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December 22, 2011

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Going green become costlier as CFL prices soars

onsumer good companies have managed to held or improved margins and reported nominal growth during Q3, 2011 as the consumption demand remains strong even in a high inflationary environment. However, the volume growth has cooled down and could see a further slowdown if interest rates continues to remain high. Import oriented industries have particularly suffered [...] Consumer good companies have managed to held or improved margins and reported nominal growth during Q3, 2011 as the consumption demand remains strong even in a high inflationary environment. However, the volume growth has cooled down and could see a further slowdown if interest rates continues to remain high. Import oriented industries have particularly suffered in this downturn due to depreciation of the rupee and rising input costs.

1. Shortage of raw materials The China angle

China is currently a producer of ~95% of the worlds rare earth materials which are vital for green-energy products including giant wind turbines, hybrid gasoline-electric cars and compact fluorescent bulbs. The increase in prices of CFL is largely attributed to rising prices of rare earth elements which are used for a coating called Phosphor on the inner surface of the fluorescent lamps that absorbs the ultraviolet light and converts it into fluorescent light, mostly in the visible spectral region. The high cost of rare earths is having a significant effect on cost of wind turbine and electric motor production as well in spite of offsetting government subsidies for green tech products. China, the only producer of rare earth minerals in the world has been cutting on its exports citing environmental reasons. China has closed or nationalized dozens of the producers of rare earth metals over last few months in order to limit radioactive residues from the rare earth industry. China is currently exporting about 30,000 tons a year only one-fourth of the worlds demand. The problem with the supply of rare earth elements is that China sees them as of long term strategic importance for their future economy (similar to how other commodities and raw materials are controlled around the world like OPEC controls oil). Figure 1: Global rare earth materials production trends (1950-2010)

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Economic Times has recently reported that various brands have increased prices of Compact Fluorescent Lamps (CFLs) by 5-15% in Nov 11. For example, a branded CFL bulb, which was selling at Rs 80 a few weeks ago, now costs Rs 90 in the domestic market. CFL bulb price rise has not been confined to India as the prices have also soared in developed nations as well. The average price for fluorescent bulbs has risen 37 percent this year in US. General Electric, facing complaints in the United States about rising prices for its CFL bulbs, highlighted that the prices of the rare earth element europium oxide has risen by 12 times in one year. Wal-Mart has also raised prices on some brands lately. The price rise is due to combination of various factors, some of which are discussed as follows:

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Going green become costlier as CFL prices soars

December 22, 2011

There is also a clear preference towards CFL bulbs among middle and upper class due to rising income levels, increasing electricity prices and awareness about environmental concerns. CFLs are also very popular in small towns facing severe shortage of electricity as they can run on battery invertors for long time. Figure 2: Annual CFL sales (million units) in India (2005-10)

Source: U.S. Geological Survey (USGS) 2. Rising Demand The Government push and increasing awareness CFL is estimated to be a Rs 2,500 crore/ US$ 500 million industry. The industry has grown at CAGR of ~35% over 2005-10. CFL is approximately 30% of total lighting market in the country pegged at Rs 8,000 crore/ US$ 1.5 billion which is still dominated by incandescent lamps. The demand for CFL lamps is expected to grow at ~20% over next 5 years after which it may slow down to 10-15% as LEDs are likely to become preferred source of lighting by that time. Indias CFL market is catching up fast with the rest of the world. Bachat Lamp Yojana, announced in Jul 07 and launched in Feb 09, is the flagship program of Indian government to ensure nationwide access to efficient lighting to all at an affordable price and to phase out incandescent bulbs from homes across India and replace them with CFLs. The government plans to completely phase out ~400 million incandescent bulbs by 2020. This would result in saving ~6,000 MW of electricity per annum.

