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Sino-US Trade War to Cause Ripple Effect of Implications in Auto Industry

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The whole world has its eyes on China and the USA as both nations are threatening to impose massive tariffs on each other in a ‘tit for tat’ trade skirmish. According to the Trump administration, the proposed tariffs are intended to punish China for pursuing its protectionist policies, currency manipulations, and alleged intellectual property (IP) theft. Fears of a possible full-scale trade war between the world’s two largest economies have caused global stock exchanges to plunge and cautioned investors as well as governments across the globe. There is no doubt that a trade war would not only hurt both economies, but it would also impact the overall global economy. As the proposed tariffs would pertain, amongst others, to vehicles and auto components, we are taking a look at potential implications this trade war might have on automotive industry in both countries.

Since his presidential campaign, president Trump has criticized China for pursuing protectionist policies, currency manipulations, and IP theft. In order to punish China for its current trade policies, and to reduce USA’s huge trade deficit with China, Trump proposed tariffs on approximately US$50 billion worth of Chinese goods coming into the country. Of these, approximately US$34 billion worth of Chinese goods including vehicles and auto parts will be subject to new tariffs starting from July 6, 2018, while the remaining US$16 billion are still under review.

The total automotive trade between the USA and China stood at US$33.9 billion in 2017. At present, in the USA, a 2.5% import tax is levied on imported vehicles and components. The current government proposes to raise this to 25% for vehicles and parts coming from China. China charges around 25% tax on vehicle imports from overseas, and now have threatened to add an additional 25% for vehicles built in the USA. Although these are just proposals for now, if they do get implemented, they will have implications on the entire automotive ecosystem in both countries, including carmakers, dealers, and auto parts manufacturers, and suppliers.

American companies won’t remain unaffected

A trade war with China will make domestic-made cars more expensive at home and less competitive in China. As a significant portion of the auto components and parts used by the US carmakers is sourced from China, increased tariffs will lead to increased production costs. Experts fear that OEMs will pass the increased costs onto the consumer. As a result, domestic auto sales are expected to witness a dip. Further, automakers based in the USA will become less competitive in China and may not be able to retain their current market share any longer.

Tesla is one of the companies that will feel the heat of higher tariffs. Chinese market accounted for approximately 17% of Tesla’s revenue in 2017. The company is already struggling to cope with the existing 25% import duties amid stiff competition from local rivals, such as BYD, NIO, and Byton, who have cheaper alternatives. American OEMs, such as Ford, GM, etc., fear that vehicles made by their subsidiaries in China and exported to the USA could end up being hit by the proposed tariffs.

Besides USA, German automakers such as BMW and Daimler will also be highly exposed since they are the largest vehicle exporters from the USA to China. Potential implications of the Sino-US trade war on companies mentioned above could lead to several job losses at US manufacturing plants. According to a report by Peterson Institute for International Economics, the trade war could result in loss of around 195,000 jobs over the next three years. Additionally, it will also impact other industry players such as auto component OEMs and suppliers, dealers, as well as local retailers.

Trade war could also hamper and limit US companies’ access to the Chinese automotive market, which is currently the largest market globally both in terms of production as well as sales. China is also the best-performing market in the world for electric vehicles (EVs) from sales, infrastructure, and government support perspective. With trade war in place, US companies could lose out to EU and other Asian counterparts on various market opportunities in China.

With trade war in place, US companies could lose out to EU and other Asian counterparts on various market opportunities in China.

Besides automakers, trade war will also have serious implications on auto parts manufacturers and suppliers as well. For example key tier-1 suppliers such as Lear, Delphi Automotive, Adient etc., rely heavily on China for their revenue. On the other side, there are many suppliers that rely on China for sourcing. China is also the largest trading partner for USA in tires. Exports in 2017 reached nearly US$2 billion, an increase of 28.2% as compared to previous year. If the proposed tariffs become reality, all these players will face business challenges on sales as well as supply-chain fronts.

Chinese companies will also face some implications

For the Chinese automotive industry, the trade war will impact mainly imported cars produced in the USA and domestic cars that use components from the USA. Since most cars sold in China are manufactured locally, the impact on Chinese auto OEMs will not be as significant as felt by their US counterparts. However, China is a major exporter of auto spare parts and components to the USA. In 2017, China exported auto parts worth US$17.4 billion to the USA. Thus, the trade war will heavily impact Chinese car parts manufacturers and exporters that rely on US business. On the EV front, new tariffs will raise the prices for parts and components imported from the USA. This in turn, will dampen the adoption of EVs due to higher initial costs and impact domestic EV sales.

Trade war is likely to hinder auto investments in China up to some extent as many companies might re-think their production and supply-chain strategies and put China investments on hold. For example, Ford has kept its plan to export Focus compact to the USA from China on hold due to the ongoing rift. Trade war will therefore impact local production as automakers serving USA market might scale down production in China. This might result in layoffs at local manufacturing units. In addition, trade skirmish with the USA will also create more obstacles for Chinese companies, such as Geely and GAC Motor, looking for market expansion in the USA.

Trade war will therefore impact local production as automakers serving USA market might scale down production in China.

 

EOS Perspective

In May 2018, president Xi announced to lower tariffs on imported cars to 15% effective from July 1, and ease ownership restrictions in automotive joint-ventures. This had somewhat cooled down the ongoing tension between the two nations. At this stage, many experts believed that the current situation will be resolved between the two nations via negotiations. However, despite three rounds of negotiations, both sides have failed to reach an agreement yet.

