Tamil Nadu Automotive Cluster - Michael Porter

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Microeconomics of CompetitivenessTamil Nadu Automotive ClusterHarvard Business School – Spring 2012Sandeep Bapat Abhinav Chaturvedi William Drewery Fei Fei Eric Hepfer

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of CompetitivenessTable of ContentsSectionPage1.0 Executive Summary . 22.0 India and its Competitive Position . Overview . 3Macroeconomic competitiveness and Economic Growth . 3Economic Composition . 6Microeconomic competitiveness and National Diamond . 73.0 Tamil Nadu Competitive Position . Overview . 10Economic Overview . 10Diamond Analysis . 114.0 The Automotive Industry . Automotive Industry . 14Indian Automotive Industry . 14History. 16Value Chain. 17Trends . 185.0 Tamil Nadu Automotive Cluster . History and Evolution . 20Cluster Map . 20Specific Activities in Tamil Nadu Cluster . 21Quantitative Analysis of Relative Cluster Performance . 21Cluster Diamond . 22Recommendations for Tamil Nadu Automotive Cluster . 286.0 Bibliography. 32i

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitiveness1.0 Executive SummaryIndia is one of the world’s most populous nations, and in recent years has attractedwidespread attention for its rapidly growing economy. In addition to national clusters such as ITand Business Services, India boasts an evolving auto cluster. India produces more than 10million vehicles annually, raking it in the top seven automobile producing nations. Nearly everymajor OEM has set up operations in India, and thousands of local firms have sprouted up toserve the industry.Tamil Nadu is one of India’s leading manufacturing states, and is home to one of the topauto clusters in the nation. Tamil Nadu is home to six foreign OEM’s, two domestic OEM’s, andover 100 local suppliers. The cluster benefits from favorable diamond conditions and has seenrapid expansion in the years since economic liberalization. Although Tamil Nadu is currently aleader in the Indian auto industry it risks loosing its competitive advantage due to a significantpower shortage and congested ports. While these actions are required to sustain Tamil Nadu’scompetitiveness, they are not sufficient to upgrade the cluster and achieve the state’s goal ofbecoming the “Detroit of India.” In order to achieve this goal, both India and the Tamil Nadugovernment must create policies to encourage R&D and attract more talent to the region.Finally, India must continue to liberalize its financial sector and reduce automotive importtariffs. Our key recommendations are summarized below:India Continue to build Automotive Centers of Excellence across India.Continue to liberalize financial sector.Reduce Automotive Import Tariffs.TamilNadu Invest in infrastructure to solve power deficit and port congestions problems.Encourage formation of local IFC’s.2

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitiveness2.0 India and its Competitive Position2.1Country OverviewIndia is the largest democracy in the world with a population of 1.2 billion. Moreover,with GDP in PPP terms at 4.5 trillion, India has the third largest economy in the World.1However, the per capita income (in PPP terms) is low at 3300. (EIU) Delhi (population: 11mm) is the political capital of the country and Mumbai (population: 12 mm) is the financial andindustrial capital.Location & Endowments: India is located in South Asia, one of the least developedregions of the world. India has hostile relations with its largest neighbor, Pakistan. Due to tenserelations between countries in the region, intra-region trade is fairly low. India has the fourthlargest coal reserves in the world and is the fourth largest producer of iron ore. The country hasrich reserves of bauxite, copper, alumina and limestone, and has the second largest arablelandmass in the world. However, India has only moderate proven reserves of oil and gas and thecountry has to fulfill 80% of its oil and gas demand through imports.2.2Macroeconomic competitiveness and Economic GrowthFor the first 45 years since independence (1947 to 1992), India adopted a Soviet stylecommand and control economy with a focus on import substitution. Severe restrictions on FDI,over regulation and a license-quota regime handicapped India’s competitiveness during thisperiod. GDP per capita grew at a sluggish pace of 1.5% between 1947 and 1992. After the oil-1IMF, www.imf.org, May 2012.3

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitivenessshock of the late 1980s, India’s current account deficit ballooned and this led to a severe Balanceof Payment crisis in 1991.In 1992 the Finance Minister began the process of liberalizing India’s economy byreducing taxes and tariffs, eliminating the license-quota regime, and encouraging FDI. After thereforms, there has been a significant increase in growth with GDP per capita growing at a 4.8%CAGR between 1992 and 2004. A second set of reforms was implemented in the 2001/2002period. Between 2003 and 2007, GDP per capita grew at an 8.2% CAGR driven by a robustglobal economy, rise in FDI and a substantial increase in savings and investment. Indiaweathered the global financial crisis well with GDP per capita growing at 6.4% between 2007and 2011. However, a lot of this growth was driven by increases in government spending and thefiscal deficit increased from 3% in 2008 to 6% in 2011. There has been a lack of reforms in thelast seven years (2004-2011) and there is growing recognition that a new set of reforms needs tobe implemented to keep GDP growing at an 8% plus rate. (EIU)Figure 1: Total Factor Productivity GrowthFigure 2: Rising Savings and InvestmentsRising Savings and InvestmentsRising Total Factor Productivity Growth5.0%Annual Productivity 0%10%0.0%1990-95Source: (EIU)1995-002000-052005-101980199020002010Source: EIU4

