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In the auto industry, many OEMs don’t know how their tier-III suppliers are doing. The inability of smaller suppliers to do business, mostly because they’re starved of cash and labour at the moment, could delay the recovery. (Photo: Bloomberg)
In the auto industry, many OEMs don’t know how their tier-III suppliers are doing. The inability of smaller suppliers to do business, mostly because they’re starved of cash and labour at the moment, could delay the recovery. (Photo: Bloomberg)

How supply chain shocks can derail green shoots of recovery

  • There are doubts about smaller component makers’ ability to ramp up production. What’s holding them back?
  • Over the next few months, labour shortages in the component ecosystem are likely to pinch. Getting back the labour, hiring and training new workers can take around four-six months

On a hot June afternoon, there was plenty of action near Maruti Suzuki India Ltd’s factory in Manesar, on the outskirts of Delhi. A vendor was selling vegetarian biryani (sic) for 20 a plate; yet another was peddling tempered glass for mobile phones; an alcohol shop was doing good business, with cars crowding around the store. Meanwhile, parked cars and employee transport vehicles made an ant line on the streets leading up to the plants of Maruti Suzuki and Honda Motorcycle and Scooter India Pvt. Ltd (HMSI)—early signs the automotive cluster is springing back to life after being mothballed for nearly two months.

In contrast, the parking lots of some nearby component makers don’t appear to be filled up. Sure, the component makers have reopened too, but one isn’t sure about their ability to quickly ramp up and support the green shoots of recovery. This is bothering a few automakers who think the cracks in India’s supply-chain will stand exposed as demand picks up in the near future, particularly for entry-level cars and two-wheelers. With India opening up, people are expected to choose personal transportation over mass transportation fuelling orders.

“The situation is like an iceberg," said Sridhar V., group vice-president and director at HMSI. “We can see ice floating but we do not know what the spread and the depth is. We have checked our stock levels and we are okay for June. Once we increase production and start selling more, the supply-chain problems will get highlighted," he added.

The lockdown has battered the supply-chain in numerous ways. Companies had no revenues but fixed expenses. Ashok Kapur, chairman of Krishna Group, a large manufacturer of seating systems, auto textiles and metal fuel tanks among others, pointed out that his group pays out 20-25 crore a month in security, leasing and electricity costs among other expenses. “Being a tier-I supplier, I can write off 50 crore for the year. But people down the line who do not have reserves like we do will be finished," he said.

In the automotive industry, original equipment manufacturers (OEMs) like Maruti Suzuki are the assemblers. The sub assemblies come from tier-I suppliers such as Krishna Group. In turn, the smaller companies—the tier-II and tier-III of the manufacturing food chain—supply components to the tier-Is.

HMSI, for instance, has over 250 tier-I suppliers. Each of the latter would source materials from three-four smaller suppliers. Many OEMs don’t have knowledge about how their tier-III suppliers are doing. That could prove to be costly. The inability of the smaller suppliers to do business, mostly because they are starved of cash and people at the moment, could delay the recovery.

As they say, in the assembly business, for want of a nail, the car can be lost.

“Right now, everybody is surviving out of their savings. But we do believe that unless there is a model to sustain the smaller suppliers, they have a real problem. Their issue is not just the ability to financially ramp up but also the ability to operationally ramp up," said Rahul Gangal, partner at Roland Berger, a global consultancy firm. Western countries, he added, were trying to consolidate small suppliers and make them into larger entities. That’s a playbook India can ape since there’s still time. The demand for automobiles or any other product is yet to pick up. OEMs can prepare. Nevertheless, it is easier said than done. “The OEMs have to ensure that the supply chain ramp-up is synced to the demand ramp-up they will experience. That is their biggest mathematical puzzle," Gangal said.

The finance choke

There’s a cost to ramping up. Ask Deepak Karandikar, founder of Pune-based Praditi Pressparts Pvt. Ltd. that sells components to automakers such as Piaggio and Chrysler. “There would be huge pressures on the bottom-line because the new normals would demand a lot of expenditure which would not be picked up by the OEMs," he said. Social distancing on the factory floor, for instance, means less output for a given area. Companies may either need to expand their real estate to retain the same levels of productivity as before or make do with less revenues. Praditi had a top-line of 70 crore and a profit margin in low single digits in 2019-20. The company doesn’t expect to make a profit in 2020-21.

Karandikar’s problems don’t end here. His customers are in a mood to squeeze him. OEMs he supplies to have increased the credit terms by 30-45 days over and above what was already in place. “I am at the mercy of OEMs and their policy changes creates a lot of pressure on my working capital. The payment cycles have been disrupted by ex parte decisions. The farce is very clear—OEMs are looking at the small guys to provide bridge finance for their working capital," he said.

In the aftermath of the lockdown, financing has emerged as the biggest headwind in the supply chain. Not just private OEMs, even government departments as well as public sector units (PSUs) have run up huge payment overdues, which are choking companies. Jumps Auto Industries Ltd supplies starter motors to the Indian Railways through an OEM. “The Railways pays the OEM and the OEM pays us. Because the OEM is not getting payments, they have stopped further deliveries. This is affecting our sales," Sanjay Malhotra, managing director at Jumps Auto Industries Ltd said.

Adding what different government bodies owe the private sector is tough maths. There are plenty of estimates. Pradeep Bhargava, the president of Mahratta Chamber of Commerce, Industries and Agriculture in Pune said about 2-3 trillion is the estimated overdue (payment) from government enterprises to their vendors, including disputed amounts. According to data from the ministry of power, distribution companies (Discoms) owed power generation companies nearly 91,000 crore as of April-end. A recent FICCI survey among its members pegged the dues at about 11,832 crore.

