Are Auto Parts Units Holding Up Growth?

Poor Supply Affected Production'

The automotive industry is in a manner different from many other sectors. Many car manufacturers have just one vendor delivering a particular part and, in many cases, inventory is kept low. The effort is to keep finished inventory to the minimum. But, due to the size and nature of the market, many firms have significant inventory in transit.

When car sales dropped in October 2008, inventory was high and most car makers were taken by surprise. Sales fell from around 107,000 in September to 82,000 in December. Commodity prices also crashed, and the stock in trade had to be written down.

 

Then the excise duties dropped, which added to the woes as vehicles had been cleared at higher excise duty rates but the market rates were expected to drop immediately. Special dealer incentives were launched to clear stock. The outlook was not good and most predicted that India’s car market would see a drop in sales.

Given the very low growth of around 2 per cent, this nearly did happen. In fact, at the time of the ordering process for the first quarter of the calendar year, no one really expected the growth to go anywhere near double digits. There was also the uncertainty around the interim budget and the budget after the elections. The strategy was to keep inventory levels low, conserve cash and deliver just in time. The component makers also followed similar strategies.

However, sales started growing, and the car makers continued to add capacity. In January 2009, more than 110,000 units were sold, a huge jump from the 82,000 units sold the pervious month. March sales were around 130,000. Interestingly, the average monthly sales were around 100,000 with well-defined peaks around the festival season. In 2009, the average monthly sale was higher at around 130,000.

Ramping up supplies took time. Perhaps many component manufacturers were uncertain about the sustainability of the growth and were, therefore, risk-averse.

Many things happened simultaneously. First, the demand for tyres grew, but the capacity was restricted. There were times when vehicles were ready and waiting for tyres. The case was similar for castings and forgings. Capacity is typically lagging requirement.And it is only now that investments are being made.

Second, licensing conditions were imposed on the import of certain components, which meant production was stopped till licences were obtained. Unfortunately, in car manufacturing even if one component, say, a bumper, is not available, it holds up production and delays delivery. Also, as volumes are low, existing suppliers do not want to manufacture in India.

 

Third, the labour unrest in September not only disrupted supplies in India but, as was widely reported, resulted in the closure of a plant in North America.

Fourth, the fuel depot fire in Jaipur disrupted the supply of critical engine components. The production of many models was affected.

 

In other cases, there is the cost issue. Either the vendor is looking at an internal rate of return that the original equipment manufacturer (OEM) does not agree to, or investments in other countries are more attractive and the parent company invests there rather than in India. In some cases, the aftermarket (products made by a company other than the original manufacturer of the car) is more attractive and supply to OEMs gets restricted. To add to the challenge, new global players are sensing an opportunity and are looking at setting up base in India.

Clearly, poor supply of components did impact production and sales of cars. The situation will be more complicated now. There is uncertainty about fuel supplies — some manufacturers may require BS II compatible components even as many component suppliers are planning to phase out production of these components or manufacture newer products. If things do not go as planned, production and sales could get disrupted. This happened in 2005, and we are working to avoid a repeat. With closer cooperation and risk taking, such disruptions could be a thing of the past.

 

'Auto Ancillaries Are Up To The Challenges’                   

Disrupted supply from auto ancillary companies affected the auto sector’s growth in 2009. But this year, the companies may be in a better position to face changes

After over a year since the cataclysmic events that led to the collapse of some of the world’s most powerful financial institutions, one can afford to take a more elevated view of its effect on the auto ancillary sector in India.

In the months prior to the financial meltdown, auto ancillary units faced two issues — increased production costs (due to raw material unavailability and price inflation) and increased pressure from customers to increase production levels due to growing demand (both domestic and overseas). Despite these, the auto component manufacturers and their customers — the original equipment manufacturers (OEMs) in India — remained optimistic about the near-term prospects and continued their capacity-expansion plans.

 

GOPAL PATAWARDHAN,chairman of Autoline Industries (BW pic by Subhabrata Das)

The financial meltdown led to a severe constriction in demand, and the above-mentioned two issues simply melted away in the heat of the crisis of overcapacity. While I do not want to trivialise the pains suffered by almost all members of the auto ancillary fraternity in the past 18 months, I do not believe that the financial meltdown that led to deceleration across all sectors will continue to be the primary pivot shaping the strategy of auto component units in India.

The tail-end of the Internet revolution led to the emergence of globally integrated supply chains across the manufacturing world. The last decade has seen the emergence of new markets that have developed partly due to the “democratisation of capital” enabled by this process of global sourcing and service delivery.

If one believes (as data suggests) that auto sales in the US, Europe and Japan will continue to remain subdued, and one accepts the prognosis that China, India and other emerging markets will see increased volume and value growth, then integrated supply chains in the auto sector will become even more critical for the competitiveness of leading OEMs, which are trying to reconcile their over-capacities to under-capacities in the emerging ones.

The question that remains is: are Indian auto ancillaries capable of competing with their counterparts in developed markets to form a larger bulk of this integrated supply chain?

The automobile market is in general quite close to being a theoretically “perfect market”. It has mature technologies, relatively low product differentiation, a large number of sellers and buyers for the products, both buyers and sellers have nearly symmetrical information, etc. Thus, automobile OEMs compete much more on price than on any other single attribute, and generate profits that are close to the theoretical “economic profit”. The only way to distort or diminish the perfect market effect (and, consequently, make a better profit), is to try and increase product differentiation, or distort the customer-seller information balance. New product introductions and complex cost engineering achieve some of this.

Auto ancillary companies have to align themselves to the above paradigm and must continue to provide their customers (the OEMs) faster and more efficient turns on new products, besides offering better prices to make more than the “economic profit”.

Indian auto ancillaries still account for an abysmally low percentage market share globally, similar to IT and software firms in the 1990s. In macro-economic terms, they have a marginally higher cost of quality due to their local supply chain infrastructure, an advantageous cost structure with regard to middle management, labour and engineering, and a relatively level playing field on finance and commodity costs.

As India’s automotive supply chain infrastructure improves with the broadening of the supply base and consolidation among tier-1 suppliers, and as auto ancillaries improve in product design and development, they will be able to create a sustainable value gap between themselves and their overseas competitors.

The global automotive industry may not grow in real terms this year, but most of India’s auto component companies will see significant growth and will be poised to ride the challenges and opportunities that lie ahead.

(This story was published in Businessworld Issue Dated 01-02-2010)