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of CompetitivenessFigure 3: Persistently High InflationFigure 4: High Current Account and Fiscal DeficitHigh current account and fiscal deficitPersistently high inflation10%12.0%CA DeficitFiscal Deficit8%8.0%6%4%4.0%2%0.0%1985-90 1990-95 1995-00 2000-05 2005-100%1980Source: EIU199020002010Source: EIUPolitical Institutions: When India gained independence from Britain in 1947, it inheritedBritish common law and a relatively well-developed administrative system. After independence,India adopted a parliamentary form of government.India was divided into different states on linguistic lines just after Independence. Today,the country is divided into 28 states and 7 union territories with each state and union territoryhaving its own local government. Areas like education, health, law and order, and certain typesof taxes fall under the purview of the state governments. There is a large income disparitybetween states in India.The Congress Party ran the government for 42 years (1947-1989). The late 1980s saw therise of the BJP and many regional/state parties. Since 1989, the central government has beenruled by a coalition led by Congress or BJP. Over the last 20 years, regional parties have gainedsignificant strength as these parties run governments in many states in the country and bothCongress and BJP need their support to form the coalition government at the center. A keypositive for economic development is that the two main political parties, BJP and Congress,broadly agree on the need for economic reforms.5

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of CompetitivenessSocial Development: According to the United Nation’s Human Development Report(2011), India has contributed to the large reduction in global poverty. In India, poverty rates areprojected to fall from 51% to about 22% in 2015. However, India still ranks 119th out of 169countries (30 spots below China) on the United Nations’ Human Development Index (HDI), acomparative measure of life expectancy, literacy, education, and standard of living.2.3Economic CompositionIndia’s rapid growth in the last couple of decades has been primarily driven by servicessectors like technology and business process outsourcing. The services sector contributes 57% tothe GDP with industry and agriculture contributing 27% and 16% only, respectively. Themanufacturing sector has been hindered by poor infrastructure, a cumbersome regulatory and taxenvironment, and stringent labor laws. Due to slow growth in labor-intensive manufacturing,52% of the population is still dependent on agriculture with only 34% and 14% of the work forceemployed by services and industry. (EIU)Exports have grown at a CAGR of 16% between 1992 and 2011 and the share of exportshas gone up from 9% in 1992 to 26% of GDP in 2011. Indian exports are dominated byCommunication Services ( 58bn) and Business Services ( 29bn). Unlike China, India has notbeen able to gain significant market share in labor-intensive manufacturing sectors. Automotiveexports constitute 9bn in 2010 with 0.7% of world market share (0.64% share increase in thelast decade). (EIU)6

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of CompetitivenessFigure 5: Export PortfolioIndia Export Portfolio2010 World Export Market Share (%)25.00%20.00%Communication Services(18.5%, 58bn)15.00%10.00%5.00%Jewelry (8%, 33bn)Textile (6%, 16bn)Business Services (3.3%,Leather goods ApparelFin ServMining 29bn)FishingOil and Gas (1.8%, 39bn)Agri HospitalityAuto (0.7%, 9bn) 12.00%14.00%Increase/(decrease) in market share (%) (2000-2010)-5.00%AutomotiveIndustrySource: Cluster Mapping Project 20122.4Microeconomic competitiveness and National DiamondFactor Conditions: India has availability of ores and minerals, and has built productioncapacities for iron and steel (raw material for the auto sector). Due to an above average highereducation system the country has a good base of engineering talent. The country has inexpensivemanufacturing labor, but the quality of labor is not adequate due to the poor condition of primaryeducation and healthcare. The government has not been able to keep pace with the huge increasein the demand for power, roads, railways, and ports. Lack of adequate infrastructure is a seriousbottleneck for the manufacturing and automotive sectors which rely heavily on electricity andother material inputs for production.Demand conditions: A growing middle class and a young aspirational population haveresulted in strong demand conditions for the automotive sector. Demand for automobiles is7

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitivenessgrowing at 10%. (Tamil Nadu 2009) However, due to the low per capita income of thepopulation, most consumers are obsessed with cost and focus less on quality. Also, highdomestic petroleum prices due to high taxes have a negative impact on automobile demand.Figure 6: Emerging Middle ClassFigure 7: Young Population in Aging WorldYoung Population in an aging worldEmerging middle class100%Middle andupper class80%Working population, forecast increase (decrease), 2010-20 in mm2010 levelIndia781mmEurope501mmChina973mmUS501mm 120k60% 60-120k40% 25-60k 10-25k20% 10k0%199520102015E2025EBreakup of population by annual family income (PPP)Source: McKinsey, Bird of Gold, 2007-50050100150Source: IMF, Morgan StanleyContext for Firm Strategy and Rivalry: Even after the 1992/93 reforms, it is still veryhard to do business in India. According to the World Bank, India currently ranks 132nd out of183 countries in terms of ease of doing business. In numerous important categories, India lagsbehind its current GDP per capita ranking of 70. The legal system is widely considered to be tooslow and labor laws are too rigid. These issues also adversely affect the auto industry in India. Anext set of reforms is urgently needed to address these issues. Government has opened up manysectors (including the auto sector) to FDI but due to the issues discussed above FDI remains low.Import tariffs on cars and auto-parts have been reduced but they still remain quite high (moredetails in cluster and recommendations section).8

