the promise of private equity (november 2006)

8/14/2019 The Promise of Private Equity (November 2006)

1/45


2/45

PREPARED BY ENVIRONMENTAL

RESOURCE MANAGEMENT


3/45

iiiEXECUT IV E SUMMARY

Table of Contents

FOREWORD vACKNOWLEDGMENTS vii

EXECUTIVE SUMMARY 1

CASE STUDY 1 4

Amrica Latina Logstica

CASE STUDY 2 16Mengniu

CASE STUDY 3 22Morion

CASE STUDY 4 27

Reclamation Group

CASE STUDY 5 32Terapia


4/45

v

Foreword

FOREWORD

IFC is committed to investing in and financing ventures that are

financial ly, environmentally, and socially sustainable. To show the

benefits of a triple bottom line approach to investing, we have

produced five case studies that show you can make money and

thereby meet the demands of the commercial marketplace and

stil l be environmentally and socially responsible. In fact, we show

that environmental and social responsibility will support and

enhance the achievement of financial imperatives.

And what better place to look for success stories than within the private

equity industry, whose clear imperative is achieving financial returns for

investors in a highly competitive environment?

The five case studies come from five private equity managerswith whom IFC has invested: GP Investimentos in Brazil, CDH China

Fund in China, Quadriga Capital in Russia, Brait Capita l in South

Africa, and Advent International in Europe. In each case the

environmental and sustainability aspects were integral to core

business competencies, contributed directly to profits, and were

implemented for commercial reasons.

We hope these stories will inspire you and provide ideas that

both enhance the success of your own investing and contribute

to a sustainable future.

Hayde Celaya

Director

Private Equity & Investment Funds Department

International Finance Corporation


5/45

vii

AcknowledgmentsSpecial thanks to all those involved in the development of this report.

AMRICA LATINA LOGSTICAAntonio Bonchristiano, GP Investimentos, the PE Fund

Alex Behring, Chairman of ALL and former GP partner

Melissa Alves Werneck, Manager of Projects, Logistics

and Marketing, ALL

Bernardo Hees, CEO, ALL

Raimundo Pires Martins de Costa,

Director of Operations, ALL

Pedro Roberto O. Almeida, Director of Human

Resources, ALL

MENGNIUStuart Schoenberger, Managing Director,

CDH China Fund

Lu Jun, Executive Director and VP, Mengniu

Lei Yong Sheng, Secretary of the Board and Chief

Administrative Officer, Mengniu

Zhang Zen Hua, Manager of Foreign Affairs Department

MORION

Reinhard Kohleick, Quadriga Capital

Yakov Vorokhovsky, CEO Morion

Olga Sidorenko, Mr. Vorokhovskys assistantSergei Olhovsky, Plant Engineer, Morion

RECLAMATION GROUP

Chad Smart, Brait Capital

Darshan Daya, Brait Capital

Dave Kassel, Executive Chairman, Reclamation Group

TERAPIAEmma Popa-Radu, Advent International

Eric Haworth, Plant Director, Terapia

Dan Petcovici, Site Engineering and

Project Manager, Terapia

INTERNATIONAL FINANCE CORPORATION

Sustainable Financial Markets Facility:

Cecilia Bjerborn

Ekaterina GrigoryevaAndrea King

Clive Mason

Dan Siddy

Fayana Willie

Private Equity & Investment Funds Department:

Simon Andrews (RECLAM)

Jean Laprevotte (ALL)

Umberto Pisoni

Sergio Pombo

Peter TropperDavid Wilton

Rebecca Xu (Mengniu)

ACKNOWLEDGEMENTS


6/45

1EXECUT IV E SUMMARY

1. Elkington, John, 1998, Cannibals with Forks: the Triple Bottom Line of 21st Century Business,Capstone Publishing, Oxford. 407 pp.

THE PROMISE OF PRIVATE EQUITY

BACKGROUND

Five case studies of companies exhibiting good examples of different aspectsof sustainability were drawn from the portfolios of private equity funds in

which IFC was an investor.

The definition of sustainability was the triple bottom line concept, broadly

defined. This term refers to the concept of triple bottom line accounting, i.e.,

that for-profit corporations could consider three levels of accounting,

traditional profits as well as environmental and social effect accounting, an

idea proposed by John Elkington in 1998.1 Implicit in the concept as applied

herein, however, was recognition of one of the criticisms of the triple bottom

line theory: that it may potentially be harmful to a business to divert

attention from its core competencies. Rather, as wil l be seen below, the

sustainable attributes noted in this study were integral to core competenciesand sound business management, contributed directly to profits, and were

implemented purely to foster the business case.

The five companies selected to be case studies are shown in table 1, next page.

KEY FINDINGS

As noted above, the concept of sustainability in this study was based on the

triple bottom line approach, with the caveat that aspects of sustainability

identified would likely reflect good business management and directly

contribute to the bottom line, as would be expected in what were primarilyemerging market businesses operating in their host country marketplace

(e.g., not exporting or part of multinational supply chains). This concept

was confirmed early on in the process of researching IFCs portfolio for case

studies, when it became apparent that positive social and environmental

aspects of individual companies were an integral part of good business

management, as opposed to a separate or parallel end goal. In all cases

Executive Summary


7/45

2 THE PROMISE OF PR IVATE EQUITY

studied, the companies pursued these

sustainable initiatives because they

increased profits and performance.

A number of themes were identified

that were replicated across the five case

studies. The themes and the cases to

which they apply are presented in table

2, (page 3). The bottom lines of the

table present the five firms recentfinancial performance and il lustrate

that the implementation of the

measures identified coincided with

strong financial performance. The data

are presented as growth percentages as

opposed to actual numbers, as three of

the five companies are privately held.

Highlights of how the themes were

manifested in each case are presented

below, and the full case studies are

presented in the ensuing chapters.At four of the five companies (ALL,

Mengniu, Morion, and RECLAM)

the CEOs/founders were the source

of the drive for excellence that

resulted in the identified programs

on which the case studies focus. In

the case of Terapia, the private

equity fund viewed brownfield

development as an opportunity

rather than an obstacle for

the transaction.

Two companies, Mengniu and

RECLAM, were dependent on

supply chains for which there was

competition, and a key part of their

business success was a direct result

of their ability to capture a signifi-

cant market share of an independent

supply chain, in both cases consist-ing at least in part of small entrepre-

neurs, via fair pricing and programs

that fostered the economic growth

of microenterprise suppliers.

Three of the companies had very

strong programs designed to

optimize worker commitment and

performance. Two companies (ALL

and Mengniu) were highly ranked

in their respective countrys

competitions for most popular

places to work. The third,RECLAM, in addition to sponsoring

sports teams and other worker

extracurricular programs, was

extremely effective in designing

direct financial reward programs

that both benefited the workers and

resulted in dramatic improvements

in worker performance and revenue

generation for the company.

Both ALL and Morion applied

programs to reduce waste and

energy consumption. ALL, primar-

ily a railroad company, was able to

significantly reduce diesel fuel

consumption through application of

improved logistics management via

technology, awareness raising and

training, and its annual Diesel

Cup competition, in whichlocomotive engineers compete to

use the least amount of fuel without

any dropoff in on-time performance

or decrease in health and safety

performance. Morion invested

in equipment upgrades and

re-engineering of the plant to reduce

water and energy consumption,

and the subsequent savings in

operating costs rapidly paid back

the initial investments and

improved profitability.All five companies had proactively

adopted various international

environmental and other interna-

tional standards, though only

Morion was a part of a global supply

chain where such certifications were

required. The other four companies

willingly adopted these standards

and the associated costs for

TABLE 1.

THE COMPANIES AND THE FUNDS

Company Sector Location Ownership Investment Fund

Amrica Latina Logstica(ALL)

Transportation and

logistics

Curitiba, Brazil Public GP Investimentos

Mengniu Dairy products Inner Mongolia, China Public CDH China Fund

Morion High technology

instruments

St. Petersburg, Russia Privately held Quadriga Capital

Reclamation Group(RECLAM)

Metal and other wasterecycling

Johannesburg, South

Africa

Privately held Brait Capital

Terapia Pharmaceuticals Cluj-Napoca, Romania Privately held Advent International


8/45

3EXECUT IV E SUMMARY

certification and reporting as

part of their CEOs drive to create

a world-class company.

