epc industry in india report by jasubhai media & kpmg

EPC Industry in India: Issues and Challenges| 53 |

EPC Report 4 Cover pages.indd 53 2/20/2011 8:19:18 PM


Chemtech Foreword 2

KPMG Foreword 3

Executive Summary 4

Acronyms Used 4

Methodology 8

Coverage and Scope 8

Setting the Context 10

Value Creation Strategies 17

Key External Drivers and Issues 22

Key Internal Issues 29

End-Use Industry Views 33

EPC Industry in India

Action Agenda for Sustained Growth 48

Acknowledgements 51

About Chemtech 52

About KPMG in India 52

Contents

EPC Report New.indd 1EPC Report New.indd 1 2/20/2011 8:13:28 PM2/20/2011 8:13:28 PM

EPC Industry in India: Issues and Challenges | 2 |

CHEMTECH Foreword

Strong infrastructure and industry are critical for India as the country sees leapfrogging growth. As far as both these sectors are concerned, India is in a sweet spot, which has created multitude of

opportunities in the fields of engineering, capital goods and construction.

Though, India has witnessed significant investments in both industrial and infrastructure space, the growth has remained restricted due to various weaknesses of the Indian EPC industry and difficulties for the foreign players to ply in the market.

At this juncture, it is an imperative to address the challenges, which restrict the growth of this sector in India and will continue to repress industrial development lest addressed.

CHEMTECH has made an attempt to address the issues faced by the EPC industry through each edition of its international conference, EPC World Expo. Renowned speakers from world over have deliberated over the topical issues that must be resolved to accelerate the development of India’s EPC sector, which would eventually lead to country’s sustainable economic growth.

As we reach another milestone year with 25th edition of CHEMTECH series of expositions and international conferences, Jasubhai Media and KPMG have come together and taken the initiative address these issues through this report. I wish to thank all the members of CHEMTECH Advisory Board for EPC who despite their busy schedules shared their opinions and guided the team to come up with the study report that aims to leverage the Indian industry.

We sincerely hope that this report would be a useful information tool for both industry as well as statutory bodies to gear up for the challenges for the Indian EPC sector during this decade.

Jasu ShahFounder & Chairman, CHEMTECH Foundation



KPMG Foreword

The Engineering Procurement and Construction (EPC) services industry in India is faced with a large and unique opportunity due to galloping Indian economy, and investments in public and industrial

infrastructure. The 11th five year plan has been an inflection point in Infrastructure investments, with them contributing upto 9 percent of India’s GDP.

The 12th plan envisages a total investment in the region of USD 1 trillion, contributing upto 10 percent of India’s GDP. Similarly, there are large investments expected in industrial infrastructure, whether it be Oil and Gas, Metals and Mining and other industries.

This large and fast build out of industrial and plant infrastructure requires a robust and growing engineering, procurement and construction services industry for spreading and management of risks, efficiency and productivity in engineering and construction and supplementing the management bandwidth of project developers.

This report in line with the theme for Chemtech’s EPC conference, takes a forward looking view on the future of the EPC industry in India, based on current issues and challenges identified for the industry.

We hope that the collective insights shared in this report contribute towards shaping future business strategies and government enablement that drive India’s long term growth in this sector.

Arvind MahajanExecutive DirectorKPMG Advisory Services Pvt Ltd



EXECUTIVE SUMMARY

The EPC industry as defi ned here is different from the pure engineering or construction industry. We define the EPC industry as comprising of companies who are involved in executing projects involving multiple engineering disciplines with overall responsibility for

the performance of a “unit” or the whole plant. The scope of work would include engineering, supplies, construction or construction management, erection and commissioning and providing performance guarantees. The EPC companies in India are evolving from

multiple routes, with engineering companies, equipment suppliers, construction companies and project developers morphing in to EPC service providers by fi lling in the gaps.

ExpectationsAs a fallout of the USD 1 tri l l ion investment expected in infrastructure and industrial growth keeping pace, there is heightened interest among the investor community from engineering and construction companies who stand

to benefi t from this wave. However, the expectations far exceed the historical performance delivered and the EPC service providers need to step up their ability to win and deliver business to meet these expectations.

Similarly, customers now expect EPC service providers to ramp up their financial and execution capabilities to be able to execute larger projects, in time and with ever improving cost structures.

EPC Engineering, Procurement & ConstructionGDP Gross Domestic ProductPPP Public Private PartnershipTSR Total Shareholder ReturnsEPCM Engineering,Procurement &Construction ManagementPMC Project Management ConsultantFEED Front End Engineering DesignO&M Operation & MaintenanceJV Joint VentureBOP Balance of PlantBTG Boiler Turbine GeneratorBOT Build,Operate & TransferBOOT Build,Own,Operate & TransferDBO Design Build & Operate

DBOOT Design,Build,Own,Operate & TransferITI Industrial Training InstituteMRP Material Requirements PlanningPNGRB Petroleum & Natural Gas Regulatory BoardPCPIR Petroleum,Chemicals & Petrochemicals Investment RegionsMENA Middle East & North Africa CGD City Gas DistributionADB Asian Development BankJNNURM Jawaharlal Nehru National Urban Renewal MissionJICA Japan International Cooperation AgencyULB Urban Local BodyE&P Exploration & Production

Acronyms Used



Value Creation Strategies and Routes to Growth

EPC companies can improve their wealth creation profi le by focusing on performance, prospects and managing risks and fi nancing costs. While performance is about improving margins by way of correct estimations, procurement and project management capabilities, and focusing on adding higher margin components to the services provided, prospects is about continuously adding newer avenues of revenue growth.

The most likely route for diversification is through penetration in new end-use industries or taking the developer route, which in fact is an imperative for growth in

sectors like Water, Roads involving BOT, BOOT contracts. International expansion by EPC companies is likely to be limited largely due to global competitive intensity and the large domestic demand.

We expect increasing number of acquisitions in this industry, as companies look to enter new end-use industries by buying qualifi cations.

Lastly, risk management and “no-surprises” go a long way in improving investor perception, and materially bringing down fi nancing costs for the EPC companies.



Key Challenges

The key external challenges faced by the EPC industry are as follows:-

Continuously evolving contracting models and relatively slower adoption of the EPC-LSTK concept, especially where customers are large public sector companies with in-house teams, and large private sector developers, who have signifi cant in-house project management capabilities. Order book uncertainty brought about by purely price based procurement decision making of customers, which has led to the emergence of large number of hitherto unknown companies winning relatively large contracts. While this is essential for capacity building, it has led to uncertainty of order book for the incumbent service providers. It also makes making investment decisions more diffi cult for companies. Shortage of skilled manpower for managerial as well as site labour. The country has its task cut-out in terms of creating skill work force for the industry. However, the onus really lies on the private sector and the EPC companies to undertake initiatives to address this “supply-chain” issue. The perception on the sanctity of contracts remains divergent, especially between Indian companies and International entrants. There is a need to establish faith in our ability to enforce contracts by standardization, following international practices and setting right dispute resolution mechanisms.

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External Internal

The key internal challenges are about managing scale and building capabilities to address issues emanating out of this:-

Project Manager Empowerment, especially in Indian companiesBalancing speed and cost control in the Procurement functionCreating a robust engineering organization and balancing between effi ciency and effectivenessAdoption of leading Risk Management practices

The challenges are accentuated for two sets of companies a) International entrants and b) mid-size companies looking to scale up.

Policy making can help mitigate some of the issues related to enabling private sector for building a skilled workforce, develoing speedier mechanisms for speedier resolution of contractual disputes, and clarifying taxation regulations related to the industry.

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There are macro level learnings to be derived from Korea’s EPC growth story, which may be replicated by the Indian industry

Government support in terms of ministerial oversight for the industry, followed by active promotion of the industry overseasCapacity building initiatives in terms of institutions for developing construction industry talentEngineering fi rms working in collaboration with construction majors, facilitated by not-for-profit engineering industry associations

Apart from the above, the report discusses specifi c end-use industry issues and demand outlook for Power, Oil and Gas and Water, bringing out nuances in terms of differences in contracting models, profi le of service providers and key challenges.

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Learnings from the

Korean Construction Industry



The report has been prepared by KPMG Advisory Services Private Limited in association with Chemtech. Leading executives from the industry were interviewed to seek inputs for the report. The representation included project developers, EPC companies, engineering consultants and construction companies.

We have collected insights based on numerous engagements with nodal agencies, infrastructure companies, engineering and construction fi rms, and foreign players looking to enter India and equipment suppliers.

Secondary research was conducted using published reports, news analysis and usage of standard fi nancial databases subscribed to by KPMG. We have leveraged the expertise and relationships of our advisory teams in the area of Infrastructure and Government and Industrial Markets spread across the country.

Taxation related inputs have been provided by our Tax team based on their working experience with clients in the area of infrastructure and engineering and construction.The report covers primarily the EPC services industry from the perspective of the following end-use industries - Power, Refi ning and Petrochemicals, Water and Water Treatment. These industries have large investments planned in the country for the next 5 to 10 years, and involve technological complexity apart from being complex from a project management perspective.

Also, they are varied and bring out the nuances of the EPC sector across most aspects. Specifi c issues related to EPC services for other end use sectors like Roads, Railways, Metals and Mining etc are not detailed as part of this report, though

many of the generic EPC industry issues identifi ed in this report would also apply to EPC services for these other industries.

Methodology

Coverage & Scope



EPC or Engineering, Procurement and Construction industry is referred to by various terms like Construction industry, Engineering and Construction, Contracting or just engineering industry. Here we defi ne the EPC industry as consisting of service providers who are capable of executing projects on a turnkey basis, including detailed engineering, procurement, construction, commissioning and performance testing.

We concern ourselves with players who are able to aggregate multiple engineering disciplines like process engineering, mechanical, structural, civil and electrical. Examples of such companies in India are Larsen and Toubro, Punj Lloyd, Tata Projects, Essar Projects etc. Players who only operate in the civil construction and structural engineering domain and would

not undertake turnkey construction of a plant or packages within a plant are not considered as EPC companies by this defi nition. It is diffi cult to draw a strict boundary in terms of what constitutes an EPC fi rm vis-à-vis construction or engineering fi rms. One way to distinguish between a classical EPC company from a primarily civil construction company is the construction intensity of the end-use sector, defi ned by Crisil as the percent of construction spend in the overall investment towards creating an infrastructure or industrial asset. For example, Roads is estimated to be close to 100 percent, while a thermal power plant is 20 percent.

The rest is towards equipment, mechanical fabrication, electrical and non-construction engineering spend.

Defining

EPC Industry



Route 1Expanding scope from being engineering companies to EPC companies. The most prominent example of this route Engineers India Limited, which is India’s leading engineering company, especially in the Hydrocarbons segment and now offers EPC services. However, successful instances of this route are limited.

Route 2 Expanding scope from being construction companies to EPC companies. This is the more commonly followed route, wherein companies have added engineering and procurement capabilities to their existing expertise in mechanical and civil construction. The leading example of this route has been Larsen and Toubro, which moved from being a fabrication and construction company in to one of the largest and most respected EPC companies in India.

Route 3 Expanding scope from equipment supply to EPC companies. This route has been more commonly followed in the engineering and capital goods segment. Companies manufacturing major pieces of equipment for a particular manufacturing process have upgraded themselves to execute projects around their equipments. Examples are Elecon, TRF who are suppliers of material handling equipment and undertake projects in Power Balance of Plant packages supplying entire Coal handling systems or in industrial plants involving large material handling components.

Route 4 A relatively new development has been of project developers backward integrating and setting up their own EPC divisions. This has been motivated by a desire to leverage their in-house project management capabilities, and to capture the margins typically belonging to contractors.

