Wednesday, December 5, 2012

The Positives and Negatives of Reliance Industries’ Strategy

Indian company, Reliance Industries (RIL) has its core business in oil and gas. But its diversification strategy has brought it under the spotlight, recently. This week, we read about IBM’s diversification strategy that drove it to move beyond main-frame computing and into services. The one thing we surely learnt from this week’s readings is that if a company must diversify, it must first realize its strengths and use them to successfully expand or diversify its business.

RIL’s profitability has been steadily declining. This can be seen in the fact that it posted its third consecutive drop in profits last quarter with net profits falling over 20%. Reliance India has diversified from its core business to enter the retail and broadband sector in India. In the past, diversification has done RIL much good making it India’s largest private sector enterprise. However, the question lies, where to deploy the company’s resources?

The Negatives
 Diversification into areas unrelated to its core competencies has exerted a lot of financial and human resources. This often leads to unnecessary rationing of resources across the various business segments that do not complement each other. Furthermore,  investments made by its subsidiaries come from RIL’s funds raised or accrued from shareholders for its core oil and gas business. This has resulted in the three business segments competing for the funds from the oil and gas business. In comparison, Bharti Enterprises, a competitor, has successfully managed to implement a similar diversification strategy. Its retail subsidiary, Bharti Retail has nothingto do with its telecom subsidiary, Bharti Airtel. They are structured in a way that money is raised separately for each enterprise and every subsidiary is focused on its own sector, not having to compete with the other subsidiaries for any resources. This is a huge problem for RIL because all its businesses are in the “high-growth” sectors competing for resources from a common pool.
Venturing into the retail and broadband space, however attractive they may be, can take away from the competitive edge of its core business that RIL most desperately needs.  

On the other hand, competing in the retail and telecom space has been difficult for RIL. In the last six years it has been unable to penetrate the Retail market and gain considerable market share, while segment focused competitors like Bharti and Birla aggressively take over the space.
While RIL fails in retail and telecom, there is rising demand for oil and gas in India, which is an emerging economy. RIL needs to invest more in this sector in order to better address the market needs.

The Positives
Much like Exxon Mobil and BP, RIL remains vertically integrated in terms of exploration, production, refining, petrochemicals and pumps. This has resulted RIL in controlling pricing and feedstock supply. Companies without this backward linkage, like Haldia Petro and NOCIL, are finding it very difficult to survive. This is an RIL masterstroke that has resulted in winning the shareholder’s confidence for the last three decades. Also, RIL has entered into a joint partnership with BP so that it can undertake initiatives like non-conventional production using shale formations and deep water exploration in order to boost its oil and gas business. This is thought to be a strategic move in response to the low outputs from their fields, rising demands and a need to attain better expertise in their core business.  

RIL believes that its shares are undervalued, which has resulted in one of the largest buy back of shares in recent times. If you were the CEO of RIL, would you completely shut down the telecom and retail subsidiaries of RIL to invest in oil and gas? Or would you rather restructure these subsidiaries to make them more independent?  


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