Three companies were involved in

different aspects of recycling. Metal

and now other disposable product

recycling is RECLAMs central

business (the aboveground mine

in the words of the founder and

CEO). Morion invested in recycling

its product water, both to recover

heat and save energy and to reduce

raw water costs. Terapia is involved

in the cleanup and recycling of

contaminated industrial site

as a sideline to investing ina former state-owned

pharmaceutical company.

Three of the companies were

formerly moribund state-owned

enterprises that were completely

turned around and reinvented as

dynamic and profitable private

sector businesses, in part through

the programs described herein.

As can be seen in table 2, four of the

five companies for which financial

data are available have experienced

very healthy growth in revenues

and EBITDA.

METHODOLOGY

IFC contracted Environmental

Resources Management to carry out

the identification and preparation of

the case studies. As stated above, the

goal was to identify cases exhibiting arange of aspects of sustainability.

Additional selection parameters were

broad geographic and sector diversity.

The case studies were identified via

interviews with IFC staff in the Private

Equity Funds Department. An initially

long list was gradually reduced to a

short list of leads, and then to the final

five through additional interviews with

IFC staff and discussions with the

investment funds staff. The companies,

and in most cases the investment

funds, were visited during 2005.To

develop the cases, a variety of materials

were used, ranging from investment

reports for the two publicly traded

companies to news stories

and interviews.

For three of the companies (ALL,

Morion, and RECLAM), the CEOs

were the primary sources of informa-tion. For the other two, company staff

and investment fund staff provided the

information. The staff of IFC, of the

investment funds, and of the compa-

nies were enormously supportive

during the process.

Theme ALL Mengniu Morion RECLAM Terapia

CEO leadership + + + +

Fostering microenterprise development inthe supply chain

+ +

Optimizing workforce commitment + + +

Eco-efficiency/energy conservation + +

Proactive adoption of internationalEnvironmental, Health, and Safetystandards

+ + + + +

Recycling + + +

Privatization + + +

Financial performance 1997-2004 1999-2003 1997-2005 2000-2004 2001-2004

Revenue growth 200% 1343% 500% 282% 156%

EBITDA growth 1560% 1740% 1660% a 810% 180%

TABLE 2.

SUSTAINABILITY THEMES FOUND ACROSS THE FIVE BUSINESS CASES

a EBIT data, not EBITDA.


9/45


10/45

5AMR ICA LA T INA LO G S T I CA

Accident and health and safety

performance has gone from poor

to being the best among Brazilian

railroads and on a par with the best

North American railroads.

Diesel fuel consumption has

been reduced by 40 percent since

privatization in 1997, thereby

improving profitability and

reducing greenhouse-gas emissions.

BACKGROUND2

Between 1994 and 1998, the Brazilian

state-owned, 22,000-plus-kilometer

national rail system, Rede Ferroviaria

Federal SA (RFFSA), was divided into

six regional concessions and auctioned

as long-term operating leases.

The winning bidders were awarded

thirty-year leases renewable for an

additional thirty years. Huge layoffs,

mandated by the pared-down but

still unsustainably large labor force

from the government-run era, andlow morale and motivation were the

most significant liabilities.

RFFSA had not been a priority of

past administrations, and there

had been little investment in the

infrastructure or attention to

performance. This was due primarily

to the governments decision in the

1960s to prioritize road transport

(e.g., trucking) over other forms of

transportation, essentially makingthe once-proud railroads obsolete.

A pre-privatization study of RFFSA

in 1996 found that 50 percent of the

bridges needed repair, with 20

percent near collapse. Some twenty

of the locomotives were steam

driven, and integration of the

regional lines was so poor that

long-distance transport was difficult

at best. In addition, RFFSA had an

extremely poor accident record.

ROLE OF THE

GP FUND

GP was well aware of RFFSAs service

and reliability problems. Some yearsprior to its investment in ALL,

GP had acquired Brahma Breweries,

one of the major Brazilian brewers.

GP decided to experiment with

shipping Brahmas finished product

on RFFSA, as the rates were favorable

versus trucking for longer distances.

GP contracted with RFFSA to ship

two rail cars of finished product, and

not only did neither rail car ever

arrive at the destination, but both

were permanently lost.3

Prior to the auction, GP had carried

out considerable research of the

railroad industry in general and

RFFSA in particular. They consulted

with CEOs and top executives of

several U.S. railroads and developed

a strategic relationship with one U.S.

railroad company, which assisted in

its pre-bid due diligence of RFFSA.

Fully recognizing the extent of

potential problems in the RFFSAconcessions, GP decided to bid for

one of the six regional concessions,

the Ferrovia Sul Atlantica, the

Southern Line, which served

Brazils three southern states, Paran,

Santa Catarina, and Rio Grande do

Sul. The public auction took place in

December 1996, and the GP-led

consortium emerged with the

winning bid of Brazilian Real 217

million (at the time approximately

US$195 million).

GP had been very successful in prior

turnaround situations and brought a

wealth of experience and successful

techniques to be applied at ALL.

These included a general goal of

reducing the average age of the staff,

an aggressive performance-based

bonus system for all employees, anda forced attrition program for

underperforming staff.

After the auction, there was a

three-month waiting period prior

to GPs takeover of operations.

During this period GP assembled a

management team with expertise

in what they determined were the

four major functional areas of the

company: human resources,

operations, sales, and finance.

In a somewhat unusual move, GP

seconded their point person on the

transaction, Alex Behring, to the new

company to be the CEO. Management

identified four goals at the outset:

Create an aggressive

corporate culture

Cut costs

Eliminate bottlenecks

Increase revenues by

expanding services toexisting customers.

These original goals are still evident

in the companys current corporate

mission statement.

2. Based on two primary sources, the ALL- Amrica Latina Logstica S.A. offering prospectus and Sull, Donald M., Fernando Martens, and Andre Delben Silva,2004, Amrica Latina Logstica , Harvard Business School Case Study 9-804-139.

3. Related by Alex Behring, former ALL CEO and now chairman, during a February 2005 interview.


11/45


THE ALL

SUSTAINABILITY

STORY

This case describes two aspects of

ALLs program that have enhanced

the companys sustainability and

profitability, or triple bottom line:

Its investment in its human

resources and reinvention of the

corporate culture to achieve its

business plan

Its efforts to improve operational

efficiency and performance,which have resulted in a dramatic

reduction in accidents and energy

consumption and emissions.

Human Resources and Corporate Culture

On day one of its new ownership in

April 1997, ALL management faced

a daunting task. It had to severely

reduce the labor force and simultane-

ously reinvent and reinvigorate the

corporate culture to achieve itsbusiness plan, which was based

largely on a dedicated, motivated,

savvy workforce.

ALL management kept the following

principles in mind during its efforts

to reinvent the companys culture

and reinvigorate the staf f:

Believe in its agreed business

case/model.

From a human resources

perspective, resuscitate aformerly proud industry (many

of the current workers grandfathers

had worked for the railroad).

Create a meritocracy with few

barriers between management and

staff, organized around subteams

with clear and measurable goals.

Remove people likely to

perpetuate the former culture.

Devolve responsibility to the

field and simultaneously seek

feedback and ideas from the

workforce on how to improve all

levels of operations, including

incidents/accidents, delivery time

performance, and fuel economy.

Challenge the workforce but

also provide incentives through

a policy of compensation tied

to performance.

Invest in the workforce through

training to improve capacity

and commitment.

ALL management moved quickly

to implement the Pillars of Culture

Change. These are described

individually below, though they

were in essence components of an

integrated program.

Reduce the Workforce While

Minimizing Impact to Morale

The labor force had been slashed

from 12,000 to 6,000 by thegovernment in the year or so before

the auction, yet there was a need to

reduce the staff by another 3,000

immediately, based on the pre-auction

due diligence carried out by GP. The

payroll, one of the major operating costs,

was still boated, and the new company

urgently needed to cut costs. At the same

time, it was critical to keep the company

running and serve its customers to avoid

losing market share, and therefore

ALL had to endeavor to create a post-

downsizing workforce with a commit-

ment to the business going forward.

