Auto Components Exports Issues and Challenges

Auto Components Exports - Issues and Challenges

S Sridhar, Avalon Consulting

Last decade was clearly dominated by the IT sector in most parameters, whether it be exports, growth in the sector, or influence in the stock market. While services sector like IT flourished, there was deep concern on manufacturing sector’s ability to compete in a global arena. Indian manufacturing sector has taken up the challenge of post liberalisation era quite well by restructuring operations and improving efficiencies. This has resulted in increasing confidence to look at global markets and, for a change from the past decade or so, even driven the recent stock market boom!

We are discovering our strengths in manufacturing in sectors earlier considered a weak area and where there were serious doubts of sustainability. We will take auto components as a case study of such a sector and evaluate the opportunity for India and what needs to be done to develop India as a base of global exports.

Why the ‘buzz’ around Auto Components?

Indian auto components industry is currently quite small compared to global standards with output of USD 4.1 bn and investment of USD 2.1 bn in 2000. compared to this, large multinational firms in the sector have turnovers in excess of USD 20 bn individually. The other feature is the extreme fragmentation of the industry driven by our pre-liberalisation policy of supporting small industries and licensing capacities.

Turnover (USD Mn	No. of Cos.
<1	101
1-10	202
10-20	50
20-30	21
>30	28

Given the poor picture presented above, why is it that there is strong interest in auto components sector today? There are three reasons responsible for this:

In the last decade, most of the leading Indian auto component companies were exposed to supplying to multinational auto manufacturers who have set shop in India like Ford, Hyundai, GM, etc. This raised the bar for quality and process orientation. As a result, there were dramatic improvements in quality of products and in process parameters.

The last 5-6 years were plagued by over capacity as a result of large capacity additions during high growth 1995-97 period. This forced auto component companies to restructure and cut costs to survive this bad phase. This has improved their cost competitiveness.

This phase also ensured that the companies focus on exports in a consistent manner to ensure that the large gaps in capacity are bridged. Earlier, exports were always a capacity filler. However, most large firms have changed the attitude and have started focusing the exports to insulate themselves from the volatile domestic market. Many of them have set significant targets to improve the share of exports from less than 5% of total sales in most cases to 25-50% of sales by the end of this decade, having realised their capability and the opportunity.

Thus, the top 30-50 firms have started believing in themselves and their ability to actually become global players in their industry. This awakening is actually leading to a new vision and initiatives to tap the international market. Hence, exports have consequently been increasing at about 25-30% per annum over the last three years and are expected to continue this growth trend even in this year. Any industry growing at 25-30% per annum (exports) consistently is bound to attract attention, especially when the global automobile industry is going through a slow phase!

But can this buzz actually be translated to big numbers? What do we need to do – at the firm level and the Government level (not just stay out of industry’s way)?

This article explores three aspects which are crucial to sustain the growth rates and enable India to lay the foundation for becoming a global hub for auto components exports in the coming decades -

Why Auto Components?

What must firms do?

What is the role of Government?

Why Auto Components?

India as a country had missed many opportunities in the past by keeping our economy insular and not integrating it fast enough with the global shifts in manufacturing which have happened in many industries. Unless we are pioneers or take part in these shifts early, we miss the boat. It is very difficult to catch up until a structural change happens once again (e.g. higher cost of the manufacturing country due to transition of the economy), which usually takes place after a long time – sometimes more than a decade. In the IT sector, we pioneered the ‘Global Delivery Model’ and we can all see the impact on our economy and the way business is changing.

Hence, in sectors where the manufacturing have already shifted from developed to developing countries, as shown in the table below, India is at a disadvantage compared to China and South East Asian economy.

Sectors	Extend of Shift of Manufacturing to Developing Countries	Share of Developing and South East Asian Countries
Apparel / Toys		High
Shoes / Leather		Medium
Electronics		Medium
Auto Sector		Low

Low:

High:

If we take electronic industry, for example, the outsourcing wave happened in 1980’s with the establishment of Electronic Manufacturing Service Firms (EMS). We were still in the licence raj when this happened. Most of the opportunity was taken up by South East Asian countries initially and, later, China. EMS has grown tremendously in the last two decades and accounted for 20% of cost of goods sold of branded players in 2000 and is expected to rise to 50% by the end of the decade. Most of these are likely to go to China and South East Asia, a lost opportunity worth billions of dollars!

