New car players would have to localise quickly to compete’

Interview with Munir K. Bana, CEO Loads Limited:

Munir Karim Bana has been the CEO of Loads Limited, a leading auto-parts manufacturer, for over two decades. He is a prominent voice in the automotive and parts industry having also served as the Chairman of Pakistan Association of Automotive Parts & Accessories Manufacturers (PAAPAM) in 2013.

Bana is a Chartered Accountant by profession and has held various positions in the private sector including serving on the boards of several multinationals. BR Research had a chance to sit with him at Loads’ plant located in Korangi Industrial Area, Karachi, to talk about the disruption we are witnessing in the automotive industry; his opinion on what the future holds for car buyers, new entrants and existing players as well as his outlook on CPEC. Here are edited transcripts of our discussion.

BR Research: Digging straight into the meat of the subject, critics wonder why local automakers that have monopolised the industry for years—despite being protected through imports for years—not made the investments to expand, not met localisation targets and not decreased prices for consumers.

Munir K. Bana: You have raised three points - I will attempt to answer each. To develop a new model, the gestation period is very long. It takes 3.5 years before a new model can be launched. When you make a vehicle, you first have to design it, and then make dies, moulds, jigs & fixtures from scratch. That requires huge investments and Original Equipment Manufacturers (OEMs) have made these investments.

Whether these dies are locally made or imported, they cost a lot. With increase in the number of new models over the years, expansion did take place in that sense. However, one should understand that planning for larger volumes cannot take place in the absence of a long term auto policy; with the long awaited policy now in place, investments by both new entrants and existing players are clearly visible.

Secondly, let’s take car prices. You say they are high. Cars are manufactured only in 35 countries, and we have compared our car prices with those from across the world purely in dollars, after excluding all taxes.  We found that Pakistani assembled cars are the cheapest in the world in dollar terms. We pay the highest taxes, as one-third of the price of our car goes into taxes, and that creates a perception of high prices.

Don’t forget that our rupee has been devaluing over the years (from Rs60 to 110 per dollar in recent years). Suzuki car prices were the only exception because volumes in India are 10 fold and their localisation levels are far higher because of these volumes.

Lastly, we have achieved substantial localisation, up to 60-70 percent in cars, thanks to duty incentives provided in the auto policy. By the way, these incentives are wrongly termed as protection, which is an irrational interpretation. Duty incentives promote industrialisation, employment, save foreign exchange and generate substantial revenues, in addition to giving impetus to the auto sector, which is the mother of all industries.

Regarding localisation, local manufacture of high tech auto parts is feasible only in higher volumes.  We need to graduate from the current volume of 200,000 to at least 500,000 vehicles per annum, to attain higher localisation.  With higher volumes coupled with localisation, prices of vehicles can be controlled as our overheads and labour costs are comparatively lower.

BRR: But higher localisation would bring prices further down. Why don’t we have the volume?

MKB: There is a way to grow, of course. China adopted a model and we proposed to the government that they adopt it as well. We suggested that the volumes of small cars can be increased if the government reduces the sales tax, say, from 17 percent to 10 percent. The sales will automatically go up, as it did in China. To help out, the OEMs and part makers could also chip in, by taking a cut on their profits. After all, it is in everyone’s interests that the volumes go up by bringing end-user prices down. This would boost sales thereby generating higher revenues for government and the auto industry, and also more than offset the cuts by government and the stakeholders. The government did not implement the suggestion as, in their view, there was no guarantee that the volumes would go up.

BRR: So you say prices for cars in Pakistan are lower but for a car like Mehran, don’t you think Rs800,000 is a lot? It is one of the poorest quality cars in the market.

MKB: Absolutely not. It is the most economical car, in terms of cost, mileage and maintenance. Imagine a motorcyclist, who risks the lives of his whole family on a two-wheeler; when he can afford to graduate to four-wheeler, he buys Mehran and is very happy! His family is secure, fuel consumption is low and 90 percent of parts are locally made. It is a good car for the middle class but it’s unfortunate that Suzuki has decided to phase out this model in the not too distant future.

BRR: What about a used imported car which is three-years old like Daihatsu Mira? It is way better in quality and sells for maybe Rs3-4 lakhs more.

MKB: No imported car is cheaper than a Mehran. And used cars also have a lot of downsides. Spare parts are not available for most imported cars. If you have an accident, you might have to scrap the car because you won’t find their parts in the local market.