ALL minimized the painful and

negative repercussions of the

downsizing by doing the following:

It was made absolutely clear from

the first day of the new ownership

that dismissals were necessary for

the company to survive, and thiswas in fact the consensus view

among most employees.

Severance actions were swift

and decisive, with the majority

carried out in the first month,

without mixed signals or mislead-

ing statements of intent (without

lies, as management phrased it).

The severance packages were

good, exceeding the government

requirements.

ALL subsequently saw to it that asignificant number of the staff let

go were hired by firms contracted

by ALL to carry out construction

and other projects necessary to

rehabilitate and upgrade facilities

and infrastructure.

4. Sull, Donald M., Fernando Martens, and A ndre Delben Silva, 2004, Amrica Latina Logstica Harvard Business School Case Study 9-80 4-139.

When we found someone who had a spark in their eyes,who wanted to do something, and was strong technically,

wed give them space and authority, managerial training,and then a new challenge. Since the new challenge usuallyrepresented an upgradealso financially speakingthatcreated instant loyalty to the new project. These peoplereally bought into our vision.

Alex Behring, now chairman but formerly CEO in the early years of ALL4


12/45


In the course of the downsizing, it was

critical to retain the right staff to

continue operations and to create the

new organization. Over the first ten

days, the CEO and the operations VP

conducted 15-minute interviews with

150 mid-level managers. On the basis

of these interviews, 30 managers were

selected as the core team who would

work with senior management to

implement change. The interviews also

identified those who were considered

unable to make the transition to the

new organization, and those individuals

were let go or demoted. Over the next

two and one-half months, over 100other employees, including both

managers and line staff, were

interviewed. The interviews served

to get the new managements message

out to the workforce in an effective

manner and also revealed the fabric

of the staff, differentiating between

higher level political appointees with

little commitment to the business, a

middle tier of skilled engineers and

managers who had been demotivated

by the destructive internal politics ofthe government era, and the main

workforce of train engineers, technicians,

and office workers who were still

largely committed to their work.

Establishing Clear,

Measurable Goals Tied

to Compensation Across

Entire Workforce

Under government management,

salaries and promotions were based

solely on seniority, and there wasno structured human resources

program (e.g., performance evaluation,

career planning, or training). The

new program established very clear

goals and a transparent system

of compensation tied to performance.

The elements were:

Long-term vision

Values/rules of the game

Quantitative annual goals

(broken into monthly targets

during the year)A clear distribution through the

company hierarchy and staf f

organizational structure of

performance bonuses.

Some 1,000 staff were assigned

individual goals, with the remainder

parts of teams with team goals.

Performance was tracked daily

against monthly and annual

targets for each team and division.

Individual charts illustratingprogress against targets for each

team were posted on the wall in the

individual teams office areas as well

as in common areas or gathering

places (e.g., hallways, and the

cafeteria entranceway).

Performance against goals was directly

tied to compensation, termed variable

compensation. Different programs

were developed for different levels of

staff. For example, for managers, fivequantifiable targets, linked to overall

corporate objectives but translated

into objectives the manager could

directly influence, were agreed on

at the start of each year (e.g.,

margins, operating costs, service

indicators). The variable compensa-

tion program was based on the

percentage achievement of the

targets and the staf f level, with senior

managers who met all targets receiving

bonuses from 50 to 75 percent ofannual salary. For middle managers,

the range was 25 to 40 percent, and

for staff from 7 to 24 percent.

The performance program also

acted as another form of staff

selection. Some individuals thrived

in this structure, while others didnt

care for it and left.

ALL freight train


13/45


Building Trust and

Communication with Workers

from the Former Railroad

ALL management recognized the

extreme importance of gaining the

trust and commitment of the former

government workers remaining after

the reductions. Management broad-

cast the message that they were sorry

about the staff reductions, but that

those were a necessary step to keep

the company alive, and management

spent a lot of time listening to the

staff and eliciting feedback and

suggestions for improving the

companys performance.

In the first year of ownership, ALL

management did two things to signal to

all employees that a new era had begun.

First, office space at headquarters and

regional offices was converted to an

open plan without walls, symbolically

illustrating new managements intent

to eradicate the barriers that had

existed between management and

staff in the government era.

Even more dramatic, ALL senior

executives went to school to become

certified locomotive engineers,

allowing them to operate locomotives.

After receiving the licenses, ALL

senior staff started a program of

spending a week or so each month on

the trains, driving locomotives with

the crews, wearing the standard ALL

uniform, and overnighting with the

crews in company dormitories. ALL

managers recognized that the field

staff understood operational realitiesand challenges far better than they

did, used this field time to learn from

the staff, and encouraged the field

staff to make suggestions for improving

operating efficiencies. This evolved

into the companys ideas competition

described below.

In August 1998, one of the worst

accidents in the companys history

occurred, resulting in a 27-car

derailment. The ALL CEO andOperations VP were in the field

and arrived at the accident site

within 4 hours. While the Operations

VP spent the next 36 hours supervising

construction of a temporary bypass, the

CEO visited the trains operators in their

Money for Merit

A cultural revolution based on results and self-esteem hastransformed ALL from a moribund state-owned firm intoa successful company.

Revista ExameAugust 6, 2003

homes. This marked the first time in

the companys history that a company

officer had visited the home of a field

worker, and it served to establish a new

relationship between management and

the train operators that was key to ALLs

subsequent success.

Seeking Ideas

from the Workforce

Building on the positive outcomes

from soliciting ideas from the

workforce, both in the offices and

from the train operators in the f ield,

in 1999 ALL established an annual

ideas competition. Ideas were

solicited on a quarterly basis, and

at the end of each quarter, an ideas

competition was held at headquartersand the top three ideas of the quarter

were selected by a panel. At the end

of the year, a major event was held

to select the top three ideas of the

year. The winners received significant

prizes, sometimes cars. In the event

that the idea came from a team,

the division of the prize was at the

teams discretion.

Reducing the Age

of the Workforce

Reducing the age of the workforce

had been an effective strategy at other

GP turnaround projects, and as under

the government no new employees

had been hired since 1985, this was

also a basic goal. The challenge was

how to attract bright, young people

to what was widely viewed in Brazil

at the time as a decrepit industry.

TABLE 1.TRENDS IN ALL WORKFORCE AGE DISTRIBUTION, 1997-2001

Age 1997 1998 1999 2000 2001

30 years 270 402 476 554 677

31 to 40 2,290 1,792 1,233 874 757

41 to 50 873 809705 661 667

Over 50 16 13 13 13 15

TOTAL 3,449 3,016 2,427 2,102 2,116


14/45


ALL moved almost immediately to

address the recruitment problem by

beginning a program of awareness

and hiring campaigns at universities

throughout the southern states and

the adjacent state of So Paulo. This

program, in conjunction with stories

of ALLs successful turnaround, led in2003 to ALLs being named one of the

100 best places to work in Brazi l by a

popular business magazine, Revista

Exame, and resulted in a dramatic

change in the companys ability to

recruit young, high-caliber staff

(see table 1).

The results were dramatic:

In June 1997, ALL was able to

recruit 32 university graduates

for 40 trainee openings.5

In 2003, there were over 12,000

applications for 18 trainee openings.

Training

One of the major labor and

cost-cutting decisions had been

to replace people with information

technologies in train operations.

These measures would also allow

centralized tracking of all trains

at all times and serve to boost

operational efficiencies and traffic

scheduling. ALL had studied the

types of systems available duringthe due diligence phase, and

knew that implementation of high-

technology systems would require

substantial training to utilize

these technologies effec tively.6

In addition, ALL management

wanted to raise internal awareness

of the core business realities,

so that workers at all levels would

appreciate as much as possible how

their actions and those of theirimmediate colleagues impacted

the companys performance. Last,

management wanted to instill a

culture of excellence with a

commitment to solving problems.

ALL identified the following

objectives that the internal

training program should impart:

Enthusiasm

Technical knowledge

Managerial knowledge

how to identify problems

and find solutions

Management capacity

(Total Quality Management

and the Six-Sigma program

were used.)

