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Tyre economics

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A report on Tyre Economics

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									 MANAGERIAL ECONOMICS


          PROJECT




        Group No: 08
        IBS Hyderabad
          Batch 2010
          Section E




         TYRONICS

                         SUBMITTED BY:
                         Shashank Jain (08BSHYD0750)
                         Nikhil Mehta (08BSHYD0492)
                        Mahima Srivastava (08BSHYD0395)
                         Deepika Mittal (08BSHYD0222)
                         Sakshi Goenka (08BSHYD0706)



   Under the supervision of

   DR. C.S SHYLAJAN
(Prof. Managerial Economics)
      IBS Hyderabad

     1st September 2008
CONTENTS

Acknowledgements ............................................................................................................................................................................. 2

The TYRE INDUSTRY- An Abstract ....................................................................................................................................................... 3

Methodology ....................................................................................................................................................................................... 4

Introduction ........................................................................................................................................................................................ 5

Supply and DEMAND ........................................................................................................................................................................... 5

SUPPLY AND DEMAND OF NATURAL RUBBER SUPPLY ........................................................................................................................ 6

demand classification .......................................................................................................................................................................... 8

Tyre Demand by Markets .................................................................................................................................................................. 10

Factors affecting supply and demand of tyres .................................................................................................................................. 11

Demand Supply Gap .......................................................................................................................................................................... 12

Elasticity of tyres ............................................................................................................................................................................... 12

CONSUMER Behavior ........................................................................................................................................................................ 13

Production Analysis ........................................................................................................................................................................... 18

Effect of technological progress ........................................................................................................................................................ 19

COST ANALYSIS .................................................................................................................................................................................. 21

Analysis of margin to variations in raw mterial cost and tyre prices ................................................................................................ 23

MARKET STRUCTURE ......................................................................................................................................................................... 24

OLIGOPOLISTIC INDIAN TYRE INDUSTRY ........................................................................................................................................... 25

CARTELS AIMING AT JOINT PROFIT MAXIMIZATION ......................................................................................................................... 27

ATMA (Automotive Tyre Manufacturer’s Association) ..................................................................................................................... 28

BRIEF ON MAJOR PLAYERS ................................................................................................................................................................ 29

Conclusion and Recommendations ................................................................................................................................................... 30

Bibiliography & REFERENCES:............................................................................................................................................................ 31




                                                                                                  1
ACKNOWLEDGEMENTS




We would sincerely like to thank Dr. C.S.Shyalajan (Managerial Economics, IBS Hyderabad) for giving us
the opportunity to work on this report and helped us in understanding the methodology that we should be
following in carrying out the task.

We thank our friends who participated with their inputs for the report.

We thank the management of IBS Hyderabad where the report was made and who allowed us to work extra
time during the weekends to get the report done in time.




                                                                                 TYRONICS
                                                                             (SHASHANK JAIN)




                                                      2
THE TYRE INDUSTRY- AN ABSTRACT



The origin of the Indian Tyre Industry dates back to 1926 when Dunlop Rubber Limited set up the first tyre company
in West Bengal. MRF followed suit in 1946. Since then, the Indian tyre industry has grown rapidly.

Tyre, Natural Rubber, Transportation and Road network Industry go hand in hand as these are interdependent
and complementary industries from microeconomic perspective.

Transportation industry has experienced a 10% growth rate year after year with an absolute level of 870 billion ton
freight.

With an extensive road network of 3.2 million km, road accounts for over 85% of all freight movement in India.
Hence need and significance of tyre industry cannot be denied which is increasing at CAGR of 15 % every year.

.




                                                          3
METHODOLOGY




     We have analyzed Tyre Industry from analysis of supply and demand situation and have discussed elasticity
     of tyres in long run and short run.

     We also discussed all internal and external factors affecting supply and demand equation.

     The impact of tax changing the price and quantity demanded and the environmental analysis taking help
     of Porter’s Model is also dealt.

     It’s a capital intensive industry so corporate consumer’s behaviors is discussed.

     We have analyzed total costs that is incurred in production of tyres and components costs that are involved
     in production process and its impact on supply if tyres

     Then, we discussed tyre industry operating in a competitive environment and how income and pricing
     factors of production change overall dynamics of the Indian Tyre industry




                                                      4
                                     “Tyres never Tire”


INTRODUCTION

     The origin of the Indian Tyre Industry dates back to 1926 when Dunlop Rubber Limited set up the
     first tyre company in West Bengal. MRF followed suit in 1946. Since then, the Indian tyre industry
     has grown rapidly.

     Tyre, Natural Rubber, Transportation and Road network Industry go hand in hand as these are
     interdependent and complementary industries from microeconomic perspective.

     Transportation industry has experienced a 10% growth rate year after year with an absolute level of
     870 billion ton freight.

     With an extensive road network of 3.2 million km, road accounts for over 85% of all freight
     movement in India. Hence need and significance of tyre industry cannot be denied which is
     increasing at CAGR of 15 % every year.



