‘Beat 'em With Innovation': Bluestar's B Thiagarajan On Competing With Global Supply Chain

India is aspiring to attain significant indigenisation across various product categories, including in light engineering and consumer appliances. Recently, India became the second largest mobile phone manufacturer, according to a report by global research firm Counterpoint. The report attributed this development to the surge in demand within the country, increasing digital literacy and strategic governmental support through ‘Make In India’ and other initiatives. In another major move, India on August 3 had announced the imposition of curbs on importing laptops, tablets and personal computers to boost local manufacturing.

But there are several complexities along the way when it comes to boosting local manufacturing in different sectors like consumer appliances. An air conditioner can be a good example to illustrate these complexities and challenges involved in the manufacturing sector.

To look at the air conditioner itself as an example of a journey of indigenisation and where we are in that process, The Core’s Govindraj Ethiraj spoke to B Thiagarajan, managing director of Bluestar, an Indian multinational home appliances company. Through the air conditioner’s journey, the two look at the broader state of manufacturing in India and if indigenisation is an absolute necessity.

“The Indian market is an aspirational middle class dominant market. In this category, you have to make the product affordable. It is connected with scale, smart manufacturing, how sustainable your product is apart from regulations, or how you can make it sustainable,” Thiagarajan said on the potential of sales in the Indian market. On India’s ability to achieve higher efficiency levels, he added, “If you want to connect to the global supply chain, you should be beating them on innovation. You can compete against the scale only through innovation. Invest more in R&D and create that ecosystem.”

Here are the edited excerpts from the interview:  

If we talk about the journey of an air conditioner, how it is manufactured today in India?

The air conditioner market has been growing and still the penetration level in the residential segment is just 7% or so. Last year, the total volume in the country sold was close to 8 million units. This context is very important. Now for the China domestic market, it will be close to 90 million units as against our 8 million. If you look at what China produces, including their exports, it will be close to 120 million units. So they manufacture air conditioners like pencils. That is what we should remember when we talk about manufacturing air conditioners. 

So an air conditioner contains a sheet metal for the outdoor unit, and there is a compressor there. There is a motor for the heat exchanger. And there is a coil which serves as a heat exchanger. There is a refrigerant, then there is an indoor unit which is getting the refrigerant, which is cooled. Then there is a heat exchanger through the coil, through your fan it happens. So there is sheet metal work, there is a coil work, there is an assembly, there is injection molded plastic inside and there is a controller for setting the temperature and other features. So there is electronics. 

Air conditioners are also a highly regulated industry. I keep saying it is as regulated as tobacco or alcohol, except that there is no syntax. So I will list that as well in order to understand this. The Goods and Services Tax (GST) on air conditioners is 28%. It is in the highest slab.

But it has always been very high.

It used to be in the 90s and all, excise duty of 150%, 100 etc., it all happened. But then in the GST regime, it is in the highest slab. The second is connected with energy efficiency because in 7% penetration, if air conditioners are going to consume so much of energy, when the penetration goes up, rightly, how more energy efficient air conditioners can be designed and manufactured. And in the past 15 years, the energy labeling norms have become more stringent. Today, we will be at the highest level in the globe. We have achieved that maturity in the country thanks to the Bureau of Energy Efficiency. Every couple of years, the energy efficiency is being improved.

 

What is an indicator of energy efficiency?  For example, how many units of power you consume…

Let us say in the year 2000, you bought a 1.5 ton air conditioner. If you are buying a five star inverted air conditioner today, it consumes only 20% of the power it consumed in 2000. So 80% reduction has been achieved over the years. So this is due to the compressor efficiency and there is a variable frequency drive which controls the speed of the compressor and it is connected with the coil design. The third element is connected with ozone depletion. So the Montreal Protocol called for the refrigerants which are used, when it is let out in the air due to leakage or anything, creating a problem for the ozone layer. So therefore that was to be eliminated. That programme is over. But the substitute which came for ozone depletion resulted in global warming. So the more friendly you are towards ozone, the higher the global warming. It is inversely proportional. So we eradicated one problem, we acquired another problem of creating global warming potential. 

