For the final project, you will create a P

UV5979 Rev. Sept. 5, 2019

Husk Power Systems: Scaling Up a Start-Up

It was January 2009 when Manoj Sinha, a student at the Figure 1. An HPS generator in a rural Darden School of Business, drove to Washington, DC, to meet village in India, 2008. a potential investor in Husk Power Systems (HPS), a start-up company that built feedstock-fueled generators in rural India (Figure 1). He parked his car, entered a modern hotel, and sat down with Stefan Ramdas to discuss HPS’s funding needs. Sinha had expected Ramdas to be interested in financial projections and EBITDA margins, and he was pleasantly surprised to find that one of Ramdas’s biggest concerns was not financial but operational in nature. The investor wanted to understand Sinha’s plan for scaling up his operations in India and other rice-producing countries. Sinha had thought about this quite a bit and had considered several options. For a brief moment, the entirety of his start-up journey flashed through his mind because he knew his response to this important question could make or break his chance at “getting to yes” with this investor.

A Breakthrough Energy Start-Up

Thinking back through the genesis of HPS, Sinha mused on the four-man partnership that made up the company:

The conception of the project was way back in late 2006. Gyanesh Pandey and I went to undergrad together in India…We thought about giving back to the community we grew up in. We were exploring education and power. Growing up, we did not have more than five, six, or seven hours of power every day. So we decided [power generation] would be best.

Gyanesh had another friend, Ratnesh Yadav, whom he had gone to school with from the 4th through the 10th grade. He had a better idea about the villages and the logistics than we had. The fourth partner, Chip Ransler, was my Darden classmate…He joined us in late 2007.

We started exploring different options to supply power to these rural areas. We looked at solar, fuel cell, wind, and jatropha biodiesel [made from the seeds of the Jatropha plant]. These were all too

Source: Gyanesh Pandey, Husk Power Systems. Used with permission.

This case was prepared by Manoj Sinha (MBA ’09) and Rebecca Goldberg under the supervision of Raul Chao, Assistant Professor of Business Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright  2011 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to [email protected] No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to [email protected]nbusinesspublishing.com.

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difficult or too hard to make or maintain…Then we looked at using rice husks for fuel. Burning the rice and running turbines—this was too expensive.

Gasification technology was from World War II. That technology was already available. We experimented by trial and error for a couple of months, and then we met the generator supplier. It was all meant to happen. We were meeting a lot of people and running experiments. It all happened at the same time, on August 15, 2007…our first successful experiment. The gasifier heated up the rice husks to a high temperature, with very little oxygen, and produced gas. That gas was filtered and went into a generator. It was a completely carbon-neutral process.

The four partners had high hopes for HPS. They intended to provide power to millions of rural Indians in a financially sustainable, scalable, environmentally friendly, and profitable manner. HPS had created a proprietary technology that cost-effectively converted rice husks into electricity. The organization had developed a power supply and distribution system that used 35-to-50-kilowatt (kW) mini power plants in villages of 400 to 500 households within the Indian “Rice Belt” and offered electricity as a pay-for-use service. HPS had successfully implemented its service in 20 villages in Bihar, India, and planned to expand its footprint to 45 villages in 2009. One power plant served three neighboring villages on average. HPS electricity replaced much of the diesel and kerosene that villagers used at the time for power generation, yielding cost savings of over 35% for agricultural and commercial customers and dramatically improving cost efficiency for household consumers. HPS projected each installation to be operationally profitable at 40% utilization and to break even in three to four years. Each power plant had an estimated life of 12 to 15 years. HPS had identified 25,000 villages of India’s 125,000 unelectrified villages within the Rice Belt as feasible implementation sites.

At the time of the meeting between Sinha and Ramdas, HPS had been operational for 18 months and had successfully deployed seven power plants. Each power plant could generate 35 to 45 kW of energy. Running the entire business on only seven operational power plants had its own set of challenges, and the management team had invested a lot of time ironing out operations, sales, marketing, billing, and collections issues. One of the keys to the success of the direct energy provider business was to have a collection rate exceeding 90%. Although this rate would have been easy to attain in the United States, collection for energy consumption in India had its own challenges. To enhance its political image, the Indian government had promised to provide free electricity to off-grid rural villages and often provided other subsidies. Indians had come to believe they should not be charged for using electricity. Indian energy companies lost between 35% and 40% of their revenue to power theft and payment default. HPS had developed several proprietary methods that raised the collection rate to more than 95%.

