Microeconomics

Analysis - Automobile Sector

Submitted By:

Sneha Anil

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Contents
Introduction ............................................................................................................................................ 3
Microeconomic analysis.......................................................................................................................... 3
Demand side analysis .......................................................................................................................... 3
Supply side Analysis ............................................................................................................................ 4
Economies of scale .............................................................................................................................. 4
Types of Elasticity................................................................................................................................ 5
Market Structure................................................................................................................................. 5
Evolution of the automobile industry ..................................................................................................... 6
From an Importer to an Exporter........................................................................................................ 6
From a luxury vehicle to the common man’s car: The India story...................................................... 6
Manufacturing base for the globe ...................................................................................................... 7
Evolving environmental regulations ................................................................................................... 7
The latest spark: Electric Vehicles ....................................................................................................... 7
Analysis of structure, market share, degree of competition .................................................................. 7
Passenger Vehicles (PV): ..................................................................................................................... 8
Commercial Vehicles (CV): .................................................................................................................. 8
Two and Three Wheelers: ................................................................................................................... 9
Performance Comparison of Tata motors and Mahindra & Mahindra .................................................. 9
Conclusion ............................................................................................................................................. 11
References ........................................................................................................................................ 12

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Introduction
Automobile industry is one of India’s key manufacturing sectors and has been recognised as
a sector of strategic importance. The contribution of this sector is 7.1% to India’s GDP and
40% share in manufacturing sector.
Globally, Indian auto industry is the 4th largest in the world with an almost 7% share in
global automobile production, and the 7th largest manufacturer of commercial vehicles in
2018.
This industry is directly and indirectly linked to the fortunes of other manufacturing input
industries such as iron and steel, aluminium, chemical, rubber, plastic, glass, machine tools,
capital goods, moulds and dies, and energy and service sector input industries like logistics,
banking and insurance, services and repair, oil and gas retail, retail distribution are also
impacted heavily by the performance of automobile industry.
Low cost of steel manufacturing base and abundance of skilled and semi-skilled labour puts
India in a sweet spot for domestic as well as global companies to set up their manufacturing
facilities in the country. Also factors like rising income, increasing middle class, good
monsoons stable inflation etc. has encouraged both urban and rural households to spend on
high value products like cars, bikes etc.
However, despite being a significant industry with favourable conditions in the recent
economic environment, the industry is suffering greatly in growth both in passenger and
commercial vehicles. Declining sales volumes and unsold inventory are leading to frequent
and long plant shutdowns in almost all players, along with dealer insolvency. Recently, there
were unfavourable regulations like the BS-VI requirement; the axle weight norms and the
budget push for electric vehicles have battered the long favoured industry.
In this report we intend to conduct an analysis of this industry including its history and the
economic factors that led to the recent obstacles.

Microeconomic analysis

Demand side analysis

An increase in demand results in a rightward shift in the entire demand curve. A decrease in
demand results in a leftward shift in the curve. In the automobile industry demand is
originating from new segments of the market. Increasing number of young professionals like
doctors, software professionals etc. have higher disposable income hence they do not mind
splurging on cars. Also the flourishing businesses and logistical networks also lead to higher
demand for automobiles.

There is an increased demand for CNG and LPG vehicles owing to the increasing price of
diesel and petrol. The demand also increases because of the growing environmental
concerns and Indian governments’ proactive measures to implement Euro-II emission
norms.

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In the auto industry substitutes-the goods that can serve as replacements for one another
goes up, the demand for the other goes up. Eg If price of a Honda car in sedan segment goes
up the demand for Hyundai car in the same segment also has a chance of going up. Also if
the price of public transport goes down less number of people are likely to buy cars.

Also fuel and vehicle are complementary in nature in this segment. Eg: If the price of petrol
increases, the demand for car and complementary goods associated with it will fall. If the
price of cars were to rise dramatically, less people would chose to buy and use cars.

Factors like purchasing power also influences the demand even though there is an increase
in income level, the inflation level prevailing in the country could decrease the value of
money and this in turn will decrease the demand for cars.

Also lack of infrastructure facilities also affects the buying decision of the consumers.
Consumers postpone their car buying decision due to poor infrastructure, roads and bad
traffic.

Supply side Analysis

According to the supply curve when the price increases the quantity supplied by the
suppliers also increase and vice versa. This is a movement along the curve. At the same time
change in the price of production techniques, Technology, Raw materials, capital etc. will
shift the supply curve. Eg: If steel becomes scarce fewer cars can be made so the supply will
fall.

