The Indian Auto Ancillaries Industry

ICRA's Sectoral Report August 2006

Development of Indian Automotive Components Industry

India's automotive ancillaries/components industry manufactures almost the entire range of parts required by the domestic automotive industry for various types of vehicles. The total domestic production of automotive components in FY2006 was estimated at Rs. 440 billion (around US$10 billion). In terms of value, the output registered a growth of 16% during FY2006 (30% during FY2005), and the industry registered a compounded annual growth rate (CAGR) of 20% between FY2001 and FY2006. Most components required by the Indian automotive industry are manufactured locally. The imports are usually restricted to items requiring special steels and components of precision engineering like gearboxes.

The size of the automotive components industry that was relatively flat for the three decades covering 1960-1990 witnessed a sharp increase from FY1995 onwards.

Growth in India's Automotive Ancillaries Production
FY	2001	2002	2003	2004	2005	2006	3-year CAGR
Value-Rs. billion
Production	179	210	245	306	365	440	21.6%
Exports	28	27	34	46	59	79	32.2%
Growth
Production	9.2%	17.7%	16.6%	25.1%	19.3%	20.4%	21.6%
Exports	47.0%	-3.5%	26.2%	35.4%	26.6%	34.7%	32.2%

 
Phase I: Period till 1985

For nearly 40 years after India's Independence, the domestic car market was dominated by two localised versions of dated European designs: the Morris Oxford (on which Hindustan Motors Limited or HML modelled the Ambassador) and the Fiat (on which Premier Automobiles modelled its Fiat, later renaming it as Premier Padmini). This lack of product activity in the Indian market was mainly because of the Government's complex licensing system that effectively shut out foreign-owned operations. The system ensured that any Indian firm wanting to import technology or products had to have a licence/permit from the Government.

The Indian automotive components industry started out in a small way in the 1940s when few companies started supplying components to HML and Premier Automobiles. The lack of access to technology, financial constraints, and the small size of the market hindered the development of the automotive components industry in the country at this point of time.

During the 1950s, the arrival of Tata Engineering and Locomotive Company of India Limited or Telco (now Tata Motors Ltd), Bajaj Auto Ltd and Mahindra & Mahindra led to a steady increase in production. This resulted in the concentration of the automotive components industry in the Western and Southern regions of the country.

Phase II: 1985-1991

The establishment of Maruti Udyog Limited (MUL) during the 1980s accelerated the pace of growth of the Indian automotive industry. The arrival of India's "people's car" (that is, the Maruti 800 model) ushered in the first boom period for the Indian automotive component manufacturers. The new car required components that would adhere to stringent quality standards. MUL's tie-up with Suzuki not only led to the technological upgrade of the Indian automotive components manufacturer, but also spawned joint ventures between Indian and Japanese component manufacturers. For the first time in its history, the Indian autocomponent industry was exposed to the modern production techniques of the Japanese component manufacturers. Maruti attempted to establish a manufacturing operation based on "lean manufacturing" techniques, which demanded just-in-time delivery, high quality and closer relations with suppliers.

Phase III: 1991-1999

Although the arrival of Maruti Udyog Limited (MUL) brought about many changes in the Indian automotive components industry, it is only since 1991 that the industry has been opened up to the world. The liberalisation of the Indian automotive industry in 1991 led to an influx of foreign vehicle manufacturers ranging from Mercedes-Benz, Ford, General Motors, Daewoo, Peugeot, Hyundai and Volvo, among others. The rapid expansion presented a world of opportunity for the components industry, which responded with huge capacity additions and modernisation programmes.

Phase IV: 1999-till date

The Indian automotive components industry finally came of age. Even though the industry faced difficult times and sluggish growth during 1997-1999, the situation has now turned for the better with Indian companies bracing themselves to face the various structural changes affecting the global components industry. In particular, several Indian companies have entered into technological collaborations and equity partnerships with world leaders in automotive components. Besides, subsidiaries of global vehicle manufacturers have set up components manufacturing units in India.

Key Products

An automobile typically consists of over 20,000 components, with each performing a different function. The components industry manufactures products that may be classified under six broad product categories (ACMA classification) as depicted in the following table.