Setting

The CONTEXT



Relevance of the EPC industry to the India Growth Story

The 11th plan was an infl ection point for the Indian infrastructure story. The 11th plan laid the foundation for large scale investments in infrastructure in India. Of the USD 500 billion planned to be invested in the infrastructure, at the current rate, it is expected that the plan will be met to 94 percent. This would amount to 9 percent of India’s GDP and is expected to go up to 10.25 percent of GDP.

Mid-Term Appraisal of 11th Five Year PlanIn order to achieve this plan, various pieces of the puzzle need to come together, and would require all stakeholders, the government, public sector undertakings, private sector to contribute their achievements in a co-ordinated manner. It is expected that the private sector would contribute 50 percent by way of fi nancing to achieve this plan. The obvious policy focus has been on building fi nancing capacity, formulation of PPP

policies in various sectors, policies around creating investment clusters, land acquisition and environmental clearances. However, the chain is only as strong as the weakest link.

Achieving this rate of infrastructure build-out calls for massive capacity building down the chain in terms of manufacturing capacities for equipments, raw material and commodity capacities (e.g. steel, cement, fuels etc) and human resources. Similarly, it calls for massive capacity building in the engineering and construction sector in terms of reasonable number of large to mid-size contracting or EPC companies available to be able to undertake Lump-Sum-Turn-Key (LSTK) and sub-contracting jobs in the country.

Purely from a construction perspective, investment in construction is estimated to double to INR 16,809 billion over



1 Source: Crisil “Construction-Opinion August 2010”

the next fi ve years (2010-11-20114-15), from INR 8,895 billion recorded during the last fi ve years1. Within this the infrastructure segment, would comprise 85 per cent of the total construction investment. Within infrastructure segment, the roads, power, irrigation and urban infrastructure sectors would contribute around 73 percent of total construction investment. The opportunity for EPC players varies by industry given the contracting models and construction intensity of each class of infrastructure or industrial asset. CRISIL Resarch estimates that investments in the industrial sector would be 1.2 times in the next 5 years as compared to the previous fi ve years while in infrastructure it would be 1.9 times, bringing the total growth to be 1.7 times.

Projected Infrastructure Investments in 12th PlanBase Yr (2011-12) 2012-13 2013-14 2014-15 2015-16 2016-17

GDP (USD Billion) 1,595 1,738 1,895 2,065 2,251 2,454GDP Growth (%) 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%Infrastructure Investment(% of GDP) 9.00% 9.25% 9.50% 9.75% 10.00% 10.25%InfrastructureInvestment(USD Billion) 144 161 180 201 225 252Total Investments (USD Billion) 1,019

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Source: Planning Commission



2 TSR computation has been done for last 3 years data for companies which have been publicly listed in the last 3 years and may be classifi ed as engineering and construction companies3 Source of data for analysis is Prowess, CMIE

Expectations from the EPC Industry

The EPC industry has gained prominent share of media, investor and entrepreneurial attention in the last 3-5 years. The stock markets have handsomely rewarded companies operating in the infrastructure, construction and EPC space,

largely on account of future expectations. Similarly, the large investment plans have raised expectations of customers from this industry.

Investor Expectations

During the period of 2008-2010, the Total Shareholders Return2 (TSR) by the EPC companies has been ~31 percent. TSR for the more broad-based Infrastructure index in the corresponding period has been only ~ 9 percent. KPMG analysis indicates that the expectations embedded in the current valuations indicate that investors are expecting the leading EPC companies to grow their order books and revenues at a rate of ~65 percent if they continue to maintain current profi tability and capital turnover

ratios, whereas the CAGR growth demonstrated in the last 3 years has been around 28 percent for the set of companies considered below3.

Hence the stock market expectation of growth of EPC companies appears to be very high. Private equity interest has also been high in the industry.

RECENT EXAMPLES OF PRIVATE EQUITY DEALS CONCLUDED

CONSORTIUM OF PRIVATE EQUITY FIRMS, INCLUDING BARING, SEQUOIA CAPITAL, FIDELITY AND DEUTSCHE BANK, ACQUIRED A 16 PERCENT STAKE IN INFRASTRUCTURE-EPC COMPANY COASTAL PROJECTS FOR $54.8 MILLION1 AVIGO INVESTED $14 MILLION IN DELHI-BASED NAFTOGAZ INDIA PVT LTD, AN EPC PLAYER IN THE O&G SECTOR.DELHI-BASED UEM GROUP, SPECIALISING IN WATER & WASTE WATER COLLECTION, TREATMENT AND DISPOSAL, MOPPED UP ` 90 CRORE FROM INDIA VALUE FUNDCHENNAI-BASED AQUA DESIGNS INDIA, A WATER MANAGEMENT ENGINEERING COMPANY, RAISED ` 55 CRORE FROM PEEPUL CAPITALCONCORD ENVIRO SYSTEMS, A WATER MANAGEMENT ENGINEERING COMPANY, RAISED $10 MILLION FROM SAGE CAPITAL FUNDS IN DECEMBER 2009

A2Z MAINTENANCE & ENGINEERING SERVICES LTD (BACKED BY IEP, BEACON INDIA PRIVATE EQUITY FUND AND MR RAKESH JHUNJHUNWALA), IS PRESENT IN POWER DISTRIBUTION EPC BUSINESS.

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Total�Shareholder�Returns�of�Select�Engineering�and�Construction�

Companies

86.3%

74.5%

50.7%

38.9%

33.6%

32.3%

32.3%

31.5%

23.3%

23.2%

20.3%

17.1%

14.7%

14.1%

13.0%

12.4%

8.6%

8.5%

7.0%

4.5%

2.3%

�3.7%

�13.5%

�20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

Era�Infra�Engg.�Ltd.

Engineers�India�Ltd.

Sadbhav�Engineering�Ltd.

Jaiprakash�Associates�Ltd.

Mcnally�Bharat�Engg.�Co.� Ltd.

Bharat�Heavy�Electricals�Ltd.

Larsen�&�Toubro�Ltd.

Ahluwalia�Contracts�(India)�Ltd.

Gayatri�Projects�Ltd.

Thermax�Ltd.

Hindustan�Construction�Co.�Ltd.

Patel�Engineering�Ltd.

Alstom�Projects�India�Ltd.

Madhucon�Projects�Ltd.

Punj�Lloyd�Ltd.

Unity�Infraprojects�Ltd.

Nagarjuna�Construction�Co.�Ltd.

Ion�Exchange�(India)�Ltd.

I�V�R�C�L�Infrastructures�&�Projects�Ltd.

J�M�C�Projects�(India)�Ltd.

Gammon�India�Ltd.

S�P�M�L�Infra�Ltd.

Elecon�Engineering�Co.�Ltd.

Source: KPMG Analysis, fi nancial data from Prowess, CMIE

In summary, the expectations from the investors are much higher than the pace at which companies have delivered performance in the recent past. This is an indicator of the strongly positive expectations surrounding the sector, and hence the need for the industry to deliver a consolidated performance in line with what is expected of them.



The value proposition offered by the EPC industry is based on the concept of risk sharing or risk transfer from the project developer to the EPC Company, at least to the tune of the capital cost of the project and to a limited extent to the initial operating performance of the plant / facility being built. In exchange for that, the project developers are willing to pay a premium for the integration services provided. Over a period of time, customers have come to expect a reduction in the total cost of putting up the plant and the time schedule through the EPC route, compared

to exectution by the developer organization or the more traditional route of procuring equipment, services and

engineering services separately and owning the integration and the project management.

It is important to point out here that given the customer expectations and the consequent EPC business model, an EPC company takes on a much higher level of real and perceived risks within a project, than other

service providers in the pure engineering, consulting or Project Management space.

Customer Expectations

EPC company takes on a much higher level of real and perceived risks within a project, than other service p r o v i d e r s i n t h e p u r e Engineering, Consulting or Project Management space.



T h e p u r e e n g i n e e r i n g , c o n s u l t i n g o r PMC serv ices companies build their business models around p r o f i t a b l e c u s t o m e r relationships, and

do not necessarily need profi tability in each project that they undertake.

However, the services of an EPC contractor are supposed to be based on comprehensive contracts with little room for interpretation and ambiguity, whereas pure engineering or EPCM service providers do not take on most of the project cost or time overrun risks which remain with the developer.

Given its business model, an EPC Company hence has to target profi tability from each contract, since the value at risk in the case of overruns is very high, in proportion to its expected margins. Further, the nature of the customer relationship continues to be “arms-length” over the period of the contract, as EPC companies look to protect themselves against time and effort overruns delays on account of the developer and a plethora of other risks that might take them off their initial estimates. At the same time, customers want to ensure that they get their plant or facility up and running, with the desired quality in time and with no extra claims raised by the contractor.

APART FROM THIS BASIC CUSTOMER EXPECTATION, DURING OUR DISCUSSIONS WITH PROJECT DEVELOPERS SEVERAL OTHER EXPECTATIONS FROM EPC COMPANIES WERE COMMONLY MENTIONED

EPC COMPANIES NEED TO IMPROVE THEIR FINANCIAL AND BALANCE SHEET STRENGTH TO BE ABLE TO TAKE ON LARGER JOBS, AND NOT DEPEND ON ADVANCES AND FAST TRACK PAYMENTS FROM DEVELOPERS TO BE ABLE TO PROGRESSINDIAN EPC COMPANIES NEED TO SIGNIFICANTLY IMPROVE THEIR ENGINEERING CAPABILITIES, ESPECIALLY ON THE FRONT END SIDE. THIS IS ESPECIALLY TRUE FOR THE ENGINEERING COMPANIES WHICH ARE RESPONSIBLE FOR PREPARING THE FEED (FRONT END ENGINEERING DESIGN) PACKAGE SO THAT LSTK BIDDING CAN BE FACILITATED. DEPLOY LATEST CONSTRUCTION METHODOLOGIES AND TECHNIQUES, BOTH MANAGERIAL AS WELL AS TECHNICAL TO EXECUTE PROJECTS FASTER AND TO BETTER QUALITY. DEVELOP EMPOWERED PROJECT MANAGERS, SO THAT THEY CAN ACT AS MORE THAN JUST COORDINATORS, AND CAN INTERFACE WITH THE SENIOR MOST LEVELS IN THE CLIENT HIERARCHY AND TAKE DECISIONS TO RESOLVE PROJECT ISSUES.

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The EPC game is

competitive,

while

EPCM game

is about

relationship &

trust



Value Creation Strategies

The “project level” value creation driver in terms of profi tability for an EPC company is its ability to a) Correctly estimate the detailed costs and time schedules of a project and

b) Manage the entire ecosystem of customers, vendors, regulators, engineers and sub-contractors, to deliver within those estimates.

Sources of Long Term Value Creation However, long term value creation requires EPC companies to improve in all three aspects that impact the market value of a company – performance, prospects, and fi nancing. While performance is enhanced both through revenue and profi t growth, future prospects are enhanced when the EPC company is positioned well to serve high growth segments and profi table

customers. Financing component of value creation involves a reduction in the risk premium and discount rate associated with future cash fl ows of the company. This can be achieved by a combination of a reduction in actual cost of borrowing and the “expected” cost of equity through improved risk management practices and reduced volatility of revenue streams.



Scale and other Value Drivers for EPC companies

Performance improves for an EPC company with scale, as it is able to leverage effi ciencies in procurement, overheads, relationship building with vendors and sub-contractors. Also, there are scale opportunities created when companies are able to invest in standardization of designs, value engineering and

investment in world-class tools and techniques.

The other two important aspects for value creation are “Growth to create future prospects” and Risk Management which are covered subsequently.



