Integration into global automotive value chains *

Co-evolution of firm and market capabilities

This paper analyzes the evolution of supplier-OEM relationship in the Indian auto industry and its
integration into global automotive value chain. Through a case study analysis, the paper studies the role
played by government policy regimes in influencing the learning abilities of firms and markets over time.
While protection encouraged learning and capability acquisition, it also increased coordination costs
through regulatory controls. Deregulation increased the capabilities base and encourages flexible work
practices by expanding the market. Complete liberalization led to realignment of global production
capabilities and integration of the industry into the global value chain. The value chain analysis has
implications for developing manufacturing capabilities and industrialization strategy.

JEL Classification code: L 62

Key words: Supplier relationship, transaction costs, capabilities, automobile industry, Asia, India.

Dr. Madhuri Saripalle

Assistant Professor, Institute for Financial Management and Research (IFMR)

Sricity, Andhra Pardesh, India

madhuri.saripalle@ifmr.ac.in

*Published as a book chapter in International Trade and Industrial Development in India: Emerging

Trends, Patterns and Issues", edited by C.Veeramani and R. Nagaraj, Orient Blackswan, May 2016.

http://orientblackswan.com/BookDescription?isbn=978-81-250-6299-8&id=24&t=c

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Introduction

This paper analyzes the integration of Indian auto industry into the global automotive value chain using
the theoretical framework of transaction costs-capability view of the firm. The focus of the paper is on
the OEMs and supplier relations which evolved from arms length to flexible forms over a period of time,
as a response to two main factors. One was the evolution of policy framework that increased/decreased
coordination costs of acquiring production/process capabilities; second was the path dependent nature of
transfer of best practices that favored a specific governance mode over the other. The global automotive
industry is also witnessing a similar development as a result of the interaction of national policies with
globalization trends, giving rise to predominantly relational governance forms on one hand, and the rise
of lead supplier firms which are well embedded in the global value chain (Sturgeon, Memedovic et.al.
2009). In an emerging economy context, there is stronger support for and evidence for the former, in the
sense that supplier relations have become more flexible over time. However, whether component
manufacturers have developed into lead suppliers is not certain as the organization of work in the Indian
industry is gravitating more towards labor intensive rather than R&D/knowledge oriented jobs.

The change in government policy regimes is central to the evolution of governance forms in the Indian
automobile industry, which evolved from arms length to flexible governance forms; as well as the
integration of Indian component suppliers into the global value chain, although not at the higher end.
However, both these developments need not be seen as independent of each other. Integration into higher
end of global value chain would require the development of modular relationship between the domestic
auto OEMs and suppliers. This requires not only production and process capabilities but a high degree of
design and innovation capability.

The paper is organized as follows. The theoretical framework is explained in the first section, followed by
propositions on the impact of policy regime on governance forms for managing supplier relations in the
Indian automobile Industry. The next section provides an analysis of the impact of policy regime on
governance forms. The third section provides an empirical case analysis1 of supplier relations in Tata
Motors Limited (TML), Maruti Suzuki Limited (Maruti) and Hyundai Motor India Limited (HMIL)
across three policy regimes. The fourth section discusses recent trends in R&D and the organisation of
production in global value chain networks and the place of Indian fi rms. The fifth section presents the
final conclusions.

1
The author would like to acknowledge the research and financial support extended by the International Motor
Vehicle Program (IMVP), U.S.A, during 2003-04.
2

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 1. Learning costs, path-dependence, and the evolution of governance forms
Governance structures are in effect a discussion of the factors influencing the firm’s boundaries. One such
important factor is the learning cost of acquiring capabilities—a concept central to firm boundaries.
Standard transaction cost theory explains firm boundaries as an outcome of governance costs in addition
to production costs (Williamson, 1985). The transaction cost approach views governance forms-- ranging
from arms length to complete vertical integration with a range of flexible and intermediate forms in
between the two--as an institutional response to overcome the costs of opportunistic behavior (ibid.).
However, governance forms are not a static one-time response to transaction costs and neither determined
by opportunistic behavior alone. They are determined by factors such as the learning cost of coordination
and acquisition of capabilities across time and geographies. Hence the discussion on firm boundaries
requires an integration of this approach with the capabilities perspective. As stated by Langlois (1992),

“..one cannot have a complete theory of the boundaries of the firm without considering in detail the
process of learning in firms and markets. The reigning transaction-cost theories of vertical integration
provide illuminating snapshots of possible institutional responses to a momentary situation. But they do
not place those responses in the context of the passage of time…. The capabilities view of the firm is in
many ways a modern reformulation of the theory of Smith and Marshall: it is a real-time account of
production costs in which knowledge and organization have as important a role as technology. The
implication of boundedness of capabilities is that no firm-even the most integrated-has the capabilities
necessary for all activities in the chain of production…”

This means that firms have to outsource or acquire capabilities to compete in the long run, and in the
absence of well developed market capabilities, this implies significant learning costs for the firm. That is,
though the transaction cost of contracting (negotiating, writing contracts) with suppliers may be low, if
they are not capable of supplying cheap components, firms have to spend significant resources in
developing internal capabilities. The cost of acquiring those capabilities is the diminution in profit from
not having taken advantage of the market's capabilities2. These costs are learning costs and defined as
dynamic transaction costs of coordinating, teaching and acquiring capabilities over a period of time
(Langlois, 1992), as a response to institutional and technological changes over time. One such factor is
the evolution of the policy framework in the context of Indian automotive industry.

2
For example, Henry Ford could have taught outside parts suppliers the techniques of the moving assembly line and
persuaded them to use them for high-volume production. But the cost of doing that would be high in terms of the
opportunity cost of doing so.
3

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While there is a rich theoretical framework for understanding governance forms, there is need for
empirical research on the evolution of governance forms over time. Gereffi et al (2005) provide a
typology of governance forms and use case studies to describe how value chains have evolved from
captive to relational, market based to explicit coordination, and vertically integrated to modular over a
period of time; highlighting the role of regulatory mechanisms, and the activities of dominant design
specialists in influencing the learning costs and thereby transforming value chains. The evolution of
governance forms also depends on the past history of the organization--governance forms are path
dependent. For example, supplier relations in the automobile industry are influenced by the country of
origin and have been found to be replicable across geographies (Florida and Kenney, 1993; Cusumano
and Takeishi, 1991).

