Indian Automobile Industry

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1 Indian Automobile Industry CCI s proposed penalty on Passenger Vehicle OEMs not materially credit negative Special Comment September 2014 ICRA RESEARCH SERVICES ICRA Comments Corporate Ratings Anjan Deb Ghosh aghosh@icraindia.com Subrata Ray subrata@icraindia.com Shamsher Dewan shamsherd@icraindia.com Jitin Makkar jitinm@icraindia.com ICRA RATING FEATURE CCI imposes penalty on 14 passenger vehicle OEMs due to their alleged anti-competitive trade practices The Competition Commission of India (CCI), which monitors anti-competitive practices in India, recently imposed a cumulative penalty of Rs billion on 14 Passenger Vehicle (PV) OEMs operating in the Indian market. The penalty follows an investigation by the CCI which suggests that PV OEMs in India restrict the availability of spare parts, diagnostics tools and technical information to independent car repairers thereby creating monopolistic control. According to CCI, most of the OEMs in India either have restrictive covenants in their agreements with auto component suppliers and authorized dealers or impose practical constraints on them in terms of selling spare parts directly in the aftermarket. This creates a virtual monopoly for OEMs in the aftermarket segment with respect to availability of spare parts and allows them to charge arbitrary and high prices. As a result, the commission has decided to impose a penalty on each of the 14 PV OEMs^, equivalent to 2% of their average turnover between FY Amongst the key OEMs, the highest penalty of Rs billion has been imposed on Tata Motors, followed by Maruti Suzuki (Rs. 4.7 billion) and M&M (Rs. 2.9 billion) (Refer Exhibit 1). Exhibit 1: OEM-Wise Penalty Imposed by CCI on Passenger Vehicle OEMs OEM-Wise Penalty Imposed by CCI OEM Penalty (in Rs. Million) Average Turnover# Tata Motors 13, ,230.5 Maruti Suzuki 4, ,568.0 Mahindra & Mahindra 2, ,123.7 Toyota ,692.4 General Motors ,289.5 Honda ,234.1 Skoda ,195.7 Ford ,892.0 Fiat ,988.8 Mercedes Benz ,537.8 BMW India ,203.7 Hindustan Motors ,923.3 Volkswagen ,626.5 Nissan Total (in Rs. Million) 25,446.6 Source: Competition Commission of India (CCI), ICRA s Estimates # CCI has computed the penalty as 2% of the average turnover of the companies between FY except for General Motors ^ A separate order with respect to Hyundai, Reva and Premier will be passed as they are yet to submit their views on CCI s finding

2 CCI Penalty: Impact on OEMs If OEMs were to make a provision for the proposed penalty, its impact is likely to be between 3-9% (on FY 2014 EBITDA) and % (on FY 2014 Net worth) for publically-listed OEMs ICRA Comments CCI has directed OEMs to create an efficient service network going forward Besides imposing penalty, CCI has also directed PV OEMs with regard to the following: To put in place an effective system to make spare parts and diagnostic tools easily available in the open market for customers and independent workshops To allow auto component suppliers to sell spare parts directly in the aftermarket without any restrictions, including on prices. In case OEMs hold Intellectual Property Rights (IPRs) with respect to certain components, they may enter into a royalty agreement or some of kind of a fee structure and allow vendors to market the parts under their brand To develop and operate appropriate training programmes for independent workshops/garages and facilitate easy availability of diagnostic tools To work towards standardizing components (across vehicles) to the extent possible such that benefits of economies of scale can be passed on to customers Not to impose a blanket condition on cancellation of warranties (if the vehicle is serviced by an unauthorized workshop) and rather develop a framework wherein it can identify if the damage has been caused by faulty repair of the unauthorized workshop and decide to cancel the warranty accordingly To improve their disclosure levels with regards to information on pricing of spare parts, available alternatives and indicative maintenance costs Proposed penalty amount not materially credit negative for most of the leading OEMs In our view, the quantum of penalty imposed by CCI is unlikely to have a material credit implication on most of the leading OEMs. Although companies are expected to contest the commission s order, we believe even if OEMs were to make a provision for the proposed penalty, its impact is likely to be between 3-9% (on FY 2014 EBITDA) and % (on FY 2014 Net worth) for publically-listed OEMs like Tata Motors, Maruti Suzuki^ and M&M (Refer Exhibit 2). Further, Tata Motors and M&M are also likely to challenge the methodology for estimating the penalty as sizeable proportion of their turnover comes from businesses other than sale of cars in India. For example, penalty imposed on Tata Motors has been computed on its consolidated turnover, which includes both the commercial vehicle (CV) business as well as Jaguar Land Rover (JLR) business. Likewise, M&M generates almost 37% of its standalone turnover from tractor business, a segment which was not under the purview of CCI s study. We believe OEMs may challenge the order and may not see immediate cash outflow given the track record of delays in conclusion of such anti-competitive litigations in the past. Exhibit 2: Proposed Penalty as a Proportion of Profits and Net worth of Publically-Listed OEMs In Rs. Billion Key Financials (FY 2014) Penalty (as % of) OEM Penalty Net Sales EBITDA Networth Net Sales EBITDA Networth Tata Motors# (9.1) % % 7.0% Tata Motors , % 3.9% 2.1% Maruti Suzuki % 9.1% 2.2% M&M# % 6.2% 1.7% M&M % 2.9% 1.3% Source: CCI, Company Releases; # Standalone; ^ MSIL has been granted a stay from Delhi High Court for CCI s fine on ICRA Limited P a g e 2

