Tuesday, May 24, 2022

Can Indian Auto Industry Overcome The Challenge Of Chip Shortage?

Chip shortage in the international market has had a bearing on the sales and revenue of car companies that were hoping to cash in on the pent-up demand from bullish consumers who wanted to purchase new vehicles in the festive season.

Can Indian Auto Industry Overcome The Challenge Of Chip Shortage?

Mohit Sharan had booked a Hyundai Creta in September this year hoping for delivery in November on the auspicious occasion of Diwali. If Sharan is lucky, he will get the car delivered to him by the end of December. Just like Sharan, thousands of other Indians with pockets deep enough to be able to plan big-ticket purchases amid the pandemic have had to wait for months for their cars.

The reason behind this delay in car deliveries is the global shortage of semiconductors, also known as the chip shortage, that has dented sales in 169 industries, including automobiles, computers, mobile phones, healthcare equipment, among others.

Chip shortage in the international market has had a bearing on the sales and revenue of car companies that were hoping to cash in on the pent-up demand from bullish consumers who wanted to purchase new vehicles in the festive season. Maruti, India’s largest carmaker, sold just 1,09,722 cars in November 2021 as against the 1,35,879 cars it sold in April this year when the second wave of Covid-19 brought the entire nation to a halt. The second-largest car manufacturer, Hyundai, sold 37,001 cars in the month of Diwali as against 49,002 cars sold in April this year.

The Anatomy of Chip Shortage

The chip industry was growing at a modest speed of 5-6% in the pre-pandemic economy. However, apart from affecting supply chains across the world, the pandemic also led to an increased demand for chips in electronic devices due to the adoption of the work from home culture. Due to this, the industry, which was pegged to grow at just 6.3 per cent in 2021, is now expected to grow at 25 per cent in the same period. This means that there would be a waiting period for every industry and since the automobile industry is in the high-value business, it will incur the highest loss until the problem is resolved.

While the automobile industry accounts for just about a tenth of the total demand for chips in the overall ecosystem of industries that use it as a component, its usage in the mid and high-range cars make it an indispensable component in the revenue stream of carmakers. A Deloitte report estimates that by 2030, about 50 per cent of a car’s cost would comprise the cost of chips used in its electronics systems. This means that the cost of cars in a country would particularly depend on the cost of chips available in that part of the world.

Global Faultlines And Where India Stands

A major reason behind the ongoing shortage of chips in the world is the dominance of Taiwan in its manufacturing. Located 180km east of China, the small nation accounted for more than 60 per cent of the total global foundry revenue last year. Interestingly, the dominance of Taiwan in the chip industry is based on just one company—Taiwan Semiconductor Manufacturing Company (TSMC)—which accounted for 54 per cent of global revenue from the chip industry last year. The chip shortage in the global economy threatens to derail many industries and governments across the world are firming up plans to deal with the situation at least for the next few years.

The European Commission has unveiled a public-private semiconductor alliance that aims to increase its share of global production of chips to 20 per cent by 2030. South Korea’s government has also offered incentives to attract investments worth $450 billion in its chips industry by 2030.

China, with its typical style of throwing the dollars, is trying to create its own capacity to become a global hub for a part that is important for the world's biggest companies. However, the West, especially the US, would not want overdependence on China for a crucial component that holds the power to drive economies crazy.

According to Time Magazine, at least six Chinese chip firms have gone bust over the past two years. It should sound like a good opportunity for India to create a cost-effective ecosystem but currently, the Indian government lacks the speed at which decisions need to be taken to compete in competitive global markets. Despite announcing big plans to create a China plus one model, the Indian government was recently left embarrassed when Tower Semiconductor, an Israel-based semiconductor foundry, complained of delays in getting approval to set up its project in India nine months after the government had floated an Expression of Interest and invited global companies to invest in India. The company had pitched for a $3-billion investment in setting up a plant in Gujarat’s Dholera.

Cost To Indian Auto Sector

Higher demand for chips has given chipmakers some room to increase prices substantially. Earlier this year, TSMC announced a 20 per cent hike in the price of chips used in automobiles. The companies will either have to increase the prices or absorb the higher cost of production.

According to Hemal Thakkar, Director, CRISIL Research, the chip shortage is here to stay and the industry will continue to suffer for the remaining part of the current fiscal.

“We anticipate a loss of about 2.5 lakh units in terms of demand for new cars due to chip shortage in FY22. This could probably be a loss of over Rs 20,000 crore as the chip shortage is more evident in higher variants and more so in a premium compact, compact SUV and large SUV segments where the waiting periods have seen a consistent increase, too,” says Thakkar.

Anurag Singh, Managing Director, Primus Partners pegs the estimated loss incurred by the automobile industry at a higher number.

“The present pending bookings for cars is over five lakh units with Maruti having a backlog of two lakh, Hyundai one lakh and Mahindra XUV one lakh units. This is true for other segments also. The production capacity exists to cover the backlog but it is due to the chip shortage that the industry is losing out on sales. This backlog translates to over Rs 25,000 crore of lost or postponed sales in the car segment alone,” said Singh.

The ongoing shortage of chips, coupled with other commodities like steel, rubber and fuel prices, is affecting the overall sales in the industry. Maruti, which has already hiked the price of its cars in the financial year twice, has announced another spike in the prices of different models in January 2022. While price hikes in the high-end cars get absorbed due to the high price elasticity of demand, it is different for entry-level cars.

“The price hike in the entry-level car segment on the back of increased commodity prices seems to have impacted vehicle sales. The increased cost of ownership (high vehicle and fuel prices) for entry-level cars has deferred buying as well. As per data reported by companies so far, the sales of vehicles in the entry and mini-level segments have declined month-on-month and year-on-year,” says Saket Mehra, Partner and auto sector leader, Grant Thornton Bharat.

Given the current state of affairs, one may ask, what is the future of the Indian automobile industry? For any answer, we all need to look towards Taiwan and China.