Writing -For the exclusive use of M. Cameron, 2015. S w W11547

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For the exclusive use of M. Cameron, 2015.SwW11547MAHINDRA & MAHINDRA IN SOUTH AFRICAR Chandrasekhar wrote this case under the supervision of Professor Jean-Louis Schaan solely to provide material for classdiscussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors mayhave disguised certain names and other identifying information to protect confidentiality.Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its writtenpermission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copiesor request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The Universityof Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca.Copyright © 2011, Richard Ivey School of Business FoundationVersion: 2012-03-15In May 2011, Pravin Shah, chief executive, International Operations (Automotive and Farm EquipmentSectors) at Mahindra & Mahindra Ltd. (M&M), a leading multinational automotive manufacturerheadquartered in Mumbai, India, was weighing his options on the company’s growth strategy in the SouthAfrican market. Shah’s dilemma was four-fold. Since 2005, Mahindra & Mahindra South Africa(Proprietary) Ltd. (M&M (SA)), the company’s fully owned subsidiary based in Pretoria, South Africa,had grown the market by importing completely built units (CBUs) from its Indian operations. Shahneeded to decide whether M&M (SA) should move to the next logical step of an agreement with a localvendor to use the latter’s surplus facility for contract assembly of M&M vehicles. Or, M&M (SA) couldskip that step altogether and invest in its own manufacturing facility. Alternatively, Shah could wait andwatch until the subsidiary logged a critical mass of vehicle sales volumes that would be sustainable in thelong term. The fourth option would be to grow the current business model of importing CBUs from Indiaby using South Africa as the hub from which to sell them to other countries in the African continent and,thereby, expand the export market. Said Shah:Each option involves tradeoffs. They have to be evaluated in light of M&M (SA)’s longterm view of the South African automotive market, which, in some ways, is unlike otherinternational markets where we are present. South Africa is clearly a growth market. It isalso competitive and fragmented. The basic question is: what is the fit that we want in it?There are issues about how we can build on the competencies we have developed duringthe last six years and the skills we need to develop, going forward, locally. The largerconsideration for whatever call we take in South Africa is the globalization strategy ofM&M, which defines the boundary.Shah needed to present his recommendation to the four-member board of M&M (SA). The board, ofwhich he was himself a member, was chaired by Dr. Pawan Goenka, president (Automotive and FarmEquipment Sectors), M&M. The decision of the board of the South African subsidiary would need to be,in turn, formally approved by the board of M&M, which, as the parent company, had 12 directors, moreThis document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 29B11M106than half of whom were independent directors. The M&M board was meeting an average of six times in ayear to discuss and decide on matters of strategic importance.CONTEXTM&M, the parent company, had six assembly plants worldwide. One was located in Egypt as part of anon-exclusive arrangement between M&M in India and a contract-manufacturing vendor in Egypt. M&Mexported components from India for assembly in Egypt of vehicles intended either for local sales or forexport. The Egyptian vendor assembled an average of 200 vehicles per month for M&M when the plantcapacity was partially dedicated to M&M, thus proving the basic viability of local assembly as a strategicoption for M&M (SA).South Africa was one of M&M’s biggest and most important export markets and was crucial to M&M’sstrategic growth. M&M had long-term plans to launch a global sport-utility vehicle (SUV) brand fromSouth Africa. It was also planning to launch a new SUV for the South African market built on analtogether new platform. Both plans supported M&M launching its own manufacturing facility.The wait-and-watch policy was a result of the South African automotive industry having just recoveredfrom a sharp decline in new-vehicle sales in three consecutive years — 2007, 2008 and 2009. In 2010,sales growth had turned positive and was expected to gather momentum. However, the global automotivemarket had not yet fully recovered from the recession, which had led to the downturn in the South Africanautomotive market. An annual survey of auto executives worldwide, had pointed to over-capacity as themajor concern globally during 2011.1 Over-capacity prevailed in both mature automotive markets (e.g., inthe United States, Germany and Japan) and in emerging automotive markets (e.g., China and India). Inthe automobile industry, which was cyclical in nature, over-capacity was not a unique problem but italways made everyone cautious.Finally, with the exceptions of Egypt and South Africa, none of the 54 countries in the African continenthad a sizeable middle class that could warrant M&M having a presence along the lines of the inroadsM&M had made in South Africa or Egypt. Each individual market needed to be developed over time. Inthe interim, M&M could cater to the African markets from its South African base, which could be used asa re-export hub. Said Shah:Contract assembly is the way to go for companies with low volumes [of less than a fewthousand vehicles per annum]. Of late, a growing number of multi-brand assemblers arecoming up in Eastern Cape Province. It is also noteworthy that contract manufacturing iscommon in the industry even between established players who are otherwise competingfor market share. Fiat, for