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http://www.dnb.co.in/smes/future%20outlook.asp

The division of production processes and outsourcing among global automobile manufacturers has led to a major reorganisation ofthe supply base within the automobile and auto component industry. This new business model being followed by global companiesholds tremendous potential for the growth of small and medium enterprises (SMEs) in India.

Defining SMEs

A well-debated issue, the definition of small and medium enterprises in India was very recently ratified. The Micro, Small andMedium Enterprises Bill, 2006, which is l ikely to take effect from October 2006, define the segment on the basis of investments inplant and machinery. Small enterprises are those with an investment of not more than Rs 50 mn in plant and machinery, andmedium enterprises with an investment of over Rs 50 mn but less than Rs 100 mn in plant and machinery. This definition hasfinally put the segment within a legal framework.

The traditional small scale industries have been in focus since Independence. The medium enterprises are recent entrants, andpart of governments policy focus lately. The small scale segment is a manifestation of Indias socio-economic development modeland has met with the countrys long-term expectations in terms of contribution to GDP, industrial base, employment and exports.This segment forms a major part of Indias industrial base.

Recognising the importance of SMEs in the industrial development of the country, the Government has initiated a range ofprogrammes in diverse areas, viz. financing, technology, innovation, market information, technical training and developmentalassistance. These initiatives are important in facilitating the growth of the SMEs. But it will be the internal dynamics of industries,and the path Indias industrial development takes, that will give a thrust to the emergence of SMEs. The auto component industryis one such sector that would give a major boost to SMEs.

SMEs in Auto ComponentsAuto component SMEs are one of the fastest growing within the SME category of industries. These units are key contributors to thetotal production of auto components and also have a significant share in the exports of the industry.

As part of a highly fragmented industry, these companies mostly are part of the unorganised sector. They operate in a tierframework, and most of the companies in the SME segment are in the Tier II or below. Few of the suppliers to OEMs are mediumscale enterprises.

The SMEs are riding a boom phase, driven by demand from global auto manufacturers. The industry is undergoing a majorrestructuring and many existing companies are expected to move up in the value chain to a higher tier. Nevertheless, sustenanceand survival still remains an issue of concern for these companies as they will have to absorb global best practices in thiscompetitive environment.

Cost competitiveness, customer orientation, lead time, are some key factors the auto component SMEs will have to imbibe to

survive in the new global set-up. At the same time, these companies face the limitations of being SMEs, like

y Low capital basey Limited generation of surplus funds for re-investment due to tight working capital cycley Lack of awareness of business opportunitiesy Inadequate exposure to international environmenty Limited geographical diversity of marketsy Obsolete Technologyy Poor infrastructure facilities

Despite these limitations, the SMEs have managed to significantly contribute towards development of Indias industrial base. Thekey risks that the auto component SMEs faces include:

y Fluctuations in the cost of production; especially raw materials like steel, aluminium, polymersy Poor negotiation powers due to fragmented nature of industry; which in turn limits their pricing powery Dependence on traders and agents to access overseas markets which threatens their competitivenessy Product substitutes due to fast-changing technology

Addressing these challenges and risks will be crucial to promoting SMEs in the auto component industry. The government hasinitiated cluster-based development geographical concentration of enterprises having similar lines of business which gives riseto external economies and favours emergence of specialised technical, administrative and financial services. This form ofnetworking of small firms is a means of achieving economies of scale. Extending this intitiative further, the government isencouraging banks to adopt a cluster-based lending approach to ease availability of funds to SMEs.

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Multinational automobile manufacturers like Magna International of Canada, Delphi and Ford of US and some European companieshave announced plans to enter the Indian markets. This bodes wel l for the auto component industry as it would enable thecollective development auto component SMEs. This will bring in better technology, skills, new products and an assured market.Strategic tie-ups and contract manufacturing is another way forward for SMEs in the auto component industry.

Looking forward, it is the best of times for Indian auto component manufacturers. The outlook for the industry is bright and isexpected to continue on a high-growth trajectory for the next 10 years. Capitalising on this growth prospect wi ll mean keeping pacewith global developments and imbibing capabilities that will give an edge to Indian SMEs in surviving this rapidly changing

competitive environment.Auto Component Clusters in India

State No.