SUPPLY AND DEMAND



   There are a lot of complicated upheavals in supply-demand and prices of natural rubber in the 1990s.
   In the years of 1995 and 1996, the rubber price rocketed to a peak (some US$1,500 per tonne). The
   major reason was the global economy was growing, especially Asian countries; on the other hand
   because China took over Hong Kong, its rubber import increased sharply from 350,000 to 502,000
   tones. However, in 1998 and 1999, the rubber price fell to the bottom in the past 30 years, some
   US$570-680/tonne for 3L category (FOB price). The event was attributed to the East Asian monetary
   meltdown and the members’ delay in contribution to the warehouses of INRO. These upheavals made
   the worlds as well as Vietnamese rubber producers confused. It was argued that the development of
   rubber trees in Vietnam should be reconsidered and whether the cultivation area would be increased.
   The investment strategy for rubber development needs restructuring. Although the rubber market
   showed many good signs in the last six months of 2000, the development of Vietnamese rubber trees
   still leave a lot of worries.



   To shed light on the above matter, we would like to present the following analysis about the trend of
   supply-demand and prices of natural rubber in the world and is also valid in India because in
   globalization no country is left by changing macroeconomic factors.




                                                   5
TYRE INDUSTRY Is dependent on rubber industry which is catalyst in production of rubbers and
hence tyres demand can be called as Derived Demand. So to study supply and demand equation for
tyres we have to uncover factors affecting supply and demand of natural rubber supply.



 SUPPLY AND DEMAND OF NATURAL RUBBER SUPPLY

The natural rubber supply depends on many factors such as the trend of increasing area and
productivity, and the natural disaster of the world's major rubber producing countries. However, if
the extraordinary

Events are excluded; the rubber supply is based on the trend of increasing area and productivity
of the world's major rubber producing countries.

1. The trend of increasing rubber area

- Thailand and Indonesia: their growing area has to be earmarked for many non-rubber plants on
but because of increasing speed of urbanization and lack of labor, there is no significant change in
rubber growing area in the time to come.

- China, India, and Vietnam: there will be a rise in their rubber growing area in future, it is
estimated that their combined area will soar by 400,000-500,000 hectares in the 2001-2010
period.

-- American countries: their rubber area will jump by 1.5% to 2% in the next 10 years.

Conclusion: The world's rubber growing area may climb by 5 to 6% in the next 10 years.

So supply side from India is going to be good.

2. Productivity trend

The rise in rubber output depends on many factors such as strains, tapping techniques, aging of
gardens. According to the Association of Natural Rubber Producing Countries' (ANRPC) experts, the
world's growth rate of rubber output is sustained at 2% in the next 10 years.

The supply of tyres in its industry depends on factors like

   •   Raw material intensity,
   •   Cyclicality, competition,
   •   Wide distribution network,
   •   Capital intensity,
   •   Low bargaining power,
   •   Branding,
   •   Technology requirements,


                                              6
       •   Margins and duty structure.

    Demand drivers for this industry are:

       •   Vehicle production
       •   Population,
       •   Regulatory norms,
       •   Retreading of tyres
       •   Automobile sector
       •   State of economy
       •   Logistics industry

    Changes in the economy have direct fallouts on the commercial tyre segments, not in the passenger
    car segment. Yes, the government infrastructure initiative the Golden Quadrilateral should provide
    the tyre industry with some consistent demand, in the coming years.

    Demand for tyres: The demand of tyres in a particular market is determined by the vehicular
    population in that market. However, the ownership patterns are now slowly changing, especially in
    the metros, dual and triple ownerships are rising affecting the demand of tyre majors.



    Growth of Automotive Market Drives the Indian Tyre Market

    The Indian tyre aftermarket is experiencing significant growth due to a combination of factors such
    as,
•   High vehicles across all categories
    India’s vehicle population grew at an average of 10.5 percent per annum from 2000 to 2005

•   Increasing industrial activity
    Rising industrial activity has led to greater demand for commercial vehicles (CVs) to transport raw
    materials and finished goods

•   Rising rate of radialization
    Demand for tyre replacement in this segment is likely to be particularly high due to pervasive
    problems such as irregular loading patterns and poor vehicle maintenance

    According to research, improper vehicle maintenance and excessive loading of CVs are major
    drivers of the Indian tyre aftermarket. While the former has a detrimental effect on the tyre and
    shortens its life, the latter causes irregular tyre flexing and excessive heat generation within the
    tyre, ultimately leading to tyre failure. However, the popularity of retreadable tyres in the CV
    segment could pose a significant challenge to tyre manufacturers on the replacement front.




                                                  7
DEMAND CLASSIFICATION



  The demand for tyres can be classified in terms of:

   ▪     Type: Bus and Truck; Scooter; Motorcycle; Passenger Car; Tractor

   ▪     Market: OEM; Replacement; Export




                               (Supply and demand graph for tyre industry)



  Tyres by Type

  The Indian tyre industry produces the complete range of tyres required by the Indian automotive
  industry, except for aero tyres and some specialized tyres. Domestic manufacturers produce tyres
  for trucks, buses, passenger cars, jeeps, light trucks, tractors (front, rear and trailer), animal drawn
  vehicles, scooters, motorcycles, mopeds, bicycles and off-the-road vehicles and special defence
  vehicles.