3 CCI Order: Key Observations Factors considered by CCI in its investigation To judge whether OEMs have indulged in anti-competitive practices, CCI has based its investigation on six different parameters which are primarily based on agreements that OEMs have with their suppliers and dealers, availability of spare parts and diagnostic tools in the aftermarket and implication on warranties (provided by OEMs) in case the cars are serviced by independent repairers. As part of its study, it has also estimated the extent of mark-up charged by OEMs on spare parts that are sold from their authorized service centers. CCI s conclusion for each of the OEM is tabulated in the Exhibit 3. Exhibit 3: Key Observations by CCI Factors # 1: Restrictions by OEMs on auto component vendors to supply parts directly in the aftermarket MSIL M&M TML HM Ford Honda Skoda GMIPL Toyota Volkswagen* Fiat Nissan Mercedes BMW Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes No Comments: According to CCI s findings, most of the OEMs apart from BMW have restrictive clause in their agreements with auto component manufacturers which restrict them from supplying parts directly in the aftermarket. These clauses are primarily on the pretext of protecting IPRs on components designed/developed by OEMs. As per CCI, while BMW does not have any clause which prohibits its suppliers, in practice, none of its suppliers are actually supplying parts in the aftermarket. Factors # 2: Restrictions by OEMs on authorized dealers to sell parts directly to independent repairers MSIL M&M TML HM Ford Honda Skoda GMIPL Toyota Volkswagen* Fiat Nissan Mercedes BMW No terms Restrict No terms No terms No terms No terms Restrict Allow No terms No terms Restrict Restrict Allow Allow Comments: As per CCI, the agreements between OEMs and their dealers are primarily of three types a) certain OEMs restrict sale of parts by dealers, b) certain OEMs do not have specific terms in their agreements, however, in practice, dealers don t allow sale or allow on limited basis for old/phased out models, c) certain OEMs allow dealers to either sell parts directly to independent repairers (Mercedes) or allow it to be sold to its customers (BMW, GMIPL). Factor # 3: Availability of spare parts in the aftermarket MSIL M&M TML HM Ford Honda Skoda GMIPL Toyota Volkswagen* Fiat Nissan Mercedes BMW PA/A PA PA NA NA NA NA PA PA NA NA NA NA NA Comments: Besides agreements between component manufacturers and OEMs, CCI has also made observation with respect to availability of parts in the aftermarket. According to its findings, for most of the relatively late entrants in the Indian market, parts are not available (on pan-india basis). For Maruti Suzuki and Tata Motors, parts are partially available and for OEMs like M&M, Toyota and General Motors, parts are available for discontinued models or on restrictive basis for ongoing models. Factor # 4: Access to Diagnostic Tools, Workshop Manuals and Special Tools Comments: In case of most of the OEMs, the availability of the diagnostic tools, workshop manuals and other equipment are available on limited basis. CCI has noted Maruti Suzuki is the only OEM that shares its technical manuals with My TVS, one of the organized players engaged in servicing of passenger vehicles Factor # 5: Implication on warranties if vehicles are serviced outside the authorized dealer network Comments: According to CCI, the above criteria holds true for almost all the OEMs except for BMW. As a result, it has argued OEMs should not impose a blanket condition on cancellation of warranties (if the vehicle is serviced by an unauthorized workshop) and rather develop a framework wherein it can identify if the damage has been caused by faulty repair of the unauthorized workshop and decide to cancel the warranty accordingly. Factor # 6: Considerable mark-up in prices and significant variation across spare parts According to data submitted by OEMs, CCI believes that spare parts are priced arbitrarily. As per CCI, the average mark-up on spare parts is at least 100% in case of most of the OEMs with the upper limit being as high as 5,000%. PA/A Partially Available/Available; NA Not Available; *Volkswagen includes Audi ICRA Limited P a g e 3