Diversifi cation is a key element of growth, and will be aggressively pursued in India. It is driven

not only from the point of growth, but also from the perspective of managing volatility in order booking. Presently, the established EPC companies operating in a limited set of industries in India, are also perceiving a high risk to their order booking levels due to the large number of new entrants into the EPC space, as well as a perceived dilution in qualification criteria from many customers that appears to be providing a level playing fi eld to the new entrants. Hence diversification has become a popular mode of seeking both growth and stability in revenue streams of EPC companies.

Route 1 HORIZONTAL EXPANSION Existing EPC companies are diversifying in to new end-use industry sectors, inspired by the large investments coming up in these sectors. For example, Punj Lloyd, a player in the Oil and Gas space, expanded in to the Power Generation EPC market and has recently won orders in the Balance of Plant EPC space. Similarly, Tata Projects has entered in to a JV with EIL to form a TEIL, to address the investments in the Oil and Gas space. The JV leverages EIL’s engineering know-how, client relationships in the Oil and Gas sector and the LSTK contract

execution capabilities of Tata Projects. There are many other examples, of such strategies being followed by companies all over the country.

Route 2 VERTICAL EXPANSION Some companies are expanding to control more of the investment value of the project, by becoming system integrators. A large proportion of these companies are equipment vendors, who believe that they have the ability to execute contracts on a turnkey basis. Examples of this route being followed being prevalent largely in the Power Generation equipment side. For example companies like Elecon, TRF which were earlier primarily material handling equipment vendors are now competing for turnkey material handling systems packages. Similarly, there are engineering companies like EIL, who are now offering EPC/ LSTK services to their clients.

The vertical expansions have been driven by the desire to enhance the top line and to control a larger share of the investment pie. Engineering services contribute not more than 5-10 percent of the total plant investments, and while engineering services have higher margins and relatively

lower risks, it doesn’t provide aggressive top line growth. Such vertical expansion into Construction and Project Execution by publicly listed manufacturing or engineering companies, is also driven by the higher earnings multiples currently associated with such “high potential” businesses. The market recognizes that construction and project management service providers will be in short supply and high demand in the short to medium term.

As a note of caution, however, it is worth mentioning that companies who enter the Projects business from product manufacturing or engineering services backgrounds, need to carefully built the required capabilities for project

Routes to Growth

DIVERSIFICATION

PROMISES GROWTH

& STABILITY IN

REVENUE STREAMS

EXPANSION MODES

Horizontal

Vertical

Backward Integration

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execution, and identify and manage their risk exposure in a higher risk business in a calibrated manner. Several traditional manufacturing companies have faced fi nancial diffi culties in managing their project businesses in the recent past.

Route 3BACKWARD INTEGRATION Many Indian entrepreneurs have typically wanted to control as much of the value chain as possible. The story is being now repeated in the EPC industry - Reliance ADAG has Reliance Infrastructure, while Essar Group has Essar Projects. GMR has its own EPC division, while the Tata Group has Tata Projects. Many other business houses have established

strong internal project execution teams. Moreover they believe they can derive substantial benefits on procurement activities through in-house procurement. Further, as an executive from one of the leading players in the industry pointed out large business houses making signifi cant investments believe that there isn’t enough expertise and scale within the existing EPC companies for assuming and managing their project risks.

In the Power Sector, for example, the only large full service EPC company that comes to mind is Larsen and Toubro, which can offer full EPC, BTG package, BoP package and also individual equipments and sub-systems. There

are few others capable of simultaneously executing a number of full EPC projects in the Power Sector. One private developer mentioned that the available set of EPC companies does not inspire confi dence in their being able to deliver projects on time and with the initial estimated cost. Typically in such scenarios, the risk of both schedule and cost is transferred back to the developer in forms of claims and counter claims on who is responsible for delays and escalations. As a result, the developer feels compelled to manage his projects on his own if he has the organization and resources to do so, and a large enough pipeline of projects to utilize these in-house resources effi ciently.

International expansion for growth has really not been a focus area for most Indian EPC companies given the growth in the domestic sector, and the stiff competition posed internationally by the global majors. However, there remain certain sectors where international expansion is likely. The Indian Oil and Gas plant engineering and construction market has all the global majors present in India. Hence, Indian companies competing with them have raised their game to the

international level in this fi eld. Hence companies like Larsen and Toubro, Punj Lloyd, Essar Projects have won business at the international level and should continue to do well in the hydrocarbons space. Similarly, sub-contractors in this space (e.g. Petron Engineering) may also be able to compete internationally, as they have been working as sub-contractors to global companies in India.

On the other hand, there are niche

International ExpansionCOMPANIES WHO ENTER

THE PROJECTS BUSINESS FROM PRODUCT

MANUFACTURING OR ENGINEERING SERVICES

BACKGROUNDS, NEED TO CAREFULLY BUILD THE

REQUIRED CAPABILITIES FOR PROJECT EXECUTION,

AND IDENTIFY AND MANAGE THEIR RISK

EXPOSURE IN A HIGHER RISK BUSINESS IN A

CALIBRATED MANNER.



EPC segments, with limited market size in India, which has prompted Indian companies in these domains to go global. Examples of this are to be found in Walchandnagar for sugar and biomass based power plants, KEC International for EPC in transmission and distribution space. Some of these expansions have been facilitated by global acquisitions as well – for example the acquisition of the mineral benefi ciation equipment business of cement major KHD Humboldt Wedag by McNally Bharat Engineering has provided them a foothold in the international market. Similarly, the acquisition of Sembawang and its subsidiary Simon Carves has signifi cantly improved the international profi le of the Punj Lloyd. KEC International acquired SAE Towers’ business, a leading manufacturer of steel lattice structures for transmission towers with subsidiaries in Brazil, Mexico and US. This is the most plausible route that Indian companies are likely to take acquiring companies in niche areas globally to create large multi-country EPC businesses. There are no large acquisitions of note in the main plant EPC market, other than Punj Lloyd’s acquisition of Sembawang.

In the domestic market, diversifi cation in to newer areas by EPC companies has been accompanied by acquisitions or JVs - particularly in the Hydrocarbons space, wherein the qualifi cation criterion

are quite stringent for entry.

Ta ta Pro jec ts acqu i red Ar tson Engineering, while entering into a JV with EIL for its Oil and Gas foray. IVRCL acquired Hindustan Dorr-Oliver to strengthen its Water Treatment business and gain a foothold in the mineral benefi ciation plant construction market. We expect the acquisitive activities of Indian EPC companies to intensify over the next 3-5 years. Opportunities for partnering or acquisition will arise as smaller, niche EPC companies fi nd it difficult to compete against large companies. Additionally, the recent bout of aggressive bidding by Indian EPC companies is likely to throw up winners and losers in the next 3 to 5 years. This will likely lead to consolidation in the industry.

GLOBAL ACQUISITIONS BY INDIAN COMPANIES

Mineral benefi ciation equipment business of cement major KHD Humboldt Wedag by McNally Bharat EngineeringSembawang and its subsidiary Simon Carves by Punj LloydSAE Towers’ business, a leading manufacturer of steel lattice structures for transmission towers with subsidiaries in Brazil, Mexico and US by KEC International

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Contracting Models

Model Role of EPC company Drivers / HighlightsEngineering Procurement and Construction Management (EPCM)

System engineering, optionally detailed engineeringDetailed cost estimationP a c k a g e a n d s u b - c o n t r a c t structuringManaging bid / vendor selection processQuality management ( including drawing approvals of vendors, sub-contractors)Supervision of construction, erection, commissioning, performance testingProject Management ( sometimes an additional Project Management agency)

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Commonly practiced in process industryPlayers like Engineers India Limited, Uhde, Foster Wheeler, Technip, Technimont ICB etcContract values are small as compared to LSTK, however high marginMinimal risk for EPCM companies, however customers now insist on incentives based on project cost and schedule as compared to original estimatesPlaces responsibility of managing risks, cost control and procurement on the project developerPreferred in the Indian context due to in-house capabilities of Indian entrepreneurs and willingness to take risks, and save margins

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EPC - Lump Sum Turn Key (LSTK)

E n g i n e e r i n g , p r o c u r e m e n t , construction, commissioningThe extent of information provided varies, typically all the drawings and designs are provided to construction companies to bid, while in some cases only the conceptual design may be provided

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Complete risk transfer to EPC companyVery large contract sizes, equal to the project investmentHigher adoption in India of this model in the infrastructure segments ( Roads, Water, Hydro Power etc)Limited adoption in the industrial segment

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Package EPC E n g i n e e r i n g , p r o c u r e m e n t , construction and commissioning of a particular unitMost likely to involve mechanical, electrical, instrumentation, utilities civil and structural scope

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Project developer splits the project in “system” or unit packagesMost commonly used method in Process plants, power plants – especially by the public sector. E.g. NTPC breaks the Power plant in to packages like BTG, Coal Handling, Ash Handling, Water Treatment etcContract sizes can be as large as INR 2000 Crores

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Contracting Models and their Drivers

The demand for the EPC industry is driven by the contracting models adopted by customers. Theoretically, the EPC industry is driven by the need to reduce the risk for the developer, at the same time leveraging the expertise of the EPC player to reduce the overall execution period and cost. Some of the prevalent contracting models are mentioned below:

Source: KPMG Research and Analysis, Industry inputs

Key External Drivers and Issues



The choice of the contracting models are driven by multiple factors

Internal capabilities of the project developerInfl uence of fi nancial institutionsAvailability of enough number of quality LSTK suppliersPrevai l ing market condit ions, including supplier power. In a capacity constrained scenario, contracting models move towards shifting the risks on to the project developers.

However, a few general trends can be drawn based on the above drivers, as follows:

In the infrastructure segments, the contracting models are moving towards transferring more risk to contractors, including operating risks in the form of BOT, BOOT models. In the industrial segment, it is expected that the EPCM or even lesser risk models will continue to dominate. What wi l l t i l t the balance in favour of turnkey models in the industrial segment is the entry of new developers, especially in the mid-scale segments, who have limited internal capabilities to execute projects without LTSK type contracts.

Order Book UncertaintyOne significant trend in industry,

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especially where projects are being awarded through the competitive bidding in the public sector, is the emergence of a large number of relatively small, unknown players bagging signifi cantly large contracts.

While it is important from a capacity building and competitive stand point, it has led to order book uncertainty for the incumbents. At the risk of sounding anti-competition, a senior management executive of a large EPC company suggested that it is not a healthy trend at all. “It is leading to contracts being bagged by companies with limited capabilities, which will affect projects in the medium to long run”. While the extent of truth in this prophecy can only be borne out over time, it is a fact that this phenomenon has increased the order book uncertainty for the incumbents.

Strategic planning methods based on projected capital expenditure and historical market shares do not throw up reliable revenue projections, and there is scramble to hedge risks by diversifying and being present in as many sectors as possible. There are numerous examples around this; a look at the portfolio of the top 10 construction companies in India illustrates this point.

Another ramifi cation of this order book

uncertainty is the appetite for investment in manufacturing or in-house value addition. The BTG manufacturing capacities of private sector companies in India like that of L&T, Bharat Forge, Thermax, BGR etc are faced with the prospects of being under utilized as most main plant equipment orders have been won by BHEL and the Chinese companies.

This phenomenon was also seen in the Roads sector, where there is consequently now a cap on how many orders can be placed on a single company, and also in the Balance of Plants in Power space, where multiple companies have sprung up to take advantage of the under-capacity scenario.