Starting from a low level of capabilities in the supplier base to a high degree of supplier capabilities,
governance forms may evolve from vertical integration to market based forms. Vertical integration
indicates a high learning cost for the firm as market capabilities are not well developed. This is
demonstrated by the case of the domestic automobile firms in India. External factors like government
policy of reservation and training programs can result in reducing these learning costs, thereby permitting
a greater degree of trust as well as power asymmetry between the buyers and seller. Subcontracting
arrangements are examples of such governance forms. These arrangements are also influenced to a great
extent by the history of the parent firm. Tata Motor’s commercial vehicle plant was influence by its joint
venture with Cummins, which was historically more inclined to vertical integration.

Relational contracting refers to circumstances in which the presence of trust permits flexibility in
arrangements between buyers and sellers, especially when there is a need to cope with uncertain future
developments. These are characterized by complex interactions between buyers and sellers, which often
create mutual dependence and high levels of asset specificity. Studies show that relational contracting
requires that supplier capabilities be well developed to support mutual interdependence between buyers
and sellers (Gereffi , Humphrey and Sturgeon 2005; Baker, Gibbons and Murphy 2002). Relational
contracting can also be influenced by constraints imposed by government policy in the labor market. For
example, a rigid labor market may encourage subcontracting arrangements between the manufacturer and
supplier, which may slowly transform from captive to more flexible governance form. as supplier
capabilities develop over time.

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Modular governance forms in the automobile industry are the result of development of modules as
opposed to discrete component parts, in order to take advantage of shorter product life cycles and
customer preferences across the globe (Veloso and Kumar, 2002). The development of modular systems
requires well developed capabilities resulting in vertical disintegration in the industry with buyer-supplier
transactions that have a high degree of complexity and ability to codify at the same time, indicating a very
low degree of learning/dynamic transaction costs (Langlois and Robertson, 1989). Suppliers in modular
value chains take full responsibility for competencies surrounding process technology, use generic
machinery that limits transaction-specific investments, and make capital outlays for components and
materials on behalf of customers (Gereffi et al, 2005). A case study of the French automobile industry
suggests that modular supplier relations require an increased degree of risk sharing on part of the OEM
and a readiness to dispose non-core activities and a strategy to acquire a cohesive set of supply chain
management capabilities (Doran et al, 2006).

Market based exchanges presuppose the presence of well developed supplier capabilities. They are
represented by arms length transactions and take place for components where the ability of the supplier to
codify the transaction is high with minimal involvement in the product development. In the automobile
industry, such exchanges take place for standard off-the shelf items only.

The evolution of governance forms however, need not follow any sequence and depends on the local
context. Supplier relations in the automobile industry are also path dependent to a great extent. For
example, relational governance forms are associated with Japanese multinationals and arms-length
relations are more predominant with U.S. firms. It has been found through extensive research that U.S.
firms were more vertically integrated and having arms length relationship with suppliers as compared to
Japanese OEMs who bought more variety of components from a fewer number of suppliers through a
long term relationship of mutual interdependence. Japanese auto projects also overlapped more activities
and exchanged information more frequently through formal and informal mechanisms. Relationships
between buyers and suppliers in the Japanese auto industry tend to be much more stable and long term
than in the US industry, with the Japanese buyers continuing indefinitely with the same auto component
supplier without extending formal contracts beyond 2-4 years.3

3
(Asanuma , B 1988a; Helper, 1989a; Mitsubishi Research Instittute 1987; in Cusumano 1991; Cusumano and Takeishi, 1991;
Florida and Kenney, 1993)
5

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In India, the evolution of supplier relations in the automobile industry coincided with a specific policy
regime, which aided the development of market capabilities and imposed constraints in other ways. Most
of the auto majors followed a policy of vertical integration during the phase of protection, which
transformed to captive relations and subcontracting arrangement in the quasi-regulatory phase. Supplier
relations were also influenced by Japanese multinationals to a great extent but were shaped by the overall
policy context. Coordination and supply chain costs decreased as supplier capabilities were diffused in the
market due to the presence of Japanese multinationals4. Firms like Suzuki formed close relationship with
many tier 1 suppliers by having equity stakes in them5. However, the local content regulation and the
need for developing capabilities from the scratch, resulted in captive supplier relations between the
Japanese OEM and Indian suppliers, rather than relational.

In the background of the above discussion, the paper presents three propositions.

Proposition 1: Protection encourages vertical integration. According to the infant-industry argument,

protection helps firm’s growth and learning process in the initial phase of industrialization, by
encouraging capacity building and acquisition of production capabilities. The restriction on import of
technology and superior components resulted in backward integration, reinforced by lack of well
developed market capabilities.

Proposition 2: Deregulation encourages flexible governance that is based on captive and relational
forms; as a means to encourage learning and overcome uncertainty in the face of competition.
Deregulation allowed firms to take advantage of economies of scope and scale and step up volumes. This
resulted in greater reliance on local suppliers, which coupled with the diffusion of Japanese practices,
resulted in the adoption of flexible governance forms.

Proposition 3: Liberalization encourages modular governance forms as a means to allow automobile

manufacturers to focus on core competencies and the component manufacturers to integrate with the
global value chain.
With liberalization, the entry of multinationals and participation of local firms in export markets allowed
firms to develop design capabilities and take on more complex projects. In some cases, firms OEMs
rationalized the supplier base by off-shoring modules than discrete components. Liberalization allowed

4
The entry of Japanese firms like Suzuki, Mitsubishi and Nissan and Mazda led to the diffusion of Japanese management
practices like Total Quality Management (TQM) and Total Preventive Maintenance (TPM).
5
Suzuki invested about 15 percent each in the equities of Bharat Seats, Macino Plastics, and Subros (a car air-conditioner
manufacturer with collaboration with Denso).Maruti Udyog Ltd. and Suzuki arranged a joint venture between local suppliers and
Suzuki’s suppliers in Japan.
6

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follow sources to be set up which could engage in research and development and engage in product
designing. According to Sako (2002), suppliers investment in R&D increases the complexity of
transaction, but reduces the switching costs of suppliers as firms have easier access to supplier-developed
technologies; thus giving rise to modular transaction. In the Indian industry, liberalization resulted in
firms setting up Greenfield investments with high volume capacities to cater to the domestic as well as
export markets. The high volume strategies enabled component suppliers to engage in risk sharing
through asset specific investments in the form of investments in raw material and tooling. This
contributed to the complexity of transaction between suppliers and OEMs. The increase in supplier
capabilities did lead to rationalization of supplier base and also resulted in suppliers taking up specific
investments though not giving rise to complete systems suppliers.