Sinha was proud of the ways in which HPS had responded creatively to these cultural challenges. He recalled:

On average, power stealing and default in India is close to 20% to 25%. For us, it is less than 5%. What happens in the villages is, it’s very easy to tap into wires and hook your house with electricity. It’s hard to catch them. Almost everyone does it. HPS is decentralized. Our wires don’t run more than one to two kilometers in length. Also, we use double-shielded aluminum wire and insulator coating on top of that. You can’t just hook onto the wire; you have to cut into it.

As Sinha prepared to respond to Ramdas, he reflected that HPS faced challenges related to expanding service to 1,500 villages over the next three to four years. He had come so far and was slightly nervous as he thought, “The next 70 generators will not be that much harder than the first 25. The next 500 to 1,000 is a

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huge deal.” He classified the issues of scale-up into three main categories: upstream, production, and downstream.

Supply Concerns

Upstream concerns primarily focused on the procurement of equipment, which included a gasifier, a generator set, and service contracts. At the time, HPS procured its generator sets from a single supplier, Prakash Genset (Prakash), which owned a patent on gas-based generator set technology. The cost was approximately $10,8001 per set. In an ideal world, the supplier would promptly provide and service the equipment; however, this had not been the case. Because HPS had only ordered seven sets in the last year, Prakash, which sold nearly 6,000 sets in that time, had not been providing HPS with high-quality customer service. A poor relationship with one’s supplier could become a critical roadblock during the expansion phase of a start-up.

Given that the company operated in India, the potential for illegal competition was high. HPS needed to maintain a competitive advantage through advanced technology and bare-bones cost. The company also wanted to avoid the bottleneck issue that might arise with a single-source supplier. HPS had considered three possible ways to resolve its upstream goal of reliably and cheaply procuring its generators at any scale.

Develop a relationship with an alternate supplier. Ankur Scientific was a large, global gasifier supplier that charged a 60% to 75% premium for its products. Benefits to using this supplier were that capacity, quality control, and production were less risky. Drawbacks included cost, lack of a personalized customer relationship, and the diminished potential for jointly developed technology.

Find a less expensive supplier in China. Uncertainties involving delivery, government regulations, tariffs, lead time, and lack of data regarding quantity and quality made this option less desirable, in Sinha’s opinion.

Invest in Prakash. Developing a long-term relationship with Prakash held some promise. In the past three months, HPS had been able to place orders for four new sets. It had also given Prakash $50,000 to ensure that all new orders were handled with the utmost importance. In response, Prakash had shown an inclination to negotiate a possible 7% to 8% discount. Because HPS worked closely with the gasifier supplier, it held an exclusive right to any improvements HPS engineers or scientists brought to the technology. Prakash’s competition manufactured similar equipment sold at a 150% to 200% premium.

If HPS wanted to ramp up production with Prakash, it would need to make capital investments to enable Prakash to scale up production and prevent obstacles. This solution implied vertical integration, and the small management team of a start-up company might not be capable of handling these expanded responsibilities. Timing was also a concern. If the expansion strategy did not come to fruition until 2011 or 2012, it would mean less return to existing investors and difficulties in raising the next round of funds. Series B fundraising efforts were targeted at $10 million to $15 million.

Develop an in-house generator set and outsource manufacture to a new supplier. If HPS succeeded in developing a new technology with a new supplier for the generator set, that would surely attract Prakash’s attention. HPS would have to invest in R&D from its limited reserve of capital to develop alternative technologies and communicate the design and production to a new supplier. HPS had actually succeeded in developing an indigenous generator set but had not tested it rigorously. It would take another year before HPS could confidently use its own generator set. There were other implications: If Prakash came to know about the in-

1 The exchange rate was (Indian rupee) INR0.45 per (US dollars) USD1.00.

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house generator set during the testing phase, it might react and increase its prices, or, in an extreme situation, might not sell its equipment to HPS. This was a delicate issue and needed to be handled with the utmost care.

Cost Drivers

The main cost drivers for manufacturing generators lay in design, geography, execution, and facilities technology.