ALL initiated various training

programs immediately, and in

August 2000 it opened the company

university, UNIALL, at companyheadquarters. Each employee is

required to attend at least one week

of training a year. Highlights of the

training program include:

Over 12,000 applications for the

trainee programs from less than

3,000 staff in 2003

UNIALLCorporate university

providing training in operations,

administration, and management

modules; all employees

receiving at least one weekof training each year

MBA in Logistics, Operations,

and Services Qualification in

partnership with COPPEAD/UFRJ

Six-Sigma Black Belt Program.

Recognizing that a significant

portion of the staff had not received

the Brazilian equivalent of high school

diplomas, management also introduced

ALL on the Tracks of Education, a free

high school equivalency program thatresulted in the award of a diploma to

those staff and prepared them for

access to higher education. Some 170

staff members have benefited from

this program and received high school

equivalency diplomas.

5. After 12 months, trainees performing well would be promoted to entry-level supervisor or assistant manager positions.

6. These included a satellite-based system that monitored track conditions and on-board computers on all locomotives, allowing real-time tracking of all equipment 24 hours per day.

FIGURE 1.

CHANGE IN EMPLOYEE PRODUCTIVITY, 19972003

RTK = Revenue ton kilometer, ALLs volume indicator; it represents the amount of net volumetransported (load) x distance between origin and destination.CAGR = Compound annual growth rate, an average annual growth rate measure.


15/45


FIGURE 2.

RELATIVE RANKING IN TERMS OF ACCIDENTS PER MILLION KILOMETERS OFTRAIN TRAVEL, BRAZILIAN RAILROADS, 2002

FIGURE 3.

RELATIVE RANKING IN TERMS OF ACCIDENTS PER MILLION KILOMETERS OF TRAINTRAVEL, ALL VS. U.S. RAILROADS, 2002


16/45


ALLs investment in its workforce

has paid huge dividends with a

dramatic increase in productivity

since 1997 (figure 1).

Improving Operational Performance

Accidents and

On-Time Performance

The former state-owned Southern Line

had a terrible accident and reliability

record. As the companys business plan

was geared to retaining and expanding

business with existing clients as well as

winning new clients based on perfor-

mance, it was fundamental that thecompany drastically reduce accidents

and worker lost days in order to

FIGURE 4.

DECLINE IN FUEL CONSUMPTION, 19972003

GTK = Gross ton kilometer, or the amount of gross mass (load+railcars) x distance,for loaded and unloaded flows.

WE CONTINUE TO PERFECT OUR CULTURE

We believe that people make the difference, in particular for a service company such as ours. In 2003, we continued to make strong investment in training,

with more than 1,000 employees having completed our corporate university program, including more black belts and green belts in the Six-Sigma qualitymanagement and problem-solving program. Our culture is based on goal achievement, and aggressive variable pay has helped us to be the only privatized companyto rank among the best companies to work for in the annual survey conducted by Examemagazine in Brazil, as well as in the Aperturamagazine guide of the 25best companies to work for in Argentina. The extraordinary commitment of our people to go the extra mile brings many benefits to our company, including higherservice quality: over 90 percent of our rail traffic arrives on time. This significantly increases the safety and reliability of our locomotive fleet. We have not onlysurpassed the safety targets for our concession, we have reached a level of safety that is comparable to that of U.S. rail operators.

ValuesFocus on the customerPeople make the difference and are compensated for resultsIntegrity and transparencyIncreasing shareholder value through profitabilitySimplicity with creativity and austerityMethodology and superior quality standards for constant improvementTeamwork in a fun and safe environmentCommitment to the community and the environment


17/45


People Who Never Cease To Do More and BetterOver the last seven years, ALL has improved its productivity and enhanced the quality of its ser vices, boasting numerous success cases.These results are mainly due to two factors: the qualification of its employees, who are always ready to develop and implement solutionsto maximize the companys performance; and the control of corporate operations, which, with the assist ance of state-of-the-art technologyand methodology, ensures ongoing improvement.

In 2003, ALL doubled its capacity of tons hauled, from 11 million tons in 1997 to 22 million. Over this same period, it increased car utilizationby 67 percent: in 1997 it was 1.98 carloads per month,and in 2003 this figure rose to 3.31. Fuel consumption was reduced by 12 percent,from 6.7 to 5.9 liters/1,000 GTK, which implies a substantial reduction in operating costs.

Train times are strict ly monitored. In 2001, when the company began a major on-time performance drive, the percentage was 56 percent,whereas in 2003 it ended the year at 90 percentan improvement of more than 50 percent. During the same period, the average transit time

of its cars was reduced by 25 percent. These results were possible thanks to investments in technology such as ACT (traffic control automation)and the Translogic system, which managed to increase operational efficiency.

In road operations, the results were also inspiring. The average remunerated kilometer increased from 9,000 km/month per vehiclein 2002 to 11,800 km/month in 2003, an increase of over 30 percent in just one year. ALLs operations now include a trucking businessand railroad operations in Argentina.

These are some of ALLs achievements over recent years that illust rate its operational excellence and show that, being focused on results,it is possible to achieve ever more daring goals without losing the focus on cost reduction.

People Who Do Not Stop Growing

The fuel for ALL to keep moving ahead is the potential and the force of its people: a great team which makes the difference.

At ALL, we believe in the potential of our people and value the contributions of each of themso much so that we have adopted a methodologythat establishes clear targets, discloses achievements, and awards outstanding collaborators. This makes ALL one of the most aggressive companiesin terms of variable compensation on the market. In 2003, over R$15 million was distributed in the profit sharing program.

But this is not all. Through various act ions, ALL prepares its collaborators to per form their functions better. UNIALLALLs Corporate University,founded in August 2000, has trained over 7,000 employees, in a total of 650,000 hours of training. In 2003 alone, over 1,100 employeeswere trained at UNIALL.

ALL on the Tracks of EducationDesigned for collaborators who have not concluded their formal school education, the purpose of the ALL on the Tracks of Education programis to provide a contribution to professional formation and to the development of societ y. Initiated in 2001, the program has already trained 170persons, and the company has invested over R$800,000.

(Source: ALL, 2003 Annual Report)


18/45


improve on-time performance. In

addition, rail accidents in the govern-

ment-owned era had caused significant

impacts to the environment and the

public at large, depending on the

location of the accident and the cargo.

Operating safety was designated the top

pillar of service. As described previous-

ly, ALL management reduced accidents

and improved operational performance

through a combination of training and

new information technologies.

Health and safety training was a basic

training requirement for all employ-ees, and accident prevention and

reduction became a focus of all teams

throughout the company and a key

metric to be charted and displayed on

the team goal charts posted through-

out the companys offices. The health

and safety message became central to

the corporate culture.

Some of the new technology systems

that required staff training for

operation are listed below:Satellite Tracking SystemCost-

effective train-tracking system,

using alternative technology that

allows for 30 percent communica-

tion cost reduction with the same

level of safety

TranslogicA proprietary

railroad operational system

that supports service-level

requirements control

OPTCAPAsset allocation

optimizer that al lows forcommercial flow prioritization

and revenue/yield maximization

OPTVAGCar trip optimizer that

allows for a reduction of empty car

traffic and maximizes service-level

compliance

On-Board ComputersProvide

real-time data for the engineer

related to speed limits, fuel

consumption, and traffic,

increasing the safety level and

decreasing operational costs

Derailment DetectorsDetect

derailed cars in traffic, minimizingincident severity

Hot Box DetectorsDetect over-

heated bearings on cars in a train,

minimizing the risk of in-service

bearing failure.

Locations of all trains across the

entire rail network can now be

monitored and speeds optimized to

reduce or avoid track or switching

delays. Incidents and accidents

have been significantly reduced

and on-time performance

dramatically improved.

Figures 2 and 3 show how ALL

ranks in terms of accidents

compared with other Brazilian

and North American railroads.

Fuel ConsumptionDiesel fuel consumption had formerly

been the companys largest single cost

item, as much as 25 percent of net

FIGURE 5.

ALLS GROWTH IN EBITDA MARGINS, 19972003

FIGURE 6.