example, assembles vehicles for Nissan, which assemblesvehicles for Renault. The major factor for consideration is the availability of surpluscapacity. On the other hand, it is possible for a company to set up its own manufacturingfacility in South Africa once it has reached annual sales of 6,000 units in which a singlebrand in its portfolio sells approximately1,500 units annually. It places you firmly on thepath of both localization of content and scaling up, which are major issues in automanufacturing globally. A volume of that order also helps build brand equity in the localmarket.1Dieter Becker et al, Global Automotive Executive Survey 2011: Creating a Future Roadmap for the Automotive Industry,”pp. 24–26, www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/Global-Auto-Executive-Survey2011.pdf, accessed August 25, 2011.This document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 39B11M106SOUTH AFRICAN AUTOMOTIVE INDUSTRYSouth Africa fared better than its neighbors (both in and out of African continent) in the businessenvironment rankings from 2006 to 2010. The country was expected to retain the lead for the period 2010to 2015 in several of the 55 parameters used as the basis for rankings (see Exhibit 1).The South African automotive industry accounted for about 10 per cent of the country’s manufacturingexports. Although its annual vehicle production was less than one per cent of global vehicle production,the industry contributed about 7.5 per cent to the gross domestic product (GDP) of South Africa.The industry was picking up momentum after three consecutive years of negative growth, which had beenpreceded by three consecutive years of record-breaking growth. According to the National Association ofAutomobile Manufacturers of South Africa (NAAMSA), new vehicle sales fell by 5.1 per cent in 2007,21.1 per cent in 2008 and 25.9 per cent in 2009. The decline was largely due to the global recession,which had reduced the flow of credit in the financial system. Locally, the South African government hadpassed the National Credit Act2 in July 2007, which regulated the flow of credit and further limited itsavailability. In 2010, however, a turnaround began. The industry had grown at 24 per cent over theprevious year, exceeding initial projections of a 7 per cent increase. The momentum was expected to besustainable. The government had targeted a production of 1.2 million vehicles in 2020 from about 0.5million in 2010 (see Exhibit 2).South Africa exported vehicles to more than 70 countries, mainly Japan, Australia, the United Kingdomand the United States. African export destinations included Algeria, Botswana, Zambia, Zimbabwe,Lesotho, Mozambique, Namibia and Nigeria.South Africans drove 1,390 variants of cars, recreational vehicles and light commercial vehicles.Domestic consumption was limited to well-known brands, such as Toyota, Volkswagen, Ford, Mazda andBMW. These brands together accounted for more than 80 per cent of new-vehicle sales in the country(see Exhibit 3). Present in South Africa were eight of the top 10 global vehicle makers, which sourcedcomponents and assembled vehicles for both local and overseas markets. South Africa also had three ofthe world’s largest tire manufacturers. More than 200 automotive component manufacturers were locatedin South Africa, including several multinationals.GROWTH CATALYSTThe catalyst for the growth of the South African auto industry had been the government’s Motor IndustryDevelopment Programme (MIDP). Introduced in 1995, MIDP had been legislated to last until 2009 andwas to be phased out by 2012. It would be replaced in 2013 by the Automotive Production andDevelopment Programme (APDP).Pre-MIDP, the import duty rates for CBUs and completely knocked-down (CKD) components were 115per cent and 80 per cent, respectively. The high duty rates were aimed at protecting the local industryfrom global competition. In 1995, under the MIDP, the tariffs were reduced to 65 per cent and 49 percent, respectively. They had continued to decline at a steady rate, reducing year-on-year to 25 per cent forCBUs and 20 per cent for CKDs in 2012.2Republic of South Africa, National Credit Act, 2005, www.ncr.org.za/pdfs/NATIONAL_CREDIT_ACT.pdf, accessed August28, 2011.This document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 49B11M106Several MIDP provisions had helped boost automotive exports from South Africa. For example, theMIDP enabled local vehicle manufacturers to import goods duty-free to the extent of the value of theirexports, thus allowing them to concentrate on manufacturing for export. The MIDP also granted vehiclemanufacturers a production-asset allowance to invest in new plant and equipment, reimbursing 20 percent of their capital expenditure in the form of import-duty rebates over a period of five years.The APDP was meant to create long-term sustainability by concentrating on localization of vehiclecontent. Meant to last until 2020, the APDP was built around four key elements: tariffs, local assemblyallowance, production incentives and automotive investment allowance. The program aimed to create astable and moderate import tariffs regime from 2013, set at 25 per cent for CBUs and 20 per cent forcomponents. It would also offer a local assembly allowance (LAA), which would enable vehiclemanufacturers with a plant volume of at least 50,000 units per annum to import a percentage of theircomponents duty-free. The investment allowance of 20 per cent would also be carried forward from theMIDP regime.All rebates of import duty were given in the form of certificates that were tradable in the open market andcould, therefore, be converted into cash. However, many automotive manufacturers used the certificatesthemselves to offset the cost of their imports. For example, to reduce the cost of their imports tradingcompanies such as M&M (SA) purchased