In the next section, the three propositions will be tested through case studies of leading firms in the Indian
automobile industry with respect to the nature of transactions in each phase of government policy.
2. Learning costs of policy regimes

The Indian automobile industry is characterized by three industrial policy regimes: protection,
deregulation or quasi-regulation and liberalization, each regime marked by a specific market structure and
technology, macro-economic environment, and external institutions. During the phase of protection6 from
1970-1984, the Indian automobile industry was heavily regulated with restrictions on foreign equity,
capacities, prices and products7. The overall costs of acquiring capabilities were high during this period
because of lack of well developed market capabilities and restrictions on access to foreign technology and
capital imports. As a result, firms resorted to significant capacity investments and learning by doing over
a period of time8, a strategy which led to considerable backward integration. This was reinforced by the
strategies of the joint venture (JV) partner, indicating path dependence of governance forms. For example,

6
Policy of protection follows from the infant industry argument (List 1856), based on a dynamic theory of comparative
advantage from trade and argues for protection for some countries at early stages of industrialization if some countries
outdistanced others in manufactures.
7
During protection (1970-84) the market structure was concentrated with entry barriers on FDI, capital/import controls and
restrictions to creating capacities and adding new product lines. The industry’s output was controlled by licensing production
capacity and restricting output to single models so as to minimize foreign exchange outflows due to imports of components. This
forced companies to enter niche segments where each enjoyed a monopoly. The reservation policy for auto components was
meant to build supplier capabilities but because of absence of volumes and scale economies, the supplier industry was highly
fragmented and underdeveloped. While these policies imposed several costs in terms of restricted access to technology and scale
economies, it also allowed firms to learn and develop technological capability to manufacture indigenously. This was especially
relevant for the Indian casting and forging industry, a supplier to the auto component industry and which became a global
competitor when the economy liberalized.
8
Kathuria (1996)
7

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Tata’s vertical integration strategy, while circumscribed by the overall lack of market capabilities, was
influenced by the vertical integration strategy of its JV partner Cummins, a European CV manufacturer.

In the quasi-regulatory phase9 policy changes allowed firms to bring about technology up-gradations
through several joint ventures (Narayana, 1997). Institutional training programs also contributed to a
decline in learning costs through diffusion of supplier capabilities. Over a period of time with the
emergence of competent suppliers, learning costs reduced and flexible governance forms, characteristic of
relational governance emerged in the automobile industry.

Post 1993, liberalization of the industry led to the entry of multinationals who brought in their follow
sources which led to increased competition and diffusion of superior supply chain practices in the
industry. In the absence of regulations supplier relations followed a path dependent approach in terms of
management, procurement and training practices. D’Costa (1998, 2004) argues that while Indian firms
traditionally relied on in-house production of components, increased competition through deregulation of
policy framework forced the Indian companies to restructure and embrace many of the flexible work
practices and forge cooperative agreements between buyers and sellers. The outcomes entailed joint
development of supplier industries with long-term subcontracting relations, introducing greater
standardization of parts, adoption of flexible machines and undertaking organizational reforms. Indian
government also institutionalized inter-firm linkages and allowed diffusion of capabilities through
training forums. Further, since 2000, several new policy measures were introduced by the government to
ease quantitative restrictions, import duties, and encourage R&D and adoption of safety and
environmental regulations. Import duties on completely knocked down units (CKU) continues to be high,
which is a reason why multinationals prefer to set up manufacturing facilities in India rather than import
the CKUs.
3. Institutional responses: Case Study of the Indian Automobile industry

3.1 Vertical integration to relational & modular: Case Study of Tata motors Limited (TML)
The case of Tata Motors demonstrates that the governance form of vertical integration emerged as a
response to policy constraints and overall lack of market capabilities. Supplier relations changed to
relational in response to liberalization and influenced by its JV partner in terms of nature of training

9
During the quasi-regulatory phase, the market structure changed in favor of the government joint venture-Maruti Udyog
Limited and the output of automobile industry increased by nearly 400%.The commercial vehicle segment was liberalized and
saw the entry of Japanese joint ventures like DCM-Toyota, Swaraj-Mazda and Nissan. However, most of them suffered setbacks
due to macroeconomic environment and foreign exchange appreciation. In 1985, policy of broad banding was introduced with
allowed manufacturers to make use of economies of scale and scope by manufacturing several product lines.

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programs. Tata Motors took advantage of global supplier capabilities resulting in the development of
modular or systems suppliers over time.

TML started its first commercial vehicle plant in the eastern state of India, which is relatively backward.
Tata Motors followed a policy of vertical integration, which was close to 40 per cent in 1977-78
(Kathuria, 1996) and an arms length relationship with suppliers. Component production for the spare
parts market was reserved for the small scale sector, which further encouraged in-house production of
components by the OEM. TML invested heavily in in-house capability in dies, forgings and machine
tools. This in-house capability gave it much flexibility in reducing innovation cycle time and gave it a
competitive edge with the new entrants during the phase of deregulation. Initially the supplier policies
were mostly arms length, and there was not much involvement in terms of product development. In the
context of relatively low capability in the supplier base, TML had a high degree of vertical integration.
Supplier relations were arms length and there was low degree of explicit coordination. This supports the
proposition that protection encourages vertical integration.