ALL REVENUE AND EBITDA PERFORMANCEVIS--VIS BRAZILS GDP, 19972003

CAGR = Compound annual growth rate, an average annual growth rate measure.


19/45

One of ALLs newly acquired reconditioned locomotives.

THE PROMISE OF PR IVATE EQUITY14


20/45


revenue.7 Investment in newer

locomotives, better maintenance,

and logistics management and other

technologies had helped to reduce fuel

consumption, but with the introduc-

tion in 2000 of a fuel conservation

competition among the locomotive

operators, fuel consumption has

declined significantly (figure 4).

The Diesel Cup is an annual

competition in which all the

locomotive operators compete to

reduce fuel consumption, with the

reward being recognition for

fulfilling a major corporate initia-tive and cash bonuses and other

prizes. To avoid any possibility of a

decline in attention to health and

safety performance resulting from

the competition, accidents or

other significant safety violations

automatically disqualify an

operator from the competition.

As a result of the program, locomo-

tive operators have become far more

focused on efficient operation of theirmachines, with greater attention to

maintenance and improvements in

fuel economy as well as reduced

downtime and better on-time

performance. This in turn has put a

higher premium on the maintenance

shop, which in turn has raised its

performance standards. The mainte-

nance shop studied the Caterpillar

corporations maintenance program

and adopted many of their standards,

including white uniforms and aclean room atmosphere for the

maintenance shop. Oil changes and

heavy lubrication operations, which

required handling and storage of

used oils and solvents, have all been

outsourced to licensed operators,

leaving the maintenance operation

to focus on lengthening service

between locomotive overhauls.

Results

ALLs results have been dramatic,

including a very successful public

offering in 2004.

ALLs 2003 Annual Review

describes the companys continuingcommitment to its employees, to the

environment, and to the public at

large, and the success resulting

from this approach.

CONCLUSIONS

Companies often avoid or delay

implementing investments insustainability for budget reasons.

This is because, in effect, they are

discounting the benefits or positive

feedback from such investments. A

central aspect of the ALL case is that

the company made the investments

described in this case within a

business plan extremely focused on

cost cutting and very carefully

controlled investments. Two tenets

of the business plan were zero-based

budgeting and what was referred toas its Vietnamese 8 approach to

capital investments.9

ALL management applied four

rules to screen and prioritize

capital investments:

Capital expenditures were

limited to those that eliminated

bottlenecks preventing the

company from growing revenues.

The lowest upfront cash alternative

was preferred, even if it was not

necessarily the largest net present

value or the most elegant solution.

Options that fixed a problem

faster were preferred to

longer-term solutions.

Reutilizing existing resources

was preferred to acquiringnew materials.

With these investment management

principles in place, ALL has made

significant investments in its

workforce and its business operations

that have clearly contributed to the

companys long-term sustainability.

This case illustrates that investments

in long-term sustainability are part

of sound fiscal management and are

absolutely integrated with it. In ALLscase, financial sustainability is one

and the same with commitment to

employees, the environment, and

the public at large.

Figure 5 illust rates ALLs increase

in profitability vs. the Brazilian

economy as a whole, and figure 6

shows ALL revenue and EBITDA

performance relative to Brazil s

GDP from 1997 to 2003.

7. Alex Behring interview, February 9, 2005.

8. During the Vietnam war, bridges were key to rapidly deploying forces across the many rivers. The Viet Cong, with limited resources, built cheap, wooden bridges,which could be rapidly rebuilt if destroyed and therefore did not require defense. The U.S. military took the opposite approach, building expensive andtime-consuming steel bridges, which they then had to defend.

9. Sull, Donald M., Fernando Martens , and Andre Delben Silva, 2004, Amrica Latina Logst ica, Harvard Business School Case Study 9-804-139.


21/45


MengniuCASE STUDY 2

INTRODUCTION

Founded in 1999, Mengniu Group (Mengniu) has grownrapidly to become the leading dairy product manufacturer

in China. Its principal products are liquid milk (UHT milk,1

milk beverages, and yogurt), ice cream, and other dairy

products such as milk powder, milk tea powder, and tablets.

Mengniu has overtaken its long-established state-owned

rivals through dedication to quality and innovation in all

aspects of its business, including marketing, governance,

and aggressive adoption of international quality and best

practice standards.

CDH China Fund, an IFC investee private equity fund,

invested in Mengniu in 2002. Mengniu went public in2004 and trades on the Hong Kong exchange.

This sustainable business case study focuses on

Mengnius commitment to:

Its supply chain, consisting of independent

small farmers

Adoption and implementation of internationally

accepted management, systems for quality

assurance, environmental management, and

worker health and safety

Its employees and the creation of a safe and

desirable workplace (recognized in 2005 as oneof the 20 best places to work in China based

on the Happy Workplace index)

Continuing improvement and innovation

through joint ventures and use of

state-of-the-art equipment.

1. Ultra-high-temperature (UHT) pasteurized milk does not require refrigeration, therproviding extended nonrefrigerated shelf life of up to nine months and simplifyingshipping and storage for the producer and consumer.

Mrs Zhangs farmyard,cows, and watchdog.


22/45

17MENGNIU

BACKGROUND

Mengniu is a manufacturer of milk

products based in Inner Mongolia,

famous for its grasslands and one of

the traditional dairy regions of

China. Mengniu was privately

founded in 1999 by a management

team with long experience in one of

Inner Mongolias state-owned milk

product companies, Mongolia Yili

Industria l Group (Yili). Mr. Niu

Gensheng, the founder and chairman

of Mengniu, had lost his position as

vice-president of sales at Yili after an

internal power struggle in 1999. Mr.Niu had worked at Yili for 17 years

and his father before him for 38

years. Mr. Niu, and the smal l but

experienced management team he

brought with him from Yili,

started Mengniu with $12,600

of their own capital.2

Mengniu competes fiercely with

Yili and the other big Chinese dairy,

Bright Dairy & Food. The three

companies collectively controlledapproximately 60 percent of the

market as of August 2005.3

In only five years, Mengniu has grown

explosively, overtaking Yili as the top

seller of milk and simultaneously

becoming one of Chinas best-known

brands. According to AC Nielsen,

Mengniu was Chinas top seller of

milk in 2004 with 22 percent of the

market and revenues of US$871

million. This represented a revenueincrease of 77 percent over the prior

year, with an increase in profits of 94

percent or US$38.5 million. In the

first half of 2005, sales increased 37

percent to US$578 million and

earnings 34 percent to US$30

million, putting Mengniu on track

to exceed US$1 billion in sales and

US$60 million in profit.4

Mengnius success is also a function

of its commitment to innovation and

quality in the dairy industry which

has led it to adopt international best

practices and to act ively seek techno-

logical and operational improvements

through joint ventures and demon-

stration projects with international

leaders in the dairy industry.

THE DAIRY

BUSINESS IN CHINA

The milk product market in China has

grown dramatically in the last decade

as a result of increasing levels of

disposable income and improved

consumer awareness of the need toimprove dietary nutrition. The growing

market for milk products is due in part

to a government program that pro-

motes consumption of dairy products

for their health and nutritional

benefits. The annual growth rate in

dairy product consumption has been

estimated to have increased from 5.4

percent to 14.4 percent between 1998

and 2002 nationwide and by as much

as 30 percent per year in urban areas.

The dairy business in China involves

the following process:

Dairy farmers bring their cows to

milk collection centers for milking.

After each milking, the fresh

milk is immediately transported

by sterilized tank trucks to the

Mengniu plant for processing.

Milk is processed 24 hours a day.

Products are packaged and

warehoused.

The products are then distributed

to the market.

The collection centers, which were

established by the government,

consist of a central milking barn

surrounded by a series of small cow

barn and feeding yard complexes

with attached residential units forthe farmer and family.

The milking barn at each collection

center is owned and operated by a

third party who milks the cows and

supplies the milk to a dairy products

company. The cow barn and residential

units in the complex are owned by the

individual farmers, who must purchase

them. The farmers must also supply

their own cows and forage. The typical

collection center/farm complex has 40farmers and their families, and the

average farmer has from two to ten

cows. All manure is collected and sold

to the farmers for fertilizer, and given

the dry climate and relatively flat

landscape, there is little runoff.