Competitive supply: If a producer switches from producing A to B the price of A will fall. It
becomes less profitable to make A hence its supply will fall.

Joint Supply: A rise in price of one product will lead to rise in another. Example rise in price
of car will lead to rise in price of car accessories. This means supply of car accessories will
increase as it becomes more profitable.

Economies of scale
Economies of scale are the cost advantages the business can take advantage of by up scaling
their production in the long run. The effect is reduction in the long run unit cost of
production over an array of output. These lower costs due to improvement in production
efficiency can benefit the customers in the form of lower market prices. This can in turn give
a competitive advantage for the business in turn leading to profits.

Internal Economies of scale: This arises from the internal growth of the firm. Large firms can
invest in state of the art machinery and specialise workforce. Also in large firms production
can be split into separate tasks to increase productivity.

External economies of Scale: This occurs outside a firm but within an industry. Eg: An
industry’s scope of operation is improved by better transportation networks this results in

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decrease in operation cost of the firm within the industry, hence economies of scale is said
to be achieved.

Diseconomies of scale: There might be an initial rise in the long run average cost caused by
diseconomies of scale. This might be due to increased control due to monitoring
productivity and the quality of output imperfectly. If workers of large organizations do not
feel as an integral part of business there might be a sense of alienation, this might lead to
loss in productivity leading to wastage of factor inputs and higher costs.

Types of Elasticity
Price Elasticity: the Indian market has a mixed bag of consumers and buyers. Buying an
automobile involves a major portion of income being spent. Hence price elasticity matters a
lot. Even a little increase in price would affect the demand for cars. In passenger vehicle
segment car is considered a luxury item hence it has an elasticity greater than 1- It is highly
elastic. Also automobile have a large number of substitute available. Consumers have a
choice of buying the substitute if price increases.

Income Elasticity: The price of an automobile is on the higher side, so it is not necessary for
everyone to be able to bear this expense. Income elasticity plays an important role as the
income is directly related to the demand of a good. When the income of the consumer
increases the demand of car also increases. Many more consumers are willing to pay the
cost of car, but as the income decreases it simultaneously affects the demand of car.

Cross elasticity: In the Indian automobile industry cross elasticity plays a major role, i.e. If
there is an increase in price of petrol will effect in decreasing demand for automobiles.
Therefore cross elasticity is a component of auto industry.

Market Structure
Auto industry follows Imperfect or Differentiated Oligopoly. If the firms produce
differentiated products, then it is called differentiated or imperfect oligopoly. In the auto
industry goods produced by different firms have their own distinguishing characteristics, yet
all of them are close substitutes of each other.

Features of oligopoly

 In auto industry in India there are few large firms. Each firm has a significant
contribution to the total output. There exists severe competition among different
firms with each firm trying to manipulate the price and volume of production to
outsmart each other.
 Firms under oligopoly are interdependent, i.e. actions of one firm affect the actions
of the other. This action and reaction level is considered determines the firm’s price
and output. E.g. A change in output or price by one firm evokes reaction from other
firms operating in the market.
 In an oligopoly firms are in a position to influence prices. But the try to avoid price
competition for the fear of price war. They follow price rigidity where the price tends

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 to remain fixed irrespective of changes in demand and supply conditions. Firms use
methods like promotions, better service etc to compete with each other.
 The main reason that few firms are under oligopoly is the barrier of entry into the
industry. Automobile is a capital intensive sector, this prevents new firms entering
the market.
 In oligopolistic competition selling price is of prime importance.
 In automobile industry group behaviour exist. All firms tend to behave as if they
were a single firm though individually independent. So price and output decisions of
competition directly affect the firms.