So there is the Kigali(Agreement) or the Paris (Agreement) calls for how to go to near zero global warming. There is a new regulation connected with that. Air conditioners come under e-waste rules as well, because quite a bit of electronics happens there. Now, India Cooling Action Plan is a framework under which the Government of India is dealing with the bilateral agencies in order to commit the targets.

So what is a global scenario? In any of the international forums, G7, G20 and all, you take it, there is a carbon footprint. In terms of carbon footprint, there are many industries which are causing this. Now, in the consumed articles, automobile and air conditioners will come as number one and two. Lighting comes, but lighting through LEDs has been solved. Advent of e-vehicles has solved the automobile problem. For the air conditioners, you do not have a breakthrough technology yet. Quite a bit of things are happening in energy efficiency improvement, but you do not have a breakthrough technology. Now, India Cooling Action Plans defines how India will move forward to keep the energy consumption under check. This is where we are. Within this whole ambit of things, I call it a highly regulated industry. You do have energy efficiency, global warming, ocean depletion, e-waste, India Cooling Action Plan all these are happening, and the industry has to grow. Now, fortunately, the growth and the regulations are moving in the same way. You cannot have an industry growing regulation here. Then you will have a collapse. You should not have regulations where the industry is left out. The industry won't grow. But so far it has happened well. Now air conditioners, fortunately, are now becoming a necessity as well, due to the architecture of the houses and the higher temperature being felt by the people and the comfort levels that are required in humid conditions. It is growing, but it is nowhere near China. Our growth rate, I would say, is at some CAGR of 10%. When it will move to the next level, we do not know. We all hope that it is going to happen in four or five years, I will come to that a little while later. 

Now, how has the market evolved? Market evolved through higher dependence on imports because China could manufacture and give it to you at attractive prices. And in order to grow the market, many players, including us at some point in time, had imported from China specific models and labeled and sold them. 

 

So one is a point where you are importing the entire product and badging and selling it here to the point that you are now maybe importing components or like a compressor. So tell us a little more about that. Which are the components that you or the industry is dependent more on or has been in the last few years from China or wherever else?

Till 2019, 40-50% of the air conditioners sold in India were imported. In the Blue Star case, it would have been 25%. 

 

So would that be tubing or compressor?

No, complete air conditioning. Now, India, because of its small market size, did not have the component ecosystem. It was 2020, the Government of India felt that we should go ahead and address this. There are huge imports they are taking. Then they moved on to look at that. It is called the SCALE Committee, which looks into how the India manufacturing story can happen. And within that what the industry needs in order to ‘Make in India’. I do not know how air conditioners got identified, but fortunately, air conditioners were identified. We were one of the early ones to get into the PLI (Production Linked Incentive) scheme.

I will come to that. So you said 20% in 2019, and 25% was your imports?

Blue Stars would have been 25%, but the whole industry had some 40-45% 

 

Entire finished air conditioners and just the label here?

Yes, labeled. 

What happened after that?

So as a prelude to the PLI, the government focus was very clear. Pawan Goenka led it and Piyush Goyal was directly involved in the exercise. So what do you want in order to make the air conditioners in India?  First point is in research and development, there is no problem. We have the capability. The whole industry has got the capability.

The issue is the scale. At a price at which China could make 120 million production versus some 8 million. That point of time, it was 6 million. So how you will be able to make it at that particular cost is the first issue. Also, you do not have a competent ecosystem. So what the government did first was to say that import with the gas filled will be banned. The moment you cannot import with the gas filled, even if you get it as two separate units, you have to take it to the factory and do the gas filling, and then you have to do the testing. So, in a manner of speaking, you need an infrastructure. So it was a deterrent. 

Second, one government did was that the custom duty will go up under a phased manufacturing programme. They said over a five year period, how the duty will go up, again, a deterrent. 

Third, they brought in a non-tariff barrier called the QCO(Quality Control Order)  which means the Bureau of Indian Standards will go and inspect the vendor and his component suppliers to certify. In any case, during COVID nobody will be able to travel. China was not allowing, so you will not be able to get QCO approval. So in a manner, you are forced to look at how I will manufacture. They introduced the PLI scheme. So the PLI scheme, actually the nomenclature, is incorrect. The production linked incentive scheme, money is not paid for producing. Money is paid for incremental sales over a previous particular year. In this case, it is FY22, over that, whatever incremental sales over a five year period, you will get paid as a ,6%, 5%, 4% like that over the years. Now that the base year is fixed, there is a threshold of investment and you have to sell more in order to earn the money. So you have understood the framework. 

