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Pre-Operation and Operation Wastes in a Public Enterprise-A Case Study

(Contributed by the Office of the Auditor General, Pakistan)

Background of the study

The control of public enterprises and their social and political accountability have been the issue of great concern among the developing nations where public enterprises are playing an increasingly important role in socio-economic development. This increasing reliance by developing countries on public enterprises in economic and social development has been responsible for emergence, of an institutionalized arrangement in many developing countries for reviewing the performance of such enterprises. In Pakistan, this arrangement took the shape of Performance Evaluation Cell (PEC) which was created in 1978 in the Auditor General's Department. The area being absolutely new, a methodology was evolved, with the assistance of a friendly country, to identify the strengths and weaknesses of public sector enterprises in key areas of their operation to reach an informed opinion as to the soundness of their operations and to recommend meaningful and practical correctives with a view to /improving their performance. The Cell identifies important problems affecting the health of an enterprise relating to the various areas of its operations and presents a well documented report to a Select Committee of the National Assembly.

The case study that follows is based on one of the PEC's reports and highlights the wastes involved at the pre-operation stages of an enterprise.

(A)    Pre-Operation Wastes

The project was neither well conceived nor timely implemented and as such involved both time and cost overruns.

The scheme of the project was submitted to Government for approval in April 1967. It was based on studies of raw material carried out by foreign consultants. Its first part (involving tapping of raw material) was approved in 1968 and the second (involving use of this

The scheme of the project was submitted to Government for approval in April 1967. It was based on studies of raw material carried out by foreign consultants. Its first part (involving tapping of raw material) was approved in 1968 and the second (involving use of this raw material) in 1977. The approved cost was Rs. 30.38 million (Rs. 11.12 million in foreign exchange) Implementation of the scheme depended mainly on availability of foreign exchange for the project which was tied up with foreign capital aid. Foreign aid was suspended in 1971. The approved scheme was later revised in 1973. Revised capital cost of the project was estimated at Rs. 54.52 million (Rs. 34.67 million in foreign exchange).

The scheme was further revised and submitted to the Government in 1975. Capital cost of the project now worked out to Rs. 88.75 million (Rs. 47.66 million in foreign exchange). Reasons for second revision included:

• increase in cost of plant and equipment after application of annual price escalation clause of the agreement;
• continuous revaluation of foreign currency resulting in substantial increase in foreign exchange cost of the project;
• increase in local cost due to more than two-fold rise in the cost of civil engineering works;
• non-provision of a major head of electrification in the original scheme.

The plant was scheduled to go into production in June 1976 for both the products A&B. But the commercial production in respect of Product A started in July 1977 and for product B in January 1978. There was thus a delay of 12 and 18 months as compared to the dates scheduled in the approved project. Actual completion cost of the project was Rs. 102.05 million which was about 15% more than the final revised approved cost. The cost and time overruns are indicated below/:

The basic raw material was to be indigenous and was got tested by a Foreign Consulting Institute. The raw material was to be supplied by a sister concern. Report on feasibility survey for the development of local raw material had stated that "first grade material (to be produced from local raw material) was as good in quality as the world's first grade". The report further stated that local material could be used "for all purposes for which this mineral is required." This opinion was based on physical and chemical tests carried out by the consultants "on the samples collected in Pakistan by the survey team". In actual operations, however, it was not found fit for use with the result that the raw material had to be imported thus involving expenditure in the much needed foreign exchange-a contingency which was non-existent in the approved project.

(B)    Operation Wastes

The basic raw material on which the scheme was-based was later found to be unsuitable and necessitated imports which were not only costlier but also involved expenditure in foreign exchange. Cost-wise 84% of the raw material and chemicals used were imported against the 24% import content envisaged in the approved scheme. Such excess expenditure amounted to Rs. 1.45 million during 1977-80.

Process wastes/rejects accounted for another Rs. 5 million during 1977-81. Wastages/rejects in production of Product A during 1977-78 to 1980-81 averaged 50% of the total material consumed, as against 10% wastage

considered admissible. Excessive consumption of material resulting from higher proportion of wastage/rejects had caused the company, during 1977-78 to 1980-81, extra expenditure of about Rs. 4 million. Consumption of materials in production of Product B was also excessive. The excess consumption during 1977-78 to 1980-81 ranged from 4% to 23%. This was over and above 5% wastage considered to be the allowable maximum, in this process. It had caused the company an extra expenditure of Rs. 1 million during 1977-78 to 1980-81.

Capacity utilisation for Product A ranged between 27% and 40% only during 1977-81. Reasons reported for low capacity utilisation were:

• deficiency of one ball mill (used for mixing and grinding of raw material). Local material, being hard, took longer time in grinding, rendering the available two ball mills insufficient to prepare the required quantity of casting slip;
• inadequate facilities for drying of pieces resulting in excessive breakages at initial stage (green pieces);
• excessive handling losses due to the process being almost entirely manual.

