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Blockchain: A Potential Disruptor in Car Rental and Leasing Industry

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Blockchain, with its ability to offer significantly more transparent and decentralized way of conducting operations, has the potential to come to the forefront of technologies which are disrupting the way most industries work today. While the application of blockchain is still currently focused largely on cryptocurrencies, the technology is slowly finding its way to a range of industries, including the car rental and leasing industry.

Car rental and leasing sectors are growing worldwide, driven by rising technological advancements in transportation and increased need for ease of mobility. A shift in demand from car ownership to car sharing (not to be confused with ride-sharing services such as Uber or Lyft) is driving the growth in car rental and leasing industries.

The process of renting a car is highly centralized, where the car rental company being the main point of contact for the driver to rent cars. Car rental companies need to maintain a fleet of cars, as well as car stations and staff to efficiently run their operations, which makes up for bulk of their operating costs. Car rental companies cover these costs from (high) rental rates charged to their customers.

In the peer-to-peer (P2P) care rental (or car sharing) model, there is no need to maintain any infrastructure or staff required to perform the task of renting, a fact that reduces the overhead costs. Lower costs offered by P2P car rental have resulted in the model gaining prominence. P2P car sharing has significant potential, highlighted by recent investments in car sharing services such as Turo and Getaround. In July 2019, US-based Turo raised US$250 million from IAC, an internet media company, taking its overall valuation to US$1 billion. Getaround, a US-based car sharing company established in 2011, raised US$300 million funding from SoftBank in 2018.

However, the P2P car sharing model is inherently prone to fraud and other illicit activities, causing lack of user trust, which in turn acts as a barrier to scaling of rental business, despite the growing demand for car sharing.

The issue can be aided by the emergence of blockchain, which is acting as the market disruptor. The use of a distributed ledger for car rental and leasing is likely to revolutionize the industry, especially P2P car sharing.

Blockchain to enable peer-to-peer car rental gain further prominence

There is a shift in paradigm from car ownership to car sharing, via car rental or leasing. The fact that vehicles are under-utilized and parked (and inactive) most of the time, while the vehicle owners incur ongoing fixed costs such insurance, tax, maintenance, and parking, is further driving this shift.

Emergence of use of blockchain in car rental offers a safe (from frauds) and reliable car-sharing platform, a fact that is likely to further promote P2P car sharing. Inherent unalterable properties of the blockchain offer a secure platform for both car owners (to list their cars) and the customers.

The concept of blockchain in car rental industry works similarly to any other blockchain transaction. Service providers (or car owners) and end clients registered on the blockchain can sign digital smart contracts which execute contract terms based on pre-agreed rules in place, similar to a regular rental model.

The smart contract also contains the necessary information, such as details of the renter (driving license proof, insurance, and credit card details) and data such as car registration number, rate, mileage, length of rental, and credentials of the car owner. All financial transactions (rental payment) can be done either through a card, or using associated cryptocurrencies and tokens purchased to get registered on the blockchain.

 

Blockchain - A Potential Disruptor in Car Rental and Leasing Industry - EOS Intelligence

The process is fully decentralized and digital without any intermediary required which is the key advantage of car rentals being executed over blockchain. Transparency of transactions made over a distributed ledger also adds to the credibility, thus lowering the risk of any fraudulent activity to a great extent.

Lower fee offered due to elimination of intermediaries is another major advantage of using the blockchain technology in car rental industry. For example, HireGo, a UK-based blockchain-based car rental start-up, claims to offer transaction fee up to 35% lower compared with traditional car rental charges under the existing B2C model. Moreover, use of smart contracts has made the system direct and reliable, as information on the contract is unalterable.

Blockchain technology is designed to encourage a sharing economy platform so that businesses such as P2P car rentals and leasing can become integrated and cost-effective, through collaboration among participants in a common, transparent, and “trustless” (or distributed trust) environment, which are the primary attributes of blockchain.

Blockchain in car leasing to improve visibility

When it comes to leasing, blockchain has even more potential. Tracking a car right from the OEM, transfer of ownership, tracking of repairs, mileage, fuel, and maintenance over a single distributed ledger can help bring visibility across the leasing journey. This in turn can help customers avert mileage fraud, while also eliminating any disputes at the end of the lease term.

With all necessary and unnecessary repairs being visible to all parties involved, calculation of charges and violation penalties is likely to become much easier.

