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Small and Medium Enterprises in the Indian Auto-Component Industry

Small and Medium Enterprises in the Indian Auto-Component Industry

Value chain governance in the automobile industry changed as the latter developed. When Maruti started operation in 1983, it was a turning point in the passenger car market. Prior to this, there was a tendency for the assemblers of automobiles to produce parts and components in-house. The "tierisation" of subcontracting evolved from the operations of Maruti. Value chain governance in the industry shifted from integrated firms to captive units. With economic reforms, the subcontractors of Maruti began supplying their products to other assemblers too. The transformation was from captive value chains to relational value chains. Small and medium enterprises manufacturing auto-components that started business in the 1980s and the 1990s have grown. In the process, small enterprises have expanded to become medium and large enterprises. But in spite of a rapid growth of production, new entrants to the auto-component industry declined in the 2000s. The necessity of high technology led to a significant hike in the initial investment required and raised barriers to entry. But the existing SMEs actively set up new units.

SPECIAL ARTICLE

Small and Medium Enterprises in the Indian Auto-Component Industry

Shuji Uchikawa

Value chain governance in the automobile industry changed as the latter developed. When Maruti started operation in 1983, it was a turning point in the passenger car market. Prior to this, there was a tendency for the assemblers of automobiles to produce parts and components in-house. The “tierisation” of subcontracting evolved from the operations of Maruti. Value chain governance in the industry shifted from integrated firms to captive units. With economic reforms, the subcontractors of Maruti began supplying their products to other assemblers too. The transformation was from captive value chains to relational value chains. Small and medium enterprises manufacturing auto-components that started business in the 1980s and the 1990s have grown. In the process, small enterprises have expanded to become medium and large enterprises. But in spite of a rapid growth of production, new entrants to the auto-component industry declined in the 2000s. The necessity of high technology led to a significant hike in the initial investment required and raised barriers to entry. But the existing SMEs actively set up new units.

Shuji Uchikawa (shujiuchikawa@gmail.com) is with the Institute of Developing Economies, Japan External Trade Organisation, Chiba, Japan.

B
efore Maruti started operation in 1983, there was a tendency for assemblers of automobiles (original equipment manufacturers) to produce parts and components inhouse. Maruti procured parts and components from both Japanese joint ventures and domestic component suppliers. These suppliers procured parts and components from tier-two suppliers. The “tierisation” of subcontracting spread. Value chain governance changed. As domestic demand for motorcycles and passenger cars expanded, small and medium enterprises (SMEs)1 entered into the market for auto-components. Although large enterprises in foreign and technical collaboration with foreign companies have maintained a major share in critical components, SMEs, which started business in the 1980s and 1990s, have grown. Some of them graduated from SMEs and became large enterprises. Under economic reforms since 1991, more domestic and foreign enterprises entered the passenger car and auto-component markets. Domestic auto-component manufacturers started supplying to several customers. The relationship between assemblers of auto mobiles and their subcontractors has changed as the automobile industry has developed. Value chain governance has been transformed.

Clusters of the auto-component industry have developed mainly in three areas. Pune and Chennai were the traditional clusters of the auto-component industry. After the Maruti factory was set up, an industrial area was developed for its suppliers, where the National Capital Region (NCR) became the third cluster. Multinational enterprises (MNEs) have established their factories in the clusters to take advantage of the cluster network. Schmitz and Nadvi (1999) emphasised collective efficiency derived from external economies in clusters, joint action among manufacturers in the clusters and external linkage to improve competitive advantage of the clusters. The transactions with MNEs are an example of external linkage. As MNEs have established their assembly factories in the three clusters, they have affected the development process there.

Bell and Albu (1999) pointed to the importance of knowledge systems, which generate technological change. The concept of a knowledge system encompasses the flows of knowledge, the stock of knowledge and organisational systems involved in generatin g and managing changes in the products, processes or organisation of production. Spillover of knowledge might have contributed to technological development in the Indian autocomponent industry.

The purpose of this paper is to analyse the process of change in the industrial structure of the auto-component industry, to

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identify change in the governance of the value chain and to explore the dynamics of change in the knowledge systems within the clusters. Section 1 examines the impact of the change in the system of value chain governance on the development process of automobile industry. Section 2 investigates the development of subcontracting in the automobile industry. Section 3 analyses tiny enterprises in the unorganised sector of the auto-component industry. Section 4 examines the knowledge system in the automobile industry. Section 5 investigates the development of the three main clusters.

1 Change of Value Chain Governance

Architecture indicates that the basic design plan consists of dividing the product into different parts, allocating the various functions to them, and deciding how to connect them. While modular architecture represents a comparatively standard interface, integral architecture is a more complex relationship of parts and functions that requires each of the parts to be optimally designed to achieve its overall performance. In open architecture, the system can be designed by mixing and matching different parts beyond the boundaries of a single corporation because the interface is standardised. Conversely, in closed architecture, it is done within a single corporation. A dramatic change from an integrated and closed architecture (mainframe computer) to a modular and open one (personal computer) was observed in the computer industry. On the other hand, the automobile is a product with an integral and closed architecture. It is difficult to simply divide it into several sub-systems, and outsource each subsystem’s entire development and production process to a supplier (Fujimoto and Takeishi 2001).