In the recent chain of events, Trump has threatened to slap extra tariffs on additional Chinese products worth US$400 billion. He also plans to restrict Chinese investments in American technology companies and technology exports from USA to China. This has opened up another front in the ongoing battle. In response, Beijing has warned to retaliate with levies on additional list of American products.

As of now, the potential effects of a full-blown trade war on the auto industry are not clear as they are still proposals. However, if tariffs were imposed, OEMs based in the USA would feel the strongest impact as they export around 280,000 vehicles to China each year.

In addition, considering that automakers today are more globalized than ever and depend on globally-integrated supply-chain networks to optimize their bottom line, a broader impact of the trade war would impact the supply-chains of many global OEMs. The business losses suffered by them will eventually pour down to auto parts suppliers, dealers, retailers, and local auto businesses, who will all feel the heat with varying degrees. It will be interesting to see how things progress and finalize over the next few days. For now, industry stakeholders are sweating over the looming trade war between the two powerhouses.

by EOS Intelligence EOS Intelligence No Comments

Africa’s Struggling Auto Market Set for Modest Recovery in 2018

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After a challenging 2016, most African economies experienced modest recovery in 2017, aided by a recovery of oil and commodity prices. The 2016 economic downturn and a decline in oil prices in Africa impacted some of the largest economies in both Sub-Saharan Africa and North Africa, including Algeria, Angola, Nigeria and South Africa. A recovery in oil prices to US$65-70 per barrel, from as low as US$30 in 2016-2017, has resulted in these economies rebounding after a period of low economic growth, and recession in the case of Nigeria. The World Bank expects economic recovery to continue over the next couple of years, and predicts African GDP to grow by 3.2% and 3.8% in 2018 and 2019, respectively. While economic conditions continue to ease, a negative sentiment has set in the African consumer markets, which has changed the outlook of the automotive industry significantly across the continent.

The article was published as part of Automotive World’s Special report on Africa.
Click to read the full article

by EOS Intelligence EOS Intelligence No Comments

Commentary: Indian Automotive Sector – Reeling under the Budget

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The Indian automotive industry has been witnessing a period of recovery and growth over the past couple of years. Every year, automakers look towards the government to provide a stimulus in the form of favorable policies and budget allocations, to spur growth in the sector. A week has passed since the announcement of Indian budget for FY 2018-2019. We take a look at its short and long-term impact across the automotive value chain.

Supply-side scenario (component manufacturers and OEMs)

The current Indian government under Prime Minister Modi has been focusing on promoting domestic production of automobiles and auto components, as a part of its “Make in India” campaign. A 5% increase in customs duty on imported completely knocked down (CKD) cars and automotive components for assembly and sale in India is seen as another step in this direction.

While international OEMs such as Volkswagen and Skoda have been left reeling under the burden of additional costs, this provides an opportunity to spur growth particularly in the domestic components manufacturing.

Another positive news for domestic automotive components manufacturers, most of which are small and medium scale enterprises, is the reduction in corporate tax rate by 5% percentage points (for companies with a turnover of under INR 250 Crores / USD 38.83 million). These tax savings can provide companies with additional capital to invest in their business, aiding their long-term growth.

Investments in road and rural electrification infrastructure also encourage OEMs to bring new products, particularly electric vehicle (EV) portfolio, to the Indian market. However, lack of an established EV infrastructure means that this market development is likely to occur only over a long-term horizon.

Demand-side scenario (individual and corporate consumers)

The key factor impacting the demand for automobiles is perhaps how deep the consumers’ pockets are (or can be) after bearing all the tax burdens – in other words, how high the disposable income is in India. This is even more relevant for the lower-end of the market (or the so-called “mass spectrum”).

Minimal income tax incentives to individuals, coupled with rising inflation, are likely to limit the disposable income of most people (particularly in the low and medium income brackets), which form the largest consumer base for automobiles in terms of volume.

A booming stock market in India attracted several consumers in the middle income group to invest their capital in equities. Levy of a 10% long-term capital gain tax (LCGT) on returns from these equities (although grandfathered till INR 1 Lakh / USD1,553) is likely to put even further pressure on consumers’ pockets, especially for those looking to finance their automobile purchases by getting the most out of their investments.

Moreover, the knee-jerk reaction to this year’s budget was also observed on the equity market. The negative sentiment has led India’s two leading stock exchanges – BSE and NIFTY – witnessing a 5% decline within a 7 day period from the announcement of the budget, thereby eroding consumer’s wealth, which may further impact consumers’ short-term decisions to purchase vehicles.

On the other hand, the support provided to the agricultural sector is likely to spur demand for tractors and small passenger vehicles in rural areas, however this demand growth is dependent on the agricultural output, and derived from it incomes, in the coming year.

Aftermarket scenario (recyclers)

For the past couple of years, automotive companies as well as aftermarket recyclers have been expecting the government to bring in the scrapping policy, which would allow consumers as well as OEMs to benefit from voluntary replacement and scrapping of vehicles older than 15 years. However, lack of any announcements related to this policy has left the aftermarket recyclers and OEMs disappointed. They will need to wait to tap the demand expected to come from voluntary replacement of old vehicles in exchange of monetary benefits.

EOS Perspective

The scenario for electric vehicles (EVs) looks bright over a long term with significant investments going into development of rural electrification infrastructure, which will impact the development of the EV ecosystem beyond the metros as well. OEMs look at this as an opportunity, and this is evident from the number of EVs and electric concept cars to be unveiled at the Auto Expo 2018, India’s largest automotive exhibition. However, in a short to medium term, the adoption of EVs is likely to be limited to the corporate sector. General mass adoption is likely to lag behind due to vehicles’ high prices, and limited distance range/capacities offered by the current EVs available in the market.