ACMA Classification of Auto Components
Product Group	Products	Share of Production (%)
Engine Parts	Pistons, Piston Rings, Engine Valves, Carburettors, Diesel-based Fuel Delivery Systems	31
Electrical Parts	Starter Motors and Generators	9
Drive Transmission	Gears, Clutches, Axles and Steering Parts	19
Suspension and Braking Parts	Brakes, Leaf Springs, Shock Absorbers	12
Equipment	Headlights, Dashboard Instruments	10
Others	Sheet Metal Parts, Pressure Die Castings, Tyre Tube Valves and Cores	19

 
With a market size (in terms of total production) of Rs. 136 billion in FY2006, Engine Parts is the largest sub-segment of the Indian components industry.

Others

All components that are not classified under any of the heads listed are clubbed under Others. The size of this segment was estimated at Rs. 83 billion in FY2006. Sheet metal components and plastic moulded parts are two of the major components in this category.

Demand Characteristics

The market for automotive ancillaries/components can be segmented into three categories based largely on the identity of the buyer:

▪	Original Equipment Manufacturers (OEMs-the vehicle manufacturers)
▪	Replacement (vehicle owners who buy parts for maintenance and repair)
▪	Exports (primarily foreign vehicle manufacturers and International Tier I suppliers).

Demand from Original Equipment Manufacturers

The pattern of growth in the automotive segment is important for the performance of the automotive components segment. This is because the components content per vehicle differs significantly across vehicle categories. Demand for larger and higher-value automobiles implies higher demand for ancillary units. Thus, the demand multiple emanating from the automotive sector in terms of segmental growth could have a significant bearing on the performance of the automotive components industry.

The Indian automotive industry has been growing at a rapid pace since 1980s but with a degree of imbalance across various segments.

Passenger cars experienced high growth rates in production during the 1980s, with Maruti Udyog Limited (MUL) clearly dominating the scene. In fact, MUL was the only car manufacturer to significantly augment capacity during this period. Passenger cars apart, various two-wheeler segments also witnessed high growth rates during the 1980s. The decision of the Government of India (Gol) to liberalise the licensing regime in 1985 led to a rapid expansion of the two-wheelers segment especially motorcycles. The change in licensing procedures was followed by the entry of four major Japanese manufacturers in collaboration or joint ventures with established Indian two-wheeler manufacturers. Domestic companies like Bajaj Auto and LML also rapidly expanded capacities during this period of 1980's. While the 1990s saw the two-wheeler segment broadly continue with the performance of the previous decade, the rate of growth was nevertheless lower.

The production of commercial vehicles (CVs), which witnessed significant growth during the first half of the 1990s, slowed down in the latter half of the same decade to post an 8.1% decline in production. There was no new entry into these sectors, with all the increase in production coming from incremental capacity additions by the two dominant local manufacturers, Telco (now Tata Motors Ltd) and Ashok Leyland Limited.

However, the real spurt in production was during the years FY2003-06, when the overall growth was in excess of 15%, with growth in the passenger cars and CV segment was in excess of 20%. Thus, the principal drivers of demand for the automotive components industry from the OEM segment (in number terms) have been passenger cars and commercial vehicles.

Replacement Demand

Both, organised sector and huge unorganised sector cater to the replacement market demand. The unorganised sector in turn is a low-cost one with the fiscal liabilities (in terms of excise duties) being not accounted for by this sector. As a result, this sector is able to supply the replacement market with significantly lower-priced (and usually lower-quality) parts vis-à-vis those produced by the organised sector. The after-market is highly competitive for components with a high price elasticity of demand and a tolerance of lower quality standards. A major channel of marketing and distribution for this sector is the typical roadside mechanic.

Interestingly, this sector has recently shown the technical competence to even replicate some of the relatively sophisticated components.

The automotive component suppliers in the organised sector also cater to the demands from the replacement market, apart from the original equipment one. Additionally, for automotive component suppliers, the prices in the replacement market are relatively higher than the prices in the original equipment market. This higher price in the replacement market is because of the higher margins charged by the component suppliers, the impact of a longer supply chain and the tax structure. Typically, the replacement market provides higher margins but lower volumes vis-à-vis the OEM market.

Five factors primarily influence the aggregate annual demand for replacement parts:

▪	Size of the national vehicle population
▪	Average age of the national vehicle population
▪	Pollution norms and Government regulations
▪	Average number of kilometres driven per vehicle
▪	Road and other related conditions.