  The scenario in India stands in sharp contrast to that in the world tyre market, where car tyres
  (including light trucks) have the major share (88%) by volume followed by truck tyres (12%). In
  India,

  However, passenger car tyres have a mere 17% share of the overall tyre market (as of FY2003).




                                                     8
                                               (Fig 1)

Truck and Bus Tyres

The truck and bus tyre segment accounts for 19% of tyres produced in India. Every truck/bus
manufactured generates a demand for seven tyres (six regular and one spare) as against three in
the case of two-wheelers and five for passenger cars. In addition, the price of a truck tyre is
significantly higher than that of a passenger car tyre (roughly 10 times) or a motorcycle tyre. Thus
the demand emanating from the commercial vehicle segment is highest in value terms.


Passenger Car Tyres

The passenger car tyre segment accounts for 17% of all tyres produced in India. With passenger
car production witnessing a growth of 12% annually over the previous year, OEM demand
accounted for about 33% of the total sales that year. The replacement market accounted for
around 63% of the total sales of passenger car tyres in FY2003. Exports accounted for 4% of the
total passenger car tyre demand in FY2003. With the stock of cars increasing, replacement demand
is likely to continue.

Motorcycle Tyres

Motorcycles and scooter tyres accounted for 76% of two-wheelers sold in the domestic market in
India.




                                                  9
TYRE DEMAND BY MARKETS




                                               (Fig 2)

Replacement Market

The replacement market, including State transport undertakings and Government buying,
accounts for around 59% of the total tyre demand .The demand in the replacement market
depends on the vehicle population, the level of economic activity, life of the products transported,
kilometreage per vehicle, the price of the tyres and the quality of the existing road infrastructure.
Additionally, the replacement market, which offers better margins, is extremely competitive. The
replacement market is dominated by the truck and buses segment, which accounts for 22% of all
tyre sales in the replacement market.

The large size of the replacement in turn is determined by the interplay of various factors as
discussed below:



▪        The replacement demand may be lower because of longer replacement intervals and
         lower business mileage if the economic activity slows down.

▪        Replacement demand in India is higher because of a low vehicle scrap page rate.

▪        Poor road conditions by lowering the life of tyres have a positive impact on replacement
         demand.

▪        Stricter enforcement of the MV Act, which seeks to prevent overloading of vehicles, will
         result in an increase in the life of tyres and thus impact replacement demand negatively.

▪        Applying a new tread or "re-treading" can extend the life of the tyre at a significantly
         lower cost, thereby lowering replacement demand. In India, re-treading finds greater
         acceptance in the commercial segment.

▪        Radialisation of tyres is likely to result in lower replacement demand. While car
         Radialisation in the country has reached a level of 65%, truck and bus radialisation stands
         at just 2-10%.

         Poor road and support infrastructure as well as traditional vehicle designs act as a barrier

                                                 10
          to Radialisation in the commercial vehicle segment. Radial technology for trucks and
          buses would help increase operating efficiencies by delivering better mileage and
          minimizing wear and tear. According to ATMA, even if only 25% of the truck and bus
          segment is radialised, the savings in fuel costs would be around Rs. 7,500 million.

▪         Introduction of tubeless tyres in the passenger car segment is also likely to affect
          replacement demand adversely.

▪         Introduction of eco-friendly radial tyres such as hyper-bonding silica technology in the
          passenger car segment may affect replacement demand adversely.



Exports

Indian companies have currently entered into sourcing agreements (for tyres) with neighbouring
countries. For instance, Ceat and J K Tyres have sourcing agreements with tyre producers in Sri
Lanka and China. This is likely to have a positive impact on tyre exports from India.

Market Players

Some of the major players in the Indian tyre industry are MRF, Ceat, JK Industries, Apollo Tyres,
Bridgestone India, Goodyear India, Falcon Tyres and TVS Srichakra. The tyre industry in India is
fairly concentrated, with the sample of eight companies accounting for 82% of production in
FY2002.


FACTORS AFFECTING SUPPLY AND DEMAND OF TYRES

High tax usage

The high tax content on tyres affects production capacity and hence affects supply of tyres

Tax structure is: 44% for Truck Tyre; 41% for Passenger Car Radial Tyre, 35% for Tractor Rear Tyre
and 76% for Truck Tyre Tube.


Increase in raw material costs

The tyre industry is highly raw material intensive. Any change in the prices of raw materials affects
the profitability of tyre companies. The raw materials used in the manufacture of tyres are rubber
and petroleum derivatives like nylon tyre cord, carbon black, styrene butadiene rubber and poly
butadiene rubber. The most important raw material is rubber-natural and synthetic. Natural
rubber (NR), with 29% weight age in the cost of raw materials used by tyre industry, is the highest
cost item.