As the mass automobile demand is expected to remain lull in the short term, the market will be driven by luxury and premium segments, which is largely unaffected by the budgetary challenges. A push is evident from OEM-side as well, with a number of premium, high-end products (such as SUVs, large displacement motorcycles, and luxury vehicles) launched at the Auto Expo 2018.

While the budget has left a lot to be desired, there are positives which bode well over the long term. The market is likely to witness a downturn in demand over a short term, as the consumers are likely to turn to preservation of wealth till the negative market sentiment prevails. Moreover, as the government invests in infrastructure projects, demand for both commercial and private vehicles is likely to pick up in the future.

It remains to be seen how soon the market witnesses a recovery in terms of automobile demand. One thing is certain, as always, when the budget comes next year, expectations will be high, partially fed by this year’s disappointments.

by EOS Intelligence EOS Intelligence No Comments

Sharing Economy: Africa Finds Its Share in the Market

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The concept of sharing economy has become a global phenomenon and after capturing several markets across Northern America, Europe, and Asia, it is now finding its way in Africa. The pre-existing sharing culture in several African countries makes this business concept gain good momentum across the continent. In addition to global companies, such as Uber and Airbnb, which have witnessed exponential growth in their limited years of business in this region, there are a host of home-grown players that are offering niche and country-specific services in this space. At the same time, sharing economy business does face a great deal of challenges in Africa’s complex markets. Safety concerns as well as limited availability and use of technology are two of the largest roadblocks for a thriving sharing economy business model. Although companies seem to find their way around these issues on their corporate drawing boards, the challenges are more intense and impactful in reality. Therefore, while the concept of sharing economy is likely to boom in the continent, it remains to be seen which companies manage to best adapt to local dynamics and thrive, and which players will fail in navigating the complexity of the regional markets.

Sharing economy businesses have been growing at an accelerating rate globally with leaders such as Airbnb and Uber taking over their traditional hospitality and travel competitors and becoming the largest players in the tourism and passenger transport sectors, respectively. After gaining huge market in several mature economies, the asset-light collaborative economic model is now making its presence felt in Africa. With vast youth population and a growing middle class, several markets in the African continent offer a huge growth potential for companies operating the sharing economy model. In 2016, Airbnb alone witnessed a 95% rise in the number of house listings in the continent, which increased from about 39,500 in 2015 to 77,000 in 2016. Moreover, the number of users of its online platform reached 765,000 in 2016, witnessing a 143% y-o-y rise, and is expected to further expand to reach 1.5 million registered users by the end of 2017. Similarly, Uber, which entered Africa in 2013 through Johannesburg, has expanded into 15 cities across eight African countries in a span of just four years and has over 60,000 partnering drivers across the continent.

This remarkable growth is underpinned by a burgeoning middle class that is looking for (and increasingly can afford) convenient and reasonable solutions. Moreover, the sharing economy concept helps Africans bridge service gaps created by inadequate resources and infrastructure present in the continent. For instance, with increasing number of tourists and a limited number of high-end and mid-tier hotels or resorts, companies such as Airbnb are in a perfect position to fill such a demand-supply gap without much investment. In addition, sharing economy companies also help ease the unemployment and underemployment issues faced across several countries in Africa. The sharing economy model helps channelize a work stream for people who are unemployed or work in the informal sector, and provide them with a formalized platform where they can sell and market their services. Sharing economy is largely dominated by workers aged 18-34, which is also the age group largely affected by unemployment in Africa.

However, the key reason for the sharing economy model to have eased so well into the African lifestyle is the pre-existence of a sharing culture, which has been prevalent informally here for many years. Unlike in many developed regions, the concept of sharing economy is not new to Africa and the main task for global players entering this market was to formalize it through tech-based platforms. Therefore, despite being one of the least developed regions globally, Africa comes as a good fit to the sharing economy model. As per a survey conducted by AC Neilson in 2014, 68% of respondents in the Middle East and Africa region are willing to share their personal property for payment, while 71% are likely to rent products from others. These numbers are much higher in Africa than in Europe and North America, wherein only 54% and 52%, respectively, are willing to share their possessions for pay and even fewer (44% and 43%, respectively) are interested in renting others’ products.

While global companies are at a strong position to capitalize on this opportunity, there are a host of local players across the African subcontinent that are also looking for a share in the pie. Although these companies have come up across Africa, they are somewhat clustered in the more developed regions of South Africa, Kenya, Nigeria, and Uganda.

sharing economy africa

South Africa

Being one of the most developed economies in the subcontinent, South Africa has openly embraced the global sharing economy phenomenon and has been the entry point into the continent for several leading international players such as Uber, Airbnb, and Fon. Uber has received great acceptance in South Africa with the first 12-month growth rates in Cape Town and Johannesburg superseding the growth experienced in other cities globally, such as San Francisco, London, or Paris (during their first year of operations). Uber provided 1 million rides in 2014, which was its first year of operation in South Africa, rising to 2 million rides by the first half of 2015. The company has also created more than 2,000 jobs in the country where unemployment levels are as high as 30%. Likewise, Airbnb boasts of similar growth in the country. In 2016, about 394,000 guests used Airbnb listings for their stay in South Africa, in comparison to 38,000 guests in 2014. During that year, Airbnb’s users generated US$186 million (ZAR2.4 billion) worth of economic activity in the country, of which about US$148 million (ZAR1.9 billion) was attributed to Cape Town, Johannesburg, and Durban. Fon, an unused bandwidth sharing company, also enjoyed success in the South African market and more than doubled its community hotspots from 21,000 (at the time of its launch in 2014) to 52,000 community-generated hotspots in 2015. Taxify is another global player in the ride sharing space. Launched in 2015, Taxify is an Estonian company offering similar services as Uber. The company has managed to acquire 10% of South Africa’s ride sharing market by offering 15% lower fares compared with Uber, while providing a higher driver payout (Uber takes a 20-25% cut from drivers while Taxify takes a 15% cut).