4 Rs. billion Industry Structure: Automotive Aftermarket Indian Aftermarket for Spares and Services Industry Structure The auto components industry in India is currently around two-thirds the size of the OEM segment. This proportion is around one to two times in the mature markets of Europe, America and Japan. This indicates (a) higher proportion of imports of auto components in India by OEMs and (b) relatively lower replacement market sales by auto ancillaries. Thus, structurally, the current size of the Indian auto components replacement market in relation to auto parts supplies to the OEM segment is much smaller than that in mature markets. This implies that the Indian auto components industry could potentially grow at a rate faster than the OEM segment, driven by OEMs thrust on localization and growth in replacement market demand. For the latter to gather steam, one of the enabling drivers could be elimination of the prevailing widespread use of fake auto parts (estimated at one-third of total aftermarket spares sales) in favour of genuine parts produced by auto OEMs and their Original Equipment Suppliers (OES). Out of the total estimated turnover of Rs. 486 billion of the automotive replacement market as a whole, around 75% is contributed by sale of auto spare parts and the balance 25% is contributed by service revenues Out of the total estimated turnover of Rs. 486 billion of the automotive replacement market as a whole, around 75% is contributed by sale of auto spare parts and the balance 25% is contributed by service revenues. These figures are excluding the contribution of sales of batteries and tyres in the replacement market. As per ICRA s estimates, the size of the replacement market, including sale of auto spare parts and labour charges for car servicing, is estimated to have grown at 15% CAGR over the last five years, although industry growth is estimated to have slowed down to around 6-7% in (Refer Chart 1). The two-wheeler (2W) segment is estimated to account for 48% of the overall pie of auto spare parts sales in India, followed by the PV and CV segments (Refer Chart 2). This indicates that although the PV market (annual sales of new vehicles) is more than double the size (by value) of the 2W market, the situation is reverse when it comes to the current size of the replacement market size where 2W replacement market (for spare parts) is roughly double the size of the PV replacement market. Chart 1: Size of Replacement Market (Auto Parts and Servicing) Chart 2: Segment-Wise Share of Aftermarket Spare Parts 3W, 3% CV, 24% W, 48% PV, 26% Aftermarket Spares Servicing Source: ACMA, ICRA s Estimates ICRA Limited P a g e 4

5 Car Servicing: Channel Structure While authorized dealers in India capture around 50% of total aftermarket revenues, this proportion is lower at around 35% in the UK Customers have multiple channels to choose from to get their cars serviced or repaired To get their vehicles serviced or repaired, PV owners in developed markets have multiple options to choose from ranging from authorized dealerships, neighbourhood garages and independent third party chains, based on their price-value expectations. The Indian market structure, on the other hand, is built largely on the OEM-patronized franchisee model (including authorized dealers and authorized service centres) that is augmented by a fragmented maze of unorganized players (Refer Exhibit 4). Besides being the only point of contact for customers for the purchase of new cars, the authorized dealers meet the customer s need for ongoing car maintenance and repair etc with generally better quality and reliability. However, since services offered by the dealer ecosystem tend to be priced higher, they do not meet the value expectations of all classes of consumers. Thus, such customers typically migrate to the unorganized market for meeting their vehicles service and repair needs. The estimated trend in leakage of dealers service load to unorganized players is given in Exhibit 5. The unorganized market is not without its own concerns related to usage of spurious parts, inconsistent quality and untrained technicians. Exhibit 4: Matrix of Services Offered to Customers by Various Car Servicing Channels Authorized Dealers OEM Authorized Service Stations Independent Workshops Multi-Brand Car Servicing^ Lube Chains New Cars Pre-Owned Cars Pre-Owned Cars Service Service Service Service Spares Spares Spares Spares Lubes Accessories Finance Finance Insurance Insurance Source: ICRA s Research; ^Includes chains such as Mahindra First Choice, Carnation Auto, My TVS Exhibit 5: Customer Retention by Car Dealerships (Pertaining to vehicle servicing) After Year n Proportion of Customers Retained Year % Year % Year % Year % Year % Source: ICRA s Research OEM-authorized dealers benefit from synergies arising from offering multiple solutions to customers under one roof. For instance, a customer buying a new car from a dealer is a potential customer for sale of accessories, insurance etc. Likewise, a customer that sticks to the dealer over multiple years for car servicing, could be a potential target for the preowned car business of the dealer once the customer s car gets old. Such synergy benefits are missing in independent workshops but they do serve other specific customer requirements at more affordable costs. ICRA Limited P a g e 5

