CASE STUDY Indian Branded Tea: Case Study of Industry Cost Data

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1 CASE STUDY Ashish Varma* Abstract The Indian Tea Industry is very significant for the Indian economy. Tea is an agro-based commodity and is subject to vagaries of nature. This case study is an amalgam of cost management and general management principles. In the last two to three decades, there has been significant competition from exporters in countries such as Sri Lanka to Indian Tea exporters. Indian manufacturers need to identify process improvement needed to enhance their ability to offer a Value proposition. The processes involved in tea manufacturing include, Withering, Rolling, Oxidation, Drying and Packing. This case study evaluates the cost structure of branded tea and makes an attempt to study the dependence of domestic auction price on domestic production and the export market by using regression analysis to study the impact of total production and total exports from India and the average global tea prices on average auction price in the domestic market in India. Keywords: Branded Tea, Cost Structure, Domestic Auction Price and Export Potential The Genesis of Branded Tea in India and the Cost Indian manufacturers need to identify process Management Paradigm improvement needed to enhance their ability to offer The tea industry in India is more than one and a half a Value proposition. The major varieties of Tea century old. It occupies an important place and plays include Darjeeling Tea, Assam tea and Nilgiri tea, all a very useful part in the national economy. Robert of which face falling profitability margins. Thus, a Bruce in 1823 discovered tea plants growing wild in need to assess the cost structure of Branded Indian the upper Brahmaputra Valley. In 1838 the first Tea is found necessary in order to manage it more Indian tea from Assam was sent to the United successfully. Kingdom for public sale. Thereafter, it was extended to other parts of the country in the 50's and 60's of the The Tea Grades in India last century. However, owing to certain specific soil Indian tea, whether grown in the foothills of the and climatic requirements, its cultivation was Himalayas in Darjeeling, in the plains of Assam or in confined to only certain parts of the country. Tea the blue mountains of the Nilgiris, is available to you plantations in India are mainly located in rural hills in a wide variety. Teas are essentially of three grades and backward areas of North-eastern and Southern leaf, broken and dust. In each of these main grades, States. the Tea is further classified according to size and the Tea is an agro-based commodity and is subject to final grades generally bear fancy names. vagaries of nature. Despite adverse agro-climatic conditions experienced in the tea growing areas over 1. Leaf Grades many years, the Indian Tea Plantation Industry is able Orange Pekoe (OP) This consists of long, thin to maintain substantial growth in relation to the and wiry leaves containing tip or bud leaf. The volume of Indian tea production during the last one liquors are generally light or pale in colour but are decade. highly flavoury when infused with high - grown Cost management assumes a great significance in the teas. Tea Industry. In the last two to three decades, there Pekoe (P) - The leaves are slightly shorter and not has been significant competition from exporters in as wiry as those of OP. The liquors, however, have countries such as Sri Lanka to Indian Tea exporters. more colour and the teas brew quicker than OP. *He is currently serving as Assistant Professor of Accounting at IMT Ghaziabad. He has 12 years of academic and banking experience. He is a Fellow member of ICWAI and an MBA Finance. sir_ashish@rediffmail.com Copyright by the MAEER's MIT School of Management - Post Graduate Research Centre. All Rights Reserved. 47