These international players are challenged by several local companies, which, despite being much smaller in size, are competing on both price as well as local expertise. In the ride sharing market, there are several smaller domestic players, such as Zebra Cabs, Find a Lift, and Jozibear. Similarly, in the accommodation sharing market, acting as a direct competitor to Airbnb is South Africa’s local, Afristay (formerly known as Accommodation Direct). The company has applied a country-specific approach and has succeeded in providing more varied and cheaper options as compared with Airbnb in South Africa. Having a single country focus, Afristay has close to 20,000 listings across 2,000 locations in South Africa. Airbnb on the other hand has 35,000 listings in the country.

Another emerging space of sharing economy concept adoption in South Africa has been seen in the medical sector, wherein players, such as Medici and Hello Doctor, are connecting patients with medical practitioners. Hello Doctor currently services around 400,000 patients in South Africa. Medici, which launched in May 2017 has partnered with the Hello Doctor and aims at connecting rural and less developed regions to remote access medical advice and consultations.

Kenya

Owing to a burgeoning middle class as well as an increasing access to education and the Internet, Kenya is a strong market for the digital sharing economy. Airbnb witnessed significant growth in Kenya, increasing its listings in the country from 1,400 in 2015 to 4,000 in 2016. The number of guests choosing to stay in an Airbnb accommodation have also expanded three-fold during the same period. Uber has received a similar response in the country, completing 1 million rides in its first 15 months of operations (beginning 2016), and having 1,000 drivers registered with them in the beginning of 2016. However, a local Kenyan company, Little Cabs, which is owned and operated by the country’s leading telecommunication players, Safaricom in partnership with Craft Silicon, a local software firm, is a stiff competition to Uber. The company, which began operations in July 2016, managed to acquire 2,500 drivers and 90,000 active accounts by the end of the year, owing to more attractive pricing and driver-payout in comparison to Uber. Moreover, it offers several services, which have not been introduced by Uber in Kenya yet. Having the backing of the leading mobile network operator, Little Cabs is attracting customers by offering them discounted mobile recharge along with trips, free Wi-Fi for passengers, and the option to process payments using M-Pesa – Safaricom’s mobile money service, which has two-third share in mobile market in the country. However, despite a smaller fleet size and less attractive services, Uber continues to be the market leader in Kenya for now, with a revenue share of about 30% (in comparison to Little Cabs, which has a revenue share of about 10%) primarily due its global brand value and first mover advantage.

Another newcomer to the sharing economy market in the country is Lynk, which aims at connecting service providers across about 60 categories to customers in Kenya. These include services such as plumbing, beauty works, tuition, or party planning. Having started operations in 2015, the company identified and recruited about 400 workers across 60+ service categories, who provided 800+ services to paying customers within its first year of operation.

All of that being said, the sharing economy concept has not had that easy of a ride in the continent and has faced one too many challenges on its way up. The main issue challenging the success of this concept has been the limited use of smartphones, which are inherent to this business model. While the use of smartphones in today’s time is taken for granted in most economies across the globe, this is not the case in Africa. In many cases, these service providers (especially drivers) are using smartphones for the very first time in their lives. Although the youth population is expanding in the continent, elevating the demand and use of smartphones, the numbers still remain extremely low – both at the consumers’ as well as service providers’ end. In 2015, only 24% of Africans used Internet on their mobiles and e-commerce penetration was mere 2%. This makes it imminent for companies looking to excel in the sharing economy space to provide training and workshops to help service providers adapt to and embrace the smartphone technology. Companies aiming to build a stronger position in the market over their existing competitors should also look at providing cost effective and easily accessible financing for the purchase of smartphones for service providers interested in registering in their sharing apps. In the African scenario, such a move would incentivize service providers to join the company’s sharing platform, potentially choosing it over other competitors present in the market, while the company would be able to expand its supply-end of the business by growing the registered service providers’ base.

The other issue that is key to operating in Africa is safety. Since the entire concept of sharing economy is based on trust, ensuring safety becomes a very important aspect in this line of work. Considering the high number of cases of theft and vandalism as well as weak regulatory system, African customers’ trust in service providers in their region is naturally lower than the western market customers’ trust in their local service providers. This impedes the service use growth and forms one of the largest barriers for sharing economy to reach its full potential in the continent.

In the transportation segment of the sharing economy market, the issue of safety is increasingly addressed by several players. To ensure safety of passengers, drivers undergo a rigorous background check that includes a multi-level verification. Companies also undertake innovative approaches to ensure only verified drivers work under the company logo in attempt to improve safety. In one such case, Uber introduced a ‘selfie protection’ feature, in Kenya, wherein a driver is required to take a selfie in the Uber app once in a while, before accepting a ride request from a customer. In case the photo does not match the one registered with the account, the account is blocked. In a market such as Africa, while safety precautions are a necessity, if marketed correctly, they can also be a differentiating and marketing factor. Along with general information and ratings, companies can also show driver’s verification details and training credentials on their app before a consumer selects a ride. In case of other services, they can also include details of the certifications undertaken by the service provider.

