In our view, this concurrent downturn across five segments remains a tale of two cities. While the commercial vehicles, tractors, and construction equipment segments are inherently cyclical – and after the robust industry growth years of 2015 through 2018, a cyclical correction was due, albeit not this deep – the segments of passenger cars and two-wheelers are supposed to demonstrate sustained growth, correlated to the rising income demographics of a large and advancing emerging economy. The fact that the latter two segments have witnessed declining sales beckons a fundamental relook at what it would take structurally to return to high-growth through six proactive actions the industry ecosystem – the incumbent OEMs (Original Equipment Manufacturers, i.e., vehicle makers), suppliers, dealers, financiers, shared mobility providers, government, and industry associations – must put in place.
1. Honour the cycle, but don’t aggravate the cyclical downswing
Business cycles are good because they ensure that competitive firms thrive, and the excesses of poor investments from boom times are weeded out. It is the “cell repair" time needed to build a “healthy body". But the industry ecosystem must also work in unison to contain the free-fall when the downcycle arrives.
Commercial vehicles, construction equipment and tractors are strongly correlated to growth in GDP, industrial output, agricultural output and infrastructure spending (correlation coefficient of ~84%). A downturn in these automotive segments is reflective of the overall slowdown in the economy, with GDP growth rates coming down sequentially over the last five quarters, from a high of ~8% in Q1, 2018 to ~5% in Q2, 2019.
A re-priming of these automotive segments will require bringing significant focus back to the core sectors of the economy. Money and capital will also need to flow back into the infrastructure sector, particularly for settling existing contractor dues and re-oiling supply chains. Investment projects – with new project announcements having fallen by 79% in Q1 FY19 vs. the previous year – must pick up pace again.
Likewise, a re-focus on the pricing of agriculture produce is called for so that farm-mechanisation trends stay accelerated. Minimum support prices (MSP) for agricultural produce, which have stagnated (e.g., MSP for rice has only risen by 3% in 2019 vs. an average rise of ~6% per year over the previous 5 years), should ideally reflect the increase in input costs for farmers.
In addition, two sectors – mining and real estate/construction – need to be galvanised out of a virtual standstill. Real estate construction, with its beneficial impact on capital purchases and job creation, needs a faster unlock, both for distressed projects but also to create an enabling environment for the continued build-out of urban, semi-urban and rural living spaces – an area where India is facing a likely shortfall of 30 million dwellings by 2022.
2. Never throttle consumption enablers
Of all the sizeable emerging economies wishing to join the ranks of the developed world in the coming decades, India is perhaps the outlier in its disproportionate dependence on its domestic consumption for GDP growth. And it can ill-afford to throttle key enablers such as growing disposable income, easy credit availability, and keeping the product pricing and usage costs optimal.
The NBFCs (Non-Banking Finance Company) have been significant credit providers to the automotive sector across segments – fleet owners (commercial vehicles, construction equipment), farmers (tractors) as well as consumers (cars, 2-wheelers). The tightening of credit lines to and by the NBFCs has resulted in 60-70% fall in automotive loan disbursals, impacting sales volumes. The overall credit availability in the economy must go up, perhaps enabled by a faster clean-up of NBFCs’ balance sheets. The recent announcement to infuse INR 1 trillion as partial guarantee to public sector banks for purchase of high-rated assets of NBFCs should help.
Lower cost of credit through cheaper loans is another strong enabler. The Reserve Bank of India (RBI) has brought down the policy repo rate to 5.15%; the real test will lie in seeing whether the financial institutions are able to pass on this real interest rate arbitrage to the buyers.
The third enabler is putting more disposable income into the hands of consumers. The consumer sentiment is down 14 per cent points over the last year due to higher personal debt and low employment confidence. Recently, with the move towards lower corporate tax rates, a positive impact on private investments is expected, eventually creating jobs and putting more money in the hands of consumers. Is there an opportunity to look for a similar virtuous cycle on the personal taxation front, to take consumption sentiment to the next level?
3. Bank on scale effects to make everyone win
This is the key learning to take to heart from China’s growth model. Keep the cost of production and indirect taxation low, so that it reflects in optimal pricing and lifecycle usage costs, that drives consumption up exponentially, thus creating scale effects to fuel rapid growth.
India, at present, is not on this path. Both the India and China car markets were similar in size in 2000 (0.6 vs 0.7 mn car sales per annum, respectively), but China leapfrogged to ~23 mn car sales by 2018, while India has reached 3.3 mn car sales. The key enablers for China have been lower tariffs – VAT in China is now 13% (reduced earlier this year from 16%) vs. 29-50% GST in India, ~40% fuel taxes vs. 49% in India, and lower real interest rates (2% vs. 5% in India). These lead to an overall vehicle ownership cost per capita income of 450% in India, which is just 97% in China, rendering vehicles relatively “unaffordable" in India.