CONTRACTS

being bagged by

COMPANIES

with LIMITED CAPABILITIES

will affect

PROJECTS in

the medium to long run



4 NSDC report on Human Resource and Skill Requirements in Building, Construction Industry and Real Estate Services

Human Resources

The shortage of skilled manpower is most acutely being felt in the construction industry. The construction industry currently employs 32 million people in the country. It is estimated that 1 percent increase in GDP translates to 1 percent increase in jobs for the construction industry. With the accelerated investment in infrastructure, this is only going to increase. If the 12th plan envisages doubling of infrastructure investment from the 11th plan, it calls for doubling of requirement for the construction industry, which indicates a large shortage of resources. While mobilization of unskilled labour at construction sites may be of relatively lesser concern, the need for doubling the skilled resources available in the country is being acutely felt. Anecdotal evidences indicate that construction managers with 15+ years of experience in building high quality roads are now drawing compensation in the same range as their peers in advanced countries, which was unheard of in the Indian context. Industry leaders are worried about the shortage of skilled

workers like carpenters, fi tters, welders, but what they lament the most is the lack of Project Managers with adequate experience and skill levels to execute the ever increasing size and complexity of projects.

The 11th plan envisages the development of a National plan for Human Resource development through training and certifi cation of construction personnel. However, industry participants feels that this large capacity building will require signifi cant private sector effort, for establishing training institutes, setting course material and reducing trainee career risks by providing absorption. While the need for upgrading the current set of ITIs and vocational training institutes is felt, more importantly, there is a need to establish training centers with private participation at major labour centers in the country, in the semi-urban and rural areasThe challenge is accentuated due to the demand centers and the supply centers being different. The supply is likely to be driven predominantly by states like Orissa, West Bengal and Bihar, especially at the minimally

skilled levels4. Centum Learning, a joint venture between Bharti Group’s Centum Learning and NSDC is one initiative, to skill and train 1.2 crore Indians on workskills in sectors like Telecom, Retail, Building and Construction. However, there is need for many more, especially from the Construction Industry itself. Hence there is an urgent imperative for collaborative action by the Engineering and Construction companies in investing in skill building at the supply centers, in a non-competitive environment. In the meantime, the government may have to refrain from disallowing the use of

foreign labour for project execution, till such time as skilled labour shortages are addressed.

While, the skilled resource

“The existing public school infrastructure can be upgraded through private participation with minimal additional expenditure with after-school hours used for providing vocational skills”- Senior Executive at an EPC company

Incremental Human Resource Requirement (including skilled workforce) in 000sProfi le of People Incremental

RequirementProject Managers and Engineers

473

Supervisors 473Foremen 946Crane Operators 7Electricians 473Weleder 473Source: Nat ional Ski l l Development Corporation and IMaCs study on Human Resource skill gaps in Building, Construction and Real Estate



requirement at the Engineer and Supervisor levels is a constraint as well, we feel that it is easier addressed as over a period of time through private sector participation in engineering education, as this is financially rewarding even with limited or no government support. What may be needed though is more specialized curriculum development (for example Power Plant engineering). A second requirement is for cross-functional engineering ski l ls and exposure. The EPC industry needs a set

of professionals to act as integrators, who can act as engineering coordinators and are comfortable with various engineering disciplines and not just one specific discipline. It is only with the availability of such talent, that companies can innovate, carry out value engineering to improve the overall productivity of a capital project.

The second of critical challenges apart from technical and skilled labor, lies in developing managerial talent. There

are few institutes focusing on teaching Project Management, especially for the construction industry in the country. In the absence of specialist fi nishing schools for Project Management, the industry relies on in-house training, and on-the-job training programs. While those are important, there is a need to go beyond the generic project management credits introduced in business schools or engineering institutions. It is strongly believed that the development mandate given to the Construction Industry Development Council and the National Institute of Construction Management and Research (NICMAR) needs to be supplemented by the establishment of some such high quality Project Management schools.

“There is a need for building a high profi le project management school along the lines of an IIT/IIM, all we need is some land allocation and the industry can do the rest” – Senior Executive of an EPC company



5 http://www.doingbusiness.org/rankings

Ease of Doing Business Ranking for India

(i) Ease of doing business in India

In the latest rankings5 for ease of doing business, India is ranked 134th in the world.

Contracts

Ease of Doing Business

Starting a business

Dealing with construction permits

Registering property

Getting Credit

Protecting investors

Paying taxes

Trading across borders

Enforcing contracts

Closing a business

134 165 177 94 32 44 164 100 182 134Source: World Bank Group, Ease of Doing Business Rankings, 2011

“Managing within a weakly enforced regulatory framework is a competitive advantage for Indian companies” - Senior Executive at an EPC company

India scores particularly poorly in the establishment of new business and construction, closure of businesses, and enforcement of contracts. While, one may argue that these rankings mean little to investors and companies

who see the immense potential of India, as also reflected in the FDI flowing in to the country. However, for many global companies contemplating entry into India, these are not encouraging indicators. One of the world’s leading

design engineering and consultancy firms, while evolving it strategy for emerging markets recently, found these rankings to be particularly forbidding in its evaluation of India’s attractiveness as a business location.

Risk Assessment of Typical ContractsDuring a recent engagement for an Indian EPC client, we studied the risk evaluation frameworks in use by international majors. We found that many international companies would rate typical Indian projects as “No-Go”. While the reasons would typically also include issues related to logistics constraints and overly

aggressive delivery periods, the primary reason for such evaluations, we found, were the typical contractual clauses, including payment and retention terms which detract international companies from taking up large contracts in India. Moreover, many EPC companies fi nd arbitration as a lengthy process in India, and hence the risk averse companies assume that in case of any disputes,

they will have to accept terms from the customer. Interestingly, as a senior executive in in an EPC firm told us, the ability to manage within a weakly enforced regulatory framework is a competitive advantage for Indian EPC companies who have learnt to operate under these conditions. For example, these companies have realized that Liquidated Damages are rarely enforced

by Public Sector clients. Further, new infrastructure developers, when dealing with large experienced EPC fi rms operating in India, fi nd it diffi cult to prevent extra claims, and costs from escalating.



We feel, the industry requires that nodal agencies in various government sectors, take up these issues, to align the project contractual clauses to international standards, particularly if they wish to receive enough number of bids in the International Competitive Bidding routes, reduce the number of disputes and raise the trust levels in the industry between project developers and engineering and construction companies.

Taxation Direct taxA typical EPC contract will have the following scope of work in a single project:

Supply of equipment (offshore and onshore); Installation / commissioningServices (offshore and onshore)Software / Technology transfer (offshore and onshore)

Under a typical EPC contract, a non-resident contractor performs multitude of activities. The scope of work under EPC contract:

Offshore: Offshore supplies and offshore servicesOn-shore: Onshore supplies and onshore services (installation, commissioning, etc.)

Taxability of payments received by foreign companies in respect of EPC

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contracts, especially in respect of off-shore supply of goods / services under a composite contract, has become a matter of great debate and litigation. Equally important is the issue in relation to withholding tax on such payments. The onshore supplies and services are normally taxable in India.

There has been a lot of litigation in relation to taxability of offshore supply and offshore services. However, the controversy in relation to offshore services is now rested with an amendment in the domestic law and accordingly offshore services are now taxable in India if they are utilised in India. A general principle which was emerged out of the judicial precedents is that profi t from offshore supplies would not be taxable in India provided following conditions are satisfi ed:

Principal to principal transactionTitle (i.e. risk and ownership) in the offshore supplies passed to the buyer outside IndiaSale consideration is received outside IndiaSale is at arm’s length

Although the above rulings suggest that offshore supply may not to be taxed in India, the taxability depends of facts of each case. Further, the revenue authorities have not accepted the above rulings and hence, it is still a matter of

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controversy and litigation. Hence, it is advisable to structure contracts in a tax-efficient manner after taking into account the peculiar facts of each case. Further, there as several provisions under the Proposed Direct Taxes Code, 2010 such as General Anti – Avoidance Rules, etc. that will have to be taken into consideration while entering into EPC contracts.

Permanent Establishment (‘PE’) IssuesDeputation of personnel for erection / installation / commissioning / designing / training activit ies is a common phenomenon in case of EPC contracts. The ambit of the domestic law of India is very wide and it tries to tax income from all the activities which give rise to some business connection in India. Based on the tax treaty, the business income of foreign companies would be subject to tax in India only if they have a PE in India. There are various types of PEs like fi xed base PE, agency PE, service PE or construction / installation PE.

Practically, in an EPC Contracts, activities take a long duration to complete, and hence PE clause (especially fi xed base, construction / installation PE and service PE) comes into play in this industry more often. This would imply that a foreign company rendering services in India for more than the specifi ed period would



be taxed in India in addition to being taxed in the country of residence only by virtue of the fact that services are being rendered in India for more than the specifi ed number of days or they have a virtual presence in India. Hence, it is important for the EPC contractor to structure their operations and contracts to mitigate PE exposure.

Association of Persons (AOP)Generally, two or more EPC contractors come together to bid for EPC contracts in the form of a consortium. In such a situation, an AOP exposure would arise. The term AOP is not specifi cally defi ned in the Act. One has to rely on the ordinary meaning and the law emerging out of the judicial decisions to determine what constitutes an AOP. Whether AOP exist or not is a very vexed issue

and much depends upon the facts and circumstances of each case.Following are the consequences of constituting an AOP:

Applicability of Maximum Marginal Rate;Issues in relation to carry forward of losses;Issues in relation to Foreign Tax Credit;Taxat ion at two level due to applicability of Minimum Alternate Tax on profi t distribution from AOP

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BROAD PARAMETERS TO ANALYZE CONSTITUTION OF AOP

TWO OR MORE PERSONSVOLUNTARY COMBINATIONSA COMMON PURPOSE OR COMMON ACTION WITH OBJECT TO PRODUCE PROFITS OR GAINSSHARING OF PROFITS AND LOSSESJOINT AND SEVERAL LIABILITY OF THE MEMBERS; ANDSOME KIND OF SCHEME FOR COMMON MANAGEMENT

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Key Internal Issues

The key internal challenge facing the Indian EPC industry today is issue of being able to manage scale and diversity, with the rapid growth in business and diversifi cation into new business areas. Other issues around improving the quality and value addition of engineering, implementing leading practices in project management, implementing modern construction methods are also specific challenges facing the industry players, but we believe these will get addressed in natural course as the EPC industry matures in India. However, the core challenge facing the mid-size, fast growing companies are around effective project management, management of growth and scalability without compromising on project and business risks, and developing systems and processes to make companies more scalable and less dependent on individuals.

Project Management“E+P+C is not equal to EPC” said

the director of one of India’s leading engineering and construction company. The glue that binds all these together is Project Management. Project Management is a science, with its own school of tools and techniques, both in the scientific and the behavioural domain.

“In our company, project managers are GODs” is the common refrain in international EPC or engineering companies. However, this is not the case in Indian EPC companies, as is evident from various perspectives provided by Indian companies as well as developers. A leading Hydrocarbon major, in an industry forum, called upon the EPC companies in India to develop better project management talent, and especially requested the Indian offi ces of global firms to rotate local talent through global assignments to develop these skills.

Most mid-size fast growing EPC companies in India are facing issues related to empowerment of Project Managers and the primacy of the Project Management function in an EPC fi rm.

As a result, projects are de facto mana-ged by Business Unit Heads or other

very senior professionals, reducing the designated project managers to co-

ordination roles, and resulting in senior management being involved in day to day project issues.

Further, with business growth, senior executive time available for a specifi c project becomes limited, resulting in loss of execution control. We suggest that fast growing mid-size companies relook at their organization structures and policies to ensure that their project managers are empowered. They should have accountability for project cost and time control, and adequate control over decisions related to the project.

“E+P+C is not equal to EPC”

RESPECT FOR SENIORITY IN INDIA LEADING TO PROJECT MANAGER EMPOWERMENT ISSUES

THE OTHER DIMENSION OF THE CHALLENGE IS THE RESPECT FOR SENIORITY IN THE INDIAN CULTURE. WHILE PROJECT MANAGERS ARE DE-FACTO CEOS OF A PROJECT, THEY MAY NOT ALWAYS BE MOST SENIOR IN THE PROJECT ORGANIZATION’S HIERARCHY. THE PROJECT TEAM MAY CONSIST OF ENGINEERING COORDINATORS, CONSTRUCTION MANAGERS WITH MANY MORE YEARS OF EXPERIENCE – WHO WOULD BAULK AT REPORTING TO THE DESIGNATED PROJECT MANAGER DUE TO THEIR CULTURAL CONDITIONING.



