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September 19, 2020

From protection to localisation

Business

September 19, 2020

LAHORE: Of all the industries in Pakistan, the automobile sector has bounced back first because its vending base was protected by original equipment manufacturers that provided vendors with liquidity during the recession and COVID-19.

Most of the other industries that failed to protect their vendors are finding it hard to go into top gear despite demand, as their vending base has been destroyed.

Auto sector went into deep crisis soon after the induction of this government. The production in all subsectors of automobiles (tractors, cars, motorcycles) declined by 15-50 percent in 2018-19 and by another 50 percent in 2019-20.

In fact, there was almost no production in the month of May and June. The original equipment manufacturers saw their profits evaporate during this period.

Some posted losses. Still they had reserves accumulated during the five years of the previous regime. They retained their workforce.

Vendors however were not so lucky. Due to competition they were operating on low margins. There were multiple vendors for each auto part of OEMs.

This deprived them of the margins of scale even when car production was high. The volume of orders was very low during the recession and COVID-19.

Most vendors were forced to curtail their workforce. Still it was not possible for them to survive with low volumes. The financial crunch was becoming unbearable.

Some leading OEMs realised the plight of their vendors. The vendors were very important for them and they could not afford to let them close.

These vendors over the years had developed crucial parts for the OEMs. The quality of their parts was approved by their foreign principals.

The OEMs had invested heavily in the development of dies and molds by these vendors. These vendors were reliable for timely delivery. In view of these facts, the OEMs never wanted their vendors to go broke.

The OEMs adopted different strategies to facilitate them.

Indus Motor (Toyota) for instance provided them with equivalent cash of the average orders they placed with each vendor as an interest free loan.

It resolved the vendors’ liquidity problem, and the loan would be adjusted against future supplies under a plan. The supplies have already started at a fast pace.

Suzuki Motor Company adopted a different approach. It fully paid the cost of the tools developed by its vendors.

Normally when it wants a new part to be developed, it pays its vendors 30 percent or so amount in advance to the vendor. The rest of the amount is amortised over a period ranging from three to five years (an agreed amount is added in the billing of each part developed by the vendor).

This time around the entire remaining balance of tooling cost was paid in one go. This provided the vendors with needed liquidity. The third major OEM though has not provided any such incentive and its vendors are in pressure.

Pakistani auto vendors have attained the ability to develop auto-parts with the precision needed by the OEM. This has encouraged OEMs to go for localisation of parts.

It goes without saying that the localised parts are much cheaper than similar imported parts. These parts match the quality of imported parts and are used by the principals of these OEMs.

The industry now is dominated by three Japanese brands that have developed the vending base.

Some new entrants mainly from Korea and China have introduced their brands in the Pakistani market under the new entrant’s policy given in Auto Industry Development Policy (program) 2016-21.

These brands are currently importing completely build up units at very low duties. For assembling they can import all parts used in their vehicle at highly concessional rates. However, after five years, they would be required to match the localisation level with their peers in the Pakistani market.

Most of them have consumed almost three years of that concession and must start developing parts locally now to be able to comply with the law by 2022 or 2023. They have not yet done that.

Tooling cost of each part is very high. Most vendors would not risk developing parts for new entrants on the same terms that they work on with existed players.

Financing the entire tooling of part would be very expensive and it would impact the cost of new OEMs. If they do not develop parts, the import of parts that are already localised would be very high because of high import duties.

The new entrants would have to establish their own vendor base and provide the finances for developing parts till the time their creditability is accepted by the vendors. The honeymoon period of importing cars at reduced duties would soon be over.

Competition for the three established players would be tough if the two main new entrants succeed in localisation of parts.