The use of a distributed ledger also eliminates the need of undertaking time-consuming paperwork at each node (or stakeholder) of the leasing value chain, thereby improving the overall efficiency of the process, while also cutting costs, making it much more cost-effective to lease a vehicle.

Similarly to its function in car rentals, a distributed ledger also eliminates high costs charged by car leasing companies, resulting in increased popularity P2P leasing of vehicles through smart contracts. Blockchain can also be used as an open maintenance log, as well as for the provision of other value added services such as insurance and toll payments.

Blockchain - A Potential Disruptor in Car Rental and Leasing Industry - EOS Intelligence

Transparency across the lease to help minimize customer disputes

The benefits of blockchain are most prominent at the end of the lease term, when a customer returns a leased vehicle. The use of an open distributed ledger eliminates any disputes that may occur between the service provider and end client, with regards to end-of-lease charges. Transparency across the lease lifecycle, including open logs of vehicle usage, mileage, fuel, maintenance, tire changes, and insurance, make it easier to calculate any end-of-lease charges, based on the pre-defined terms of the smart contract. These charges can also be automatically paid in the form of cryptocurrencies or tokens, as per the provisions in the smart contract.

Blockchain entries can also help leasing companies estimate the approximate value of the vehicle at the end of the lease term, making it easier to decide whether to remarket (re-lease) or dispose of the vehicle, as well as reducing the overall time and resources required in the remarketing process.

Newer blockchain-based platforms expected to drive growth

The global automotive blockchain market is likely to witness growth of 31.1% CAGR between 2020 and 2030, with Asia witnessing the fastest growth. Majority of this growth is attributed to proliferation of car rental and leasing in countries such as India and China, where people are seeking easier means of mobility and are making cautious effort of reducing traffic in metro cities.

Several companies in the region started investing in building platforms using blockchain. In 2017, Mumbai-based Drivezy, an Indian car sharing company, successfully developed a car rental and leasing platform using blockchain, in which users can rent cars and make payments using cryptocurrencies and tokens. In 2018, the company raised US$20 million in a Series B funding through an initial coin offering (ICO). Such investment is encouraging further start-ups looking to utilize blockchain for car rental and leasing.

Darenta ICO, a Russian car rental start-up, developed a platform for existing car owners to rent out their cars using a digital solution that employs geolocation, smart contracts, and other blockchain technology. Launched in 2018, the company has already expanded its presence in 20 countries, and plans to enter the USA and Canada, followed by other European and Asian markets (including China) by 2020.

Several major companies have also invested in developing other technology platforms using blockchain technology, which could have applications in the rental and leasing businesses. In 2017, Ernst and Young, for example, launched a blockchain-based platform called “Tesseract” to support an integrated and autonomous mobility. Through this platform companies and individuals can share cars, while payment and insurance are handled through blockchain. In 2017, Renault also launched a prototype blockchain platform to track information about a car’s maintenance history, including repair shops and dealerships at one place, through a digital maintenance log prototype.


Explore our other Perspectives on blockchain


Lack of acceptance of cryptocurrencies likely to pose challenges

While blockchain has plenty of benefits, broad scale deployment of the technology faces certain challenges as well – one of the most crucial ones being recognition of cryptocurrencies in key emerging markets in Asia, including India and China. Most blockchain-based solutions are looking at ICO to generate funds, issuing their own cryptocurrencies (mostly based on Ethereum tokens), which also act as a mode of transactions and payments for the service. Lack of regulation of cryptocurrencies is currently limiting the adoption of blockchain technology in the rental and leasing space.

Also, for the blockchain technology broad scale implementation, there is a need for high performance computers (or supercomputers) along with highly skilled workforce to handle the blockchain. Such challenges can cause delay in widespread adoption of blockchain technology for car rentals and leasing system at a larger scale.

EOS Perspective

Currently, blockchain is considered synonymous to cryptocurrencies such as bitcoin, which is still very unstable and is commonly seen as an investment rather than a mode of transaction. Such a perception is likely to continue to prevail in the short term. Once the paradigm shifts from cryptocurrencies being looked at as a mere investment tool, to being considered as a mode of transaction or a trustless platform, which utilizes inherent properties of blockchain, the overall acceptance of blockchain is also expected to increase. This shift is also likely to bring more stability in cryptocurrency prices, which in turn is also expected to generate a more positive regulatory outlook in favor of cryptocurrency and blockchain technology.