Organization Design & Management: Building the Engineering

ORGANIZATIONAs we discussed earlier in evolution of EPC companies, most EPC companies are likely to evolve from the construction or the developer route. In both the cases, the key capability gaps would remain in the domain of engineering. While Project Management is the execution arm, engineering does and should function as the brain, adding competitive advantage in terms of standardization, value engineering and technology leadership.

Engineering which being a knowledge based function requires careful design of organization structures, career paths and development strategies, and a different approach to performance assessment and management as compared to the other functions in the organization.

Also, with rapid diversification, the centralization vs. decentralization question stares at managements of

EPC companies, who would like to balance effi ciency with effectiveness. For example, companies tend to cen t ra l i ze “end-use / p rocess” independent engineering disciplines like civil, structural and electrical, while the other disciplines are de-centralized. However, there is no right answer, it needs to be carefully assessed in light of the company’s portfolio, strategy and culture.

Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change

Risk ManagementLess than one third of the survey respondents in KPMG-PMI Infrastructure report,

had confi dence in their risk management capabilities.

The EPC business model revolves around taking ownership of project

risks. Hence it is absolutely critical for EPC companies to establish robust

processes for risk identifi cation and risk management. Such a process would

address risks identified at both the sales and execution stages of the project.

While the ideal situation w o u l d b e f o r E P C companies to be able to identify, mitigate or provide for all risks at the tendering stage, this is usually not practical, given the need to complete bids within a specifi ed deadline, and to not rely indiscriminately on additional contingency margins that may impair



Source: PMI-KPMG Study on drivers for success in infrastructure projects 2010 - Managing for change

The KPMG-PMI study in 2010 also highlighted the some concerns on the comprehensiveness of risk identifi cation by companies, given the high incidence of projects having suffered due to risks

that were hitherto unidentifi ed and hence not mitigated. Critical improvements are also required to acquire a robust level of sophistication and maturity in risk mitigation. Routinely used mitigation

the competitiveness of the bids. Hence while key risks are identifi ed and mitigated during the bidding stage, a large number of additional or minor unmitigated risks may need to be addressed during ongoing project execution. Most leading international EPC companies, process all enquiries / tenders through a risk identifi cation process based on which, go-No-go decisions are taken, and risk ratings are assigned to each project or proposal.

The more sophisticated systems also have contingencies and margin policies

based on risk ratings. Similarly, the portfolio of projects is weighted based on risk categories as strategic planning inputs. Another common element is Independent review of risks by personnel not directly involved in Project Sales or Execution. With the rapid growth in order books, and a senior management stretched for time, it is essential that Indian companies also rely less on individual or subjective experience and expertise, and more on agreed risk management tools and objective frameworks which can be used even by less experienced people with the

help of knowledge and experience that is codifi ed into these tools. These risk assessment frameworks, customized and developed with the inputs from senior management of the company, can fl ag off critical risks in the tenders, and ensure awareness and more informed decision making during bidding. Also, nuanced and differentiated processes of project execution, monitoring and control and staffi ng of projects based on the risk assessment will help in focusing the best and most careful decision making capacity towards the most risky of the projects in a company’s portfolio.

strategies are either ‘reduce’, transfer or avoid. While “accept risk” type strategies are used infrequently, ‘exploit’ strategies are rarely used. The industry thus is yet to reach maturity levels at which mitigation strategies are leveraged to exploit project risks and are used as means to maximize project income potential.

Risk reporting and monitoring are the remaining links in the risk management process that are cr i t ical for i ts effectiveness. Evolving information systems can make timely and accurate project information for report ing purposes. The information reported should comprise early warning indicators and provide content that facilitates decision making.



Procurement

Procurement can be a vital element infl uencing timely and profi table project delivery in EPC projects. In projects with low construction intensity like Power projects, Refining and Petrochemical complexes and other industrial plants, just the standard “bought-out” components may comprise anywhere between 30-50 percent of the project value, apart from other procured items like construction materials and sub-contracted services.There are several reasons leading to complexity in the procurement function of an EPC company:

Number of individual items to be procured for a large project, within specific and often varying deadlines.Cost targets for Procurement are usually set at individual component level, not at an overall Procurement budget leve l – s ince sen ior management usually does not

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disclose overall project cost budgets for confidentiality and flexibility purpose. The constant trade-offs between procurement time and procurement costs to meet the often confl icting goals of cost control vis-a-vis schedule control on a project.

It requires companies to evolve strong sourcing teams, capable of vendor discovery and price discovery on a larger scale than would be required in a manufacturing set-up. In most manufacturing companies, rate contracts, differentiated procurement processes for minor vs. major items, and MRP based procurement processes reduce the transactional overhead signifi cantly.

Moreover, most public sector units have made, depending on how one looks at it, the job easier or more diffi cult for contracting companies by providing vendor lists. This has resulted in vendor development take a backseat as the

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burden of that job has been transferred to developer or the consultant.

This is however, not the case with private sector clients, especially new entrants. EPC companies we believe, would benefi t signifi cantly from an increased focus on vendor development, including supporting high quality emerging vendors in getting themselves accredited with PSUs.

Given this context, we feel Procurement capability can emerge as a strategic differentiator for improving performance and winning business in the EPC industry. It requires efforts on the part of engineering, procurement and client facing personnel to discover, qualify new suppliers and convince customers to include them in their approved lists or allow deviations on the projects. We feel however, in the emerging high growth but hyper competitive scenario for EPC companies, this would be a worthwhile investment to make.

EFFICIENCY IMPROVEMENT INITIATIVES FOR PROCUREMENT FUNCTION

REDUCE CYCLE TIME, BY DESIGNING THEIR PROCUREMENT PROCESSES FOR INCREASING DECISION MAKING SPEEDREDUCING THE NUMBER OF TRANSACTIONS BY STANDARDIZATION AND IDENTIFYING COMMON ITEMS ACROSS PROJECTS EXECUTED IN THE PAST IMPROVE THE COMPETITIVENESS OF THEIR SUPPLIER BASE BY CASTING THEIR NET WIDER, INCLUDING ELEMENTS OF GLOBAL SOURCING IN THEIR STRATEGY

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6 And not necessarily poor planning

End-Use Industry Views

Power Generation Units – especially thermal power plants are likely to be amongst the largest opportunities for EPC players in the short to medium

term. The thermal power and nuclear power units both have relatively lower civi l construction component and require superior capabilities in terms of

equipment sourcing, engineering and integration management as compared to other infrastructure classes like Roads, Ports etc.

Demand OutlookBy 2015, India would need to increase its current generation capacity of 152 GW to 205 GW (an increase of 53 GW) till year 2014-15 for meeting the base load capacity requirement to support growth of economy at 8 percent and address unavailability of power in many parts of the country. To meet the peak load capacity requirement, the installed capacity requirement would need to be more than 270 GW.

The generat ion capaci ty gap to meet baseload requirements varies

significantly across regions and is estimated as 62 GW in Western Region, 62 GW in Northern Region, 54 in the Southern Region, 24 GW in the Eastern Region and 3 GW in the North Eastern Region of India in the year 2014-15. This projection implies an average annual generation capacity addition at the rate of 16 GW per year during the period 2007-08 to 2016-17 (covering two 5 Year Plan periods in India viz. XIth and XIIth). During the IXth (1997-2002) and Xth (2002-2007) 5 Year Plan periods, the average annual generation capacity

a d d i t i o n i n t h e country has been 3.6 GW and 4.2 GW respectively. The poor performance in the past is attributed to implementation d e l a y s 6 b y t h e public sector utilities coupled with hitherto limited private sector participation.

A bottom up analysis of expected plant

additions was conducted based on a variety of sources such as the CEA database for upcoming additions, industry reports and KPMG’s internal assessment. Only those plants which have reached an appropriate state of readiness for commencement of commercial operations within the period FY 2010-15 have been considered for capacity addition. Effective supply addition for each year of the period (FY 2010-15) was calculated based on the total capacity addition. We expect a total capacity addition of 99 GW in this period. Assuming a similar rate, this translates in to an approximate opportunity size of INR 500,000 crore (i.e. over USD 100 Billion) towards capital expenditure for these plants. The majority of this investment will be towards thermal power plants, of which 80 GW are likely to be commissioned by 2015. The opportunities for EPC players, equipment vendors are for projects which are likely to get commissioned beyond 2012-13 as they are the ones which are mostly likely yet to be tendered out - for balance of plant equipment if not main plant equipment.Source: KPMG Research and Analysis

Expected Capacity Addition (GW)

Power Generation



7 Source: http://www.sify.com/fi nance/ntpc-likely-to-fl oat-rs-18-000-cr-tender-news-equity-km4bvDidjib.html

End-Use Industry Specific Issues

The thermal power industry has been one of the fastest to adopt the EPC model

The Power Generation industry has seen one of the fastest adoption rates in terms of EPC contracting model. Prior to the reforms in the power sector and the policies around public private partnership models, power plants were being constructed by the state level generation companies and NTPC. The tariff regime and operating models of some these power generation entities at that time did not require utmost attention to projection completion on schedule and to cost budgets. However, with the competitive power pricing policy PPP bids, - wherein one can participate in developing power, only if you are the most effi cient on capital cost as well as operating cost - has led to increased focus on executing projects on time and within budget. Most projects are being fi nanced by project fi nance companies and fi nancial institutions, who demand that developers manage the project budget escalation risks.

Internal teams at even established generation companies are stretched, and at the same time, there have been a large number of new power sector entrants, some with limited background in executing large projects. Hence

the entire sector is favourably inclined towards contracting project execution on a LSTK basis. The current landscape indicates that large public or private sector generation companies like NTPC, given their internal engineering and project management talent pool, will continue to buy individual packages, keeping the integration to themselves.

However, they may combine multiple power plants in their portfolio, going for combined bids to get the best prices and reducing transactional bidding costs. NTPC floated a tender for different packages for 11 units of 666 MW each, the award of which is likely by first quarter of 2011. With this move, NTPC is expecting to bring down the cost/MW of setting up power plants, which many experts believe today is at about 5.5 crore/MW7. State level generation companies, most of whom are currently on the twin package mode (BTG and BoP), may continue to procure in that manner.

The trends in the private sector are interesting, where a distinction needs to be made between large business groups like Reliance ADAG, Essar Group, JSW Group, Sterlite Group, GMR Group, Lanco etc who are likely to build large portfolio of power projects in the future, vis-à-vis smaller players with fewer

generation projects in their planned portfolio.

While complete power plant as a single EPC/ LSTK package is still rare in the Indian scenario. Moreover, the trend of not awarding the entire EPC job (i.e. both BoP and BTG of a power plant) to one single service provider has been driven by:

Distinct set of competencies required for the BTG and BoP packages. While BTG is technology, equipment and manufacturing intensive, BoP requires complex integrat ion capabilities of sub-systems to be sourced, erected and commissioned from different sources.A single LSTK package would amo-unt to a range of around INR 6000 crores for a typical 2X660 MW project, requiring EPC companies with large balance sheet and risk bearing capability. It will be diffi cult to find enough number of such contractors to get a competitive bid.

