India's Small Car Dream

The term "small car" is both relative and subjective. A small car in the US or the Middle East is regarded as big in countries such as India and Indonesia. Within a particular country, too, the small car market has fairly heterogeneous products. While a car equipped with the latest technology such as the Suzuki Swift is a small car, the basic Nano, which is available at one-third the price of the Swift, also belongs to the same segment.

A car that has limited or no luxury features and is more functional, offering customers basic mobility and value for money, can be considered a small car. Excise duty rules in India define a small car as one that is shorter than 4,000 mm with an engine size smaller than 1,200 cc, if gasoline, and 1,500 cc, if diesel. From a price perspective, it is difficult to objectively define a small car. According to the standard Indian income classification, any car costing up to INR 500,000 can be considered a small car.

For the purpose of discussion and research, we have considered the Society of Indian Automobile Manufacturers' (SIAM's) segmentation, according to which the mini segment and the compact segment constitute the Indian small car market.

The Small Car Market in India

India is primarily a small car market, mainly due to the country's demand fora cost- effective mode of transportation. Of every four cars sold in India, three are small. Domestic sales in the small car segment more than doubled from 0.54 million units in FY04 to 1.2 million units in FY10. The small car segment is also driving India's car exports, contributing 95% to the country's total exports.

 
In 2009, India surpassed Japan and became the largest small car market in the world, accounting for the sale of around 900,000 small cars, as compared to 700,000 sold in Japan. India is now the second-largest exporter of small cars, behind only Japan. Led by small car exports, the country surpassed China in 2009 by exporting 412,256 passenger vehicles as compared to China's exports of 369,600 units (including commercial vehicles [CVs]) during the same period.

It is interesting to note that while the car market in India is largely petrol-fueled, customers are increasingly showing preference for diesel and CNG/LPG due to their lower running costs.

 
Tata Motors' in-house development of the Nano has come as a paradigm shift in the small car industry. By lowering the price point to almost half of the lowest price point previously and creating a new benchmark in vehicle pricing globally, the Nano and similar products are expected to increase the presence of small cars in the country significantly and provide access to a larger customer base.

A. Demand: A Large Consumer Pool

1. Domestic Demand

India is an emerging nation, shifting steadily from an agri-based economy toward a service and manufacturing oriented country. Low-cost modes of transportation across vehicle segments in India hold significant growth potential, since the country's national per capita income is fairly low, at approximately US$1,000. The two-wheeler segment, for instance, is relatively popular and constitutes more than three-quarters of vehicles sold in India. Moreover, two-wheelers account for only half of the number of bicycles sold in the country.

Companies Planning to Manufacture Small Cars in India Bajaj Auto Ltd ▪  Bajaj Auto's ultra low-cost car, Lite, which the company is manufacturing in alliance with Renault-Nissan, is expected to be launched in 2012.   ▪  The car will be launched at a base price of US$2,500.   ▪  Bajaj Auto is setting up a plant with an annual capacity of 400,000 units in Pune to manufacture the small car.   Hyundai Motor Company ▪  Hyundai plans to launch its small car priced below the Santro by early 2012. The car is expected to be priced at around INR 200,000.   ▪  The company aims to export its small cars, including the i20, to 10 more countries, including Australia, by the end of 2010.   ▪  Hyundai also plans to triple its i10's monthly exports to Vietnam by the end of 2010.   Toyota ▪  Toyota intends to launch its small car, Etios, by the first quarter of FY12 with a localization level of 70%.   ▪  The car will feature a 1.2-litre petrol engine and is likely to have a diesel-engine variant.   ▪  The company aims to increase its production capacity in India more than tenfold, at an in vestment of INR 24-25 billion by 2012, and make it a hub for the production of Toyota's small cars.   General Motors (GM) ▪  GM plans to export its small cars to Bhutan, Bangladesh, Nepal and Sri Lanka in 2010.   ▪  The company aims to export 20% of its total volume from India to Europe and the Asia-Pacific region in 2011.   ▪  GM also intends to launch another small car in India by 2012, through its JV with China-based Shanghai Automotive Industry Corporation.   Honda ▪  Honda plans to launch a small car in India, Nepal, Bhutan and Bangladesh by 2011.   ▪  Designed in Japan, the car will be produced at the company's Greater Noida plant in Uttar Pradesh.   ▪  It is expected that 80% of the car's components will be manufactured in India. The car is likely to be priced below INR 500,000.   Nissan ▪  Nissan plans to make India its export hub, catering mainly to emerging markets.   ▪  The company has transferred the production of its small car, Micra, from the UK to India.   ▪  Nissan launched the Micra in India in July 2010 and started exporting the car to Europe from August 2010.   Peugeot ▪  Peugeot plans to invest INR15 billion in the manufacture of small and low-cost cars in India for both domestic and export markets.   Ford ▪  Ford recently launched its small car, Figo.   ▪  The company has invested US$500 million in its plant at Chennai to make it a regional centre of excellence for the production of the company's small cars and low displacement engines that cater to its operations in the Asia-Pacific region and Africa.   Volkswagen (VW) ▪  VW plans to capture a larger market share in India and make India its small-car manufacturing hub.   ▪  The company aims to export its hatchback, Polo, to SouthEast Asia, the Middle East and Africa from India from the Q2 of FY12.

 
Rising middle-class aspirations and sustained increases in disposable income characterise the long-term India growth story. The need for low-cost regular mobility, along with growing aspirations, has opened up significant opportunities in the small car space.