According to a typology by Gereffi, Humphrey and Sturgeon (2005), market-based relationships among firms and vertically integrated firms make up opposite ends of a spectrum of explicit coordination; the transition has been from integrated firms to relational value chains via an intermediate stage of captive value chains.2 First, market linkages do not have to be completely transitory and can persist over time, with repeat transactions. As transactions are easily codified and product specifications are relatively simple, the costs of switching to new partners are low for both parties. Second, modular value chain governance can come about when product architecture is modular. Although suppliers in the chains make products to a customer’s specification, they take full responsibility for competencies surrounding proces s technology and use generic machinery that limits transactionspecific investment. In the chains, the cost of switching to new partners remains low. Third, relational value chain governance can be expected when product specifications cannot be codified and transactions are complex. Tacit knowledge is exchanged between buyers and sellers. Both parties often create mutual dependence and high levels of asset specificity. Spatial proximity, trust and reputation are important to support it. Fourth, value chain governance tends towards captive value chains when the complexity of product specifications is high but supplier capability low. Low supplier competence in the face of complex products and specifications requires a great deal of intervention and control on the part of customer. As customers seek to lock-in

52 suppliers in order to exclude others from reaping the benefits of their efforts, the suppliers face significant switching costs and become captive. Fifth, hierarchy governance is characterised by vertical integration through managerial control. This framework of value chain governance is useful to explain the development process in the Indian automobile industry.

When Maruti started operations in 1983, it was a turning point of the passenger car market. Prior to this, there was a tendency for assemblers of automobiles to produce parts and components in-house. As the volume of production was not large, economies of scale could not be derived. Marginal parts and components were outsourced to many small enterprises (Kumar 2010). Value chain governance was characterised by vertically integrated firms. There were a few large enterprises during the period. Foreign companies such as Motor Industries (Bosch) and Goetze India (Federal-Mogul Goetze) started production of critical components in the 1950s and supplied to some assemblers. In the 1960s, groups of auto-component manufacturers such as the TVS group and the Kalyani group introduced advanced technology through foreign and technical collaborations. The groups consolidated their base through import substitution and accumulated capital and technology to become MNEs in the 2000s. But outsourcing was not a major procurement strategy before 1983. Technology in the auto-component industry did not develop fast due to lack of competition and slow growth of demand.

Maruti started operations from completely-knocked-down, imported components and increased production rapidly. As it had to raise the local content, following a phased manufacturing programme, Suzuki brought its subcontractors in Japan to India. Some joint ventures between Japanese and Indian companies were established to supply critical parts and components to it. Procurement from joint ventures was counted as local content. Existing Indian and foreign auto-component manufacturers also got a chance to supply to Maruti. It had to procure parts and components from suppliers all over India to meet the target of local content. These suppliers procured parts and components from their subcontractors, which worked as tier-two suppliers. “Tierisation” of subcontracting spread from the operations of Maruti. The main value chain governance in the automobile industry shifted from integrated firms to captive value chains.

The monopolistic structure of the market for passenger cars allowed Maruti to develop its suppliers. It was keen to develop subcontractors to improve its supply chain, giving technical and financial assistance (Okada 2004). On the other hand, Maruti adopted a strategy to procure the same parts and components from two suppliers to avoid risk of delay of delivery and encourage competition among them. Subcontractors were evaluated regularly from the viewpoints of cost reduction, quality of products and delivery time. Maruti changed the allotment of orders to its subcontractors, depending on their performance. Suppliers had to try to improve their performance to get more orders.

In the two-wheelers market, some joint ventures were set up and some Indian firms entered into technical collaborations in the 1980s. Companies like Hero-Honda and Bajaj got a large share of the two-wheelers market. As suppliers to them increased their sales, “tierisation” of subcontracting progressed

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in the two-wheelers industry. A large production volume is a necessary condition for subcontracting to develop. Although some joint ventures were set up in commercial vehicles during the 1980s, subcontracting did not develop due to low production volume. Finally, some of the foreign collaborators withdrew because of low growth of production.

Under the economic reforms since 1991, foreign direct investment (FDI) was liberalised and industrial licensing was abolished. More domestic and foreign enterprises entered the passenger car and auto-component markets. Some foreign automobile manufacturers brought their subcontractors to India to supply critical components to them. Hyundai set up an assembly factory in 1996. While it brought 17 subcontractors from Korea, it also started procurement from domestic firms (Park 2004). Although the domestic market was growing, competition became tough in the auto and auto-component industries. As a result, two auto manufacturers went bankrupt.

The severe competition made Maruti change its procurement strategy. It had procured parts and components from 400 subcontractors in the 1980s. After the economic reforms, its subcontractors started to supply their products to other assemblers. The main value chain governance shifted from captive value chains to relational value chains. As it could not monopolise the market due to entry of other assemblers, the costs to assist all subcontractors were too high to bear. As a result, it reduced the number of subcontractors from 400 during the 1980s to 220 during 2000s (SMRJ 2007).

