It could be, arguably, a tipping point for the Indian auto industry. In February, France’s Renault and its Japanese affiliate, Nissan, announced plans to team up with Indian tractor giant Mahindra & Mahindra to build the country’s largest passenger car manufacturing plant. The Rs. 4,000 crore ($902 million) facility in Chennai will turn out 400,000 cars a year from mid-2009 on. Industry rumors suggest that eventually the number could double to 800,000. Were that to happen, it would almost match and thus double the number of cars — 1.1 million — that the entire Indian auto industry now produces each year.
Over the next three to four years, some Rs. 35,000 crore ($8 billion) may be invested in building manufacturing capacity in India for another two million cars each year, with half a million earmarked for exports. As a result, by 2010, India’s capacity could triple to 3.1 million cars a year, making it the same size as China’s market today. (By way of comparison, in the U.S., auto makers sold 7.6 million cars in 2005, according to data updated in January by the U.S. Bureau of Transportation Services.)
Thanks to low manufacturing costs combined with a robust and growing vendor base for components, some observers believe India could emerge as a global hub, at least for small cars. In fact, nine of the world’s top 10 automobile companies have a presence in India. Yet constraints are clearly present, such as poor road infrastructure and high taxes on petrol. Also, growth is occurring against the backdrop of competitive pressures on auto giants such as Ford and General Motors. India Knowledge at Wharton spoke with Wharton faculty, senior executives at Indian automobile companies and consulting firms, and researchers at Mumbai-based research firm Corporate Database about the road that lies ahead for India’s auto industry.
The biggest factor that is driving auto sales is India’s rapidly growing domestic market, encouraged by 9%-plus GDP growth and rising incomes across its much-touted 250-million-strong middle class. Autopolis, a British consulting firm, predicts that the top six global auto companies will lose market share to companies like FAW and SAIC in China and India’s Tata Motors, to name a few. A survey by the Economist expects 60% of the incremental demand of 2.8 million vehicles to come from Asia by 2020, with China and India topping the charts.
John Paul MacDuffie, a professor of management at Wharton and an automobile industry expert, is not surprised at the explosion in the Indian auto market. He has seen this phenomenon occur in other countries, too. “There was a sign that India is moving in this direction from the opening up of the economy, the welcoming of foreign investment and other things that were helping economic growth,” he says. “There seem to be some relatively predictable points in the rise of per capita income when different stages of what people describe as ‘motorization’ happened.”
Manish Mathur, principal at A. T. Kearney’s New Delhi office, who oversees the firm’s automotive practice, says the penetration of vehicle financing in India is an important factor. He says such financing accounts for 85% to 90% of all cars bought; typically up to 80% of the car’s value is financed. By contrast, he says, the penetration of vehicle financing in China is considerably lower, even as it boasts nearly three times India’s passenger car volumes. In the U.S., about 56% of consumers and 41% of businesses financed their vehicle purchases in 2005, according to the latest available data from the federal Bureau of Transportation Services.
About two-thirds of the planned investments in the Indian passenger car industry — about Rs. 24,000 crore ($5.4 billion) — will come from Tata Motors, Maruti and Hyundai and other companies. The Tatas are expected to invest Rs 10,000 crore ($2.2 billion), and this includes outlays for a new, low-cost car, a joint venture with Fiat and capacity for commercial vehicles. Maruti plans to invest Rs. 4,000 crore ($900 million) in its plant in Manesar near New Delhi, after which its capacity will increase from 600,000 cars to 900,000 cars. Hyundai is doubling its Indian capacity to 600,000 cars at a cost of Rs. 5,000 crore ($1.12 billion). Honda Motors will spend Rs. 1,800 crore ($400 million) to triple capacity to 150,000 units by 2010. General Motors is investing about Rs. 1,300 crore ($280 million) in its second Indian plant in Pune, near Mumbai, where its capacity could more than double to 140,000 cars in a year. Industry watchers expect it to produce its economy car, Chevrolet Spark, at the facility.