Luckily for India, auto sector is laggard in outsourcing and hence, the opportunity is still open for us.

It is not that the auto sector worldwide was not focused on cost cutting. It was just that their priority was elsewhere - in rationalising the number of product platforms and in tiering of vendors. Many MNCs slashed the number of product platforms (for example from 20 to 6) for better standardization, economies of scale and lower design costs. They also resorted to tiering of vendors, with tier 1 vendors acting as system integrators.

However, these have still not helped auto players to improve profits and hence, the pressure to reduce costs continues for American and European car manufacturers. They are also realising that their core business must be profitable rather than making money from complementary businesses like finance, service, parts, etc. Any big reduction in cost will come only from outsourcing manufacturing to developing countries… hence, this will be the next wave of cost cutting for global auto majors.

No developing country has taken a leadership position in this sector. Therefore, India does not have a huge gap to bridge in this sector. China also does not have high economies of scale, as is prevalent in most sectors where they have a much larger domestic market compared to India produces about 2 mn cars per annum while India produces about 1mn. We must caution that China’s auto sector is growing at a scorching pace (>50% per annum) and hence, three years down the lane, the difference could be high and India may find it difficult to catch up unless we act now. All south East Asian nations including China have less than 2% of world trade in auto components sector.

In future, competition for leadership is essentially going to be between China and India. In terms of quality and engineering strength, we currently lead China and we need to be capitalising on this. Auto components is still largely a virgin territory in terms of supply to OEMs… like software services in the last decade and is an opportunity we cannot afford to miss.

World trade in auto components and accessories in the beginning of the decade was about USD 250 bn and this could easily reach USD 500 bn by the end of the decade. India should atleast target 1.5% of this trade - i.e. about USD 7 bn by 2010.

The implication is that we have to increase our exports seven times in the next 5-6 years from about USD 1 bn last year. At this level, exports will nearly equal the domestic market. Even at this level, it should be noted that we are likely to be a small player in the international area. However, it will create a strong base for us to further increase our market share in the coming decades to emerge as a global hub for auto components.

What must firms do?

There has to be specific firm level initiative to make this happen. The SWOT analysis of Indian Auto Components sector is presented in exhibit 1.

Exhibit 1: SWOT Analysis of Indian Auto
Components Sector

Strengths

Threats

▪

Application Engineering

▪

China

▪

High Quality - Low Cost (There are even Deming Award winners)

▪

Complacency

▪

Consistency in Quality

▪

Ability to cater to low valumes

Weakness

Opportunities

▪

R & D

▪

MNCs focussing on low

▪

Lack of scale

cost outsourcing

▪

Supply Chain

opportunities

Infrastructure

▪

Trend likely to increase

▪

Manufacturing

in future

Infrastructure - Hence

▪

India and China are the

Capital Requirement

two countries on the

▪

Marketing

radar

Each firm needs to have a clear strategy focusing on the strengths to cater to the opportunities. At the same, time look at ways to mitigate the weaknesses.

Strategy can manifest itself in several forms as provided by examples in exhibit 2.

Exhibit 2: Strategic Options Arising Out of SWOT Analysis

Options

Remarks

▪

Focus on products/markets which have the following characteristics:

▪

We are good at low volume game (learn the scale game in the meanwhile).

Order models where the volumes are

▪

Transplant manufacturing.

low for a western manufacturer to

▪

Look at who owns the design (Tier 1 or

focus.

Tier 2 supplier) and approach them for

Only require strength in

subcontract manufacturing (beef up

manufacturing and in application

R & D over a medium term).

engg.

▪

Labour value addition in assembly operations.

High labour components (say, more

▪

Castings, Forgings, etc.

than 30% is manual content).

▪

Auto related software development.

Intermediate technology.