Post deregulation, TML entered the SUV segment (special utility vehicle) wherein, most of the product
development took place in-house. Supplier development consisted of broad functions along the lines of
purchase, quality control and advice on investments for new product development; without much
interdependence among them10. Odaka (2000) contrasts the supplier policies of TML and Maruti Suzuki
and finds that TML’s supplier policies in the 1990s were arms length as compared with the Japanese joint
venture firm. By mid-90s, TML developed long term relations and started to outsource to its reliable
suppliers, thus supporting proposition 2 that deregulation encourages flexible governance forms. The
relationship between TML and its suppliers were cooperative and open and it was instrumental in
developing the suppliers through technical and financial arrangements (Kathuria 1996).

In the 1990s import of foreign technology and FDI in automotive industry was liberalized. Tata Motors
which was known for its high degree of vertical integration, developed cooperative agreements with its
suppliers during this phase (Kathuria, 1996) because of increased competition in the machine tool sector
and increased capability of the component sector. In 1997, TML bought the Nissan plant in Newzealand
and set up a Greenfield manufacturing facility at Pune. It acquired design collaboration with the Italian
design house IDEA and produced the first indigenous Indian passenger car in 1998.

10
In 1997, TML had 1200 suppliers at its Pune plant and supplier development comprised of four functions-- ancillary
development, quality control, purchases and product development. These functions independently looked after various aspects of
supplier development, performance and quality, bidding process and advise on tooling-up production for new product
development. (field survey)
9

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 Low to high explicit coordination
From 1998, with the setting up of car plant, there was a drastic change in supplier relations with the
setting up of a horizontal coordination system among suppliers; the Supplier Quality Improvement
Program (SQIP); to strengthen the capability of suppliers. This model was adopted from Tata’s
technology partner-Cummins. SQIP consisted of a cross-functional team of 32 engineers who were
assigned to four suppliers selected for TML’s car project. The team started “simultaneous engineering” at
ERC to develop components jointly with suppliers and introduced self-certification, whereby each worker
was responsible for certifying the product at every stage, eliminating the need for inspection and reducing
defects at an early stage.

Figure 1: Supply chain integration at TML:

S1 Delhi

AC unit Auto Plastics

30 Amp S2 Pune- Systems
Maharashtra
Relays

S3 Skin dashboard
60 Amp Maharashtra Facial cover
Relays Wiring Centre console
harness

Engineering Research S4
Center (ERC)-Electrical Maharashtra TAPS cockpit Tata Motors
Controllers
Division unit

S5 Gurgaon Hazard Wiring

Haryana

S6 Cross Member
Maharashtra

S7 ERC Radio
antennae

S8 Cigarette
Tamil Nadu lighter

S9 Steering
Tamil Nadu column
Source: Field Survey

10

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Supply chain integration: Figure 1 shows how supplier relations were restructured by reducing the
interface between Tata motors and its suppliers across various states, for the assembly of dashboard
cockpit system. The consolidation of supplier relations reflects the process of reduction in coordination
costs between TML and its suppliers, representing a decrease in the dynamic transaction costs.

Some of the suppliers like Auto plastic systems11 graduated from component supplier to systems supplier
by undertaking the entire process of coordinating with various suppliers, assembling the entire cockpit of
passenger car and delivering it Just-In-Time (JIT).12 These joint ventures reflect the fact that as the
capabilities in the supplier base increased, the complexity and ability to codify transactions also increased
significantly, reducing the overall learning costs associated with acquisition of capabilities.

Based on its well developed supplier network, in 2008, TML successfully launched the cheapest car in
the world—Tata Nano. The suppliers contributed know-how as well as financial investments in the
project. For example, Rane Group designed hollow steering shafts, thereby saving cost and cutting
weight. MRF has tweaked the tires to bear extra weight on rear wheels. Since the project was inspired by
two-wheeler industry, components were designed with a substantial scope for cost cutting. The Nano’s
instrument cluster is inspired by the minimalist clusters on mass market motorcycles. The suspension
system, cables and lamps borrow from scooters and motorcycles. The tall-design car has McPherson
struts stabilizing the front and uses a suspension system similar to those on motorcycles at the back, to
balance for a higher centre of gravity and a rear-mounted engine.

Supplier relations under Tata motors were thus transformed over a period of time from arms length to
relational to modular, as learning costs decreased under successive policy regimes, thus supporting all the
three propositions.

3.2 From captive to relational governance: Case of Maruti Suzuki Limited (Maruti)

Maruti’s case highlights how supplier relations transformed from captive to relational during the
transition from quasi-regulatory policy regime to a liberalized policy regime.

Maruti was formed in 1984 under government patronage, with an idea to manufacture a “national car”
that would be cost competitive and incorporate the latest technology. It had a virtual monopoly for a
decade and had its capital costs amortized, yielding a highly depreciated car plant by the time the industry

11
Unlike other joint venture companies with Tata Motors, this auto plastics company is a 100 percent subsidiary having a
technical tie-up with Faurecia of France, the largest cockpit supplier in Europe with a 70 per cent market share. (Asia Africa
Intelligence Wire, July 2004).
12
Field survey, 2003.
11

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was liberalized, giving it a cost advantage over the new entrants. The local content requirement and
stringent quality requirements forced Maruti to develop joint ventures13 with many local suppliers. New
industrial agglomerations emerged in the national capital region (NCR) encouraged by fiscal incentives
from the state government. Because of lack of supplier capabilities, Maruti had to develop supplier
relations from the scratch by providing tooling, raw material assistance and training to many suppliers in
the initial period of its operations.

High to low degree of power asymmetry

Captive relations require a relatively high degree of power asymmetry. In the initial period of its
operations, Maruti reduced learning costs through captive relations and institutional training programs.
Maruti introduced flexible supplier practices through subcontracting arrangements with its joint venture
partners which allowed it to practice just in time (JIT) with some dedicated suppliers, in an environment
where poor infrastructure prevented the adoption of JIT. It could also reject the excess supply in case of
reduction in demand. According to D’Costa (2004),
“…it was also able to expand its capacity from 130,000 to 180,000 without any significant capital outlays
by having flexible labor practices and joint ventures for a press shop. The supplier relationship allows it
to adjust demand downwards and negotiate prices through a detailed cost breakdown. Such practices
were also prevalent with other Japanese OEMs manufacturing light commercial vehicles, who had
adopted the ‘value engineering approach’ which breaks down cost of inputs by identifying wastes or
redundant products rather than altering the final product itself. This in turn requires open discussion of
costs and assumes significance in the context of proprietary information under arms length transactions”
(D’Costa, 2004, pp:15-22).

