India as a Global Base for Automotive Manufacturing and Services - International Challenge

KPMG Survey 2007

Cost and quality remain the underlying issues of India's auto industry internationalization. Indian makers are being challenged on both counts: costs, especially labour costs are rising for Indian manufacturers, while the cost reductions that should come with infrastructure improvements are painfully slow in materializing.

The quality imperative means that Indian makers have to seek new technological resources through alliances and acquisitions, challenging the capital and management resources of companies that are often small and family owned. These are the themes of six propositions on India's international challenges that we put to leading automotive executives in this report.

Cost will continue to be the key competitive advantage for India

India's low labour costs and high level of available management and engineering skills have maintained the competitiveness of domestic auto companies and made it an attractive location for direct manufacturing investors. How long will India be able to maintain this cost advantage?

India is at the bottom of the cost curve right now, but that will change. A senior executive of component maker Endurance Group agrees: "HR is going to be a restraint. The turnover rate is already almost 20 per cent a year in many management levels. Unless companies can learn to retain people for longer, all the benefits of having talented people available will be lost."

 
The global automotive industry is under increasing cost pressure relating to raw material and some other costs (including growing pension and healthcare costs in developed economies), while consumers have begun to demand vehicles with a lower "total cost of ownership". The result has been shrinking margins for many of the world's large businesses, whether vehicle makers or component suppliers. (Figure 6)

Consequently, automakers are looking for lower costs. The fall in number of vehicle platforms and the increase in number of models per platform have made it easier for large automakers to globalise production and sourcing, and take advantage of lower cost structures in emerging economies such as India and its competitors.

Although India's primary cost advantage is in low labour costs coupled with good availability of trained workers, labour remains a small component in the total costs of manufacturers. Raw material costs are by far the largest cost portions: steel and rubber constitute the two main raw materials for automakers, and strong global demand is likely to ensure that prices for steel and rubber remain stable or increase in the medium term. (Figure 7)

 
Most raw material costs are determined by world markets, although proximity to the source can yield significant cost reduction. Prakash Kodlikeri of Kalyani Lemmerz comments that "In some raw materials, we often have a price advantage in India. For example, in finished steel I can usually get a 10-12 per cent price advantage compared to buying steel from somewhere like Germany." But it remains labour costs that manufacturers can most consistently cut by sourcing or manufacturing in low cost countries. (Figure 8)

 
"Many companies believe that India's labour cost advantage is eroding rapidly", says Prakash Kodlikeri of Kalyani Lemmerz. "It is getting more and more difficult to retain automotive talent - especially with so many large manufacturers coming in. The shortage started in IT, but now you see it in manufacturing as well, and if you don't plan ahead you will face disruption."

Our survey of executives from Indian companies and MNCs for this survey showed that a majority of the respondents (72.4 per cent) agreed that reduction in 'total delivered costs' was the primary reason why global auto companies chose to source from India. Other considerations were the availability of quality suppliers (58.6 per cent), the responsiveness of suppliers (24.1 per cent) and the advantage of India also offering a large domestic market (10.3 per cent).

In interviews, companies cited three leading critical issues for maintaining cost advantage:

