New Delhi: The new royalty payment arrangement between Suzuki Motor Corp. and Maruti Suzuki India Ltd is expected to be beneficial for both the Japanese parent and its most valuable subsidiary in India, as the local unit is expected to outpace industry growth in India in the next few years.

According to the new pattern announced after the fourth quarter earnings, royalty payment of Maruti Suzuki has been delinked from the fluctuations in the currency market. Also, after the sales of a certain model reaches a threshold—to be set by the parent—the royalty to be paid by Maruti will come down, boosting the company’s Ebitda (earnings before interest, taxes, depreciation and amortization), or operating margin.

Suzuki will also reimburse the money that Maruti spends for research and development work in India, which will also strengthen the books of its subsidiary.

The Suzuki Motor Corp. board has already cleared the new arrangement. The new royalty pattern was approved by the board of Maruti Suzuki after the third quarter results of FY18.

According to R.C. Bhargava, chairman of Maruti Suzuki, as the Indian market continues to grow, the amount of royalty would also have grown proportionately. “Now, when we reach a particular number of volumes automatically the royalty will be reduced. So, we have an advantage."

“It’s an arrangement that will be beneficial for both Maruti and Suzuki. Though Suzuki will get a royalty at a lower rate, the actual amount they receive as royalty will be more as Maruti sells more cars in the Indian market," Bhargava said in a phone interview to Mint.

Had it not been for the new pattern, the royalty that Maruti pays would have consistently increased in the future as the size of the Indian automobile market is tipped to grow annually at 9-10% in the next 4-5 years.

On the other hand, Suzuki, which depends on Maruti for a significant share of its revenue, will get more royalty, though at a lower rate, as the new arrangement states reduction in royalty payments once a certain level of volumes has been achieved.

Also, there is a cap of 5% in royalty payments in rupee terms in the new system, which would help the company expand its margins at a time when overall increase in costs due to new model launches and high commodity prices, especially of oil and steel, have taken a toll on the margins.

The new pattern will cover only the last three offerings of the company—Ignis, the new Dzire, and the Swift.

Ajay Seth, chief financial officer of Maruti Suzuki, said in a press conference on Friday that by 2021, it is expected that most of the offerings of the company will be covered by the new arrangement.

“Maruti Suzuki will launch the new Ertiga (a multi-utility vehicle) probably next year and the full model change of Ciaz (a mid size sedan) will be launched by 2020. The new Alto (a mini car) will also be launched when the new emission norms will kick in. So by 2021, most of the offerings will be refreshed and will come under the new arrangement," said a person aware of the company’s plans for the next few years.

The new norms though, will help the company become operationally more efficient in financial terms. According to an analyst at a foreign brokerage, if the royalty payment comes down to 5% or below the from the current level, there will be a 50-60 basis points operating margin expansion, which will help the company. One basis point is 0.01%.

If the prices of commodities like steel and especially oil continue at the current levels, then the reduction in royalty will be an advantage in the long run. Also, in the Rohtak R&D hub of the company, a lot of development work is taking place on upcoming vehicles, which will be reimbursed by Suzuki.

“There is an incentive on our part to sell more and more and there is an incentive for Suzuki as well. So, it is not unfair on anyone. As the Indian market grows, likelihood of reaching the cut-off point becomes a reality. It is difficult to estimate the reduction for us since all the new models are not covered by the new pattern yet," added Bhargava.