Evolution of the automobile industry

From an Importer to an Exporter

India began as an importer of automobiles. It was before India’s independence in 1942 that
Hindustan Motors manufactured its first automobile in India. After independence Indian
government tried to boost this sector by encouraging manufacturing.
In 1952, when the government appointed its first tariff commission with the aim of indigeniz
ing this industry, the automotive sector formally emerged. The subsequent periods saw the
emergence of many Indian companies like Mahindra and Mahindra, Bajaj Auto, Ashok
Leyland, Escorts and many indigenous offerings in two-wheelers, off-road vehicles, cargo
and passenger commercial vehicles.
The biggest transformation to the industry came in the wake of the economic liberalization
in 1991. India was now open to entry from global players, albeit with the restriction of
forming partnerships with Indian firms. Another crucial change was the announcement of
India's new automobile policy in June 1993 containing measures such as automatic approval
for foreign holding of 51% in Indian companies, de-licensing, abolition of phased
manufacturing programme, reduction of excise duty to 40% and import duties of knocked
down to 50%. One of the key JVs that the industry saw was Maruti and Suzuki which swept
the market around 60% of the market shares. Because of the uniqueness of the market, JVs
took a shape of their own and built strong brands and introduced innovative products in the
market e.g. Escorts Yamaha.
As the supply started exceeding the domestic demand Indian companies ventured into
exports to lucrative markets across the globe. In early 2000’s Suzuki began exporting to
main European markets. This was followed by exports to Asian and African markets by
Maruti Suzuki and other domestic players.

From a luxury vehicle to the common man’s car: The India story
Cars were regarded as ultra-luxury products, its manufacturing was strictly licensed, the
tariff structure was restrictive and manufacturing was limited. From 1960 to 1980s,
Hindustan Motors dominated the Indian market, which owing to its Ambassador model
collected a big quantity of market shares. The economic reforms post liberalization enabled
global automotive manufactures to enter the Indian market through joint ventures. These
joint ventures were the cause of innovative product design leading to extensive market
penetration. Maruti-Suzuki’s Maruti 800 gave access for cars to the middle class along with
comfort of driving and fuel efficiency. Hyundai also transformed the space with its small car
offerings and garnered a huge chunk of the market share. The “small car” model was

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adopted by many other players like GM and Daewoo with less success, but still remains a
coveted space for auto makers. Customer interest in city car, MUV and SUV segments have
also peaked in the recent past.

Manufacturing base for the globe

In 2002 the government altered auto policy allowing 100 per cent Foreign Direct Investment
in Indian automobile industry. The Indian auto industry became a level playing field and
almost all global players established their facilities in India. Even with these reforms Indian
automobile sales were low compared to other developing countries. This lead to the
Automotive Mission Plan 2006-2016 was released in 2007, which visualizes India as an
emerging destination in the world for design and manufacture of automobiles and auto
components with output reaching a level of $ 145 billion accounting for more than 10 per
cent of the GDP and providing additional employment to 25 million people by 2016. Today
India has become a manufacturing base for many multinational automobile manufactures.

Evolving environmental regulations

Environmental regulations from the government have evolved too. The last decade saw a
new regulatory restriction in the form of emission norms known as ‘Bharat Stage’, based on
European emission standards, come into force. New norms tend to make inventory obsolete
and affect production adversely. Another government announcement was the scrapping of
vehicles older than 15 years. Emission regulation is stricter in states such as Delhi where the
pollution is a major concern, leading to restrictive regulation by the state governments.

The latest spark: Electric Vehicles

Electric vehicles have been in production in India for nearly two decades with limited
success due to weak demand. Hybrids such as Toyota Prius have not been adopted by the
consumer. The current government has made multiple regulatory and budgetary policy
pushes to advance the case of EV adoption, including scrapping of vehicles older than 15
years and budget considerations for EV start-ups.

Analysis of structure, market share, degree of competition

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Passenger Vehicles (PV):
India is self-sufficient in passenger vehicles. In 2017, passenger vehicle sales in India crossed
the 3 million milestone for the first time. Also, domestic production exceeded domestic
sales by around a fifth in 2017. The surplus production of 720,000 units was exported to
Mexico, South Africa, UK and Italy.

Passenger car sales accounted for 70% of total passenger vehicle sales whereas; utility
vehicle sales claimed a quarter of total PV sales in 2017. Maruti Suzuki, Hyundai and Honda-
the three major players accounted for around 70% of overall Passenger Vehicle production
in FY2017.

Passenger-vehicle production in India grew at a CAGR of 5% between 2010 and 2017 and
reached almost 4 million units by 2017. Production growth slowed down in 2013 and 2014
but rose close to 8% per year on average in 2015-17 because of capacity expansion of
automobile manufacturers in India.

Output of passenger-car grew by a CAGR of 2.5% in 2010-17 to 2.7mn units. On the other
hand, utility vehicle production grew by a 19% CAGR that exceeded 1mn units for the first
time in 2017.