In Mengnius case, each farmer has a

contract to supply milk to Mengniu

through the third-party collection

centers, which also are contracted to

Mengniu. The farmers are paid incash after each milk ing, based on

the quantity of milk produced.

Mengniu also provides quality

control supervisors.

2. Personal communication with CDH China Fund; Business Week, Chinas Free Range Cash Cow, October 24, 2005.

3. Business Week, Chinas Free Range Cash Cow, October 24, 2005.

4. The Standard, Chinas Business Newspaper, Top Stories: Mengniu reaps 34 percent gain in profits as sales climb, August 24, 2005.


23/45


The milk truck transfer operators

own their own trucks but are also

contracted to Mengniu. The trucks

are sterilized after each load at the

Mengniu plants sterilization center.

Mengniu has some 3,000 collection

centers under contract in China,

with some 1,800 in Inner Mongolia.

ROLE OF THE CDH

CHINA FUND

CDH China Fund took a very

active role with Mengniu in the

following areas:

1) Restructuring of the companys

ownership and shareholding,

which incentivized management

to build long-term shareholder

value as opposed to short-term

personal wealth.

2) Improved internal corporategovernance, which provided the

foundation for the company to

manage rapid growth (at times

greater than 100 percent year to

year) and create a sustainable

platform to effectively compete

in a highly competitive market.

3) Development of a stock option

plan, which further supported and

emphasized long-term, sustainable

profitability.

4) Execution of an IPO : CDH

was a key advisor to management

throughout the IPO process,

which was a huge success.

Mengnius going public was a

critical part of the companys

long-term viability, given

the need for capital to expand.

Equally important, going public

raised the companys profile and

reputation and increased access to

market intelligence.

5) Board-level Activity: CDHs

Managing Partner, Mr. Jiao Zhen,

was appointed Chairman of the

Board and continues to be an active

member, providing invaluable

advice to Mr. Niu and the manage-

ment team on business strategy and

corporate finance issues.

CDH did not, however, have a specific

role in the sustainable business aspectsdiscussed in this case study.

THE MENGNIU

SUSTAINABILITY

STORY

This case describes four aspects ofMengnius business model that have

enhanced the companys sustainability

and profitability, or triple bottom line:

Commitment to and technical and

financial support for the small

farmers in the supply chain, which

has fostered entrepreneurial

growth in this sector

Commitment to its workers,

resulting in the companys

top-20 ranking among places to

work in China

Implementation of international

quality standards and certifications

Continual improvement and

innovation.

Commitment to Supply Chain

One of Mengnius key competitive

strengths is its ability to obtain a

steady supply of high-quality raw

milk. Its supply chain consists of

some 500,000 dairy cows owned by

300,000 small, independent farmers

in Inner Mongolia and adjacent

provinces, with an average of 1.67

cows per farmer.

Prior to the creation of Mengniu,

the state-owned dairy company, Yili,effectively had a monopoly as the only

buyer of raw milk in the region. Yili

was able to set prices and keep them

The ZhangsPart of the Mengniu Supply Chain

Zhang Xiu Fang and her husband were traditional dairy cow herders from the western reaches of InnerMongolia. Seeking a better quality of life, they heard about Mengnius rapid growth and decided toexplore opportunities in the Mengniu supply chain. In 2003, they moved to a collection farm where thedairy farmers were contracted to Mengniu. The company helped them to get bank loans to purchase ahouse and farm unit. In the last two years, they have been able to increase their herd from 10 to 50 cowsby leveraging their earnings with the bank to buy additional cows. They have also increased their peranimal production via the technical support they have received from Mengniu.

The Zhangs have profited from the arrangement but have concerns, because milk prices are steady butforage prices have been rising. They also miss their children who remained in their home town, but theyare now participants in Chinas economic growth and own a truck, have a television with a satellite feed,and have achieved a higher quality of life than would have been possible in their former village.


24/45

19MENGNIU

low, in part because the supply then

exceeded the demand.5

Mengniu was able to capture supply by

offering a fair price and establishing

contracts with farmers guaranteeing

to purchase their milk at fair market

value. The more entrepreneurial

farmers saw this as a market

opportunity to increase production by

investing in more cows. Mengniu also

assisted the farmers in obtaining loans

from local banks, which al lowed them

to purchase farmettes at collection

centers, as well as more cows.

Mengniu established the following

principles for dealing with the

supply chain:

The farmers must supply milk

to the collection center.

Mengniu will pay the established

market value for the milk.

Mengniu will not pay more than

other companies, but neither will it

purchase milk for less than the

established market value or

contrive to pay less.

Mengnius pro-farmer program has

been extremely successful, as evi-

denced by its milk collection perfor-

mance. At the end of its first year,

Mengniu was collecting 19 tons a day,

whereas in 2005 they were averaging

5,000 tons a day, an increase of 263

times over six years.

Through its supply chain program,

Mengniu has in effect served as anincubator for small business

development, helping its small

suppliers to access finance and

fee-based technical support, and

training in animal husbandry to

optimize their production. This has

in turn improved the well-being and

economic situation for the small

farmers in their supply chain and the

local economy (see box on previous

page). The modern animal husbandry

techniques have been drawn from

best international practice, thereby

improving the environmental

sustainability of the small dairy

farmers in Mengnius supply chain.

Commitment to Workers

Mengnius extraordinary growth and

expansion would not have beenpossible without a dedicated work-

force. Since its founding, the company

has taken measures to create an esprit

de corps and worker dedication to the

companys mission.

In addition to financial performance

incentives, the company has created an

elaborate campus environment at its

headquarters, including apartment

complexes with gardens, fountains,

shopping centers including grocerystores, and recreation centers complete

with pools and other sports facilities.

There is also a large U.S. suburban style

neighborhood development for those

with families, featuring individual

houses with grass lawns and winding

streets with newly planted trees. The

company developed these facilities

for those workers who can rent or

purchase. For purchasers, the company

arranges financing for employees to

purchase the housing of their choice.

Mengniu was selected in 2005 as one

of the 20 best companies to work

for in China by the annual China

Happy Workplace index competi-

tion conducted by CCTV and based

on research conducted by Beijing

Universitys Social Investigation

Research Center.

Implementation of International QualityStandards and Certifications

As a part of Mengnius focus on quality

and innovation in the dairy industry, the

company has aggressively adopted and

implemented international best practices

and standards encompassing food safety

and quality, worker health and safety

standards, and environmental manage-

ment. Mengniu is certified for and

reportedly rigorously compliant with:

ISO 14001, the internationalstandard for environmental

management.

OHSAS6 18001, the international

occupational health and safety

management system specification.

Mrs. Zhang in front of her newtruck and farmyard.

5. Dairy product consumption in China has increased dramatically in the last decade due to government programs that have advertised the health benefits of dairy products, andbecause of more effective marketing and distribution by companies such as Mengniu.

6. Occupational Health and Safety Assessment Series.


25/45

One of Mengnius seven state-of- the-art milkprocessing plants headquarters.



26/45

21MENGNIU

It is comprised of two parts, 18001

and 18002 and embraces BS8800

and a number of other publications.

HAACP, or Hazard Analysis

and Critical Control Point

certification, the U.S. Food and

Drug Administrations standard

for food safety and quality control

during production.

Mengniu is also certified under the

Chinese Department of Agricultures

Green Food Net program. This

rating system examines agricultural

sector companies against certain set

standards, including compliance withnational environmental standards

and technical product standards

established by the Department

of Agriculture.

Continual Improvement and Innovation

One of the major factors in Mengnius

success has been its dedication to

improvement and innovation, both in

the dairy industry and companywide.

This is reflected in its aggressiveadoption and certification program

for quality standards described

above, as well as its purchase of

state-of-the-art equipment and

business liaisons with leading

international companies in the

dairy industry.

State-of-the-Art Equipment

Mengnius seven enormous produc-

tion plants at company headquarters

use the latest Tetra Pak machinery andequipment. The entire system, from

filling and packaging to palletizing

and warehousing, is computer

controlled. In the modern warehouses

at the rear of each modular produc-

tion plant, robotic forklifts automati-

cally carry and stack pallets of

packaged products. Mengniu also has

a sophisticated training program to

educate workers in the operation and

maintenance of the equipment.

