The Indian and Chinese Auto Component Markets

A comparative assessment of two emerging global suppliers

A T Kearney Report

Margin pressures are driving auto manufacturers in developed markets to source components from low-cost countries. This, coupled with the growing demand for automobiles in India and China, is expected to fuel the soaring prospects of their domestic auto component industries. Although global tier-one suppliers have not yet established a measurable manufacturing footprint in these nations, several suppliers have aligned with large local companies. In the brakes segment, in particular, top manufacturers have the quality and capabilities to supply global customers. But India and China will need to invest more heavily in R&D if they are to emerge as true world-class suppliers.

The automotive markets in India and China have grown rapidly in recent years. Sales of passenger vehicles in China, for instance, increased by a compound annual growth rate of more than 40 per cent from 2001 to 2006. India's sales during the same period rose 14 per cent.

To keep up with this phenomenal growth, domestic production has taken off. It is a trend that is expected to continue as both countries claim larger roles in the global economy, adding significantly to the consumption power of their citizens. For example, Chinese passenger vehicle production is projected to grow 15 per cent annually, from 5.1 mn units in 2007 to 9 mn units by 2011. In the same time frame, India's production is expected to grow from 1.5 mn units to 2.3 mn, or by 11 per cent annually (Figure 1).

 
Naturally, such growth rates have attracted the attention of leading global auto manufacturers and auto component companies, especially in view of the stagnant growth in developed markets. All are eager to sell into these new markets and to take advantage of lower costs across the entire value chain, from product design to integration and delivery. In response to foreign interest - and investments by local manufacturers intent on meeting domestic demand - Indian and Chinese auto component manufacturers have ramped up their capabilities tremendously. They have not only improved product quality but also their technological sophistication. Indeed, more Indian and Chinese suppliers are thinking beyond domestic markets and are improving their production processes to emerge as true global competitors.

As a result, both countries offer potentially attractive sourcing solutions for North American and European manufacturers. U.S. auto component imports from China grew from nearly $2 billion in 2001 to more than $5 billion in 2005, an annual increase of approximately 32 per cent. Imports from India rose from roughly $180 million to $460 million, or 27 per cent (Figure 2).

 
But as the auto component markets in India and China develop, important questions still remain. Can Indian and Chinese suppliers meet the manufacturing standards for quality of developed countries? Are they capable of supplying more than just components - graduating to assemblies and modules? To help answer these questions, A T Kearney assessed the supplier base in both countries. Our study compared emerging structures, supplier capabilities and relative competitiveness in both the macro and micro dimensions of the industry (see sidebar: About the Study).

About the Study With the Indian and Chinese auto component industries assuming increasing global significance, the overriding questions for OEMs become: Do India and China have the required capabilities in product design, manufacturing, quality and delivery to meet foreign manufacturing standards? Are suppliers in both countries capable of supplying more than just components, and can these emerging nations also graduate to assemblies and modules? Even if the answer to all these questions is yes, there remains the issue of competitive advantage. What advantages do Indian and Chinese companies offer compared to those doing business in the rest of the world, not to mention to each other? To help manufacturers answer these questions, we assessed the auto component supplier base in India and China. The study's objective was to compare the countries' emerging industry structures, supplier capabilities and relative competitiveness. For the purpose of the study, we also assessed both macro and micro dimensions of the industry. For the macro analysis, we focused on the size, growth, ownership profiles and fragmentation of the industry, as well as how each government's policies affect growth. Our microanalysis concentrated on the brakes segment, which is characterized by high engineering value added, assembly-level integration and system design requirements. Additionally, we compared the cost structures, quality and product development capabilities of suppliers in both of these countries. The results of this study provide a clearer understanding of the current state of competitiveness that exists for component providers in both India and China.

 
Macro Analysis: Indian and Chinese Auto Component Industries

India and China are expected to become formidable component exporters in the near future. Government support for this expansion and for promoting global competitiveness makes both markets even more attractive as potential component sources for foreign manufacturers.

The following offers a detailed overview of the Indian and Chinese auto component markets.

Market size and growth. The Chinese auto component industry currently dwarfs its Indian counterpart. China's auto component sales increased 42 per cent annually from 2001 to 2005, going from $8.7 billion to $50.2 billion. In comparison, the sales growth in the Indian auto component industry went from $3.9 billion to $11.3 billion. Although, an impressive 23 per cent increase seems almost sedate compared to China. But these divergent growth rates should moderate in coming years. The Chinese market is expected to cool down to a more sustainable rate of 18 per cent annually and the Indian market to 16 per cent, bringing the two nations more in line with each other (Figure 3).