these certificates, when they were available at low prices in theopen market. Said Nico M. Vermeulen, director, NAAMSA:A trading company, which imports CBUs at 25 per cent duty and sells them either in thedomestic or export markets, will not get any certificate because it is neithermanufacturing nor adding value locally. An assembly plant, which imports CKDs at 20per cent import duty, must meet with three conditions in order to be eligible for acertificate: be registered with the Department of Trade and Industry; assemble aminimum of 50,000 vehicles per annum; and export. The value of the certificate for anassembly plant is linked to the value of export income it generates. A manufacturingcompany must produce 50,000 vehicles per annum to be eligible for a certificate which islinked, not to exports as in an assembly plant, but to the value added in the form of localcontent. A manufacturer gets the certificate, irrespective of whether the products are soldlocally or exported, as long as it provides evidence of content localization.3MIDP differed from APDP because it incentivized exports of vehicles and components, whereas APDPincentivized value added through local production. Both incentives were in tune with the outcomes thegovernment was seeking at different points of time. The gradual decline in tariff protection was aimed athelping the domestic auto manufacturing companies become efficient in several ways. They could secureeconomies of scale, rationalize product platforms, focus on exports, compete globally and benchmarktheir operations against the best in the world. NAAMSA had estimated that the average annual volumesof production per platform would need to increase to a minimum of 80,000 units for a local company tobecome globally competitive. Similarly, employee productivity would need to improve from 15 vehiclesto 30 vehicles per employee per annum.3Interview with case author, September 02, 2011.This document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 59B11M106CONSUMER CLASSIFICATIONSouth Africa had a population of 50.6 million, of which the black Africans comprised 40.2 million, whiteAfricans 4.6 million, coloured Africans 4.5 million and Indian/Asian Africans 1.27 million.4The SouthAfrican Advertising Research Foundation (SAARF), an independent trade body, had segmented SouthAfrican adult consumers (ranging in age from 15 to 50-plus) into 10 categories known as LivingStandards Measures (LSMs). The measures graded people from 1 to 10 in an ascending order of theirstandard of living. Instead of using traditional metrics such as race and income, the SAARF LSM, whichhad won an award as the “media innovator of the year,” grouped people by using such criteria as degreeof urbanization and ownership of cars and major appliances. The grading was meant to help marketersand advertisers of goods and services to identify, as accurately as possible, their target markets (seeExhibit 4).The data for the year ending December 2010 had reiterated a major trend that had long been evident inSouth African marketing. The buying power of black African consumers, comprising the largest group inthe middle-income (LSM 5–8) market, was rising. Said Ashok Thakur, CEO of M&M (SA):The mindset of white African consumers, who have been the bedrock of the vehiclesmarket in South Africa, is similar to the mindset of consumers in the countries of WestEurope. They buy well-known brands because they trust them. That explains why therehas been a strong influence, for decades, of German brands in the South Africanautomotive market. However, as the percentage of black African consumers enteringhigher income bands goes up, one would think that black Africans will acquire thebuying habits and preferences of white Africans who are already in those bands. But, ourexperience in South Africa proves the opposite.The black African consumers were buying Western European brands, and more recently Japanese andKorean brands, not because they trusted them but because they did not trust the local brands. This elementof rebound had strategic implications for companies such as M&M (SA). The brand savviness of blackAfricans provided room for automotive brands other than those from Europe, Japan and Korea tostrengthen their brand equity so that they could lock in sales from the growing black African consumers.M&M (SA) saw this situation as an entry-level opportunity.A June 2010 McKinsey Quarterly research article into South African consumer goods had led to similarconclusions. It showed that 49 per cent of middle-income black consumers but only 26 per cent ofmiddle-income white consumers agreed with the statement: “I purchase branded food products becausethey make me feel good.” Among upper-income black Africans, those agreeing with the statementjumped to 65 per cent, while only 22 per cent of upper-income white Africans agreed. Of all blackAfrican consumers surveyed, 71 per cent agreed with the statement: “I have to pay careful attention sostores do not cheat me.” In electronic goods, more than 60 per cent of black African consumers agreedthat “products with no brands or less-known brands might be unsafe to use.” In both cases, far fewerwhite consumers concurred.5According to Thakur, the South African automotive market was also witness to three other trends thatcontrasted white African and black African consumers. White Africans earned more and also spent more,4South Africa.info, “South Africa’s Population,” www.southafrica.info/about/people/population.htm, accessed August 18,2011.5Bronwen Chase et al., “A Seismic Shift in South Africa’s Consumer Landscape,” McKinsey Quarterly, June 2010,www.mckinseyquarterly.com/search.aspx?q=south Africa, accessed August 16, 2011.This document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 69B11M106leaving them with less disposable income to invest in discretionary