A. M. Naik describes how he established a culture of value creation at one of India’s leading companies.
A. M. Naik joined Larsen & Toubro, one of India’s largest engineering and construction firms, as a junior engineer in 1965. He was appointed its CEO in 1999 and was elevated to chairman and managing director in 2003. Naik soon embarked on a restructuring mission. He says that today the transformation is about 65 percent complete but has already had a powerful impact: over the past decade, the company’s equivalent market capitalization has multiplied about 30 times, dramatically outpacing the market as a whole. From 1999 to 2010, annual revenues grew to about Rs 44,000 crore (US $9.5 billion) from Rs 7,402 crore (US $1.6 billion).
Founded in 1938 by two Danish engineers, L&T began as a company that imported equipment from Denmark and grew rapidly through the rest of the past century. By 1999, when Naik became CEO, the company was a complex organization. It had multiple divisions in a wide range of businesses—some small, others large. In HR appraisals of the company’s 20,000 employees, seniority seemed to matter more than performance or merit. The stock price was stagnant, and employees were leaving because they saw little chance for advancement and because the external market for talent was buoyant. L&T was ripe for a takeover and indeed was embroiled, on two separate occasions, in takeover battles by two of India’s biggest corporate groups.
As chairman, Naik’s main agenda was to keep the company independent. His gambit: create shareholder value and attract and retain the best employees by restoring a merit-based performance-management system and by instituting greater rewards for high performance. Naik worked on multiple fronts, pushing for scale and competitiveness in all business lines.
Naik met with McKinsey’s Ramesh Mangaleswaran and Adil Zainulbhai at L&T’s Powai complex, in suburban Mumbai, and discussed the role of leadership in transformation, creating value, and how he changed an entrenched culture, in part, by involving thousands of employees in the planning process.
The Quarterly: Why did you start the transformation of L&T?
A. M. Naik: Well, it has been a long journey of 46 years in Larsen & Toubro. In the mid-1970s, local Indian management took over the reins. L&T was extremely merit-oriented until 1974. Afterward, it wasn’t. I meet people who worked for ten years or more at L&T and left, and those who were meritorious should never have been allowed to go. I don’t think it was actually said by anybody in authority that “now we’ll slow down everyone who’s young.” But in reality, there was a feeling that “maybe he can wait.” Promotions started to be driven by seniority. We lost a lot of people, people with the ability and the motivation to take us to the next level of growth.
The Quarterly: So is it fair to say that you had been planning some kind of transformation for many years before you became the company’s leader, as you observed things you didn’t like?
A. M. Naik: Yes, I said, “Someday, when I have freedom, I’m going to bring the merit system back.” The fact that the company was aging and we couldn’t see who would be our successors compounded that desire. What impelled us even more was that from the mid-1990s onward, the economy in India liberalized; and external opportunities for our talent further increased. Given that L&T had a range of businesses (and therefore a range of capable managers) and had historically attracted the best talent in the country, we became a hunting ground for talent. As we had several bright people working much below their real potential because of the move away from merit-based promotions, their urge to leave was high and we could not stem the attrition.
We had a second challenge—L&T was also undervalued in the stock market, which made us vulnerable to takeover. We are good engineers. In fact, we used to jokingly refer to ourselves as Larsen & Toubro & Genius Ltd. But that made us tremendously complacent when it came to business performance, and people in the company didn’t understand what it meant to create value. If the company is cheap, anyone can buy it. If the company is very valuable and expensive, people will think twice. So I was constantly thinking, “What will keep Larsen & Toubro independent? What will make it less vulnerable to a takeover?”
Through all this I was thinking, “What will I do differently when I get a chance?” In April 1999, six months before I took over, I made a document: a 90-day action agenda from the day I took charge.
The Quarterly: What was in your document?
A. M. Naik: Talent always remained the highest priority in my mind, and therefore rebuilding the meritorious organization as a retention tool. I said, “Let me start writing this down. One, I will bring merit back in L&T. Seniority will be respected because the senior people have contributed largely to make L&T what it is, and therefore the change may be somewhat slow because it has to be smooth.” Nevertheless, the direction had to be set that seniority would not be the only governing factor. That’s one.
Two, L&T was in too many businesses that were too small, very diversified, and hardly understood by anyone, so the portfolios needed to be rationalized.
Three, L&T had been a professionally managed company, and we were very proud of that. However, while we were creating a marvelous bridge and making a nuclear reactor and all that, unfortunately there was no emphasis whatsoever on value creation. I think nobody understood what it really meant to enhance the value of the company and what that could mean to every individual.
And as a corollary, as a retention tool for exciting people, I gave a stock option, initially, to 500 people, which later on rose to about 3,000. We were the first major “brick and mortar”—non-IT or -finance—company to do this in India. None of the employees understood the value of a stock option at the time, because it was given at the market price as allowed by the regulator. But I knew that if the company was transformed, the value was going to multiply. Today, its effective stock price—after adjustment for splits and demergers—has gone up 37 times, and the market has gone up around 4 times since 1999.
The Quarterly: How did you manage the portfolio rationalization?
A. M. Naik: I started the analysis of every single business in the company and put them into three categories: core, noncore, and “grow to sell.” I defined them on multiple parameters. We are a builder to the nation, and therefore building infrastructure, power plants, and hydrocarbon plants will remain core. Though this was a difficult way of making money, we said, “This is something that many companies won’t do, and let’s not deviate too much from being an engineering excellence company.” And what is not in line with that and is also not creating value—both at the same time—I made noncore. There were some areas where the demand was huge, but they were commodity businesses, like cement. These were labeled “grow to sell.” The ones that were very marginal and absolutely noncore, I said, “Sell right away.” Many of those we couldn’t sell, so I said, “Close them, just get out of it.”
