Improving the profitability of any business involves not only a focus on boosting sales, but also continuous efforts to control costs. The automobile industry is no exception. While costs, in general, refer to all expenses, such as raw materials, employee costs, fuel and advertising spends, raw material / input cost control here assumes greater importance for vehicle manufacturers.
This is because the auto industry is raw material intensive, with expenses amounting to 65-75 per cent of sales for most companies. The industry is also cyclical in nature, ie., sensitive to the business cycle, such that revenues are higher in periods of economic prosperity or expansion, and lower during periods of economic downturn or contraction. Thus implying that cost reduction of any form can make a meaningful impact on the profit margins in the years of slowdown in vehicle sales.
So how are companies playing this game?
Localisation efforts
One of the ways to control costs is to reduce dependence on imports of components/parts for vehicles. India is considered a low-cost manufacturing base, hence, increasing the level of local production of components/parts helps bring down costs. An added incentive is that localisation also helps with reducing the risk of currency fluctuations that arise when paying for imports.
Take for instance, Maruti Suzuki. In the latest quarter ended March 2015, the company’s import content for raw materials stood at 16 per cent, a good 10 percentage points lower than about three years ago. This, along with factors such as a superior product mix and cheaper costs of raw materials, such as steel saw, the company recorded multi-year high margins of 15.8 per cent.
Imports have gradually come down from 26 per cent in 2011-12, to 19.5 per cent two years ago and 16 per cent now. The company aims to bring this down further to about 12 per cent.
Similarly, with the use of common rail fuel injection engines gaining popularity among truck and bus manufacturers, Bosch, the market leader in diesel engines for vehicles, is looking to improve localisation for this crucial component. The company in early 2015 announced that it has localised the production of injectors in Nasik and the manufacture of pumps in Bangalore. It also sources the electronic control units for these common rail engines from a sister concern, Bosch Automotive Electronics, set up in India.
More affordable
Luxury car makers too have been concentrating on localisation to help make these cars more affordable. This is because local assembly of CKD (completely knocked down) cars work out cheaper than import of CBUs (completely built units), which carry a hefty import duty.
BMW assembles cars such as the 1, 3, 5 Series, X1 and X3 at its Chennai plant. Thanks to their common parentage (Volkswagen) Audi’s A4, A6, Q3, Q5 and Q7 are assembled at the Skoda plant in Aurangabad. Force Motors assembles engines both for Mercedez Benz and BMW. Higher demand is also prompting other players to Indianise their vehicles. For instance, Tata Motors has begun assembling the hugely popular Range Rover Evoque at Pune in April 2015. With this, the price of the basic variant, for instance, has been slashed to around ₹48 lakh from the earlier asking price of ₹55-60 lakh.
Backward integration
Another oft used route to control input costs is backward integration. Take the battery industry. To be able to withstand a run up in prices of lead, the key raw material for batteries, Exide industries acquired two lead smelters – now called Chloride Metals and Chloride Alloys India. It currently sources half its lead requirements from these smelters. With the company recovering from the market share losses it suffered in the last 1-2 years, it is hoping to expand its margins to 15-16 per cent this year, from the current levels of 10-12 per cent. If lead prices rise, this backward integration should help rein in costs and achieve the desired margin expansion. Following Exide, Amara Raja Batteries has also bought out lead smelters.
Similarly, tyre manufacturers, such as Apollo Tyres, have invested in rubber plantations to control the cost of natural rubber, the major raw material for tyres. In 2011 when rubber prices touched a multi-year high of over ₹220 a kg, Apollo took about 10,000 hectares of land in Laos on lease to grow rubber. With rubber prices beginning to heat up in 2015 after a lull in the last two years, this investment could come in handy now. Other companies, such as JK Tyres which shed investment plans earlier following the fall in rubber prices, could now reconsider that decision as well.