ELGi Equipments: Little big genie

For Jairam (Jay) Varadaraj, global domination by an Indian company was always conceivable. Even as a doctoral student of international business at the University of Michigan, U.S., his final dissertation was titled: “Internationalization of Indian firms: A study of technology acquisition, exports and foreign direct investment.” This was in 1987, in pre-liberalised India. His professor and avant-garde management thinker C.K. Prahalad was not impressed with his protégé’s choice of topic. He told Varadaraj that he was wasting his time; Indian companies did not have the muscle to make it internationally. But Varadaraj, 27 then, was neither dismayed nor swayed.

Over the last three decades, the third-generation entrepreneur and managing director of Coimbatore-based air compressor maker ELGi Equipments has made his thesis his mission. So much so that in 2010, he announced his intent of making ELGi the second-largest air compressor manufacturer in the world by 2027. (It is currently seventh in the global pecking order. In India, it is already No. 2, behind Atlas Copco.)

Varadaraj’s ambition is powered by the size of the opportunity. The global market is pegged at $15 billion, 80% of which is accounted for by the organised sector, comprising market leader Atlas Copco and Chicago Pneumatic, among others. The larger companies (including Kirloskar Pneumatic and Ingersoll Rand) have a similar hold on the $2-billion domestic market; the unorganised sector controls 20% of the industry and includes hundreds of manufacturers that play in the low end of business. The demand, in turn, is driven by the ubiquity of the air compressor. This low-key industrial equipment sneaks its way into everyday life. Compressed air is used as a source of energy for railway braking systems, as air cleaners in dental chairs, and in food and beverage processing. It helps move unfinished vehicles and weld components in the modern automobile assembly line. You might also recognise it as a regular high-decibel feature of a walk in any city. Picture those noisy machines used to dig into rocks and hard concrete. In fact, air compressors are so common that they consume 10% of Europe’s energy output.

Varadaraj’s confidence, then, is understandable. What is noteworthy is his roadmap to top-of-the-class. For one, it doesn’t include any shortcuts. Going global can mean merely setting up offices in many countries, he points out. Or, exporting unbranded components to large global players. Take Bharat Forge and NRB Bearings whose products get used by the biggest automotive makers in the U.S. and Europe. These strategies create scale, but Varadaraj doesn’t just want to be the biggest. He wants to be the best.

For that, ELGi must operate at the premium segment of complete products, engineered in its own brand name, in the most advanced markets. This is the next logical step for Indian manufacturers, agrees Harshbeena Zaveri, managing director of NRB Bearings and member of the Confederation of Indian Industry’s National Committee on Capital Goods and Engineering. “India now makes components that are exported to make capital goods machinery globally and the next step will be to make the machines,” she says. The AB (Always Better) series, unveiled by Varadaraj at the Hannover industrial fair earlier this year, is integral to this strategy. Five years in the making, the new products have the potential to revolutionise the business, he says. He is particularly optimistic about the oil-free variant, available for commercial sales from next year onwards.

For context, compressors fall into two broad categories: oil-lubricated and oil-free. Lubricated compressors account for 80% of the market because of higher energy-efficiency and lower costs. The oil-free option is three times more expensive but mandatorily used in contamination-free environments like the pharmaceutical and food processing industries. They are the greener alternative too, with the potential to save the nearly 2 million litres of oil that lubricated compressors dispose as waste. (Without the waste, they are also easier to maintain.)

The AB series oil-free product will be close to the efficiency of a lubricated compressor and priced at par, says Varadaraj. Factor in the lower maintenance costs and his hope for a game-changing product seems justified. “The machines are designed to be hassle-free and we are confident that we can pitch to replace even the lubricated compressors,” he says. “The opportunity is very big for us.”

The markets, however, are yet to provide significant validation of Varadaraj’s selfassuredness. ELGi’s market capitalisation is modest at ₹4,400 crore; it doesn’t get traded at high volumes either. As a result, it isn’t tracked by several broking firms. But those who do follow ELGi’s fortunes show optimism. Nearly 10% of ELGi’s stock is held by mutual funds and another 18.58% by foreign institutional investors.