Then I held a meeting with top managers and invited a lot of external speakers. All the speakers wanted L&T to reorient itself to create value. One of the external speakers said plainly, “Have you seen the trading of your stock? Nobody trades your stock. It’s lying in one corner. Nobody is interested in your stock, because while they know it’s a great company and it will do great jobs, it has nothing to offer to the shareholders.”
The Quarterly: Was the company behind you?
A. M. Naik: As of the day of that meeting, no. But by the time eight months passed, our blueprint was ready. I created excitement in the organization by being participative in creating the vision. We involved one in four employees, about 7,000 people. I visited 38 locations of the company, made my presentation, and explained why L&T was vulnerable. Slowly, everyone understood the message: saving L&T is your first priority, and to save L&T as an independent company, you have to create value.
As we started the process of creating a vision, I said the two crucial, nonnegotiable objectives were value creation and becoming an Indian multinational; you can’t depend on business in one country. The rest of the vision, everyone else could fill in, modify, substitute, recreate. A very methodical and participative process was followed at all the locations. That included workers, union leaders, supervisory leaders—everyone. When the vision was finalized, everyone could say, “That word was mine,” you know? Maybe that word was in the minds of a thousand people. But the process created a shared vision everyone could believe in.
The Quarterly: How did you proceed from there?
A. M. Naik: The first step was to create a mind-set, among employees, that value creation for the business and differentiation amongst people go hand-in-hand. Rewarding high performance also meant that we became more decisive with nonperformers, something that was tough and difficult in the Indian and in the L&T culture. I said, “First and foremost, please remove the bottom 5 percent,” because there had been accumulated nonperformance of 30 years. I pushed that and, in November 1999, separation of nonperformers happened for the first time in the history of Larsen & Toubro. Then I called the union, and I said, “I’m going to give you a voluntary-retirement scheme.” That was launched, also in 1999, and a few hundred people took advantage of it and left. This was less to cut costs but more to create a differential benchmark that would encourage value creation and growth.
Earlier, if a talented employee got a $100 bonus, the nonperforming person, who should never have been in the job, would still have got $65 or $70 instead of zero. If top talent got promoted in three years, then mediocre performers were promoted in five. So I created a new reference point: if you’re inefficient, you will stay at zero.
Then, in August 2000, I asked my top team again: “Should we start meritorious grades for employees who are very good?” I reminded them that if you lose an employee who gets a nine or ten out of ten, that is equal to losing 20 who get four or five out of ten. Finally, that August, I was able to initiate what we call the Management Leadership Program.
But I didn’t see any progress for some time. It wasn’t just internal issues; the economy was extremely bad, and there were certain legacy issues that I had to clean up. Then there was a threat to buy us out by a large Indian business group. That took a huge amount of time to fight off.
It was early 2004 before we started to see real progress. Even then, the change was extremely slow. There was no resistance, but there was no will to make hard decisions, because when you want to create a meritorious organization, you also have some unpleasantness from the people who want seniority.
So what do you do now? You are between the devil and the deep sea. If you remove the senior people, then you’ll create a trauma—ill will in the company. And if you block the young generation, then you compromise on future leadership and growth. So therefore the response was extremely slow.
I had pushed through the Management Leadership Program by sheer force, and it was for the very young people, under 30, so it did not affect anyone very senior. But slowly it began to show results. We were able to move participants faster into new jobs, and they showed real results. Then some people said, “L&T is a technology company, so we should have a Technology Leadership Program.” I said, “Fine.” Then another set of people said, “We have very hard-working people on the shop floor, and therefore we need them to be appreciated.” I said, “Fine. We will create a Supervisor Leadership Program.” An international agency was brought in to manage these programs so that everyone would have confidence that there was no vested interest. Never before had any company in India launched this kind of systematic and scientific program, and we had to do it right—otherwise our people would get upset. This was a great sign that the whole company understood the idea of a meritorious organization.
The Quarterly: What do you see as the role of leadership in a company like L&T, which is a professionally managed business as opposed to a family-run one?
A. M. Naik: Professional managers are required to follow up on what needs to be done, and therefore they can maintain value—say, 1x. Leaders, depending on how much motivation and inspiration they can provide, add more—they grow value by, say, 2x or 3x. And if you’re an entrepreneur, the multiplier is more, say, 5x. If you have leaders who are entrepreneurial, and at the same time inspire professionals to perform at their very best, you can multiply value manifold. So do you want to be an x as a professional manager or to do more as a leader or to achieve even more as an entrepreneurial leader?
The Quarterly: How do you sustain motivation?
A. M. Naik: Earlier, we were a somewhat diffused business. Now, we have sharpened the focus within each business, even if we have not pruned the overall businesses radically. For instance, instead of doing $2 million projects, we now do $20 million and above. The same individual therefore gets motivated to do bigger jobs. That has motivated employees and has also brought the attrition rate down.
Of course, the method for focus and motivation differs from business to business. Switchgear, for example, I dealt with by motivating the product designer because that was a winning point. I used to go and sit in the design workshops. Of course, it was also done partly for me to understand the business because I didn’t come from an electrical business.
The Quarterly: Where is L&T now?
A. M. Naik: The transformation is 60 or 65 percent complete. Revenue is five times higher than it was a decade ago, net income nine times higher, and we now have more than 38,000 employees. There is a lot more that needs to be done until the next generation takes over. But we are on the right path.