An increase in supplier capabilities over a period of time resulted in collaborative arrangements between
Maruti and its suppliers, transforming supplier relations from captive to relational. For example, during
its capacity expansion, Maruti set up a new press shop as a joint-venture rather than conduct arms-length
exchange with suppliers. Such collaborations reduce investment requirement, thereby freeing up capital
for other uses (D’Costa, 1998).

The change from high to low degree of power asymmetry is reflected in the nature of training programs
from vertical to horizontal. Maruti, in collaboration with the government invited “quality gurus” from
Japan who formed supplier clusters and imparted training on the principles of TQM/TPM and other

13
Automotive joint ventures increased from 4% to 18% in the 1980s (D’Costa, 1998)
12

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Japanese management practices. The clusters were trained by two eminent Japanese consultants: Tsuda
cluster (for TQM principles) and Yamaguchi cluster (for TPM principles). Some of the tier-I companies
interviewed in the sample credited Maruti with exposing them to Japanese work practices through the
cluster approach. MUL also helped its suppliers in getting training from AOTS, a non-profit Japanese
organization set up in 1959 in Japan to promote technical assistance to developing countries and to
enhance mutual understanding. In 2004, number of suppliers decreased from 400 to 250 (217 were tier-I).
Of these 14 were joint ventures with Maruti-Suzuki and the rest were joint ventures with other companies.
In the same year, Maruti started a “Centre for Excellence”, a joint investment with some of its tier-I
suppliers, with Maruti holding the majority stake. The Centre undertook three kinds of activities: total
preventive maintenance (TPM), Kaizen and training for Japanese production systems; training on
principles of total quality management (TQM) and systems audit. Both productivity and quality
improvement programs are adopted using clusters of five-six companies.

High complexity of transactions

Relational governance forms are characterized by high complexity of transactions unlike market
transactions with arms-length relationships. Post liberalization, significant changes in government
policies coupled with increase in supplier capabilities led to internal reorganization and change in supplier
relations within Maruti. This in turn increased the complexity of transactions between Maruti and its
suppliers.
In 1999, the government exited from the partnership and gave up its equity stake in Maruti. This was
followed by significant restructuring of internal organization. Prior to 2000, there were seven vendor
development activities which were centralized and grouped by their function-- Materials I (MI) and
Materials II (MII). After 2000, the supply chain activities were decentralized by nature of components
procured- vehicle components and consumables. The unit dealing with components was divided into six
departments, each of them dealing with clusters of suppliers of similar technology. Their broad functions
included vendor selection, development of suppliers, and assistance in terms of tooling and finally price
negotiation. The consumables unit dealt with logistics (shipping and transportation), imports, exports and
global sourcing of components14. The internal restructuring reflects a move towards making the supply
chain modular in terms of the complexity of transaction with the supplier.

14
At Maruti, teams from Suzuki’s supplier department began visiting the plant to place orders from Maruti’s tier-I
suppliers since 2004, if they matched the cost and quality. However, exports through tier-I supplier were found to be
quite low unlike the American or Korean companies, where many of the tier-I suppliers supplied to their overseas
operations.

13

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Maruti’s case thus suggests that it although it faced significant costs of developing supplier capabilities,
the institutional support enabled it to share the learning costs with the government and forge flexible
subcontracting arrangements with the suppliers. These relationships transformed from captive to
relational as some of its tier-I suppliers became partners in supplier development.

3.3 A mix of relational and captive: Hyundai Motor India Limited (HMIL)15

In 1996, Hyundai Motor Company (HMC) established a 100 per cent owned subsidiary, the Hyundai
Motor India Limited (HMIL), to manufacture cars in India. It represented an investment of more than
US$ 450 million. By May 2000, the Chennai plant was producing 100,000 vehicles a year and had
captured 14 per cent of the Indian market. HMIL produced two models in Chennai: Santro (999 cc) and
Accent (1,499 cc), both of which achieved approximately one quarter of their respective market segments
during the first four months of 2000. HMIL began its operation in Chennai with a workforce of 1,400
operating in a one shift production system in October 1998. By January 2001, the workforce had
increased to 3,000 workers and a three-shift operation.16 As on 2004, HMIL had 77 suppliers. Apart from
52 joint ventures with Korean and other companies, HMIL invited 13 new Korean suppliers (fully owned
subsidiaries) to set up production, in the supplier park near HMIL.

The governance structure at HMIL indicates a medium degree of explicit coordination and power
asymmetry. Having entered the Indian market in the post-reforms era unlike Maruti or Tata Motors,
Hyundai had the advantages of brining in its follow sources and establishing a relational strategy with
many tier-I suppliers early on.

Explicit coordination and power asymmetry

According to a CEO, transactions with suppliers were based on trust and informal contracts. HMIL has a
close relationship with all its vendors located in the supplier park. Vendors were also taken abroad to
Korean units (at the vendor‘s expense) for learning experience. According to a supplier, HMIL gives

15
This section is based on interviews conducted with suppliers of Hyundai Motor India Limited (HMIL), & Ford
India (FIL) located in and around the supply parks of the companies. A total of nineteen tier I and six tier II /III
companies were interviewed. Of the nineteen, only six were dedicated suppliers to HMIL and FIL, each having a
different technology partner. The joint ventures included Indo-Korean, U.S-Korean, Indo-U.K Indo-Japan and Indo-
U.S partnerships.
16
Lansbury et al (2006)
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advice not only in production and supply related issues, but managerial, finance, production planning and
processes and receives a similar level of commitment from its supplier17.