Import of tyres

Even though the Government has imposed a restraint on the import of used tyres into India,

                                                  11
occasionally there are reports of import of such tyres in a clandestine manner, sometimes as new
tyre at low value, since there is no restriction on import of new tyres or as tyres under the "others"
category. Many countries such as Japan, Bangladesh, Pakistan, Philippines, Thailand, Kenya, South
Korea, etc. have either put a complete ban on import of used tyres or have placed stringent
conditions on such imports.

Tyre Exports

The product focus of tyre exports from India has been Traditional Truck Tyres. Globally this
segment of tyre export is shrinking due to greater acceptance of radial tyres. Over the years, China
has emerged as a major exporter in bias tyre category. Additionally, export of Indian tyres to select
countries is subjected to non-tariff barriers (NTBs) by way of standards, tests, etc. India's share in
exports to these countries (especially USA) is progressively declining. If the trend is not reversed,
Indian tyre industry will find it extremely difficult to regain its erstwhile position in these markets.



DEMAND SUPPLY GAP

The demand for tyres is either in the domestic market or in the export market. As far as domestic
demand is concerned, the OEM and the replacement segments are likely to witness strong growth
given the current performance of the automotive sector. Given the strong linkages of tyre industry
with automotives, its demand is likely to be strong over the short to medium term. As for the
export demand for tyres, the outlook is positive, even though some downsides remain.

Thus, the demand-supply gap is likely to be an important issue for the Indian tyre industry over the
short to medium term.



ELASTICITY OF TYRES

Tyres have unitary elasticity.

Even though tyres are a want if we drive a car, the decision to buy them is not as immediate as
buying gas (unless we have a flat and must buy one to get back on the road). You can shop
around for the best price as there are a number of brands and stores that sell tyres. You can buy
new or used tyres so you have some substitutes. So even though we think of tyres as wants,
there is a greater flexibility in buying tyres than in buying gasoline. This contributes to the higher
elasticity of tyres .




                                    Approximately Unitary Elasticity
                                    Tyres, short-run                   0.9
                                    Tyres, long-run                    1.2


                                                      12
Complementary goods are those that are normally used in conjunction with each other, such as
cars and car tyres. An increase in the price of tyres would lead to a reduction in the demand for
cars. Whereas a reduction in price would produce the opposite effect.

The increase of the price of automobiles will cause fewer automobiles to be purchased, and thus,
fewer tyres as well. The relationship between the price of automobiles and the quantity of tyres is
inverse.



So we can determine now Automotive industry, Truck and Bus industry is dependent on Tyre
industry and hence are complementary.




CONSUMER BEHAVIOR

Total Utility: Total utility refers to the total satisfaction derived from all the units of a commodity.

Marginal Utility: The extra satisfaction that a consumer receives by consuming an extra unit of a
good is marginal utility.


                                     MU = ∂(TU) / ∂Q




Law of diminishing marginal utility states that the marginal utility of goods tends to decline as
more of a good is consumed over a definite period of time as the satisfaction derived from each
additional unit decreases.

Analysis:

In the tyre industry, law of diminishing marginal utility doesn’t apply. The utility derived from each
additional unit need not decrease. Because the consumer (automobile industry) is just concerned
about the final working condition of the car or any automobile, if the car is working in existing
situation then consumer won’t buy else they will have to take the plunge. The automobile industry
is just concerned about the overall working of car which the consumer is ready to accept.




                                                   13
CONSUMER SUPRLUS:

This is the difference between the amount we are willing to pay and what we actually pay (i.e. the
market price for the product). The level of consumer surplus is shown by the area under the
                                                                                     page:
demand curve and above the ruling market price as illustrated in the diagram on next page




                                  enotes
In the figure given above, Price denotes the actual price which the automobile industry is willing to
pay but they have to pay just P1. And the shaded area represents the consumer surplus.



                                    material
 “The tyre industry is highly raw-material intensive, with raw material costs accounting for
 70 per cent of the cost of production. Fortunately for the industry, the rubber and carbon
 black prices have taken a beating recently, which means lower costs for the tyre
 industry”.

The reason being there has been decrease in prices of raw materials of tyre industry. So tyre
industry would not mind supplying tyres to automobile, transport sectors at the same price as earlier
or even a bit lower.




                                                 14
In Fig given above, Pw denotes the price charged by tyre industry for its tyres. So we see that the
amount of consumer surplus is the triangle above Price Pw. And consumer is buying Qw units here.

“d” represents the dead weight loss.

“a” represents the producer’s surplus.

Pwo represents the price that consumer is willing to pay for the tyre.


The tyre industry has been severely hit by rise in input costs and even a price hike by 25% has not
helped it tide over the losses, according to PK Ruia, chairman of the Ruia Group that runs Dunlop
India Ltd, Falcon Tyres and Monotona Tyres. After the 81 st annual general meeting of Dunlop
India, Ruia told reporters that with the rubber prices going up from Rs 90 per tonne to Rs 140 per
tonne and other input costs also escalating, production cost has gone up by more than 60% in the
last four months.