In spite of competition, a few large enterprises maintained a high market share in critical components. Bharat Forge accounted for more than 50% in crankshafts, Motor Industries (Bosh) more than 70% in spark plugs, and Goetze India more than 40% in piston rings between 1991-92 and 1996-97. Gokan and Vaidya (2004) ascribed the reason to reliability. While assemblers demand high quality and reliability, the suppliers try to meet the standards imposed by customers. Mutually reinforcing relationships is a significant entry barrier to potential suppliers.

Annual production of passenger cars (in numbers) increased from 2,64,000 in 1994-95 to 16,20,000 in 2008-09. Motorcycle output also went up, from 6,48,000 in 1994-95 to 68,02,000 in 2008-09. Consequently, annual production of auto-components rose from $4,470 million in 2001-02 to $18,000 million in 2007-08. Although some newcomers, established in 1980s and 1990s, gained market share in the 2000s, a few large enterprises still maintained their market dominance in critical components. Bharat Forge accounted for more than 60% in crankshafts, Bosh more than 75% in fuel injection equipment, and Federal-Mogul Goetze more than 25% in piston rings between 2003-04 and 2008-09 (CMIE 2010).

2 Entry of SMEs as Subcontractors

In this paper, subcontracting is defined as long-term commitments to supply parts and components or provide services with and without documents of agreement. Subcontracting does not necessarily entail a rigid and exclusive contract. While subcontractors can supply to several customers, subcontracting is not a permanent agreement. Subcontracting is possible under the forms of captive value chains, relational value chains, and

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modular value chains. Assemblers produce some models and change models regularly. Specifications for each part of the new model as well as the price thereof are determined during the development period prior to the model change. In the case of critical components, assemblers and component suppliers co-develop them. Once a subcontractor receives an order for a part (when the commercial production of a new model is launched), the order is normally renewed or continued. But, when the life of a given model comes to an end, there is no guarantee that a subcontractor that has been supplying a part for that model will receiv e an order for the same kind of part for the new model.

Subcontractors must meet the demands of a parent company at three critical points: (i) price reduction by some targeted percentage within a certain time span, reflecting efforts to reduce costs;

(ii) high reliability in quality assurance; and (iii) high reliability in keeping up with the delivery schedule. On the other hand, parent companies support improvements in production efficiency by subcontractors through technical assistance, such as training subcontractors’ employees and dispatching engineers to subcontractors’ factories. Moreover, learning through repeated transactions with a particular parent company results in new skills being developed in addition to the basic technological capability that subcontractors accumulate. Asanuma (1989) referred to this accumulated learning as a relation-specific skill and noted that the effect could be expected from competitive spot bidding if the transaction was repeated for certain period.

A relation-specific skill indicates vertical flow of knowledge from a parent company to a subcontractor. It concurs with the argument by Bell and Albu. In their argument, knowledge systems and production systems overlap. The production system encompasses the product design, materials, machines, labour inputs, and transaction linkages involved in production of goods to a given specification. A relation-specific skill develops under repeated transactions, including in subcontracting.

Foreign and domestic assemblers utilise subcontracting when domestic suppliers meet their requirements on price, quality and delivery. There are three necessary conditions for the development of subcontracting in developing countries. First, expected production volume of an item of part or component must reach a minimum volume for domestic suppliers to secure economies of scale. Foreign assemblers compare import prices of parts and components with their procurement prices from domestic suppliers. Domestic assemblers compare procurement prices of outsourcing with production costs in-house. As quality control and production management are easier in-house, procurement prices should be less than production costs. Economies of scale are a determinant factor in reducing production costs to the level that meet the demand of assemblers. Local content regulation had forced foreign assemblers to procure parts and components from domestic suppliers in spite of higher prices than those of imported parts and components before the World Trade Organisation prohibited such regulation. Even after the regulation was withdrawn, domestic suppliers could compete with imports in India. At that point of time, Indian suppliers could compete on price in the domestic market due to economies of scale and lower transportation costs compared to that of imports.

Second, R&D is necessary to meet the quality requirements of Figure 1: Distribution of Companies Operating in 2010 on the Basis of Year of Commencing Production and Size

products from foreign and domestic assemblers. Suppliers in de

veloping countries must reduce defects and improve accuracy. R&D develops the suppliers’ ability to identify, assimilate and exploi t outside knowledge. It depends on investment and human resources. Highly skilled persons are indispensable for its success.

Third, management skills are important to maintain punctual delivery. Suppliers must manage well not only production inhouse but also procurement from tier-two suppliers. Tier-one subcontractors start outsourcing to tier-two suppliers after their production volume rises. Tier-two suppliers specialise in specific processes and produce parts. Tier-one suppliers play the role of coordinator of tier-two suppliers. As they can control the quality and delivery of components, assemblers benefit from subcontracting by saving on overhead costs associated with controlling and coordinating the supply chain.

As mentioned earlier, growth of production of passenger cars and motorcycles accelerated from the 1980s onwards. A few foreign and domestic large manufacturers were operating even

Table 1: Increase of Number of Employees between 2005 and 2010

Size of Enterprises Small Medium Large Large

Number of employees below 101 101 to 300 301 to 500 above 500

Number of companies which

increased number of employees

by more than 20% between 2005

and 2010 49 69 32 57

Their share in total companies 59.0 62.7 55.2 56.4

Source: ACMA (2005 and 2010).

