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Bajaj Auto gains from outsourced non-critical manufacturing

Bajaj Auto gains from outsourced non-critical manufacturing
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First Published: Tue, Apr 13 2010. 01 15 AM IST

Reducing costs: Bajaj Auto’s two-wheeler manufacturing facility in Chakan, near Pune. A group of 50 component manufacturers supply all the components required at the unit. Sandesh Bhandare / Mint
Reducing costs: Bajaj Auto’s two-wheeler manufacturing facility in Chakan, near Pune. A group of 50 component manufacturers supply all the components required at the unit. Sandesh Bhandare / Mint
Updated: Tue, Apr 13 2010. 07 06 PM IST
Mumbai: When Indian auto makers were bleeding during the economic downturn, Bajaj Auto Ltd, too, saw two-wheeler sales plummet, but still managed to protect its profitability.
Cutting costs by radically changing manufacturing processes over half a decade—initially at its factory in Chakan, near Pune, and later at other facilities—was the reason the country’s second largest maker of motorcycles remained in the black despite the sales plunge.
The strategy has also made the firm confident in projecting on 25 March sales of 4 million two- and three-wheelers in 2010-11. Sales rose 30% to 2.5 million two-wheelers in the year ended 31 March.
Economic headwinds saw Bajaj’s volumes dropping 35% to 417,111 units in the three months ended 31 December 2008. Bigger rival Hero Honda Motors Ltd posted a smaller drop, with sales declining 4% to 857,806 units. Two-wheeler industry sales fell 14.8% to 1,707,049 units in the December 2008 quarter from 2,004,086 units a year earlier. Despite the drastic drop in volumes, Bajaj reported 14.5% margin on sales in that quarter, compared with 14.7% a year earlier.
Reducing costs: Bajaj Auto’s two-wheeler manufacturing facility in Chakan, near Pune. A group of 50 component manufacturers supply all the components required at the unit. Sandesh Bhandare / Mint
The feat involved the way the auto maker, known primarily for its ubiquitous scooters, designed and produced motorcycles. It decided to massively outsource the manufacture of parts to a core group of suppliers, thus cutting down heavily on variable costs.
Kevin D’sa, vice-president of finance at Bajaj, credits the company’s ability to defend profit margins to this move. At present, 72% of the firm’s costs to sales are variable, while fixed costs are at 6%, he said. The remaining 22% is reflected as revenue minus cost of sales and operating expenses.
“This protects the company in the event of a slowdown or downturn and resultant volume contraction,” D’sa said.
The move also improved manpower productivity by five times since 2002, and reduced Bajaj’s suppliers from 800 to 185. Today, just 15 vendors supply 75% of the components used at its Pantnagar facility in Uttarakhand. At Chakan, 50 suppliers cater to 100% of its requirements.
Frugality pays
The cost-cutting at Bajaj underscores the ability of Indian auto makers to produce inexpensive vehicles in large numbers, which has led to the country emerging as a global manufacturing hub for both local and international firms, particularly for small cars.
What has received less attention is the fact that India is also the second largest market for two-wheelers, after China, spelling a profitable opportunity for firms selling motorcycles and scooters if they can hold their costs to a minimum.
For Bajaj Auto, the efforts started almost a decade ago when its promoter Rajiv Bajaj mandated managers to produce “Japanese-quality” motorcycles at frugal Indian manufacturing costs.
Initially, there was no reference point on which to base ideas. “We didn’t have any great concept of what it should be like,” said Pradeep Shrivastava, president, engineering, who has worked with the firm for 24 years.
The management tried out a strategy of outsourcing non-critical manufacturing functions to a core group of vendors, short-listing and grooming them to be its single-source suppliers.
“Every part they made had to be perfect, and quality had to be ensured, not inspected,” Shrivastava said. “We, hence, started having a very deep relationship with our suppliers.”
Vendor relations
The deepening relationship showed when Bajaj started building a factory at Pantnagar, which started operating in 2007. The core group of vendors invested Rs205 crore at the facility, which can produce nearly one million two-wheelers annually, said D’sa. Bajaj invested Rs170 crore, of which Rs108 crore was for the land and the building.
Thai Summit Neel Auto Pvt. Ltd, which earns more than half of its revenue from supplying sheet metal parts to Bajaj as one of its core suppliers, invested around Rs100 crore in Pantnagar. It was unable to meet debt obligations when the economy ran into a headwind and volumes fell dramatically. But group president V.K. Kapur isn’t complaining. “No two-wheeler maker has entrusted such high level of confidence on its vendor as Bajaj,” he said.
Varroc Group managing director Tarang Jain said supplying to Bajaj has helped the firm’s revenue grow threefold to Rs10,000 crore since 2002-03. Half of its revenue accrues from supplying to Bajaj.
Although Bajaj didn’t offer financial compensation when volumes contracted, it started making payments in 15-30 days instead of 90 days, Jain said.
By offloading the manufacturing of non-critical components to vendors, Bajaj Auto also managed to reduce depreciation cost—the diminishing value of physical assets, a significant fixed cost—even though production capacity increased significantly, said D’sa.
On 31 March 2001, the firm’s annual capacity was some 2.32 million vehicles across factories and depreciation cost was Rs177 crore. By 31 March 2009, capacity jumped to almost 4 million, but depreciation fell to Rs130 crore.
Depreciation cost as a percentage of net sales have halved from 3.15% in 2003-04 to 1.5% in 2008-09, which is at par with the industry average. It will go down further to 1.2% in 2009-10, said brokerage BNP Paribas Securities India Pvt. Ltd.
For Hero Honda, the depreciation to net sales is 1.3%, its chief financial officer Ravi Sud said.
Implementing the strategic change wasn’t easy, Shrivastava said. A lean unit based on the just-in-time—or zero inventory—model required revisiting a string of physical and operational aspects.
Core theme
“Build technology inside and parts outside,” Shrivastava said, summing up the firm’s manufacturing philosophy.
To be sure, Bajaj’s strategy has been earlier mastered by India’s consumer electronics and pharmaceutical firms.
As companies begin to understand cost behaviour at various stages of a product’s life cycle, “offloading some manufacturing is a natural outcome”, said Kumar Kandaswamy, partner at global consulting firm Deloitte.
Auto firms, he said, will increasingly look at re-positioning themselves as brand, distribution, innovation and technology owners.
But some other analysts worry whether the model will remain as effective when demand peaks. “There will be a cost associated with it,” said Joseph George, an analyst at BNP Paribas. George said while the strategy allows Bajaj to share fixed costs when volumes contract, it will also have to compromise on margins and share the profit with vendors when demand rises.
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First Published: Tue, Apr 13 2010. 01 15 AM IST
More Topics: Bajaj | Auto | Chakan | Manufacturing | Scooters |