purchases, such as automobiles. BlackAfricans earned less but also spent less and seemed to have higher disposable incomes. Second, whiteAfricans were buying used vehicles rather than new vehicles although their brand preferences remained.Black Africans, on the other hand, were buying new vehicles. Third, white Africans preferred functionalattributes (such as good mileage), whereas black Africans preferred features, based on aesthetics, designand comfort, in their automobiles.M&M COMPANY BACKGROUNDM&M was founded as a steel trading company in Mumbai, India, in 1945, by two brothers, J. C.Mahindra and K. C. Mahindra. Two years later, M&M entered into automotive manufacturing bylaunching Willys, the iconic World War II jeep, on a franchise from Willys-Overland Motors, theAmerican maker of general purpose utility vehicles (UVs). Willys was the country’s first UV. Thecompany began manufacturing farm equipment in 1960. The UV and tractor platform gradually becamethe company’s core competence.The company had extended its core competence, over time, into the full spectrum of the automotive valuechain. By 2011, it was producing two-wheelers at one end, small turbo prop aircraft at the other, andtrucks, buses, pickups and cars in between. Positioning itself on the platform of “motorized mobility,” thecompany had also started making powerboats, securing a presence in the transportation media across“land, sea and sky.”The mobility platform had generated opportunities for synergies across the company’s auto categories.Broadly, they prevailed in sourcing, product development and quality control. Common for all productswas the use of raw materials such as steel and aluminum, which were used in castings and forgings. Theautomotive and tractor divisions had a common engine development team. The processes for qualityimprovements at the supplier end were uniform across categories. Synergies also prevailed at the level ofoperations. For example, transmissions and other aggregates were shared between different vehicles.M&M had also diversified into unrelated areas branching into financial services, information technology(IT), hospitality, infrastructure and other areas. The group was in a total of eight businesses (see Exhibit5). Each business operated autonomously under its own CEO. Some of the CEOs were members of theGroup Executive Board of the parent company. Each was a growing business in an emerging market likeIndia. The group had 45 operating companies, some of which were listed on local stock exchanges.M&M was one of India’s leading multinationals and had 113,000-plus employees, of whom 12 per centwere foreigners and Indian expatriates, located across 79 countries. It had consolidated revenues of 6370billion for the year ending March 2011 and profit before tax of 45 billion (see Exhibit 6). The group wascash flow positive. It had $650 million surplus and internal accruals were growing every year.BUSINESS MODELThe business model followed by M&M was rooted in what the company called “engine theory.” Theparent company was viewed as an engine with multiple pistons. Each business vertical was in the natureof a piston. For example, the automotive sector was one piston, IT was another and so on. Each pistonwas a driver in its own right, focused not only on what it did best but also on improving the performance6Indian rupee (₹44.9908= 1US$), www.exchange-rates.org/Rate/USD/INR/5-20-2011, accessed November 16, 2011.This document is authorized for use only by Megan Cameron in AMBA 660-1 taught by Rosemary Hartigan, University of Maryland – University College from August 2015 to December 2015.For the exclusive use of M. Cameron, 2015.Page 79B11M106of the engine. The more verticals the company added, the longer and stronger the crankshaft grew. Eachvertical was also receiving the horizontal benefit, or the crankshaft benefit, of group synergies that, inturn, improved its performance. Each vertical was free to form joint ventures to acquire new skills andleverage sourcing, manufacturing and technology of partners outside M&M.The company had mandated what it called the “50 per cent rule” for each business, wherein even ifdemand fell by as much as 50 per cent, each business had to remain profitable. The objective was not onlyto provide enough room for business cycles, global shocks and other external factors but also to create amultiplier effect when volumes grew in times of more consistent activity.The analyst community was treating M&M as a conglomerate on the ground that it had ventured, over theyears, into newer businesses, which they considered to be non-core areas. While valuing the company,analysts were, therefore, giving it a conglomerate discount of 10 to 15 per cent. But the management ofM&M saw the group as a federation of independent companies, benefiting from both business focus andgroup synergies. It was of the view that unlike a conglomerate, M&M provided an opportunity forinvestors in the parent company to participate in the equity of distinctive businesses that were creatingshareholder value. Thus, according to the management, M&M should have received a federationpremium, instead of a conglomerate discount.The parent company saw its role as an allocator of capital. The group was trying to find a sweet spotbetween being a private equity firm (which juggled a diverse portfolio of investments and used leverageto create short-term value for each investment) and a family-run conglomerate (which focused on skilldevelopment and took a longer-term view of business).AUTOMOTIVE PRODUCTSIn addition to the production facilities that had become part of M&M as a result of acquisitions over theyears, both in India and overseas, M&M had six assembly plants outside of India and nine manufacturingplants of its own within India. The company had an 88,…

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