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of CompetitivenessFigure 8: Hard to do Business / High CorruptionFigure 9: Low FDILow FDI InvestmentHard to do business / High corruption(rank among 175 countries)3.0%India’s GDPper capitarankAnnual FDI investment (% of w/licensesEase ofDoingBusiness1751501251007550250Source: 00-052005-10Much higher FDI (% of GDP) in China, Vietnam, ThailandSource: EIURelated and Supporting Industries: India has a healthy steel sector, thriving automotivecomponents and engineering services sectors, and an IT services sector (IT-enabled systems forOEMs). India also has been able to develop a relatively healthy financial sector, but there is aneed to liberalize this sector further so that the cost and access to financing for the SME (Smalland Medium Enterprise) sector can be improved.9

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitiveness3.0 Tamil Nadu Competitive Position3.1State OverviewTamil Nadu is the most southern state in India and its capital city is Chennai. The statepopulation is 72 million, representing 5.96% of total population in India. The Gross StateDomestic Product (GSDP) in 2011 was 97.7 billion, which ranks 3rd among all Indian states.The state has one of the highest levels of urbanization, with 49% of residents living in urbanareas and accounting for 9.6% of the total Indian urban population.2 Tamil Nadu has a highliteracy rate (80%) as well as an established healthcare system with 323 hospitals.33.2Economic OverviewGSDP per capita in Tamil Nadu has grown at a CAGR of 14.1%, consistently higher thanthe Indian average. (Tamil Nadu 2009) GSDP has grown at a 14.9% CAGR, with the percentageconcentrated in the service sector increasing from 57% in 2005 to 61% in 2010. FDI inflow in2011 was 7.3 billion, among the highest of all states, though most of the investments went intothe power sector.4 According to the Department ofEconomics and Statistics of Tamil Nadu, exportsFigure 10: GSDP vs. IndiaGDPfrom the states’ ports and airports reached 19.7billion in 2009.5 The cost of doing business isSource: Tamil Nadu 2009Tamil Nadu state presentation, November 2011: www.ibef.orgIbid.4Center for Monitoring Indian Economy: cmie.com5Tamil Nadu Department of Economics and Statistics, www.tn.gov.in/deptst/, accessed April 2012.2310

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitivenessrelatively low, and a 2009 Mercer study on the cost of living in 143 cities revealed that Chennairanked 135.6 The state has 21,256 factories, employing a total of 1,114,421 workers, which ranksfirst in the number of workers employed in factories. 7Aside from the automotive cluster, textiles and engineering are the two main clusters inTamil Nadu. The textile sector is next only to agriculture with regards to labor employed in thestate. Tamil Nadu’s yarn cluster accounts for 60% of India’s yarn exports. 8 The engineeringsector produced 4.7 billion in products in 2010 and employs over 250,000 people.3.3Diamond AnalysisFactor Conditions-Tamil Nadu has some of the best academic institutions in Indiaproducing English-speaking engineers, researchers and skilled workers for the state’s clusters.As of 2010, the state had 33,326 primary schools, 9,966 middle schools and almost 5,000 highschools for its 72 million people. The school dropout rate is only 1.23% at the primary level and1.9% at the upper-primary level. The state has ample hospitals and other health care facilities.The population’s average life expectancy is 65 for males, and 67.4 for females. 9With regards to physical infrastructure, roads and railroads have been developed rapidlyover the past decade; reaching 5,958km of railroads covering 536 stations, as well as almost 90%of roads being surfaced roads as opposed to previously non-surfaced roads. However, motorvehicle congestion remains a challenge, as the growth of vehicles per square km dramatically6Investintamilnadu.comPresentation of government of Tamil /sector presentation/presentation tamilnadu.php?mode 038Tamil Nadu state presentation, November 20119Tamil Nadu Socio Economic Indicators, State Planning Commission, Government of Tamil Nadu711

Tamil Nadu Automotive Cluster AnalysisMicroeconomics of Competitivenessexceeds the rate of growth for roads.10 In addition, the state has four domestic and twointernational airports, with Chennai international airport being the 3rd busiest in India. Whilei

Tamil Nadu Automotive Cluster Analysis Microeconomics of Competitiveness 3 2.0 India and its Competitive Position 2.1 Country Overview India is the largest democracy in the world with a population of 1.2 billion.