6 Car Servicing: Customer Retention by Authorized Dealers Data submitted by OEMs to the CCI For its study, the CCI had sought data from PV OEMs regarding the proportion of customers who sought services of their authorized dealers post warranty. The data provided by OEMs to the CCI is reproduced below in Exhibit 6. Based on this data, the OEMs argued that a significant proportion of their customers do not return to the OEMs dealership network in the post warranty period. As per OEMs, this implied that substitutes for servicing and repair of various models of OEMs cars were available and availed by car owners in the aftermarket. However, CCI, in its order has not accepted the OEMs contention and finds these contrary to its own findings. The proportion of cars being serviced at authorized service centers has gradually risen for Maruti Suzuki and M&M over the past few years Exhibit 6: Proportion of Customer using Authorized Dealerships In Post-Warranty Period OEMs % of Customers using Authorized Dealerships Maruti Suzuki : 27% : 29% : 33% M&M : 33% : 40% : 52% Tata Motors ~41% Hindustan Motors Ambassador Brand: 27% Pajero: 95% Ford ~50% Honda ~64% (Excluding Brio) Skoda 0-4 Years: 68% 5-7 Years: 34% 8+ Years: 14% General Motors 3-4th Year: 78% 4-5th Year: 62% Toyota 4-7th Year: 71% Volkswagen All Brands: 92% Fiat ~42% Luxury Segment OEMs Audi 80-85% Mercedes Benz Upto 4 Years: 89% 5th Year: 81% BMW ~78% Source: CCI s Order; OEM s Estimates The data shared by OEMs with CCI suggests that: The proportion of cars being serviced at authorized service centers has gradually risen for Maruti Suzuki and M&M over the past few years Although the proportion varies across OEMs, the customers of OEMs like Maruti, Tata and M&M with relatively well established servicing network and bigger population of vehicles on road find it easier to get their cars services outside In addition, the proportion falls quite sharply after the warranty period and ageing of the vehicle Data for luxury car OEMs suggests that a higher proportion of cars are serviced at dealerships even after expiration of warranty period ICRA Limited P a g e 6

7 Car Servicing: Cost to Customer Spare parts and lubricants are estimated to account for 40% of average car servicing costs The cost elements related to general servicing of any car may be classified into four categories, namely, Lubricants, Spare Parts, Labour and Value-Added Services (VAS). A representative break-up of the above costs for servicing a typical A2 segment car by any authorized dealer is given in Exhibit 7. The data suggests that labour (including VAS) constitutes around 50-60% of the total cost of servicing any car, lubricants constitute around 32% and the balance cost is attributable to spare parts. The lubricants used in cars generally have standard specifications and are sourced by OEM-authorized dealers or independent garages from Castrol, Servo, Mobil and Indian Oil or their distributors. Thus, for any independent workshop, the biggest supply chain hurdle remains the availability (or lack thereof) of genuine spare parts. This apart, given the increasing sophistication of modern cars and greater use of electro-mechanical systems, fault diagnosis in cars requires use of technology intensive tools like scanners and diagnostic equipment. Even if independent workshops are able to make investments in purchase of such tools, lack of training and technical manuals constrains them in being able to repair the car. It is in this context that CCI avers that PV OEMs have created a monopoly, while denying market access to independent workshops for gaining supply of genuine spare parts and diagnostic tools and equipment. For general repair/ service, labour costs account for around 50-60% of the car owner s total bill at an OEMauthorized dealer Exhibit 7: Cost Mix for Customers related to Servicing of a Typical A2 Segment Car Cost Elements 20,000 km Service 30,000 km Service 40,000 km Service Average Lubricants^ 41% 23% 32% 32% Spare Parts 9% 6% 12% 9% Labour 29% 40% 37% 35% Value-Added Services (VAS)* 21% 31% 19% 24% Total 100% 100% 100% 100% Source: ICRA s Estimates ^Lubricants comprise of engine oil, gear oil, brake fluid and engine coolant *Includes services like engine de-carbonizing, teflon coating, upholstery dry cleaning etc Independent workshops currently do not have access to all spare parts of an automobile There could be three broad categories of auto parts that are used to build a car: (i) Parts designed and manufactured in-house by OEMs (such as body panels) on which they exercise direct control in terms of supplies to authorized dealers (ii) Parts designed by OEMs but manufactured by OES (such as rear axles, chassis parts) where contractual terms restrict the latter from supplying directly to the aftermarket (iii) Parts for which broad specifications are defined by OEMs, but parts are designed and manufactured by OES (such as wheel bearings, batteries, tyres) where the latter have their own aftermarket distribution channel. Thus, for the first two categories of parts, independent workshops do not have easy access which restricts their ability to serve customers for all types of jobs. Even multi-brand car servicing chains (despite their organized nature) face challenges in terms of forging tie-ups with a large community of vendors for spare parts. Such organized chains need to partner with multiple intermediaries including OEM-approved vendors, importer traders, aggregating brokers and even authorized dealers. Through these tie-ups, while organized chains get relatively easier access to fast-moving spare parts such as air filters, oil filters, fuel filters, spark plus, shock absorbers etc; for many of the other parts (such as body panels and instrument panels), ensuring continuity of parts access currently remains a continuous challenge. ICRA Limited P a g e 7

