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Carmakers face strategic choices in emerging markets

From RIA Novosti.| February 16 , 2007

Never before has the global automotive industry looked so flat, as it’s today. Unlike the early 1990s, when manufacturing was the preserve of the G6 countries (US, Germany, France, UK, Italy and Japan) today with manufacturers scouting for low cost destinations to absorb overhead costs, continental boundaries seem to be melting. The propensity of the global OEMs and suppliers to offshore is on a rise and the trend of having multi-locational facilities to achieve optimum benefits is gaining ground.

Although the new world order has thrown open numerous opportunities in terms of a low cost manufacturing destinations, what has really shot into prominence over the past few years are the BRIC (Brazil, Russia, India and China) countries. If Goldman Sachs BRIC report is anything to go by, over the next 50 years, the BRIC economies could become a much larger force in the world economy to reckon with. If things go right, in less than 40 years, they could be larger than the G6 countries in US dollar terms.

Carmakers face strategic choices in emerging markets

Goldman Sachs report

Sample this. As per the report, the relative importance of the BRICs as an engine of new demand growth and spending power may shift more dramatically and quickly than expected. Higher growth in these economies could offset the impact of greying populations and slower growth in the advanced economies.

Rising incomes may also see these economies move through the ‘sweet spot’ of growth for different kinds of products as local spending patterns change. With today’s advanced economies becoming a shrinking part of the world economy, the accompanying shifts in spending could provide significant opportunities to global companies. Being invested in and involved in the right markets — particularly the right emerging markets, may become an increasingly important strategic choice.

The findings of the BRIC report are of great significance to all the manufacturing verticals, but what lends uniqueness to the automotive sector, in particular, is the dynamics of consumer tastes and demands, which vary from market to market. Herein lies the challenge in responding to these geographies with new strategies and products.

The emerging strength of BRIC has found its manifestations in more ways than one with all the global OEMs following the BRIC strategy. One can hear it echo when time and again OEMs based in HCCs (high cost countries) keep reiterating how important all these markets in their overall business gameplan and why they cannot, possibly, afford to choose to invest in one and overlook the other.

As per one of the findings included in the annual ‘Global Automotive Financial Review’ by PricewaterhouseCoopers, ‘BRIC countries would account for more than 40 percent of the forecast global light vehicle assembly increases and represent 52 percent of the industry’s forecast global capacity expansion.’

Fiat for instance, which so far has been ignoring the BRICs, is now looking at Brazil with keen interest and envisages atleast 15 percent of its global turnover to be accounted by South America, as per a report published in ‘Emerging Markets Weekly’

An analysis of each of the BRIC members gives a perspective on the competitive advantage each of them offers along with the market-specific risks.

Brazil

Brazil’s auto industry is the tenth largest in the world and accounts for 12 percent in country’s GDP. It plays host to the largest number of car assembly plants - around 30 brands in the world. Among the emerging markets of the world, it is the biggest target for Foreign Direct Investment.

The 1990s held a significant place in Brazil’s auto history with the industry having witnessed an increase of over 60 percent and domestic sales having grown by almost 65 percent. In 2000, Brazil produced 1.68 million vehicles.

There are almost 16 auto components companies in Brazil, which have a turnover of more than $10 billion. Some of them include Delphi, Visteon, Bosch, and Valeo. All of them are from high-cost countries and are looking at multi-locational facilities in emerging markets. The country is rich in ethanol, iron ore and bauxite, which gives it an edge of sorts over its other BRIC counterparts.

Brazil has been a key location for global carmakers since the mid-1990s. This is attributed to two factors. Firstly, in the context of the manufacturers scouting for emerging markets, it was placed first with respect to the size of the potential regional market — it’s the seventh largest national market for passenger cars. Secondly, it has played and continues to play an important role in the automobile world as an arena to experiment with new manufacturing-related solutions such as the development of modular products has helped carmakers share investment with suppliers, a process called mutualisation and then the provision of public support by local governments has reduced costs associated with carmakers’ investments, a process called socialisation.

Flex fuel engines

One of the strong points of the Brazilian industry is the predominance of flex-fuel engines, which run on petrol, ethanol or blend of the two. Owing to depleting fossil fuel resources and volatile oil prices, the auto industry the worldover, has been working on alternative fuel technology and most ca makers either have or are firming up plans to set up R&D centres in the country for developing alternate fuel technology vehicles.

