CHANGING TRENDS IN THE AUTO ANCILLARY INDUSTRY

Increasing Tierisation and Consolidation likely

Constrained profitability due to high investment requirements and declining pricing
flexibility
Declining integration levels by Vehicle Manufacturers (VM) to expand market
The Rs. 120 billion (bn) auto ancillary industry is fragmented with over 5,000 players
manufacturing several components across different product segments with each product
segment having around three to five key players. The industry comprises the organised sector
and the unorganised sector of which the former comprises around 300 medium and large-sized
units accounting for 75% of the industrys turnover. The unorganised sector in contrast
comprises over 5,000 small-scale units concentrating mainly on low value-added segments of
the industry and catering to the replacement market. Their competitiveness stems from lower
pricing, enabled by lower operating costs and exemption from excise duty.
Market Segmentation
The auto ancillary industry can be broadly classified on a functional basis into engine parts,
transmission and steering parts, suspension and braking components, electrical equipment and
others. The engine parts segment is the most significant contributor to the ancillary industry in
terms of value and accounts for around one-third of total production.
The market for auto ancillaries is classified into original equipment (OE) market, the
replacement market and exports. Approximately 40% of the demand in terms of value is
derived from the OE market while exports account for 10% and the replacement market
accounts for the balance. However, this segmentation varies across components and the size of
the replacement market depends upon the durability of the component, the criticality of the
component in the performance of the vehicle, the stringency of emission norms, the availability
of reconditioning options and the scrappage rate of vehicles in the country.
Original Equipment Manufacturers (OEM) market: The OEM market for auto
ancillaries is characterised by cyclicality in line with the end-user automobile industry. The
component manufacturers commission capacities and undertake production in line with the
production schedules of the Vehicle Manufacturers (VMs). Servicing the OEM market
requires access to technology necessary to meet quality requirements, ability to meet the
stringent delivery schedules of the VMs, price competitiveness and in some cases proximity
to VMs.
Replacement Market: The size of the replacement market in India is significant owing
primarily to the large vehicle base approximating 40 million vehicles. The low vehicle
scrappage rate in the country, also necessitate frequent replacement of parts. The
replacement market acts as a steadying factor in the industry, and provides a partial hedge
against the risk of recession in the auto sector. The component manufacturers enjoy better
bargaining power in the replacement market as compared to the OE market and as a result,
the margins in the replacement market are higher.
Export Market: The domestic industrys focus on exports has been recent and has been
part of industry initiatives to counter the cyclicality in the domestic auto sector. During the
period between 1993-94 and 1997-98, Indias ancillary exports have grown at a CAGR of
19.3% to touch Rs. 12.3 bn. Growth in the export market is however constrained by poor
price-competitiveness on account of the domestic industrys uneconomic size of operations,
higher defect rates of Indian products, high investments required to be made in
warehousing facilities and inadequate technological development. A significant portion of
the industrys total exports is to the overseas replacement markets and the domestic
component manufacturers have limited exposure to the global OEMs.

The domestic automotive industry was traditionally characterised by high import tariffs and
quantitative restrictions on imports, which led to a high level of indigenisation of vehicles built
in India. The limited range of vehicles available in the market, the relatively long life cycle of
vehicles, the well-defined and clearly demarcated end-user markets across OEM clients,
together with the high levels of vertical integration of domestic vehicle manufacturers limited
the growth of the domestic auto ancillary industry. Moreover, the licensing policy of the
Government also acted as an entry barrier and effectively prevented competition resulting in
inefficient manufacturing systems.
The entry of Maruti Udyog Limited (MUL) in 1983 initiated a new phase of development in the
industry and led to large volumes and quantum improvements in quality and infusion of new
technology. MUL encouraged the establishment of joint ventures with Suzukis Japanese
suppliers. The establishment of several manufacturing units provided a further impetus for
growth to the auto-components industry and an overall increase in competition levels in the
industry. The liberalisation of the Indian automobile industry followed by the entry of the major
VMs including General Motors, Ford, Honda, Hyundai, Daewoo and Fiat marked the second
phase of development in the industry. The Governments insistence on indigenisation norms
provided the domestic auto ancillary industry lead time to develop the capabilities required to
service the sophisticated end product requirements.
The strong growth in the auto sector during the period 1993-94 and 1996-97 led to large
capacity additions in the ancillary industry. However, the subsequent years (1997-98 and 199899) have been characterised by a slowdown in the commercial vehicles (CVs) and passenger
car segments of the auto sector resulting in an over-capacity situation in the components
market. While production in the ancillary industry registered a CAGR of 31% during the
period between 1993-94 and 1996-97, growth in the industry slowed down to 6% during the
period between 1996-97 and 1998-99. Consequently, increasing intensity of competition and
decline in the pricing flexibility of players led to a fall in the profitability of component
manufacturers. However, the eleven-month period between April 1999 -February 2000 has
witnessed a significant recovery in the CVs and passenger car segments of the auto sector
leading to an upturn in the components industry.
Emerging Trends
Declining integration levels of VMs: In order to improve their cost-competitiveness
(lower fixed costs) during periods of auto slowdown, the large VMs in India are reducing
their levels of integration by hiving-off of certain component divisions into separate
companies. The falling levels of integration are expected to expand the size of the domestic
auto ancillary market while intensifying the competition simultaneously. By reducing inhouse manufacturing and increased outsourcing, the need for investment and technical
upgradation is transferred from the VM to the auto ancillary manufacturer. Further, the
increasing competition levels in the ancillary industry and the resultant pressure on
component prices may also permit VMs to derive cost advantages.
Adoption of global logistics and supplier systems: In line with global trends, the Indian
auto ancillary industry is currently witnessing the emergence of single-source supplier
systems which require the component manufacturers to make significant investments in
dedicated facilities, such as design, tooling and production for the manufacture and
delivery of the required components. Hence, component manufacturers are increasingly
exposed to the risk of model failure. Driven by the need to be cost-competitive in the
scenario of increasing competition levels and declining pricing flexibility, auto
manufacturers are also resorting to implementation of inventory management techniques,
such as Just-In-Time, which in turn has resulted in an increase in the working capital
requirements of component manufacturers.