In addition to this, the limited use of plastic money – which is the main form of payment in sharing economy-based businesses globally – is another speedbump in the operation of such a business model in Africa. While several ridesharing companies are tackling this issue by introducing cash payments, it remains a limiting factor for companies whose services nature leaves a limited scope for introducing cash payments option, e.g. Airbnb.

Regulatory barriers and outburst of traditional competitors is another challenge, however these issues are common for players across markets globally, though in various intensity. We have talked about it in more detail in our article in October 2016, Sharing Economy Needs Regulator Support. Companies such as Uber have had to face several regulatory roadblocks, the latest of that being a July 2017 lawsuit ruling recognizing Uber drivers as employees (instead of the company-preferred ‘driver partners’) as per South Africa’s labor laws. While the company does have plans to work around this ruling as it currently only applies to the seven drivers who filed the lawsuit, such issues have the potential to disrupt the companies’ smooth operations in the country. There have also been severe protests from traditional taxi companies and Uber has faced several safety-related problems with Uber drivers being attacked and cars being burnt in Kenya, as well as cases of smashed windscreens at railway stations in South Africa. To counter this, the company has posted security guards outside railway stations in Johannesburg for the security of the drivers.

EOS Perspective

While the concept of sharing economy seems to fit perfectly in the African lives, it does require the companies to follow a very localized approach accounting for specific regional dynamics in order to blend with the countries’ local fabric. While this gives an advantage to the local companies that better understand customer needs, it becomes difficult for them to match the scale of global leaders who have hefty marketing budgets.

Although sharing economy has largely captured the travel and passenger transport, with medical, education, and several other vocational services also seeing new businesses entering with sharing economy model, it is the crowd financing segment that might see the next boom in Africa. African region houses several dynamically emerging economies, with huge hunger for capital, and digital crowd funding platforms can help SMEs connect with potential investors, and help African start-ups with seed capital. In addition to basic investment, these platforms can also offer mentoring opportunities to small start-ups. While there already are a couple of companies, such as VC4Africa, that are operating in this space, crowd financing as a sharing economy business still has great potential to be tapped in Africa, especially beyond the Tier 1 cities of Johannesburg and Cape Town, where ideas are in abundance but there is lack investment and support.

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Originally published on EMIA on 21st December 2017.

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NAFTA 2.0 – Mexico Left with Little Choice but to Renegotiate, and Fast

Over the years, NAFTA has been one of the most contentious FTAs that have ever been inked, especially for the USA. While the treaty and its merits (or mostly alleged lack of them) featured in political campaigns of a few previous US presidential candidates, NAFTA’s shape and scope have never been revisited in its many years of existence – until now. Mexico, along with Canada, wishes to maintain the NAFTA as is, however US president Donald Trump has strongly condemned the treaty and, though earlier threatened to walk away from it completely, has agreed to attempt a renegotiation. Any possible changes to the shape of NAFTA might have profound impact especially on Mexico, however, the country has little choice but to renegotiate. Some of the negotiation objectives, such as tougher ‘rules of origin’, can be greatly damaging to Mexico’s several sectors, including the automobile industry. The upcoming elections in Mexico in July 2018 may further complicate matters – if the renegotiations are not completed by then (which is a highly probable scenario), they may be brought to a standstill, especially if the government changes. This presents a great deal of uncertainty for companies that have investments in Mexico.

The North America Free Trade Agreement (NAFTA), which came into force in 1994, removed trade tariffs and duties on most goods for trade between the USA, Mexico, and Canada. While the deal has been mostly considered a positive in Mexico and Canada, its benefits have often been debated in the USA. The main reason behind this remains the high US trade deficit with Mexico (which stood at around US$64 billion in 2016) and the loss of several US manufacturing jobs to the south of the US border.

The NAFTA issue also found itself at the center of Donald Trump’s 2016 presidential campaign, as he called the treaty one of the worst trade deals ever signed by the USA and talked about withdrawing from it once he came to power. Although several previous presidential campaigns also involved talks of renegotiating NAFTA (including campaigns of both Democratic candidates – Barrack Obama and Hilary Clinton, in 2008), none has been as strong-worded as Trump’s campaign. Therefore, with Trump coming to power in 2016, revisiting the 23-year old treaty became largely inevitable.

Chapter 19

Initially threatening to back out from NAFTA, Trump agreed to renegotiations, which according to him would ensure bringing jobs back to the USA. However, a few aspects on the renegotiation agenda are a hard line for Mexico. Firstly, the USA wishes to eliminate Chapter 19 of the treaty, which encompasses a dispute settlement mechanism wherein dispute resolution (in cases such as anti-dumping and countervailing duty disagreements) is undertaken by independent and binational panels instead of domestic courts. This prevents NAFTA countries from putting unfair duties on products from other NAFTA countries to protect their own industries. While the USA is trying to disregard this clause, Mexico is largely opposing it, as without Chapter 19, it would become much easier for the USA to implement protectionist policies and duties that would inherently threaten free trade. However, Mexico is not alone in pushing back this change as Canada also strongly opposes any change in the dispute settlement mechanism.

Impact of NAFTA on Mexico

NAFTA Minimum Wage

Another negotiation objective (where Canada stands in support of the USA), is to incorporate some kind of standardization for trade-related labor issues and wages, by introducing a minimum wage across the three NAFTA participants. This will be greatly damaging for Mexico, which has for long benefited from lower wage rates that have incentivized several industries, such as automobiles, to shift base to Mexico to reduce costs and maximize profits. Stating that wage-related policies are an internal matter, Mexico has strongly opposed any such amendments and may make this a non-negotiable aspect.