▪	The Infrastructure Deficit: "What will upset the cost advantage is if India's promised infrastructure improvement fails to deliver," believes AK Taneja, Past President, ACMA & President of component maker Shriram Pistons. He adds: "There is a lot being done but the infrastructure deficit in highways, city roads, and ports is huge. I don't know any country where the basic infrastructure is developed other than by the government - private industry can chip in but the real work of building infrastructure belongs to government. And don't forget the infrastructure of health and education - these are beginning to crack up too."
▪	The Pace of Automation: Companies believe that increasing the level of automation in auto manufacturing has the potential to counter rising labour costs. 'The cost of finance has come down, the cost of the technology which used to be massive has come down, and above all the government has cut import tariffs," argues one large component maker. "Only three or four years ago, no Indian company could afford to get into robotics while they were still paying import taxes of 30-40 per cent. Now those taxes have been cut, and where before I would never have dreamt of importing robotic production lines, now we are beginning to do that. "Rajiv Dube, Head of the passenger car business at Tata Motors agrees. He states: "The cost advantage will only be retained if Indian capital can be used to develop low cost automation in manufacturing. That is the way to preserve our lower cost. But it must be low cost automation - it isn't going to help if we have to import automation at the same price that the developed world has paid."
▪	Management Improvement: Some companies say that the management productivity of Indian automotive businesses is low. A senior executive of component maker Endurance Group believes that improved management techniques could improve India's cost advantage even as labour rates are rising. He says: "We have to look at value improvement, we have to look at business process management. Business process management puts a big emphasis on shop floor productivity and on the yield you get from raw materials, which are 50-75 per cent of our cost base. This is happening now but there is always a lag of 5-7 years between beginning to implement BPM and seeing some results. So we have to wait for improvements."

 
India will emerge as a key source of Research & Development (R&D) and engineering services for the global automotive industry

India's IT industry has already built a reputation for delivering intellect intensive services to global industry. Will India's auto engineering sector be able to replicate this success?

"There needs to be a greater realisation of India's potential by the global auto industry," comments Rajiv Dube of Tata Motors. ''The global players are almost all in India now, but they have focused or meeting demand with existing products. They are gradually waking up to the kind of engineering talent there is in the industry, but they are still not using it to any great extent."

India's attractiveness as an R&D location is already an established fact: More than 125 Fortune 500 companies have already set up their R&D bases in India. There are already signs that automakers too are choosing to use India's auto engineering potential to cut the high cost of design as auto model lives shrink and the imperative grows to innovate at lower cost. (Figure 9)

 
Indian companies are already drawing on local engineering design capability where in the past they relied on imported auto design, allowing companies like Tata Motors and M&M to develop entirely new vehicle platforms locally.

The global engineering services market is set to grow. One recent study forecasts growth from the current annual USD750 billion to USD1 trillion by 2020. India's engineering services sector already earns around USD1.5 billion through global outsourcing, of which the automotive services share is around USD300 million. Many executives interviewed for this report felt that this sub-sector of the engineering services industry has the potential to grow considerably, given continued government support and further integration with the existing Indian IT services industry. "This is more an issue of vision than an issue of capability to deliver," argues Rajiv Dube of Tata Motors. "Indian companies are designing and producing their own products, so clearly it can be done. But in automaking, the Indian IT companies have really focused on efficiencies in processes and systems, not on new design." However, he adds that original design is already being achieved in some sectors of the industry: "Overseas component manufacturers have shown more faith than the vehicle makers in Indian engineering," says Dube.

 
In survey responses, low wages were cited as the continuing primary driver of growth in the engineering services sector, followed by superior manpower quality, diversity of service offerings, and continued government support. (Figure 10)

In interviews, companies cite three leading critical issues for developing global R&D services:

▪	Vision: Rajiv Dube of Tata Motors believes that India remains dependent on the view global auto businesses take of India's engineering potential. "This is something that has to be led by the global auto companies." Sunil Rekhi of General Motors agrees that a step change in vision is needed: "People are used to using India as a back office, but they are not so used to India leading the design and engineering process," he believes. "The European and U.S. players are still not doing this, even the Japanese have been very slow to move highend, high value-added work out of Japan. But for us, this is the future."
▪	Training: Some companies believe that more focused training will be needed before India can emerge as a provider of global engineering services. "It will take more than five years for India to achieve this," argues Suhas Kadlaskar, Director of Corporate Affairs of DaimlerChrysler in India. He adds: "India is turning out somewhere between 200 and 300 thousand qualified engineers a year, but that doesn't mean that all those engineers are employable in a global automotive industry. You need very specific skills. You need to be able to take a global approach, and that requires experience and training. The global players will have to do a lot of training to fulfill this target." A senior executive of component maker agrees, saying, "We still need to move to a more focused auto-engineering capability - and that means trained talent availability."
▪	Graduated Approach: Some companies consider that India needs to implement a graduated approach to developing an auto engineering service sector that extends to original research and design. "You have to respect the natural order of technology development," argues AK Taneja of Shriram Pistons. "First come engineering services. Then design & development and prototyping. Testing and validation follow. Then finally you reach the point where you can develop as a research hub. We will need to develop these abilities progressively - I believe the time for investment in basic research is probably a decade away."