Table 2: Size-wise Distribution of Tier One and Two Suppliers in 2010

Size of Enterprises Small Medium Large Large

Number of employees below 101 101 to 300 301 to 500 above 500 Total

Tier-one suppliers 86 126 84 197 493

(17.4) (25.6) (17.0) (40.0) (100)

Tier-two suppliers 72 94 60 137 363

(19.8) (25.9) (16.5) (37.8) (100)

Figures in parenthesis indicate percentage. Source: ACMA (2010).

before 1983 and accumulated the minimum ability of technological development. These developments were basic conditions for subcontracting to take off. It is noteworthy that many SMEs en

200 150 100 50 0 Before 1981 1981 to 1990 1991 to 2000 2001 onwards 101 to 300 301 to 500 above 500 below 101

Source ACMA (2010).

employees. It suggests that new small enterprises may face difficulty in competing with existing companies that have advanced technology. A larger firm size (employing more than 100 employees) and sufficient capital are required to enter the autocomponent industry.

Comparing the number of employees in 2010 with data on the same companies in the 2005 Buyers Guide, a change of size can be observed. Data on 352 companies are comparable between 2005 and 2010. Although 29 companies decreased their number of employees, 55% to 63% companies in four categories of size increased their number of employees by more than 20% (Table 1). Not only large enterprises but also SMEs increased their number of employees. Some small enterprises graduated and joined the ranks of medium enterprises in the second half of 2000s. As a result, the share of small enterprises in the total members of ACMA decreased from 27.4% in 2005 to 20.3% in 2010. The existing SMEs could enjoy the benefits of growing demand.

One characteristic of subcontracting in India is that there is no difference of size between tier-one and tier-two suppliers in 2010 (Table 2). Among the 363 tier-two companies, 309 are supplying to tier-one suppliers as well as automobile assemblers. A company is supplying to several companies in tier-one and tier-two, which confirms that the main value chain governance in the automobile industry is relational value chains. Even large enterprises em

ployin g more than

Figure 2: Imports and Exports of Auto Parts ($ million)

4,000 employees are

2500

Buyers’ Guide, published by Automotive Component Manufac

Exports of parts of Motorcycles (HS code 8714) Imports of parts of Motor Vehicles (HS code 8708) Exports of parts of Motor Vehicles(HS code 8708)
to tier-one suppliers.

tered the auto-component industry and became tier-one and tiersupplying to not only

two subcontractors.

2000

assemblers but also

1500

turers Association of India (ACMA), is useful to examine entry of In spite of the de

Manufacturers of components for two-wheelers, four velopment of local

SMEs.

1000

wheelers and tractors are its members. As membership is not subcontracting, FDI

500

compulsory, members do not cover all manufacturers. Although

has induced an in

the data is somewhat biased, as foreign assemblers look for can

crease in imports of

0

didates of subcontractors among its members, we can assume the

FY 1..FY 2..FY 2..FY 2..FY 2..FY 2..FY 2..FY 2..FY 2..FY 2..FY 2..

auto-components. In

data reflect the trends of tier-one and tier-two subcontractors. 2010 Buyers’ Guide has data of the year of commencing production and the number of employees. Both data on 567 companies are available. Figure 1 shows that enterprises commencing production in the 1980s and the 1990s accounted for 56.6% of total companies. Only 46 companies (8.1%) among the 567 started after 2001. In spite of rapid growth of production, new entry into the auto-component industry declined clearly in the 2000s. Moreover, only 12 companies among the 46 employ less than 101

Source: Government of India (2010b). many cases, MNEs bring an existing model from their home countries to the Indian market with little modification to save on R&D and investment costs. While introducing new models on the Indian market, they tend to assemble imported parts and components. In the 2000s, imports of parts of motor vehicles rose rapidly (Figure 2). On the other hand, exports also rose dramatically during the same period. Indian autocomponent manufacturers regard exports as an alternative outlet.

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Figure 3: Structure of Auto-Component Industry

Assemblers Large and SMEs Supply Tier-one Tier-two Export market Gap Supply Domestic Replacement Market Tiny enterprises in unorganised sector

Some of the auto-component manufacturers are exporting their products to foreign assemblers and tier-one suppliers as subcontractors. Foreign assemblers and tier-one suppliers are procuring parts and components mainly from suppliers in the clusters near their factories. But they are producing specific models in small lots. Indian SMEs have a chance to meet demand in this niche market in which large, foreign auto-component manufacturers do not have an interest due to the small size of market. Not only large enterprises but also SMEs are exporters. Among the 585 ACMA members, 226 and 197 exported to foreign assemblers and tier-one suppliers respectively in 2010. Moreover, 181 exported to foreign replacement markets. The exporters not only enjoy international competitiveness on price and quality but also have the ability to develop an export market.

