European automakers seek firmer foothold in India
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When Volkswagen reported group vehicle sales in India had more than doubled in 2011, vaulting over the 100,000 mark, it looked as if everything was going according to the carmaker's meticulous plan to seize global vehicle sales leadership within a single decade.
India was one of the few glaring white spots left on Volkswagen's map of the world, and amid all the euphoria surrounding developing economies at the time, analysts at Booz & Company predicted the country would overtake Germany to become the world’s fourth-largest auto market by 2015 with a volume of more than 5 million vehicles.
On schedule, Volkswagen added a third shift to a new factory in Pune by April 2011, churning out VW Vento and Skoda Rapid sedans specifically designed to meet the tastes of Indian car buyers. The full-scale manufacturing plant opened two years earlier after completion in record time. At 580 million euros, the plant represented the single-biggest investment by a German company in India.
Since almost three-quarters of new car sales in India are bought with loans, an unusually high financing level much more common to mature markets, Volkswagen gained approval from authorities to begin offering customers tailored financing packages as well. By leveraging its global scale, diverse product range and decades-long experience in emerging markets such as China and Brazil, the group seemed well on its way toward establishing itself as a major player on the Indian subcontinent, quickly catching up to rivals such as Toyota and Honda, which already enjoyed a big head start.
Fast forward to today and VW Group serves as a warning to other European carmakers, such as PSA/Peugeot-Citroen, which are considering another foray into India.
The market shrank last year by 8 percent to 2.55 million vehicles, returning to the level of 2011, after interest rates on car loans soared to about 12 percent in the midst of a currency crisis. Sales of VW brand and Skoda cars have fallen even more drastically. VW Group’s share has dwindled and the automaker has quietly shelved overly ambitious targets after management misjudged political risks, muddled its brand strategy and botched both its model and powertrain lineups.
“We want to be a significant player in the Indian market, too. However, our focus is not on mere market share,” said Mahesh Kodumudi, head of VW Group India, in an e-mailed reply to questions from Automotive News Europe.
VW isn’t the only automaker to stumble as India remains one of the world’s most challenging car markets, having claimed more than one European victim. Peugeot was one of the first to enter the market, assembling the 309 in the mid-1990s. Heavy losses, a months-long labor dispute at its Kalyan plant and problems with local partner Premier prompted Peugeot to back out of the market just a few years later. Fiat has been undermined by multiple changes in its India strategy over the years, while General Motors simply pulled the plug on German brand Opel there in 2006.
After ditching its joint venture with India’s Mahindra four years ago and launching a string of flops, Renault finally landed a hit with its Duster, one of the only affordable SUVs on the market. Thanks to the Duster’s appeal with the country’s extremely cost-conscious middle-class customers, Renault is now the No. 1 European brand in the market. Yet it still sold only about 24,000 vehicles in India during the first half, according to data from Focus2Move, 90 percent of that volume came from the Duster. While German premium brands Audi, BMW and Mercedes-Benz dominate the country’s luxury segment, their success means little given that premium models account for just 2 percent of overall demand in the market.
Photo credit: Bloomberg
Part of the problem for European automakers is their inability to lower their manufacturing costs through economies of scale. With Maruti Suzuki capturing 44 percent of the market and Hyundai another 16 percent, the remaining dozen or so car brands are competing for a little more than one-third of the market. Subtract the premium players and that leaves about 800,000 unit sales that are split 12 ways. The bulk of that volume is in the extremely cost-competitive small and minicar segments.
“That’s a very small, very fragmented pie that is being divided up. So if the market becomes sluggish then earnings will be very badly hit,” said Mohit Arora, executive director at J.D. Power Asia Pacific. “I don’t think many of the European or even American manufacturers in India are profitable at this time.”
In an attempt to gain scale, carmakers are forced to turn their Indian plants into export hubs. VW, for example, now sells the Vento in 32 other markets, such as Mexico, just to keep the plant operating at about 75 percent capacity utilization, a level generally seen as needed for a factory to break even. Roughly half of all production out of VW’s Pune plant is destined for overseas markets this year.
Another problem is the unique difficulties and pitfalls associated with running a business in India, a country whose recent rapid growth masked deep-seated structural problems in the broader economy and the transport sector more specifically.
Home to 1.2 billion people and Asia’s third-largest economy, India has long been regarded by carmakers as the next China because of the emergence of its overwhelmingly young and educated middle class. While the country’s untapped potential is massive with about 20 cars per 1,000 people – less than half the level of China – poverty remains rampant. India’s per capita income rivals parts of sub-Saharan Africa and one-third of the world’s poor live in the country. Fuel costs remain a major concern, leading to the widespread popularity of thrifty diesels and minicars. Road building can’t keep pace with car sales, poor surfaces and traffic conditions require dealers to maintain a robust spare parts and service network, and congestion effectively serves as a natural bottleneck for demand. “The country’s infrastructure needs are massive,” the World Bank said in a report.
Because so few people own cars, tastes have yet to mature, which makes it difficult to predict the behavior of Indian car buyers. It’s easier to make a splash with a single model like the Duster. India’s own Tata Motors got it horribly wrong when it made a huge bet that families traveling on the back of a single scooter would happily trade in their two-wheeler for the comfort of a car if they could just afford one. Tata’s visionary answer, the Nano, flopped as buyers feared the stigma attached to a vehicle marketed as the “world’s cheapest car.”