Design: direct material and training cost. The expense of the generator was primarily dependent on parts and training cost. Costing out the most expensive parts enabled HPS to evaluate potential part substitutes. See Exhibit 1 for a breakdown cost analysis of three generator alternatives that HPS considered in the early stages of decision-making. Given that HPS was responsible for training the technicians who operated the villages’ generators, simplicity was key. Any increase in the generator design’s complexity was directly proportional to the training costs. There was significant risk inherent in managing the cost of training and in identifying and hiring skilled technicians in rural India.

Geography: transportation costs, wage rate, and excise duty. Remote locations in India were accessible by road. Local, reliable suppliers minimized initial transportation charges and reduced the time required to procure spare and maintenance parts. Wage rates for skilled technicians working on a small scale in rural areas were higher than what was required for the same technician in an urban area working in a larger-scale facility. The excise rate was also different for each Indian state and at times could be up to 15% of the cost of the equipment. Consequently, strategic geographic placement of the plants could have a large impact on the site’s profitability.

Staffing: Staffing depended on the scale of the facility as well as the level of technology and amount of automation used there. A large facility with high automation and a steady demand could be easier to staff than a smaller facility with erratic demand. Part-time workers were not easy to find; the availability of a skilled workforce was inconsistent. Newly trained workers might easily take their skills and find higher wages in another location.

Generator production: Sinha found that production costs could be significantly reduced by using more advanced manufacturing technology. Unfortunately, this automation was capital-intensive, and until his capital needs were met, HPS would be forced to focus resources on more expensive, less technologically advanced generator production. Another factor was capacity: Prakash produced 6,000 generators per year, whereas a smaller, local manufacturing facility would produce 50 generators per year.

Internal Capabilities

Sinha knew that with scale came not only challenges, but also opportunities to realize efficiencies. By far, the most difficult challenge HPS faced in scaling up internal operations was in locating and training people and empowering them to participate in process improvement and in their own career advancement. “Human ability is so important,” he recalled. “Pay a premium to the workers. We do a road show, we advertise, and get talented people on the team. That’s the only way to achieve that milestone.”

Process improvement planning was something Sinha and his management team had thoughtfully considered. Sinha knew that ground-level operators and technicians would discover potential operational improvements. Because the workforce was relatively uneducated and used to working under a chain of

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command, however, employees were afraid to question anything. HPS intended to take steps to empower its employees so process improvement would take place at the ground level.

The establishment of an independent training center seemed like a good idea. HPS management had observed that operators were afraid to tinker around with the machines because they feared the power plant would fail during regular hours of operation. To circumvent this issue, the company planned to invest in building a small workshop and training center that would facilitate training a sufficient number of people for expansion and allow trainees to share ideas with each other. It was management’s responsibility to dispel the fear of failure and instill in the workers the ability to take calculated risks. Management was contemplating a new policy of “no punishment for breaking stuff worth $2,500” in the hope that it would allow trainees to take calculated risks in experimenting with new ideas and give them a sense of ownership. HPS’s long-term goal was to share innovative best practices across the organization.

At the time, HPS was already training all the operators, plant developers, and accountants to carry out daily activities. To motivate these employees, HPS had come up with an incentive structure to ensure that every employee received a fair chance to enhance his or her skills and grow as a leader of the organization. The company had developed a road map for each technical operator and collections associate that he or she could take to become a cluster manager within two to three years. The operations supervisor’s responsibilities included leading a set of seven to eight power plants, training the employees of these plants, and eventually helping to execute HPS’s plan of organic growth. Similarly, the person in the role of billing and collections could grow into the role of cluster accountant. By creating such a road map, HPS management hoped to encourage employees and set them up for long-term success.

The HPS management team hoped to discover new ways to reduce the company’s overall cost and increase efficiency in the central part of its process. Power plants operated above 60% capacity in the evening when households received power. During the day, however, only small businesses and irrigation pumps were supplied with electricity, which resulted in an average utilization of 35% to 40%. HPS management planned to overlap these two operations to maximize the utilization to about 85% at peak and increase average utilization to more than 60%.