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8 Economic Times, 23rd January 2011

Typical Outsourced Package Structure by Thermal Power Plant Developer Segments

The large business houses like Tata, Reliance, JSW, Adani have signifi cant in-house capabilities as far as project execution goes. Moreover they have substantial leverage with equipment vendors and sub-contractors due to their large portfolios. (Reliance has demonstrated this by entering in to an agreement with Shanghai Electric

Company for main plant equipment supply for all its thermal power plants, and in the process also getting access to cheap funds. Estimates put the savings on fi nancing cost alone at INR 6500 Cr. for just the Sasan UMPP project being developed by Reliance Power8.

With that kind of leverage, it is hard

to imagine, large private companies wanting to outsource setting up of power plants to EPC companies on a turnkey basis. If EPC companies are looking to capture this private sector market in utility power plants, we believe they will have to bring a value proposition which reduces power plant capital expenditure costs by at least 10 – 15 percent over the currently prevailing benchmarks, through effi cient global procurement and strong project execution capability.

“Do the EPC companies really deliver for us?”- Power Plant Developer

Central Sector PSU State Sector PSUs Private Sector UMPPsEPC Contract for Entire Plant (BTG + BOP)

· Not Applicable Rajasthan Rajya Vidyut Utpadan Nigam Ltd (RRVUNL) Projects

· Companies like GMR, Jaypee, Essar, Indiabulls which have their own Project companies

Not Applicable

* Balance of Plant – EPC

DVC projects to be tendered as single BOP package·NLC also expected to go for BOP in the NLC TPS – III

· Some state generating c o m p a n i e s l i k e Maharashtra, Madhya Pradesh, Chattisgarh are going for the BOP route

The new entrants and small-to-mid size players in the IPP market may go for BoP

BOP route unlikely given the scale of orders and also due to the fact that most large power developers have EPC companies

Coal Handling Plant (CHP)

· N T P C , N L C – s e p a r a t e C H P package

S t a t e g e n e r a t i n g companies going for split packages have CHP separate

· Companies going for split packages have CHP separate

Tata Power Mundra UMPP awarded CHP separately to Krupp: Reliance Infra undertaking Sasan UMPP on EPC basis

Ash Handling Plant (AHP)

· N T P C , N L C – s e p a r a t e A H P package

Some state generating companies combine AHP with Main Plant but that is slated to change

· Companies going for split packages have AHP separate

S e p a r a t e p a c k a g e s expected from the UMPPs

W a t e r Packages

· NTPC and NLC – separate packages

S t a t e g e n e r a t i n g compan ies o f West Bengal, ie, WBPDCL and DPL will give complete water packages; rest will split

· Water packages will be split

Water packages will be split

Source: KPMG Research, News Analysis



9 Report of the Committee to study Design Features of Boilers and Auxilaries being sourced from Chinese Manufacturers, September 2008

Hence in terms of contracting model, the following trends are likely to sustain / materialize

Majority of the public sector projects or projects of new developers are likely to be on twin package route (BTG and BoP)Most large business houses in the Thermal Power business will manage their projects in-house to leverage their portfolio, faith in their internal project management and

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procurement capabilities, and hence will place smaller sub-contracting or equipment orders. In the BTG segment, the Chinese companies will likely continue to have the second largest market share, after BHEL. It may be diffi cult for Indian companies in JV with foreign partners to make inroads in to this market due to the cost advantage offered by the Chinese players due to overcapacity in their domestic market. While quality concerns

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regarding Chinese supplies have been expressed, we understand from our interview respondents that there is no conclusive evidence to this effect. In fact a CEA study9 in 2008 found no material reason to doubt the quality or the technology offered by the Chinese suppliers. On the other hand, BHEL is the most established player in Indian with ~60 percent market share and with recently augmented capacity should continue to protect its market share.



10 Refers to opportunities for engineering and construction companies as well as equipment suppliers, not restricted to those on offer through the EPC-LSTK model

Refining and Petrochemicals

Demand OutlookOil and gas constitutes about 65 percent of the global and 40 percent of the Indian primary energy consumption. In the Indian context, the primary energy consumption over the last fi ve years has increased by over 6.5 percent CAGR as compared to global increase of about 1.7 percent CAGR. The overall contribution and pace of growth of oil and gas provides a perspective on the importance of this segment to the Indian economy.

Oil and gas is one of the few sectors which exceed the investment targets as laid out in the Government’s five year plans. For instance, in tenth fi ve year plan, the actual expenditure was 112 percent of planned outlay at INR 1,08,003 crores. Similarly, during the midterm appraisal of eleventh plan, government has to revised its planned outlay to INR 2,69,461 crores from INR 2,29,278 crores, a 17 percent

increase in planned expenditure. This is mainly because of aggressive investment plans by oil and gas companies in India. The actual expenditure during the fi rst two years and 4 months of eleventh plan (up to August 2009) is INR 1,08,625.91 crores which is 47.38 per cent of the plan approved Outlay. The Oil and gas sector is poised for growth. Many public

and private companies have announced their investment plans in the various streams of the oil and gas sector such as exploration and production, oil and gas pipelines, petroleum refi neries, liquefi ed natural gas, city gas distribution and petrochemicals. All these investment plans would create a robust opportunity for EPC companies. The total value of the EPC10 opportunity in India for Oil and Gas sector can be pegged at USD 60 - 65 billion in the next fi ve years. On the upstream side, an investment of about USD 18 - 20 billion has been envisaged in the next fi ve years for development of offshore fi elds and laying pipelines. A substantial part of this investment is expected to be done by ONGC in developing the east coast gas discoveries and maintaining production from existing discoveries. Moreover, the government is

Five year plans Planned Expenditure vs Actual Expenditure

0

50

100

150

200

250

VII Plan VIII Plan IX Plan X Plan XI Plan*

Planned Expenditure Actual ExpenditureActual expenditure as % of planned outlay

127

169

67

112

-

*XI plan actual expenditure is only up to August 2009Source: Planning Commission

Inves

tmen

t (in

INR

thous

and c

rore

s)

EPC Investment opportunity in Oil & Gas Sector

60-6523-43

21-23

12

118-20

0

10

20

30

40

50

60

70

Upstre

am

Oil Pipe

lines

GasPipe

lines

Refine

ries

LNG Te

rmina

ls

CGDNet

work

Petroc

hem

icals

Total

Inves

tmen

t (in

USD

Billio

n)

Source: KPMG Analysis



11 Including offshore engineering centers supporting global projects12 Not an exhaustive list of projects, examples provided only to demonstrate instances of work executed in India

also planning to offer shale gas blocks in second half of 2011, which will create more opportunity over and above the aforesaid investments. The midstream segment would see a spurt in investments given that the PNGRB is in the process of awarding four key pipelines segments more than 4,000 kms. Further there has been plan to launch additional pipeline such as Asansol-Howrah, Chennai-Nellore and other pipeline segments as part of national gas grid. This would mean an EPC opportunity of about USD 12 billion in natural gas pipelines. Additionally around USD 1 bill ion investment opportunity exists in crude oil and petroleum products pipelines. Further, to meet the domestic gas supply constraint, LNG regasifi cation terminals have been planned at Kochi, Mundra and Ennore which would require the capex investments of about USD 3 billion by 2015. In the downstream segment, refinery sector has seen number of announcements by companies for expansion of existing plants and setting up of Greenfield refineries. The new refi neries are expected to increase the India’s refi nery capacity by 55 mtpa. Given that refi neries are highly capital intensive, the EPC opportunity can be pegged at about USD 21 - 23 billion. Besides this, some companies have announced firm additions in their petrochemical production capacity which would mean

an EPC opportunity of USD 2 billion. In addition, the Ministry of Chemicals and Fertilisers has approved proposals of about USD 35 billion in three regions under its fl agship Petroleum, Chemicals and Petrochemicals Investment Regions (PCPIR) policy. These three PCPIRs are — Visakhapatnam and East Godavari districts in Andhra Pradesh, Bharuch in Gujarat and East Midnapore in West Bengal. We have not included investments in PCPIR in our overall estimate. City Gas Distribution (CGD) is another downstream segment which is set to see a spurt in investment opportunities, due to new domestic gas discoveries and bidding by PNGRB.

The regulator has already completed the bidding for 13 geographical areas

in fi rst two rounds and plans to have offer further 16 cities in next two rounds. Thus even if one were to assume a conservative spread per city, the EPC opportunity in CGD network is about USD 3-4 billion in the next 5 years.

End-Use Industry Specific IssuesThe Hydrocarbons industry is unique in terms of player profi les as the very best in the world have a presence in India. Here is just a sample list of companies operating in India, not just by means of having offshore engineering centers, but having won & executed projects in India. Our discussions with these companies indicate that they have at least 20 percent of their India center manpower deployed on Indian projects.

Source: Company Websites and News Reports

Company India Offi ces11 Examples of India Projects12 Foster Wheeler

Chennai, Kolkata and Gurgaon

IOCL Paradip Refi nery FEED package

Uhde India Mumbai, Pune PMC for Refi nery Units of BPCL, Mahul, Jacobs India

Ahmedabad, Vadodara, Mumbai, Delhi

PMC and EPCM for Manali Refi nery Resid Upgradation

Technip Chennai EPC for Ethylene Storage System of Chemplast Sanmar

Tecnimont ICB

Mumbai, New Delhi EPC for Polypropylene plants at IOCL Panipat

Linde Vadodara Hydrogen Plant at IOCL BarauniAker Solutions

Mumbai Engineering, Procurement, Project Mana-gement and construction/commissioning assistance for Reliance Polypropylene plant

Examples of International Engineering Companies Presence in India in Oil and Gas



It is a phenomenon very unlike the other sectors discussed like Power Generation or other infrastructure segments. One of the differentiating factors is the engineering and equipment intensity, put together as the technological intensity of the projects. This is an area where the relative strengths of the international companies are believed to be superior. Moreover, the qualification criteria are stringent and past experience in a particular type of unit / package is demanded. As a result, it has been observed that international companies have established their niches. Amongst Indian companies, the key players include Larsen and Toubro, Punj Lloyd and recently Essar Projects, which has received large size orders in the recent IOCL refi nery project.

The industry is also unique in terms of the prevalent contracting models, with very little being given out as LSTK contracts. The various reasons cited for this phenomenon are as follows

Limited set of LSTK contractors in the Oil and Gas sector, capable or willing to execute large turnkey contracts. While the EPC companies believe that process plants are too complex and the quality of front end and basis engineering which will provide the solid ground for firm estimation is lacking, the

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user industry feels that the EPC companies are just not willing to take large risks in this sector. While L&T and Punj Lloyd are among the few Indian companies capable of taking up large LSTK packages, the international companies do not have Indian balance sheets of the size wherein they can afford to take such large risks. The international parent companies hesitate taking up large projects in India on account of their internal risk assessment policies. Addit ionally, there is ambiguity related to various taxation issues, which results in limited number of bids being received in an international competitive bid route. One of the state-run refi ning and marketing company highlighted the lack of enough number of global bids received, when they did break their contracting pattern to attempt awarding large LSTK packages. KPMG’s tax experts believe there are ambiguities in Indian taxation laws related to importing of capital equipment for projects, and also in taxation on work performed in India for global companies, which force these companies to either not bid, or bid very conservatively. The complexity of the process industry makes it diffi cult to prepare detailed and comprehensive fi xed-cost bids. The preparation of the

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FEED, so that it is good enough to give it out for LSTK itself takes about a year, followed by bidding and contracting for another year. This process adds a good two years to the 3 odd years of project execution cycle. Moreover, Indian user companies seem reluctant to spend that kind of man-hours and cost towards front end engineering. Majority of the capital expenditure is being done by the state run oil marketing companies, ONGC or Reliance. While the state-run companies have their large in-house teams developed over the years to take on the integration challenge, companies like Reliance are well-equipped to assume the project risks on their own, given their entrepreneurial history and esteemed project management capabilities. In that light, the LSTK model or larger packages would be possible only in the event that the internal teams of Petroleum companies are stretched on account of a large number of capital expenditure projects ( which it appears, is not the case), or there are mid-size refi ning and petrochemical companies setting up plants in India. The answer in terms of encouraging mid-sized players to invest in India seems to have been found in the form of PCPIRs being set up in the country which will encourage foreign

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as well as domestic investment, with the feedstock being supplied by the anchor investor. Though not exactly falling in this bracket, ONGC’s petrochemicals venture, OPaL, being set up in the Dahej PCPIR is a case in point. ONGC has limited in-house expertise in petrochemicals, and hence there is a clear difference in the way it has gone about its procurement. The EPC order for the ethylene cracker has been placed on a consortium of Linde and Samsung Engineering India. This is one of the largest EPC contracts awarded in India in the Oil & Gas sector. Also, it

marks the entry of the famed Korean EPC companies to India.

