The Hindu Business Line : Bumpy ride ahead for small cars?

Fiscal year 2009 was a testing time for the automobile industry. But most manufactures were optimistic about a brighter 2010; and to a large extent the year didn't disappoint, with strong sales growth and a plethora of new launches.

One key driver of automobile sales in recent months has been the popularity of hatchbacks or compact cars. The lower price tag, relatively high fuel efficiency, plus lower cost of maintenance are its biggest pluses. Further, the absence of a boot makes the job of negotiating through crowded roads easier, apart from relieving the driver from having to scout around for a parking space.

Backed by all these advantages, small-car makers have found the drive smooth so far. But 2011 may pose some challenges for the industry. Here's why:

Matching the scales

In the last two to three years, car maker in India have taken to expansion programmes to capture more market share. Maruti Suzuki, for example, plans to produce one million cars by the end of this fiscal. The company said it plans to expand production base to 1.3 million cars by FY11 and by January 2010, the company will take a call on production expansions. Hyundai India works on two shifts to produce six lakh cars annually and soon intends to go on to the third shift.

If these expansions are resorted to the two companies put together will add another six lakh cars into the market, of which about half, or three lakh, are expected to be small cars. GM India and SkodaAuto India also have plans to expand their production lines in the small car segment in the coming fiscal. Bajaj-Renault-Nissan's ultra low cost car will join the bandwagon by 2012. With all the expansion and launches lined up for 2010, the moot question to ask is if the market is ready to absorb all these cars?

Decline in exports

Cheaper raw material cost, including low labour cost, is an important reason why India is gaining ground as an export hub for small cars. Though until the early months of 2008 domestic demand was adequate to absorb production, exports (mainly to the European countries) played a major role in ensuring that there was no large slippage in sales the rest of year.

Hyundai India and Maruti Suzuki have been the major exporters, while Tata Motors, GM, Fiat, Honda Siel and Skoda have small contributions from exports.

Exports accounted for 10 per cent and 50 per cent of 2008-09 sales volumes of Maruti Suzuki and Hyundai India respectively.

With European countries likely to withdraw the stimulus programme that is now helping the car market there, these companies do face a possibility of slippage in sales from that market. In November, Hyundai India witnessed 4 per cent year-on-year decline in exports while Maruti's exports for the month are marginally lower than its August numbers.

Though emerging markets in Latin America, Africa, South Asia and Middle East appear promising as diversification options in the long term, manufacturers may experience near-term decline in exports until their presence in these markets is scaled up sufficiently.

For the next year the focus will be on the domestic market, if the industry has to make good the decline in exports and justify its expansion plans. But how strong is the domestic market?

Passing on the costs

Raw material accounts for roughly 80 per cent of the production cost of passenger cars. Due to relatively longer term contracts for purchase of raw materials, car manufacturers did not see any major saving on input costs even during the commodities meltdown.

Now with the prices of steel, aluminium and rubber rising from their lows, car makers may witness renewed cost pressures. They plan to pass this on by hiking selling prices in January 2010 followed by another price hike in April.

The price rise is pegged at Rs 20,000-Rs 40,000 across segments. Given the price sensitivity of hatchback buyers, if growth will remain intact after price hikes is something to watch out for.

The second major challenge would be sustaining the pace of volumes growth, on a high base. Hatchbacks were the saving grace for Maruti Suzuki, Hyundai India, GM India, Fiat India Automobiles and even SkodaAuto India in FY 09. Taking cues from this, competition in the segment has been hotting up.

Honda Siel was quick to launch Jazz in July 2009 and plans to launch a compact car next year. The hatches have cast such a spell that global players such as Toyota, Ford, Volkswagen, and Nissan – who were sceptical about making “yet” another small car for India – are expanding their production facilities to accommodate hatchbacks.

Maruti Suzuki, Hyundai India and Tata Motors, which were once ruling the A2 segment, are already facing competition from global brands such as GM, Honda, Fiat and Skoda.

With launches from Toyota, Ford, Volkswagen and Nissan, and later from Bajaj- Renault-Nissan, a reshuffling of market share for Maruti Suzuki and Hyundai India appears possible in the forthcoming fiscal.

Rolling back concessions

Withdrawal of excise duty benefits and interest rates turning up again in are other challenges for the industry next year.

Compact cars have enjoyed lower excise duty since 2008. An evident revival in passenger cars market could see a reversal of this benefit in the forthcoming budget.

Similarly, with recovery becoming well established and inflation likely to rise, the Reserve Bank of India is seen to act on interest rates early next year.

Unlike the sedans, demand for hatchbacks is interest rate sensitive, especially in the urban market.

Of course, the revival in automobiles industry has brought a string of labour troubles, which can lead to production delays and more manpower costs. Labour unrests in Rico Auto and Pricol are indicators that such instances may not be one-off.

Related Stories:
Auto sales: The low-base effect
Ford India to export small cars from mid-2010
For Toyota, small car will be the litmus test
Small cars, big impact
Competition hots up in premium compact car segment
Audi redefines small car paradigm