HMIL’s supplier relations were adopted from its home grown model wherein it has introduced a Japanese
style subcontracting system and a supplier association. Hyundai is regarded as one of the primary
innovators in the use of supplier associations, so called "Hyungdong hoe".18 In India, HMIL set up five
vendor quality forums in different zones of the country, with 13-14 suppliers in each forum. The forum
meets once a month, and in every meeting, “shining examples” are presented by vendors on various areas
of production and housekeeping. Joint improvement activities are undertaken inside the R&D division of
the plant. Some examples included improvements on horn failure due to oxidation and need for a filter in
the breather and such other activities of adaptive nature. Vendors were encouraged to achieve a rejection
rate of 100 parts per million (PPM) through regular monitoring and quarterly five-star auditing of
suppliers. After the initial period of monitoring of 3 months, the vendor was audited and given
certification for 100 PPM. During 2001-2004, 45-50 vendors achieved the 100 PPM standard of rejection,
all of which were tier-I suppliers.

Complexity of transactions
Given the fragmented nature of the automobile industry and small volumes, HMIL followed a policy of
single sourcing with most of the suppliers in the cluster. By committing to volumes of 50,000 cars per
annum, it secured appropriate prices19 and quality from reliable vendors. Standard items were purchased
from multiple vendors; however, for critical items like automotive wheels and gears, single sourcing
policy was followed, unlike Maruti which had double sourcing policy for each component20.Single
sourcing policy was possible because of a higher degree of capabilities in the supplier base that could deal
with the complexity of transaction. But as the supplier still had to depend on the OEM to a great extent
for design and coordination, their ability to codify the transaction was low, thus indicative of a relational
strategy.

17
An example of this commitment occurred when a major fire mishap took place in a sub-vendor unit, Polyflex.
Polyflex supplies seat moulds and polyurethane foam to another unit, Hanil Lear, which makes the rest of the seat
including the frame and upholstery. The fire substantially disrupted the seat supply chain to HMIL. The OEM
salvaged the first few days by airlifting the moulds, foams and even some machines required for creating alternative
supply facilities from South Korea. By midnight as many moulds were removed and shipped to Polyflex‘s units in
other cities, which were again restored within five days. The seats were retrofitted in the cars with the help of all
vendor companies in the supplier park
18
Chung (GERPISA, 2000)
19
The suppliers were asked to calculate their costs on the basis of the initial volumes promised with subsequent
reductions in prices later.
20
Okada & Siddarthan N.S., 2007
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Of the 1400 or so parts, fifty were made in house, while the rest outsourced. Ninety per cent of outsourced
parts were procured locally, while the remaining ten per cent--typically critical engine control and
electronic components (like sensors) were imported. Domestic suppliers were asked to source their raw
materials from established Korean suppliers abroad. Typically, an inventory of four hours to two days is
maintained, and all suppliers are asked to maintain warehouses near HMIL. In Korea, some vendors
assemble near the assembly line itself, a practice which the Indian counterpart is trying to emulate. For
items like interior panels and crash pad assembly, the survey found that a few module suppliers
assembled, tested the component and did sequence feeding on the assembly line. To achieve minimum
travel time of components, vendors were asked to follow principles of lean manufacturing and to invest in
setting up direct lines to the assembly.

Risk sharing & investment in tooling: There are two ways of providing tooling assistance to the
suppliers by the customers or the car manufacturer—direct supply of tooling or through loans for
acquiring tools. In the former case, the cost of tooling is calculated separately from the unit cost of the
component and subtracted from the total component cost. In the latter case the tool cost is amortized or
spread out across the component cost. The two methods of assistance in raw material probably reflect
risk sharing attitudes as well as trust displayed by the customers. The general trend in the industry with
respect to tooling and machinery is that the component manufacturer does not invest in tooling costs, as
that will increase the business risk. Given the low volumes in the domestic market and increasing pressure
to reduce costs, suppliers do not prefer to share risks and prefer the OEM to bear the tooling cost.
However, under the tax laws, the OEM does not get a tax benefit for bearing the tooling cost; whereas the
supplier would, acting as a disincentive for the OEM. Among other reasons, lack of trust (or high
monitoring costs) with machine usage is also a factor acting as a disincentive21.

HMIL procures raw material and bears the tooling costs for its suppliers. One of the suppliers of sheet
metal components had total investment worth Rs 850 million, of which Rs 500 million worth of
machinery and tooling came from the OEM and the supplier‘s technology partner. At another supplier,
100 per cent of the machinery was imported from Korea. Similarly at yet another supplier, tools, dies and
fixtures were supplied by its technology partner, which is a supplier to the parent firm in Korea. This is in
contrast to Ford India, which did not provide its suppliers with machinery or raw material but gave loans

21
At Maruti for instance, tooling cost was borne by the OEM initially and discontinued later unless the supplier was
not in good financial condition.
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to its suppliers to invest in certain tools, dies and fixtures, which were then amortized in the component
cost by the supplier.

As the practices vary in the industry, the suppliers are not incentivized to undertake risk sharing activities
to a great extent. The lack of uniformity in the industry is the result of path dependent nature of supplier
relations as shown by the above cases. Commitments towards volumes and capacity investments are path
dependent and firm specific, which shaped the complexity of transactions and influenced supplier‘s risk
sharing capabilities as well.

Supply chain integration

According to Chung (Gerprisa, 2000), HMC reduced its tier-I suppliers further by integrating them under
a single auto parts company-‘Mobis’- which is expected to be a specialized supplier of core modular auto
parts to the company. More recently, many of the suppliers of Indian subsidiary have been integrated
under Hyundai Mobis which procures material from suppliers, assembles and supplies complete modules
to the car manufacturer22.

4 Integration in the global automotive value chain

Since liberalization of the automobile industry in 1991, the capacity in the Indian automobile industry has
expanded multifold. Production of vehicles has increased from 2171973 units in 1991-92 to a million
units in 2005-06 and 25527186 units in 2014-15.23 The industry witnessed a compound annual growth
rate of 12 per cent during 1991-2015. India ranked sixth in automobile production (4 wheelers) globally
as of 2014 (OICA, 2014). Total vehicle exports increased from a mere 103106 units in 1991-92 to
3573806 units in 2014-15, with a compound annual growth rate of 18 per cent during this time period.
The share of vehicles exports in total production increased from 5 per cent in 1991-92 to 14 per cent in
2014-15 (figure 2). It declined momentarily during 1993-94 to 1999-00 because of more emphasis on
domestic sales and unfavorable macro economic conditions.