 

India will emerge as a leading exporter in the small car segment Many of the companies interviewed for this report felt that the Indian auto market would develop as one of the world's leading small car markets in the next five years. Will that small car expertise also provide a platform for India's emergence as a small car exporter? The Indian auto market is dominated small cars fall into what the industry calls the 'A1' and 'A2' segments - mini and compact cars between 3.4 and 4 meters long. Sales of small cars in India continue to be driven by affordability and fuel economy. The global market, however, is driven by different considerations: the relatively low retail cost of fuel and the lack of space constraints mean that North America may see only a marginal shift toward smaller cars in the next five years. In Europe, Japan and South East Asia, there is likely to be a greater shift due to increased parking and usage restrictions, environmental concerns over large car recycling costs, and increasing fuel taxes, all of which should create new opportunities for low cost exporters with small car experience. The emergence of a significant small car market in Africa will add an additional dimension to the opportunity. Many companies interviewed for this report felt that China would emerge as India's main competitor as a global small car exporter (72 per cent of respondents). Thailand (14 per cent), Malaysia (10 per cent) and Poland (3 per cent) were also cited as candidates. In interviews, companies cited physical infrastructure as the leading critical issue for small car exports. "The infrastructure solution is a long way off - this is our biggest challenge," says Shriram Parameswaran, India country head of the Eaton Corporation, a diversified industrial manufacturer. Rajiv Dube of Tata Motors adds: "There are still not many ports you can export from, and the feeder rail lines to those ports that exist are insufficient. Plus the railways have not woken up to the freight potential." But Shriram Parameswaran of Eaton also comments that part of the solution may lie in companies making more investments in their supplier networks. "You need to place factories at strategic locations," he argues. "Hyundai for example has done this very successfully in the south of India - they are close to the port facility in Chennai, but they have also succeeded in building up a supply chain all around that hub."

 
The top five Indian OEMs will see a growing proportion of their revenue coming from international sales

The leading Indian auto manufacturers are in the process of transforming themselves from exclusively local players to global companies. How significant will their international operations become in the next five years?

"For the near future, the international story may not be so much global as regional," says Rajiv Dube of Tata Motors. "We can compete against Europe's high cost base, and we can export into Asia Pacific. I'm not sure we can beat the Russians, and I'm not sure we can make big inroads into the U.S., not yet. But we are very optimistic about Africa."

Exports are an increasingly significant element in the growth of the Indian auto industry, more than doubling in share of sales from 2001 when Indian producers sold 3 per cent of vehicles abroad to 8 per cent of sales in 2005.

The foreign sales of Indian auto makers are also increasingly made through directly owned or joint venture (JV) based foreign operations, rather than exclusively through exports from Indian manufacturing facilities. Indian companies have bought capacity or made alliances with other automakers in East Asia, South America, Africa and Europe, and total exports as a proportion of sales are close to an average of 9 per cent for the Top five OEMs together.

Current trends suggest that exports of two-wheelers have the best growth prospects. TVS and Bajaj Auto have a strong presence in Asian and Latin American markets where there is strong demand for two-wheelers. Both companies recorded export growth of over 50 per cent in 2006, and both companies have expanded manufacturing capacity in Indonesia.

