Ashish Bharat Ram has good reason to be a satisfied businessman. Production lines at SRF, of which he is the managing director, are fully booked for the next three months. The company makes nylon cord used in cross-ply truck tyres. Truck production may be down but the demand from the replacement market is robust. Once the crop standing in the fields is harvested over the next two months, transporters will get more business, more tyres will be bought and Bharat Ram’s factories will run at full capacity.
Business wisdom would suggest Bharat Ram is in an enviable position. He is one of the two producers of tyre cord in the country and his market share is almost four times that of his rival. Till some years back, there were about eight producers of nylon tyre cord. Some of these were bought over by SRF. Ideally, he should be dictating terms to his buyers. Yet, Bharat Ram wants to diversify into new fields and reduce his dependence on tyre cord. The reason? Through persistent bargaining, coupled with rising imports, tyre makers have squeezed his profit margins. Thus, tyre cord accounts for 50 per cent of SRF’s turnover but a much smaller portion of its profit. You can’t be a supplier to an original equipment manufacturer, feels Bharat Ram, and still make money.
This is the new realisation that runs through the country’s automobile equipment manufacturers. Thus, Bharat Ram is eyeing opportunities in chemicals where he will have several buyers and some intellectual property to protect his margins. Bharat Forge, similarly, wants to diversify into components for new buyers like aircraft makers. AIS, which lords over a large chunk of the automotive glass market in the country, wants to sell glass to real estate developers in a big way. The Amtek Auto Group wants to get into steel. The list is long and growing.
A recent study done by ICRA Management Consulting Services on the financial performance of 47 automobile component companies from the July-September 2007 quarter to the October-December 2008 quarter paints a dismal picture. During the period, operating revenues declined from Rs 5,801 crore to Rs 5,326 crore at a compounded annual rate of 6.6 per cent. Operating profits fell from Rs 851 crore to Rs 438 crore at 41.2 per cent per annum.
This was also the period that saw commodity prices (steel, aluminium, copper etc) touch new highs. What the declining numbers therefore suggest is that the terms of trade have moved against the component makers. Their bargaining power with automobile makers has worsened in the last few years. Automobile companies, on their part, have played the China card (components can be imported from there at up to 30 per cent lower prices) extremely well. Some have agreed to cap Chinese imports at 30 per cent!
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Only a handful of automobile companies actually work with their component suppliers on reducing costs. Maruti Suzuki, for instance, works with its vendors to cut costs and not prices. It has, in fact, set up a centre of excellence, which has a corpus of about Rs 20 crore and is manned by as many as 40 engineers, to advise the suppliers on how to keep their costs under check through value engineering, better inventory management etc. But such examples in the industry are very few. Most automobile companies simply press for annual price reductions. Not all contracts, especially those written with small component manufacturers, have a cost-escalation clause.
Japanese automobile companies work on long-term relationships with their component suppliers. They even take an equity stake in their key suppliers. This was a trend Maruti Suzuki started in India too. Again, such examples have never been more than a handful.
With technology upgrades, sale of spare parts in the after-sale market are not what they used to be. Component makers therefore have no option but to depend on automobile makers for volumes. And the automobile makers know that they have got this advantage. One component maker, for instance, had to say no to Tata Motors which wanted to source a part from him. The margins offered did not justify the investments in the new lines.
To make matters worse, several large automobile companies have taken the sale of spare parts in the after-sale market in their own hands. They buy parts from component makers at very low margins, mark up the prices and sell them through their dealer-cum-service centre network. The extra margin that could have gone to the component maker is thus pocketed by the automobile company and its dealers.
The reason is not hard to find. Because of the highly price-sensitive market, automobile companies have no option but to keep their prices on a tight leash. Dealer margins are wafer-thin — not more than a few thousand rupees in most small and mid-sized cars. Where they make money is sale of spare parts.
And it is not just the component makers — consumers too get a raw deal in the bargain. In Europe, this is already a matter of anti-trust investigation. The situation needs to be remedied as early as possible if India wants to have a viable components industry.