Auto Parts Export Potential from India

By: Hari Sud
October 15, 2005
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Indian economists have classified auto parts export segment of business as key area of future development. This business in US alone is worth $150 Billion a year. Recent Chapter 11 bankruptcy of Delphi Corporation is a reminder that a low cost producer of these components is needed. That component maker could emerge in India, China, Malaysia and Mexico. Time for gas-guzzler cars in US is over. The Delphi was a parts supplier primarily for General Motors, whose assembly lines produced larger luxury cars and vans. As soon as the GM’s fortunes went down with the rising gas prices, Delphi’s fortunes followed. The latter lost $5 Billion last year alone out of its total sales of $28 Billion. Soon (in 3 to 5 years) the GM will be re-tooling itself to produce smaller more fuel-efficient cars. This is the time frame Delphi needs to re-organize and become a more efficient parts supplier. When it comes out of the bankruptcy, Delphi would have re-organized, cut its labor costs, reduce its legacy costs (massive pension bill) and sourced some of its products from abroad. Delphi has significant operations abroad. Two third of its work force is outside US, in Europe, Asia and Latin America. Within the continent of North America, Mexico has a significant operation. This operation is mostly located at US- Mexico border. Other Delphi’s facilities are located in Singapore, China, Turkey, Brazil, Poland, Portugal, South Korea, and India. These operations supply the local market. None of these facilities were built to leverage low labor costs for the US market. This bankruptcy has opened door not only to cut high auto manufacturing labor costs in US but also to source parts in Asia (India – China) in a big way.

What is hurting the US Auto Makers?

There are two fundamentals, which went against the US carmakers in last 20 years. First, cheap crude oil spurned demand for larger gas-guzzlers, which the US automakers dutifully supplied. Second, spiraling labor costs together with other legacy costs, which the parts makers were saddled when GM and Ford spun them out of their fold (about five years back). Crude oil climbed from about $18 a barrel in 1986-87 to $65 today. This resulted in a stampede to buy cheap fuel-efficient cars in last two years (Japanese car makers benefited). GM unable to supply smaller cars offered deep discounts, resulting in lower prices for the parts they procured from Delphi and others. Labor costs stayed uncontrolled for most of the last decade. In last ten years alone the hourly wage of a US autoworker has climbed from $16 an hour to $28 an hour. Labor leaders are not blameless in this situation. They just were not thinking globalization and its impact on parts and cars they produce. Now Delphi has gone into Chapter 11. Carmakers in Ford, Chrysler and GM are not much better off. Their stock is as close to junk status as possible and bankruptcies loom. Hence stage is set for a thorough shake up of US auto industry.

GM will soon make smaller cars and so will Ford and Chrysler. Delphi and Visteon (Fords Parts supplier) will make parts as required by both the parents, but the re-negotiated labor agreements, productivity gains, sourcing products from outside will be the name of the game.

Hence, is there an opportunity for India to supply some of these parts? Sure there is.
India / China and Auto Parts

China is the darling of US manufacturing sector when it comes to locating plants and facilities in low labor cost countries. In last two years a series of strains have appeared in this happy co-operation. It resulted in big a dispute in 2005 over Chinese textiles exports and their currency valuation. The already bloated China – US trade deficit in China’s favor is not sitting well with the US lawmakers. What is holding the US back from acting strongly against the Chinese, is their foreign exchange reserves of $500 Billion in US currency. This is a significant amount, transfer of which would force US into a major recession. This strained economic relationship coupled with occasional political outburst by US on Chinese defense spending; North Korea and Taiwan is likely to prevent a wholehearted transfer of technology and auto parts manufacturing plants to China.

Hypothetically, If all the US Auto parts makers were to set up a major shop in China and source products from there, the already $250 Billion current account deficit in trade every year will double. US cannot afford that; hence they will look for an alternative source. That does not mean that US will not set up auto parts manufacturing in China. They will, but selectively. China offers a tremendous cost advantage. The wage costs will be one third (wage component is 45 to 50% of the parts costs). Freight will be higher. This coupled with high inventory costs (Just in time inventory management will no longer be possible); other fixed charges and return on investment will give Chinese parts makers a 20% cost advantage. This is a significant reduction. All automakers would wish to have this cost reduction. It is the long-range political and strategic thinking in the US, which is standing in the way. Hence major relocation of auto parts making to China is unlikely.

For US auto makers to source parts from Brazil, Europe, South Korea and Mexico does not add much to the cost reduction, hence they have to look elsewhere.

India as a potential supplier is slowly entering the psyche of auto parts makers. Prior to that, they could think of one place only i.e. China. Now India with 8.1% growth in 2005 has caught up with their thinking. Also, India has a highly skilled labor force at about the same cost as China. It has a weaker infrastructure but it has better banking system and a greater opportunity for R & D. The latter benefits outweigh any advantage Chinese may have. Hence, India is natural for this opportunity.

