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BW Businessworld

Discount Drivers

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No sooner had the finance minister announced a cut in excise duty on vehicles in his interim budget that car manufacturers made it clear that they would pass on the benefits to customers. As a consequence, all original equipment manufacturers (OEM) announced reductions in the sticker price of cars. Given the state of the economy, most OEMs even announced additional discounts. A car buyer could now enjoy the twin benefits of lower excise duty and hefty discounts offered by OEMs. However, something seems to have got lost in translation. Despite the obvious benefits to customers, with the potential to boost sales, OEMs face the prospect of squeezed margins and losses.

Interestingly, the very same manufacturers had cited a rise in input costs to hike prices in January. So what had really changed for the OEMs to now make them go  that extra mile to attract customers with rebates?

For starters, here’s what the FM announced: The excise duty on small cars, two-wheelers and commercial vehicles was to be cut by 4 per cent — from 12 per cent to 8 per cent. The duty on medium and large cars was to go down by 4 per cent as well — from 24 per cent to 20 per cent, and that on sports utility vehicles (SUV) by 6 per cent — from 30 per cent to 24 per cent.

Promptly, the top OEMs, including Maruti Suzuki, Hyundai, Honda, Tata Motors, General Motors and Mahindra & Mahindra, announced plans to pass on the benefit to customers. Besides, almost all car dealers were offering far more discounts than what the OEMs were advertising to woo potential car buyers.

But why announce a lower discount and then give more to customers? “That is mainly because if tomorrow market conditions improve, they can immediately roll back the unannounced discounts without any fuss,” says a Delhi-based former India head of a top OEM. “Discounts are given at any point of time depending on market conditions. If demand increases, discounts disappear,” says R.C. Bhargava, chairman, Maruti Suzuki.

For Indian car makers, 2013 has been one of the worst, with car sales dipping 9.6 per cent in the calendar year to 18,07,011 units. In January too, car sales were down 7.6 per cent against the same period a year ago. The excise duty cuts have brought some cheer to the February sales figures, which have gone up by 1.4 per cent (year on year).

It’s Raining Offers
The reduction in car prices has been so steep that some industry experts believe the current spell of discounts could be the biggest that the Indian automotive industry has witnessed.

While, officially, car manufacturers have already slashed prices by around 4-6 per cent, combined with the other ‘offers’, the rebates work out to around 8 per cent in most cases. Also, just to give customers that little extra nudge, most manufacturers have calculated the excise duty “leniently”, say industry trackers. So, while the 4 per cent excise cut is applicable on ex-factory cost (transportation and other expenses are additional), most car manufactures are calculating it on the ex-showroom price of a car.
 
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“A lot of companies are giving discounts, but, at the end of the day, no one is making any money,” says V.G. Ramakrishnan, managing director, South Asia, and global co-leader, automotive practices, Frost & Sullivan. “Several schemes have been announced — be it cash discounts or an insurance waiver — to help the customer save money. Some dealers are even selling cars at Rs 60,000-70,000 below the ex-showroom price.”

Following the excise cut announcement, market leader Maruti Suzuki cut prices in the range of Rs 8,500 and Rs 31,000. Hyundai cars were cheaper by anywhere between Rs 10,000 and Rs 1.35 lakh, depending on the model. Similarly, Honda slashed prices between Rs 14,500 and Rs 45,000. M&M reduced prices between Rs 13,000 and Rs 49,000.

But how did the OEMs manage to offer such large discounts — over and above the excise duty cuts — despite rising input costs? “The input costs have, in fact, come down in the past four months. It is just an annual ritual to lure customers by saying that prices will increase next year,” says an executive with a Delhi-based OEM.

Unintended Effect
The excise cuts were meant to boost car manufacturers’ revenues. But almost all of them have ended up taking a hit. Here’s why. After the duty cut announcement by the government, OEMs began passing on the benefit to customers. But what about cars that were already with dealers (shown as sold on manufacturers’ books) and have the old price tag? Most manufacturers said they would absorb the price difference and show it in their books.



For example, the 12 per cent excise duty applicable earlier on a small car costing Rs 3 lakh (ex-factory) works out to Rs 36,000. This car is already with the dealer. It would now have to be sold for Rs 12,000 less after the 4 per cent reduction in duty. The loss of Rs 12,000 per car would be absorbed by the OEM.

Ideally, manufacturers could have offset this loss by curtailing discounts already on offer prior to the excise duty cut. But most OEMs refrained from doing so fearing a further fall in sales. “After the excise duty reduction, consumers will scout for deals at the new price. It’s the OEMs or their dealers who will have to bear the burden of the higher excise duty paid earlier on the entire inventory,” says Delhi-based Puneet Gupta, associate director,  IHS Automotive, an automobile consultancy. “The inventory constitutes the cars on display at the dealership, those in the warehouse or in transit.”

Industry trackers say the fallout from the pre-excise duty cut inventory on the books of OEMs will be to the tune of Rs 800 crore. The only hope for OEMs now is that sales spurred by heavy discounts will make up for this loss. “We are compensating our dealers (for the loss due to revised excise duty) and it will have a negative impact on our balance sheet,” says Rakesh Srivastava, senior VP, marketing and sales, with Chennai-based Hyundai Motor India. “But we are giving out discounts so that the customers benefit.”

It is evident from the February figures that potential car buyers haven’t taken the bait. However, industry trackers are optimistic that discounts will help improve sentiment and customers will start making their purchases by May.

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(This story was published in BW | Businessworld Issue Dated 07-04-2014)