Once blockchain gains prominence, we are likely to witness a lot more start-ups promoting peer-to-peer car sharing (rental or leasing), driving a change in the way people look at their cars. Idle vehicles will increasingly be considered as assets which can generate a source of additional income via car sharing model, resulting in better overall utilization of cars.

ICOs are likely to remain the most common mechanism to generate funds. While the technology has several potential uses, which are expected to disrupt the car rental and leasing market in the near future, the state of blockchain acceptance currently remains highly speculative, primarily due to its close association with cryptocurrencies.

by EOS Intelligence EOS Intelligence No Comments

China Accelerates on the Fuel Cell Technology Front

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For the past decade, China has been on the forefront of the New Energy Vehicles (NEVs) revolution. Although most of its focus has been on battery-powered electric vehicles (BEVs), the government has recently also begun to put its financial might behind hydrogen fuel cells for vehicles. Unlike battery-powered vehicles that need regular and long-periods of charging (therefore are more suitable for personal-use vehicles), hydrogen fueled vehicles do not need frequent refueling and their refueling is quick. This makes them ideal for long-distance buses, taxis, and long-haul transport. However, the existing infrastructure to support fuel cell-powered cars is limited. Thus, despite having inherent benefits over electric vehicles (especially in case of commercial vehicles), fuel cell vehicles fight an uphill battle to build a market for themselves in China, owing to the challenges in acceptability, infrastructure availability, and sheer economies of scale.

Over the last decade, the Chinese government heavily backed the production and sale of electric vehicles through substantial subsidies, investment in infrastructure, and favorable policies. This resulted in the sector picking up rapidly and reaching 1.2 million vehicles sold in 2018. However, the government has begun to reduce the subsidies provided to the sector and the focus is slowly shifting to fuel cell vehicles.

How do fuel cell vehicles work?

Fuel cell vehicles use hydrogen gas to power their electric motor. Fuel cells are considered somewhat a crossover between battery and conventional engines in their working. Similar to conventional engines, fuel cells generate power by using fuel (i.e. pressurized hydrogen gas) from a fuel tank.

However, unlike traditional internal-combustion engines, a fuel cell does not burn the hydrogen, but instead it is chemically fused with oxygen from the air to make water. This process, which is in turn similar to what happens in a battery, creates electricity, which is used to power the electric motor.

Thus, while fuel cell vehicles are electric vehicles (since they are solely powered by electricity), they are similar to conventional vehicles with regards to their range, refueling process, and needs. This makes them ideal for long-haul commercial vehicles.

Chinese government bets big on fuel cell vehicles

Under China’s 13th Five-Year Plan, the government has laid out a Fuel Cell Technology Roadmap, in which it aims to operate over 1,000 hydrogen refueling stations by 2030, with at least 50% of all hydrogen production to be obtained from renewable resources. In addition, it has set a target for the sale of 1 million fuel cell vehicles by 2030.

To achieve these ambitious targets, the Chinese government plans to roll-out a program similar to its 2009 program – Ten Cities, Thousand Vehicles, which promoted the development and sale of battery electric vehicles and hybrid vehicles. It currently plans to promote fuel cell vehicles in Beijing, Shanghai, and Chengdu. Considering the vast success garnered by this program, it is likely that the government will also be successful in achieving similar targets for fuel cells.

Moreover, while the government is phasing out subsidies for BEVs, it is continuing them for fuel cells. As per the government guidelines issued in June 2018, US$32,000 purchase subsidy is available for fuel cell passenger vehicles, while US$48,000-US$70,000 purchase subsidies are available for fuel cell buses and trucks. However, for the buses to receive subsidy, they are required to drive a minimum of 200,000 km in a year.

While the government is phasing out subsidies for BEVs, it is continuing them for fuel cells. As per the government guidelines issued in June 2018, US$32,000 purchase subsidy is available for fuel cell passenger vehicles, while US$48,000-US$70,000 purchase subsidies are available for fuel cell buses and trucks.

Moreover, the government also provides subsidy for the development of hydrogen refueling stations. A funding of US$0.62 million is available for hydrogen refueling stations having a minimum of 200kg capacity.

In addition to these national subsidies, state-wise subsidies are also available for several regions such as Guangdong, Wuhan, Hainan, Shandong, Tianjin, Henan, Foshan, and Dalian. Local subsidies differ from region to region and are given as a ratio of the national subsidy. For instance, it equals 1:1 in Wuhan, while it is 1:0.3 in Henan province. On the other hand, local or state subsidies are cancelled for BEVs (except buses).

