The Machinist - Oct 2015

Invest In Yourself

Distractions at this time can be dangerous. It is quite possible that the future of the automotive industry in India depends on sticking to the knitting.

Last month, in the annual session of the Automotive Component Manufacturers Association of India, the chairman of the Suzuki Motor Corporation, Mr Osamu Suzuki, made a couple of important points. These points, though stated with a simplicity characteristic of the Japanese, have deep ramifications for the consumer market, the automotive industry and the health of individual companies in this sector.

 Invest In Yourself

Make (good products) in India

The first was to point out that “Make in India” would necessarily need to be supported by a Quality in India initiative. Mr Suzuki pointed out that the increasing frequency and scale of recalls by the automotive industry was very visible and would affect the perceptions of investor companies in judging India as a manufacturing base.

In India, the concept of recalls is relatively new. Long a producer driver market, people used to be grateful to receive a product and were not going to quibble about “minor” details like quality and aesthetics. When you are dying of thirst, it’s unlikely you will be debating whether the water should be still or sparkling. This was an aeon ago and today, the automotive industry is one of the most competitive industries in India where domestic manufacturing is involved. It might very well be the most competitive. In competitive markets, you cannot take your eye of the ball.

Indian consumers are getting accustomed to global quality standards, both in terms of products and practices. This is a one-way street and there is no going back. Consumer acceptance of recalls is so far not alarming. When the voluntary policy of recalls was announced by SIAM in 2012, the then SIAM President, Mr Vikram Kirloskar, described the policy as increasing transparency in the industry and one that will boost consumer confidence. This has certainly been borne out. Whether it was recalls of the Suzuki Swift Dzire, the Ecosport or Honda’s City, the car sales did not seem much damaged by the recalls. It is certainly a progressive move by the industry.

Honeymoon? For how long?

This is not the case when viewed from a production perspective though. While Indian consumers might be impressed that manufacturers are willing to admit mistakes and to reach out to rectify them, no engineer is going to be impressed by the number and simplicity of the parts that are at risk. After all we are not talking about hi-tech features, but simple things like fuel tank components and seat belt sensors.

Tom Peters said “Almost all quality improvement comes via simplification of design, manufacturing … layout, processes and procedures”. But day to day pressures and changes actually causes a gentle and steady build-up of complexity. It takes a strong leadership focus on quality to bring back that simplicity that is the basis of sustainable quality. This industry is going to see a lot of feature additions and technology changes. It is a time for a strong leadership focus on redesign and re-engineering to bring back a quality focus.

After a honeymoon period, consumers will start tracking recalls and social media based quality reports more closely. Why should they risk their money with an unreliable manufacturer now that they have choice? So, Mr Suzuki is very correct in pointing out that global investors will be concerned about committing to increasing capacity in a market that seems to struggle with producing products of the correct quality. 

Stick to the knitting

Mr Suzuki’s second comment is much more interesting. He requested companies in the auto component sector to re-invest profits in their existing businesses rather diversify out of them. He specifically named diversification into hotels and leisure. Now, when it comes to over the top returns, real estate has always been a horse to back in emerging markets with fast changing demographics. So, why this concern? Is it just to ensure that there are components available for the OEM factories? Or is there something more behind this to be concerned about?

A market worth fighting for

The automotive industry in India is not a small one. The sixth largest manufacturing base in the world, India is currently producing over 3 million passenger vehicles and over 19 million 2-wheelers. The last 5-year CAGR of sales in the component industry has been 11.1%. So profit pressures notwithstanding, this will be an important market in the future. Important for any large global player.

However, vehicles are changing and changing fast. Just as the telecom industry went through a revolution, so is the automotive industry. Through a combination of regulation and more so consumer demand, features that were not seen in Indian cars 5 years ago are rapidly becoming standard. These are altering the sophistication of components, for example styling and materials, and is also altering the technologies in use. Passenger comfort and infotainment systems are creating a sea change in complexity. At a time like this, it is disturbing that Indian companies in the sector are investing only 0.5% of sales in R&D, compared with the 3-4% in US, Europe and China.

Diversification is fun

When such changes are afoot, it is hardly the time for auto component leaders to be distracted with diversification. Corporate strategy studies have shown that unrelated diversifications are inherently risky. They are fun and keep people occupied in a project style of working, but they really don’t yield substantial shareholder value. This is because, the industry models, the capabilities required and the management bandwidth needed to learn new areas are often underestimated. In a classic HBR article (From Competitive Advantage to Competitive Strategy, HBR May 1987), Michael Porter describes an analysis of unrelated diversification over a period of over 3 decades, done by companies with deep managerial talent, including companies like GE. The story is not encouraging. He shows that 74% of unrelated acquisitions end up getting divested. It shows that building capability in one industry, does not easily translate to other industries. If it were that easy to learn a new industry, then it would be easy to enter and grow in auto components as well. In reality, shareholder value is actually reliant on the core, base business and not the diversification itself.

Core business risks

Meanwhile, what happens in the core business that has been fuelling this diversification? If the core business fails to invest and keep up, its product portfolio will age. But markets will not stop evolving. And at the end of the day, the consumer’s need will be met. The Indian consumer is definitely not going back to an era where people booked a car and waited 7 years for delivery. So, if existing auto component manufacturers are not in a position to meet market needs, either in terms of capacity or capability (more likely), there is likely to be a surge in imports or new entrants. Free trade agreements will expand and imports will rise. In the last 5 years, against an 11.1% growth in sales, imports have grown at 18.2%. This will accelerate.

If not imports, then new entrants can be expected. To capture share, they will enter with higher technological capabilities and establish themselves in this growth market. Since they will offer the higher end components to OEMs, it is likely that they will capture a disproportionate share of the industry profit pool. This will leave companies who have not upgraded their capabilities and focused elsewhere to continue making lower end products that generate revenues without profits.

That’s what lies beneath

So, it seems that Mr Suzuki’s warning is a timely one and should not be viewed as a simple recommendation. This is an industry that will change rapidly and requires a strong focus on quality standards. It also requires management teams to focus on staying ahead of the curve, if not at least on it. This will require an investment of time and money. Distractions at this time can be dangerous. It is quite possible that the future of the automotive industry in India depends on sticking to the knitting.

The author is Partner & Managing Director – Indian Operations, CGN & Associates India Pvt Ltd