 
The anticipated slowdown in Chinese growth is attributable to three main factors. Growth in passenger vehicle sales is expected to slow to around 14 per cent annually. This is due in part to the Chinese government's efforts to reduce the nation's overall economic growth to a more sustainable pace. Global auto companies doing business in China are also beginning to invest in and source from other low-cost countries to hedge their current overexposure to China. Finally, competitors from other low-cost countries such as India are actively working to ramp up their size and scale and become credible alternatives to the Chinese juggernaut.

Supplier landscape. The automotive landscapes in India and China are quite similar: Both are still highly fragmented, with large numbers of small competitors. Only about 9 per cent of the nearly 5,000 Indian auto component companies have revenues exceeding $1 million. In China, the percentage is only slightly higher at approx 12 per cent.

However, our study found that the Chinese market is more fragmented overall. There are more than twice as many companies (12,000) in its auto component sector, and while the top 10 suppliers in India account for 31 per cent of the market, in China the top 10 suppliers comprise just 18 per cent. The reason is that Chinese suppliers serve a more fragmented local original equipment manufacturer (OEM) market than India's, with manufacturer footprints scattered widely across the country. For example, the top two passengers vehicle OEMs in India command more than 60 per cent of the domestic market share, but in China they account for just 22 per cent.

Leveling the Playing Field In most major areas, India and China appear to have leveled the playing field as far as foreign investors are concerned. Consider the following: Foreign ownership and entry barriers. Neither China nor India has restrictions on foreign-owned investments. China, however, requires a minimum investment for establishing a facility ($190 million for engine production and $64 million for an R&D center), and foreign direct investment (FDI) in auto components must first be approved by the government. Domestic sourcing and localization. Neither country regulates sourcing of parts from local suppliers. However, China offers tax incentives to encourage companies to source from local suppliers. Import duties. India has no import quotas but high (60 per cent) import duties on completely built units (CBUs), which restricts imports significantly and promotes local production. There are no special concessions extended for semiknocked- down units (SKDs) (they are also 60 per cent). And import and customs duties on auto components fell to 13 per cent in 2007 from approx 44 per cent in 2001. China, by comparison, has phased out its import duties and reduced its import tariffs on vehicles to 25 per cent, down from 70 to 80 per cent pre-WTO. Import tariffs on SKDs are 25 per cent and 10 per cent on vehicle components (down from 15 to 50 per cent pre-WTO). Research and development. Both India and China offer fiscal and financial incentives to promote R&D (150 per cent tax relief on R&D), which India is planning to extend for another 10 years and China for another five years. Euro III emission norms have been implemented in India since 2005; China adopted Euro III norms in 2007 and plans to adopt Euro IV before 2010. Other regulations, India recently introduced a value-added tax (VAT) to replace multiple state taxes on raw materials and sales. China exempts import duties on machinery used in the production of auto engines, assemblies and auto electronics, and offers a VAT refund for product exports (13 per cent of cost-of-goods sold). Also, bonded warehouses are no longer allowed to store imported cars.

 
Government policy. Changes in government regulations in both countries have spurred the growth of local suppliers. Initially, India and China maintained high import duties on vehicles and components to encourage domestic production. Since then, both governments have progressively reduced import duties, improving their auto sectors' prospects for cultivating foreign business. For example, China reduced import duties from 50 per cent in 2001, prior to joining the World Trade Organization (WTO), to 10 per cent currently. During the same time frame, India lowered import duties from 44 per cent to approximately 13 per cent.

Both governments also actively encourage foreign investments in their automotive and auto component sectors. A significant pan of China's success in this area results from its WTO membership. Between 2002 and 2004, the opening up of its markets led to more than $6 billion in foreign investment from global OEMs and tierone suppliers. Such significant investments have increased China's capacity and production levels.

Today, both countries have eased regulatory frameworks to the point where there are no discernable differences in government policy (see sidebar: Leveling the Playing Field).

Micro Analysis: Focus on the Brakes Segment

To gain an in-depth understanding of how the Indian and Chinese auto component industries operate, our study also evaluated their supply bases in one select area, the brakes segment. The analysis focused on two key dimensions:

Supplier landscape. Supplier success in the brakes segment is generally achieved by adding value through engineering, so the segment typically commands high margins. Globally, most large brake suppliers are improving their system design capabilities - from complete brake assemblies to front corner modules - to gain a competitive advantage. As suppliers in low-cost countries gain maturity in the brakes segment, North American and European OEMs are increasingly sourcing components and some sub-assemblies from offshore suppliers.

The Indian brakes market is slowly catching up with the more developed nations' markets in terms of sophistication. Suppliers are already manufacturing anti-lock braking system (ABS) units for domestically produced passenger vehicles, and are expected to mass-produce electronic stability control (ESC) within a few years. Similarly, the Chinese passenger vehicle industry has seen increased penetration of ABS and ESC.