Contracting Models: Medium Term OutlookAs far as the hydrocarbons and the process industry is concerned, it will likely continue to see the dominance of the EPCM model of contracting. However, to reduce the complexity of procurement and integration, the individual packages being procured for a Greenfi eld refi nery or similar plant, are likely to come down from the current 20-25 to may be 10-15 packages and even less going forward.

Indian EPC companies looking to enter the Hydrocarbons sector, have to overcome the challenge of qualifi cation.

The routes adopted by them to build their credentials have included a) act ing as sub-contractors to

international companies, b) bidding in consortiums or c) acquiring small companies which

have partial qualifi cations.

However, as compared to EPC in other industries or infrastructure segments, it is a more gradual process to establish oneself in the Oil & Gas sector in India.



13 Techpetro Asia Newsletter (April 5,2010)14 SAM group – Water - A Market for the future (2010)

15 ADB: www.adb.org/India/main.asp; World Bank: go.worldbank.org/E9RO7F96W0; JICA: www.jica.go.jp/india/english/activities/16 Planning Commision of India 17 ‘India Infrastructure at crossroads’ Thomas Reuters. September 24, 2010

Water

Demand OutlookWater Resource Management – A Critical Global Challenge and Burgeoning Opportunity The Worldwide Plant market for water treatment has been estimated at USD 380 Billion Dollars as of 200913. Water demand is increasing due to growing levels of industrialization and the spurt in global population. However regions

with high demand are not well connected with regions of high supply. Given the demand-supply mismatch and increasing emphasis on sustainability, water management is a sector expected to experience high growth.

Structure of the Water marketNearly 50 percent of water use is

for industrial purposes in developed countries as opposed to 80 percent for agricultural use in developing nations. Both public utilities and private players operate in this space with private players accounting for 44 percent of the serviced water in Europe as opposed to only 12 percent in South East Asia14.

Key Characteristics Description IndiaIndustry Structure Global move towards consolidation has led

to the formation of multinational corporations like Veolia, Suez etc having presence in more than a number of nations and latest reported revenues of over 10 billion USD

Growing opportunity in the Indian market has led to the growth of Indian fi rms in partnerships with global majors, intending to participate in the planned privatization of the water utilities market in India.

Technology Patented In-house technologies possessed by most companies. No one technology dominates

Procurement of technology through tie-ups with foreign majors

End Use Consumers Industry consumes nearly 50 % of all water Agriculture consumes over 80 % of total waterDomestic opportunity Historical infrastructural activity surrounding

heavy industry development and emphasis on sustainability provided the necessary project management experience.

Very little penetration of the Domestic market.Large opportunity going forward

Typical Contract Mode

DBO/BOT (Design Build Operate,Build Operate Transfer). Focus on both building and operation of the facility

EPC (Engineering Procurement and Construction). Also DBO/BOT basis contracts.

Source: KPMG Research and Analysis

Comparison of Global Water EPC Market with India

Indian Scenario: A growing market with a lot of opportunityDue to the multiplicity of issues plaguing the sector, the Central, State and Local governments are investing signifi cant amounts of money in the sector. Add-itionally, funding to the water sector by development banks is increasing manifold. Investment in urban water supply and sanitation has increased

during the first decade of the 21st century, driven by increased central government grants made available under Jawaharlal Nehru National Urban Renewal Mission (JNURM) and funding from development agencies such as ADB, World Bank and JICA15. The 11th Five-year plan (2007–2012) foresees investments of INR 127,025 crore (USD 28.6 billion) for urban water supply and

sanitation, including urban drainage and solid waste management16. While private sector interest in the sector has increased, critical barriers such as poorly written contracting documentation, large timelines to project award and sub-optimal risk sharing mechanisms continue to hinder the growth of private sector investment in the water sector in India17.



Opportunity Drivers and Trends for EPC companies in Water Segment

Opportunity Area Drivers and TrendsWastewater Treatment Stringent enforcement of sewage disposal norms

Shortage of Water for Industrial useOpportunity in building sewage collection infrastructure and Treatment plants

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Water Treatment and Transimission

Increasing UrbanizationOpportunity in the form of EPC / BOOT model including metering and collections

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Industrial Water Infrastructure

Large capacity additions in Power and SteelEPC is the preferred Contracting model

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Desalination Reducing cost of desalinated Water, couple with water shortageMedium term adoption in the industrial sector

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Water Management Leakage reduction programs by Municipal bodiesSmall projects, opportunity for engineering and equipment suppliers

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Agricultural Demand Irrigation projects and driving effi ciency of water usage to agricultural consumers. Limited opportunity for EPC players

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End-Use Industry Specific Issues

Structure of the Indian Private Sector A snapshot of some companies operating in the sector along with their area of

operations is mentioned below:




18 Industry Inputs

Contracting Models for Private Sector Participation in Water Projects

Contract Defi nition Duration Skills Sought Risk Transfer PaymentTurnkey Contract to private sector

to design and build the system for a fixed fee; funded by the public sector

Construction period

E f f i c i e n c y i n construction

Low Time & activity linked fi xed fee

Design-Build-Operate

Contract to private sector to design and build the system for a fixed fee, and to operate the system for a few years; funded by the public sector

5 – 10 yrs E f f i c i e n c y i n c o n s t r u c t i o n with operat ion & maintenance e f f i c i ency f o r some time

Medium T i m e & a c t i v i t y l i n k e d f i x e d f e e – constructionPerformance-based fee - operation

Design-Build-Finance-Operate

Private sector builds, fi nances and operates a facility and sells products/ services to users; could be partly fi nanced by the public sector as well

15 – 30 yrs F i n a n c i n g , c o n s t r u c t i o n eff ic iency and o p e r a t i o n s efficiency for a longer time

High P e r f o r m a n c e - b a s e d fee – operat ion post commissioning (revenues from end-users + subsidy from ULBs, if any)

Management Contract

Private sector carries out the operation and maintenance of some or all components of the water system

5 – 15 yrs O p e r a t i o n e f f i c i e n c y T y p i c a l l y includes a design component

M e d i u m – High

Performance-based fee – operation

FBC (Fee-Based Contract)

Private sector carries out one or more specified tasks while the public authority remains primary provider

1 – 3 yrs Skills as sought Low Fixed fee (per unit)


There is a need to standardize contracts to a limited set of standard models and a general set of services, in order to speed up contracting processes and the speed of award of contracts. In summary, we expect the water sector to become a major and attractive opportunity for EPC companies as well Infrastructure players in India, driven by:

Stricter enforcement of regulations surrounding industrial waste Pub l i c sec to r inves tment in urban renewal programs like the

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JNNURMIncreasing urbanization and lifestyle requirements for waterMajor Power Generation and Steel Plant projects. Water treatment can emerge as an additional revenue source & a hedge against declines in other Industrial markets for domestic EPC fi rms.

Further, given the fact that a large number of contracts in the water space will be awarded by ULBs across the country, given the fi nances of most ULB’s in India,

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the future mode of collaboration will tilt towards PPP model participation rather than stand alone EPC contracts18

Going forward, we expect several major business groups to foray in to the Water sector, and indeed, several of India’s largest conglomerates have already done so. Given the likely preference for PPP / BOT, BOOT models to emerge in this sector we are likely to see more EPC companies becoming project owners and developers as well in the water segment.



19 Techpetro Asia Newsletter (April 5, 2010)20 Techpetro Asia Newsletter (April 5, 2010)

20

Snapshot of Some Relevant International Trends

The global plant market was valued at USD 1.6 trillion dollars as of 2009, of which nearly USD 730 Billion dollars worth of projects were open to foreign

player participation19.

Of this power, water treatment and oil exploration and production (E&P) activity

form the largest portion of the market. A chart representing the breakup between various sectors in the construction industry is given below.

Breakup of Global Plant Market

Going forward, the “international bidders eligible” component of the global plant market is expected to increase to 1.11

trillion dollars by 2015. Asia Pacifi c and the Middle East in particular will be the key growth drivers for this region and are

expected to contribute to about 58 % of all orders generated globally.



21 http://cdiver.net/news/south-korean-fi rms-taking-work-in-the-middle-east/

Characteristics of the Global Construction Market21

The global construction market is essentially split into three major segments




22 http://www.khl.com/magazines/international-construction/detail/item61017

The Growth of the Korean EPC Industry – Some Observations22

The Korean Construction industry picked up steam after the Korean war in the 1950s, fi rst by rebuilding essential domestic industries and real estate destroyed during the war and then by taking these skills and capabilities to international projects. The Middle East with its oil revenues represents Korea’s

biggest foreign market for construction activities though Korean companies have diversifi ed into other regions recently.

Middle Eastern contracts accounted for 73 % of total international contracts in 2009. Korean companies have increasingly bid and won projects in

the Oil and Gas and Petrochemical space in the Middle East, a result of decades of project execution and growing engineering and technological prowess. Some key enablers for the Korean construction industry have been mentioned in the following table, along with comparison with India.

Key Enablers for Korean Construction Companies and Comparison with Indian Industry

Key Enablers Korean Companies Indian IndustryProject Management Experience

Large range of projects executed nationally and internationally

Only a few Indian companies have broad as well as deep experience in the domestic market. Indian companies have limited foreign penetration

Government Support

Favourable Economic policies and indirect support through the promotion of research institutes and various infrastructure programs

Limited or no direct or indirect governmental support to the industry

Domestic Engineering Firms

Korean Firms focused solely on engineering exist which work in collaboration with the construction majors

Only one (publicly owned) engineering major which is expanding its portfolio to undertake construction projects. Limited presence of foreign engineering fi rms in domestic projects. However, a large offshore engineering services sector being built by global majors.

Industry Bodies Industry bodies exist in a variety of spheres-technical, economic and labour related providing support and engaging with the government on industry issues

Labour unions exist , however there are no dedicated industry bodies for the EPC construction industry

Skilled Manpower

Large pool of both labour and engineers available due to academic support via various related disciplines

Large pool of both labour and engineers available

Domestic opportunity

Historical infrastructural activity surrounding heavy industry development provided the necessary project management experience. However the opportunity in the domestic market has slowly become saturated

Large opportunity going forward in the domestic market

International Leverage

A signifi cant portion of Koreas energy needs are met by the Gulf Cooperation Council (GCC) leading to Korea being an important source of revenue to the GCC

Indian EPC and construction fi rms presently have limited leverage to win contracts in foreign countries. This may improve along with India’s growing economic importance with its major trading partners

Domestic Ancillary Industry Support

Equipment often procured from overseas – domestic ancillary industry support has not necessarily been an imperative for Korean construction industry

The equipment industry is growing and maturing in India, and can be expected to provide a differentiator in the long run to Indian construction companies




24 Company Annual Reports , http://cdiver.net/news/south-korean-fi rms-taking-work-in-the-middle-east/

23 http://www.koreanewswire.co.kr/?job=news&no=345887, http://www.businessweek.com/investor/content/oct2007/pi20071010_252795_page_2.htm http://www.investkorea.org/InvestKoreaWar/work/journal/content/content_main.jsp?code=4580101

Support from Government and other bodies23

The Korean Ministry of Land, Transport and Maritime Affairs is the primary government body dealing with Korean overseas construction activity through its arm the International Contractors Association of Korea. It provides support in the form of providing a forum for the industry to interact with the government and through various initiatives like providing dedicated construction training to Koran manpower, the opening of educational courses through partnerships with academic institutions like the Korean

Institute of Construction Technology etc. Various research bodies like the Korean Institute of Construction Technology (KICT), Korean Institute of Construction Safety Technology (KICST),Korean Institute for International Economics and Trade (KIET) etc exist to provide research and other support to the construction industry. Following the enactment of the Engineering Services Promotion Law, the Korean Engineering and Consulting Association – a non profi t group of engineering companies,

was set up which helped stimulate the domestic engineering services industry. In addition through the use of various treaties and regional agreements, the Korean government assists in promoting business for Korean firms in other nations. Thus Korea posseses a skilled set of manpower and has domestic industries capable of providing construction materials like steel, cement at low cost to facilitate the rise of the Korean construction industry in the international arena.

