What started as a small fire—a dip in sales volume of commercial vehicles in September 2018 immediately after the regulatory change in axle load norms —has turned into a full-blown conflagration in a year, engulfing at least five segments of the broader automotive industry in India. Commercial vehicles, passenger cars, two-wheelers, tractors, and construction equipment are down 15% to 40% in their monthly sales volume (year-on-year). It’s a slowdown so severe that it has led to inventory pile-up, stalled production lines, drying up of the supply chains, languishing dealership operations, postponed investments and hurtful job losses.
For the first time in several decades, all five of these broader automotive segments are seeing a concurrent downturn. There is little phase lag in the cyclical downswing across segments. The burden is on the forward and backward value chains, all at once. Second, the downswing amplitude in sales volume in a few segments has reached 30-40% this time around, against the earlier downswings of 10-15%.
While the commercial vehicles, tractors, and construction equipment segments are inherently cyclical—and after the robust sales growth years of 2015 through 2018, a cyclical correction was due, albeit not this deep—the segments of passenger cars and two-wheelers should not be demonstrating anything but secular growth, correlated to the rising income demographics of a large and advancing emerging economy.
So, what is the outlook for the coming year? When is the turnaround in growth likely to happen? Well, it depends on proactive actions that the industry ecosystem —the incumbent original equipment manufacturers (or vehicle makers), suppliers, dealers, financiers, shared mobility providers, government, and the industry associations —is willing to put in place. Here are six habits that high-growth sectors use to fuel their growth.
Don’t worsen the downswing
Business cycles are good in a free market economy, as they ensure the competitive firms thrive, and the excesses of poor investments are weeded out. It is the “cell repair" time, needed for a “healthy body". Yet, the industry ecosystem needs to work in unison to contain a free-fall when the down-cycle arrives.
Commercial vehicles, construction equipment, and tractors are strongly correlated to growth in GDP, industrial output, agricultural output, and infrastructure spending. A downturn in these automotive segments is reflective of the overall slowdown in the economy, with GDP growth rate coming down sequentially over last 5 quarters, from a high of ~8% in Q1, 2018 to ~5% in Q2, 2019.
A re-priming of these automotive segments will require significant focus back on the core sectors of the economy. Money and capital need to flow back into the infrastructure sector, particularly in settling contractor dues and re-oiling the supply chains. Investment projects, with new announcements having fallen by 79% in Q1 FY19 compared to the previous year, must pick up the pace again.
Likewise, a re-focus on the pricing of agriculture produce is called for so that farm mechanization trends stay accelerated as they have been for the last three years. Minimum support price (MSP) for agricultural produce, which have stagnated (e.g., MSP for rice has only risen by 3% in 2019 vs. an average raise of ~6% per year over previous 5 years), should ideally reflect the increase in input costs for farmers so that they are left with surplus to invest in mechanized equipment which increases their output and creates a virtuous cycle.
Don’t hurt demand 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 country which would disproportionately depend on its domestic consumption for its GDP growth. Only the foolhardy could undermine its importance by throttling key enablers such as disposable income, easy credit availability, and product pricing.
The automotive sector is the bellwether of discretionary consumer spending, but it significantly depends on access to consumer credit. Here lies one of the major causes that precipitated the recent downturn. Credit crisis from high-capex industrial and real estate companies with overleveraged balance sheets has spilled over to NBFCs who are significant credit providers to the automotive sector across segments—fleet owners (commercial vehicles, construction equipment), farmers (tractors) as well as consumers (cars, two-wheelers).
Tightening of credit lines by NBFCs has been reflective in the significant cut down in loan disbursal, impacting sales volumes. The slowdown is also putting pressure on the MSME balance sheets of dealerships and smaller suppliers, which will aggravate the crisis, as these are funded by NBFCs too. The overall credit availability in the economy has to build back up, perhaps enabled by a faster clean-up of NBFCs’ and other financial institutions’ balance sheets in the interim.
Lower cost of credit through cheaper loans is another strong enabler. RBI has been softening the policy stance on rates over the last few quarters and has brought down policy repo rate to 5.15% at a time when inflation rates have also moderated. The real test is for financial institutions to pass on this real interest rate arbitrage to the buyers to enable the revival of demand.
The third enabler is putting more disposable income in the hands of consumers. Recently, a big step forward has been taken in the domain of direct taxation in the form of lowering the corporate tax rates. Is there an opportunity to look for a similar virtuous cycle on the personal taxation domain too to take the consumption sentiment to the next level?
Vehicle manufacturers can also innovate on providing new ownership models to buyers (e.g., fractional ownership, variable cost per ton per km rentals for fleet, and so forth) that reduces the upfront threshold for buyers and add to the positive momentum.
Never waste a downturn
Any downturn or crisis is the best time for players to create structural competitive differentiation in most sectors. This is the time to get leaner and efficient, invest in mid-term priorities at a time when the organization does not feel consumed to just meet the brimming market demand. The winners and losers are often separated during the times of downturn and crises.