Size of National Vehicle Population

Clearly, more the number of vehicles, higher the aggregate demand for replacement parts. With new vehicle registration currently increasing at a CAGR of more than 10%, the prospects of replacement demand for automotive components in India appear bright.

Age of National Vehicle Population

It is evident that higher the average age of the national vehicle population, greater the expenditure on replacement parts. This is particularly true for a country like India where the scrappage rates are relatively low. Also, a longer use of the vehicle would ensure higher replacement demand and a lower OEM demand.

Vehicle scrappage norms are not yet widely prevalent in India (except for the NCR of Delhi), which has ensured a fast increase in the stock of vehicles on Indian roads and higher replacement demand for automotive components.

Number of kilometers driven per vehicle

The level of economic activity has a clear implication for the demand for transport services in a country. Higher the level of economic activity, higher the demand for freight and passenger transport. In particular, the level of economic activity has a strong bearing on the demand for components from the commercial vehicles segment. Similarly, the performance of the agricultural sector has strong implications on the demand for automotive components, especially those required in tractors.

In terms of passenger travel, the trends indicate that people are driving their vehicles for longer distances every year. A variety of factors has contributed to this trend: wider suburban spreads in virtually all the major cities where bulk of the vehicle population resides; greater demand for travel-based leisure activities; relatively poor progress in the expansion of public transportation systems in the urban and rural areas; and various other factors. The demand for replacement parts would increase as the wear associated with higher mileage of vehicles per year increases.

Road Infrastructure

The road infrastructure in India needs to be evaluated from the perspective of the inter-modal mix. Railways and roadways are the principal modes of transport in the country. In India, in FY1951, the railways, with an around 85% share of the total freight movement in the country, was the preferred mode of goods transportation (road transport then held a predominant share of the residual). However, since then, with the growth of the railways failing to keep pace with the traffic requirements of a growing economy, the inter-modal mix has changed in favour of roadways. During the past 50 years, the railways to roadways ratio for freight movement has reversed, with currently railways accounting for around 30% of the total freight movement in the country. In the passenger traffic segment, the share of railways has declined from 68% in FY 1951 to 15% currently.

This change in inter-modal mix has meant that the number of vehicles plying on the roads has increased, leading to road congestion. It is estimated that about 2% of the road length in the country carries about 40% of the road traffic. This has led to deteriorating driving conditions like increased traffic congestion and low vehicular speed, besides higher pollution levels.

Driving Conditions

Besides congestion, the poor average quality of Indian roads is a significant factor adding to the wear and tear of vehicular parts. In India, the poor condition of the roads have significantly influenced the demand for different parts. For instance, internationally, axles are not high-replacement demand products. But in India, because of the poor quality of roads, axles have a high replacement demand.

Export Demand & Competitiveness

The Indian auto components sector has presently a competitive edge arising out of low-cost advantage mainly on account of the availability of low-wage, high-skilled manpower; and high quality & productivity through the adoption of quality/production concepts such as total quality management (TQM), total productivity management (TPM), and Six Sigma. Further, almost all the prominent players in the Indian auto ancillaries industry in the organised sector have links with at least one international player. With technology changing at a fast pace, access to technology through collaborations or joint ventures with foreign players are likely to be a key success factor for this industry. Auto ancillaries suppliers are also increasingly participating in component development and designing, which were earlier done by vehicle manufacturers in the international market.

India's exports of auto ancillaries have increased at a 3-year CAGR of 33% during FY2004-06 because of increase in sourcing of auto components from India by several developed countries. Many major Indian players have commenced direct supplies to the major global OEMs like General Motors, Mitsubishi, etc. In fact, the share of export revenues accounted for by OEMs has increased from 30% in 1999 to 70% in 2005.

 
The US is the largest market for India's auto ancillary exports, accounting for 22.5% of total exports. Exports to the US increased 28.2% (yoy) during April-September 2005 to Rs. 13.06 billion.

International automotive players with operations in India are increasingly sourcing components from Indian automotive component manufacturers. For instance, Hyundai and Fiat are sourcing parts locally for their Santro and Palio models in India, respectively. The demonstrated ability of Indian component makers to make supplies to global automotive manufacturers in the country has opened up the possibility of the component makers supplying the same OEMs in other countries as well.