22
The move by Hyundai to sell the Indian spare parts division to Mobis was met with resistance by the employees
and was later remedied through a legal solution (Business Line May 2007).
23
The figures include two/three wheelers, four wheelers and tractors.
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Figure 2: Vehicle production and Exports from India during 1991-2014

Source: ACMA, SIAM, 2002-2004, www.Indiastat.com

Figure 3: Exports of auto industry

Source: US Comtrade database (includes HS codes 8701-8711 and 871410, does not include rubber parts)

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In terms of nominal value, total exports of the Indian automobile industry increased from $4 billion to
$140 billion during 1991-2014; clocking a compound annual growth rate of 20 per cent. Despite this
impressive growth, the share of machinery and transport equipment exports in total merchandise exports
is only 7 per cent in India as opposed to 41percent in Thailand during 2013.

The share of component exports has been declining from 45 percent to 27 per cent in 2014 (figure 3),
indicating an increase in exports of completely built units. A recent study (Tiwari Meenu, C.Veeramani
and Manjeeta Singh, 2015) finds that India’s share of assembled products grew higher than parts and
components in its network trade24. These consisted of CKDs of small cars, motorcycles and mobile
phones. They find that during 2000-2010, the increase in share of vehicle exports in manufactured exports
has been brought about by assembled vehicles. However, despite this modest expansion of export oriented
assembly activity in recent years, India remains a net importer of assembled network products.

Composition of exports

How far has the industry been able to integrate itself with global production networks? The automotive
mission plan (2002-16) emphasizes that given the strong domestic demand for small cars, India has the
potential to become the Asian hub for small cars (Becker-Ritterspach, Jutta C.E. Becker-Ritterspach
2009). Subsequently many multinationals announced their small car plans for India, raising expectations
that India would become the global production hub for small cars. Maruti exports its small cars to Europe,
while Ford started exporting Ikon as knocked down kits to Brazil, Mexico and South Africa and Hyundai
exports its models i10, i20, Eon, Verna to 119 countries. Nissan also exports Micra to these countries and
overtook Hyundai in 2-15 as the top exporter of small cars from India. However, given the huge domestic
demand, export share of passenger cars has not increased significantly over the years as table 1 shows.

Table 1: Export share of various segments

Total
Exports CV PC/MUV/UV 2-W 3Wheelers exports
1994-95 15882 24142 117629 24941 184757
1995-96 16389 31321 114039 32214 197004
1996-97 14276 39205 125131 21973 204396
1997-98 14058 33010 125504 18595 194057
1998-99 10108 28122 100002 21138 162506

24
Network products generally do not contain any end products that are produced from start to finish in a given
country (Tiwari et al 2015).
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 1999-00 9282 28419 83237 18388 142072
2000-01 13779 27035 111138 16263 173042
2001-02 11870 53165 104183 15462 190267
2002-03 12255 71648 179682 43443 317710
2003-04 17227 129316 264669 68138 494865
2004-05 29940 166402 366407 66795 615820
2005-06 40581 175772 513256 76885 794160
2006-07 49766 198478 619138 143896 989830
2007-08 58994 218401 819713 141225 1217746
2008-09 42673 335739 1004134 148074 1535291
2009-10 45007 446146 1140134 173282 1794546
2010-11 76297 447403 1531619 269968 2385287
2011-12 92258 508783 1975111 361753 2937905
2012-13 80027 559414 1956378 303088 2898907
2013-14 77050 596142 2084000 353392 3110584
2014-15 85782 622470 2457597 407957 3573806

Source: ACMA (2002), SIAM (2010)

Among four wheelers exports, passenger cars comprise the majority share of exports increasing from 56
percent in 1994-95 to 88 per cent in 2014-15. However, if one considers the total export of vehicles, the
share of total passenger vehicle exports (including utility and multi-utility vehicles) in total exports
increased from 13 per cent to 28 per cent in 2001-02 and gradually decreased to 17 per cent in 2014-15,
losing their share to two wheeler exports. Hyundai and Maruti Suzuki are the top exporters of passenger
cars, with market shares of approximately 65 percent and 33 percent respectively. The overall low exports
of passenger car segment in total vehicle exports suggest that India has not yet emerged as a global
production base. Rather, the manufacturing plans of multinationals are focused towards satisfying the
domestic demand for small cars, which has been propelled by rising incomes and easy availability of
finance across rural and urban India.

If one compares the growth pattern in production and exports of India and Thailand during 1991-2008,
one can find a striking difference in terms of the share of component exports which has steadily declined
from 40 to 20 per cent in Thailand reflecting a shift towards export of completely built units. In India, the
share declined from 32 per cent in 1991 to 28 per cent in 2008. Although both countries encouraged
domestic technological capability building through local content regulation (LCR) during early 1990s,
they differed in terms of the way it was implemented. Specifically, the emphasis on one-ton diesel pickup
truck as the target of LCR established Thailand as the production hub for all automobile majors. The
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exemption from domestic taxes for suppliers of components to export vehicles also made production for
exports cost-efficient in Thailand. As a result, Thailand has emerged as global production hub for
passenger cars and pick up trucks, where MNCs like Toyota and Honda manufacture and export one-ton
pick ups to more than 100 countries (Athukorala and Kohpaiboon, 2010). In India, the tax structure
continues to be cascading in nature for domestic production, although components supplied to Export
oriented units (EOUs) get tax exemption. These factors could explain why multinationals prefer India
more for component manufacture and exports, as opposed to fully built vehicles.

Figure 4: Imports of Auto industry

Source: US Com trade database

Total imports in terms of value, have registered a compound annual growth rate of 16 per cent during
1991-2014, with components comprising the major share of imports of nearly 90 per cent (figure 4). The
rise can be seen to be sharper from 2004, when the free trade agreement (FTA) between India and
Thailand was signed wherein, customs duties and tariffs were reduced on key raw materials required by
the auto industry.