Inferences:-

   •   Increase in tyre price leads to increase in prices of automobiles.
   •   Now the consumer has the choice to buy or not to buy new cars according to his budget.
       May be they would prefer to wait till the prices come down.
   •   So this modifies the demand for automobiles and hence tyres.
   •   This leads to shift in supply curve and hence new equilibrium is reached at a higher price
       and less quantity.

   Conclusion: Both Tyres and Automobiles are complements.




                                                  15
INCOME CONSUMPTION CURVE (ICC)

Concept:

ICC represents the locus of different control equation points resulting from change in Money
Income keeping the relative price ratio constant.

Analysis:

In the tyre industry, the ICC is a relatively vertical line as any change in income has a very minimal
effect on the consumption. As the price of tyre increases a consumer would avoid buying another
tyre because the number of tyres required by the automobile remains constant. We can observe this
in the given figure that a decrease in income leads to an inward shift in Budget line from AB to A 




B. Equilibrium changed from e to e .




PRICE CONSUMPTION CURVE (PCC)

Concept:

Price Consumption Curve represents the locus of different controls equilibrium point resulting from
change in the relative price ratio keeping the Money Income constant. In simpler words, along PCC,
Money remains same but relative Price ratio changes.

Analysis:

In the Tyre industry, the PCC is a relatively vertical line as shown in the figure. An increase or

                                                    16
decrease in the price has a very minimal impact on the consumption. An increase in price would not
have much impact on the consumption of tyre in automobile industry. This can be observed from
the diagram, with increase in price, the budget line shifts inwards from AB to AC. The initial
equation is at e, where consumption is at Q1 and the final equilibrium is at C2 where the
consumption is at Q2. With an increase in price, there have been minimal or no change in quantity
consumed.




                                  PCC




                                                             B     Quantity
                                Tyre




Income Effect - Income effect describes the effects of changes in prices on consumption.
According to the income effect, an increase in price causes a buyer to feel poorer, lowering the
quantity demanded, and vice versa. Although the buyer's actual income hasn't changed, the change
in price leads to buying the same quantity of a good at a lower price and this leaves consumers with
more income left over. Some of this income will then be spent on buying more of it, so the total
quantity bought rises.


Substitution effect: - The substitution effect measures the change in the purchase of a good, which
arises out of the change in its relative price alone. Substitutes are the product that can replace the
actual product in terms of utility. In substitution effect, utility remains constant whereas the price
changes. Tyre is a segment where the determination of substitution effect is not possible as there is
no substitute available.


       Price effect: - Price effect is equal to the sum of income effect and substitution effect.

                                                  17
PRODUCTION ANALYSIS



  The major inputs in production of tyres are: Raw materials

  Raw materials                          By Value (%)                       By Weight (%)
  Rubber                                 52                                 49
  Carbon Black                           23                                 10
  Nylon tyre cord                        8                                  24
  Chemicals                              15                                 12
  Others                                 2                                  5
  Total                                  100                                100

  For production analysis we can consider major inputs like Rubber and carbon black where
  production analysis can be studies keeping one factor of production constant.

  A company will always operate in increasing returns to scale. In long run manager can vary all
  factors of production to have total product curves.

  The production analysis of any industry involves the transformation of its factor inputs into factor
  outputs. The factor input can be anything from labor, raw material; cost ect.The production
  function represents the technology of an industry and gives the picture of economy as a whole of
  that industry.




                                               18
    In tyre industry, the factor inputs are cost of production of the tyre, availability of rubber, crude
    oil, and labor cost. The process of production is technically efficient if it uses it’s at least one factor
    or more than one factor in less quantity.



    In the case of tyre industry, if we take availability of raw material as one factor input, say X and
    plot it against output, say Y, we get a production curve which is shown below




EFFECT OF TECHNOLOGICAL PROGRESS

The other very important factor in production analysis of any industry is technology.
Technological change may involve innovation of new products, improvement of cost reductions
for existing products, or better ways of managing the operations of that industry. As knowledge
of new and new efficient methods of production become available, technology advances. The
advancement in technology can range from being very simple to very complex.

In case of tyre industry, new technological innovations have resulted in better functioning of
tyres, increased level of satisfaction among customers’ and increased customer loyalty.
Technological advancement also ensures decrease in production cost by increasing economies of
scale i eif technology improves then more number of units can be produced in less time and less
cost as labor charges can be decreased by increasing use of technology.

For example radialisation of tyre is considered to be one of the most important advancement in
tyre technology.

Major players in tyre industry like MRF and JK tyres have already gone in to full fledged radial
tyre production. Radial tyres , as described later in the report, are more efficient and more safe
for Indian roads. But one drawback of a technology advancement is that it is always

                                                    19
accompanied by increase in price, which makes the consumers all the more apprehensive to try
the new product. But in the long run the consumers benefit from it as it is obviously better than
the old tyre and even the cost reduces following the economies of scale.




In the above graph, output is on the y axis, input is on the x axis. The production function shifts
upwards because of the technological progress. This indicates that higher level of output can be
obtained with the same level o input .hence technological progress can be a major factor in
increasing labor productivity.