Competitive Advantages

▪	Low labour costs (low labour costs pulls down the total cost of production, typically in assembled parts such as clutches and lighting equipment). For instance, wage rates in India are currently 60% cheaper than that in developed markets.
▪	Less stringent environmental regulations (environmental regulations have rendered the production of parts like castings cost prohibitive in developed countries). For instance, the metal casting process generates dust and it is estimated that foundries in Europe and USA on account of stringent environmental compliance spend roughly 5-6% of their sales on pollution control. Such costs are almost negligible in countries like India and other Asiatic nations.
▪	Low minimum economic scales and possession of established technology (as in castings and forgings). Given these competitive advantages, India is therefore widely regarded as having an advantage in terms of low labour costs, strong engineering skills, and machining and processing capabilities. Hence, labour intensive and assembly-oriented components are likely to be sourced from India. The exports of the automotive component manufacturers are targeted at the following groups of buyers:
▪	International vehicle majors such as Volkswagen, Volvo and so on. Exports are largely to their operations in developing countries since these manufacturers do not find it cost effective to source components from their own plants or from other local units. For instance, domestic component manufacturers such as Bharat Forge, Rico Auto, Sundaram Fasteners supply directly to global OEMs.
▪	Vendors who supply to component manufacturers like Delphi, Dana Corporation and Valeo. As an example, recognising the cost advantage involved, most global OEMs such as Ford, General Motors and Volvo, and Tier-I companies such as Navistar and Cummins have set up international purchase offices in India in the last 2-3 years, to source components and export them to their global plants.
▪	In the last couple of years, many global automobile manufacturers have identified India as a manufacturing base for some of their models, which are then exported to other countries. For instance, in the passenger car segment, Hyundai's Santro Xing and Suzuki's Alto are being exported. Two-wheeler manufacturers Yamaha Motors and Honda Scooters are also exporting some of their models. Similarly, Indian OEMs such as Bajaj Auto (World Bike 125cc), TVS Motors and car companies such as Tata Motors (City Rover) and M&M (Scorpio) are also exporting fully built vehicles. As components form more than 50% of their cost of manufacture, the export of vehicles increases the demand for domestic auto components.
▪	The replacement market, which accounts for a large proportion of the exports of components from the Indian market. This is due to the fact that a significant portion of the Indian components is exported for the replacement markets for out-of-production models in these countries. As Tier-I vendors located in these countries meet the demand for current models, the production of components for out-of-production models is outsourced to countries like India.

Challenges faced by Indian component exporters

In comparison with the total size of the global auto component market of more than US$1.2 trillion, Indian component exports are miniscule at US$1.8 billion in FY2006. Although the growth in the export of components is much higher than the growth in domestic markets, Indian exports have not been able to capture a larger market due to various hurdles faced by Indian component manufacturers. For instance, the forging market offers a huge scope for untapped exports. Bharat Forge is now venturing into passenger car segment of the forging market (Ford Motors) in USA.

Product liability clause

Most international OEMs also enforce a product-liability clause, which stipulates that suppliers will be charged punitive damages in case of a line stoppage or product recall caused by supply of defective components. As per industry reports - for instance if Ford or Delphi suffers a line stoppage due to a vendor problem, the punitive damage could be as high as USD 5000-15000 per minute. This factor significantly constrains Indian companies from dealing directly with large international OEMs.

Lead time in winning international contracts is high

In the case of export contracts from international OEMs, the lead time from the request for quotation till the time of commencement of actual supplies can be as high as 3-4 years. However, once a contract is won, the entry barrier for other competing vendors is high.

Maintaining cost competitiveness and ensuring faster responses

Global OEMs require vendors to commit to a 5-10% reduction in prices every year. Besides ensuring cost competitiveness, component vendors are required to scale up their production to meet increasing demand.

Cyclicality in Demand

The pattern of growth in the auto ancillaries is cyclical and is directly related to the growth in the automotive industry. Currently, the cycle is on the upswing but there is a perceived uncertainty with the sustainability of the upswing, given the expected lower growth in automotive production during FY2007.