Brazil offers a platform for prototypes that would influence the sector in the coming years. Volkswagen, GM, Fiat, Puegeot are some of the OEMs which have been and will invest in the R&D centres in the country and are creating opportunities to export their vehicles, components and expertise.

‘On back of huge demand from emerging countries like India and China, I do not see the oil prices showing any signs of plummeting. Hence Brazil, which is a champion in bio-fuel, (50 percent of its cars run on bio-fuel) would continue to benefit from it,’ explains Principal Consultant, Price Waterhouse, Abdul Majeed.

Market specific risks

The Brazilian industry, however, has its own limitations and risks. Majeed has cautioned that the country’s overdependence on agriculture could turn out to be risky in the face of a sluggish growth in agriculture. ‘Growth is closely tied to agriculture. Unlike India where we also have service sector contributing to the GDP, Brazil’s economy is completely agriculture-led. In a scenario when there is a slump in agriculture, the economy could be badly hit.’

Secondly, it has a history of high inflation, interest rates and import duties designed to protect domestic industry. Volatile exchange rates poses another threat to the industry, particularly, exports. ‘Fluctuations in the currency are having an adverse implication on exports. Volkswagen, or instance, which is one of the early entrants, has been a significant exporter, but of late, it has taken a hit because of currency fluctuation.

As investors burnt their fingers during the Brazilian economic crisis of the 90s, they don’t invest in Brazil they way do it in China and India,’ said Majeed. Past economic instability and exchange rate volatility is still reflected in the buying and consumption patterns.

Owing to its geographical location, which makes it closer to the US, it stands at an advantageous position vis-à-vis other BRIC countries like China and India but the high labour cost proves to be a deterrent. Moreover, it’s difficult to find local labour in some parts of the country.

Logistically, with inland transport system still rather underdeveloped, just-in-time delivery is challenging. Lastly, the relatively high import duties encourage local production and leads to export vulnerability.

Russia

The Russian auto industry, till very recently was largely the preserve of few homegrown manufacturers and pre-owned cars were generally imported. However, in the recent past, industry has realised it cannot compete on a large scale with their counterparts of foreign make and as a result, OEMs have been forced to revisit their production plans radically and fine-tune their strategies. Hence the Russian industry is presently the most dynamically growing segment in terms of institutional  transformation process.

Numerous withdrawals by the national carmakers from production of Russian models coupled with their U-turn to foreign brand cars on the one hand and rolling off car assembly lines by foreign automobile giants on the other hand, is the crux of the transformation process being witnessed in the Russian automotive industry.

The industry’s cause was further helped by government’s policy in March 2005 on tariff structure pertaining to components imported for industrial assembly. Import duty was pared to 3 to 5 percent from 12 to 15 percent and duties on some components, in the engine, for instance, were reduced to zero percent

Sales of new passenger cars are now gathering momentum. In June 2006, a total 133,354 new passenger cars were sold. The growth momentum witnessed by the industry in the last three years, has made it one of the most attractive markets of the world. The high demand for new cars has been largely attributed to widespread credit programmes and favourable economic conditions that have boosted personal incomes. Expansion in local production and changes in the taxation regime have also impacted the domestic market. The reduction of tariffs on imported components, coupled with duties on new imported vehicles being maintained at relatively high levels, will result in more foreign cars meeting international emission and safety standards being assembled in Russia, thus generating more momentum in the new foreign-car segment.

Russia scores over China, India and Brazil, in terms of its geographical location, more so, if one has to address the Western European market. In. fact, there are many Chinese and Indian companies seriously considering the Russian market to get a foothold in the advanced markets of the world, said Majeed.

Market- specific risks

High dependence on credit coupled with high price sensitivity makes it difficult for marketeers to find a right price, quality balance. Secondly, volatility in labour cost due to demand of skilled labour in specific region cats as a deterrent for the industry. Underdeveloped railroad network and overloaded inland transport system makes it logistically very challenging.