Now around 4500-5000 crores worth of investment has been committed by the industry, in any case, because import is becoming unattractive. So, manufacturing capacity today is actually doubling. In 18 to 20 months, India's air conditioning manufacturing capacity has doubled. The PLI is not on the finished goods. PLI is on the components or sub assemblies. So what is slowly happening is the component ecosystem is developing. Except for a few items where India still has got still a problem, which is the compressor. But by the way, over the years from the time you started your career, the compressor used to be the heart of the system. But now it isn’t. The electronic drive is a big component within the air conditioner apart from the compressor. Electronics, India is not having a problem in manufacturing for developing an IP or manufacturing. But the compressor is a huge capital cost and you need scale. For example, if someone wants to set up a compressor, at least you need a 2 million kind of volume. See, Bluestar will do 1 million this year. And we did eight lakh units, our own sales. The industry is 8 million, our volume was eight lakhs. This year hopefully the industry will become 10 million and we will be doing 1 million.

But 1 million, you cannot justify a compressor manufacturing. I need to do 2 million in order to do so. But if I am an air conditioner seller, if I do a compressor, I would not be able to sell it to anyone. So globally, if you look at it, the players who have crossed 1 million, or 1.5 million over a period of time, have got their own compressor. 

 

And why can't you sell a compressor to someone else?

So it is a competing brand, right? So the question is if I have to sell to any one of my competitors, all three competitors should either come together to set up a facility.
Actually, Piyush Goyal tried that also. Whether Indian manufacturers who hold close to around 55% market share can come together and set up. So then you need technology. You have invested in that. But our preference was that, look, if there is a foreign manufacturer who is coming and setting it up, allow them to do so. 

 

Would LG be the one in this case? 

No. The world's largest manufacturer of compressors is GMCC, for example. Then Highly. They have a facility in India. In fact, GMCC is in Maharashtra, Highly is in Gujarat. They have invested. So the question is we should not be shutting doors to someone, right? If more people are coming and setting up here, it is fine. 

 

And they are OEM suppliers to all the air conditioner manufacturers?

Mostly. See in India, it is not that all are manufacturing compressors. Everyone will have to depend. It will take some more time, but otherwise the point I am making is any other component that infrastructure has come up with now. It is today we can claim that the manufacturing sector has arrived and in that air conditioning also as manufacturing has come up.

 

You talked about 25%. So would it be correct to say that today it's zero? We are not importing finished anymore? 

Maybe my estimate is 5% or so. Because some niche models are getting sold, some 10,000 numbers, it may get imported like a vertical air conditioner, that kind of stuff. Otherwise, I don't think it is, it will not be competitive. First of all, you won't get a QCO approval so very easily.

 

In terms of cost, let us say if you were to go back to 2019 and maybe use it sort of in a pro-rata way, how would that compare today with what we are manufacturing in India versus, let us say, with what you were importing at that point ?

Landed cost is matched, there is absolutely no problem. So let us say, for example, you imported something in 2019 and early 2020. If it has landed here, that landed cost of that you will be able to make it in India. But the difference is when the landed cost means that the manufacturer has made some profit. So that will be the gap you have to still match. I suspect we will be able to match it in the country for a different reason altogether. Basically in India, you have the raw material prices also high. Say for example in Vietnam, if somebody is manufacturing, the operating prices of steel and many other things in Vietnam will be lower. And they do have a Free Trade Agreement with China. Now they are part of the larger Free Trade Agreement of that bloc itself.

Second is that if you look at India versus Thailand, the FTA, the finished goods come under FTA.  Components do not come under or raw material does not come under the Free Trade Agreement. So therefore basic input costs may be higher in India. Secondly, you do have higher interest costs. The cost of capital is very high. So that is another element. The third element is logistics costs are prohibitively high in India. So we have to do a lot of work in order to bring it down., I will tell you, in our commercial refrigeration, deep freezers the total cost of packaging,transportation, loading, unloading can be 14%. In an EBIT, which is 8% to 10% that much it costs because it is a heavy voluminous item. So it is a huge country where you are transporting and the logistics infrastructure is the other issue which boosts the cost. So therefore, if you ask me in terms of design, engineering, and getting the product, there is no problem but input costs and the other costs are higher in India, including the cost of capital.

