Control of vendors to help Maruti Suzuki check Gujarat costs

Written by Roudra Bhattacharya | New Delhi | Updated: Jan 30 2014, 15:26pm hrs
MComponents supplied by vendors account for 80% of vehicle cost. PTI
BY retaining charge of vendor relations at the new Gujarat car factory to be set up by its Japanese parent Suzuki Motor, Maruti Suzuki India will ensure that the cost of producing cars there remains on par with its own two plants in Haryana.

Since components from suppliers amount to 80% of the cost of a vehicle, combining sourcing for Gujarat operations with its own plants in Haryana will help Maruti keep production costs low by deriving benefits from higher economies of scale. Maruti currently has an annual capacity of 15 lakh units across its two plants in Haryana, to which Gujarat will initially add 2.5 lakh units by early 2017 and take it up to almost 18 lakh at full capacity.

Maruti chairman RC Bhargava told FE: Around 80% of the value of a car is sourced from vendors; so, that will be done by Maruti and not by Suzuki Motor Gujarat (SMGPL) directly. He added that over the next 2-3 months, Maruti will sign several agreements with its new Ahmedabad-based affiliate.

The first pact will be a 15-year contract manufacturing deal which will decide how the fair price of cars sold to MSI will be arrived at, while other agreements will decide the terms for leasing out Marutis 1,190-acre Gujarat land to SMGPL, apart from HR and vendor support. All transactions will be done at an arms length basis.

The pricing of cars sold by SMGPL to MSI will take into account the cost of material, labour, electricity, depreciation of equipment and other consumables, but not include any profits.

The pricing of cars sold will be based on the contract manufacturing agreement, Bhargava said.

Senior and mid-level management from both MSI and SMGPL will also maintain daily contact and meet at frequent intervals to make sure there is no mismatch between production and market demand. At present, the industry practice is that production plans are decided a month in advance by the marketing teams on the basis of demand forecasts.

Just as we inform our plants in Haryana right now, we will be giving production targets to the Gujarat plant and pick up as many vehicles as they produce. However, since there will be two companies, very close coordination will be needed; so, they will have to meet regularly, Bhargava said, adding that a formal structure for such interaction is yet to be decided.

SMGPL, which will invest R3,000 crore initially will be headed by N Aizawa, deputed by SMCs Japan office, who is likely to be made MD for the new entity. Other managers, plant supervisors and workers will either be deputed from or transferred from MSI.

However, supply of cars from the Suzuki-owned plant to Maruti could potentially attract provisions of Sections 92B (A) and 40 (A) 2 of the Income Tax Act, experts said, adding the applicability of the same would hinge on the structure of the arrangement between the two entities. If both entities are taxed at the marginal rate of corporate tax applicable to domestic companies (that is, if neither enjoys a tax holiday or exempt status or a concession), then under current circumstances, the taxman may not have a reason to suspect an erosion of tax base, says Rajiv Chug, partner, EY.

While Section 92 B (A) introduced last year extended the concept of transfer pricing to transactions between domestic entities, Section 40 (A) 2 gives the assessing officer the power to disallow a deduction if she feels the expenditure claimed by the assessee in transacting with an entity with, say, a common shareholder base, is excessive or unreasonable having regard to the fair market value of the goods, services... As the two are partners in business and could have common/related directors, the section can be invoked with regard to Suzukis supplies to Maruti Suzuki from the formers proposed wholly-owned plant. The taxman needs to be satisfied that the expenditure that Maruti could claim in buying cars from the Suzuki plant is not excessive or unreasonable.

On Tuesday, investors had reacted adversely to the news of SMC setting up a new subsidiary for the Gujarat plant, with the companys share price closing down 8.12%. However, on Wednesday, the Maruti scrip recovered to close up 7% at Rs 1,674.35 on the BSE.

What has foxed analysts is the rationale behind such a structure. According to the Maruti management, the basic reason is that SMC has surplus cash which earns it less than 1% interest in Japan. The other alternative of providing soft loan to MSIL could have run the risk of currency fluctuation; so, the current arrangement is the best.

A Kotak Securities report said: In the first phase of project (in the next 3-4 years), there will be no negative impact on the companys financials. On the contrary, MSIL can earn treasury income on savings from capex. After the first phase, further capex requirement would be funded by MSIL but the plant would be 100% owned by SMC (though MSIL will get depreciation benefit). Further, since the capacity expansion for the next many years is expected to happen at the Gujarat plant, MSILs dependence on this plant will increase significantly.