Carmakers complain that much of the difficulty stems from India’s own inflexible bureaucracy, chronic lack of supply-side reforms, numerous tariffs and a government resorting to whatever means necessary to boost tax revenue. A study published by the McKinsey consultancy in February, for example, criticized India’s complex and archaic regulations, “balkanized” tax regime, and web of at least 43 national laws and many more state laws governing labor conditions. “India’s manufacturing sector is characterized by a glut of sub-scale, low-productivity enterprises,” McKinsey concluded.
Companies with more than 100 employees on their payrolls need to obtain government approval for layoffs, which encourages the harmful creation of a two-tier work force that sparks social tensions between permanent staff and their lower paid contract brethren. “India loses more days every year as a result of strikes and lockouts than any other country,” employer association AIOE wrote in a study published in 2012. Only weeks later, fresh clashes at a Maruti Suzuki plant claimed the life of an HR official, the fourth auto industry manager to die at the hands of his own employees since 2008.
‘Nothing to offer’
While Volkswagen enjoyed an initial boom thanks to the Vento and Rapid, growth began to stall in 2012 after management failed to spot a key trend that emerged due to changes in the regulatory environment. To reduce traffic on congested roads and gain control of widening fiscal and trade deficits by cutting down on subsidies and crude oil imports, the Indian government lowered excise duties for vehicles shorter than 4 meters and equipped with small engines. Carmakers such as Maruti Suzuki picked up on that, launching the popular Dzire notchback.
“After the change in the regulatory environment, the two fastest-growing segments in the Indian car market are sedans and SUVs below 4 meters and we currently have nothing to offer,” a VW source said. While other import brands are already succeeding with their sub-4 meter cars, such as the Honda Amaze sedan and Ford EcoSport SUV, Wolfsburg could only muster up the Taigun SUV study at the Delhi auto show earlier this year. Worse, VW has been slow to offer a competitive diesel. Only with the July launch of the refreshed Polo hatchback did VW start offering a 1.5-liter turbo-diesel specially designed to fulfill Indian excise tax requirements. VW just announced it would soon start building the motor in Pune in order to avoid incurring import duties.
As a result the Polo is the only car in VW’s range that receives the lowest possible excise duty of 8 percent. Unfortunately for Volkswagen, hatchbacks are not in fashion. The slightly longer, Polo-derived Vento sedan, by comparison, is slapped with a 20 percent charge, a huge difference for cost-sensitive Indian car buyers.
Of course, demand could swing in the other direction should Delhi decide to reduce the gap in preferential tax treatment. “To enhance our presence in the Indian market, we would need a wider portfolio of products,” Kodumudi said. “Volkswagen is considering options for new models in these segments [of sub-4 meter sedans and SUVs], but no decisions have been taken so far.”
VW Group made matters worse by also willingly sacrificing Skoda volumes to align its brand strategy in India with the rest of the world, where its flagship VWs are more upmarket than those of the group’s Czech marque. In India, however, Skoda is seen as an aspirational brand that has a premium cachet dating back to its launch in 2001. The effort to reposition it below VW did not go over well with Skoda customers and sales of the brand in India have suffered. “You may have a strategy that you can eloquently explain to an investment community, but the man on the street believes Volkswagen is out here to kill Skoda as a brand,” said an India-based analyst who asked to remain anonymous. In the end, the automaker ended up with some VW models that were priced at a premium to Skoda, and others that were priced at a discount, which confused customers, analysts said.
VW was forced to lower its targets for India, aiming for a market share in the high single-digit percentage range across all brands instead of the double-digit share it previously hoped for. “Back in 2009 when Pune went on stream, there was a phase of euphoria surrounding emerging markets such as India. But the economy and overall business conditions developed much differently than the assumptions made at the time, so we had to adjust our targets,” the VW source said.
VW is not the only European carmaker to experience difficulty breaking into the Indian market. Fiat allied with Tata, building and selling cars via a joint venture until deciding to set up a network of exclusive showrooms with the goal of reaching 150 dealerships by the end of this year. But service problems and a product range consisting currently of just two models have limited its growth. Given the crowded state of the market, IHS Automotive analyst Anil Sharma recommends that France’s PSA avoid the high entry barriers in the volume segment by returning to India using its upmarket DS brand as an alternative to the more mainstream Germans.
‘Good days are ahead’
Overall, the outlook for car sales in India is brightening, even for VW Group. Gujarat’s pro-growth minister was swept to power in national elections after promising that “good days are ahead,” handing his party the first absolute majority in decades.
“The landslide election victory by Prime Minister Narendra Modi, combined with governor Raghuram Rajan at the helm of [Indian central bank] RBI, is a potential game-changer for India,” Japanese brokerage Nomura said. “It is not an exaggeration to expect India to stand out as the biggest EM [emerging market] turnaround story in the next five years.” India’s carmakers are also happy, calling budget proposals by the new Modi government “the right message to foreign investors.” Auto sales rose in May for the first time in more than 15 months, according to Indian vehicle association SIAM, helped by an extension of the cut in the excise duty for cars until December 2014.
The changes also offer an opportunity for Europe’s carmakers, since the government is looking to strengthen outdated safety rules. India has the highest overall number of reported road deaths in the world and roughly one out of every
3.5 accidents results in a fatality as most cars lack basic safety features such as antilock brakes. The Volkswagen Polo is the first car in its class to offer airbags as standard equipment in all trim lines. “If some of those safety norms were to come, the European manufacturers could find a more even ground to play on,” J.D. Power’s Arora said.
With the government no longer acting as a key part of the problem and instead becoming a part of the solution, it is now up to Europe’s carmakers to execute on their India strategies.
You can reach Christiaan Hetzner at email@example.com.