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The structure of component industry

The organized sector in the auto component industry is dominated by a few large business houses, doing
well manufacturing relatively low-technology products such as castings and forgings, sheet metal, brake
linings, pistons and piston rings, wheels and oil pumps. Companies within this segment have succeeded
starting as joint ventures and then assimilated technologies to chart a path of their own (India Nippon
Electricals), while others have surrendered large equity stakes or sold out to MNCs (Premier Instruments,
Denso India). A third category includes companies that have started with technical collaborations but then
have successfully acquired competitiveness on their own. Examples include the TVS group of companies
like Sundram Fasteners, which won the best supplier award from GM for five consecutive years, and
Sundaram Brake Linings, which exports asbestos-free friction material to over 50 countries and has won
the Deming supplier award. Deemed exports by auto component industry has also increased as many of
their tier-I suppliers of Ford and Hyundai supply to the overseas operations of Ford and Hyundai. The
liberalized policies allowed firms to develop capabilities through exports to multinational companies
abroad. For example, Sona Koyo set up an engineering design and outsourcing company for its
international clients. Rico Auto and Sundaram fasteners had laboratories with latest software for reverse
engineering, designing and testing of parts. However, post liberalization, some of the foreign partners
increased their stakes in the joint ventures25 and some have acquired the domestic company. At the same
time, there was an increasing trend in outward foreign direct investment and domestic auto component
companies acquiring foreign companies. Some recent outward FDI includes acquisition of German auto
parts maker Scherer & Trier GmbH & Company KG by Motherson Sumi systems limited; acquisition of
Germany-based Scholz Edelstahl GmbH by Amtek Auto Ltd through its 100 per cent Singapore-based
subsidiary Amtek Precision Engineering Pte Ltd. Likewise, many global OEMs are planning to make
India a component sourcing hub for their global operations (IBEF 2013).

Research and Development

The trends in research and development during 2002-11 (Tables 2 and 3), show that it is increasing for the
vehicle manufacturers but is on the decline for the component manufacturers. This development is similar
to the Thailand automotive industry, where there are very few tier I suppliers involved in the design and
supply of modules. Prior to the abolition of ownership restriction on foreign-affiliated firms in 1997, there
were many more first-tier local suppliers operating under technology licensing agreements with foreign

25
Koya Seiko Co of Japan hiked its stake to 21 per cent from 8 per cent in Sona Koyo Steering systems in 1998.
WABCO and TVS split ways in 2009 with WABCO’s interest in expanding its brake business in India.
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part producers. Since then the technology owners have taken over most of these local firms, a feature
which is an integral part of the global auto industry (Athukorala, 2010).

Table 2: R&D intensity in the Indian Auto component Industry in %

Engine Electrical Suspension Transmission Sheetmetal Tyres Other
2002 1.0 0.5 0.7 0.4 0.0 0.5 0.9
2003 0.9 0.6 1.0 0.5 0.0 0.3 1.2
2004 0.8 0.6 0.9 0.4 0.0 0.3 0.9
2005 0.9 0.8 0.9 0.3 0.0 0.2 0.8
2006 0.9 0.6 0.7 0.9 0.0 0.2 0.8
2007 0.7 0.5 0.6 0.3 0.0 0.2 0.6
2008 0.7 0.4 0.8 0.3 0.0 0.2 0.5
2009 0.9 0.4 0.8 0.4 0.1 0.3 0.6
2010 0.7 0.3 0.8 0.4 0.1 0.2 0.7
2011 0.8 0.3 0.8 0.2 0.0 0.3 0.8
Source: Prowess database, CMIE

Table 3: R&D intensity in the Indian Automotive OEMs in %

Rdint_ Rdint_ Rdint_ Rdint_
Comm.Veh Divers.Veh Passeng.Car Two/three wheeler
2002 1.2 1.9 0.4 1.0
2003 1.4 1.8 0.3 1.1
2004 1.1 1.7 0.4 1.0
2005 2.0 1.6 0.4 0.9
2006 1.9 1.9 0.3 0.7
2007 2.2 1.6 0.2 0.7
2008 2.9 1.9 0.2 1.0
2009 4.5 3.4 0.3 0.8
2010 2.6 3.3 0.4 0.8
2011 1.9 3.1 0.7 0.6
Source: Prowess database, CMIE

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5. Conclusion
Learning costs under various policy regimes
Learning costs in the Indian automobile industry were high in the era of protection because of lack of
market capabilities and restrictions on imports and foreign capital. At the same time, by restricting
competition, protection encouraged acquisition of capabilities through learning by doing. A liberalized
policy regime speeded up the learning process through capacity expansions and joint ventures with
foreign firms. Many component firms acquired global presence through exports and acquisitions abroad.
External institutions like government training programs and supplier clusters also helped to decrease
learning costs, eventually resulting in de-verticalization. The case of Tata Motors illustrates this example
as it restructured from a vertically integrated structure to a disintegrated structure later in the 1990s.

We can thus find three models of governance structure transformation (Table 3)

1. Arms length to relational and modular in case of TML

2. Captive to relational in case of Maruti

3. Relational and captive governance forms in the case of HMIL

Table 3: Governance form and policy regime

Complexity Explicit
& ability to coordination
codify Supplier & Power
transactions capabilities asymmetry TML Maruti HMI
Vertical
Protection Low Low High Integration
Quasi-regulation Medium Medium Medium Relational Captive
Liberalization High High Low Relational Relational Relational

With the emergence of India as a manufacturing hub for small cars, technology will play an important
role in redefining OEM-supplier relationships with more focus on cost cutting and collaborative
partnerships. Tata’s small car model was possible with supplier commitments to undertake asset specific
investments and collaborate in R&D. This may well pave the way for a modular OEM supplier
relationship where suppliers’ capabilities are well developed to undertake turnkey projects with low
switching costs for the OEMs.

The question is, with changing governance structure, how far has the industry integrated into global
production networks and at what stage of the value chain? As the trend and composition of exports and
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imports point out, the share of exports in total production of vehicles has not increased significantly. In
value terms, import of components constitute almost 88 per cent of total vehicle imports, suggesting that
the industry may be relying on import of high value items and there could be a duality in terms of
outsourcing of cheaper parts on one hand and research and development on the other.

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The author would like to acknowledge the comments received from anonymous referees.

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