Foreign sales of passenger and commercial vehicles are likely to see more modest growth in the absence of new investments in foreign manufacturing and sales operations. Tata Motors, for example, projects exports to grow at 13 per cent over the next year, against domestic sales growth of 18 per cent. Many companies believe the day when India offers real volume competition in the world's mature passenger car markets is a long way off.

Executives interviewed for this report concur that expansion of foreign sales beyond 20 per cent of total sales for the top five Indian automakers would require more aggressive expansion abroad. A significant segment of respondents to our survey (41 per cent) felt that such foreign sales growth could only be achieved through more mergers and acquisitions. Some 28 per cent of respondents felt that current domestic production infrastructure is sufficient to further increase exports; 21 per cent felt that Indian makers would have to invest in more sales subsidiaries abroad.

In interviews companies identified two critical issues for international sales:

▪	More Global Products: Several companies comment that it remains for India's indigenous automakers to build their product range and manufacturing scale. The domestic market is going to be more important over the next five years at least, as long as India lacks the kind of economies of scale that China has, as an exporter.

 

Critical Issue: Global Branding Many respondent companies agree: in the vehicle business, reputation is critical. "Establishing our brands as quality brands in key markets is going to be a huge challenge," says the head of manufacturing at one large Indian vehicle maker. "We have to sell against established players, and we are going to have to spend a huge amount of time and energy on demonstrating the qualities of the brand." Many companies have not yet grasped that brand building requires substantial and long term investment, says this executive. "You know, even in India it has not been easy to sell a brand with our own name and our own technology. For many Indian companies, not just vehicle makers, this is one of the biggest challenges - overcoming perceptions on performance and quality." However, some companies believe that the rising reputation of the component industry holds a lesson for India's vehicle makers. "It is true that a vehicle made in India does not command the respect of a vehicle made in Europe or the U.S.," says one U.S. component maker. "But things are changing, especially for the component makers. Today anything coming from Bharat Forge for example is recognized as first quality. Anything coming from Sundram Fasteners is recognized as first quality." How can vehicle makers achieve the same sort of reputation that the best component makers enjoy? This U.S. company believes that better market understanding is needed: "We have not looked hard enough into the psyche of the customer. In the end it will not matter where a vehicle is made - what will matter is how that vehicle speaks to the customer." "Everybody has brand building challenges," says another U.S. vehicle maker. "Joint ventures can help, of course. But you must never forget that it takes years to establish a brand, and it takes minutes to blow it to pieces."

 

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Distribution: Companies believe that Indian auto businesses are still at the stage of building technology and manufacturing joint ventures: marketing and distribution networks remain to be built. Access to international warehousing and distribution by the domestic players has grown increasingly easy, thanks to the streamlining of export procedures. "Reforms that affect international business have moved much faster than internal reforms," say industry executives.

 
Large auto component manufacturers will increasingly seek growth through acquisitions

India's auto component makers are typically small, family owned and in need of scale, customers and technology. Will they succeed in finding those essentials through acquisition?

"If you really want to access the technology that component makers need, that will have to be through acquisition," says Suhas Kadlaskar of DaimlerChrysler. "But there is no need for us to re-invent the wheel - it is better to use the benefits of acquisition and JV."