Tetra Pak has a strong commitment

to the environment and sustainability

as well, and its equipment is designed

to minimize environmental impacts

and energy and water consumption.

Tetra Pak works closely with

Mengniu to optimize performance

and minimize impacts.

Strategic Liaisons with

International Companies

Mengniu has sought out a number of

strategic relations with leadinginternational firms to improve its own

business as well as to raise the bar in

the Chinese dairy industry as a whole.

In 2005 alone, these included:

An alliance with the Danish

biotechnology firm Chr. Hansen,

which provides ingredients to the

food, dairy, human health and

nutrition, and animal health

industries. Chr. Hansen and

Mengniu are teaming up to

promote probiotic culturesfor yogurt in China. Probiotic

culture yogurt is extremely

popular in Europe for its

enhanced nutritional benefits.

A joint venture with the

Scandinavian food firm Arla Foods

for the production of milk powder

packs. China is the worlds largest

consumer of milk powder packs.

A joint venture with the Australian

company Autasia, a specialist in

dairy cow breeding and husbandryand part of the Japfa Group and the

Indonesian-based Salim Group, in

the state-of-the-art Inner Mongolia

Mengniu Autasia Model Dairy

Farm. The 600-hectare farm has

a planned capacity of 10,000

breeding cows and features a host

of innovations to promote contented

cows, including robotic milk ing

machines that allow the cows

to milk themselves; hay from 12

species of grasses; piped-in music;

foam sleeping mats; and self-

grooming rotary brushes.

CONCLUSION

The sustainability aspects of Mengniu

can be attributed at least in part to its

many associations with international

leaders in the dairy industry. But the

paramount reason for the companyscommitment to and successful

implementation of these measures

is the vision of its founder and the

management team.

Second, while these initiatives

identified have been presented as

specific aspects or initiatives, they

are actually fully integrated within

Mengnius business plan.

Last, in the conventional businesssense, at least part of Mengnius

success would be attributed to

brilliant marketing and strong

policies and programs to build

worker satisfaction and dedication.

But from a sustainability perspective,

these could be considered elements

of a strong stakeholder engagement

program. Mengniu has demonstrated

a great knack for understanding the

marketplace, and for using this

understanding to develop productsand advertising campaigns that

have been extremely successful in a

short time. Similarly, the extremely

high worker satisfaction rating is

evidence of a management team

that is fully engaged with its

workers, understands what they

want, and is delivering.


27/45


MorionCASE STUDY 3

INTRODUCTION

Morion is a St. Petersburg, Russiabased developer

and manufacturer of high-end quartz frequency-control

devices. These devices provide the precise time and

frequency on which modern electronics depends.

Applications range from watches and cell phones to

navigation (GPS) and space and satellite technology.

Morions customers include the International Space

Station, Nokia, Motorola, and Alcatel.

Quadriga Capital, a private equity fund in which

IFC has invested, invested in Morion in 2000 alongwith the EBRD. Morion remains privately held, and

detailed financial data were not disclosed.

This sustainable business case study focuses on Morions

successful efforts to improve operational efficiencies and

profitability by reducing energy consumption and

reducing water consumption and wastewater generation.

BACKGROUNDMorion means black quartz in Russian, and the conver-

sion of synthetic quartz crystals into extremely precise

oscillators is Morions business. Vibrating quartz crystals

are the heart of nearly all frequency-control devices,

which provide the basis for electronic clocks and the

control of electromagnetic waves in virtually all modern

electronic products. The use of quartz crystals began with

military applications in the late 1930s and has expanded

Morion final crystalquality testing facility.Equipment bankscontain crystals beingsubjected tocontinuous tests to

weed out substandardperformers.


28/45

23MORION

to virtual ly all modern electronic

technology (see table 1.)

Morion traces its history back to theestablishment of the Siemens and

Halske telegraph company in St.

Petersburg in 1855. The company

subsequently became involved in the

early days of the quartz frequency-

control business in the 1930s.

In 1994, after the company had been

state-owned for 70 years, Dr. Yakov

Vorokhovsky, head of the research

and development department,

initiated a management-led buyout

and conversion of the company intoa private joint stock company.

Dr. Vorokhovsky soon began to

reinvent the company. In 1990, the

company had 1,500 employees and

sales of US$1.7 million. The staff was

bloated, as in most Soviet-era state-

owned enterprises, and the staff was

gradually cut, but Dr. Vorokhovsky

and the management team

endeavored to retain the best employees

and improve company morale. The

process was not as difficult as it mighthave been in other settings, because as

a state-owned company, salaries were

very low and payment irregular.

In the end, the workforce was reduced

to 500, but average salaries increased

from US$17/month to US$500/month.

Dr. Vorokhovsky implemented a

number of other initiatives to make

Morion a desirable place to work,

including cleaning up and modernizing

the bathrooms and bringing in an

outside contractor to operate acafeteria for the workers.

Morion has experienced steady

growth since privatization.

Sales were US$2.4 million in 1997

and were projected to be US$15

million in 2005. The company has

continually improved its internal

quality control and production

efficiencies, and this has helped it

overcome the former market percep-

tion that Russian companies were

incapable of providing consistentquality and on-time delivery. As a

result, the company has both pene-

trated and in recent years increased its

share of the international supply chain

to the cellular telephone market and

space industry and plans to continue

to penetrate these markets and

develop new ones.

ROLE OF THE

QUADRIGA

CAPITAL FUND

In the Soviet era the emphasis was on

production versus efficient use of

resources, as the state controlled

TABLE 1.MAJOR APPLICATIONS OF QUARTZ CRYSTALS

Military andAerospace

Research andMetrology

Industrial Consumer Automotive

Communications

Navigation

GPS

IFF

Radar

Sensors

Guidance systems

Fuses

Electronic warfare

Sonar buoys

Atomic clocks

Instruments

Astronomy and geodesy

Space tracking

Celestial navigation

GPS

Communications

Telecommunications

Mobile/cellular/portable

radios, telephones and pager

GPS

Aviation

Marine navigation

Instrumentation

Computers

Digital systemsCRT displays

Disk drives

Modems

Tagging/identification

Utilities

Watches and clocks

Cellular and cordless

phones

Pagers

Radios

Stereos

Color TV

Cable TV systems

Home computers

VCRs and video camerasCB and amateur radio

Toys and games

Pacemakers

GPS

Engine control

Car stereo

Clock

Trip computer

GPS


29/45


prices, and market forces were

irrelevant. Heating costs, substantial

given the long and cold winters, were

paid by the state, and conservation

measures such as insulation, double-

glazed windows, etc. were not

considered. Morions bui lding,

a sprawling, multistory labyrinth

typical of Soviet-era architecture,

was quite inefficient in all aspects

of building services, including

winterization measures, heating

and cooling, and boiler efficiency.

Quadriga was very familiar with

the state of affairs in former Sovietenterprises, and specifically aware

of how these costs impacted Morions

financial situation. The initial

environmental due diligence

screening of Morion had identified

that the company was paying an

annual US$50,000 charge for raw

water and wastewater discharged

(in the Russian system, only the

incoming raw water is metered, and

wastewater volume is calculated on

the basis of raw water consumption).

Given the companys tenuous

financial condition in the early years of

Quadrigas involvement, the $50,000

charge was significant. While aware of

these opportunities, Morion was

focused on survival and did not have

the time or capital to invest in

developing solutions. Quadriga urged

Morion to pursue remedies and agreed

to finance the necessary investments.

This led to the three programs described

herein being implemented and the

development of a corporate culture

focused on optimizing manufacturing

performance and reducing waste and

pollution. To ensure success, Morionhired Sergei Olhovsky, a civil engineer,

whose sole role would be to manage

the development and implementation

of the program. Mr. Olhovsky has

been creative in his approach, using

abandoned equipment in one

application to save capital costs.

