 the association was renamed Indian Earthmoving and Construction Industry Association Ltd. with the objective of making the body a national point of reference for the Indian earthmoving and construction equipment industry. In 2012 the association redefined its role to become a truly representative body of the Indian construction equipment industry and to expand its scope of services, and became the Indian Construction Equipment Manufacturers Association (ICEMA). ICEMA represents 53 leading companies that manufacture, trade, and finance a variety of products, including hydraulic excavators, wheel loaders, backhoe loaders, motor graders, vibratory compactors, cranes, dumpers, tippers, forklifts trucks, dozers, pavers, batching plants, and diesel engines. About Excon 2013 Excon 2013, the seventh International Construction Equipment and Construction Technology Trade Fair, was held at Bangalore International Exhibition Centre, from November 20 24, 2013. Excon 2013 is the third-largest construction equipment exhibition in Asia and the largest in South Asia. The exhibition showcased a wide variety of equipment, technology, and products with a specific emphasis on efficiency, productivity, environment, and safety. For more information, permission to reprint or translate this work, and all other correspondence, please email: insight@atkearney.com. 2014, A.T. Kearney, Inc. All rights reserved.