The law of returns to scale:
The law of returns to scale refers to the long run analysis of production. It refers to the effect of
scale relationships which implies that in the long run output can be increased by changing all the
factors in same proportion or by different proportions. There can be three types of returns to
scale constant return to scale (CRS), decreasing returns to scale (DRS), and increasing returns to
scale (IRS).

In tyre industry, there are many factor inputs which can be variable in the long run as well as in
the short run. The long run is the period of production which gives managers adequate time to
vary all factor inputs whereas, short run is the production time in which in which only one or
none factors can be varied. In case of tyre industry, technological advancement, innovation of
new products, price of crude oil and inflation rate are long run variables. The short run variables
include capital of the firm and availability of skilled labor.




                                                   20
So if we increase or change factors of production in tyre industry also We can gain a clearer
understanding of returns to scale by examining diagrammatically via isoquants as in the above
figure. We can assume a two-input, one-output production function, Y = (L, K). Consider a factor
configuration denoted by (K*, L*), which yields output Y =Y*, as noted by point e in Figure. If we
increase both capital and labor by the factor then notice that we obtain a new factor
configuration (p* K*, p* L*) which yields output Y = p*Y*, as noted by point e in Figure. This
"increasing scale" is represented by a movement along the ray from the origin with slope L*/K*.




COST ANALYSIS



Description of raw materials from cost point of view

Natural Rubber: Natural Rubber accounts for nearly 50% of the value of the tyre. In India mixture
of both natural as well as synthetic rubber is used for making tyres. India’s 90% of the rubber



production comes from Kerala. Annual consumption of NR by tyre industry is 3.50 lakh tonnes,
valued at Rs. 14 billion. Over 85% of natural rubber consumed' by the industry is procured
domestically. 15% is imported. However the tyre industry, that consumes 57 per cent of the
natural rubber produced in the country, is facing the worst ever raw material crisis. But
fortunately, recently natural rubber prices have witnessed a drop of more than 25% from peak
levels of Rs11, 100 per quintal on

June 3, 2006 to Rs8, 225 as on September 16, 2006. With rubber accounting for almost 50% of

                                                  21
the total raw material expenditure for most of the companies, this nosedive in prices will bring
about a sharp improvement in operating margins. Margins may further be increased by the

recent price hikes that has been done by the tyre companies in order to counter the rising price
of other raw material (Although the companies are expected to take a rollback but the extent
would be lower than the hike taken in the recent past.)




Carbon Black - Carbon black is a key raw material used in the manufacture of automotive tyres.
More than 70 per cent of the demand for carbon black is from the tyres segment. Truck tyres
consume 20 Kgs of carbon black per tyre, while smaller tyres like Maruti consume 1.5 Kgs.
Overall approximately 60 – 65% of the carbon black produced in India is consumed by the tyre
industry. The upward spiral in the crude oil price pushed up the prices of carbon black. The price
of carbon black firmed up by about 25 per cent compared to a year ago.

Nylon Tyre cord - Almost 90% of nylon cord manufactured in India is consumed by the industry.
The tyre cord fluctuates in consonance with the prices of caprolactum, its main input. Its price
has been moving around Rs 80/Kg in recent years.

PBR and SBR - The two types of synthetic rubber used in tyres are Poly Butadiene Rubber (PBR)
and Styrene Butadiene Rubber (SBR). The former is used in most of the tyres, while the latter is
mainly used in the radials for passenger cars. Synthetic rubber accounts for 9 per cent of the raw
material cost. Unlike in the case of natural rubber, India imports 60 per cent of its synthetic
rubber requirements.

Effect of increase in raw material price

 Tyre companies usually have a fixed per-unit cost with auto majors. Which means, even if the
raw material price shoot up, they have to bear the brunt of it as the auto companies are
unwilling to share the increase in cost. Besides, the government is supporting the raw material
prices, which has already been increased substantially. All this has led to low profit margins in
tyre industry as compared to other industries.



                                                  22
ANALYSIS OF MARGIN TO VARIATIONS IN RAW MTERIAL COST AND TYRE PRICES




The scenario 1 provides basic cost structure of tyre manufacturing company.

The rubber prices have seen significant amount of volatility before reaching historical highs and
then dropping down sharply in the recent past. We will operating margin of 10 as 1000 basis
points.

In the scenario 2, we have taken into account a 10% rise in rubber price (other factors remaining
the same) and its impact on operating margins, which has shown a decrease of 500 basis points.



The volatility in crude oil price also plays a role in the movement of operating margins for tyre
manufacturers as the prices of carbon black and nylon tyre cord move in line with that of crude
oil prices. In the scenario 3 we have accounted for 10% rise in other raw material costs along
with a 10% rise in rubber cost. The net impact is 800 basis points fall in the operating margins
from that of the original cost structure.



Tyre manufacturers in order to sustain margins had to raise end product prices. We have
assumed 3% rise in prices for replacement market, 1.5% rise for the OEM (Original Equipment
Manufacturer) segment and 0.5% rise in the export segment. All this represents a cumulative
growth of 2.2% in sales, volumes remaining the same.