In addition, broader sustainability and

technical demands were pushed down

the supply chain by the multinational

firms considering purchase of Morion

products. For example, Nokia, which

has subsequently become a major

purchaser of Morion products, had

stringent material requirements for

suppliers, including a prohibition on

the presence of lead and cadmium in

soldering of circuits. Nokia would not

agree to purchase Morions products

until these standards were met,

resulting in adoption of these stan-

dards for all its products.

Second, Nokia also required that

Morion be ISO 14001 certified, which

the company subsequently achieved.

Morion would likely have had a verydifficult time achieving these higher

performance standards without

Quadrigas financial support.

Last, achievement of these international

standards has allowed Morion to access

other international markets where

these same standards are applied.

Hence, Quadriga was able to

significantly influence Morions

environmental sustainability, whichhas contributed to the companys

overall financial sustainability.

THE MORION

SUSTAINABILITY

STORY

This case describes three Morionprograms that have enhanced the

companys sustainability and profit-

ability, or triple bottom line:

Measures implemented to reduce

natural gas consumption


water consumption


electricity consumption.

Dr. Vorokhovsky in a Morion control room.


30/45

25MORION

These measures are described below,

preceded by a description of the

context for the measures.

Natural Gas Use Reduction

Morion began its program for reduc-

ing natural gas consumption in 2000.

The first and most significant measure

was to redesign and retrofit the boiler

to make it more efficient. Morion was

able to realize considerable cost

savings in this project by obtaining

an abandoned boiler from another

plant, rehabilitating it, and using it to

replace the previous boiler, which wasoversized and inefficient.

In addition, as Morions primary

use of water is for cooling production

machinery, hot water was recycled

from the cooling line back into the

boiler feed stream to take advantage

of the already elevated temperatures.

The total investment was approximately

US$5,000, and the investment was paid

back within six months.

In Year 2 (2001) Morion focused on

improving the thermal efficiency of its

building. The major effort, and cost,

was instal ling double-glazed windows

throughout the building. The compa-

ny also improved the seals around the

doors and cut off other leaks to the

outside, generally improving the

buildings performance.

In Year 3 (2002), Morion made a

series of additional incrementalimprovements to the heating system

to improve performance.

The net result is that Morion has

reduced absolute gas consumption by

more than 55 percent, from approxi-

mately 700,000 m3/year to approxi-

mately 300,000 m3/year. The reduction

versus an output metric (e.g., versus

FIGURE 1.

NATURAL GAS CONSUMPTION AT MORION, 2000-2004

FIGURE 2.

WATER CONSUMPTION AT MORION, 2000-2004

each $1,000 of production) is even

more impressive (see figure 1).

Morion has reduced gas consumption

from approximately 140 m3/$1,000

of production to 22 m3/$1,000 of

product, or approximately

85 percent.

Water Use Reduction

In 2000, Morion implemented a parallel

program to reduce water consumption.

Morion obtains water from the munici-

pality of St. Petersburg. Enterprises are


31/45


charged Ruble 22/m3 (approximately

US$0.78/m3), and the charge covers both

water and wastewater, though only the

incoming fresh water is metered.

Morion used to discharge all its

heated water. As part of the gas

reduction program described above,

Morion now recycles the hot water,

thereby saving both energy and raw

water costs. In addition, Morion

purchased a system of electrical

coolers that allows them to recycle

water used for cooling multiple times.

Absolute consumption of waterdecreased approximately 10 percent

from 2000 to 2004, from over 70,000

m3/year to approximately 63,000 m3/

year. In terms of product output in

dollars, Morion reduced consumption

in that period by approximately

65 percent, from 14 m3/$1,000 of

production to 5 m3/$1,000 of

product (see figure 2).

Electricity Use Reduction

Morion began its program to reduce

electricity use in 2001. There were

four primary programs under this

initiative:1

Replacement of older equipment

with more modern and efficient

equipment

Replacement of boiling/evaporation

unit for distilled water with a

reverse osmosis unit

Monitoring of consumption to

determine use patterns andprocesses with heaviest usage to

then reexamine for possible

efficiency improvement

Parallel improvement programs

throughout the plant to improve

production quality, one of which

FIGURE 3.

ELECTRICITY CONSUMPTION AT MORION, 20002004

1. This initiative was financed by an EBRD credit for modernizing production, and Quadriga managed the process.

was installing an air conditioning

system to improve clean room

standards and working conditions

for staff.

As shown in figure 3, Morions net

consumption of electricity from 2001

to 2004 actually increased by 150,000kW/hr with increased production, but

consumption relative to production

decreased f rom 380 kW/hr to approx-

imately 300 kW/hr per US$1,000 of

production, a 21-percent decrease in

electricity consumption per US$1,000

of product.

CONCLUSIONMorions investments in energy and

water efficiency have reduced its

production costs, improved working

conditions and worker productivity,

and allowed the company to meet

environmental supply chain require-

ments. Further, the investments

helped Morion overcome a major

negative market perception: that

Russian companies utilize dated

technology and are incapable of

meeting stringent Western quality

standards and on-time delivery ofproducts. Morions efforts to reinvent

the company and optimize its produc-

tion efficiency and consumption of

resources are helping it overcome this

stigma as well as contributing directly

to the triple bottom line.

All of the investments made have had

rapid payback, with the longest

payback being the reverse osmosis

system (14-month payback), and the

shortest being the boiler upgrade,which had a 6-month payback.


32/45

27RE C LAM AT ION GROUP

Reclamation GroupCASE STUDY 4

INTRODUCTION

Reclamation Group (RECLAM) is the largest recycler

of ferrous and nonferrous scrap metal in South Africa.

The company is privately held and was founded in 1998

with a business plan to purchase and consolidate small,

family-owned steel scrap recycling businesses into a larger

company. The companys vision was that waste and scrap

steel represented an aboveground mine, and that by

consolidating a number of smaller, established steel

recyclers, improving operations, and raising standards,

it could reinvent a formerly dirty industry into

an important business sector contributing tosustainable development.

Since 2000, having assembled a base infrastructure

of steel scrap recycling centers throughout South Africa,

the company expanded into other recyclable commodities,

including glass, paper, cardboard, rubber, and integrated

waste management services to become the one-stop waste

management/recycling solution. Brait Capital, a South

African private equity fund, invested in RECLAM in 2000.

BACKGROUND

RECLAMs business is the purchase, processing, and sale

of ferrous and nonferrous scrap metal. The company

has 60 facilities and 2,300 employees. RECLAM is an

industry-leading concern and the largest such operation

in Africa. The company was founded and is still largely

based in South Africa, though branches have been opened

View of main plant,with truck driving ontoone of the twoweighbridges.


33/45


in Mozambique, Swaziland, Malawi,

Kenya, Zambia, and Botswana.

RECLAMs primary business is the

recycling of ferrous metal (e.g., steel),

though the company also handles

smaller quantities of nonferrous metals

(e.g., aluminum, copper, brass). The

plants receive all manner of metal

scrap, from steel fabricator scrap to

decrepit vehicles and other metal trash.

The metal recycling business involves

the following stages:

Receipt/collection : Metal scrap is

sourced from a variety of suppliersin South Africa and neighboring

countries, and the scrap metal is

transported to the closest process-

ing facility. RECLAM receives

metals directly from manufactur-

ers; collects metals from manufac-

turers via waste collection

contracts using the RECLAM truck

fleet; and buys metals from the

informal sector (e.g., individual

collectors/haulers).

Separation: Metal is separated fromnonmetal waste.

Weighing/grading: This enables the

company to determine load value

and payment.

Processing: This step involves

separating all waste, including

hazardous wastes disposed of

properly); cutting; fragmentizing

(cars, trucks); and compressing.

Final product:Storage and delivery

constitute the final stages.

There are three tiers in RECLAMs

supply chain of metal scrap:

Contracts with major metal

working companies that deliver

scrap with their own trucks

RECLAMs collection truck fleet,

which picks up scrap from larger

clients

The informal or microenterprise

sectorindividuals or small

groups who earn a full-time or

part-time livelihood by collecting

and hauling metal waste for sale to

recyclers such as RECLAM.1

RECLAM has recently expanded into

glass, paper, and cardboard recycling.

The companys concept is that on the

back of its ex

the promise of private equity (november 2006)

Documents