1. Outline the important determinants of demand for automobiles.

How are
cross and income elasticity of demand relevant to Maruti’s managerial
decisions?

INTORDUCTION

The automotive industry is one of the most important economic sectors by revenue. India is
probably the most competitive country in the world for the automotive industry. n. The Government
of India encourages foreign investment in the automobile sector and allows 100 per cent FDI under
the automatic route. To boost manufacturing, the government had lowered excise duty on small
cars, motorcycles, scooters and commercial vehicles to eight per cent from 12 per cent, on sports
utility vehicles to 24 per cent from 30 per cent, on mid-segment cars to 20 per cent from 24 per cent
and on large-segment cars to 24 per cent from 27 per cent.

DETERMINANTS OF DEMAND FOR AUTOMOBILE INDUSTRY

 Interest rate – It is one of the factors that affect demand made by consumers. Although
drop in it helps very few people to shift from base to deluxe model, a large shift can be made
only if customers want to take long term loans rather than short term loans so as to avail
interest benefits. There is negative relationship between interest rate and demand of
commodity

 Price- It is one of the major factor that affects demand of cars in market. As the law of
demand states that with an increase in price demand of commodity decreases and vice
versa.

 Advertising & marketing- Due to advertising & marketing many companies have been
successful in increasing their sales. In general both have positive relation with sales.

 Income level of consumers- Income level of consumers is also very important factor.
Increase in per capita income increases the consumption tendency of the customer. Growth
in per capita income and rising aspirations and changing lifestyle is leading to increased
preference for cars.

 Global crude prices – Global crude prices decides Indian petrol and diesel prices. There is
negative relation between fuel price and demand of cars as reduction in prices of fuel will
increase affordability of cars and ease out its maintenance

 New launches- Car sales increase when a new model hits the market. Due to increased
competition in Indian car market, frequency of new model launches has increased

Cross elasticity - In car industry of India , cross elasticity plays a major role in it because in price
elasticity price of a good affects the demand of other related goods . Therefore, as car is a major
good and petrol is related god both are directly related, increase in price of petrol will affect
decrease in demand of car. Therefore, cross elasticity is relevant to Maruti’s managerial decision .
The automobile industry was at a crossroads where the costs of raw materials and
operations continued to increase substantially without a corresponding rise in the
prices of the products sold. For companies in this sector, it was very difficult to sustain
profit levels that met the expectations of stakeholders and the market. It seemed that
the solution lay in the implementation of more efficient production. As prices had
remained sticky for an extended period of time and costs kept rising, firms needed to
innovate to bring costs down. Manufacturers continued to add new features to their
products and in the process discovered cost-cutting measures.

The rise in the price of crude oil had not helped the cause of the automobile sector in
India. Fuel prices had increased, which significantly impacted the growth of the sector.
In 2014, while addressing the media, Maruti chairman R.C. Bhargava in fact put the
blame for declining sales squarely on increases in the prices of petrol and diesel. These
prices had increased by 20 per cent in the last two years, adversely impacting car
sales. The price of petrol was deregulated in India and was linked to crude oil prices.
The price of crude oil had increased from $25.64 per barrel in 2001 to around $110
per barrel in 2014 (see Exhibit7). Apart from the rise in crude prices, local taxes on
petroleum products were very high in India, which further raised the prices. The diesel
price was regulated and kept low through subsidies. This helped car manufacturers
like Maruti to charge a premium on diesel cars. However, the price of diesel was
slowly being deregulated in India. With a new union government that was firmly
focused on reforms, the diesel price would soon be deregulated. Once this occurred,
diesel variants of cars would lose their edge over petrol variants. The deregulated
diesel price would further adversely impact the demand for automobiles in India.

Income Elasiticity – As car is a luxury good, so it is not necessary for everybody to

have the expense of car . Income elasticity is very important factor as the income is
directly related to the demand of good. When the income of the consumer increase
the demand of car also increase more and more consumers get ready to pay the cost
of car, but as the income decreases it simultaneously affect the demand of car .
Therefore income elasticity is another component of car industry of India.