 
Another characteristic of the brakes segment is that it typically presents high barriers to entry, thus restricting the market to large, organized competitors. There are several reasons for this: Brakes have safety and product liability concerns, and companies must invest significant amounts of money to set up testing and validation facilities for complete brake systems. Also, continuous innovation through the introduction of new products, such as ABS and ESC, requires a high level of technical sophistication, which smaller firms, especially in low-cost countries, often lack.

In the short run, this may create a hurdle for many companies in India, and especially so in China because of its more fragmented market. Although there are more than twice as many Chinese companies with revenues exceeding $1 million, the Indian market is more concentrated (Figure 4), Its top five companies own 80 per cent of the market, a share accounted for by 12 companies in China. Indeed, the Indian brake industry is a near-oligopoly, with the top two companies-Brakes India and Robert Bosch - controlling more than 60 per cent of the complete brake system market. Moreover, three of the top five Indian brake and brake component manufacturers are controlled by a single conglomerate, the TVS Group. In terms of revenue, however, the top five companies in India and China have roughly the same combined sales. Interestingly, although there are more Chinese companies with revenues exceeding $1 million, the top two Indian companies are larger than their Chinese counterparts.

Except for Robert Bosch in India and Mando Brakes in China, most global OEMs have not yet penetrated these two developing markets.

 
The top Indian and Chinese companies are for the most part wholly owned domestic companies. Historically, many of these local suppliers have entered into technical collaborations and joint ventures with global tier-one suppliers to acquire and improve their technology and basic product design capabilities (Figure 5). Similarly, most multinational corporations form technological collaborations in these countries instead of setting up large manufacturing presences. Even companies with manufacturing subsidiaries in China or India are not large in scale, with the exception of Robert Bosch India (Figure 6).

 
However, thanks to its head start, China is exporting nearly 10 times more brake and brake component parts globally than India. In 2005, India exported 51 million brake and brake components compared to China's 543 million. Exports are expected to continue their steady rise in coming years as more Chinese suppliers, driven by intensifying domestic price competition, develop or expand their overseas customer bases.

Supplier capability. Currently, most tierone suppliers doing business in India and China are component manufacturers that establish joint ventures and technological collaborations for assembling complete brake systems. So far, none has graduated to the assembly of complete modules. Additionally, these brake assemblers use a large portion of local manufacturing content, and have developed strong engineering and basic product design and integration capabilities (Figure 7).

 
R&D investments. Although the product development capabilities of both Indian and Chinese suppliers are still evolving, a majority of these companies allocate from less than 1 to 1.5 per cent of revenues to R&D. Most Indian and Chinese companies remain "part-to-print" suppliers and are not yet developing products on their own, but our study did find some cause for optimism. Some of the top suppliers in China actually spend between 2.5 and 3 per cent of revenue on R&D, on par with global standards, while their large Indian counterparts still lag behind, spending an average of 1.5 to 2 per cent of revenue on R&D.

Quality capabilities. Quality remains an issue in both countries. The majority of suppliers fall well outside the global quality benchmarks, with many scores exceeding 50 defective parts per million (ppm). Indian tier-one suppliers fare slightly better than their Chinese counterparts, with defects in the range of 50 to 200 ppm. Chinese tier-one suppliers have a higher overall defect rate, but with a broader range of performance (10 to 350 ppm). Some multinationals have actually exceeded global quality standards in China, producing brake parts with a defect rate of roughly 10 ppm" and some leading Indian and Chinese brake suppliers currently meet global quality standards on their own. Most of the top five Indian and Chinese suppliers have a quality level of less than 120 defective ppm - a value that is acceptable for export.

At this point, almost all organized suppliers in both India and China are ISO 9000 certified. Most suppliers also abide by TS 16949, which global OEMs consider mandatory for exports. Indeed, many Indian companies, such as Brakes India, Sundaram-Clayton, Sundaram Brake Linings and Rane Brake Linings, have received the Deming Prize for quality.

Cost competitiveness. Chinese suppliers are slightly more competitive than their Indian counterparts in regard to wages, steel prices, power tariffs and taxes. While raw material costs are comparable, Chinese wage rates are 15 to 50 per cent lower depending on the skill level. Additionally, Chinese suppliers enjoy a higher subsidy on their power usage, which enhances their overall cost advantage (Figure 8).

 
To estimate the full impact of the above factors on unit cost, we compared the price paid by OEMs before the value-added tax (VAT) for one front-disc brake module for a B-segment car (a small hatchback). Our study shows that the benefits enjoyed by the Chinese suppliers translated into a cost advantage of approximately 9 per cent over that of their Indian counterparts (Figure 9).

Reaching World-Class Status

 
Based on our overall assessment of the supplier base in the brakes segment, it is clear that Indian and Chinese component suppliers have the potential to emerge as global suppliers, manufacturing not just components but assemblies and modules. But first, companies in both countries will need to improve quality and invest more heavily in research and development. Only then will they emerge as true world-class suppliers to the developed world's automotive manufacturers.