However, a source from the industry body said that this was not an exhaustive survey—several organizations avoid revealing. The ministry of micro, small and medium enterprises runs a Delayed Payment Monitoring Portal which states that the total pending amount from central ministries, central departments, central PSUs, the Railways, ordinance factories, state governments and state PSUs as on 14 June 2020, were over 5,000 crore.

For now, high receivables have scared private banks who no longer want to lend to small manufacturing suppliers. Private banks have a risk matrix. When a supplier slips below a certain risk rating, there is little credit forthcoming. “Everybody needs to start paying everybody. State government departments and PSUs who have not paid suppliers for a long long time must pay up," Bhargava said. “The moment money gets paid, the receivables will go down in the balance sheet and banks would be encouraged to lend."

Manpower blues

Prabhu Gandhikumar’s family-owned foundries in Coimbatore—Gandhikumar Foundry and Neocast—witnessed an unexpected uptick in demand for castings sold to pump manufacturers post lockdown. The foundries produced about 120 tonnes of castings a month pre-covid and volumes have ramped up to similar levels in June. The secret: his father paid and fed the migrant workers during the lockdown. Few left. “Many foundries in Coimbatore are not functioning due to lack of manpower. Whoever has the labour today are getting good orders," Gandhikumar said.

One hears similar stories from Kolhapur in Maharashtra, another hub for castings. The order book for foundries are building up but there is little labour to meet the demand. Finding local replacements for migrant workers in the foundry business isn’t easy—castings involve melting and solidifying metals and thereby working in a high-temperature environment. In industrialized states, locals historically preferred jobs further up the value chain, vacating manual labour positions for migrants. This has come to bite both the foundries and the pump-makers.

Grundfos Pumps India Pvt. Ltd, a manufacturer of pumps, is seeing demand for agricultural pumps on the back of an expected good monsoon season. “Until the lockdown, we built stocks. We are making sure we complete the orders that were already placed. But when things go back up to 60-70% of the normal sales, we expect an issue on deliveries from the foundries. There would be tightness in the supply chain in India," Ranganath N. Krishna, who is “water ambassador" at Grundfos Pumps, said.

Over the next few months, labour shortages in the component ecosystem are likely to pinch the auto industry more. Raw material costs in India’s auto component industry totals about 70% of revenues on average; the cost of manpower is between 10% and 12%—considered to be high. Vinnie Mehta, director general of the Automotive Component Manufacturers Association of India, pointed out that in a situation where the cost of raw materials, electricity and land is rising, the only variable suppliers can squeeze is the manpower. “The component industry, therefore, shifted to contractual labour. Four-five years back, 50% was contractual labour and today, it is at 70%," he said. The contractual labour has mostly migrated back to their villages. “As the ramp-up happens and when the schedules from the OEMs become steeper, there will be a challenge in terms of production," Mehta added. Getting back the labour, hiring and training new workers is expected to take anywhere between four and six months.

Buyer of last resort

The demand side may not be a lingering headwind for companies such as Maruti Suzuki because of the range of entry-level vehicles the company makes. R. C. Bhargava, chairman of Maruti Suzuki, indicated as much in an interview to Business Standard. Automakers making mid-market and premium cars, however, could feel the demand crunch more than the supply chain pains.

Rajeev Singh, partner at Deloitte, an automotive consulting expert, projects passenger vehicle sales in units to drop between 10% and 20% in 2020-21. As consumers scale back on spending, how could one revive demand? Just like financial crises need a lender of last resort, could there be a buyer of last resort in India today?

“The government has to increase its own consumption. If the government starts to consume, the common man will consume," Singh said. His suggestion: the Indian government must mandate all ministries, PSUs, the police and the army to stop using older vehicles—yes, a number of PSUs still use Ambassador cars made in the 1990s. “If the government replaces all the vehicles over the next 12-24 months, it would keep the OEMs busy. The older vehicles should be scrapped, which would create more jobs and industries," he added.

Besides auto, other manufacturing industries too want the government to spend more. In the least, award RFPs (request for proposals) whose technical evaluations are done.

NCR-based Precision Electronics Ltd makes communication equipment among other products for defence public sector units such as BEL and telecom companies like BSNL. “All the government agencies who have taken out RFPs, please place orders on a war footing," Ashok K. Kanodia, managing director of Precision Electronics, said in a tone that bordered on pleading. “There are those at a final stage but orders are not being taken out. Why are you delaying? We are counting days."

If the orders are released quickly, small companies would be able to turn around the losses incurred in the first quarter over the course of the next three quarters, Kanodia added. Precision Electronics Ltd. is a listed firm—it lost 5 crore on revenues of 29 crore in the year ending March 2019. In the nine months to December 2019, the company did better and turned a profit.

50 crore is my share of orders won. Orders I have lost would be three times this money. If the government releases these orders, hundreds of companies will get business and they would support another 5,000 small businesses," Kanodia said.

While industry awaits orders, the writing on the wall is clear. Many small firms would go belly-up—a survey by the All India Manufacturers’ Organisation stated that around 35% of India’s MSMEs were in the process of shutting shop. In the Darwinian fight, a few of the suppliers would eventually merge. And supply chains, as they exists today, are likely to get restructured in preparation for future demand.

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