Small Size by Global Standards

Supply Characteristics

While the Indian automotive components industry has the ability to produce a wide range of products, it currently lacks depth. With a size of close to US$10 billion, the Indian components industry is very small by global standards. In rupee terms, the automotive components industry reported a turnover of Rs. 440 billion in FY2006. Of this, the organised sector accounted for 80% of the total value of production with the rest coming in from the unorganised sector.

Fragmented Industry

Even though the Indian automotive components industry is relatively small by global standards, there are close to 425 players in the organised sector and over 5,000 in the unorganised sector competing against each other for market share.

The share of the organised sector has increased over time. Players in the organised sector supply the vehicle manufacturers directly. Most component manufacturers and OEMs have also increased their distribution systems to make their products widely available. Although some of this "unofficial" production goes to minor vehicle manufacturers, particularly the assemblers of two- and three-wheelers, the bulk goes to the replacement market.

Market Share Concentration

The automotive components industry is a combination of different product segments, with each segment having a different market structure. However, the number of companies present in each segment differs because of the difference in the level of technology requirement. Although each product segment has a large number of players, a few players in each segment dominate the automotive components market. No single company is a prominent player in more than one product segment. This is because of the differences in technology and market characteristics for each segment. However, there are a few groups with various companies in different product segments.

Geographical Concentration of Component Makers

In a bid to lower freight charges and facilitate faster delivery, automotive components manufacturers are located largely around their OEM customers. This is particularly so since most of them are directly supplying to the OEM producer. The Northern region, which hosts OEM manufacturers such as Maruti, Hero Honda, Escorts, Eicher, LML, Swaraj Mazda and Punjab Tractors, has the maximum number of automotive components manufacturers with a share at 41%. The Western region, which has OEM manufacturers such as TELCO, Bajaj Auto, Kinetic and M&M, follows next, with 32% of the components manufacturers being based there.

Size of Unorganised Sector

During FY2006, this sector accounted for around 20% of the total component production of Rs. 440 billion. Compared with the around 425 large and medium-sized component units in the organised sector, the number of unorganised small units exceeds 5,000. Many of these unorganised units are located in the northern states of Delhi and Haryana.

The number of players in the unorganised sector varies widely across products because of a number of factors. Unorganised players are more likely to be involved in the production of low technology products having lower production complexity, such as gaskets, engine valves, pistons and sheet metal parts.

The Counterfeit Components Market

The Indian automotive components market has long been affected by the presence of a large spurious-parts market. Spurious automotive components are a great threat to the domestic automotive components industry. The small units engaged in counterfeiting enjoy cost advantage, as they usually do not pay the taxes. The organised sector players, on the other hand, have to contend with a tariff structure.

The spurious-parts market is particularly thriving for automotive components in the commercial vehicles segment followed by cars and two-wheelers. Often, the spurious parts used in the replacement market are reconditioned versions of original components.

International Sourcing of Technology

Almost all the prominent players in the Indian automotive components industry have links with at least one international player. They operate in one of the three ways: as a subsidiary of an international company; as an Indian joint venture with an international company; or in a technical tie-up with an international company.

The liberalisation of the Indian automotive industry in the 1990s served to usher in global automotive players into the country. However, following the liberalisation, the Government stipulated that the automotive joint ventures would have to achieve 70% indigenisation within five years. This local-content requirement (which has since been abolished) had necessitated improvements in technology and production quality of the Indian automotive components industry.

Rising Quality Consciousness

The average quality of automotive components produced in India has been improving gradually, particularly during the past few years. Significantly, eight Indian companies currently hold the Deming Prize for quality.

Besides the decline in end-of-the-line rejection rates, customer level rejection rates have also come down significantly for Indian automotive component manufacturers. International companies maintain their customer rejection rate at an average 200 PPM. In the recent past, certain Indian companies have attained a customer rejection rate of up to 500 PPM, with a few attaining even a zero customer level rejection rate.

With the stakes for the OEMs getting higher, the pressure on component manufacturers to improve quality has gone up. The stringent quality norms imposed by the OEMs have forced Indian companies to upgrade their facilities.

Increasing Focus on Productivity

The increasing pressure on the margins of the OEMs has translated into increasing pressure for the component manufacturers to deliver at lower cost. This has forced component manufacturers to enhance productivity through various techniques.