But 2019 saw drop in sales at the country’s largest car maker i.e. Maruti Suzuki India Ltd.
The sales fell nearly 37% YoY. Hyundai Motor India Ltd - which is ranked second, recorded a
10% drop. Sales at Mahindra and Mahindra Ltd, local units of Toyota Motor Corp. and
Honda Motor Co. fell 16%, 24% and 49% respectively. Sales of these five companies, which
together make up about 85% of India’s passenger vehicle market, have fallen nearly 31%
YoY.

Commercial Vehicles (CV):

The commercial vehicle market was hit hard in 2013-14 when the Indian economy slowed
down. The CV market is still recovering from it. CV production in 2017 dropped to 830,000
units from 887,000 units in 2011. Production growth slowed down as export fell while
domestic market stayed strong. Bangladesh and Sri Lanka are the main importer of India’s
commercial vehicle. The main export markets for buses is Sri Lanka and Senegal and for
tractors are the US and Turkey. India is self-sufficient in commercial vehicles, with domestic
production 5% higher than domestic sales in 2017.

By segment production analysis tells us that production of light CVs rose by 8.1% to 504,000
units, while medium and heavy commercial vehicles (MHCV) output fell by 5.6% to 326,400
units.

The decision by Indian Supreme court to ban the sale and registration of Bharat Stage III (BS
III) vehicles from April 2017 hit the MHCV segment hard. Demonetisation reform that
caused infrastructure, mining and manufacturing output to fall also affected the MHCV
segment. All this reduced the investor’s confidence leading to low spending on capital
goods.

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Almost 65% of CV sales in FY2017 were held by Tata Motors and Ashok Leyland. In the same
year the largest four players controlled 77% of CV sales. Domestic sales were down by
12.27% YoY in the CV segment.

Since the customers are postponing purchases because of poor freight availability, the
market is exhibiting subdued demand.There has been a severe shrinkage in total industry
volumes across segments because of drop in unrestricted consumption, the slowing
economy, poor liquidity conditions in tight financing environment, excess capacity created
on account of increased axle load norm and slow-down in execution of infrastructure
projects over past few quarters.

Two and Three Wheelers:

In terms of market penetration, the two- and three-wheeler segment of India’s automotive
industry is the largest that accounts for around 83% of domestic vehicle production and
sales. This is because for the average Indian consumer with lowest disposable incomes in
the world, two- and three-wheelers are cheap and affordable compared to four-wheelers.
In 2016, India became the largest market of two-wheelers in the world and sold 17.7mn
units. With reported sales of 16.8mn units, China ranked second. India exported a total of
3million two- and three-wheelers mainly to Colombia, Sri Lanka, and Nigeria.
Since three-wheelers are used mainly for commercial purposes, the economic growth
affected its production. But output of two-wheeler grew progressively between 2010 and
2017 with a CAGR of 8%.
Over the same period, three-wheeler production averaged a modest 2% CAGR.
The weaker demands both from the domestic and foreign markets led to reduction in
production by 12% in 2016. The reason for this was replacement of three-wheelers by
aggressively priced, small, four-wheeled mini-trucks.
In 2017, there was a partial recovery when production grew by 5% to 832,800 units. In the
same year, 80% of total automobile production in India accounted for two-wheelers.
Motorcycles accounted for 65% of total. Scooters production has expanded more than
three-fold from 31% and reached 7mn in 2017. Motorcycle output has increased up by an
average 5% CAGR over the same period to 14.3mn units.
The slow market environment dominant in the first quarter has continued in the beginning
of the second quarter and its impact can be seen in dispatch volumes. The outlook for the
rest of the year will depend on factors like the progress of monsoon and festive season off
take as well as improvement in the liquidity situation.

Performance Comparison of Tata motors and Mahindra & Mahindra

Tata motors:

Tata motors a $42 billion organization is India’s largest automobile company. Its product
portfolio comprises of a wide range of cars, sports utility vehicles, trucks, buses and defence
vehicles. Tata Motors' sales were up 15.7% y-o-y in FY2018/19.The medium and heavy
commercial vehicle sales went up by 16.5%.

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Mahindra & Mahindra

Mahindra & Mahindra Limited is an Indian multinational car manufacturing corporation. It was the
company to introduce India’s its first utility vehicle. Its product portfolio includes passenger
vehicles, electric vehicles, pickups, and commercial vehicles. They specialise in delivering on
durability, reliability, environment-friendliness, and fuel-efficiency.

