BackWeakest link in automobile supply chain hit the hardest
The slump in the auto sector has taken its toll not just on automobile makers, but the entire ecosystem of the industry
Premium(Abhijit Bhatlekar/Mint)
A few months ago, V.M. Jagtap grudgingly decided he could do with seriously lower production, running just one shift five days a week at his Ranjangaon auto parts factory near Pune. He made a few more grudging decisions: to diversify out of the auto sector, to merge units that make much the same things for different firms, and, as part of that, to lay off one-fourth of his workers.
Jagtap’s underutilized factories epitomize the state of affairs of the 5,000-odd small- and medium-scale auto parts makers—those with annual turnovers of ₹ 100-500 crore—in Maharashtra’s Pimpri-Chinchwad industrial cluster that are facing the heat owing to the prolonged slowdown in India’s automobile sector. Several other firms in the Pimpri-Chinchwad auto belt, too, are preparing to diversify into seemingly safer businesses.
Jagtap’s desperation is understandable. He’d been reduced from operating his Ranjangaon factory for three shifts six days a week, and his unit at Bhosari in the same Pimpri-Chinchwad belt too is underutilized.
His companies, Fairfield Castings Pvt. Ltd and Ranvik Engineering Pvt. Ltd, earned combined revenue of ₹ 80 crore in 2012-13, which seems unlikely now. To save on costs, Jagtap is considering merging units that make sheet metal parts for Tata Motors Ltd, Fiat Group Automobiles India Pvt. Ltd and Piaggio Vehicles Pvt. Ltd, among others. But the merger, which he hopes to conclude by end-March, will also mean asking at least 25% of the 250 people employed by his factories to leave.
“I can’t absorb this shock any more," said Jagtap, outlining plans to diversify into manufacturing steel tubes and reducing his firm’s exposure to the volatility of the automotive sector.
Car sales in India rose 12% to 133,486 units in August compared with 115,705 units a year ago after declining for nine months in a row, as the slowing economy, high interest rates and negative sentiments have dissuaded buyers from making new purchases. The numerous small auto parts makers have been hit the hardest.
“The policy for small-scale is only on paper. Such industries have to fend for themselves," said Srinivas Rathi, a partner at Platemasters, a manufacturer of sheet metal press components for auto makers.
The revenue of the ₹ 50 crore firm that has been supplying parts to Tata Motors since the 1990s declined by 25% in the first quarter of fiscal 2014. “OEMs (original equipment manufacturers) have changed their ways of doing business. They want better quality, but at the same cost," said Rathi.
Weakest link
Of the 700 auto component firms listed with the Automotive Component Manufacturers Association of India, 70% are small companies, said Vinnie Mehta, executive director of the industry lobby. “This (small firms) is the weakest link in the supply chain," he said.
Mehta attributes the high number of such suppliers to the low entry barrier of yesteryears. But with auto makers becoming more process-oriented and conscious of quality, the small companies were already struggling to survive unless they had the requisite quality, technology and skilled workers, he said.
Add to this the slowdown in the auto sector that has left these companies grappling with an inventory pile-up in their factories and high fixed costs spread over the production of fewer parts. Not to forget the high working capital management and interest costs charged by banks due to the suppliers’ stretched balance sheets.
“We are walking a tightrope," said K.H. Badami, director at Dynamic Industries Ltd, which counts Tata Motors and Mahindra and Mahindra Ltd (M&M) among key customers for its sheet metal and stamping parts. Owing to the slowdown, his firm’s revenue in the past six months has halved from ₹ 4 crore a month earlier.
Another problem is that many of these parts makers draw more than half of their revenue from Tata Motors and the rest from M&M, Piaggio, Bajaj Auto Ltd and Volkswagen Group Sales India Pvt. Ltd.
Clearly, the high dependence on Tata Motors—which saw its passenger car and commercial vehicle sales drop to 877,799 units in fiscal year 2013 from 926,353 units earlier and its profits contract 76% to ₹ 301 crore—has put parts makers in a spot. Many of these firms have been supplying to Tata Motors for over three decades.
Auto makers say they have always encouraged auto parts firms to diversify customers and products, and are doing their bit to help them.
“We don’t share a cold relationship with our suppliers and work as partners," said Rajan Wadhera, chief executive (technology, product development and sourcing) for the automotive and farm equipment sectors at M&M.
Though M&M does not deal with small- and medium-scale firms directly, it encourages its top suppliers, who farm out work to smaller firms, to improve efficiency and diversify into varied segments.
“The downturn is the best time for them to revisit the processes and strategies," Wadhera said.