 

So what is the most important metal input cost in an air conditioner? I am assuming it is copper or would there be others as well? 

Steel as well as copper. 

What is, let's say, more price sensitive at this point of time?

Exchange rate for the simple reason you are getting the copper, these are called the inner grooved copper tubes. So, you know, copper is a highly regulated industry and you have the cathodes and somebody processing into a tube. Within that tube there has to be an inner groove, which Hindalco is now trying to make in India. That factory is yet to come up and it is a regulated commodity. Second is the electronics content is very high. So you are dependent on the chips and others 

The tubes, which are very tiny tubes go around and that is you are importing as a complete tube or are you making the tubes yourself? 

No, nobody makes the tube. It is a highly specialized product. Hindalco will start making it. Otherwise, the tubes are coming, that will be getting imported. You get the compressors imported and local, some 30% local vendors are available, but 70% of compressors get imported. 

 

So what point do you feel we will be closer to if we have to be a more 100% indigenisation level for all the components within an air conditioner at an affordable cost?

My philosophy has been slightly different in the sense that the Indian manufacturing industry should look at creating their own IPs and innovation. For the simple reason, if you cannot compete, how will you compete with 120 million players with yours? If you want to connect to the global supply chain, you should be beating them on innovation.

First of all, the real problem according to me is that like 0.65% of the GDP in R&D, where it is going to take us because it is negligible compared with any other country. If you take the top hundred firms that have invested in R&D, we are nowhere near specifically the manufacturing sector in engineering. Some IT companies have done more than the engineering companies. Now, I am of the firm view we should look at the innovation which will include alternate materials, how you will bring down the material content in order to compete. This is the first part. 

The second principle of mine is that we should not be madly pushing indigenisation for the simple reason that if somebody else has got the resources, if we can give it to you at competitive price, we should go ahead and do that. So the example I keep telling is that I can make pizza at home. I will first of all order the raw materials. Some get all those raw materials and go ahead and spend their own time and with all that it will be expensive. When I calculate all that and it may not be as tasty as some 150 rupee order it gets delivered. So just because I want to do it myself, as a passion is something different. But on a serious business basis, I do not think we should do this. 

 

So conversely, you're also saying that Indian manufacturers may not be able to achieve that level of efficiency, particularly in input ?

In certain cases. If somebody else is more competent, please depend on them. You should not be trying to say that everything I want to make here. Yes, you have to generate employment, you have to grow the manufacturing industry but there are numerous areas to do that. But don't, what will happen if the consumer will end up paying more price for that. You won't be able to grow the market. Second point I am saying is you can compete against the scale only through innovation. Invest more in R&D and create that ecosystem. The third is I am saying if something is available, go ahead and do that, get it from there. It is not necessary, we have to be indigenous. Keeping that framework, I think in about five years time, import content in an air conditioner manufactured may reduce to some 15% to 20% level.

From how much today? 

Today it may be 30%. 

So it's a long journey from 30 to 20% 

So the thing is that you asked what is sensitive? Exchange rate is sensitive. So in the television interviews, the copper has come down, steel has come down, will the price come down? But the exchange rate if you see in the one year period is much more than the percentage of raw material input cost that has gone down. So it is important to reduce the import content.

 

As you look ahead now, you mentioned electronics. So there's a lot of interesting innovation that happens in electronics. Your air conditioners are now talking to your mobile phones and you can set things in that. How much of that is a driver in the potential of future sales in terms of what consumers will choose or is there something else that could make consumers choose which could be more indigenous as compared to maybe what we see today?

In my whole journey of some 44 years of my career, many flop stories are there. In 2016, we launched something like wifi ready air conditioners.  I do not think we crossed 100 numbers of sales. Even today, it will not be even 1%. See, the Indian market is an aspirational middle class dominant market. In this category, you have to make the product affordable. So you will come across things connected with scale, the other is connected with, of course, smart manufacturing. The third is connected with how sustainable your product is apart from regulations, how you can make it sustainable. 