3 Decline of Tiny Enterprises

Tier-one and tier-two subcontractors and exporting manufacturers are outsourcing to various sizes of manufacturers – tiny enterprises in the unorganised sector to large enterprises employing more than 1,000 workers. To find the conditions of outsourcing, a factory survey was conducted between April and June 2010 in the NCR. The target of the survey was companies employing less than 400 persons. Among 17 companies, three are mainly supplying products for foreign replacement markets. Thirteen companies are supplying parts and components to assemblers and tier-one suppliers. Four companies are procuring parts from tiny and small enterprises employing less than 50 workers. Many of the managers interviewed pointed to the technological gap between tier-one/tier-two suppliers and tiny enterprises. The tier-one and tier-two suppliers are keen to improve productivity and actively interact with customers to receive suggestions. On the other hand, tiny enterprises are not keen to invest in equipment and in upgrading their quality standards. Although some of tier-one and tier-two suppliers are sending their engineers to the latter for technical assistance, the technological gap between them is expanding. An exporter of auto-components who was buying products from tiny and small enterprises started manufacturing in-house to maintain the quality of products. Although some tiny enterprises are supplying parts as tier-two or tier-three suppliers, most of them do not have any linkage with tier-one and tier-two suppliers.

Many tiny enterprises are supplying to the domestic replacement market. Replacement parts are categorised into four groups:

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original equipment (OE) spare part, branded parts, non-OE branded parts and imported parts. OE spare parts are produced by tier-one suppliers and sold by assemblers. Branded spare parts are produced by tier-one and tier-two suppliers and sold under the brand name of a tier-one supplier. Non-OE branded spare parts are manufactured by smaller suppliers and sold under the manufacturer’s own branded name. In 2006, OE spare parts, branded spare parts, non-OE branded spare parts and imported parts accounted for 34%, 39%, 18% and 3% of the market share respectively (IMaCS 2010). While the share of OE spare parts is increasing, the share of non-OE branded spare parts is declining. As the importance of quality and durability is recognised, demand shifts from low price products with low quality to high price ones with high quality. In other words, demand of replacement parts supplied by tiny enterprises is shrinking.

In addition to these enterprises, there are jobwork units specialising in specific processes like machining, foundry work, heat treatment and forging. They cater to the auto-component industry as well as other industries, but face uncertainty due to irregular jobwork and intense competition.

The technological gap between tier-one/tier-two suppliers and tiny enterprises is pointed out by some studies. Awasthi, Pal and Yagnik (2010) conducted a survey in Punjab in the late 2000s. Among 183 tiny enterprises and SMEs, 49 are engaged in supply to automobile assemblers and tier-one suppliers in domestic and foreign markets and exporting to the foreign replacement market. One hundred and thirty-four companies, including 106 tiny enterprises, are catering to the domestic replacement market or doing jobwork. The technological gap is clear from the difference of investment in plant and machinery. While investment in the former was to the tune of Rs 100 million, the latter had investment of barely Rs 1.2 million. Low investment leads to low quality of products. Although the rejection rate in the former was 0.35%, the same in the latter was 10.5%. There was no major linkage between the former and the latter because the former integrated manufacturing to secure quality. The former produced 95% of the total value by themselves, got 3% through the unorganised sector and 2% through specialised job workers. The study found that monthly remuneration of jobwork unit owners hardly exceeded that of an organised sector worker.

Kumar (2010) categorised auto-component manufacturers in Chennai into three groups: (1) large enterprises supplying to automobil e assemblers as tier-one suppliers, (2) vendors as tiertwo suppliers to large enterprises, and (3) tiny and small enterprises catering to domestic replacement markets. Although tiny and small enterprises had taken advantage of excise duty concession, severe competition forced them to reduce sales prices to a level which did not guarantee the entrepreneur’s interest in the long-term.

Figure 3 shows the industrial structure of the auto-component industry. Tiny enterprises commencing production before 1980 could grow to medium and large enterprises. Many auto-component companies in tier-one and tier-two are run by families. Six companies among 17 in the sample started from tiny enterprises employing less than 10 persons. At present, the second or third generation of the owner-family is managing companies in the tier-one and tier-two categories. The new generation has a good educational background, engineering knowledge, and enough experience. But the present conditions of tiny enterprises in the unorganised sector are different. It is very difficult to secure the accuracy demanded by tier-one and tier-two suppliers without expensive machinery, which they cannot get due to shortage of capital. The low-end replacement market is shrinking. Tiny enterprises will be phased out in the future.

The decline of tiny enterprises can be observed in official statistics. Here, the manufacturing sector is categorised into two groups. The organised (registered) sector is defined as those factories employing 10 or more workers using power; and those employing 20 or more workers without using power. The Annual Survey of Industries (ASI) coverers this sector. The unorganised (unregistered) sector includes smaller factories than the organised sector. Moreover, the unorganised sector is categorised to three parts: (1) own-account manufacturing enterprise (OAME) being run without any hired worker employed on a fairly regular basis, (2) non-directory manufacturing establishment (NDME)

Table 3: Growth Rates of Number of Establishments, Number of Employees and Gross Value Added (%)