8 ICRA Comments Comparison: Availability of spare parts of PVs and CVs in the aftermarket Unlike PVs, the spare parts distribution network for Commercial Vehicles (CVs) follows a different ecosystem. While for PV OEMs in general, availability of spare parts in the aftermarket is relatively limited, it is not the case in CVs as their parts are readily available from a wide network of dealers-operated retail outlets. This fragmented and unorganized channel sources components from organized spare part distribution companies like India Motor Parts & Accessories Limited, T.V. Sundram & Sons, Jullundur Motor Agency, The Associated Auto Parts Limited etc. These players in turn source majority of the spare parts from auto ancillaries, which develop and manufacture components on behalf of OEMs. We see two key factors that explain the differences between the spare parts distribution network for CVs and PVs: Given the highly cost sensitive and fragmented road logistics industry in India, most of the CV owners tend to get their trucks serviced at independent workshops to save costs. This necessitates OEMs to ensure availability of spare parts across the country through a wide network of dealers in order to reduce downtime and limit usage of fake parts. Secondly, the PV dealerships have a greater dependence on spare parts business for their profitability. This would especially hold true for OEMs who currently have a relatively smaller population of cars on Indian roads. We believe that break-even levels of PV dealers are also higher than CV dealers due to high cost (primarily rentals) associated with maintaining showrooms at relatively up-market locations. In contrast, CV outlets cum service stations are generally located in the outskirts of cities or not so prime locations. Conclusion This recent CCI order that slaps a penalty on PV OEMs in India for indulging in alleged anti-competitive practices isn t an isolated example of regulatory activism. Similar intervention by regulatory authorities has been on display even in other automotive markets including the Block Exemption Regulation in Europe, Right to Repair Act in the USA and the more recent anti-trust rulings in China that has forced many foreign car makers in the country to slash both car prices as well as prices of spare parts. While many of the Indian PV OEMs who are affected by the penalty imposed by the CCI are expected to appeal against it, in case the order gets implemented as proposed, it is likely to have the following impact on various stakeholders: Stakeholder OEMs Authorized Dealers Independent workshops Customers Source: ICRA Research Impact of CCI Order on various stakeholders if implemented as proposed If OEMs could support availability of spare parts to channels beyond their authorized dealers, it could help them grow their spare parts sales which currently account for 7-8% of their revenues. This could also help arrest proliferation of spurious spare parts in the automotive aftermarket. However, since debunking spare parts exclusivity to dealers may hamper dealer margins, OEMs may have to support margins of dealers in an alternative manner Post warranty service jobs may get scarcer for dealerships as consumers will have an option to go to other channels for getting their cars serviced at more affordable rates Independent repair shops may have an easier time capturing dealers' service business as availability of all types of spare parts will improve More choices will be on offer for getting cars serviced at affordable rates; at the same time, customers will have to exercise caution in approaching independent workshops employing trained mechanics who use bonafide spare parts ICRA Limited P a g e 8

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