2 MITSOM PGRC KJIMRP Vol.II-Issue.03 January-April 2. Broken Grades fanning and dust grades. These teas are usually Broken Orange Pekoe (BOP) These are smaller destined for teabag production. than any leaf grades and usually contain tips. The liquors have good colour and strength. Fannings or Pekoe Fannings These are smaller than BOP and are quick brewing and give good colour liquors. 3. Dusts These are smaller particles of tea and are very useful for quick brewing. The liquor produced has both strength and colour. Dusts are extensively used for catering purposes. The Branded Tea Manufacturing Processes where Costs are Incurred Rolling. (Source) 1. Withering The objective of withering is to reduce the 3. The CTC Production Method moisture in the tealeaf by up to 70per cent (varies CTC stands for crushing, tearing and curling. The from region to region). Tea is laid out on a wire withered leaf is often cut to a uniform size by mesh in troughs. Air is then passed through the machine. Then the leaves are fed into the CTC tea, removing the moisture in a uniform way. This machine where they are crushed, torn and curled process takes around 12 to 17 hours. At the end of in a single operation by metal rollers. The this time the leaf is limp and pliable and so will extracted cell sap is collected and added to the roll well. leaves again. The crushed leaves are then oxidised, dried and sorted. The CTC method is mainly used in Indian regions. 4. The LTP Method The third method of producing black tea is the LTP method, named after the inventor of the relevant machine, the Lawrie Tea Processor. In this method, the withered leaves are often levelled before being processed in the LTP machine. Here they are virtually torn to pieces by blades rotating at high speed. This is followed by the usual oxidation, drying and sorting procedures. Withering. (Source) 5. Oxidation (fermentation) Once rolling is complete, the tea is either put into 2. Rolling troughs or laid out on tables whereby the Tea is placed into a rolling machine, which enzymes inside the tealeaf come into contact with rotates horizontally on the rolling table. This the air and start to oxidise. This creates the action creates the twisted wiry looking tealeaves. flavour, colour and strength of the tea. During the rolling process the leaves are also broken open, which starts the third process. 6. Drying Instead of the more traditional and gentle rolling, To stop the oxidation process, the tea is passed two other methods are used for the production of through hot air dryers. This reduces the total mainly black tea for the finer end of the scale, ie, moisture content down to about 3per cent and 48

3 stops the enzyme activity and oxidation and now business to what is now a global branded the dried tea is ready to be sorted into grades beverages business. Over 65per cent of the before packing. consolidated revenues now come from markets outside India, mainly in developed retail markets; 7. Packing and over 90per cent of the turnover is from Tea is normally packed in large wooden boxes branded products with the balance coming from and exported. It can further be packed in smaller business to business plantation and extraction packages, tea bags etc. activities. The company had restructured its plantation operations by demerging its erstwhile Analysis of Cost Structure of Tea: Factors North India plantations to a separate company, Affecting Cost Amalgamated Plantations Private Limited (APPL) 1. Commodity Prices for Tea The Tea marketing companies buy tea from 4. Exchange Rate various auction markets in India and then blend As 65 per centper cent of a company s revenue tealeaves from different regions and grades to comes from markets outside India and export obtain particular tastes and price for its tea prices are dependent on exchange rates of other brands. Their cost of sourcing from the auction producing countries as well as that of consuming markets depends not only on the auction prices countries, its revenue is dependent on exchange but also on their own global sourcing rates. In order to reduce risk, a firm needs to efficiencies. Auction prices for tea are affected by hedge against changes in the exchange rate. Also, production of tea in various regions, climate with global sourcing operations to reduce overall conditions (rainfall weather etc), productivity of cost of raw material, the cost is dependent on area under tea, labour costs and productivity of import prices and exchange rates. labour utilised. TATA tea continuously monitors and balances the mix of investments keeping in mind economic 2. Profitability of Company Owned Plantation exposure and strategic and operational needs, Operations domestic and export demand and product mix. Plantation is the upper end of the supply chain. Cost at this end depends on regional land quality, 5. Distribution, Marketing and Selling Costs yield of the farm, high labour cost for plucking As branded products contribute 90 per centper and weather and climate conditions. But for cent of a company s turnover and 65per cent company owned plantations, the firm has direct revenues are from sales abroad, it needs to invest control over the utilisation of available resources. in efficient distribution channels, product We cannot compare cost of auction and contract differentiation, branding and marketing buying with cost of sourcing from owned activities. operations as the quality and grades of tea from both these sources is unknown. Research Design and Methodology The paper makes an attempt to study the Dependence 3. Plantation Vs Market Sourcing of Domestic Auction Price on the domestic As the climate and weather conditions change, Production and Export market. For this purpose a the tea crop prices change due to supply demand regression analysis was performed to study the dynamics. The challenge in this dynamic impact of Total Production and Total Exports from environment is to evolve a sourcing strategy and India and Average Global Tea Prices on the Average a suitably hedge between a combination of public Auction Price in domestic markets in India. auctions and private contracts. TATA tea has, over the last decade, consistently made strategic The Data Source was Tea board of India, authentic moves to transform from what was data and the Data span was monthly data from Jan predominantly a domestic Indian tea plantation 2008 to Aug