BRR: Why don’t you make parts for the imported variety too?

MKB: We cannot manufacture parts for imported used cars, because the volumes are not guaranteed over a longer period of time. As I said, dies are costly investments and we cannot make dies for each variety of vehicle. Who will pay for it? The OEMs pay us through amortization of die costs over the 5 to 6-year life of the local model.

In worse case scenarios, high tech parts of used cars have to be imported by individuals at exorbitant costs. You cannot maintain a used imported car on a long term basis, as the car is simply not economical. These cars are ultimately scrapped, cannibalised and sold as scrap.  You might still see 20-year-old locally manufactured cars on the roads but have you ever seen a 20-year-old used car?

BRR: If Mehran is so popular as you say, why isn’t Suzuki keeping it?

MKB: Yes, Mehran is Suzuki’s highest selling car, but their decision has been made for commercial reasons, as continued supply of CKD kits could not be guaranteed over the longer term. Its replacement, the new Alto-660cc would be a hi-tech car, which will give good mileage but may not be priced close to Mehran 800cc.

India had a similar 800cc basic car called Maruti, which was very popular, but ultimately died its own death when the market demand went down to 100 units a month. Mehran’s market demand still exists and that is one reason we are disappointed, because Mehran is 90 percent localised and many of the small parts manufacturers’ livelihoods depend on Mehran.

BRR: We were talking about used cars. How have they affected local automakers?

MKB: For one, the duties on import of used cards are fixed and concessionary. Secondly, only the overseas Pakistanis are entitled to avail this concession. The concessionary scheme is meant specifically for overseas Pakistanis, who could either bring their own cars to Pakistan through Transfer of Residence or Baggage schemes or gift it to their family through the Gift scheme. We have no grudge against Pakistanis bringing their hard earned money home in shape of cars and they deserve the concession.

What hurts us is that the scheme is illegally used by the mafia car dealers to commercially import used cars through false declarations. They buy copies of passports of Pakistanis living abroad (or returning home) and import cars in bulk in their names.  All the used cars are imported from Japan, because three-to-five-year-old cars are usually sold off (due to high taxes there on older cars).

Fortunately, after auto industry’s strong representations, Pakistan’s government has recently clamped down on this scandalous import, through new rules whereby overseas Pakistanis will have to remit customs duties from abroad in foreign currency, with proof that the money was remitted by the person himself.

BRR: Let’s pivot toward Loads’ operations. What are your expertise areas, and market shares? 

MKB: Our primary product is exhaust systems and we provide a complete assembly, including piping, chambers, silencers and catalytic converters to ensure emission control. Under Euro-II standards, it’s mandatory for all cars to be protected by a catalytic converter, which converts poisonous gases to oxygen and water vapour. We are proud to have the leading market share of exhaust systems, as we are the sole suppliers to all major vehicles of Toyota, Honda, Suzuki, and Hino, with 95 percent share of the OEM supply chain market.

Recently, we have graduated to the next level in automation of production, through acquisition of robots & laser welding equipment in addition to our portfolio of weld-penetration testing equipment. With continuing expansions, we are confident that we can meet the requirements of the new OEMs, who are currently entering the market.

Our other product is the radiator that is made from brass and copper.  With technology gradually changing to aluminum radiators, we have moved our niche to selected OEMs and tractor manufacturers, but our major thrust is now towards the after-market. The latter is the spare parts market, where millions of cars and heavy commercial vehicles that are running on the roads, turn to us for their radiator replacements.  My estimate is that we have 60 percent share in the spare parts market as we are known as the authorised manufacturers and customers prefer using authorised products, rather than the second-caliber supplies in the market. We continue to increase our share every year.

Our third product is sheet metal component. Within the body of the vehicle, there are thousands of parts that go into making the structure of the vehicle —including pillars, flooring, walls, partitions—and there are many other controlling elements. Those parts come in different sizes, shapes and material specs. And each part varies from vehicle to vehicle. While materials vary from simple low tensile to hi-tech high tensile steel parts, we specialise in high tensile and aluminum parts.

BRR: Now you are going into Alloy wheels. Tell us about your expansion.