Consequently, in the scenario 4, with increased tyre prices and increased raw material prices,
Operating margins increased by 210 basis points as compared to third scenario but still lower
than the basic cost structure by 690 basis points.



Finally in scenario 5, we have considered recent fall in rubber prices and relaxing crude prices.
We have assumed 5% fall in rubber prices and 5% fall in prices of other raw materials. With
increase in prices already in place, the operating margin increases by 430 basis points to 840
basis points as compared to fourth scenario. However, it is still lower by 160 basis points as
compared to the basic cost structure.

                                                  23
   MARKET STRUCTURE




Indian Tyre industry has an oligopolistic market structure, in which a few sellers dominate the sales of a
product and the entry of new sellers, is difficult or impossible. Also this industry requires intensive capital
and great market network to have cascade profits. So it is very difficult for small start ups to sustain the
market.

Thus Indian Tyre Industry follows the features on Oligopolistic market as:

   •   Only a few firms supply the entyre market with a product that may be standardized or
       differentiated.
   •   At least some firms have large market shares and thus can influence the price of the product.
   •   The firms in the oligopolistic industry are aware of their interdependence and always consider the
       rivals’ reaction when selecting prices, output goals, advertising budgets and other business policies.
   •   The demand curve faced by oligopolistic firm represents different quantities of output that the firm
       can sell at different prices. When any firm changes its own price, rivals will also change their prices
       and as a result the demand curve faced by an oligopolistic firm loses its definiteness.
   •   The market is concerned with the group behavior and basically depends on the behavior of the
       members of the group.

       All these market characteristics are evident in the Indian Tyre Industry.

       Only a few firms supply the entyre market where some firms have large market shares and thus
       can influence the price of the product

       While the tyre industry is mainly dominated by the organized sector, the unorganized sector holds
       sway in bicycle tyres. The major players in the organized tyre segment are MRF, Apollo Tyres, Ceat
       and JK Industries, which account for 63 % of the organized tyre market. The other key players
       include Modi Rubber with 11%, Kesoram Industries with 7% and Goodyear India with 6% share.
       Dunlop, Falcon, Tyre Corporation of India Limited (TCIL), TVS-Srichakra, Metro Tyres and Balkrishna
       Tyres are some of the other players in the industry. MRF, the largest tyre manufacturer in the
       country, has strong brand equity. While it rules supreme in the industry, other players have created
       niche markets of their own.




                                                       24
                               Market Share in Tire Industry
                                Goodyear
                                  India
                                   6%           Others
                                                 18%

                                 Kesoram
                                Industries                MRF, Apollo,
                                   7%                     CEAT and JK
                                                             Tyres
                                Modi Rubber                  59%
                                   10%



                                                    (Fig 3)




OLIGOPOLISTIC INDIAN TYRE INDUSTRY

      The major tyre players fight to take the largest part of the cake i.e. the market share in the industry.
      For this they try to keep the price which has been determined on the basis of average cost
      principle, and would tend to remain rigid. The basic postulate of the average cost pricing is that the
      firm sets the price equal to the average total cost which includes not only average variable cost but
      also a gross profit margin. Thus they follow the kinked demand curve, which works on the
      following assumptions:



  •   There are many firms in the oligopolistic industry
  •   Each produces a product which is a close substitute for that of the other firm
  •   Product qualities and advertising expenditure are constant
  •   Each oligopolistic believes that if he lowers the price of his product, his rivals will also lower the
      prices of their products and that if he raises, they will maintain the prices at the existing levels.
  •   So, If the firm raises its prices it will lose some but not all of its customers. For the same reason if
      the firm lowers its prices it will not succeed in luring away all the customers of its rivals.




                                                         25
    The demand curve of an Indian tyre market which has settled to a prevailing market price.




    This is the so-called kinked demand curve of the oligopolistic market. Above the kink the demand is
    elastic whilst below it is inelastic. The best policy for the oligopolistic is to stick to the going rate and
    try to increase the market share using non-price variables hence oligopolies tend to have sticky
    prices.



    INDIAN TYRE INDUSTRY IS GOING THROUGH THE SAME SCENARIO

    Major Tyre manufacturers like Apollo, Ceat, MRF and JK Tyres are defending their market share
    from the onslaught of global majors by expanding capacity, which will take their combined capacity
    to 4.4 million units by 2010. As Bridgestone, Michelin, Yokohama, Goodyear and Pirelli are making
    inroads into the country's Rs 19,000 crores (Rs 190 billion) tyre market, local manufacturers are
    setting up new plants or expanding the existing facilities to take on the competition.

    Here are the few examples wherein company tries hard to have the larger piece of cake:

•   Apollo Tyres is investing Rs 320 crores (Rs 3.2 billion) to increase the output. The company is
    setting up a Greenfield radial facility in Tamil Nadu for trucks, buses and cars. Besides, it has
    planned an off-the-road tyre facility in Gujarat.
•   Ceat Tyres, the country's fourth largest tyre maker, will pump in Rs 800 crores (Rs 8 billion) to set
    up two facilities of 230 tonne/per day capacity. JK Tyres, which has reportedly bagged the order for
    Tatas' much-awaited Nano, will invest Rs 150 crores (Rs 1.5 billion) in a new plant.