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Source: Elcom India 3. Rising cost of import (raw materials, taxes, currency depreciation etc) In October 2010, the Chinese announced plans to not only cut their production, but also to reduce exports by one-third. This has led to whopping 800% rise in Phosphor prices from over just five months. Pphosphor once represented roughly 10% to 15% of the cost of a typical CFL, it now exceeds 50% (or more in some models) of the total lamps production cost. Glass tubes are another significant component of CFL products, constituting ~45% of CFL component costs. In addition, Indian companies have to pay a hefty tax of ~22% on imports of rare earth material. As rupee has depreciated by ~15% in 2011, the cost of import has also gone up several times. The indus-

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Going green become costlier as CFL prices soars

December 22, 2011

try has been lobbying hard to the government to remove taxes on rare earth imports to keep prices of the energy-efficient bulbs under check. Figure 3: Phosphor Price rise in 2011 (RMB/ Kg)

difficult due to long distances and high transport expenses. Currently, CFL manufacturers provide a product warranty varying from 6-12 months from the date of purchase. This has been a major concern for CFL makers in India because market malpractices have led to significant claims for returns. For example, in 2007-08, Havells return rate was 12.7% of its CFL sales. To rectify the situation, the company withdrew its products from certain states where malpractices were rampant. As market stabilizes in other states, it re-gains the market share lost and significantly improved its return rate to 1.9% in 2009-10. In contrast, return rate for local nonbranded CFLs is still as high as ~10%. 5. Pricing strategy high profit margins, a cash cow for manufacturers

Source: TCP Bulletin

4. High return rates increase effective cost of production and distribution

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The CFL market in India is complex, comprising of 12 major brands and hundreds of small players. About 40-50% of the market is dominated by the unorganized sector. The industry depends on large amounts of imports, with even branded products using large amounts of imported components. It is the unorganized and import-based nature of the industry which makes the regulatory and quality control challenge difficult but critical. To improve the production quality, the Bureau of Indian Standards had revised the standards for CFLs (increased the power factor, an indicator of lamp efficiency, from 0.5 to 0.85 and fixed 6,000 hours as the minimum life for all CFLs. CFLs have a high failure rate in India due to high fluctuations in electricity supply and lack of adherence to product specifications, especially in the rural areas. Replacement of the bulbs is particularly

Various incentives by Indian Government to bulb manufacturers and rising electricity cost has resulted in soaring demand for energy efficient bulbs. However, the profit mongers, retailers and manufacturers, continue to charge super premium on these bulbs. A recent news article has discussed the profit margins CFL suppliers are charging from helpless consumers in the name of saving energy. CFL bulbs are generally priced so high to extract maximum profit from elite and environment conscious rich clientele who are willing to pay an exorbitant price. However, with a rising inequality in incomes, poor India can barely afford a meal and Rs 10/- light bulb, let alone a Rs 100/- CFL. It is pertinent to note that The maximum cost of production of a standard 20 Lm CFL is only ~ Rs 40/ US$ 0.8, computed with the concessional duty on import. If all costs, such as banking, clearing, forwarding, inward transportation, labor, other overheads, selling, distribution, and marketing including a profit margin of 15% are included, the price of the CFL bulb will not exceed Rs. 54/ US$ 1. Please note that these are conservative estimates

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Going green become costlier as CFL prices soars

December 22, 2011

and the actual cost of production is likely to be just Rs. 20/ US$ 0.5 considering the benefit of economies of scale. CFL is a manufacturers dreams come true as they are charged almost four times the production cost. Interestingly the average discount offered to the retailers across all states is >40% on the MRP in addition to several volume linked performance incentives. There is vast difference in pricing of branded and non-branded bulbs. Nonbranded CFLs, primarily catering to price sensitive rural populace sell the products at ~75% discount to corresponding branded CFL. The idea is to churn CFLs in high volume and give shorter warranty (6 months vs 12 months for branded) to make up for high return rates.

Outlook
As China continues to restrict supply of rare earth materials, the prices are likely to only increase in short term. The first round of price increases has just beginning to surface with most manufacturers implementing their price increases in staggered manner. The timing of the latest price increases is politically awkward for the lighting industry and for environmentalists who backed a shift to energyefficient lighting. Going forward, the CFL industry is expected to increasingly consolidate away from the unorganized sector as the shift towards higher quality gains further momentum and the benefits of scale accrue to the larger players. Also, the price differential between branded and non-branded will further reduce due to economy of scale in production and increase in demand for newer technologies like LED.

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