India’s Auto and Auto Parts Industry

Car making is one of the fastest growing segments of the industry in India. Owning a car is a passion for every middle class family in India. India produced and sold 1.2 million cars in 2004, ranking itself to be the tenth largest producer of cars in the world. Indian made component of the cars is about 85%, with 15% specialized components still imported. In addition commercial vehicle production has also kept pace with fast economic development. All these require auto parts, most of which are manufactured in the country. Delphi has a parts making operation in India, which makes shock absorbers and struts, catalytic converters, steering column etc. Similarly, Ford’s parts supplier – Visteon has a presence in India. They all supply the local market. Only a few components are exported.

By international standards, the auto parts and ancillary hardware makers in India are small and lack specialized technology for export. Technology to begin mass production at American and Japanese standards will have to come thru technology transfer. The latter is possible with sharp US focus to make India into a strategic sourcing center, very much in line with India becoming a strategic sourcing center for software development. The latter took 7 years. In less time than that, India could be a major supplier of auto parts.

Benefits to US Auto Makers for setting up shop in India

Labor cost, the 50% component of any auto part, will be cut by two third, if sourced from India. The same benefit exists if China (or any other Asian country) supplies parts. India has one point in its favor i.e. the workforce will be relatively young. This will spare the companies of high medical cost and absenteeism. It is unlike China where, thanks to the official one child policy for the last 25 years, overall age of the work force is much higher. Older people tend to get sick often and absent from work. This is the key point why Hyundai auto plants in US have a higher productivity. Reasons – Hyundai have hired all its workers recently who are young, where as all the US auto plants have a work force much older with a high medical and absentee bill. Other benefits not stated above to locate shop in India include:

• Low cost R&D capability, which would supplement effort in US.

• High innovation in engineering and technology will continuously cut costs (Tata’s new car facility is the key example).

• India as world leader in software development will certainly provide expertise to improve auto parts manufacturing.

• India is hungry for FDI and would welcome this opportunity.

Costs and Other Benefits

Cost of building an auto parts infrastructure in India will be high. To supply $25 Billion worth of auto parts to US every year say by 2010, India will needed roughly same amount of Foreign Direct Investment over five years. In addition internal investment will have to be made to produce high grade steel, aluminum, plastics, rubber etc. Power supply for this industry, which is already short, will further strain the existing system. This industry if it smartly plays its cards could concentrate in one region where upcoming nuclear power plants are to be located. That will permanently fix the power situation. In addition this huge supply will require port and rail infrastructure to keep the parts moving to meet the “Just In Time” requirements as much as possible.

Benefits to India other than employment to thousands include:

• High value, high margin manufactured goods trade.

• Overall skill of the labor will improve. Soon they will match their counterparts in US and Europe, attracting other high value manufacturing.

• With current account surplus with US, India could buy in US a lot more than it buys today. This will benefit the US economy.

It is a good deal for US. It is a great potential for India.

Advantages over China

China today has all the facilities to attract the parts makers. They are hoping that this opportunity is coming their way. But, it is not. US are a lot wiser in its investments abroad today than 25 years back when the first US dollar arrived in China. They do not wish to put all their eggs in one basket. Hence India as a second strategic sourcing site is under consideration. US will allow China to continue with whatever manufacturing it has grabbed in past 25 years. Future investments will be carefully directed. That is where India has entered the US thinking process. India has settled almost all its Cold War differences with US. This has resulted in current Bush Administration doing their best to grant India an equal status among the five equal nuclear powers of the world. This strategic agreement is a signal to the industry and businesses to consider India as an alternative. India’s English-speaking labor force will be an asset to the US. A well-developed banking system will facilitate financial transactions.

A few internal issues need to be addressed in India. These include old and antiquated labor laws and a very slow acting bureaucracy. These are easy to fix, just in the same way as the Communist boss Deng fixed China’s similar problems from 1978 to 1985. Sight of a dollar spurned Deng, an ardent Communist, to become a capitalist. Sight of dollar will change a lot of Indian politician’s mind.

Quality Management

Product quality is a major issue, which India will have to address, before it becomes a major supplier. Japanese overcame their quality issues in early fifties. At that time Japanese products, mass-produced, in American supplied factories broke down often. To overcome this, they made quality as their national passion. South Korea followed the suit in seventies. Chinese are doing the same as they graduate from dollar store items to Wal-Mart merchandise. India will have to listen and learn and follow the lead. Labor unrest, the major reason for bad quality in North America, and also in India will have to be politically, morally and legally tackled.

This is one additional break; which India’s economic planners have been looking for. Opportunity is there; it is for India’s business and political leaders to exploit.

Hari Sud

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