Andhra Pradesh 1

Delhi 1

Gujarat 5

Haryana 3

Jharkhand 1

Karnataka 2

Maharashtra 5

Madhya Pradesh 1

Punjab 4

Tamil Nadu 1

Overview of auto mobile industry

he Indian auto component industry has been navigating through a period of rapid changes with great lan. Driven by globalcompetition and the recent shift in focus of global automobile manufacturers, business rules are changing and liberalisation hashad sweeping ramifications for the industry. The global auto components industry is estimated at US$1.2 trillion. The Indian autocomponent sector has been growing at 20% per annum since 2000 and is projected to maintain the high-growth phase of 15-20%till 2015.

The Indian auto component industry is one of the few sectors in the economy that has a distinct global competitive advantage interms of cost and quality. The value in sourcing auto components from India includes low labour cost, raw material availability,technically skilled manpower and quality assurance. An average cost reduction of nearly 25-30% has attracted several globalautomobile manufacturers to set base since 1991. Indias process-engineering skills, applied to re-designing of productionprocesses, have enabled reduction in manufacturing costs of components. Today, India has become the outsourcing hub forseveral global automobile manufacturers.

Innovation and cost pruning hold the key to meeting the global challenge of rising demand from developed countries andcompetition from other emerging economies. Several large Indian auto component manufacturers are already gearing to this newreality and are in the process of substantially investing in capacity expansion, establishing partnerships in India and abroad,

acquiring companies overseas and setting up greenfield ventures, R&D facilities and design capabili ties.

Some leading manufacturers of auto components in India include Motor Industries Company of India, Bharat Forge, SundaramFasteners, Wheels India, Amtek Auto, Motherson Sumi, Rico Auto and Subros. The Indias Top 500 Companies, published by Dun &Bradstreet in 2006, listed 22 auto component manufacturers as top companies in India with a total turnover of US$ 3 bn. Thesecompanies are in the process of making a mark on the global arena, and some have already acquired assets abroad.

Industry Structure

The total turnover of the Indian auto component industry is estimated at US$9 bn in 2006. The industry has the resources tomanufacture the entire range of auto products required for vehicle manufacturing, approximately 20,000 components. The entry ofglobal manufacturers into India during the 1990s enabled induction of new technologies, new products, improved quality andbetter efficiencies in operations. This in turn effectively acted as a catalyst to the local development of the component industry.

The Indian auto component industry is extensive and highly fragmented. Estimates by the Department of Heavy Industries,Government of India, indicate there are over 400 large firms who are part of the organised sector and cater largely to the OriginalEquipment Manufacturers (OEMs). Another 10,000 firms exist in the unorganised sector that operates in a tier-format. The firms inthis segment operate in low technology products and cater to Tier I and Tier II suppliers and also serve the replacement market

Around 4% of the companies operating in the auto component segment cater to 80% of the demand emanating from OEMs. Withinthe unorganised segment, apart from supplying in the aftermarket, a number of players are also involved in job work and contractmanufacturing.

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Source: ACMA

The range of products manufactured, with each broad product segment having a different market structure and technology, hasnegated any possible concentration of the market in a few hands. The market is so large and diverse that a large number ofplayers can be absorbed to accommodate buyer needs. However, there are a select few large companies that have integrated theiroperations across the value chain. The key to competing in this industry is through specialisation by product-type, and integratingoperations across the related area of specialisation.

An interesting insight provided by a study conducted by the National Council of Applied Economic Research revealed that themarket segments for auto components included OEMs constituting 33%, local components having 25% with the balance 42%comprising of spurious market including re-conditioned parts. A large part of the spurious or grey market companies are in theunorganised sector.

The regional base of auto component manufacturers is mostly concentrated in the West, North and South of India.This regionalconcentration of auto component manufacturers has been dictated by the emergence of automobi le manufacturers in theseregions. The set up of Tata Motors, Bajaj, Mahindra & Mahindra and TVS in the 1950s and 1960s laid the foundation for autocomponent manufacturers in the West and South, whilst the entry of Maruti during the 1980s created the base in the North.

Industry Growth

Production of auto ancillaries was estimated at US$10 bn in 2005-06 and has been growing at a robust 20% per annum since2000. Exports of auto components have been strong growing at 24% per annum since 2000. This growth in exports if sustainedfor another five years will see Indias auto components exports will touch US$ 5 bn by 2011 from the US$ 2 bn at present.