Rules of Origin

However, one of the most dampening renegotiation objectives, especially for Mexico and in particular for its the automobile industry, are the restrictive changes to the rules of origin. As per the current NAFTA rules, for a car to qualify for a tariff-free entry in the NAFTA region, 62.5% of the value of the car must have originated in NAFTA countries. Thus, over the years, automobile manufactures have perfected their value chains, wherein auto components such as body-works, engines, gear panels, etc., are manufactured in various parts of NAFTA countries, and then assembled in another part of the region, to attain greatest benefits in terms of costs and quality. However, the current US administration is proposing changes to these rules, which may wash away a great deal of efficiencies and synergies attained by global automobile manufacturers under the current rules. As per the proposal, the US government aims to increase the US content in the finished vehicles to 50% for these products to attain tariff-free entry into the USA. In addition to going against the basic fabric of a free-trade agreement, this will jeopardize the competitiveness of the North American auto industry, which has greatly depended on integrated supply chains that also have deep roots in Mexico. This definitely spells bad news for Mexico, as the economy has significantly benefited from investments made by global automobile manufacturers in the country.

Moreover, apart from increasing the share of US content requirement to 50%, the US administration has also proposed raising the regional content requirement for NAFTA to 85% as against the current 62.5%. While this may seem to be a positive amendment for the region in general, analysts call it largely counter-productive as not all components can be competitively sourced from the North American region. If brought into action, automobile companies would have to spend huge sums to try to source/produce most components in the North American region at competitive prices. However, if they fail to accomplish that (which is quite likely) and as a result are unsuccessful in qualifying for tariff-free entry into NAFTA, they would shift to suppliers outside NAFTA and pay WTO tariff of 2.5% to access the North American market (which they will pass onto the consumers). Such developments might mean that by increasing regional content requirements, the region may end up pushing automobile players away from the region rather than encouraging them to continue and intensify their operations. This will be catastrophic not only for the Mexican automobile sector, but also for the US and Canadian auto market. To make matters tougher, the new proposal asks for technology-based automotive parts, electric vehicle batteries, etc., that are currently not included in the origin tracing list (as they did not exist when the NAFTA was originally negotiated). Most of these products are now sourced from Asian markets.

Due to the US president’s known cold sentiment towards NAFTA, the onus of ensuring the treaty remains unterminated is on Mexico and Canada. While Mexico (along with Canada) has previously mentioned that the American demands to change the rules of origin are unworkable with and unacceptable, the Mexican government is working on a compromise proposal to toughen the rules of origin clause in hope to meet the USA somewhere half-way. As per the proposal, Mexico is willing to accept the extensive tracing list and is also willing to negotiate on the 85% North American content requirement in exchange for the USA withdrawing from the 50% US content provision. The tracing list proposal will be drawn in a manner ensuring that low-cost technology-based components that are currently sourced from Asian countries would be sourced from within North America, especially Mexico. However, the proposal, which is not finalized yet, is not expected to be presented in the current (fifth) round of talks.

Sunset Clause

Mexico and Canada’s openness to negotiate can also be gauged by their willingness to work around the sunset clause proposed by the US administration during the fourth round of negotiations. As per the proposed clause, the treaty will expire every five years unless the member countries agree to keep it in place. While the remaining two parties refused to accept this clause when proposed, they have softened their stance on the matter during the current negotiations and counter-proposed a five-yearly review system. This showcases Mexico and Canada’s keen desire to ensure NAFTA is preserved and their willingness to work around USA’s fixed stance. While the review proposal may be a better option compared with the sunset clause, purely from a business or investment point of view, it still leaves room for a great amount of uncertainty for companies looking to invest, as five-year horizon is too short for several heavy-investment industries such as automobiles.

2018 Mexican Elections

Lastly, it is extremely critical that the negotiations are completed by the set date of March 2018 as any delay will result in their overlap with the 2018 Mexican elections and that will further complicate the matters. NAFTA has not only been instrumental in providing Mexico with economic stability, but has also played a significant political role, especially in terms of economic policy. The basic framework of the treaty has ensured protection for investments and, to an extent, economic equity as over the years it restricted the government from granting protections, incentives, and subsidies to a set of companies or industries, while discriminating against others. The termination of NAFTA would allow the future government to modify the current economic framework of the country, and this will directly impact Mexico’s attractiveness as an investment destination. This becomes all the more relevant in case the leftist candidate, Lopez Obrador, comes to power in 2018.

Mexico’s Contingency Plans

While Mexico is certainly hopeful and is working towards retaining the NAFTA, it is not putting all its eggs in that one basket alone. Mexican government is looking at deepening Mexico’s ties globally and reducing its dependence on the USA. Mexico is currently negotiating with the EU to modernize its existing FTA which is expected to be completed by the end of 2017. Moreover, it is looking at Argentina and Brazil as alternative sources of agricultural imports to replace those from the USA. In a similar move, Mexico’s foreign minister, Luis Videgaray, met with his Russian counterpart in Mexico to discuss Mexico’s openness to do business with nations other than the USA. In November 2017, Mexico participated in a meeting of the nations that were formerly a part of the Trans-Pacific Partnership (TPP), which ceased to exist in its previous form in early 2017 (we talked about it in our article TPP 2.0 – Minus the USA in May 2017). This meeting resulted in an official announcement that the TPP nations will negotiate a new deal, without the USA, and that it will be called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The creation of CPTPP will provide a much-needed cushion to Mexico’s automobile industry in case NAFTA fails. Also, in case NAFTA toughens its rules of origin but the CPTPP relaxes them, Mexico may continue to be part of the global automobile supply chain (this time in combination with CPTPP members such as Japan, Canada, and Chile – instead of the USA).