1989-90 to 1994-95 to 2000-01 to 1994-95 2000-01 2005-06

Organised sector Number of establishments 2.9 9.0 2.8

Number of employees 2.9 3.6 7.5

GVA at 1993-94 prices 7.7 4.8 24.3

Directory manufacturing Number of establishments -8.8 24.3 -2.4

establishments (DME) Number of employees -5.3 20.5 0.9

GVA at 1993-94 prices -14.7 29.4 6.0

Source: For organised sector, ASI (various issues). For unorganised sector, Government of India (1995, 1998, 2002, 2007 and 2008).

employing less than six workers, and (3) directory manufacturing establishments (DME) employing six or more workers, including household workers. The National Sample Survey (NSS) covers the sector. The national industrial classification (NIC) was revised dramatically in 1998. In this paper, data before 1997-98 on motor vehicles, trailers, and semi-trailers (Division 34 of NIC-98) are arrange d to be comparable at the two-digit level. However, as motorcycles were classified at four digit level after 1998-99 onwards, data are not available from NSS because it has only two digit data. DME accounted for 80.7% of total gross value added (GVA) in the unorganised motor vehicle and component sector in 2005-06. DME is the most important in the unorganised sector. Moreover, Table 3 indicates growth rates of number of establishment, number of employees and GVA of motor vehicles and their components at 1993-94 prices in the organised sector and DME. The trends of the organised sector are different from those of DME. The number of establishments rose between 1994-95 and 2000-01 due to a reclassification of industries. Establishments undertaking repairing service have been included into Division 34 of NIC-98 after 1998-99. In fact, the number of establishments in the organised sector jumped from less than 2,000 before 1998-99 to more than 2,600 after 1998-99. The sudden rise of number of establishments, number of employees, and GVA in DME might have been caused by this inclusion. While GVA of the organise d sector rose by 24.3% between 2000-01 and 2005-06, the same for DME grew by only 6.0% during the same period.

DME could not enjoy the benefits from the rapid expansion of the domestic market. The number of establishments declined from 7,802 in 2000-01 to 6,924 in 2005-06 in DME. Competition might have excluded them. As a result, the number of employees in DME increased marginally from 63,284 in 2000-01 to 66,024 in 2005-06.

4 Knowledge System and Technological Development

The knowledge system is different between large enterprises and SMEs. Large enterprises have five main sources of knowledge to improve productivity and quality of products: (1) co-development with assemblers, (2) learning through repeated transactions with particular customers, (3) in-house R&D, (4) foreign technical collaboration, and (5) acquisition of foreign companies.

Co-development with MNE assemblers is a good opportunity to absorb technology of international standard. But the chance is limited to a few suppliers that produce critical components. One advantage of subcontracting with assemblers is the learning that accrues from repeated transactions. Relation-specific skill is added to the accumulated skills of subcontractors to meet the demands of assemblers related to price, quality and delivery. Large enterprises have R&D departments. They do not only develo p new products but also analyse products of competitors and research the production method to reduce costs and improve quality.

Most of the large enterprises entered into foreign technical collaborations in the past or are still maintaining such arrangements. Technology in the world market is changing very rapidly. MNEs are investing huge amount of funds in R&D to innovate in the developed countries. Indian large enterprises do not have enough funds to compete with MNEs equally in innovation. They want to introduce advanced technology and foreign technical collaboration is an efficient way to introduce such technology and stay competitive in the short run. Such collaborations keep development costs of new products low by saving time and funds for R&D. In some cases, Indian component manufacturers start exports through the channel provided by their foreign collaborators. Component manufacturers in developed countries hand over markets where they are losing price competitiveness to their Indian counterparts and earn licence fees and royalties from the patents and know-how. Indian manufacturers can get technology to gain an advantage in the Indian market and diversify into export markets. But collaboration with foreign companies is not always stable. Foreign companies change strategy, depending on market conditions. There is an example. An Indian company entered into technical collaboration with a foreign component manufacturer because the assembler introduced its subcontractor in home country as a collaborator. But the collaborator himself wanted to set up its own factory in India to supply to the expanding market. After the collaborator set up a factory in India, the parent company gave the order of new models to it. The Indian company got only the orders of the old model. The assembler gave preference to its business links in its home country. Finally, orders to the Indian company shrunk rapidly.

In the 2000s, large Indian auto-component companies acquire d foreign companies in the developed countries.3 Sundaram

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Figure 4: Trends of GVA at 1993-94 Prices in Three Clusters

(Rs million) Delhi Pune Chennai

50,000

40,000

30,000

20,000

10,000 2003-04 2004-05 2005-06 2006-07 2007-08

Source: ASI, Unit-level Data from 2003-04 to 2007-08.

Fasteners of the TVS group acquired a British company in 2003. At present, it is operating in five countries. Bharat Forge of the Kalyan i group acquired Germany companies in 2004 and an American company in 2005. At present, it is operating factories in six countries. A main reason of acquisition of enterprises in developed countries is to absorb advanced technology. The Indian companies could take over not only capital and market but also the manpower from foreign companies. This manpower enables the Indian company to develop new products in the future in additio n to accumulation of R&D in the foreign affiliate. Although the effects of acquisition on technological improvement have not yet made their appearance, foreign takeovers have the potentiality to make it easy for Indian auto-component companies to catch up with the standards of the developed countries.