Country Motor Vehicle Automobile Per Capita

Production Density (Cars Income
(in 2014) per 1,000 in US$PPP in
People) 2013–14

India 4,145,194 12 $3,843

China 19,271,808 44 $9,055
Brazil 3,342,617 178 $11,747
Russia 2,231,737 233 $17,518
U.K. 1,576,945 457 $36,569
France 1,967,765 481 $35,295
U.S. 10,328,884 423 $51,714
Japan 9,942,711 453 $35,855
Germany 5,649,269 517 $38,666

Per capita income is also related to income elasticity of demand as per capita income
rises the purchasing power of people also may rise .

2. What are economies of scale? Where do the economies of

scale for Maruti come from?
Economies of Scale refer to the cost advantage experienced by a firm when it
increases its level of output. The advantage arises due to the inverse relationship
between per-unit fixed cost and the quantity produced. The greater the quantity of
output produced, the lower the per-unit fixed cost. Economies of scale also result in a
fall in average variable costs (average non-fixed costs) with an increase in output.

Economies of scale are the cost advantages that a business can exploit by expanding their scale of
production. The effect of economies of scale is to reduce the average (unit) costs of production.

There are different types of economies of scale and depending on the particular characteristics of an
industry.

Internal economies of scale

Internal economies of scale arise from growth of the business itself examples include

1) Technical economies of scale - Large-scale businesses can afford to invest in expensive and
specialist capital machinery. For example, a supermarket chain such as Tesco or Sainsbury's can
invest in technology that improves stock control. It might not, however, be viable or cost-
efficient for a small corner shop to buy this technology.
2) Specialization of workforce- Larger business split complex production process into separate tasks
to boost productivity. By specializing in certain tasks or process , the workforce is able to
produce more output in same time.
3) Marketing economies of scale- A large firm can spread its advertising and marketing budget over
a large output and it can purchase its inputs in bulk at negotiated discount prices if it has
sufficient negotiation power in the market.
4) Managerial economies of scale – This is a form of division of labour. Large scale manufacturers
employ specialists to supervise production systems, manage marketing systems and oversee
human resources
5) Financial economies of scale- Larger firms are usually rated by the financial markets to be more
'credit worthy' and have access to credit facilities, with favourable rates of borrowing. In
contrast, smaller firms often face higher rates of interest on overdrafts and loans. Businesses
quoted on the stock market can normally raise fresh money (i.e. extra financial capital) more
cheaply through the issue of shares.
6) Network economies of scale- Network economies are best explained by saying that the extra
cost of adding one more user to the network is close to zero, but the resulting benefits may be
huge because each new user to the network can then interact, trade with all of the existing
members or parts of the network.

External Economies of Scale

External economies of a scale occur within in a industry

 Development of research and development facilities in local universities that several

business in area can benefit from
 Spending by local authority on improving the transport network for a local town or city
 Relocation of component supplier and other support business close to the main centre of
manufacturing are also an external cost saving

Economies of scale for Maruthi

Maruti had been contemplating entering Gujarat and setting up a plant with an installed capacity of
300,000 units per year with an investment of INR60 billion. It was expected that any new facility
would be more efficient, as it would use the latest technology and subsequently the cost of
production would be lower. Therefore, once operational, the facility would help Maruti achieve
better economies of scale so that it could compete better and sustain its profits.
Maruthi achieved the economies of scale through opening the new plant in Gujarat .
In the medium term, the margin may improve with lower fixed cost at its new Gujarat plant. The
company has indicated that it will be able to achieve the target of 2 million production mark by
2020, a year in advance. This means the production ramp-up from the Gujarat plant will be faster
than Street expectation.

The rising proportion of the Gujarat plant will help improve margin in two ways. One, the fixed cost
per unit will be lower due to economies of scale. Second, the Gujarat plant will produce high margin
models such as Vitara Brezza and Baleno. The share of Brezza and Baleno is expected to reach nearly
one-third of the total sales volume compared with about 20% in March 2017. The operating margin
(EBIT) for Gujarat plant was estimated to be negative in FY17. It is expected to be 8-10% and 10-12%
for FY18 and FY19, respectively , according to Nomura, a brokerage.
With nearly 20% annualised earnings growth between FY18 and FY19, healthy return on equity of
23% and consistently improving free cash flow due to limited capital expenditure will help sustain
the company's premium valuation.