▪

Where we can use our strengths in

Focus on commercial vehicles and

application engg.

other niche areas where margins are

▪

Indian players are used to high

higher.

operating margins

The key challenges are in developing appropriate management processes for customer management, long supply chains and marketing. Auto component companies could learn from Pharma and software services firms, especially in customer management processes. The other key aspect is a mindset change required to operate in an environment where margins are wafer thin… large auto component MNCs operate with margins less then 5%. The room for error is minimal. So far, auto components firms were focussing on process capability at plant level. This needs to pervade across all management functions. Unlike other industries, product liability clauses are very stringent, especially in the US market and unless appropriate processes and risk control measures are in place, it could wipe out companies. The challenge, hence, is to manage growth without compromising quality and process level issues… a tall order!

The growth target envisaged will require aggressive investment… our estimate is that to raise exports to USD 7 bn will require fresh investments to the tune of USD 3-3.5 bn in the next 7-8 years, which is more than the existing investments of USD 2.3 bn in auto omponents industry. This needs to come from both domestic companies as well as FDI. Domestic firms may need to aggressively raise capital to meet growth targets and to reach the vision of 30-50% share of exports in total turnover. Some of options for raising capital are:

Within the group (prioritizing);

Increasing leverage;

Unlocking value (eg:- Real estate to productive manufacturing assets);

Have an open outlook for investments from risk appetite agents like private equity investors.

What must Government Do?

Government’s policy of attracting investments in the auto sector has enabled establishment of several auto multinationals and their component subsidiaries in India. MNC’s like Ford, Hyundai have successfully localized the components and this is being carried forward for global sourcing. Also three cars – Ikon of Ford, Santro of Hyundai and India of Tata Motors (tie up with Rover) are being exclusively manufactured in India for global markets. The best form of exports and the greatest value addition happens when a complete car/systems are manufactured in India and exported. For example, Hyundai is targeting to export 80,000 cars from India, Toyota Kirloskar has set up an auto transmission aggregate facility with a capacity of 150,000 nos/annum. Even India companies like Ashok Leyland are looking at exports of aggregates like engines as tier 1 supplier to global firms… these are positive signs for the auto components sector and the liberalisation policy of Government. However, the Government needs to do more.

In terms of auto sector policy, let’s compare ourselves with China. Indian auto policy is highly domestic oriented and centres around road infrastructure, environmental issues and safety regulations. China’s auto policy on the other hand clearly gives priority status to the sector and focuses o consolidation and developing large players as shown in exhibit 3.

Exhibit 3: Tenth Five Year Plan Auto Components
Policy of China - Key Features

▪	Specific structural adjustment target to achieve consolidation in industry
▪	For key parts, top three suppliers of achieve 80% share
▪	Develop strong Tier 1 suppliers
▪	Target 60% domestic sales, 40% exports for these suppliers

China is very clear on the need and support for consolidation in the industry. Quote “Priority shall be given to strong enterprises. Leading enterprises with certain product development capability, good market prospects and high technical level, production scale and economic returns shall be encouraged and supported for further development”… China’s Tenth Plan Document Excerpts on Auto Components Sector Policy.

The key learning we need to take away is that this is a sector where scale is important and Government should actively promote large players and groups in auto components sector to enable them to achieve critical mass. Smaller firms in India needs to become tier 2 or tier 3 suppliers to large firms… that is the only way they can survive in the long term.

The ‘To do list’ for Government is many and could be quite repetitive. We are summarising in exhibit 4, the key focus areas and we hope these will be addressed as the second-generation reforms.

Exhibit 4: Role of Government

▪	Implementation of new SEZs
▪	Lowering transaction costs in exports
▪	Easy exit for unviable businesses
▪	Labour market flexibility
▪	Port infrastructure
▪	Power sector (central government has provided the blue print for state governments to reform)

The timing of these reforms is crucial not only for auto components sector, but for India as a whole, especially in manufacturing. We are now experiencing good times with the economy projected to grow beyond 6% GDP this year… an ideal year, economically speaking, to start reforms. Let’s hope, we do not miss another opportunity…

Note: The author is a Partner and Stakeholder in M/s Avalon Consulting, a strategy and management consulting concern.