Apart from subsidies given to fuel cell infrastructure and vehicle manufacturers, the price of hydrogen is also heavily subsidized, making it cheaper than diesel in many cases.

China’s fuel cell vehicle market picks up steam

The government’s backing and subsidies have stirred interest of several international players towards China’s fuel cell vehicle market. Considering its success and dominance of the BEV market, these players are placing their bets on China achieving similar volumes and success in the fuel cell sphere.

Chinese companies have also begun to invest heavily in fuel cell technology companies globally. In May, 2018, Weichai Power, a Chinese leading automobile and equipment manufacturer, purchased a 20% stake in UK-based solid oxide fuel cell producer, Ceres Power. Similarly, in August 2018, Weichai Power entered into a strategic partnership with Canada-based fuel cell and clean energy solutions provider, Ballard Power Systems. As part of the strategic partnership, the company purchased 19.9% stake in Ballard Power Systems for US$163.3 million. In addition, they entered into a JV to support China’s Fuel Cell Electric Vehicle market, in which Ballard holds 49% ownership. Through this partnership, Weichai aims to build and supply about 2,000 fuel cell modules for commercial vehicles (that use Ballard’s technology) by 2021.

China Accelerates on the Fuel Cell Technology Front - EOS Intelligence

Global leader in industrial gases, Air Liquide, has also partnered with companies in China to be a part of the fuel cell movement. In November 2018, the company entered into an agreement with Sichuan Houpu Excellent Hydrogen Energy Technology, a wholly-owned affiliate of Chengdu Huaqi Houpu Holding (HOUPU), to develop, manufacture, and commercialize hydrogen stations for fuel cell vehicles in China. In January 2019, the company also partnered with Yankuang Group, a Chinese state-owned energy company, to develop hydrogen energy infrastructure in China’s Shandong province to support fuel cell vehicles in that region.

Another global player, Nuvera Fuel Cells (US-based fuel cell power solutions provider) has also engaged with local companies to foster growth in China’s fuel cell vehicle market. In August 2018, the company entered into an agreement with Zhejiang Runfeng Hydrogen Engine Ltd. (ZHRE), a subsidiary of Zhejiang Runfeng Energy Group based in Hangzhou. Under the agreement, Nuvera will provide a product license to ZHRE to manufacture the company’s 45kW fuel cell engines for sale in China. While the fuel cells will be initially manufactured in Massachusetts, it is expected that they will be locally manufactured by 2020.

In December 2018, the company signed another agreement with the government of Fuyang, a district in Hangzhou (in Zhejiang province), to start manufacturing fuel cell stacks locally in 2019. The agreement also includes an investment by Nuvera to establish a production facility in Fuyang region. These fuel cell stacks will be used to power zero-emissions heavy duty vehicles (such as delivery vans and transit buses), which comprise 10% of on-road vehicle fleet, but account for 50% fuel consumption.

In addition to the fuel cell energy producers, global car manufactures have also shifted their attention to fuel cell vehicles market in China. In October 2018, Korean car manufacturer, Hyundai, entered into a MoU with Beijing-Tsinghua Industrial R&D Institute (BTIRDI) to jointly establish a ‘Hydrogen Energy Fund’. The fund aims to raise US$100 million from leading venture capital firms across the globe to spur investments in the hydrogen-powered vehicle value chain. This agreement will help the Korean automobile manufacturer identify and act upon new hydrogen-related business opportunities in China and will eventually help pave the way for Hyundai Motors to make a foray into the Chinese fuel cell vehicle market in the future.

A bumpy road ahead for fuel cell vehicles

While the industry players are working along with the government to meet the ambitious targets set by the latter, fuel cell vehicles must overcome several challenges for them to be a realistic alternative to conventional and electric vehicles.

Currently, the infrastructure for fuel cell vehicles is by far insufficient. More so, it is extremely costly to develop, costing about US$2 million to build a refueling station with a capacity of about 1,000 kg/day. While the government is investing heavily in developing hydrogen refueling stations (for instance, China Energy, China’s largest power company, has been building one of China’s largest hydrogen refueling stations in Rugao City, Jiangsu Province), it requires long term partnerships and investments from private and global players to meet its own targets. Until an adequate number of refueling stations is constructed, especially on highway routes (facilitating truck and bus transportation), fuel cell vehicles will remain in a sphere of concept rather than commercial and mass use.