EOS Perspective

It is safe to say that Mexico and its automobile industry have a lot riding on the NAFTA negotiations. While Mexico along with Canada are working hard to ensure NAFTA stays, US president’s tough stand on several aspects and his willingness to walk out of the deal in case his demands are not met, complicate the negotiations greatly. It is uncertain how the situation is going to develop, and even if NAFTA continues, new provisions that might find their way into the revised treaty may not offer a great deal of benefits for companies to invest and for intra-regional trade to flourish.

The pressure of upcoming elections in Mexico in 2018 makes the situation even tighter. If the negotiations are not completed before the elections, all progress made up till then can easily go in vain in the event of the government change. Therefore, companies are extremely cautious about investing/expanding in Mexico at the moment, and are likely to wait at least up till mid-next year. They may find respite in the fact that the Mexican government is trying to do its best – both in terms of being flexible during negotiations as well as diversifying its export markets and import sources – but this respite might just not be enough to ease investors’ minds and businesses’ worries over the operating and trade environment within the North American region.

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Turbocharging Trumps Supercharging in the Battle for Engine Downsizing

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Naturally aspirated engines have dominated the automotive landscape for decades. However, growing emphasis on the need to improve air quality in recent years has placed significant pressure on global vehicle manufacturers to improve fuel efficiency and ultimately reduce CO2 emissions. Not only have OEMs been subject to growing pressure from consumer groups and environmental activists, but there has also been a stronger push by…

The article was published as part of Automotive World’s Special report: Turbocharging and supercharging.

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Breaking Bad, Building New: Customer Engagement Model for Automakers

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Digital transformation buzz has revolutionized the way companies operate and interact with their customers across virtually all industries. Automotive industry is no exception. Customer expectations today are more demanding than ever, primarily due to the service level benchmarks set up by the likes of Amazon, Uber, and Apple, as well as due to plethora of information customers can get through the internet and social media. The rise of digital channels is fundamentally transforming the entire auto retailing business. In order to stay ahead of the game, automakers will have to break their legacy systems and build new customer-centric marketing models.

The automotive industry has always been characterized by an extremely time consuming as well as complex sales processes that often result in an unpleasant customer experience. The industry notion “People love shopping for cars; they hate buying cars” precisely depicts the challenge auto retailers have to deal with and the need for industry players to rethink their sales and marketing models to enhance the overall customer experience. The Apple and Amazon retail ethos of seamless customer interaction, simple and streamlined sales processes, effortless and speedy customer services has become the benchmark for all retailers. Even in the automotive industry, changing customer preferences, digital transformation, increased connectivity are reshaping the entire retail supply chain, with major impact on the final parts of the chain involving direct customer interaction. The rise of cutting edge technologies, tech and information savvy consumers, and new market entrants are forcing traditional players to rethink and reinvent their entire business models.

The advent of technology has significantly lowered entry barriers for new entrants in the automotive retail segment, who have brought innovative business models and fresh ideas to help customers find, evaluate, and buy new vehicles. With slogans such as “Skip the dealership” and “Find deals. Not dealers!” new players such as Roadster or Rockar are transforming automotive retailing by offering a bargain-free and smooth car buying experience that can allow the customer to purchase a car and have it delivered to their doorstep within few hours. Traditional retailers have started to realize that, equipped with massive information at their fingertips, car buyers today are better informed than ever when it comes to car purchasing. One bad experience and customers will be very reluctant to ever come back to the same retailer. Despite this realization, many companies are still ‘moving metal’ the old-fashioned way using traditional media and other marketing approaches to attract consumers to their stores.

Statistics from many industry studies make it clear that with the mass proliferation of technologies, car buying journey is becoming increasingly digital, with most customers spending a significant part of their buying time online. Studies indicate that more than 65% of the information-gathering and decision-making process is already made prior to visiting a dealership. Therefore, it becomes vital for OEMs and dealers to rethink their entire marketing and customer engagement approach. They need to interact more effectively and engage consumers early and throughout their purchase journey.

OEMs and dealers need to understand that the whole process of buying cars is quite different from the process in some other retail segments. For example, to buy consumer electronics, many consumers visit the store to see/touch/feel the product and then buy it online because of the price benefits and other offers. In case of buying cars, most customers do their research and comparison online. They visit the local dealership to see/touch/feel the car and buy it there to benefit from special discounts and offers. Hence, it is very crucial to have an integrated and seamless transition across various channels in a frictionless manner.

The introduction of new business models (direct-to-customer) and customer experience strategies (highly interactive and pressure-free brand stores) created by the likes of Tesla, or Rockar, have caught the eyes of many traditional players, who have gauged the significance of realigning their marketing and customer engagement strategies as per demands of the rapidly evolving industry. Many OEMs and dealers have started to take a hard look at their entire customer lifecycle processes to assess the current gaps and address them. Companies are reconfiguring their touch points across channels by eliminating redundant processes and services. Recently, automakers such as BMW, Audi, and Mercedes have rolled out brand stores similar to Apple’s, where customers can visualize their cars, configure them to their own specifications, get experts to answer their questions, and even buy cars in a non-pressurized sales environment. Having already seen some positive results, these OEMs are likely to ramp up their efforts to roll out such brand stores on a larger scale across cities, states, as well as countries in the near future. While not all automakers have plans to launch such stores at present, it is expected that it will not be long before OEMs with no such current plans observe and eventually follow the footsteps of OEM players that have already reaped these rewards and showed what advantages such stores can offer.