MKB: It all happened in Australia. The industry was shutting down because of competition from imported cars so, gradually all the car makers shut down shops, and went home. As a result, all the parts makers who were servicing them had to sell their businesses too. We bought one of the plants that made alloy wheels—it was more affordable than buying a brand new plant and was in good condition.  Alloy wheels are currently imported by the OEMs for their hi-end cars, as these are not made in Pakistan. The other cars use steel wheels, which are made in Pakistan. We believe that our plant will replace import of alloy wheels, as they are very costly to import due to heavy duty and high freight incurred on their imports.

BRR: Do you have orders?

MKB: Orders come after you have made samples and reached agreement on specifications, which is a long process. But yes, in principle, we met the OEMs and they welcomed the move, because it means increased localisation for them, which will reduce their costs for sure. We have announced to PSX that we will be raising funds for this new plant through an IPO by our subsidiary, which will set up the plant in a Special Economic Zone.

BRR: How long will it take for new players to come in? Have you met with them, and what is your estimate of future car volumes?

MKB: They are saying two years, but it will take at least three. These are huge projects that require an assembly plant as well as a whole range of parts manufacturers and dealers’ networks across the country. Such large investments take time to mature. The three existing players are well entrenched and have their own network of suppliers and dealers.

Yes, the new players have been talking to us and they will definitely test us since they don’t have experience with us. While they have a lot of freedom to import parts under the new auto policy, it is in their own interest to localise quickly to be able to compete with current players. The latter have a big advantage and a head start. As for volumes, there are no indications, but they will definitely start with conservative numbers to test the market.

BRR: Everyone seems to agree that the demand is for smaller cars. But why is no one bringing them? New players have no such plans either.

MKB: It is because of a simple reason. Each car, big or small, is a complete vehicle that requires four wheels, 5 seats, radiators etc. but the expected price difference between a small car and a big car is high. Therefore, for OEMs, margins drop as they move down in size. Cost of die or cost of assembly won’t be less for a smaller car. The assembly plant is the same. If you have limited capacity; why make a small car and sacrifice margins?

BRR: With the new players, do you think there might be a shift in customers moving from Toyota to the latest brand perhaps?

MKB: I doubt there will be a shift. In fact, the bright side is that, whenever new players enter, the overall market size expands and everyone gains from it, which is why Toyota, Suzuki and Honda are all welcoming new players.

We would ask new players to invest in us, which is what existing OEMs have done. Take the example of Japan. You go to Toyota or Suzuki in Japan and you will find that the OEM sits like a grandmaster in the middle and around it are its parts manufacturers. OEMs want part makers to be close to them, to nurture them, support them, monitor them and train their people. Secondly, they don’t keep any inventories and work on a Just-In-Time basis. The parts go straight to their assembly lines, which saves carrying cost, space as well as handling costs.

Suzuki Pakistan is another example. They bought a land 30 years ago and declared to the government a portion allocated for parts manufacturers. Once volumes went up, they installed the parts manufacturers there. We have a factory there too.

BRR: Tell us about the scope of exports in this sector. Why aren’t we exporting more?

MKB: We have nominal exports. But let’s first talk about the local markets—the spare parts for old cars—which we are not supplying to. The reason is that we have to compete with Chinese imports that are under-invoiced. Then to top it all, our duty structure is so strange that we have fixed the prices of parts, per kg instead of per unit. Whether it is hi-tech part or simple part, the nominal duty is based on the weight. The technology in the part is not even considered. Because of fixed duty and under-invoicing, we can’t compete here.

For exports, the enabling environment in our country is too complicated. Our biggest hurdles are the SROs governing exports, duty rebates etc. Having said all that, competing with China and India is impossible. Their local volumes are high, overhead costs fixed and exports are sprinkled with incentives. We just can’t compete with them due to our high costs of doing business and the heavy presumptive taxes on each and every transaction.

BRR: With CPEC, do you see substantial growth for local industries, especially in the trucking sector?

MKB: There are some new players that might be coming. MAN SE is planning to come with National Logistics Cell while FAW is already here. There were a lot of second hand trucks being imported but these have been reduced. The growth in this industry is not just coming from CPEC but also other areas.

If you want my opinion on CPEC though, you can see that China is spreading its wings world over. Pakistan falls in its plans but we are up to our necks in debt because of it.

The worst part is that they bring in equipment and vehicles duty free. I’ll give you the example of a wire manufacturer. When they saw these power plants coming up, they invested $30 million in factory expansion, but when they quoted to the Chinese power projects, they were turned down because CPEC projects were allowed duty free imports. So not only is the government losing on revenues with CPEC but localisation will also be lost.