Capacity utilisation of Product B ranged between 62% to 66% during 1978-79 to 1980-81. Factors included:

• the presses in use were statedly of obsolete design resulting in frequent break-downs;
• non-availability of standby presses;
• heavy process losses due to defective presses.

Low capacity utilisation of the two products during 1977-81 resulted in non achievement of even the break­even production during 1977-81. The causative factors in low capacity utilisation and resultant process losses were also attributed to defective purchase planning and coordination.

Planning of purchases was found to be lacking as was evident from the instances given below:

(a)    Mixers:

Main reason given for below capacity utilisation of the product A plant was shortage of a mixer. It was decided by the Management in October 1978 to have a mixer fabricated locally at a cost of Rs. 325,000. It was to be delivered in February 1979. The machine was actually delivered in May 1980. A contract for its installation was concluded in January 1981 but the work had not been completed by the end of April 1981 (date of evaluation). Meanwhile two such equipments supplied by foreign suppliers reached Pakistan in September

1980 the release of which could not be obtained until April 1981 due to a reported dispute regarding payments of customs duty and sales tax. The end result was that as many as three equipments had been procured by the company but the product A plant continued to operate at below capacity level due to delay in their installation.

(b)    Spares for presses:

Spares for product B presses had a short life and required frequent replacement. The spares indented in mid-1980 by the Production Department could not be procured until April 1981 (date of evaluation). Meanwhile presses suffered from frequent break-downs. The gravity of the situation was evident from the fact that technical break-downs of presses during July 1980 to March 1981 aggregated 2,479 hours and process loss on occasions soared as high as 80%.

(c)    Imports:

No effort was made to diversify the source of procurement in case of imports in order to obtain goods at competitive rates. It was considered that sources of procurement could be diversified to achieve economy without detriment to quality of production.

(d)    Over-purchasing:

A tendency of over-purchasing stores and spares was observed. Certain stores and spares were found to be redundant. The funds of the company were thus tied up unnecessarily in unused and non-usable stores and spares. This was not desirable particularly in view of tight financial position of the company.

Products of the company were categorised according to quality into grades designated as "Standard" "Economy" and "Sub-standard". "Standard" grade production of product A during 1977-79 averaged 30%. It increased to 45% during 1979-80 but again declined to 27% during July 1980 to April 1981. This was far below the standard of 50% laid down in the guarantee clause of the agreement for supply of plant and equipment. Excessive low quality production had the effect of substantially reducing the sales revenues of the company. Reasons for excessive low quality production of product A were stated to be:

• development of cracks in the roof of the kiln. This caused falling of specks from the roof (covered with sand etc.) which affected the quality of finished goods. Development of cracks was attributed by the Management to "design and construction fault at plant erection time".
• non-maintenance of required temperature (45°C) especially in winter, in the casting hall due to its high roof. This did not allow the moulds to dry up in time thereby causing deformation and cracking of the products;
• non-availability of skilled labour.

'Standard' grade production of product B also deteriorated during 1980-81. This was attributed to:

• use of worn out punches in presses due to delay in import of quality punches;
• heavy process losses due to defective presses;
• use of sub-standard material due to delay in procurement of material of appropriate quality.

Sale price of lower grades was 10% to 35% less than that of 'Standard' grade product. Excessive production of inferior quality product had therefore considerably affected the sales revenue of the company.

The company employed 508 employees on March 1, 1981 as against a strength of 364 personnel assumed in the approved scheme. This showed 40% (144 persons) excess employment. Overstaffing had the effect of:

• increased cost of establishment per ton of production;
• decreased productivity per employee. Productivity per employee during 1977-80 ranged from 4.6 tons to 5.3 tons. This was less than half of productivity of over 12 tons per person envisaged in approved scheme.

MIS and internal control were found lacking in that:

• capacity performance of the product A had never been tested. No realistic appraisal of production performance was thus possible;
• quantitative standards for various inputs like raw material, chemicals, fuel and power in terms of unit finished product had not been determined. Effectiveness of control on inputs was therefore reduced;
• record on production side was not being maintained properly. For example details of breakages and rejects of finished items of product A for the period prior to January 1980 were not available. Similarly details of raw materials consumption in production of product A for the period prior to August 1979 were not forthcoming. Meaningful analysis covering rejects and quantum of inputs and outputs was therefore not possible;
• weights of various items of product A adopted by the company's Finance Department in preparing their cost accounts differed from actual weight intimated by the Production Department;
• No proper cost system was installed to timely throw up wastes in various areas for corrective action.

Product A of the company faced stiff competition not only from the indigenous but also from the imported products. Its quality did not compare favourably with that of imported goods. Moreover price differential available to the consumer vis-a-vis imported goods was relatively small. The company faced tough competition in relation to marketing of Product B as well.

Conclusion:

Excessive consumption of costly material, excessive low-grade production, under utilisation of production capacity, less than break-even level of production, inability to market even this low production with consequent accumulation of unsold stocks, excess employee strength resulted in accumulation of a loss of Rs. 12.5 million and erosion of 90% equity within 3 years of the commencement of production.