New Delhi: A close observer of the global auto industry for at least a decade now, Vikas Sehgal started his career with Daewoo Motor’s Indian subsidiary and was part of the Cielo launch team. His next job was Ford Motor Co.’s global manufacturing and product operations at the firm’s Michigan, US, headquarters.
In his stint with Booz and Co. Inc., where he is a principal and executive director in India, he has consulted with global auto companies ranging from Chrysler Llc. to Fiat SpA and Indian companies such as Tata Motors Ltd. His other areas of specialization include private equity, innovation and emerging markets. He discusses the global slowdown in the automobile business, its impact on India and how firms here can deal with the slowdown. Edited excerpts:
Where do you expect the auto industry to be in the next two-three years?
The auto industry has seen a massive boom from 2001 to 2007 and that increased global volumes by 30-40% and also increased revenue per unit and overall revenue. The world has right now—give or take a few million—between 60 million and 65 million units (2007-08 data). This is expected to fall to 55-57 million in 2009. That is an eight-million drop.
And the growth in the world was driven by the US market, which went from 14-15 million units to 17-18 million. The European market had a three-four million increase. Russia, India, China, all had massive increases. In five years, these three markets added about eight million units. That growth and profitability it brought along meant that the world got used to a very different economics in the auto industry.
Tepid expectations: Sehgal says the fall in auto sales in European and US markets is so large, there’s little Bric markets can do to compensate.
The next 12 months is going to be bad. The fall which is happening in the European and North American markets is so large that it doesn’t matter what the Bric (Brazil, Russia, India and China) markets do. They can’t compensate for that.
On top of that, revenues are going down disproportionately higher with prices coming down. So the capital spent in the good golden years will lie unused and the combination of falling sales has resulted in disaster for companies. Toyota and Honda are losing money because they were investing in very high capacity expansion; Toyota’s worldwide capacity is touching 10 million units and this year,?I?doubt they’ll sell more than 7.8 million. A 20% drop in capacity utilization is a death blow for most companies. While Toyota can withstand (it), they’ll get hit badly.
Are there signs that developing markets such as India and China will become more crucial for global auto firms in the years to come?
India is icing on the cake to global companies, numbers are still so small. The US, Japan and Europe are the dollops. And China, you can say, is the cone. So India will not pick up precedence over China or Russia. India is a very interesting market, but it’s not make or break.
What should auto companies be doing to remodel themselves in these hard times?
It depends who you are. The auto industry (on the car side) is very distinct by region and segment. People always talk about numbers. What matters is what you make and how much money you make out of it. You have to recoup your capital investment along with the variable cost, with some margin attached to it.
What is happening is that the guys who work in the mass market need to sell a lot more vehicles and since there’s very high competition, the market runs in very short cycles. The profitability of a product goes like this (draws a rapidly rising graph that falls quickly).
Hyundai and Suzuki are better off as they have very wide footprints around the world. Tata and Mahindra are in a very precarious position as they are concentrated in one small market.
Do you see companies cutting back on investments? For instance, Honda has pushed back on India expansion...
In India, (the last time) capital expenditure (for the auto industry) went down was in 2001— down by 50% (and then rose in the intervening years...). In 2008, it (the growth in capital expenditure) is expected to be negative. This expenditure (there was a massive increase in capital expenditure between 2003 and 2007) was driven by massive sales increases. Sales revenues were going through the roof and they were making these capital plans based on that. Problem is that you spend capital today and get the returns two-three years from now.
So, in the next two-three years you’ll see a massive drop in capital expenditure. Expect a recovery only in 2010. On the other hand, prices are going down dramatically. Next year, prices will go down (further) by 8% in India. Sales (by revenues) are down by 4%. This is a death knell for an industry with high fixed costs.
What about auto component makers? In the past they’ve picked up cheap assets in Europe but they’ve struggled with…
They picked up very expensive assets, actually. With the tanking of the industry—these assets are very capital-intensive—component makers need to diversify. Go into other sectors like machinery. Cut your cost structures immediately. Shut the plants if you have to. Don’t try to sustain losses. Take hard decisions now as opposed to tomorrow.
Now that it’s possible there could be new merger and acquisition opportunities, how should companies be looking at these?
Be very careful what you’re buying; 70% of products in the car industry by value added are not exportable. They can only be shipped around by trucks, not by plane. So only 30% of products that go into cars are globalizable. (Companies need to) see if this is something they have competence in and if they can be shipped around the world.
The assets available around the world are not suitable for the Indian market. India buys very small, very economical cars, which have very different requirement in terms of specifications, safety structure, and so on. Buying assets for Europe and forcing them for India won’t work. If there are 100 companies available, less than 10% don’t make sense for them and with the (rest) 90%, you’re taking too high a risk. That’s what happened in 2005-06.
Indian auto parts firms are among the top when you look at domestic industry in terms of efficiency and costs, etc. Given that, what would be the four-five areas still left that they could trim costs in?
I would say on the variable costs through supplier base consolidation, rationalization, quality improvement...they can save 10-15%. On top of that, they can save 5-10% through labour productivity, another 5% from engineering-based cost reductions and another 5% through logistics. So you can cut 20-25% if you take hard decisions.
Which companies will eventually emerge as winners from the current downturn?
Hyundai is a big winner in India and globally. To win in India, you have to win globally because your product cost is global now. You cannot be a mass market player and just be focused on one country unless you’re a two-wheeler maker, because then you have volumes in India. The (car) market is very small—it won’t cross two million units (on an annualized basis) even in the latter half of 2010—(so) that you can’t be a local player and be a viable operation in the long run.
You have to be global in your segment. It doesn’t mean if you are a mass market player you go and buy someone in the high segment and become global. Are you getting enough volumes for your platform? is the key issue. For that you have to be global and get your quality in line.
I am a little concerned about Suzuki as they get about 25% of their volumes from India but only 20% of the profit. But they’re still a strong player.
The Tatas have some hard times ahead. I won’t call them unviable; that won’t be fair. But they face some very hard decisions and (need to) rethink their strategy. On the truck side especially, they need to think whether it makes sense to have truck and car operations separate from each other. Try to ensure that Jaguar-Land Rover is not going to?impact car operations in India.
Other guys are marginal players.