 And the thing is, you have to make the product affordable, because 65% of room air conditioners today are consumed in tier 3,4 and 5 towns, and 95% are first time buyers and 45% are consumer finance dependent consumers. So you can imagine, in this target segment, you have to introduce a product at the entry levels, functionally superior, durable, that kind of stuff. The other gizmos, I do not think it will work. But where we should make use of electronics should be in energy efficiency improvement.  Not for when you are leaving the office, you will switch off through your wifi and all that stuff. When we launched and we failed, we did some research, we understood that for wifi enablement, you should keep the wifi on at home. The people switch off the wifi when they leave for the office. 

The next is, if you recollect, we had introduced decimal cooling that 24, 24.5, 24.6, anything you can set. I do not think consumers are standing in queue to get this whole thing. So it is very clear. It is a functionally superior, energy efficient, environmentally friendly product at an affordable price. Then only you can grow the market. 

And the star rating, for example, clearly helps, because that helps consumers?

No, I am not very sure. The question is, even today, less than 30% is 5 stars.

But that is also more expensive compared to a three star, right? 

True. But the thing is, over the years, what happens is when every energy label changes, five stars will become four stars, three stars will become two stars, two stars will get eliminated. So you are moving up. But the very fact that 65% to 70% of the people are buying three stars means they are not able to afford it.

I think the point that you said earlier is interesting. You said that we are now consuming electricity, or one fifth the electricity that we were consuming 20 years ago.

That's right. 

How do you look in the years ahead in terms of how air conditioners could get consumed and do you think that the way climate is changing will make you change your own marketing and sales approach? Or do you feel that the way we see summers that's sufficient for us to sell what we want? 

We have to come to terms with the following things. You are playing a cricket match in London. It can rain and then it will be some Duckworth Lewis method. You do not know who will win. The game completely changes. If you are in an air conditioner business, you should be prepared for a bad summer. Now, what is actually happening is if you analyse the data that once in three, four years a bad summer or a wet summer is very much likely. Equally, we are seeing one trend. The peak sales used to happen in the middle of May. It moved to the first week of May, it moved to the last week of April, it moved to the middle of April. Nowadays, this year we saw peak sales happening in March because February was very warm.

 

But this has never happened… the March peak?

March peaking has never happened. April 15 being the peak happened last year. Not this summer, 2022 summer it has happened. So very clearly we are seeing. This is an important trend. So the question is that people are not waiting for the peak summer. They are buying ahead. 

The second part, what I am very clearly seeing is the average age of a buyer coming down. So we do not have published data, but our limited data shows that now 35-40 year olds are all very distinct decision makers for air conditioners, which used to be some 45 to 50 kind of a thing. Now a significant amount of youngsters are making decisions on buying air conditioners. Third trend within India, more than a third of the buyers are not buying air conditioners for themselves, they are buying for parents or children. So that is very clearly evident.  In this whole system, festival season demand has been inching up, so that also will balance the seasonality.
So fine, you are a cricket captain, won the toss, batted but rain came then Duckworth-Lewis. You do not know what your target is going to be, how you are going to meet. Then you should be having some strategies inbuilt into your business planning, which is what we are beginning to do.

Earlier when you were dependent on import, you were building up the inventory and you did not have a manufacturing ecosystem here. So January, February, March, the imports start coming and our LC has opened and April will come, May will come, even though it is raining, you will lump the inventory. But very distinctly this summer the inventory pressure is not there because of a local manufacturing ecosystem, you are able to quickly correct. Therefore the money is not blocked for you. So the other part is connected with how you will have complementary products within the company to support this. Look, Blue Star is an air conditioning commercial refrigeration and MEP contracting company.So what we ensure is our B2B and the B2C have the right balance. For example, our Q1 results, we could deliver decent results, basically because we had the B2B contributing to the revenue and the profitability. 

Most people would know you for your B2B or institutional.

That's right. 

Were you going to add something else in terms of numbers?

The important thing is that more and more I see the R&D challenges are away. The Indian air conditioning industry can develop products for India as well as the globe. That is no longer a challenge. Scale indeed is a challenge, and I think it will get resolved. And very clearly for you to compete in the global market, local scale is very important. Local market also will have to grow. And I think in the foreseeable future, India will also be a player participating in the air conditioning refrigeration market for the globe. So far, it was dominated by China. I think we will be able to do that.