Another challenge faced by the industry is that hydrogen, the main fuel, is also considered to be highly hazardous, and storing and transporting it is currently difficult. Moreover, it is difficult to convince customers to purchase hydrogen-powered vehicles because of this perceived notion of hydrogen being unsafe. In addition to providing subsidies and incentives for building fuel cell vehicles, the government must also invest in marketing campaigns and enact policies that raise awareness about hydrogen in fuel cell vehicles as a safe and green energy.

In addition to providing subsidies and incentives for building fuel cell vehicles, the government must also invest in marketing campaigns and enact policies that raise awareness about hydrogen in fuel cell vehicles as a safe and green energy.

A lot of new technologies are also being explored to further make transporting and storing hydrogen safer. A German company, Hydrogenious Technologies, has developed a carrier oil that can carry hydrogen in a safe manner. This oil is non-toxic and non-explosive and thus makes transporting, storing, and refueling hydrogen safe. Moreover, using hydrogen mixed with this carrier oil to refuel fuel cell cars follows a similar refueling process as that of a conventional car, with one cubic meter of the oil carrying about 57kg hydrogen, which in turn is expected to give a car a driving range of 5,700km. However, the carrier oil is still in its nascent stage of development and would take time and resources to gain commercial applicability.

However, one of the largest challenges that fuel cell vehicles face is direct competition from battery electric vehicles. BEVs have a 10-year head start over fuel cell vehicles whether it comes to government support, technological development, infrastructure, or acceptability. Moreover, BEVs are cheaper both in terms of cars price and cost of running, which is an important factor for consumers. In addition, BEV players are constantly working towards reducing charging time and increasing driving range. Since both are green technologies, it is likely that the consumer prefers the one which has now proven to be a successful alternative to conventional vehicles in terms of pricing and supporting infrastructure. Although higher subsidies for fuel cell vehicles may help bridge the gap, it is yet to be seen if fuel cell cars will be able to give stiff competition to their green counterparts.

EOS Perspective

There is no doubt that the Chinese government intends to throw its weight behind the fuel cell technology for automobiles. In 2018 alone, the central and local governments spent a total of US$12.4 billion in supporting fuel cell vehicles. This has helped attract the attention of several local and international companies that want a share of this growing market.

It also helps that hydrogen as a fuel has several benefits when compared with battery power, the key advantages being short refueling time and long driving range. Moreover, some consider hydrogen to be a cleaner fuel when compared with battery power as the electricity required to create hydrogen (which is created by pumping electricity into water to split it into hydrogen and oxygen) can be derived from renewable sources from China’s northern region, which are currently going to waste.

Despite these inherent benefits, it will be difficult for fuel cell vehicles to catch up with battery-powered vehicles as the latter have significantly advanced over the past decade (leaving fuel cell vehicles behind).

Moreover, China’s model of promoting green energy is yet to pass its ultimate test, i.e., to sustain and flourish without government support. Since the government has now begun to phase out its support to BEVs, it is to be seen if the large group of domestic electric vehicle makers can survive in the long run or the market will face significant consolidation along with slower growth. Thus it becomes extremely critical for the Chinese government and companies in this sector to understand the feasibility of the market post the subsidy phase. Fuel cell vehicle market should take advantage of learning from the experience of battery powered vehicles sector, which was the pioneer of alternatives to conventional combustion vehicles.

by EOS Intelligence EOS Intelligence No Comments

Commentary: The Suzuki-Toyota Partnership – Are Such Partnerships Here to Stay?

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In February 2017, Suzuki and Toyota signed a memorandum of understanding (MoU) for business partnership. The two Japanese carmakers drafted framework for collaboration on future technology development, joint manufacturing, and market development projects. Both companies agreed to share their R&D, product portfolio, infrastructure, and dealer networks in India.

The collaboration includes mutual supply of passenger vehicles between the two companies for the Indian market. Maruti Suzuki (Suzuki’s Indian subsidiary) will supply Toyota with between 30,000 and 50,000 units of Baleno and Vitara models, while Toyota will provide Suzuki with 10,000 units of Corolla annually. These vehicles will be marketed nationally through their respective sales networks. In addition, Toyota and Denso Corporation (owned by Toyota) will offer technology transfer to Suzuki for developing a compact and highly efficient powertrain. Toyota’s Indian arm, Toyota Kirloskar Motor (TKM) will manufacture models developed by Suzuki for sale in India, Africa, and other emerging markets via their global sales networks. Further, in November 2017, both companies announced plans to co-develop and introduce electric cars (EV) in India by 2020. For this, they are setting up a lithium ion battery plant in the Indian state of Gujarat.

