To Chairman, Tata Motors Ltd
Issue Profitable Production of the Nano
A primary issue Tata must consider is the current and future profitability of the Nano. In order to determine if their strategy of entering the small car market is feasible, the influences on the industry must be evaluated. If evaluation of the industry indicates that future profitability is in question, the company must consider canceling the project, or focus on areas where Tata can influence the industry to improve the likelihood of profitability.
One must consider the sensitivity to prices and the affordability of the car to the primary target market (India). Case Exhibit 3 estimates that 21% of households have income levels high enough to be considered part of the target market (ie: families that may own a motorcycle or small car), with almost all (98%) residing in the $4000-$10000 income bracket. Even at low gros margins, the Nano would be 22% of household income for those families that make $10000 annual income. Although 40 million households are estimated to be in the $4K - $10K income bracket, it can be expected that a small number of these will be earning $10,000. Therefore, the target market can be considered greatly reduced, and their price sensitivities very high. However, as discussed, it can be assumed that these households already have a motorcycle, and approx 2 million could switch to a cheap car. In the analysis of Case Exhibit 6 there is no reference to Labour or SG&A costs for the Nano. When these are estimated (general and admin costs assumed to be negligible due to Tata’s current operations of vehicle production), the cost of the Nano rises to a point where $2200 (USD) per unit price will not be profitable. If the 24% Post Manufacturing Tax remains (p.18), a promotional budget is included (assumed to be 20% of per-unit sales up to first 250,000 units), and labour cost/unit is included (Appendix Exhibit 1), the sale price of the Nano must rise to approximately $2600USD (Appendix Exhibit 2). Also, current profitability is a poor indicator for future profitability. A rise in raw material price will mean a rise in price of supplies (eg: steel). The already near-zero profit margins will diminish without an increase in selling price.
Tata is entering a new market, and a careful analysis of the competitive forces in India must be carried out (see Appendix Exhibit 3 – Porter’s Five Forces). Considering rivalry, Tata is the leader on price. This gives them a very important competitive advantage in a highly price-sensitive market. Although market share has large potential for increasing, the threat of new entrants increases the rivalry over the coming years. The advantage for Tata lies in sourcing low-cost inputs through a unique supply chain.
The supply chain is supported by inputs from suppliers in close proximity to the Tata facility, and is characterized by a high number of suppliers competing with one another for the Tata business. There are many input substitutes available with a relatively low purchasing cost. This places Tata in a strong position over suppliers and allows them to manufacture cars at a low cost.
The competitive force of the buyer can be considered low for the Indian market. Since the Nano will be the cheapest car available, it may be the only option for many car buyers and there will be few substitutes available until foreign competitors can establish a similar low-cost structure. The buyer gains leverage with very high price sensitivity, essentially in the form of affordability.
The barriers to entry are in favour of Tata. They can realize economies of scale in terms of increasing their capacity for vehicle production, their efforts in promotion, labour and material inputs, and distribution facilities. These will be difficult barriers to overcome for new entrants, and high (or...