India’s automotive industry is accelerating fast. Triggered by market liberalizations that have kicked off a cycle of investment and growth, car demand this decade has been advancing at 20 percent a year. Provided there is no backsliding by policy makers, the domestic market could support sales of up to one million vehicles a year by the end of the century. Many hold high hopes of India also becoming a significant exporter to other LDC markets.

Not surprisingly, the world’s car manufacturers are scurrying to sign up Indian partners. General Motors, Peugeot, and Daewoo, to name but three, have all announced joint ventures.

What has received considerably less international attention, however, is the state of India’s automotive components industry. The reality is that although Indian demand for car components is likely to quadruple by the turn of the century, India’s components industry faces substantial challenges in supporting that growth.

The state of play

Protectionism. Protectionism has dealt the Indian automotive components industry a weak hand with which to withstand the competitive onslaught that is about to be unleashed.

Government restrictions aimed at limiting consumption and protecting domestic industry have stifled vehicle demand: total annual revenue from all car component production stands at approximately $2.6 billion, representing just 1 percent of the world components market. From such a small industry base, Indian manufacturers will find it hard to capture the economies of scale necessary to compete regionally, let alone globally.

A high level of industry fragmentation will make competing all the more difficult. As a result of regulations designed to favor smaller enterprises, India’s 350 or so major component manufacturers generate average revenue of only $4 million a year. Between them, these 350 manufacturers have 96 percent of the market, leaving thousands of small-scale enterprises sorely exposed in a liberalized market (Exhibit 1).

Another legacy of protectionism is India’s isolation from the world marketplace, a factor that has discouraged investment and restricted access to the new technologies involved in modern car manufacturing.

Insulated from imports by tariffs as high as 100 percent, Indian components manufacturers have had little incentive either to invest or to cut prices or costs. The result has been low volumes, although at high margins. Foreign manufacturers entering India are bound to use their bargaining power to force these margins lower, which will inevitably further limit Indian suppliers’ ability to invest and close the gap with global standards.

Quality and technology. And there’s a sizable gap to be bridged. India’s car manufacturers have to put up with an average 2,900 faulty parts for every million they receive from suppliers—a rate 10 times worse than that enjoyed by leading Western assemblers (Exhibit 2). Indian component suppliers themselves have to contend in turn with an astonishingly high 31,500 rejects for every million parts delivered from their own sub-suppliers (Exhibit 3).

These rates handicap even the most efficient factories as sorting, testing, and rework come to dominate and distract from the fundamental business of adding value. Quality will have to improve quickly if Indian manufacturers are not to be squeezed out by more advanced foreign firms seeking to capture the market’s growth.

Indian suppliers will also have to make great leaps in technical competency. As domestic demand grows for better-performing cars that meet higher regulatory standards, so too will the technical content of components, particularly electronic applications. This will require whole new sets of skills quite alien to traditional "metal-bending" firms.

Low-cost labor. Despite all these drawbacks, a major reason for Western enthusiasm about India’s automotive supply base is its low cost position, seen as largely offsetting any quality or technology shortcomings. In India, low costs are primarily the result of cheap labor. However, cheap labor may not entirely compensate for the costs of raw materials such as steel, which—again because of protectionist rules—can be higher than elsewhere in the world. Logistics costs can also wipe out much of the labor cost advantage, especially if the finished parts are exported.

Counterfeit products. A final problem for Indian and foreign suppliers alike is the size of the counterfeit market. As might be expected in a low-income market such as India, where cars tend to be kept for a very long time, there is a huge aftermarket (Exhibit 4). Although this is an obvious target for suppliers, it is one that has been largely lost to black-market producers, whose cheap copies can sell for as little as half the price of the real thing. Counterfeit products currently account for up to 50 percent of the entire aftermarket, yet prosecuting black marketeers is a low priority on the law enforcement agenda.

Meeting the challenge

In the face of these challenges and the likely rate of growth in the industry in the next few years, there are a number of steps that Indian component suppliers can—and should—take:

Investment. First, they will need to invest rapidly to meet exploding demand; otherwise domestic and foreign suppliers will quickly step in to take their place, either alone or through unequal joint ventures. Tata, India’s largest business group, has already set up a components division to investigate joint ventures before the best partners are signed up. Evidence to date, however, suggests that most Indian suppliers are repeating history and not spending enough.

Quality improvement. Second, quality has to improve. Many Indian managers are already talking about improving their product and process quality standards. Now they need to add actions to words and introduce systems to ensure that the message gets through to those who have to implement the improvements on the shop floor.

Technology challenge. Third, managers must address the technological challenge. If R&D spending as a percentage of sales is any measure of the industry’s preparedness, the outlook is poor. Exhibit 5 shows the extent to which India’s R&D spending lags—though the gap is understated given India’s low labor costs. The gap is understandable, since indigenous car manufacturers have traditionally asked only for low-tech "build-to-print" parts. However, new manufacturers will expect a much higher level of technical expertise. Here, India may be better able to fill the gap than other LDCs, as the country has no shortage of well-qualified engineering graduates.

Ownership structure. Finally, Indian suppliers will have to tackle the issue of family ownership. As in other sectors of Indian industry, many car component firms are privately owned. While there is nothing inherently wrong in this, it can make it more difficult to raise capital for expansion and to attract the best professional managers. Families will more than likely have to relinquish some day-to-day control of their businesses as they modernize—and with it, some share of equity.

Survival

Indian components suppliers should not underestimate the competitive challenges that lie ahead. Car manufacturers will demand ever greater capabilities and capacities from their Indian suppliers, which, if they survive the next decade, will earn lower margins than they do today, but on far greater volumes. Those suppliers that succeed will almost certainly be much larger than they are now, and they will probably have several strong alliances in place: an overseas partner that can share the investment needed to raise quality and secure access to technology; close cooperation with several sub-suppliers to ensure the quality of their own supplies; and perhaps alliances with logistics companies to provide more reliable export passage.

These challenges are significant, but not insurmountable: suppliers in Taiwan and Japan overcame them years ago, as their counterparts in Brazil and Eastern Europe are doing today. The key to success will lie in breaking old patterns of behavior as demand continues to soar. The reward will be world-class scale and skills for those that persevere.