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Auto ancillaries: In the driverís seat - Views on News from Equitymaster
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  • Mar 1, 2004

    Auto ancillaries: In the driverís seat

    While some Indian companies were winning plaudits for their work in the services field such as IT (information technology) and BPO (business process outsourcing), companies from the manufacturing sector werenít exactly treading the same path. However, if the developments that have taken place recently in the auto ancillary industry are any indication, it will not be long before the domestic auto ancillary industry does a repeat act. And this newfound optimism in the industry is not without reason.

    For one, the industry exports have grown at a CAGR of 19% in the last five years. Secondly, many among the best global auto makers have started either outsourcing from the Indian auto ancillary companies or have set up their own manufacturing bases in the country. So, what is it thatís making some of the best names in the global auto industry make a beeline for Indian shores and driving this new wave of auto components outsourcing. Letís try to find out:

    The worldís biggest car market, the US is not exactly in the best of health. Although this is not a new phenomenon, this time around itís not the sales that are worrying the US car manufacturers (the industry has seen four years of record vehicle sales and in 2003, the industry is likely to have closed the year with sales in excess of 16 m cars). Still, the industry is struggling to make ends meet. The reason is the overcapacity that is prevalent in the US markets. Even as thousands of cars are piling up unsold, the Japanese are flooding the US markets building up efficient new plants.

    US car and light truck market share%
    1996 2003*
    US big 3 72.5% 63.9%
    Japan 17.9% 22.6%
    Source: Economist

    This unprecedented glut is forcing carmakers to slash prices and consequently, putting enormous amount of strain on margins. This however, is not likely to continue forever and the US automakers will have to fight their Japanese counterparts on the cost front. Therefore, one viable alternative for these companies is to outsource components from cost competitive destinations like India.

    This is where the low cost advantage of the Indian auto components manufacturers comes into play. It is being estimated that while Indian companies spend 3%-15% of sales on labour cost, global companies spend 20%-40% and therefore it is only natural that the US automakers find it cheaper to import components from India rather than manufacture it in house or source it from US based suppliers.

    Another factor that has led to the growth in exports from the auto ancillary industry is the changing perception about the ĎMade in Indiaí products. While the Indian manufacturing industry is not exactly known for its cutting edge technology and stringent quality standards, things are beginning to change. The fact that as many as six companies boast of the coveted Deming awards (four auto ancillary companies and two auto companies) is a testimony of the fact that the Indian auto ancillary industry is capable of manufacturing products that are at par with the best in the world in terms of quality. It would be pertinent to add that not a single Chinese company has as yet won the Deming quality award. Not only this, about half of the auto ancillary companies in India have QS 9000 certification, considered to be an important pre-requisite for supplying to the US based OEMís. The point we are trying to impress on is not that we have got these awards. The fact is that Indian companies are not afraid of competition in the global markets. There has been a sea change in the mindset, per se. This may seem a very broader argument, but it is not.

    The growth of the domestic auto industry has also helped increase the quality awareness among Indian components manufacturers. The entry of global players such as Ford, GM, Toyota and Honda into the Indian market has allowed the Indian manufacturers to work with these players on global production, quality and delivery systems. It has also helped the global players to see for themselves the evolution of many auto components manufacturers and they are therefore now entrusting them with more work.

    Another reason we are bullish on the industryís export prospects is the huge global market. The size of the export market is estimated to be around US$ 1 trillion out of which about 75% is accounted for by the OEMís and the remaining 25% by the replacement market. Therefore, in addition to the US, the auto ancillary manufacturers can also focus on the European and the growing Chinese automobile market. Already, a couple of companies have made some strategic acquisitions in the European markets (Bharat Forge acquired a German forging company and Sundram Fasteners acquired precision forging business of Dana Spicer Europe). This would help these companies to reduce their dependence on the US markets and open up windows of opportunity in the European markets. In fact, Sundram Fasteners is also setting up a plant in China to cater to the Chinese domestic market, which is also growing at a very fast pace.

    Therefore, on account of a host of favorable factors given above, according to industry estimates, the exports from the Indian auto components industry should total roughly around US$ 50 bn by 2015 (thatís a 39% CAGR from current levels).

    However, there are a couple of caveats. While the Indian IT industry got a headstart over its rivals, the same cannot be said about the auto components industry as countries like China and Thailand might put a spanner in domestic industryís wheels. While China has huge economies of scale and lower labour cost than India in some areas, Thailand is believed to have excess capacity (legacy of East Asian crisis) and depreciated assets. Therefore, these countries are capable of beating India at its own game, that of low cost.

    US component imports (US$ m)
    1998 1999 2000 2001 2002
    India 99 117 150 141 177
    China 863 1,041 1,368 1,483 1,884
    Thailand 309 374 362 380 516

    As can be seen from the above table, while Chinaís exports to the US have grown by a CAGR of 27% over the last four years, that of Thailand and India have grown by 14% and 16% respectively. However, in 2002, both Chinaís (27%) and Thailandís (36%) exports have grown at a faster rate than Indiaís (26%). Therefore, if this trend is to continue, we might not be able to catch up with the two Asian giants as far as components exports to the US is concerned.

    Another key factor to consider is that the auto ancillary manufacturers largely belong to the small-scale sector. These smaller players have been deprived of both capital and technology and if the sector as a whole has to become competitive, the small-scale sector deregulation has to accelerate. Otherwise, it will only be Tier I players who will benefit from the growth opportunity.

    But there is a light at the end of the tunnel for the domestic manufacturers. It is being observed that over the last few years, automakers have been increasingly passing on greater responsibilities to their suppliers and they no longer want mere manufacturers but suppliers who can provide them with complete set of services like research, development and design, testing etc. and this is where India can score over its Asian rivals, as thanks to the countryís IT advantage, it can bridge the gap faster than its rivals.

    As is evident from the figure above, thanks to the countryís vibrant educational system and large pool of talented engineers, the country ranks ahead of even developed countries like USA in terms of design and machining capabilities and availability of qualified engineers. Therefore, once the global auto industry comes out of the current quagmire, costs will not only be the only competing factor and component makers will have to cope up with the pace of auto makers in terms of designing capabilities and this is where India will have to wrest the initiative away from its major rivals like China and Thailand. Therefore, investments in setting up design centers is the need of the hour and the countryís IT expertise will have a big role to play in this.

    Following is the list of some of the key companies that we feel would be the major beneficiaries of the current auto components outsourcing wave.

    Exports from some key companies
    (Rs m) Exports (% of sales)
    Company FY02 FY03 %change FY02 FY03
    Bharat Forge 1,104 2,714 146% 26% 44%
    MICO 1,928 2,490 29% 13% 16%
    Motherson Sumi 479 1,062 122% 16% 25%
    Sundram Fasteners 817 961 18% 21% 21%
    Exide 357 434 22% 5% 5%

    If the growth in exports from the above mentioned companies is any indication, the task of achieving US $ 50 bn worth of exports by 2015 seems to be well within our reach.



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