Tata Motors has always encouraged suppliers to develop multiple customers, spokesperson Minari Shah said in an email. For the auto components industry in Pune, there is a wide variety of customers that include makers of two-wheelers, three-wheelers, trucks and passenger cars. Also, Pune being in the proximity of Mumbai, exports are a viable possibility, Shah said.
Cost of inventory
Reading out a text message from an M&M supplier, Badami of Dynamic Industries said, “Our customer has asked us to not supply any material for W201 (code name of M&M’s utility vehicle XUV500) for the remaining days of the month (June). I have no choice but to bear the cost of the inventory now."
With auto makers scheduling production cuts to align supply with depressed demand, such a communication circulating among the stakeholders in the supply chain is not unusual. While those at the top of the pyramid are able to survive by virtue of their scale and size, for small suppliers like Badami, staying afloat becomes a challenge as the slowdown also means he has to arrange for working capital from banks as payments from customers gets stretched.
“The real impact on us as a supply chain is working capital management, besides, of course, being tied down with non-moving inventory," said Asheet Pasricha, joint managing director at Trinity Engineers Pvt. Ltd. The company’s mainstay is supplying forged parts to medium and heavy commercial vehicle makers.
With the demand for trucks and buses dropping to 793,150 units in fiscal year 2013 from 809,499 units in the year before, Trinity’s revenue shrunk 15% last year. In the first quarter of this fiscal year, revenue has been down 15-17% compared with last year. “So far we have refrained from retrenchment, but if the situation continues, (we) would be forced to do so," he said.
Pasricha’s firm has drawn up a way to deal with the sudden drop in demand for parts from auto makers and the resultant loss the suppliers face—a graded pricing structure with pricing closely linked to volumes. “When the volumes pick up, we give discounts and vice-versa. This has enabled us to protect bottom line," he said.
Another risk is that of delays in the launch of a vehicle, which would leave a supplier saddled with all kinds of inventory including raw material, work-in-progress and finished goods, said Sulajja Firodia Motwani, vice-chairperson of Kinetic Engineering Ltd, which supplies engine parts and aggregates for Tata Motors’ Nano car. The line set up for the Nano is currently operating at 55% of its installed capacity because of tepid sales, according to Motwani.
Motwani has straddled the other side of the business as well, with Kinetic Engineering manufacturing two-wheelers. “Life for OEMs is not easy either," she said, pointing to the escalating costs of product development and marketing, and shrinking product life cycle.
Structural changes
Small suppliers in the Pimpri-Chinchwad belt have also been affected by the structural changes in the auto components business over the past decade, say experts.
Auto makers agree. Over the years, auto makers have raised their expectations of suppliers and want them to graduate from merely manufacturing parts to supplying entire systems so that auto makers can focus on their core functions of research and development, product development and marketing, said Kumar Kandaswami, senior director and country leader for manufacturing at consultancy Deloitte Touche Tohmatsu India Pvt. Ltd.
While large suppliers have coped well with the structural transformation by buying technology and diversifying the customer base, the smaller ones are stuck in neutral due to their lack of financial muscle, managerial bandwidth and low volumes.
“These firms are extremely vulnerable as for them pricing and cost is the only differentiator to get business. They deal in low value, undifferentiated products," said Kandaswami. Their stretched balance sheets mean they cannot raise fresh debt and no private equity funds are interested in these firms, he said, and added: “They are caught in a bind. The only asset they have is real estate. The sector is ripe for consolidation."
Even as small- and mid-sized suppliers are caught in a time warp, their customers—auto makers—have moved on. They have been consolidating their supplier base each passing year to cut costs and improve efficiency.
M&M, for instance, has halved its vendor base from 800 five years ago. They are also increasingly depending on sister firms for parts and aggregates—Tata Motors has Tata AutoComp Systems and M&M has Mahindra CIE (formerly Mahindra Systech).
To tide over the slowdown, many of the auto parts makers in the Pimpri-Chinchwad area are looking at diversifying into non-auto sectors. Kinetic Engineering has adopted a so-called backward integration strategy to beat the blues. Besides tightening costs, Motwani’s firm has moved back some of the processes that it had asked vendors to supply.
This, according to Motwani, will help the company utilize its manpower better. Moving functions like a turning and forging operation will ensure better absorption of fixed costs and reduction in overall costs, which eventually will translate into better margins, she said.
“Diversifying in non-auto like power generation has enabled us to keep our heads above water," said Trinity’s Pasricha, adding that he expects the share of non-auto business for his company to increase from 12-13% to 30% in the coming years.
Fairfield’s Jagtap, after 37 years in the auto parts business, says he has given up hope on the sector and plans to begin producing electric resistance welded pipes for engineering firms by the end of December. “My elder son is against investing in automobile sector," he said.
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