Future Growth Plans of the Korean Construction Industry24

The international growth of the Korean construction industry has picked up steam over the last decade with an increasing number of orders especially in the oil and gas space in the Middle

East. The graph below illustrates the rise in the international order book of the Korean construction industry over the last 5 years. Most Korean Construction Companies are diversifi ed,

operating both in the civil and industrial construction space. Large corporations dominate and the Top 5 companies accounted for over 60% of the total order book as of 2009.

Source: Techpetro Asia Newsletter (April 5, 2010)Korean companies overseas plant Contracts ($ Billion)



Advantages of low cost of construction and the ability to take up risky fi xed price contracts have won Korean companies contracts in the plant space in the last 5 years. Samsung Engineering is pursuing a strategy of building up a strong base in the Middle East and then further expanding into Northern Africa. Korean companies are increasingly focusing on Sustainable Development as one of the key goals for the future

and are also expanding their activities into other segments like nuclear power, water treatment etc in addition to their presence in civil works. There is also a greater focus on the development of technological and engineering skills to enable Korean companies to operate in a wide range of business domains and industry sectors. For example, Daewoo has prepared a long term action plan called GET which includes three strategic

concepts – Globalization, Expansion of Profi t Pool and Transformation through Innovation and other corporations have similar blueprints for growth25.

Thus the Korean Construction Industry aims to have a spectrum spanning presence with operations in various industry segments through the buildup of technological ability and a credible reputation.

EPC Industry in India: Action Agenda for Sustained Growth

What fo l lows is a summary o f considerations by various stakeholders for the growth and development of the EPC industry in India.

Overall Industry Level ActionsThere are certain elements of an industry action agenda which have been pointed out by various industry participants as the need of the hour for the EPC industry.

The major EPC industry players may need to come together to help in building a talent pool for the industry,

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and contribute in related capability development initiatives, EPC industry participants in India need to enhance the sensitivity and focus on Environment, Health and Safety standards, and close the gap between Indian and global practices in this respect. Most industry participants agree that the overall standards on safety need to be raised in India. The Industry participants, either jointly or individually need to develop or invite independent agencies for benchmarking of projects, collect

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data on each project executed, so that more industry knowledge is publicly available as case studies and benchmarks for future planning of projects and improving upon past performance. Need fo r improved indus t ry collaboration and representation in both Government and other for a on issues related to the EPC industry. While there are broader fora available for the construction industry, the EPC industry per se is “under-networked” and not adequately represented currently.

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25 Source: Company Websites



Policy Agenda

In recognition of the critical role played by the EPC industry and related service providers in enabling the growth of the Infrastructure and Industrial sectors of the country, concerned policy makers should take note of the policy and regulatory imperatives for support and strengthening of this industry in India. As the Korean example indicates, there is an important role to be played by an active and supportive policy environment in the success of the construction industry in an economy. Some of the key directions for action would include: 1. Addressing the weaknesses of the

present legal mechanisms in the area of practical “enforceability” of construction contracts and setting up speedier dispute resolution mechan isms in the case o f infrastructure construction projects. This would give confidence to more competent global players to participate in this sector in India, which in turn would make Indian industry more competitive.

2. Standardization and simplifi cation of EPC and related contracts for some of the core infrastructure segments where Government entities are the project owners or franchisors – for example, the Water sector. In several such sectors there exists today a number of different types of contracts of varying complexity, and perceived risk, which hinders broader

participation in such contracts, as well as lengthens the contract bidding and award timelines. Unclear and poorly written contracts also lead to greater levels of disputes and litigation, commonly resulting in project delays.

3. Facilitate and encourage PPP models in vocational education for this sector, supporting the setting up training institutes and capacity building in the skilled labour supply market for engineering and construction industry.

4. C lar i ty and s impl i f i ca t ion o f taxation policies for EPC service providers, which wil l enhance global participation, and reduce transactional overheads and overall cost of projects

Some Considerations for International Entrants in the Indian MarketWhile it is well known that India’s need for Infrastructure and Industrial capacity build out will represent a very large market for the foreseeable future, International construction and engineering / EPC companies need to be aware of additional considerations as they evaluate their plans for the Indian market:1. While large in aggregate, the Indian

market is varied and complex. It is highly segmented in terms of a wide range of business and contracting

models, representing opportunities and risks of very different types.

2. A deep understanding of the local market and regulatory environment is critical to long term success. To this end, international companies would fi nd it important to take a medium to long term and patient approach to building their business in India. Judicious selection of partners for specifi c segments / markets would also help to build local market understanding quickly

3. The attractiveness of various market segments within each of the major end-use sectors may be very different for International companies vis-à-vis Indian players. International companies would fi nd it benefi cial to assess in detail, the specifi c types of projects, packages and customer types where their deeper technological and managerial capabilities can be a source of competitive advantage, as well as provide suffi cient returns to offset their higher cost structures vis-à-vis Indian counterparts.

Some key considerations for Indian EPC companies:1. Indian EPC companies planning to

diversify into new segments / end-use industries, would need to select these industries with care depending on core capabilities, risk appetite,



and existing competition and develop a differentiated value proposition to compete. Potential routes of such entry have been described in an earlier section.

2. Mid-sized companies which have growth quickly in the recent past, may need to allocate management attention and budgets towards building core capabilities in the area of Project Management and Risk Management, if they have not done so already.

3. To achieve a high degree of scalability of their business in a fast growth scenario, some of the following initiatives should help the Indian EPC companies:

� � Developing an empowered pool of Project Managers, by putting in places systems, processes, and training and appropriate leadership frameworks.

� � Develop ing a robust Risk Management framework, embedded into the tendering and project execution processes. Continuously and consciously improve the ability to measure, manage and exploit risks over a period of time. An adequate Knowledge management system is a critical enabler for enhancing this capability.

� � Revisit the organization structure as the number and complexity of projects under execution go up – the

trade offs between centralized vs decentralized reporting of support functions like procurement and engineering can change with scale and diversity of project types.

Finally, build control, efficiency and standardizat ion into key project management processes and technology platforms, which will allow effi cient scaling up of the business while managing risks and gaining from past experience.



Acknowledgements

We would sincerely like to acknowledge and thank the following industry leaders for providing their valuable views for this report (in alphabetical order)

K Venkataramanan, President, E&C Division, Larsen and ToubroLeja Hattiangadi, Jacobs, Director, Business DevelopmentPothen Paul, India Country Manager, Aker SolutionsP D Samudra, Executive Director, Business Development, Uhde IndiaP K Chandra, Chief Operating Offi cer, McNally Bharat Engineering Company LimitedP K Johari, CEO, ONGC Petro additions LimitedR Jaishankar, Advisor, SNC-Lavalin Engineering IndiaRajiv Mittal, CEO, VA Tech WabagRussel Waugh, Managing Director, Leighton Contractors IndiaSS Gangawati, President Strategic Planning, Walchandnagar Industries LtdSwarup Mukherjee, President, Projects, Walchandnagar Industries Ltd

Apart from the above, we sincerely thank the members of CHEMTECH Advisory Board for their initial direction, our clients in the Infrastructure and Industrial Markets sectors who provided validation on specifi c issues in the report.

This report also would not have been possible without the commitment and contribution of certain individuals within KPMG. The initiative for this report was led by Vishal Mehta, under the guidance of Biswanath Bhattacharya and was supported by Abhijeet Deshmukh.

Finally, we thank CHEMTECH FOUNDATION team for continual support in facilitating and participating in industry interviews.

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KPMG ContactsArvind MahajanExecutive Director and HeadBusiness Performance Servicese-Mail: [email protected]: +91 22 30901740

Hemal ZobaliaExecutive DirectorTax e-Mail: [email protected]: +91 22 30902706

Biswanath BhattacharyaDirectorBusiness Performance Servicese-Mail: [email protected]: +91 22 30902521

Vishal MehtaManagerBusiness Performance Servicese-Mail: [email protected]: +91 22 39896000



About KPMG in IndiaKPMG is a global network of professional fi rms providing Audit, Tax and Advisory services. We operate in 146 countries and have 140,000 people working in member fi rms around the world. The independent member fi rms of the KPMG network are affi liated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Each KPMG fi rm is a legally distinct and separate entity and describes itself as such. KPMG in India, the audit, tax and advisory fi rm, is the Indian member fi rm of KPMG International Cooperative (“KPMG International.”) was established in September 1993. As members of a cohesive business unit they respond to a client service environment by leveraging the resources of a global network of fi rms, providing detailed knowledge of local laws, regulations, markets and competition. We provide services to over 2,000 international and national clients, in India.

KPMG has offi ces in India in Mumbai, Delhi, Bangalore, Chennai, Hyderabad, Kolkata, Pune and Kochi. The fi rms in India have access to more than 2000 Indian and expatriate professionals, many of whom are internationally trained. We strive to provide rapid, performance-based, industry-focused and technology-enabled services, which refl ect a shared knowledge of global and local industries and our experience of the Indian business environment.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2011 KPMG, an Indian Partnership and a member fi rm of the KPMG network of independent member fi rms affi liated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity

About CHEMTECH

THE CHEMTECH FOUNDATION has connected the Chemical Process Industry in India with a constant focus on innovations and technology. What started as a simple idea of a Trade Fair over 35 years continues to revolutionize the chemical industry today.

The Chemtech Group has a presence across all the 6 major industry areas, connecting the entire value chain of the Chemical Process industry.

Its specialised media offerings of Events and Information Services serve as platforms for the exchange of ideas and technology.

Chemicals & Process IndustriesFor equipment, services or developing processes for the Chemical and Process industries. Event: Chemtech World Expo | Publications: Chemical Engineering World | Chemical Products Finder

Pharma & BiotechFor avenues in manufacturing, packaging and formulation services to Pharma and Biotech industryEvents: Pharma Bio World Expo | Publications: Pharma Bio World

Water ManagementFor the entire value chain of water management - industrial, residential or commercial. Event: WaterEx

Shipping, Marine and PortsFor those part of the Supply chain logistics and storage Events: Shipping, Marine & Port Expo | Publications: Shipping Marine & Ports World

Oil and GasFor the entire ‘Upstream’ value chain related to Oil & Gas exploration, production and transportation Events: Oceantex | Publications: Offshore World

Power and EnergyFor opportunities in the renewable and non-hydrocarbon energy sector Events: Enertech

Industry Automation & ControlFor the process chain covering Industrial and Process Automation, Instrumentation and Industrial Electronics Events: Industry Automation & Control



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Tel: +91-22-4037 3737, 2287 4758/59, Fax: +91-22-2287 0502Email: [email protected], Website: www.chemtech-online.com

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