Downstream Process

HPS’s primary downstream challenge was marketing. When selecting a site, HPS required an abundant rice husk supply, and it needed to be able to light over 1,000 compact fluorescent lights (CFLs) in the first 90 days of installation, which translated to 400 to 500 households in a three-village area. Marketing challenges existed primarily in educating the consumer about the cost, consistency, and environmental benefits to the energy HPS provided.

Although HPS provided a cheaper and more efficient substitute to kerosene-based lanterns, it consistently experienced difficulty increasing the total penetration rate beyond 50% to 60%. Individually educating people about the benefits of clean lighting, the improved luminosity of CFLs as compared with kerosene lanterns per rupee, and other advantages was time-consuming and had limited success.

HPS formed a development committee that was similar to the sales department of a big corporation. Employees of this division received a hefty bonus if they succeeded in helping HPS meet its initial goal of 1,000 CFLs in the first 45 to 60 days of installation. The committee was responsible for commissioning the basic infrastructure, which included leasing land, constructing a slab for equipment, signing up customers in advance, and meeting a target of at least 300 connections in a period of 30 to 45 days. These workers were

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paid on a sliding scale basis that depended on the time it took to meet the target and the number of connections achieved above 400 households.

It was also critical that HPS grow organically to increase the utilization rate to more than 75%. HPS had two approaches to solving this problem, which included offering bulk discounts and collaborating with appliance manufacturers to promote other appliance uses.

If a household signed up to use four CFLs, there was no monthly charge for using a fifth CFL. The minimum was two CFL connections for any household. This strategy helped HPS quickly reach the 1,000- CFL mark, but it resulted in a loss of customers who thought it was too expensive to pay the $1.50 monthly fee. But the reality was that these households would save $2.00 by not burning seven to eight liters of kerosene for lighting lanterns.

It was important for HPS to inform customers about the benefits of TV and other electrical appliances to promote their uses. HPS planned to collaborate with big corporations such as General Electric Company, Videocon (an Indian consumer electronics/electrical appliance supplier), and Wipro Limited (an Indian information technology services firm) to showcase uses of low-wattage appliances that could increase household efficiencies. HPS management hoped this strategy would increase overall power usage per household.

The use of electricity had other quality-of-life benefits that extended far beyond the ability to watch television. Sinha spoke of his experiences watching the lights come on in a village for the first time:

It is an amazing feeling to see a village light up at night. The children who used to hang out and play when there was no light source—they used to play video games. Now they are studying. Although we are a for-profit company, the satisfaction we get is amazing. We have really seen a lot of changes. The first is education. Another—the women can do other things, not just cleaning. They have more time on their hands. This is what motivates me.

Marketing to increase the number of HPS applicants was another downstream concern. Newspapers and other traditional advertising media did not exist in rural India. To mitigate this problem, HPS management asked employees to visit their villages and surrounding areas to tell people about their experiences with HPS. In the past two months, applications had increased to exceed 20.

The Investor’s Concerns

Sinha explained HPS’s short- and long-term goals to Ramdas:

Right now, the immediate goal is to raise money so we can do 50 more plants in the next six quarters, by the end of 2010. I’m going to remain in the United States for another eight to twelve months to raise money and move to India in 2010.

HPS is also undergoing the gold standard carbon certification process. Another potential source of revenue for us is the sale of carbon offsets. The protocol for this is up for review in 2012 and may benefit us tremendously.

A third potential source of revenue is a secondary product that we are experimenting with that uses the waste product of our burning of the risk husks, called rice husk ash (RHA). You can use RHA waste in multiple applications. If you mix RHA with 5% to 10% cow dung, you get ash balls. This

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can act as a replacement to charcoal. It has similar heat content to coal but is much cheaper to produce. We are planning to call it green coal.

Sinha further articulated to the investor the details of HPS’s long-term expansion plans in India and other emerging countries, including strategies for optimizing growth, developing a team of motivated employees, minimizing the risk of failure, and maximizing returns to potential investors. He shared his cash flow (Exhibit 2) and profit and loss (Exhibit 3) projections with Ramdas as well. Sinha and his team were determined to get some of these alternatives implemented on-ground to enable explosive growth in the next three to four years. Sinha believed firmly that it was “okay to be 80% correct and to try different alternatives on the ground rather than waiting for the best strategy that is 100% right.”

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