Domestic large auto-component manufacturers are getting knowledge from MNE assemblers in India through repeated transactions and foreign companies in developed countries through foreign technical collaborations. As the automobile is a product with an integral and closed architecture, assemblers of automobiles and motorcycles are playing an important role in developing new models. Domestic assemblers are introducing new technology through foreign technical collaborations. Vertical spillover effects from MNEs and domestic assemblers to large domestic auto-component manufacturers are effective.

SMEs in the auto-component industry have five sources of knowledge to improve productivity and quality of products:

(1) R&D mainly through reverse engineering, (2) suggestions from customers, (3) training of engineers provided by suppliers of machinery, (4) cluster development programme organised by ACMA, United Nations Industrial Development Organisation (UNIDO) and assemblers, and (5) advice from consultants. The five sources were pointed out by managers in the survey conducted.

SMEs cannot spend enough funds to develop their products by themselves. Reverse engineering is a common method particularly for exporters to the foreign replacement market. If they maintain quality, they may get an opportunity to supply to foreign assemblers and component manufacturers as tier-one and tier-two suppliers. Suggestions from customers are useful to improve productivity and reduce the defects ratio. Engineers of assemblers and large auto-component manufacturers visit the factories of subcontractors regularly and provide advice to them to control quality in the supply chain. Many managers in the sample companies appreciated suggestions from customers. Subcontractors are actively implementing suggestions to renew orders in the future . ACMA and UNIDO organise cluster development programmes. In these programmes, managers of SMEs visit factories and give comments

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on production management and quality control. Some assemblers have similar programmes and invite their tier-one and tier-two suppliers. The development of computer numeri c control (CNC) machine s did away with the need for skilled workers. Once engineers set the programme, semi-skilled workers can operate these machines. The machine suppliers give training to the engineers on how to programme the machines afte r the SMEs buy the same from them. Some SMEs in the sample employ consultants.

Suggestions from assemblers and large auto-component manufacturers in tier-one are the most important source of knowledge for SMEs. Large enterprises, including MNEs, are playing an important role in the production systems as well as the know ledge systems. The industry association also contributes to the diffusion of knowledge among SMEs. But its effects are limited to some areas because its members are producing different products by different methods. Members can share only the common method in production management and quality control. Horizontal spillover effects among SMEs are working but their role is much less compared to that of the vertical effects.

Tiny enterprises in the unorganised sector are trying to improve productivity. Unni and Rani (2008) conducted a survey in Delhi NCR, Chennai, Pune and Ahmedabad-Rajkot in 2004 and 2005. Among the 101 companies surveyed by them, tiny and small enterprises accounted for 24.8% and 62.5%, respectively. Tiny enterprises in the samples did not generally produce the full components but undertook their machining, which could involve turning, tapping, milling or grinding operations or making press components. Although a large proportion of owner-managers were educated below the higher secondary level or were graduates without any technical degree, they attained skills through work experience in auto-component and machine tool companies. Most of them established their contracts from their previous companies. Unni and Rani (2008: 125) found an effective and positive correlation between the growth of sales turnover and relationship with customers and concluded that “small and tiny firms have a huge potential to grow if they are linked with large firms”. However, the linkage with tier-one and tier-two suppliers is not always stable. Tier-one and tier-two suppliers may stop outsourcin g or change subcontractors when conditions change. As competition reduces the profit margins of tiny enterprises, they cannot invest in machinery. Tiny enterprises are required to accumulate special skills which make them different from others.

5 Development of Clusters

As mentioned, the auto-component industry has developed in three clusters: Delhi NCR (Delhi, Gurgaon, Faridabad, and Gautam Budh Nagar districts), Pune (Mumbai and Pune district), and Chennai (Chennai, Tiruvallur and Kanchipuram districts). All three clusters have assemblers and tier-one and tier-two suppliers. Delhi NCR has developed rapidly since Maruti was established. Pune and Chennai are traditional clusters. Tata Motors and Bajaj Auto are located in Pune. Ashok Leyland and TVS groups are located in Chennai.

Figure 4 indicates cluster-wise trends of the GVA of motor vehicles and their components (Division 34 of NIC-98) and motorcycles and their components (Division 3591 of NIC-98) at 1993-94 prices.

Figure 5: Distribution of Census Sector Units Operating in 2007 on the Basis of Year of Commencing Production and Size

Delhi NCR

70 60 50 40 30 20 10 0 Above 500 301 to 500 101 to 300 101 to 300

before 1981 1981 to 1990 1991 to 2000 2001 onwards

Pune

50 40 30 20 10 0 Above 500 301 to 500 101 to 300 below 101

before 1981 1981 to 1990 1991 to 2000 2001 onwards Chennai

below 101 101 to 300 301 to 500 Above 500 40 30 20 10 0

before 1981 1981 to 1990 1991 to 2000 2001 onwards

Source: ASI, Unit-level Data from 2003-04 to 2007-08. Figure 6: Growth of Employment in Three Clusters (Persons)

140,000 120,000 100,000 80,000 60,000 40,000 20,000 –Delhi Pune Chennai

2003-04 2004-05 2005-06 2006-07 2007-08

Source: ASI, Unit-level Data from 2003-04 to 2007-08.

