Interesting group project assessing whether Tata Motors should build a manufacturing plant in Vietnam or Malaysia, written after we spent some time in and around Ho Chi Minh City talking to business owners.

1. Tata Motors – Stage 42009Sariya Ahmad / Natalie Ballard / Henry Jenkins / Robert ReevesFEMBA 10C Group 18/1/2009 rightcenter Overview To avoid depending on the cyclical automotive economy of India, Tata Motors (TTM) began expanding into new products and markets, both domestically and internationally, in 1997. This expansion resulted in a greater Asian market presence. TTM appears to execute the following strategy: researching countries with products and/or markets countercyclical to India, finding a strategic partner in that market, selling TTM-branded products within the target market and then exporting their products regionally. The stage 3 analysis of TTM in Malaysia suggested that the most successful strategy is to continue this trend. One potential partner was singled out for TTM -- a Malaysian vendor called Proton, a local auto manufacturer with existing knowledge of the large and medium automotive market in Malaysia. If Proton was unwilling to take part in a joint venture, an alternative for TTM would be to collaborate with a larger auto component supplier that was looking to vertically integrate into the passenger vehicle segment using primarily local management and local branding. That strategy addressed the risks of the Malaysian market while leveraging strengths and opportunities (TTM’s management style, government support and the labor pool’s knowledge and skills). This paper presents the major market and non-market factors influencing a decision to further penetrate the Asian automotive market by focusing on Vietnam as a possible manufacturing location. The factors undergoing a detailed analysis are the Vietnamese auto market, its economy, FDI and government assistance, the impact of trade relations and Vietnamese culture and work force. Comparing Vietnam to Malaysia, it is apparent that TTM should manufacture and distribute from Malaysia. The recommendation is that TTM focuses on manufacturing its ultra low-cost passenger vehicle (Nano) in Malaysia and export to AFTA-participating countries (including Vietnam). Automotive Market The automobile industry in Vietnam is relatively young. However, the accession into WTO and strong indicators of growth are set to spur the activity in Vietnam's automobile sector. Vietnam's production of automobiles registered an average growth rate 30.67% annually for the past six years. While the General Office of Statistics does not break out automobile exports, its “Machinery, transport and equipments “ export category has grown from $1.3 billion in 2002 to $5.6 billion in 2007. However, automotive exports appear to be a small portion of that as manufacturers are focused on the domestic market. That may be an opportunity for a manufacturer such as TTM to build a plant focused on exports. Domestic demand is growing, as Vietnamese are spending more on automobiles in areas that have a reasonably developed infrastructure. They are changing their lifestyle as they become more affluent. With a general increase in income per head, more Vietnamese are electing to switch from motorcycles and purchase cars. A flexible bank loan structure has also propelled growth in the passenger vehicle segment. On the other hand, the government recently imposed a 50% luxury tax, making cars too expensive for most mass-market customers and almost crippling demand. These indicators signal a significant potential market for this economy, assuming government intervention doesn’t ruin it. According to the Vietnamese Automotive Manufacturing Association (VAMA), car sales tripled in the second quarter of 2008 in comparison to the previous year, during an economic slowdown. This surge was attributed to an increase in the income of Vietnamese and an “all time low” of car prices. “VAMA also revealed that domestic sales recorded by 16 car manufacturers surged 180% and reached 34,095 units during the period January-March 2008. Only in March, the sale figures grew almost three times of what was recorded in the same month last year (at 13,091 units). Moreover, the country’s import of Completely Built Units (CBUs) in 2007 was around 28,000, 224% high from a year before.” Annualized demand calculates to 164,000 units. Approximately 80 million Vietnamese work in the farming industry and are one of the larger customer segments for the car industry as they require small vehicles for transportation. “Till 2006, spending on buses, coaches, and taxis had increased and it is showing high demand for road transportation. In this scenario, cost effective and low cost passenger cars may see a healthy future ahead.” While domestic demand is much lower than other countries, the Nano competes in a segment between motorbikes and four-wheeled vehicles – a segment likely much broader than current demand statistics reveal. There has been some reduction of risk associated with the automotive industry since the government has greatly invested in large infrastructure development. Some of this construction was evident in the highways and bridges outside of the heart of Saigon observed during the FEMBA international residential (IR). Unfortunately there is no consistency with government action. Fred Burke, Managing Partner at Baker Mackenzie, stated that the Vietnamese government did not have a structured funding mechanism in place (e.g., a functioning bond market) for infrastructure development. Based on personal observations of Ho Chi Minh City (HCMC) and its surrounding along with the opinion of Baker Mackenzie, it was evident that the urban areas lacked sufficient roads, parking, and other facilities that support any significant expansion of automobiles. While there was significant future opportunity to build