India’s vehicle makers are being forced to spend more than ever before on new models, thanks to demanding buyers—a strategy that is not just keeping them on their toes but also eroding their profit margins amid slowing overall sales.
India, Asia’s fourth largest vehicle market, is attracting investment not just from local firms such as Tata Motor Co., but also international ones such as Renault SA. While consumers enjoy greater choice, it has dramatically changed the landscape for vehicle makers. Just a decade ago, for instance, car models rarely changed every two years, unlike now.
Marketing research firm TNS India Pvt. Ltd says 63% of the total sales for passenger cars last year came from customers who bought an additional car or replaced their existing cars with a newer model. In 2003, such customers constituted only 46% of the total sales.
“New models always attract attention,” says Jnaneswar Sen, senior general manager, marketing,Honda Siel Cars India Ltd. Honda Siel claims that during the launch of its high-end sedan Civic in July last year, 60% of initial buyers were existing Honda owners. “About four to five years back, this figure would have been 20-30%,” says Sen. “The trend of replacing cars faster and acquiring a second car has gathered momentum over the past three to four years.”
Bajaj Auto Ltd, India’s second largest bike maker, which is planning to launch Exceed, a new 125cc bike with a more fuel-efficient engine, expects existing consumers will switch to the new bikes instead of buying older models such as its 100cc bike Platina and 135cc bike Discover.
“We are expecting around 40% demand from our existing customers,” said S. Sridhar, chief executive officer, two -wheelers, Bajaj Auto, earlier this month. “A large share of it will be from the existing Platina customers and a smaller share from Discover owners. We aim to further work on Discover to check the cannibalization from Exceed.”
Bajaj Auto declined to share its research and developmental cost for developing the new engine. However, it said it would incur an additional cost of Rs10 crore in marketing expenses for the new bike.
While customers moving from Platina to the new bike may not hurt the company much—the 100cc bike is not a profit-making model—switchovers from Discover may bite as Bajaj enjoys 15% operating profits margin on the model.
According to a 14 June report by Macquarie Research, research and development and advertising expenses for the two-wheeler industry as a percentage of sales has gone up to 5% in 2005-06 from nearly 4% in 2001-02. And it is expected to be 5.5% by 2008-09. The industry spent an estimated Rs1,100 crore on R&D and marketing in 2006-07.
“Research and development expenses have increased as cutting-edge technology is required to maintain a competitive edge,” wrote Macquarie analyst Deepak Jain.
A total of 17 new two-wheeler models and variants were launched in fiscal 2007—considerably more than the launches in the previous year. And the life cycle of each model is estimated to have fallen from seven years to about five years. The variants are mostly used to prop up the shelf life of existing products.
This means higher research costs for Bajaj Auto and TVS Motors and higher royalty expenses for the likes of Hero Honda Ltd. The newer models of Hero Honda have a higher royalty payout than older models such as the Splendor. The collaboration pays a fee for the technology it brings in from Japan’s Honda Motor Co.
“Companies have a loyal group of customers whom they want to keep moving up to their higher value products,” says Pradeep Saxena, senior vice-president, TNS India.
The research and development cost for companies such as Tata Motors has also increased substantially. According to its annual report, the research and development cost of the company, as a percentage of its net turnover, has gone up to 2.9% in 2006-07 from 1.6% in 2002-03. The company, which has promised to launch India’s cheapest car for Rs1 lakh next year, spent Rs797 crore on overall research and development in 2006-07. Tata Motors is the largest maker of trucks and the third largest maker of passenger cars in the country. It did not give a breakdown for passenger car development costs.
“The initial expenditure on development and marketing of product definitely puts negative pressure on the operating margin of a company in short term,” says Vaishali Jajoo, an analyst with Angel Broking Ltd, a Mumbai-based brokerage. “But if the model is successful then it helps the company gain market share.”
However, the growth rate for passenger cars in the first four months of 2007-08 has slowed down to 12.6%, compared with 20.7% achieved in 2006-07, as higher interest rates for loans shrunk demand. Two-wheelers have been affected more severely in the first four months as the industry has seen a 9% fall in sales compared with a 11.4% growth achieved in 2006-07.
“Investment for larger number of models can be justified with the rise in their volume,” says Sachin Mathur, head of research at Crisil Ltd.