Based on the NCAER's classification of income strata, the "Deprived" category has significantly decreased in the past decade from 72% to 52%. The 20% of households that have exited the "Deprived" category have become "Aspirers," while several "Aspirers" have ascended to the middle class category. According to the current population size, 28.4 million households belong to the middle class category, cumulatively owning as many as five million cars.

Assume that no household owns more than one car. The remaining 23.4 million households that do not own a car currently, but have rising disposable incomes and aspirations, reflect a significant opportunity for the small car segment in the country.

2. Export Potential

Globally, the industry is witnessing a shift in demand for fuel-efficient products. Concerns around environment protection and climate change are gaining momentum and have started to alter the demand pattern, at least in mature markets. This, accompanied with fluctuating gasoline prices, is causing a shift of preference toward smaller and fuel-efficient modes of transport.

The market for small cars is expected to continue growing. While the European market is already relatively strong, the North American market is yet to gather pace and catch up.

 
B. Supply: A Low-Cost Manufacturing Base

1. Frugal Engineering Capability

Frugal engineering is the ability to execute a project in less time with fewer resources and at a lower cost. This capability is giving India a competitive advantage that transcends just labour costs and can be seen in many areas from mobile phones to vehicles. It includes the ability to be more flexible, adaptive and manage with minimal resources. International players are partnering with Indian companies to adopt and leverage these capabilities in local R&D and manufacturing facilities. This trend is visible in both the vehicle manufacturing and component industries. India now needs to capitalise on this potential to create a competitive edge.

2. Low-Cost Labour Base

Labour cost (wages per hour) in India is one-sixth of that in industrialised nations such as Japan, Western Europe and the US. The cost of an entry-level engineer is US$8,000 per annum, which is around 45% less than that of an American counterpart.

3. Skilled Workforce

India produces the highest number of engineers in the world, with 0.4 million qualified engineers graduating in the country each year. Although the employability of these engineers is not so high and skill gaps do exist, its employable pool makes India an attractive manufacturing destination.

4. Government Support

In 2006, the Government of India (Gol) reduced the excise duty on small cars from 24% to 16% to encourage small-car manufacturing in the country. Government support has since continued, and excise duty rates on small cars have been further reduced. Currently, small cars are taxed at 10%, whereas bigger cars are taxed at 22% + Rs.15,000.

5. Cost-Effective Supplier Base with Improved Quality

Over the years, India has developed an excellent base of quality component suppliers, best known for their low-cost manufacturing capabilities. An increasing number of Indian suppliers have achieved various quality certifications. Currently, the country has 11 Deming award-winning automotive companies, the highest number after Japan.

6. Increased Focus on Infrastructure

The Gol has increased its focus on the development of infrastructure by improving the quality of the country's roads, highways and ports to support the industry's growth. This is expected to improve India's logistics and facilitate its exports. Various special economic zones (SEZs) have been established in the country, which, in addition to offering several fiscal benefits, facilitate regulatory clearances.

Competing with China

Among the BRIC countries, China is the one country that India is most often compared with. From an automotive industry standpoint, both India and China offer significant cost advantages, are regionally located in Asia and contribute significantly to the growth of the global automotive industry. Exhibit below illustrates how India fares as compared to China in various aspects.

 
The median age in India is 24 years as compared to 37 years in China. This is an advantage for India, both from a working population point of view as well as from a consumer pool perspective. Although India scores over China on various parameters, there is a clear difference of scale. China's GDP is three times that of India. China is also active in foreign markets, investing three times more than India in such markets. Foreign Direct Investment (FDI) in China is 10 times that of FDI in India. In 2009, the Chinese auto industry produced 13.8 million units (cars and commercial vehicles) as against 2.6 million units produced in India. As such, while India is considered China's closest competitor, it has a long way to go before it surpasses China.

Action Plan for the Indian Auto Industry to Maintain its Competitive Advantage

1. Build scale

The Indian automotive industry is now building scale due to a growing domestic market. Achieving scale will help the industry realize greater economies of scale. It will also provide the risk-taking ability required to diversify into global markets and service large export orders at competitive costs.

2. Build R&D capabilities for vehicles and components

India currently lacks the capability to manage high-end work such as product prototyping. R&D centres set up by various international manufacturers in India are confined to the basic localisation of imported parts and data services. Overall, domestic vehicle manufacturers spend approximately 1% of their turnover on R&D as compared to the global average of 5% to 8%. Component suppliers depend either on their global counterparts or OEMs for technology. Suppliers need to focus on product innovation and designing capability needs.

3. Develop a first-mover advantage in new emerging markets such as Russia, Africa and Brazil

Indian companies need to start setting up a base in emerging markets and consider either acquiring or forming JVs in such countries to access their manufacturing bases and save on time and effort. This is also likely to give them adequate time to gain an in-depth understanding of such markets and offer products and services more effectively.

4. Leverage India's small-car production development capability

Frugal engineering, as showcased through the Tata Nano, should be extended to other product segments. This is likely to help Indian companies lower the cost of their products at the design stage itself and gain a competitive edge over various international players planning to enter India's small car industry.

5. Focus on green technologies

With the demand for fuel-efficient and non-fossil fuel-based products rising across the globe, the Indian auto industry should concertedly start investing in green technology. China invested as much as US $ 35 billion in green technology across sectors in 2009. This is higher than the investment made in the US.