In line with this, the current slowdown provides an opportunity for the automotive industry to undertake significant transformation and build a leaner and efficient industry. Tactically, they could rationalize their variant spreads and become more focused players in the market, optimize supply chain workflows by consolidating their supplier base, and imbibe new-age manufacturing.
Structurally, a strong re-look should be done at platform strategy to significantly bring down cost base through modularity of product design; a case in point being a leading car manufacturer of the country, who has more than 7 of its car models, and >60% of its sales volume on one platform. Can vehicle manufacturers cut the number of their vehicle platforms to half or even less, and gain benefits of much lower cost structure and much faster time-to-market with new products?
Digital and analytics (DnA) is transforming businesses, and the automotive sector should not be behind in embracing this transformational agent. The entire ecosystem should embed DnA in core processes to modernize them.
Bank on scale effects
This is the key learning from the China growth model. Keep the cost of production low, reflecting in optimal pricing and life cycle usage costs—which are supported by a moderate indirect taxation regime—that drives consumption up exponentially, thus creating scale effects in sector after sector to fuel rapid growth.
India is right now not on this path. Both India and China were similarly sized car markets in 2000 (0.6 vs 0.7 mn car sales per annum respectively). While China leapfrogged to ~23 mn car sales in 2018, India’s car market growth has been more gradual, reaching 3.3 mn car sales by 2018.
Some of the enablers for the China market has been lower taxes—VAT of 13% flat vs. 29-50% GST in India; 40% fuel taxes vs. 49% in India—and lower costs through lower real interest rates (2% vs. 5% in India).
In the automotive sector, scale-effects benefit the entire ecosystem across vehicle manufacturers, suppliers, dealers, consumers, and the government. Building scale would require moving towards lower taxes structure (e.g., optimal GST for the sector, simplified and lower taxation on fuel) and right cost structure through optimal vehicle specs and credit rates.
A significant contributor to scale could be a structural push towards exports. India has the potential to take the lead in exports in segments where we have an inherent advantage—2-wheelers, small cars, right-hand-drive vehicles. Already, approximately 15% of domestic production is exported, but this can be structurally pushed through with targeted incentives towards 30%.
A tech-agnostic regulation
Consumer is queen in most market segments. She is definitely so in the automotive sector, where consumer-choice almost always trumps any forced technology offerings. The consumer would weigh a complex set of buying factors in arriving at their buying decisions, comprising functional and economic criteria.
The implication is framing regulations in the sector, which should be from the point of view of outcomes (e.g., emission standards, fleet emission norms, safety requirements), and not to push one technology versus the other.
Let the market forces prevail to decide between an internal combustion engine (ICE, i.e., petrol, diesel, CNG fuelled) vehicle, 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). In the longer run, this will foster the right kind of innovation that matters to the consumers.
Competing technologies can co-exist under uniform regulation paradigm which best suit an individual’s needs and use case, e.g., in 2022, it will make complete commercial sense to run BEVs as taxis with daily usage of ~200 kms, while for a light user with daily use of 15-20 kms, a petrol/ CNG vehicle will be most economical. A push to this user to own and run an EV will have additional costs that have to be borne by someone in the ecosystem.
It is also important to maintain consistency of stance across industry participants. Confusing signals vitiates the consumer’s clarity and timing of what to buy, when to buy, leading to significant exacerbation of a downswing in demand. It also leads to false expectations in the consumer’s mind of the rewards of delaying their buying decision which may not accrue.
Prepare for roadblocks
The force of rising income demographics will create opportunities for the incumbents and the upstarts. India’s average incomes are rising by roughly 10%, the middle class will more than triple to ~100 million households by 2025, and, hence, the question should not be whether the growth will happen, but it should be how to enable the growth and prepare for it.
And it is not about choices—millennials vs others; shared mobility vs conventional mobility; BEV vs ICE—but about how to harness the power of the collective. The ecosystem should be solving a different set of questions. Are there different ownership models for millennials who have fewer proclivities towards vehicle ownership? How should shared mobility players be leveraged to increase the overall mobility market? How to leverage EVs for their real advantages?
The structural issues to solve are around a) adequate road density as peak-time traffic speed is starting to be grinding halt, b) enough alternative fuel availability, especially CNG, to not artificially create adoption barriers, c) sufficiently developed EV supply chain to support vehicle manufacturers’ electrification journey in India, and d) availability of sufficient and optimally-priced credit.
The automotive industry is at the cusp of creating the next ‘S’ curve in its evolutionary journey. And considering the positive benefits that the sector has on the overall economy, the full might of the industry ecosystem should now come behind the sector to support this upward inflexion in the trajectory.
Rajat Dhawan is a senior partner at McKinsey and Co., and leads the advanced industries practice across the Asia-Pacific region; Brajesh Chhibber is an associate partner at McKinsey and Co. Both are based in Delhi.