EOS Perspective

As digital transformation continues to revolutionize the auto retailing landscape, there is no doubt that advancing technologies will make the car buying process increasingly digital for the years to come. We can expect a rapid surge of various online platforms that provide customers with the ability to easily research, evaluate, and buy cars. Operating within such a highly competitive marketplace with changing customer preferences, auto retailers will have to transform their business models to become more customer-centric and deliver on customers’ expectations. They will have to reinvent customer engagement frameworks to create ones that are built around customer needs, and are simple, frictionless, more transparent, quicker, and convenient for today’s savvy car buyers. On the one hand, this will help OEMs and dealers win more business, while on the other hand customers will benefit from an accelerated and hassle-free sales process, resulting in an improved customer experience.

Although transforming current customer engagement model seems inevitable, this will not come easy and will involve massive changes in existing marketing models. At present, majority of industry players lack the resources, infrastructure, and systems required to execute this transformation. In addition, as signification investments will be required, amid current business environment with high cost and competitive pressure, many automakers as well as dealers will still continue to engage in sales the old fashioned way or adopt a ‘wait-and-watch’ stance. At a dealer level, implementation of new customer engagement model will be much slower primarily due to capabilities and resources constraints.

In the end, one thing is obvious – in order to retain today’s customers and to win new ones, OEMs and dealers will have to reinvent their marketing and customer engagement strategies. To achieve this transformation, these players will have to work together to deliver rich brand experience and match the simplified and streamlined buying experiences set by Amazon and others. OEMs and dealers should take John F. Kennedy’s words to heart “Change is the law of life. And those who look only to the past, or the present, are certain to miss the future.”

by EOS Intelligence EOS Intelligence No Comments

GCC to Introduce VAT: What It Means for Businesses, Economy, and People

The Gulf Cooperation Council (GCC) countries are gearing towards rolling out a 5% Value Added Tax (VAT) starting January 1, 2018. Economies of GCC countries are highly dependent on the oil and gas sector revenues, which account for about 80% of the GCC governments’ budgets. The recent volatility in oil prices have battered GCC nations’ revenues, which motivated the governments to initiate a reform in the form of indirect taxation with a goal to diversify income sources. VAT is a measure that will impart more stability and robustness to the governments’ income considering the outlook for crude oil still remains volatile, while diversified revenue sources will cushion the GCC economies in times of financial crisis.

A standard rate of 5% will be applied on most products, except specified food items, domestic public transportation, and healthcare, education, and financial services. The proposed VAT rate is much lower in comparison with rates in most European countries, China, and Australia. Nonetheless, the GCC countries still stand to gain in income with the tax implementation – for instance, the UAE is forecast to generate US$3.27 billion revenue during the first year of VAT introduction.

Industries such as construction and automotive are likely to benefit from VAT implementation, while retailers might feel a pinch due to dwindling margins. The sentiment among the citizens is wary to say the least – for instance, according to a survey conducted by CFA Society Emirates, citizens of the UAE did not seem quite optimistic towards the economic impact of VAT across certain parameters such as price inflation, cost of doing business, and inflow of foreign direct investments (FDI).

GCC to Introduce VAT

EOS Perspective

Introduction of VAT could empower the GCC economies by bolstering revenue generation, aiding infrastructure development, and improving productivity levels. While some may believe that VAT implementation could tarnish GCC countries’, particularly the UAE’s, competitiveness and tax-free haven status, it is important to consider that GCC markets’ attractiveness goes way beyond only the tax benefits. GCC’s appeal also lies in developed infrastructure, competitive labor costs, lower trade barriers, and proximity to the developing Asian and African markets – implementation of a new tax reform will not change this favorable business environment.

There have been some discussions regarding the negative implications of VAT, considering residents and businesses have grown accustomed to high incomes and low deductibles for a long time. Post VAT implementation, businesses are expected to incur certain additional costs related to administrative expenses, upgrading IT systems, and training staff members, among others.

Also, highly competitive industry sectors, or those operating with thin margins are likely to witness cash flow burden, as they will be required to meet the VAT costs on purchases before they can be reclaimed from the government – in certain scenarios, when the businesses end up paying more as VAT to suppliers as compared to the VAT collected from customers, the difference can be reclaimed from public funds. The way businesses operate is likely to fundamentally transform once VAT is applied, however, with adequate preparation businesses should be able to introduce systems and processes to avoid unnecessary cost implications as well as smoothly align themselves with the new tax system.

The way businesses operate is likely to fundamentally transform once VAT is applied, however, with adequate preparation businesses should be able to introduce systems and processes to avoid unnecessary cost implications as well as smoothly align themselves with the new tax system.

VAT is not expected to have much impact on a common man, as vital household expenditure items will be exempted from it – this includes about 100 varieties of staple food items and essential services such as healthcare and education. However, for a section of the population with an appetite for luxury goods, services, and lifestyles, as well as for tourists (along with VAT, they will have to pay duty tax again on some goods in their country of origin) the brunt of new taxation is likely to be felt.

Nonetheless, a modest tax rate of 5% will ensure that certain social-economic distortions often associated with VAT are minimized. Also, the decision to exempt a few vital sectors (basic food items, and healthcare, financial, and education services) will ascertain that they are not affected by the tax reform.

VAT imposition is expected to become an essential part of GCC regions’ economic reforms and the taxation policy will immensely aid in diversification of revenue sources. Further, the pre-implementation period should be used by the GCC countries to develop a modern tax administration system that ensures compliance, so that once VAT is implemented, businesses and residents are able to smoothly adapt themselves to the new taxation policy.

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