ICICIDirect analyst Chirag Shah has predicted a rise in ELGi’s stock to ₹350 in 2020 from the current ₹278. “The export business [of ELGi’s] will grow at a 15% CAGR in the next two years and profits will touch ₹171 crore in 2021,” he says. The stock’s price-toearnings (P/E) ratio (57.39) is encouragingly at a 50% premium over the capital goods industry’s average (30.75).

Big-ticket investor Nemish Shah is among the believers too, holding 1.69% of ELGi in his personal capacity. Not surprising, since the cofounder of Enam Holdings is known to be positively inclined towards the capital goods sector. Though the reclusive Shah was not available for comment, a private fund manager, who has worked with Corporate Database, Shah’s equity research outfit in the ’90s, explained his former boss’s interest in ELGi: “His [Shah’s] investment idea was to spot companies in a long-term growth phase. He would put money in early and hold on to the stock for decades and make phenomenal returns in the bargain.”

Elgi’s long-term potential vests in the vast scope of the ₹2.8-lakh crore capital goods sector, which could grow to ₹6.5-lakh crore by 2022 (estimates the Department of Heavy Industry’s National Capital Goods Policy, 2016). Half of this is accounted for by the electrical power segment, of which air compressors are a part. In recent years, there hasn’t been much cheer for any of the sub-sectors: Apart from meagre growth rates, the country is a net importer; its R&D expenditure is 0.9% compared to China’s 2.0% and Korea’s 3.6%, while domestic manufacturers fare poorly against value addition, quantity, quality, and process sophistication benchmarks.

Simply put, if ELGi pulls off its plans, it will be a poster boy for the industry. Once the globalisation strategy comes into full effect, Varadaraj expects 80% of ELGi’s business to come from overseas markets, up from 35% today. “When you catch up and become the best in what is currently offered, you earn your right to play in the market,” he says. “When you get ahead [on quality], that is your right to win the market.” That explains why, just as he won’t compromise on the ELGi brand, he will not hide behind cheap labour. “Tomorrow, we want to be able to set up a factory anywhere in the world, including the U.S. with its factor cost of labour, and still be competitive,” says Varadaraj, unconcerned that the trend is for global companies to turn to cheaper manufacturing destinations.

For instance, Atlas Copco and Siemens use lower-cost India as their base to manufacture and export certain products to their clients. ELGi, meanwhile, has an assembly plant each in Italy and the U.S., apart from its manufacturing base in India. Setting up factories in Western markets will help push the brand, he says. Varadaraj is taking a cue from Japan-born auto major Toyota which established a factory in the U.S. to take on Ford and General Motors in their home market.There are success stories, albeit small, at home too that should encourage Varadaraj. Mohini Kelkar, the co-founder of Aurangabad-based metal polishing equipment maker Grind Master, took a similar risk in the 1980s. She decided not to compete with mass-market Korean and Taiwanese players and, instead, focus on the premium segment. Result: Her firm is now one of a handful of players competing with European firms in the region. Recently, Grind Master supplied a machine to Nissan in Japan, which will be used to smoothen engine components for the auto giant’s latest generation fuel-efficient engines. “Ultimately, for the capital goods industry, it is all about having the best technology which will make the best commercial sense,” she says.

That augurs well for Varadaraj because, while much has changed in ELGi’s business portfolio, technology has been the cornerstone of the company’s revolution over the years. Not only has it slowly built its product and process arsenal to offer world-class compressors, it has also been able to do so cheaply by tweaking its shop-floor techniques. Consider that ELGi is the only compressor maker with its own foundry for casted components like casings. It has developed in-house the ELGi Locus, its equivalent of the Holroyd rough milling machine, which is used to finish metal components. Six years of development later, the Locus was a sixth in cost and 150% more efficient. This is significant for a business where tooling costs alone account for 15%-18% of the final product. “We can now produce the component at just one-fifth the cost,” says Varadaraj. This streamlining is a result of the single-mindedness he has managed to bring to the company he inherited.