India’s passenger vehicle business has evolved from rather modest beginnings in the mid-1950s, and was a near duopoly for more than three decades with two domestic manufacturers — Hindustan Motors and Premier Automobiles. The entry in the mid-1980s of Maruti Udyog, a government-supported joint venture with Japan’s Suzuki, triggered consumers’ imagination. It dominated the market for more than a decade. Real competition emerged in the late 1990s when Hyundai of Korea introduced its Santro model, a hatchback. Next came Indica, a diesel-driven small car from Tata Motors, India’s largest maker of commercial vehicles.
Meanwhile, multinationals such as Ford, GM and Peugeot had introduced some international models through their Indian joint ventures. These could not meet the Indian consumer’s need for a low purchase cost, higher fuel efficiency, a comfortable ride in city conditions and low maintenance costs. So the small car continued to rule the road. After a while, Peugeot and Daewoo folded their Indian operations, while Fiat, Ford and GM struggled to build a meaningful presence for almost a decade. After 2000, sales of Honda and Toyota cars have climbed rapidly, but neither has a small car among its offerings. So, even today, 85% of the Indian passenger car market is ruled by the top three players in the domestic market.
Tata Motors may change the rules of the game with a car priced at Rs. 100,000 ($2,200) in 2008. Its target is said to be at least one-fifth of seven million two-wheeler buyers who may want to graduate. This will mean 1.4 million cars, more than the current size of the domestic car market. Tata Motors already profitably sells its Ace, a light commercial vehicle, for Rs. 130,000 ($2,920), and it is 80% outsourced. Market leader Maruti, too, is said to be considering a 20% cut in the price of its base product, the Maruti 800. Maruti is launching five new models, with a plan to export a fifth of its incremental output. The global players in the Indian market are also in overdrive. General Motors has targeted a market share of 10% by 2010 (currently at 3%). Toyota wants a 10% share (currently at 4%) of this market. Others with plans to set up operations in India or expand include Volkswagen, BMW, DaimlerChrysler and Audi.
India’s strong base of auto ancillary manufacturers significantly increases its appeal as an investment destination for foreign car makers. Many of these companies have acquired facilities in developed markets and successfully grown their international business. For example, ancillary maker Toyota Kirloskar is poised to hit annual revenues of $1 billion, driven largely by exports. Mercedes Benz also exports more components out of India than the revenues it generates from its domestic vehicle sales.
“India now has a good base of component suppliers,” says Arindam Bhattacharya, partner at Boston Consulting Group in New Delhi. “Its only challenge is that it needs to scale up.” Yezdi Nagporewalla, head of the automotive practice at consulting firm KPMG in Mumba, notices an increase in auto design and engineering work being executed in India. “Many companies are transferring their research work to India,” he says. Adds Pawan Goenka, head of the automotive business at Mahindra & Mahindra, “To call ourselves an automotive hub, we need to become a center for design. Companies are setting up R&D centers but they’re still small. We have so far managed possibly two truly ground-up, Indian-made vehicles — the Indica and the Scorpio.”
Car makers are themselves taking the initiative to develop vendor bases in India. Says Goenka: “For our Logan [sedan] project, Renault facilitated the entry of a couple of vendors from Europe into India. They have set up shop here.” He believes the same could happen for the Nissan-Renault venture with the Mahindras. Volkswagen, too, is said to have bought some land for vendor development projects. Hyundai has brought in a few vendors from Korea, and they are located close to its plant in Chennai.
Exports as a Driver
Industry experts are convinced that India is an attractive base from which to export cars to third country markets, according to media reports. Carlos Ghosn, the CEO of Renault and Nissan, has been quoted as saying that sourcing cars from India for the world markets is 35% cheaper than Europe. Toyota Motor director Kira Okabe reportedly said, “I have a vision to make India a manufacturing base. I want this to be a model of low-cost production with high quality. In fact, my challenge is to show my management that India can become the lowest-cost production base anywhere for Toyota.”
Goenka estimates that manufacturing in India is cost-effective but adds that China could be cheaper by about 12% to 15% today. “That suggests that any car maker targeting only the export market would prefer China as a manufacturing base. But for those looking at a mix of the domestic and foreign markets, India makes sense.”
Big Small Car
Vivek Gupta, managing director of consulting firm A. T. Kearney’s Indian operations, agrees that India’s cost advantages may not be the most compelling. He says it’s a little early to tell if global auto majors have determined that India is their first choice to manufacture small cars for export markets. “Such investments in India by global majors are at an embryonic stage,” he says. “It could very well be China or Korea that will become the small car hub of the world.”