4 MITSOM PGRC KJIMRP Vol.II-Issue.03 January-April Regression Variables Y = Avg auction Price India in `/Kg X1 = Production of tea in thousand Kgs X2 = s in `/Kg X3 = Global Tea Price in $/Kg Regression Analysis Results Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 32 ANOVA Significance Df SS MS F F Regression E-10 Residual Total Standard Coefficients Error t Stat P-value Intercept Estimated E Production Exports E-07 Global Tea Prices Regression Interpretation Adjusted R square value of 0.78 suggests that 78per cent of variation in price of tea auction was predicted by the independent variables that were considered. The overall model is valid as significance F value is greater than While Production and Export price variables are significant in explaining variation in the auction price, the Global Tea price variable is insignificant based on the given data. Based on coefficient values, the auction price equation can be determined as follows: Auction Price = * Production * Exports Dependence of Domestic Auction Price on Multiple Factors For the purpose of this case study, correlation analysis was performed to determine the relation between variation in yearly average auction prices for tea in Indian auctions and various factors such as area under tea plantation, region wise breakup of production, small versus big plantations, Export Price of Indian and other tea producing countries, labour employed, domestic consumption and Productivity. Correlation Results Correlation Matrix Total Area Percentage Assam West Tamil Kerala Export Export Export Total Per capita Productivity All India under Tea big growers Bengal Nadu Price Price Price Labor Consu- Kg/ Avg Auction India Sri Lanka China mption Hectare Price Total Area under Tea Percentage big growers Assam West Bengal Tamil Nadu Kerala India Sri Lanka China Total Labor Per capita Consumption Productivity Kg/Hectare All India Avg Auction Price

5 Data Source: Tea board of India Data Span: Yearly data from 2000 to 2007 Price variation for different product categoriesy (Packet, bulk & Instant) Y = All India Avg Auction Price in Rs `/Kg X1 = Total Area under Tea plantation (India) in X2 = Percentage of area under tea plantation for big growers X3 = Assam area under tea plantation in X4 = West Bengal area under tea plantation in X5 = Tamil Nadu area under tea plantation in X6 = Kerala area under tea plantation in X7 = (Indian tea) X8 = Sri Lankan Tea X9 = China Tea X10 = Total Labour employed per hectare X11 = Per capita domestic consumption X12 = Productivity Kg/Hectare The factors considered here show a high correlation with Auction Price, mostly above 0.5 and show a high correlation with each other as well. One needs to consider these factors separately for evaluating their impact on the Auction Price. Overall, the analysis of cost structure of branded teas in India reveals important areas which should be useful for strategic planning and business growth to achieve a larger national interest in Tea export. References Financial Express Labour cost should be shared equally between tea companies and government 18 May Punnathara, C J. Tata Tea divests control in tea estates in Kerala Businessline (Apr 2, 2005): 1. Emblemsvag, Jan Activity based life cycle costing. Managerial Auditing Journal 16. ½ (2001): Korpi, Eric; Ala-Risku, Timo. Life cycle costing : A review of published case studies Managerial Auditing Journal (2008): Albright TL, Reeves J, (1992) A case study on the impact of material yield related cost drivers on economic improvement Journal of Management Accounting Research, Sarasota Fall 1992, Vol 4, p 20. Ryan, M (2001) Variance Analysis, normed costs and public safety organizations Results and Conclusion Applied Economics, Vol no. 33, Iss 6 p 755. In a Similar manner, a regression can be performed Connel, R (1996) Measuring customer and service profitability in the Finance Sector, London, UK : Chapman &Hall. for: Simon, R (2000) Performance measurement and Control system for implementing Dependence of Production yield on size of strategy Upper Saddle River, NJ : Prentice Hall, Bruns, W and Kaplan R (1987) Accounting and Management : Field study plantation. perspective Boston Harvard Business School Press. Dependence of Auction Price on tea district. Merchant K A (1989) Rewarding Results: Motivating Profit center Managers Boston Harvard Business School Press. Dependence of on world demand Martison, O (1994) Cost accounting in the service IndustyIndustry, Montvale NJ, and other producing nations. Institute of Management Accountants. 51