At least one Indian autocomponent manufacturer will join the world top 20 component companies The component industry is the fastest growing sub-sector of the Indian industry. Will one or more of India's leading component makers reach the global top 20 within the next five years? "I think there is a real opportunity for volume production of components," says Sunil Rekhi of General Motors. "As a result GM is now looking at the possibilities of fully integrating Indian components into the global sourcing process." And Shriram Parameswaran of Eaton adds that India's component makers have a market advantage compared to vehicle makers, "Because the component makers have a Business to Business (B2B) model, their products are invisible products so they don't face the same branding issues. That explains the huge growth in the components industry." Despite the fact that Indian automotive component companies are achieving high growth in overall sales and in exports, auto executives interviewed for this report do not expect to see an Indian company enter the global top 20 within the next five years. Bosch, the largest global supplier had annual sales of USD 64.8 billion in 2006,5 while the largest individual Indian maker, Bharat Forge, had only USD 1.06 billion sales, 6 followed by Amtek Auto at USD 670 million 7 and trailed by Sundram Fasteners in third place with USD 230 million in sales. In our survey executives ranked lack of appropriate technology as the key obstacle when it comes to Indian component companies chieving global scale. Other factors cited were the fragmented nature of the Indian component industry (ranked second), the inability of smaller companies to achieve global quality standards (ranked third) and the weakness of Indian infrastructure (ranked fourth). Asked what the preferred route to overcoming these obstacles and achieving global scale should be, international alliances were ranked first and more investment in R&D ranked second. Domestic alliances and new investment in domestic capacity ranked third and fourth respectively. In the interviews companies identified the challenge of managerial professionalism as the key critical issue for the emergence of global component businesses. AK Taneja of Shriram Pistons says: "The biggest challenge for the family owned component makers - and these form the backbone of component industry in India - is to develop the professionalism you need to build scale. A single location business is all very well but a multilocation business serving domestic and international customers requires a different level of professionalism. These companies need to develop and rely more on systems and procedures and less on traditional hands-on management."

 
The Indian auto component manufacturing industry is currently worth USD 15 billion annually, according to the Automotive Components Manufacturers Association (ACMA), which forcast the industry to grow to USD 18.7 billion sales in 2009 and USD 40 billion by 2016.

Such growth forecasts are based on component makers continuing to make successful acquisitions of U.S. and European companies to build technology capability and customer bases. Several of India's largest component makers have already increased international sales thanks in part to acquisition, and the ten largest makers already make an average of 32 per cent of sales abroad. Bharat Forge and Amtek Auto in particular are now more international than Indian, with international sales of 71 per cent and 54 per cent respectively.

Although the majority of India's component makers remain small with sales of less than USD 5 mn, domestic & foreign, acquisitions have led to the emergence of a small core of larger companies. There are quite a few USD 20-30 mn companies today.

Typically, Indian component companies acquiring overseas assets continue to service the new customer base through the acquired company rather than shifting manufacturing and customer service to India, although they are likely to seek savings by sourcing some specific products from India. In our survey of executives from Indian and international auto companies for this report, the majority of respondents believed this acquisition trend would continue but be intermittent and driven by opportunity.

A majority of the respondents (55 per cent) felt that growth through acquisition would be unsteady and very opportunity driven. The need to acquire complementary product operations was ranked as the most important driver of component company acquisitions. The need to grow internationally was ranked second, while the search for a bigger customer base and the need to build management capability were ranked third and fourth respectively.

One way to get into the big league is to acquire technology-rich companies abroad." In interviews, companies identified three critical issues for component companies' acquisitions:

▪	Strategy: Companies comment that there are many acquisition opportunities not worth taking. "It would be very ill-considered for Indian companies to go about making indiscriminate acquisitions. Just because there are loss-making companies on the market that do have existing customers that doesn't mean they are good acquisition targets. You can't turn those companies around just by shifting operations to India. There are labour issues, there are regulatory issues, and there is nothing that says you are going to keep those existing customers. So one needs to look at entities that are profitable and are going to continue to be profitable." A senior executive agrees, saying, "We are only interested in profit-making companies - we are not in the turnaround business"
▪	Capacity: Companies argue that it remains important for businesses seeking acquisitions to develop the capacity to integrate acquired businesses. AK Taneja believes that the management challenge of integrating international assets is considerable. "India has [many] family owned component companies that are all faced with a new situation," he says. "It calls for multi-location operations, for decentralization, for delegation. This is the challenge."
▪	Financing: The majority of Indian component makers are family controlled, and face hard choices when it comes to raising finance. "This is an issue that is troubling a lot of companies," says AK Taneja. "Do you go public? Are you willing to dilute your equity? Or should you just grow slowly?" The auto components business has been very small scale, and there are still only a handful that have reached global scale.