The Hindu Business Line : Commercial vehicles on the kerb

To get an insight into current problems in the commercial vehicles industry, one need not look at interest rates and the global financial crisis, but rather seek answers in the very nature of how road transport industry is organised in the country.

— Nissar Ahmad

The structure of the industry is geared to low margins, to the detriment of the fortunes of the commercial vehicles manufacturers.

D. Sampathkumar

With 40 per cent production cutbacks and four-day work weeks, the commercial vehicles industry is making news in ways that go beyond traditional assessments such as ‘global slowdown’ and ‘financial turmoil’. Equally, the traditional explanation, that the industry is ‘cyclical’ and that it just now happens to be on the downward slope of a boom-bust cycle, isn’t very satisfactory either.

Incidentally, no broking house research report on a company in the commercial vehicle industry is complete without a reference to this notion of ‘cyclicality’. However this begs the question: What is it that makes this industry a cyclical one unlike, say, the market for toothpastes?

No stranger to high rates

Compounding the perplexity of the average investor is the response from the makers of the commercial vehicles themselves during periods of downturn. Query them as to why they are not selling enough trucks, the answer invariably would be that the industry is hurt by high interest rates in the economy.

Leave aside the fact that high interest rates which often border on the usurious, haven’t prevented Bollywood or its assorted mutant varieties such as the Kollywood (Tamil film industry) or Tollywood (Telugu) of the film industry from registering healthy growth rates or star salaries going through the roof.

More pertinent is the fact that the industry is no stranger to the phenomenon of high interest rates. Right through the 1970s and the 1980s the road transport sector had to contend with 18 per cent-plus rates of interest on loans raised, to finance purchases of old/new vehicles.

For those wishing to buy new vehicles, there was also the prospect of having to shell out a black market premium for out-of-turn of allotment of trucks by dealers. That did not deter the hundreds if not thousands of lorry drivers/cleaners turned would-be owners — the traditional route for entrepreneurship in the industry — from joining the ranks of potential customers of these vehicles.

Why cyclical?

The reality is perhaps a little more nuanced than the superficial explanation of slowdown in the commercial vehicles industry that is now in public domain. Any industry can be only as robust or profitable as the operations downstream allow it to be.

In understanding what is happening to the commercial vehicle industry, one must therefore look to the features of the road transport sector to see if it contains within, the seeds of ‘cyclicality’ that everyone talks about in the context of commercial vehicles.

So how do trucking operations fare in the context of traditional metrics of success in an industry? The bulk of the industry is in the unorganised sector. So statistics on financial performance are hard to come by. Performance of a few listed players suggests that the operations are not such that would excite the average stock market investor.

Between March 2004 and September 2008, sales of about 10 such companies (truckers) grew at a compounded annual rate of about 13 per cent on an average. When you consider that inflation itself averaged around six per cent, the value addition in real terms is in single digits. Even this is built around an above-average performance by a couple of integrated logistics solution providers.

Indeed, the GDP of all forms of transportation other than Railways grew on an average by only 14 per cent between fiscal 2004 and 2007. So there is not much scope for creaming away profits by the vehicle manufacturers that would have accrued to the providers of road transport services.

Low on differentiators

The fragmented nature of ownership of road transportation assets affects value creation in more than one way. The transportation service itself is seen as a commodity business, with little distinction seen by consumers between different players in moving goods from location A to B. That meant road transport operators couldn’t invest in ‘brand building’, ‘product positioning’ and such other marketing management approaches to value creation for vehicle manufacturers to cream away portion in higher sales and profits for themselves.

A vibrant secondary market in commercial vehicles coupled with easy credit from the informal sector, made it possible for would-be entrepreneurs to enter in large numbers.

A single truck owner-operator was in a better position to capture business efficiencies than a fleet operator. At least, the cost of setting up and maintaining management control systems for the larger ones, out-weighed any superior efficiency from running fleet operations.

This is analogous to the village level cooperative dairy farming, where products are aggregated at the processing level and marketed as value-added products on the lines of Amul, in contrast to the corporate dairy farming model practised in the West. We know that the efficacy of the former model is attested to by the renowned management expert C. K. Prahlad himself.

The truck operators who are entering the business after a stint as employees for another operator would have only marginally higher expectations of reward.

Consequently truck rentals within the industry would settle at a marginal premium to subsistence levels incomes of owner-drivers. In other words, the structure of the industry is geared to low margins, to the detriment of the fortunes of the commercial vehicles manufacturers.

Consigned to low margins

Indeed, so fragmented is the trucking industry structure that it is the economists’ ultimate dream of ‘perfect competition’. Such a structure affects the fortunes of the commercial vehicle industry in other ways as well. Every truck operator is basing his investment decisions not on what others are deciding about augmenting capacities under their control, but rather on the basis of where he himself would like to be in the future.

A compact ownership structure involving relatively fewer but large fleet operators in the trucking industry is conducive for more rational exercise in capacity planning. Importantly, it allows for decisions by individual enterprises to factor in what others are planning in their own capacity creation calculations.

But the disparate market structure of the trucking industry does not allow for orderly conditions to prevail. The market forces eventually sort out these investment excesses through business failures and subsequent economic growth soaking up excess capacities, and so on.

In the short run it ends up sending distorted signals of potential demand to commercial vehicles.

We need to look, not at interest rates and global financial crisis for an insight into current the problems of the commercial vehicle industry, but rather seek answers in the very nature of how road transport industry is organised in the country.

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