Ordnance Factories: the tough path to reform

(Part I of a two-part series)

by Ajai Shukla
Business Standard, 5th Sept 07

The short 40 km drive from New Delhi to the Ministry of Defence’s (MoD’s) Ordnance Factory at Muradnagar was a journey back in time to 1943, when the British first set up the factory. Two old women, squatting next to a charpai, wound a length of jute rope around a piece of metal shaped like a bomb; striking a matchstick, one of them set the rope afire. I was told they were “heat-treating” a bomb for the Mirage 2000 fighter. Little has changed since 1943 in the factory’s manufacturing methods; little has needed to. With captive customers in the Indian military who resentfully pay a “no-profit-no-loss” price for the goods produced in the 39 OFs, there has been little incentive to provide better products at cheaper prices.

Until now, that is. On 18th May 07, the MoD top brass handed out an ultimatum to a gathering in New Delhi of General Managers of all OFs: gear up or perish. India’s next army chief, Lt Gen Deepak Kapoor, intoned a list of complaints against the OFs that he said the army had conveyed many times before. Defence Minister AK Antony spelt out the bottom line, warning the managers, “The future of the OFs depends upon the decisions that you will take during these deliberations.”

Mr Antony’s exhortation to change is not the first that the OFs have heard. But with the MoD now serious about a greater role for the private sector in defence production, change is in the air. Before long, as many as 15-18 private companies could be nominated as Raksha Udyog Ratnas (RuRs), providing bitter competition for OFs and defence PSUs.

The Ordnance Factory Board (OFB), based in Kolkata, has already proposed bold steps towards rejuvenating the OFs. Mr Sudipta Ghosh, Chairman of the OFB, has told Business Standard that he has approached the MoD with the following suggestions:

• The 39 OFs switch from their traditional, non-commercial system of “no-profit-no-loss” accounting to the commercial accounting systems that most companies use. This would involve each OF preparing a proper Balance Sheet, and a Profit & Loss Account.

• Instead of the present “no-profit-no-loss” pricing of products, market dynamics should determine prices. The OFs should be allowed to make profits on items where they are competitive and cross-subsidise items that require a subsidy.

• Profits will be used for modernising existing OFs in order to provide a greater share of the military’s requirements.

• Selected OFs be nominated as R&D centres, where products could be improved or new products developed.

• OFs will provide customers with warrantees on all products, with immediate effect.

These are revolutionary changes for the MoD’s “departmental factories” which will churn out some Rs 6500 crores worth of military equipment this year, ranging from clothing to heavy tanks. Over the years, the crippling combination of cost-plus accounting, assured customers, mediocre managers, highly unionised labour and the shutting out of competition has created the ultimate manifestation of the license raj.

The MoD has welcomed the OFB proposals cautiously. Secretary for Defence Production, Mr KP Singh says all OFs will implement commercial accounting as soon as the Institute of Chartered Accountants of India (ICAI) and the C&AG give the green signal. Sources in the C&AG department say this could happen very shortly.

Mr KP Singh sees the proposed accounting systems as a useful way to judge the OFs’ systems and performance, a baseline by which, “you’ll come to know what is the health of a particular factory vis-à-vis other factories. Which manager is doing better and which manager is doing less.”

But Mr Singh has ruled out the more radical suggestions of profit-making and market-determined pricing. The MoD may wish to insulate the OFs from free market competition, but this appears to the OFB like imposing full corporate accountability, without giving the freedom to operate like a regular corporation.

(Next, in Part II: Ordnance Factories setting up a marketing corporation)