Till the 1990s, the auto component industry was solely dependent on the domestic automobile industry to drive the demand forancillary products. This composition of the market however is undergoing radical changes with global outsourcing gaining

momentum. In recent times, exports has emerged as a significant driver of growth, and the demand emanating from global OEMsand Tier I manufacturers has opened new opportunities for the auto component industry in India. At the same time, a bright

outlook for the domestic automobile industry also offers significant growth potential, given the fast rising income levels with arapidly growing middle and high income consumers.

Share of exports in total production has risen from 10% in 1997 to 18% in 2006. The composition of exports in terms of theproportion of OEM and aftermarket has also undergone a sweeping change since the past decade. The ratio of OEM to aftermarkethas changed from 35:65 in the 1990s to 75:25 in 2006. While exports have been booming, there has been a sharp rise in imports

of auto components as well , especially in the last three years. From an import of US$ 250 mn in FY03, they have gone up toUS$750 mn in FY06. This is a healthy trend, indicative of rising domestic demand.

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Investments

Since 2000, the auto component industry has recorded an investment level of Rs 18 bn and has attracted US$ 530 mn in terms offoreign direct investment. Investments in the sector have been growing at 14% per year. In 2005-06, investments touched US$4.4 bn, and are expected to grow significantly in future.

The Investment Commission has set a target of attracting foreign investment worth US$ 5 bn for the next five years to increaseIndias share in the global auto components market from the present 0.4% to 3-4%. This is a sizeable target considering themeagre amount of FDI currently coming into the industry. The changing perception of global auto makers is however fast alteringthis scenario.

With less than 1% share in the global market, India has tremendous potential to emerge as a supply base. Several global giantslike Ford and Toyota have already set up base in India to source auto components. Outsourcing is fast catching up with domesticOEMs as well, with most Indian OEMs today sourcing nearly 70-80% of their component requirements from vendors.

This changing business scenario is leading to an inevitable outcome of consolidation within the industry. The takeover of KarMobiles by Rane Engine and of Gero Auto by Uma Precision are few instances. However, such mergers and takeovers will be fewand far in between in the auto component industry, unlike the churn out anticipated in other emerging industries the principalfactor being the vastness of the market and the range of products that need to be delivered.

Rather than domestic consolidation, the general trend at present is for the large auto component manufacturers to establish aglobal presence. Top auto component manufacturers have already set up base in the global markets, especially in Europe. Overall,there have already been 16 acquisitions, with six made in 2005. The industry is the third highest among the Indian industries afterIT and Pharma, in acquiring overseas assets. These acquisitions have largely been in Europe and the USA. This trend has beenpossible as the auto ancillary industry in these countries have been collapsing, thus making it affordable to acquire thesecompanies. Nevertheless, this will provide a base for Indian companies to access the European and American markets.

Indian auto component companies are also setting up bases in other emerging economies, who are potential competitors, forinstance, Sundaram Fasteners greenfield facility in Zhejiang and Bharat Forges joint venture with the Chinese automotive majorFAW Corporation. Another auto component manufacturer with plans to enter China is PMP Components, which intends to set up asourcing base to establish itself as a low cost supplier.

These trends are indicative of the changing business environment in the country. Top auto component manufacturers are gearing totake big risks. Their cross-border vision has established them as global companies. Though the going-global phenomenon is limitedto a handful of companies, the smaller companies are also indirectly gearing to this trend by entering into formal manufacturingcontracts and specialisation.

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Prospects

Looking forward, the industry displays tremendous potential in generating employment and boosting entrepreneurship in thecountry. The spate of new investment plans announced by global and domestic automobile manufacturers promises the emergenceof India as a global hub for auto components.

The industry is transforming, and the boost in demand will see the emergence of several new players in the industry. The vastmarket for auto components, and the diverse products and technology involved ensures a place and role for many. At the sametime, the entry of several global automobile manufacturers will bring in more regulation into the industry and see a pruning of thespurious market. Among the smaller players in the unorganised segment, this implies moving away from being standalonecompanies, to entering into either contract manufacturing or being ancillary units. The newly defined rules are specialisation,development and delivery that hold the key to success in the auto component industry.