3. What kind of market structure prevalent in the Indian Automobile

industry? What are the Maruti’s competitive advantages? How can Maruti
sustain its profitability in the future ?

The auto sector is one of the biggest job providers, both directly and indirectly. The turn of the
twentieth century witnessed the dawning of the automobile industry. y. The automobile industry is
one of India’s most large and growing industries. This industry shared 22 per cent of the country's
manufacturing gross domestic product (GDP. It is estimated that every job created in an auto
company leads to three to five indirect ancillary jobs. India’s domestic market and its growth
potential have been a big attraction for many global automakers. India is presently the world's third
largest exporter of two-wheelers after China and Japan. India is also a prominent auto exporter and
has strong export growth expectations for the near future. In April-March 2016, overall automobile
exports grew by 1.91 per cent. PV, Commercial Vehicles (CV), and Two Wheelers (2W) registered a
growth of 5.24 per cent, 16.97 per cent, and 0.97 per cent respectively in April-March 2016 over
April-March 2015.

Mobility are one of the key outcomes of growth and development of any economy i.e. increased
mobility will further promote economic growth and development since it connects people to jobs,
markets, and services, and gives people a chance to gain equity in the political, economic, and social
spheres. Considering an insatiable demand for vehicles in an economy that is expected to grow at an
average of 7% for the next 20 years, the automobile sector in the country will require
disproportionate amounts of natural resources which will not only have economic cost implications,
but also have strong environmental and social impacts. Future growth will be associated with
increased raw material extraction, processing of primary materials for production of auto.

Indian Government Initiatives: Following steps taken by government to boost up the industry

i).The Government of India promotes foreign investment in the automobile sector and allows 100
per cent FDI under the automatic route.

ii).To encourage manufacturing, the government imposed lowered excise duty on small cars,
motorcycles, scooters and commercial vehicles to eight per cent from 12 per cent, on sports utility
vehicles to 24 per cent from 30 per cent, on mid-segment cars to 20 per cent from 24 per cent and
on large-segment cars to 24 per cent from 27 per cent.

iii).The government’s decision to resolve VAT disputes has also resulted in the top Indian auto
makers namely, Volkswagen, Bajaj Auto, Mahindra & Mahindra and Tata Motors announcing an
investment of around Rs 11,500 crore (US$ 1.87 billion) in Maharashtra.

iv).The Automobile Mission Plan for the period 2006–2016, designed by the government is aimed at
accelerating and sustaining growth in this sector. Also, the well-established Regulatory Framework
under the Ministry of Shipping, Road Transport and Highways, plays a part in providing a boost to
this sector.

v).The Government of India-appointed SIAM and Automotive Components Manufacturers

Association (ACMA) are responsible in working for the development of the Indian automobile
industry

Competitive advantages of Maruti

 Maruti also stands to gain from India’s gradual move towards CNG, away from the
expensive and polluting diesel. It is the only company that currently makes vehicles with
factory-fitted CNG engines.

 Maruti already controls about 50% of the Indian passenger car market. In 2015, it reported
revenue of Rs49,970 crore ($7.6 billion) with a net profit of Rs3,711 crore ($566.9 million).
Set up in 1981 as a joint venture between the Indian government and Suzuki Motor
Corporation, the company started by producing the iconic Maruti 800, a small petrol car
which eventually went on to sell more than two million units
  Yet, despite its past success, Maruti will be going up against both domestic
and international carmakers who are actively scaling up their small car production in
India. Over the last year, Tata Motors launched two models—the Tiago and Bolt—
while global players, including Renault, Ford, and Volkswagen, have also launched new
small cars.
 All the global companies are now looking at India to drive sales and they are all focused on
small petrol vehicles to do that. So, going forward, Maruti will face some serious
competition from global automakers such as Ford, GM, Toyota, Renault, and even Indian
companies such as Mahindra,” said Majeed. “The global focus is now shifting towards petrol
cars.”
 The lower-cost strategy is followed by the usage of a reliable network of suppliers, efficient
manufacturing, just-in-time inventory systems, extensive after-sale service support, the
realization of economies of scale and stringent waste management and control. The
competitive advantages for cost leadership flow from factors such as the economic size of
operations, low initial investment, high level of indigenization, fully depreciated
manufacturing plants and high labour productivity .