According to Goenka, the obsession with small cars is misplaced. He wants the government to reduce duties on all types of cars, not just small cars. “Automobile plants do not get built everyday,” he says. “If India loses the opportunity now, it may not come again in a hurry. So the government should perhaps rework the automobile policy to promote the manufacture of larger cars.”
The small car, however, happens to be India’s sweet spot, says A. T. Kearney’s Mathur. He says small hatchbacks sell the most in India, unlike in the developed markets or even China. Examples of Indian hatchbacks are Tata’s Indica, Maruti’s Zen and Hyundai’s Santro — that space is described as the “A” and “B” segments of the market. “If I were to plot size on the X axis and volume on the Y axis, it is an exponentially dropping curve in India,” says Mathur. “It’s a bell curve in other countries.” He says the mid-segment, or the “C” category that is made up of sedans such as Maruti Esteem and Tata Indica, is growing rapidly.
India may not go the way of developed markets in its automobile market preferences, but it would still do well to watch changing industry trends there, especially as it is at the cusp of a new growth era. To consolidate or not is one recurring theme across most industries. Big is not necessarily bountiful in this industry any more, says Wharton’s MacDuffie. He points to consolidation attempts that didn’t pan out well: General Motors’ string of international tie-ups with small equity stakes, Ford’s purchase of several companies, and DaimlerChrysler’s recent move to undo the Chrysler acquisition of nine years ago (analyzed elsewhere in Knowledge at Wharton).
“Certainly the era when all the companies thought that the only way to survive was to be big has probably passed,” says MacDuffie. “That is because not only have many of the global mergers or tie-ups had difficulties, but the most successful companies have stayed independent and some of them are even relatively small, such as Honda and BMW.” He adds that Toyota has stayed “resolutely independent, and obviously they are the dominant auto maker now.”
Legacies of wage costs and inefficiencies in supply chains and manufacturing processes are some of the key, well-documented problems at the Big Three auto companies. MacDuffie says some of these legacy costs “are probably fairly unique to the context and to the moment,” but does think there are some lessons that could be relevant to the Indian auto industry. Those, he says, have to do with flexibility in production systems and “the limitations of the mass production mindset” in the U.S. industry. “The U.S. was once a market — even as late as the 1950s — when one Chevrolet model could hold 25% of market share; the diversity of products was very low,” he says. “It was possible for GM to have two, three or four plants making just one model of one product line.” All that has changed, and MacDuffie estimates there are more than 200 different models produced in any given year.
In India, too, as MacDuffie points out, the 80% market share that Maruti enjoyed at one time did not last. “India won’t immediately go to the stage of product proliferation that we see in the U.S. or in Europe, but any manufacturer would be well advised to be prepared from the start for a market that will steadily value variety more and more,” he says. “Even if at Time T you don’t use all the flexibility, at T +1 the fact that you have it gives you a competitive advantage over others.”
The challenge for both Indian and Chinese auto companies in terms of exports will be in breaking into the developed markets that are already mature with near-flat growth. The U.S. market, for instance, grew by just 5.5%, to 7.6 million passenger cars, in the five years leading up to 2005. Here, Gupta feels partnering is the most likely route for Indian cars to gain a presence in the U.S. market. “It won’t be too long before we see a joint venture between an Indian and a North American auto major. Tata Motors would be a frontrunner here,” he says.
MacDuffie tempers that optimism and says “the expectations for quality are quite high and the regulatory standards are also demanding” in developed markets. “I don’t want to underestimate the power of the idea of starting to export to the U.S.,” he says. “It energized the Japanese and it energized the Koreans, but it’s a tough and slow process. It may happen more quickly than it happened for the Japanese and the Koreans, but we are talking of at least a 10- or 15-year period to do it in a successful way.
“On the other hand, the domestic market in India is growing very rapidly, and it may perhaps have somewhat less demanding customers and lesser regulatory constraints,” says MacDuffie. He feels there are more reasons for Indian auto makers to focus on the “more local and more immediate opportunity” in their home market. “They could use it as a training ground, and to make sure they have a strong presence in the growing domestic market.”