 Increasing emphasis on quality: The entry of global vehicle manufacturers in the

domestic market is leading to the adoption of global quality control practices in the
domestic industry. Effective quality control leads to improved export competitiveness,
better quality perception in the retail market and increased acceptance by global passenger
car manufacturers operating in India. Self-certification is an emerging concept in the
industry, which obviates the need for a quality check to be undertaken by the vehicle
manufacturer as the components are delivered directly to the OE clients in a ready-to-use
quality certified form. However, enforcement of quality control calls for increased
investments in technology and automation of facilities.
Declining Pricing Flexibility: As the auto ancillary industry is characterised by derived
demand, pricing flexibility in the industry is constrained by the pricing pressures on the
end-user auto sector. In the scenario of price-based competition amongst VMs, the
component manufacturers are faced with considerable pressure on their realisations and are
frequently required to absorb increases in the cost of production with consequent pressure
on profitability. Consequently, operational efficiency and cost control initiatives
increasingly determine profitability in the industry. However, certain players in industry
segments such as fuel injection equipment and engine valves have not been significantly
impacted, primarily on account of their strong competitive position in terms of market
presence and operational efficiencies.
Technological Changes and Impact on Profitability: The expansion in the range of
vehicle models, particularly in the passenger car segment, has warranted significant
investments in the design and tooling capabilities of component manufacturers. Further, the
increase in the number of variants has the effect of reducing the batch size thereby leading
to lower asset utilisation levels and an increase in the cost of production.
Tierisation: The demanding requirements from the new VMs, the need for investments in
new capacity, quality improvement systems and technology upgradation are expected to
lead to the emergence of tierisation in the industry. The Tier I manufacturer outsources
sub-assemblies from various Tier II players, (who buy sub-components from Tier III
players), and assemble entire system modules to be used as inputs by the VM. The Tier I
supplier would be made responsible for the quality of the sub-assembly including the subcomponents and would be required to make significant investments in quality control and
inventory management. Players engaged in the manufacture of complete assemblies and
having superior inventory and production management systems, quality certification for
their product and processes and financial strength are well positioned to emerge as Tier I
players.
Consolidation: As witnessed in the global markets, the domestic auto ancillary industry is
also likely to increasingly witness consolidation. Additionally, it is also likely that the
foreign partners would gradually try to increase their stake in the joint ventures formed
with the Indian players. Further, domestic manufacturers of components are likely to
explore mergers and acquisition possibilities to emerge as sub-assembly manufacturers.
Entry of foreign players is also likely in the product segments requiring a high degree of
quality and technological support.
Future Scenario
The recovery in the CV and passenger car segments is expected to translate into a significant
growth in demand for ancillary segments over the short to medium term. Growth in the twowheeler segment would continue to be strong with the motorcycle segment expected to record a
high growth. Tractors would continue to witness a moderate growth of 10% over the medium

term. Component manufacturers with exposure to the two-wheeler and tractor segments would
therefore continue to witness steady growth rates.
However, growth in the domestic ancillary market would also be dependent upon growth in the
replacement market. The increasing stock of vehicles in the country and the rising scrappage
rates of vehicles are expected to be the key demand determinants in the replacement market.
Further, the increasing share of high-value vehicles and increasing outlay for vehicle
maintenance necessitated partly by stringent governmental regulations are expected to drive
volumes growth in the replacement market. Moreover, reduced competition from the
unorganised sector due to the rising complexity of the vehicle parts would also lead to
significant growth for the organised sector.
The export earnings from certain segments of the industry, where global players have
commissioned significant capacities such as brakes, shox etc. are expected to increase as these
players are developing India as an export base. Existing players would continue to increase
focus on exports in order to counter downturns in the end-user auto sector.
The industrys profitability would be dependent to a large extent on the performance of the
CVs segment over the short to medium term, as this segment is characterised by reasonable
pricing flexibility. Companies with varied exposure across vehicle segments would also benefit
as they enjoy the flexibility of cross-subsidisation, which in turn may lead to higher sales and
increase in market share. Over the short to medium term, the performance of players in the
replacement market assumes importance in order to maintain steady cash flows.
The impact of tierisation in the domestic industry is expected to increasingly relegate a number
of small and medium-sized units to servicing the replacement market over the long term. This is
expected to increase the pressure on profitability in the replacement market. Moreover, the
emerging trend of single-supplier sourcing is expected to find increased acceptance resulting in
lower pricing flexibility for component manufacturers unless significant volumes from the
replacement market is implied. Further, the large number of variants and models is expected to
result in lower capacity utilisation levels and a consequent decline in operating profitability.
This could however be partly countered by the establishment of flexible manufacturing
systems, which would enable the manufacture of low batch volumes. Moreover, the reduction
in the number of vehicle platforms would also translate into significant volumes for the
component manufacturer and result in lower developmental cost of components.