Comparison:
Parameters TATA MOTORS MAHINDRA&MAHINDRA
1. Sales 32,928 units 10,276 units
2. Operating profit 7.13% 12.38%
margin
3. Current Ratio 0.54 1.08
4. Gross Profit 2.66% 8.91%
Margin
5. D/E ratio 0.79 0.07

1. Sales for TATA motors may be high than that of MAHINDRA & MAHINDRA but
considering the recent news published by ECONOMIC TIMES, it shows a dip of 34%,
whereas MAHINDRA shows an uplift of over 2.5 times. Explanation for the remaining
factors affecting the two company’s production, sales and management of funding and
competition in the market are discussed below.
2. Higher operating profit margin indicates that more proportion of revenue is converted
into operating income, which implies that the company is able to manage its operating
expenses efficiently and is choosing the right set of inputs taking into account the costs
of each of them. Clearly, M&M is performing better in this sense and is able to manage
its isocost line and isoquant line appropriately.
3. Current ratio: It measures the efficiency of a company to convert its products into cash.
Handling competition and various economic jargons come into play here. TATA motors
might have trouble getting paid on their receivables or have long inventory standing idle
with it which imposes liquidity crunch and hence restricts their investment affecting the
PRODUCTION and hence SALES.
4. Gross Profit Margin: Due to extremely low gross profit margin, TATA motors might have
issues paying its operating expenses and build itself for the future. Whereas, at the end
of each day, M&M hold 8.91 rupees on the sales it makes, which makes it possible to
plan accordingly in the long-run. On the other hand, TATA really doesn’t have money
rather it infused money from outside or adjusted from taxes.
5. D/E Ratio: This being higher implies that TATA is aggressive in financing its growth by
debts, which in today’s Indian economy will not work in favour because of unfavourable
govt. policies and regulations and the increase in NPAs in the economy/market.

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Conclusion
Despite long term advantages that the auto industry has, there have been many recent
short bursts of troubling changes for the automotive industry which have left it in a difficult
situation currently. Passenger vehicles are seeing a 31% drop in growth, the likes of which
was last experienced two decades ago. Commercial vehicles (21%) and two wheelers (12%)
are also suffering similarly drastic dips in growth.
Such changes could be dismissed as creating a temporary impact that auto companies can
recover from over time. But all these changes occurring at the same time has led to an
interaction effect leading to low consumer demand. This effectively means unsold
inventory, dealer insolvency and frequent plant shutdowns for nearly all players - domestic
and global.
Some such changes had little or no impact, being in the past, like demonetization; however
others like the BSIII ban, upcoming BSVI norms, relaxed axle loading norms for commercial
vehicles, pricing issues associated with GST implementation have compounded on the back
of increasing cost of inputs for the supply side. After the last price hike in Q4FY2018, auto
makers were gearing up for a second price hike.

This plan for a hike was however floundered by the demand side constraints. Overall
consumer demand has dropped, due to increasing cost of ownership and maintenance,
increasing price of oil, and weakening of currency and due to overall shrinkage of spending
of the domestic consumer. After growing for four straight years in average and below
average monsoons, demand for automobiles has lost its lustre. For commercial vehicles,
financing has grown to be a customer concern with troubles faced by banks and NBFCs in
the past few years. The only hope for domestic sales is in rural India, which is strongly
dependent through agricultural output on the monsoons.
Another cause for concern is that the frantic actions of the industry players are acting
counterproductively to demand. Many of the players are asking for reducing GST from 28%
to 18% and stimulus packages. The consumer is waiting for government to provide these as
he will be the beneficiary of any such schemes. Meanwhile, the sales of automobiles
continue to suffer. The auto makers have offered steep discounts and additional features to
offset these, with almost no success so far.

Automotive players are banking on exports more than ever. But their expectations may not
be matched sufficiently since the exports for any standard auto firm is around 5-10% only. It
is yet to be seen if the auto firms can piggyback on exports till the problem has resolved, or
more ambitiously, if the industry will witness bold moves that benefit both supply and
demand.
In the long term, the factors remain unchanged. The auto industry remains fundamentally
strong backed by low penetration of passenger vehicles, favourable demographic, increasing
working age population, rising income levels, increasing affordability & aspiration level of
Indian consumers. There are high hopes of the industry bouncing back, humbled after a
difficult struggle. This could also pave the way for EV production and adoption, as hoped by
the government, opening up new supply and demand channels for the industry.

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References

https://www.ibef.org/industry/india-automobiles.aspx

Artice: EMIS Insights – Indian Automobile sector report 2017-2021

Article INDSEC Monthly auto report - July 2019

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