What does it mean for both OEMs?

By tapping into Toyota’s under-utilized manufacturing capacity in India, Maruti Suzuki will get access to the much needed extra production bandwidth. The OEM has so far relied heavily on Fiat for its diesel engines. With the new collaboration, it will have access to Toyota’s superior diesel engines that will help Suzuki to improve its brand perception in the Indian market. The partnership will also provide Maruti Suzuki with a chance to take a stab at the executive sedan space by offering Toyota’s Corolla via its sales network. Lastly, Suzuki will leverage Toyota’s technology and EV expertise, an area where the OEM is relatively weak and definitely needs improvements.

The partnership will give Toyota access to Suzuki’s expertise in India. It will hopefully help it to penetrate the low-priced compact cars market, a segment it has failed to crack so far. The OEM relies mainly on diesel car sales in India. However, the new partnership will help Toyota to fill the current product gaps, broaden their portfolio with petrol cars from Suzuki, and achieve higher sales in India.

What does it mean for Indian automotive industry and customers?

At present, both carmakers have started sharing a few of their models with each other. However, there is a potential for more models in pipeline, followed by joint product development and manufacturing platform sharing (shared engineering and production efforts for different vehicle models). This is likely to lead to the introduction of new cars in various market segments. The co-developed cars are promised to have Toyota’s technological sophistication as well as Suzuki’s affordable ticket price, providing customers with broader and better options. In addition, the partnership can be expected to make both carmakers compete with each other for performance improvement, this will result in enhanced products and services for customers.

From an industry perspective, the joint manufacturing will result in creating more local jobs. Volume production will mean that both OEMs will also look to source components locally for cost savings. This will provide some boost to domestic components industry and government’s Make in India initiative. Suzuki’s size, scale, market knowledge, as well as unrivalled supply chain in India, along with Toyota’s global expertise and technology know-how, make this tandem a great fit in the context of kick-starting, promoting, and meeting the Indian government’s ambitious 2030 EV targets. In the EV space, the partnership will contribute to manufacturing more efficient cars and aid in development of the automotive and ancillary industries.

Are such partnerships here to stay?

Since growth opportunities in developed automotive markets are confined, global carmakers have set their eyes on emerging markets as these are projected to represent around 60% of the total global auto sales by 2021. India is on a fast track towards becoming the world’s third-largest auto market thanks to the rapidly growing passenger car market. According to IHS Markit estimates, annual new car sales are expected to reach 5.1 million in 2020, an increase of about 30% from 2016-2017 figures. Therefore, it looks like a logical move for global OEMs, such as Toyota, to look at all possible collaboration avenues to capture the growth opportunities in these markets.

The global automotive industry is constantly evolving triggered by rapidly rising new technologies, changing customer preferences, and multiplying sustainability policies. Carmakers globally are faced with massive costs to develop new technologies for highly energy-efficient cars. To remain competitive in such rapidly changing industry, OEMs need to increasingly look for strategic collaborations that will enable them to work together and leverage their shared expertise to optimize cost as well as performance. As a result, increasing number of alliances are seen where carmakers collaborate by sharing platforms and joint manufacturing for cost savings in R&D, manufacturing, and components procurement. This is especially true in emerging markets where growth opportunities are ample, but own set of challenges exists, and such alliances are increasingly becoming catalysts for growth. Recent examples include five MoUs signed between Mahindra and Ford to jointly develop new products in India and other emerging markets, or a similar alliance between China’s Geely Group and Daimler.

While the coming together of two Japanese OEMs with two different working cultures may pose its own challenges, both carmakers need this collaboration to succeed for their own reasons. For Toyota, the reason is to increase its presence in a country that is soon to become the world’s third-largest auto market. Suzuki’s reason is the much needed technical know-how to enter the EV space. While the success of this partnership at present remains uncertain and it will be interesting to see how this partnership pans out in the next few years, one thing that is certain is the fact that one can expect more such collaborations in the near future, as carmakers will look for partners to better penetrate new markets, develop new products to grow, at the same time optimize their R&D, manufacturing, and procurement costs.

by EOS Intelligence EOS Intelligence No Comments

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

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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.

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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

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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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