Sustain profitability in future

 Customers demanding attractive designs, higher fuel efficiency, as well as more

convenience and safety features in new car models, have acted as a spur to Maruti Suzuki
India.
 The Report outlines that future work will also draw upon more vehicle interior technologies
related to enhancement of aesthetics, with advanced projects on model development to be
in line with global trends for future readiness.
 Maruti Suzuki has initiated steps towards technology adaptation and innovation in
component and vehicle evaluation. About 87 percent of its local Tier I suppliers are located
within 100 km radius of its operating facilities while all its component makers adhere to the
Green Procurement Guidelines meeting European Union’s end of life vehicle standards for
auto parts and accessories
 Among the new initiatives, Maruti Suzuki is expanding use of computer aided engineering
for testing of new materials. Vehicle body design using high tensile material and new light
weight energy efficient structure is underway
 “The Boosterjet engine was an important introduction in our engine family. By mounting it
on the popular premium compact model Baleno, we expanded the brand to reach out to a
new segment of customers.

4. Explain the challenges and opportunities for car manufacturers in Indian

Market ?

 The Indian automotive sector has witnessed excellent growth in the recent past and is all
set to carry on this momentum. The Indian automobile industry has come a long way since
its launch in erstwhile Bombay in 1898. Currently, the automotive sector is contributing
majorly to the Indian economy both in terms of revenue and in terms of employment.

 India is expected to emerge  as the world’s third-largest passenger-vehicle market by

2021.1 It took India around seven years to increase annual production to four million
vehicles from three million.2 However, the next milestone—five million—is expected in less
than five years. Hitting that mark will depend on today’s rapid economic development
continuing, with a projected annual GDP growth rate of 7 percent through 2020,3 ongoing
 urbanization, a burgeoning consuming class, and supportive regulations and policies.
Directly or indirectly this sector employs more than ten million people in the country. The
Indian automotive industry comprises heavy vehicles, passenger cars and two-
wheelers. While the heavy vehicles sector is dominated by major players like Eicher Motors,
Mahindra and Mahindra, Ashok Leyland and Tata Telco, the major car manufacturers are
Hindustan Motors, Maruti Udyog, Ford India Ltd, Hyundai Motors India Ltd. and Tata
Motors. In the two-wheeler segment, the dominant players are Bajaj, Hero Honda, TVS and
Yamaha.  Since independence, there has been several limitations that the automotive
sector has overcome.  Measures such as reduction of tariffs on imports, relaxation of the
foreign exchange and equity regulations, and refining the banking policies played a major
driver in turning around the Indian automobile industry.

Overcapacity. Like all industries, automobile manufacturing experiences ups and downs.

Overcapacity is the problem that occurs when a manufacturer has already invested the
resources (such as payroll and materials) into building a certain quantity, only to discover
later that they do not need to produce as much as they had planned for. The result is an
over-expenditure that can damage cash flow and result in waste. The best way to avoid
overcapacity is to invest in increased production floor responsiveness and better master
production scheduling.
 Sustainability. Consumers are increasingly concerned about sustainability. Manufacturers,
therefore, must strive to create more eco-friendly cars and to be more efficient in production.
 Globalization. Increased global competition means lower market prices for many vehicles: once
again, most solutions call for increased efficiency in order to offset a lower margin of profit.
 Urbanization. Modern consumers have a different set of criteria for their cars, many of which are
related to urbanization. They include smaller vehicles, better maneuverability, and increased fuel
mileage,
  Attracting talent. As the automobile industry continues changing, manufacturers will
need to continue attracting the best and the brightest talent in order to adapt to the times