Determinants of Outsourcing in the Automobile Sector in India.

AuthorSahu, Santosh K.


Outsourcing or in-house production is a fundamental decision faced by every firm. In the last decades, outsourcing appears to be trending upward; many activities that once were performed in house are now outsourced to external suppliers (McMillan, 1995; Abraham & Taylor, 1996; Campa & Goldberg, 1997). Outsourcing is a practice used by different firms to reduce cost by transferring portions of work to outside suppliers rather than complete it in-house. On the other hand, vertical integration has also become a problem mainly due to the cost factor. Hence, firms in general tend to outsource their work and concentrate on their main activity to gain more from specialization. Grossman and Helpman (2002b) argue "firm seems to be outsourcing an ever expanding set of activities, ranging from product design to assembly, from research and development to marketing, distribution, and after-sales services". For example, it has been estimated that the American aircraft manufacturer Boeing and its European counterpart Airbus subcontract thousands of components from different manufacturers to be assembled into their passenger aircrafits. The empirical significance of production modes with partial subcontracting (as opposed to extreme production modes with exclusive in-house production or exclusive outsourcing) can be exemplified by the telecom (mobile phone manufacturing) industry. In this industry, Nokia, Motorola and Ericsson all apply outsourcing, but at different degrees. It is estimated that 15-20 percent of Nokia's production of mobile handsets is outsourced against 30-40 percent of Motorola's production, whereas, Ericsson outsources a dominant part of its production. In contrast, the German rival Siemens is known to apply outsourcing to a very limited extent (The Economist, 2002).

Domberger (1999), Ukalkar (2000), Grossman and Helpman (2002a) and Shy and Stenbacka (2003) present a large number of additional examples of outsourcing practices from a large spectrum of different industries. Firms outsource not only their final-product-related services, but also many input-related activities, such as research and development (R&D), advertising, and the production and services of many other intermediate inputs. Most observers refer to cost savings as an explanation for the large upswing in the outsourcing of manufacturing, but other than this production cost based approach, there is a transaction cost based approach where it is said that monitoring costs increase at an increasing rate as a function of the number of outsourced component production lines. Consequently, as the fraction of outsourced production lines becomes sufficiently large, in-house production will outperform outsourcing for some components or activities despite the marginal cost advantages associated with outsourced production.

There is another approach which analyses the flow of outsourcing to developed countries. It assumes if a low cost product has some sophisticated parts in it other than which the rest can be assembled or made competitively in a low technology embodied poor country then that part has to be outsourced from the technologically advanced foreign firms. From the above given facts it is clear that cost minimization and competition being factors in the outsourcing decision market characteristics like firm size and R&D which becomes entry barriers to firms and influences competition and factors like exports in competitive markets become important.

The automobile sector has one of the largest amounts of outsourcing and hence, seems quite suitable for this study. For about 50 years after the first car arrived in India, they were directly imported. During the years between the wars small start-ups for an automobile industry was made when assembly plants were established in Mumbai, Calcutta, and Chennai in India. It was towards the end of the War II that the importance of establishing an indigenous automobile industry in India was realized when Premier Automobiles Ltd. (PAL) and Hindustan Motors (HM) set up factories in the mid-40s for progressive manufacture rather than assemble from imported components.

Independent India classified automobiles as an industry of importance, which would be controlled and regulated by the Government. In the decade that followed the establishment of the industry in 1954, local manufacturers concentrated on import substitution and indigenization. Model changes were minimal. Winds of liberalization in the early 1980s came as a series of liberal policy changes rapidly introduced marking a crucial turning point for the automobile industry. The de-licensing of the industry in 1993 opened the sluice gates for a flood of international auto-makers that rushed into what they saw as the last remaining untapped market. The next couple of years saw an unprecedented growth in the industry with assembly lines working overtime to meet demand. Slowly, with the IT and services sector boom in India and a growing middle class the demand for small and mid-sized cars began to grow which led to several Indian and foreign firms entering and prospering in the market and ending the monopoly of Maruti in terms of market share. With the growth of Indian firms like Tata and Mahindra & Mahindra (M&M) Indian automotive sector started to spend more on R&D to not only sell in India but also to capture markets abroad. Similar sort of purchasing power in east European and certain Af rican countries made them ideal locations for export of cars that were tailor made for Indian markets. In recent years, many foreign companies like Hyundai have also started setting up plants in India. The main automobile hubs in India are based at Chennai, Gurgaon-Manesar, Pune, Ahmedabad, Halol, Aurangabad, Kolkata, Noida and Bangalore. Chennai is the biggest hub accounting for 60 percent of Indian auto exports. The auto components industry, although largely concentrated near automobile hubs, is fairly widespread in other parts of the country too. Table 1 presents the turnover and asset for 2014 for the select automotive firms in India.

Most of the companies which are included in the above table invest in their in-house R&D units. Indian companies like Tata Motors Ltd, Mahindra & Mahindra are at par with foreign multinational companies. From 2001-2002 to 2005-2006, the Indian automobile sector has grown at an average annual rate of over 18 percent in terms of output at constant 1993-1994 prices and the auto-component sector has grown at about 26 percent. During the same period, in terms of domestic sales in numbers, two-wheelers segments have grown at over 13 percent per annum; three-wheelers at more than 15 percent, commercial vehicles at about 25 percent and the number of passenger vehicles by 17 percent per annum. There are two distinct sets of players in the Indian auto industry, (1) automobile component manufacturers and (2) the vehicle manufacturers, which are also referred to as Original Equipment Manufacturers (OEMs). While the former set is engaged in manufacturing parts, components, bodies and chassis involved in automobile manufacturing, the latter is engaged in assembling of all these components into an automobile unit.

Automotive Component Sector

The Indian automotive component manufacturing sector consists of 500 firms in the organized sector and around 31,000 enterprises in the un-organized sector. In the domestic market, the firms in this sector supply components to vehicle manufacturers, other component suppliers, state transport undertakings, defense establishments, railways and even replacement market. A variety of components are exported to OEMs abroad and after-markets worldwide. The automobile manufacturing sector, which involves assembling the automobile components, comprises two-wheelers, three-wheelers, four-wheelers, passenger cars, light commercial vehicles (LCVs), heavy trucks and buses/ coaches. In India, mopeds, scooters and motorcycles constitute the two-wheeler industry, in the increasing order of market share. India is a global major in the two-wheeler industry producing motor cycles, scooters and mopeds principally of engine capacities below 200 cc. However, there are a lot of differences in terms of the two sub-sectors in the automobile sector.

The effective rate of protection on automobiles is much higher than on components. This differential rate of effective protection distorts resource allocation and investment patterns in the industry. The auto-component sector has much higher employment-generation potential and export-intensity than the auto assembly segment of the sector. The component manufacturers are now globally competitive and are also maintaining reasonable profitability levels despite a tariff protection bias. Therefore, a study which differentiates amongst these submarkets is important in order to better understand how outsourcing of the Indian automobile sector is affected by different factors. The objective of this work is to findout the determinants of outsourcing based on the market structure and technology imports. Here, we shall use a panel data framework in order to...

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