‘Among the BRIC countries, Russia is a different ballgame altogether,’ said Majeed. He feels a lot of it can be attributed to the country’s Communist legacy and organised crime. Companies are scattered and they are set up in a way that they aren’t competitive. An ageing people and fairly widespread corruption are other negatives attached to the Russian industry, observers said. ‘One has to have an extremely high appetite for risks, if one is looking at the Russian market,’ said Chairman and Managing Director, Hi-Tech Gears, Deep Kapuria.

Of the four BRIC countries, the risk of the government taking away a company’s business — or that someone will take away the business and the government won’t protect the company — is probably highest in Russia, feel industry experts.

China and India

As mentioned earlier, while most OEMs are pursuing the BRIC strategy aggressively, the spotlight is clearly on China and India, the fastest emerging markets in the BRIC economies.

On the back of robust domestic demand, engineering and technical prowess and a stable economic policy, these two markets have been witnessing a double-digit growth over the last several years and are on the radar of most global OEMs, which are looking at investing in emerging markets.

‘In US Dollar terms, while China could overtake Germany in the next four years, Japan by 2015 and the US by 2039, India has the potential to show the fastest growth over the next 30 and 50 years. The growth could be higher than 5 percent over the next 30 years and close to 5 percent as late as 2050,’said the BRIC report.

Both China and India offers distinctive competitive advantages. India’s forte has been the cerebral power (read software skills) and quality. The country is home to largest number of Deming Prize winners outside Japan and has been able to set a quality precedent of sorts globally.

China’s strong point has been its huge capacities and the capability to create them ahead of demand.

‘While we can compete with the Chinese manufacturers within the four walls of our companies, we can’t win the Chinese treasury, where they are putting capacities much ahead of the demand. They are selling without being bothered about the cost elements adding to the topline is their priority. This is in contrast to India, where most of the companies are entrepreneur-driven and are always looking at the bottomlines, feels Kapuria. (see larger interview on page  ) Majeed seconds Kapuria, ‘China has an edge over India in terms of scalability as they opened their economy a decade before us.’

Looking at macro-indicators, against China’s foreign exchange reserves of $875 billion, India’s forex stands at $180 billion. Industry analysts are of the view that Indian players have accepted the fact that they cannot compete with China in terms of volumes, they are hence focussing on their core competency — quality.

‘When you talk about component supply base, you cannot have quality components, if you do not have value addition, somewhere, you ought to have high value addition. I think China is better in terms of components where you do not require much quality but when it comes to high engineering components, India is better off, ‘ said Majeed.

However, during the past five years or so, China has been churning more scientists and engineers, and that’s starting to draw more foreign direct investment in R&D centres than the other three BRIC countries.

China seems to be firing on all cylinders to catapult itself to the league of manufacturing superpowers like South Korea, Germany, US and Japan. As per a recent report published in New York Times, China’s Lifan is said to be eyeing a car engine plant of DaimlerChrysler and BMW in Brazil. It plans to buy the plant, take it apart, piece by piece, transport it halfway around the globe and put it back together again at home. The move clearly is a corollary of China’s failure to develop its own version of sophisticated, reliable engines — one of the biggest technical obstacles facing Chinese automakers as they modernise and prepare to export to the US and Europe, said Western automotive analysts.

Growth Deterrents

Political pressures have stymied labour reforms, leading to inflexibility in these laws. Poor network between cities and infrastructure bottlenecks is another restraint. China on the other hand has high degree of labour migration coupled with rising labour costs.

Logistically, a not so efficient green channel mechanism has caused just-in-time delivery issues. Fragmented nature of auto component industries is said to be another limiting factor for both the countries. Lastly, while the local political will to change often slows down decisions in India, the Chinese government‘s policy, which mandates overseas companies to have joint ventures and issues such as intellectual property rights are areas of concern.

It cannot be disputed that each of the BRIC economies is a low-cost manufacturing destination and offers immense potential to global OEMs. Having said that, one cannot chose to ignore the gradual but steady developments taking place in Latin American and Mercosur countries. Even markets like Mexico, Cambodia, Vietnam, and Indonesia are coming up in a big way, feel experts. Mexico, for instance, is a very attractive, cost effective destination to address the whole of the US market. Moreover, the key assumption underlying BRIC report’s projection is that the BRIC maintain policies and develop institutions that are supportive of growth. Each of them faces significant challenges in keeping development on track.

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