Foreign Acquisitions by Indian Companies

ndian Company Acquired Country

e

Carl Dan Peddinghaus Germany

CDP Aluminiumtechnik Germany

Federal Forge USA

Imatra Kilsta AB Sweden

Scottish Stampings Ltd Scotland

umiWOCO Group Germany

G&S Kunststofftechnik GmBH Germany

GWK UK

New Smith Jones Inc USA

Zelter Germany

asteners

Bleisthal Produktions GmBH Germany

Cramlington Forge UK

CDP GmBH Germany

Shakespeare Forgings UK

RBI Autoparts SND BHD Malaysia

Fuji Autotech France

Source: Auto Component Manufacturers Association

Future Outlook

Current trends indicate a smooth run for the auto component industry. In fact, since 2000, this is one sector which has made aglobal mark and has been identi fied as a sunrise industry. The industry is transforming from being highly domestic-centric, to aforce ready to face global competition.

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The factors that will drive growth for the auto component industry are:

y The growth expected in the domestic automobile industry will give a fillip to the auto component sector. The Indianautomobile industry offers great potential considering the low penetration along with rising income levels and a rapidlygrowing middle class. These factors wi ll see a boost in demand for vehicles, especially passenger cars and two wheelers.These two segments are estimated to grow at between 10-12% for at least the next five years.

y The entry of global OEMs, making India as their manufacturing base, has given a big boost to the industry. For instance,Skoda plans to source parts for its European operations from its Indian base and raise indigenisation level for Indianmodels to 70%. This trend has also enabled Indian companies to gain a competitive edge in the global market. Further,the model of cluster-based development prominent in this sector will provide economies of scale.

y Export of automobiles has also emerged as a key component of growth. Rising exports of Indian-made vehicles likeM&Ms Scorpio model, Bajaj Autos Bikes, Tata Motors City Rover are indirectly increasing the demand for Indian autocomponents. Also, the export of India-made models of global OEMs like Hyundais Santro Xing and Suzukis Alto hasgiven a boost to the industry.

y De-regulation and the Governments poli cy initiatives have facilitated growth and focus has now shifted towardsattracting foreign direct investments. Also, the Governments initiative towards road development will give a boost todemand for vehicles and indirectly auto components.

y The Governments initiatives towards opening up channels of finance.y Investments coming in for research and development wi ll keep the industry abreast of the latest technology.

Entry of global OEMs has transformed the Indian automobile and auto components landscape. India is being perceived as a majormarket for cars and two wheelers by global OEMs. Before the end of 2006, at least 30 new car models are expected to be launchedby foreign OEMs.

These factors portend a robust auto ancillary industry in India and the overall expected good growth will provide severalopportunities for the emergence of new enterprises. Extending their reach to global markets is the pre-dominant outlook amongthe top auto component manufacturers in the country. The vision to compete globally comes from the inherent strengths theIndian auto component industry possesses. Some features are:

y Cost reduction of 25-30% in production in the domestic market compared to overseasy Low labour costsy Designing, engineering and technical skillsy Established quality systemsy Availability of raw materialsy Adaptability to new technologyy Investments in research and development, coming in from global OEMs. This stands out positively in favour of India. Key

players are not only willing to invest in R&D but also in mechanical and engineering operations. These investments areexpected to increase in the near future

Though India rides on these inherent strengths, a few risks exist that the auto component manufacturers may have to confront.

y A global slowdown can derail the prospects of the industry.y Volatility in the prices of metals and other inputs could erode the industrys cost competitiveness. Further, global OEMs

expect a commitment of 5-10% reduction in prices every year.

y Tier I manufacturers taking up greenfield projects overseas.y Intense competition from counterparts in other emerging economies may add pressure on margins of manufacturers.

The Indian auto component industry is poised for robust growth ti ll 2010. There is a perceptive exuberance in the industry andgrowth estimates indicate a booming industry. Going by current trends in production and exports of auto components, indicate adoubling of the domestic auto component industry by 2010. The production of auto components could grow to US$22 bn by 2010.Similarly, Indias exports of auto components could grow to US$4.5 bn as compared to US$1.8 bn in 2005. Expected growth inproduction and exports of auto components is shown in the graphs below.

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This growth outlook implies opportunities for the small and medium enterprises. The overall trend is encouraging, but remaining

competitive in this changing scenario will be the toughest challenge. The combination of low manufacturing costs along withquality systems would give an edge to companies in terms of pricing and quality. Expansion and diversification wil l help break intonew markets. It would be imperative for these companies, which are largely based on traditional management practices, to imbibetechnology in a big way. The SMEs can exploit these opportunities through joint ventures, collaboration and technical tie ups.Knowledge, specialisation, innovation and networking will determine the success of the SMEs in this globally competitiveenvironment.

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