Varadaraj’s business legacy dates back to 1918 when his grandfather L.R.G. Naidu started a bus service in Coimbatore and, later, two airline companies. ELGi Equipments was only set up in 1962, after the transportation businesses were nationalised by the government. Varadaraj entered the picture in 1987, and added garage service equipment to the company’s existing business of air compressors. The early years were baptism by fire for the young optimist who had to learn to let go to meet his growth aspirations. This meant taking the tough calls.

Back in the mid-’90s, ELGi had invested ₹4 crore—a considerable amount at the time—to set up a captive unit to make wiring harnesses for Tata Motors’ commercial vehicles. Tata had promised to buy 3,000 sets of harnesses but couldn’t even buy half that number or allow a price increase as a compromise. As a result, Varadaraj had to make a slump sale of the business to Kalyani Brakes. Similarly, he also wound down a profit-making business of pasteurisers and bottle washers as he reckoned the global beer companies entering India would bring their own vendors. “We closed several other small businesses that had largely begun in the licence era,” says Varadaraj, whose family is the sole promoter group of the air compressor-focussed ELGi Equipments.

The garage equipment business remains a subsidiary while the emphasis on air compressors has helped grow revenues from ₹715.5 crore a decade ago to ₹1,863.5 crore in FY19; profits grew from ₹57.9 crore to ₹103.10 crore during the same period. This has also permitted Varadaraj to make investments without taking on too much debt, and slowly expand into new geographies and invest in product research.

The general management style is part of the global approach which, for a few years, had meant taking his eyes off the Indian market. This led to a stagnation in sales and profits between 2013 and 2017. The company lost nearly 5% of its domestic market share as competitors consolidated their position. There was a hiccup in China, too, where the strategy to offer the top-of-the-line product at a 25% discount backfired as the channels wanted a cut of another 20%. ELGi suffered a big loss and had to pull out of China, leaving behind a skeletal service arm in 2017.

However, Varadaraj regrouped quickly. Last year, ELGi acquired Pulford, a compressor distributor in Australia; in 2012, it had acquired Italian manufacturer Rotair and U.S. distributor Pattons. ELGi is already present in Indonesia and Thailand. “The building blocks for establishing our brand are now more or less in place,” he says. Experience in important markets like the U.S. and Europe has enabled them to take quick investment decisions.

Recently, when two distributors in Los Angeles wound up their businesses, ELGi—which had so far only operated out of the East Coast—moved in to set up its own dealership there. The company is looking to up its market share in the U.S. from 2%-3% to 10%-15% over the next three-five years. “Our Los Angeles move is a good example of our growing understanding of the market,” says Anvar, Varadaraj’s son and global brand leader, who oversees the U.S. operations from his base in Charlotte, North Carolina. Their learnings have, for example, helped them draw in replacement customers. As an additional sop, ELGi has guaranteed that the air screw—a critical component—would not need to be replaced through the 10-year lifespan of the compressor. Typically, the screw gets worn out and needs to be changed after five years. And the replacement can cost nearly 50% of the entire machine. Likewise, for the European market, ELGi has started making its machines in its Italian factory to increase acceptability. Though the Italian blue-collar workers are paid four times their Indian counterparts, the European operations are profitable because of lower manufacturing costs, says Varadaraj.

Much of the obvious buoyancy in his mood is linked to his hope from the state-of-the-art AB series, but he knows its market performance will depend on how competitors react to the new product. His biggest rival, Atlas Copco, has already launched the latest generation oil-based compressor, which it claims will reduce energy consumption by 50%. Varadaraj has global patents for the new oil-free compressor but is aware he can take nothing for granted. He points out how Samsung was sued by Apple for infringing its design patents in a case that took years to settle. By then, mobile phone technology had taken many leaps ahead and Samsung had caught up with Apple in the global sweepstakes.

But with trademark conviction, Varadaraj says he expects a “hockey stick growth” for ELGi in the next decade. “It should be more like an ice hockey stick [which is longer] growth given that we are from India,” he smiles.

This story was originally published in the November 2019 edition of the magazine.