In the automotive sector, scale-effects benefit the entire ecosystem across vehicle manufacturers and suppliers (with cost structure reducing by 12-15% with a doubling of scale), dealers, consumers, and the government. Building scale requires moving towards a lower tariff structure (e.g., optimal GST for the sector, simplified and lower taxation on fuel) and optimal credit rates.
A significant contributor to scale could be a structural push by OEMs and suppliers towards exports. India-based OEMs have inherent advantages in 2-wheelers, small cars, right-hand-drive vehicles, and so forth. Already ~15% of domestic production is exported, but this can be structurally pushed through with concerted action and targeted incentives towards ~30%.
4. Adopt a coherent and consistent tech-agnostic regulatory stance
Consumer-choice almost always trumps any forced technology offerings. The consumer weighs a complex set of buying factors comprising both functional and economic criteria before arriving at any buying decision.
The regulations should be framed from the point of view of outcomes (e.g., particulate matter emission standards, fleet emission norms, safety requirements), rather than to prefer one technology over the other. Let market forces prevail to decide between an internal combustion engine (ICE, i.e., petrol, diesel, CNG fuelled) vehicle and a hybrid electric vehicle (HEV) or a battery-electric vehicle (BEV), let consumers take a view based on their usage requirements and total cost of ownership (TCO). For example, in 2022, it will make complete commercial sense to run battery electric vehicles (BEVs) as taxis with a daily usage of ~200 kms, while for a light user with a daily use of 20-30 kms, a petrol/CNG vehicle will be most economical.
It is important to clarify that some EV subsidization is needed given that customers do not factor in the societal costs fully while taking their TCO-based decisions, but this should not be done through over-taxing the ICE vehicles.
5. Never waste a downturn
It is at the time of a downturn or crisis that winners are separated from losers. This is the time for players in every sector to create structural competitive differentiation.
The current slowdown provides the automotive industry with the opportunity to build resilience across the entire ecosystem. The Indian automotive industry lags in its overall productivity, being at ~40% level of the Japanese automotive industry and ~60% level vs. China. The big agenda for vehicle manufacturers is reducing operational complexity and lowering cost structures – there is an opportunity to rationalise their variant spreads, optimise supply chain workflows by consolidating their supplier base, and imbibe new age manufacturing 4.0 practices. Structurally, a strong re-look at the platform strategy is needed to significantly bring down the cost base through modularity of product design – a case in point being a leading car manufacturer which has more than 7 of its car models (representing >60% of its sales volume) on just one platform architecture, leading to lower cost structure and much faster time-to-market for new products.
Digital and advanced analytics (DnA) are transforming businesses, and the entire automotive ecosystem should embed DnA in its core processes, unlocking a potential of 4-5% return on sales (RoS) from such DnA transformation.
6. Embrace the new, but also the power of ‘AND’
Rising income demographics is a fundamental propelling force – akin to the force of gravity – that will create opportunities for both incumbents and attackers alike. Car penetration in India is currently 28 per 1000 inhabitants, which is already 180 in China and over 800 in the US. Average incomes in India are rising by ~10% and the middle class is likely to more than triple to ~100 million households by 2025 – and hence the question should not be whether growth will happen, but how it should be managed.
An important implication is that it is not about the tyranny of ‘OR’ – millennials or others, shared mobility or conventional mobility, BEV or ICE – but how to harness the power of ‘AND’. The ecosystem should be solving a different set of equations – are there different ownership models for millennials who have less proclivity towards vehicle ownership? How should shared mobility players be leveraged to increase the overall mobility market? How should EVs be leveraged to benefit from their real advantages? Which vehicle and user segments will continue to prefer ICE over the longer-term?
The ecosystem must also address what could be roadblocks to all round growth in the future. The structural problems likely to spring up pertain to ensuring adequate road density in cities (where peak-time traffic speed has come to 13km per hour); enough alternative fuel availability, especially CNG; a sufficiently developed EV supply chain to support vehicle manufacturers’ electrification journey; adequate technology access by suppliers to participate through exports in the ACES adoption of OEMs globally; and availability of sufficient and optimally-priced credit.
The automotive industry has the potential to create the next inflection in its journey. To get there, it must embrace these six actions with the full might of the industry ecosystem rallying behind it to support an upward inflection in its trajectory.
Rajat Dhawan is a Senior Partner in the Delhi office of McKinsey & Company and leads the Automotive & Advanced Industries Practices for the Firm across the Asia-Pacific region; Brajesh Chhibber is an Associate Partner in the Delhi office of McKinsey & Company.
This is an edited version of the article that appeared in print.