While GVA in Delhi has grown constantly, that in Chennai grew relatively slowly. Figure 5 shows that establishment of new units accelerated in the census sector in three clusters during the 2000s. Two common phenomena among the three clusters can be observed. First, small-sized units employing less than 101 and medium-sized units employing 101 to 300 accounted for more than 60% of the newly established units during the 2000s. Second, new units were established by existing companies. Unit level data have information on how many units the company has. If the company does not have any other units, it is a new company. In Delhi, 69 units were established between 2001-02 and 2007-08.

Among these units, only nine were set up by new companies. In Pune, only three among 49 were established by the new companies. In Chennai, only eighth among 29 put in place by the new companies. Many new units employing less than 300 employees were established by existing companies. These small and medium size units were set up not by large enterprises but by SMEs.

Four companies in the samples of the survey are running multiple factories. There are two main reasons to set up multiple factories. First, the limitation of space constrains expansion of capacity. They have to set up new units to increase production. Second, new units are located at the place close to their customers.

Although new entry of companies became inactive in the 2000s, existing SMEs set up new units actively. SMEs are the dynamic branch in the auto-component industry. Mazumdar and Sarkar (2008) ascribed the main characteristic of the Indian manufacturing sector to its dualistic structure. It has an exceptionally large proportion of employment in the lowest size group employing six to nine workers, i e, DME and the highest size group employing more than 500 workers. But this argument is not applicable to the auto-component industry. The share of DME in total employment of motor vehicles, trailers, and semi-trailers was 15.5% in 2005. Many SMEs employing from 100 to 300 workers are graduating to large enterprises.

As production rose, the number of employees in the organised sector units increased in the three clusters (Figure 6). In other words, the growth of demand for motor vehicles and motorcycles created employment in the organised sector. But this does not mean that the workers therein got a stable job. The practice of introducing contract workers on the production line has spread in the auto-component industry to avoid labour conflicts. The share of contract workers in all workers was 58.0% in the manufacture of bodies (Division 341 of NIC-98) and 36.8% in manufacture of parts and accessories for motor vehicles and their engines (Division 342 of NIC-98) (Government of India 2010a).

Two SMEs among the 17 samples of the survey have the policy to employ only permanent workers. They make much of the good relationship with workers. On the other hand, many SMEs which were set up from the 1990s onwards tend to depend on contract workers. They replace many workers after the termination of their contracts and keep only the skilled workers as permanent workers. Although the practice can reduce labour costs, it prevents sharing of knowledge among employees and gives disincentives to active involvement in improving productivity.

6 Conclusions

The Indian automobile assembler had a tendency to produce parts and components in-house. After Maruti started operations in 1983, it procured parts and components not only from Japanese joint ventures but also from existing Indian and foreign auto-component manufacturers. These suppliers procured parts and components from the subcontractors, which worked as tiertwo suppliers. “Tierisation” of subcontracting spread from the operations of Maruti. The main value chain governance in the automobile industry shifted from integrated firms to captive value chains. After the economic reforms, the subcontractors of Maruti started supplying their products to other assemblers too.

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The value chain governance shifted from captive value chains to source of knowledge for SMEs. Large enterprises, including MNEs, relational value chains. are playing an important role in the production systems as well

Large domestic auto-component manufacturers are getting as the knowledge systems. knowledge from MNE assemblers in India through repeated SMEs, which started business in the 1980s and 1990s, have transactions and from foreign companies in the developed coun-grown. In the process, even tiny enterprises could grow into metries through foreign technical collaborations. As the automobile dium and large enterprises. Graduation from tiny and small enteris a product with an integral and closed architecture, assemblers prises occurred. In spite of rapid growth of production, new entry of automobiles and motorcycles are playing an important role in into the auto-component industry declined in the 2000s. The nedeveloping new models. Vertical spillover effects from MNE and cessity of high technology raised the initial investment amount and domestic assemblers to large domestic auto-component manufac-hiked entry barriers. Although new entry of companies became turers are effective. Suggestions from assemblers and large auto-dormant in the 2000s, the existing SMEs actively set up new units. component manufacturers in tier-one are the most important SMEs are the dynamic sector in the auto-component industry.

Notes

1 In accordance with the provision of the Micro, Small and Medium Enterprises Development (MS-MED) Act, 2006, the micro, small and medium manufacturing enterprises are defined in terms of investment in plant and machinery. Investment amount in micro, small, and medium enterprises is less than Rs 2.5 million, from Rs 2.5 million to Rs 50 million, and from Rs 50 million to Rs 100 million respectively. But in this paper, tiny, small, medium, and large enterprises are defined as those employing below 11 employees, from 11 to 100, from 101 to 300, and above 300 because definitions in industrial statistics depend on the number of employees.

2 Humphrey and Schmitz (2000) categorised value chain governance into four types: arm’s length market relations, network, quasi-hierarchy and hierarchy. Gereffi, Humphrey and Sturgeon added modular value chain to the four types.

3 R Nagaraj (2006) pointed out that although outward flow of FDI from developing countries was increasing, India had two unique points. India’s FDI is going mainly to developed countries and is concentrated in the manufacturing sector: pharmaceutical and automobile industries.

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