•   MRF Tyres does not want to sit on its oars either and so is planning a new facility in Tamil Nadu.




                                                     26
      Global players, meanwhile, are betting big on their India plans, Michelin, Yokohama and Pirelli are
      eyeing local production. Bridgestone, which already has cornered the largest share in the
      passenger car radial category, is planning a truck and bus radial plant. It will invest $200 million for
      the Greenfield plant.

      Local players are trying to take the battle to the shores of the multinational players. This strategy
      also helps them reduce dependence on the domestic market.

  •   Apollo Tyres, for instance, will set up a 7 million units a year tyre plant, costing 200 million, in
      Hungary, which will also cater to the European and US markets.
  •   Ceat Tyres is setting up a dedicated export facility in India to cater to the Europe markets.

      The Indian market is growing faster than the US and European markets and consumes 75 million
      tyres per year. The industry has posted a 19-20 per cent growth in the last year. Within two years,
      according to ATMA executives, the market size will cross a whopping Rs 22,000 crores (Rs 220
      billion).



      Apollo Tyres Joint Managing Director Neeraj Kanwar said, "International players have given us a
      wake-up call. It will force us to improve our productivity and efficiency in terms of cost and other
      factors."



      In this kind of Oligopolistic market where competition is very intense and you have such large
      players price fixing becomes a major problem, so the going rate tends to be fixed by the larger
      firms acting by mutual consent or joining the collusion like ATMA i.e. (Automotive Tyre
      Manufacturer’s Association)



CARTELS AIMING AT JOINT PROFIT MAXIMIZATION

      Oligopolistic firms join a cartel to increase their market power, and members work together to
      determine jointly the level of output that each member will produce and/or the price that each
      member will charge. By working together, the cartel members are able to behave like a monopolist.
      The cartel members choose their combined output at the level where their combined marginal
      revenue equals their combined marginal cost. The cartel price is determined by market demand
      curve at the level of output chosen by the cartel. The cartel's profits are equal to the area of the
      rectangular box labeled abcd in Figure 3

       Note: That a cartel, like a monopolist, will choose to produce less output and charge a higher price
      than would be found in a perfectly competitive market.




                                                      27
                                                 (Fig 3)



      The Central Agency i.e. ATMA will set the price defined by the intersection of the industry MR and
      MC curves. Thus equilibrium condition prevails when MR = MC and the distribution of profits is
      decided by the central agency of the cartel.



                    E                ASS
ATMA (AUTOMOTIVE TYRE MANUFACTURER’S ASSOCIATION)


      This acts as economic agent in tyre industry.

      Apart from setting the price for the Indian Tyre Industry, the primary function of the Association is
      also to be an interface between Government Departments and the tyre companies in having two
      way communications. Further, the Association briefs its members of the changes in Government
                                                                               tyre
      Policy on issues related to Indian economy and industry in general and tyre industry in particular.

      The members of ATMA are;

  •   APOLLO TYRES LTD
  •   BIRLA TYRES
  •   BRIDGESTONE INDIA PVT. LTD.
  •   CEAT LTD
  •   FALCON TYRES LTD
  •   GOODYEAR INDIA LTD
  •   JK TYRE & INDUSTRIES LTD.
  •   MRF LTD




                                                    28
BRIEF ON MAJOR PLAYERS


     CEAT

     Being the second largest selling brand in India with a market share of 14.6 per cent, Ceat caters
     primarily to the replacement market. Due to the strong growth in the OEM sector, the share of the
     replacement market in the total revenue of the company has fallen.

      With the advent of multinationals like Goodyear, Michelin, Bridgestone and Continental, a major
     shakeout in the industry is imminent and the same could result in Ceat, which is already operating on
     thin margins. Ceat in collaboration with Goodyear has already promoted South Asia Tyres for
     manufacturing radial tyres in India.


     APOLLO TYRES LTD. (ATL)

     The company has traditionally been the market leader in the truck and bus tyres segments. ATL
     caters to the replacement segment of the domestic market. Following its takeover of Premier Tyres,

     ATL's market share has risen. Besides the core truck and bus tyre business, fairly considerable part
     of its turnover comes from automotive tubes and flaps, for which it has commissioned a plant in
     Pune.

     Despite a reversal in the fortune of the automobile industry, the chief user base of the company's
     products, the demand for truck tyres, particularly in the replacement market, was not encouraging.
     Even as tyre producers grapple with over-capacity and high levels of inventory, the government
     stirred a hornet's nest by proposing free imports of used and second-hand tyres. ATL has conversion
     agreements for small tyres with TCIL, Stallino Tyres and Radio. Its exports are routed through
     Apollo International to the US, Germany, Brazil, Sudan, Egypt, etc. A well-entrenched position in
     the replacement market, favours ATL and the declining price trend of key inputs like natural rubber
     and carbon black may provide relief to its wafer-thin margins. At the current price level the scrip has
     emerged as an attractive buy; thus accumulate its shares in small lots.




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