up developing rural areas to support automobiles, this expansion may be years away. Nothing punctuated the point more than the late arrival of Jean-Marc Merlin, Chairman of Apple-Tree Group. He was over an hour late to the IR speaking engagement due to excessive flooding on the roads in HCMC. Companies expanding into Vietnam have faced many challenges when partnering with local Vietnamese companies. Domestic automotive manufacturers are state-run, so profits are second to employment. Foreign vehicle manufacturers such as Mercedes-Benz and Ford are already established in Vietnam, setting the state for potential red-ocean competition. Some companies have stated that the Ministry of Industry should support foreign interest in Vietnam since the long-term effects could be extremely lucrative for the country. To have a successful vehicle market, the automotive components, accessories and other related peripheral industries must significantly develop. While TTM is effective in creating joint ventures to enter a market, the challenges involved in working with local Vietnamese companies may not yield success. Economy It is evident both from research and from the entrepreneurs who spoke to the class (especially Mr. Merlin), Vietnam has a dynamic market. HCMC, Hanoi and Da Nang are developing into major cosmopolitan cities with high business potential. Since 2006, Vietnam has developed many attractive qualities for foreign companies including rapid growth in consumer demand, a generally accommodating government, increased social stability and a young, hard-working labor pool. Following a similar direction as China, the Vietnamese economy is changing from a planned economy to a market economy. With the Communist Party in Vietnam encouraging market reforms (doi moi) that “include greater transparency of laws and regulations,” Vietnam has become a country with a high degree of activity in foreign direct investment. Further, the open market has triggered the open expression of an already entrepreneurial culture. Because of these reforms, Vietnam is among the fastest growing economies in the world with real GDP growth between 6-8%. Even in the current global recession, Vietnam’s GDP is expected to grow by 4.2%. Poverty is on the decline; a sustained increase in per capita income and an increase in the number of small businesses have created a large demand for imports. As raised by Messrs. Merlin and Burke, Vietnam presents many legal and political issues that require more clarity and consistency to easily start and maintain businesses. Vietnam has the advantage of possessing a large amount of natural resources and a beneficial geographic location for trade. It shares a border with China and is in close proximity to Thailand and Singapore. These states have positively influenced Vietnam though venture capital projects, particularly in the high-tech activities. For example, in February 2006, Intel was awarded a license to invest $600 million in a semiconductor and test manufacturing facility in HCMC. This location was chosen over India and China, primarily because of the cost advantage Vietnam has over its rivals. During the visit to Intel, the Finance Controller stressed the importance of heavy government backing during construction of the site. Intel worked with local Vietnamese companies on the massive construction site to build a large fabrication plant. There were many months of delay due to accidents during construction, creation of processes for safety and general issues with paperwork. Issues like these can be major roadblocks to starting a business when other more business-friendly locations in Southeast Asia exist. Foreign Direct Investment / Official Developmental Assistance The increase in foreign direct investment (FDI) spurred the Vietnamese government to announce a list of 17 major projects to improve the country’s infrastructure by 2020. This improvement includes additional roads, creating opportunities for the use of passenger vehicles in areas that were previously not reached by automobile traffic. These projects will be funded by Official Developmental Assistance (ODA) and FDI. The estimated total cost of initiating these projects is $68 billion. The proposed infrastructure improvements include: the North-South expressway, Ho Chi Minh Highway and other expressways that connect various cities in Vietnam; ports in the North (at Lach Huyen) and the South (at Van Phong), in which the state-run Vinalines has heavily invested; airports in the provinces of Dong Nai and Kien Giang; and additional terminals added to existing airports. All of these improvements create the potential to move goods in and out of the country en masse, enabling higher volumes of trade. “Long Thanh airport will be developed into Vietnam’s biggest international airport at an estimated cost of $2 billion. It will be able to handle the Airbus A380 airliner, and will receive 100 million passengers and five million tonnes of cargo each year.” Even with all of this actual and promised infrastructure development, supply-chain issues continue to be a major headache for many of the companies visited in HCMC. From furniture to textiles to beverages to semiconductors, all the companies struggled to get their products to market in Vietnam. How TTM would be able to move large numbers of its vehicles around Vietnam in a timely manner could be very challenging. Trade Relations As WTO member, Vietnam has the opportunity to establish itself in the permanent normal trade relations (PTNR) category and increase long-term bilateral trade and investment. The Vietnamese government has made a clear commitment to obey international standards that are required by the WTO. With its WTO membership, booming economy and increased FDI, the Vietnamese economy is projected to double in the next decade. This economic expansion will create more demand for foreign goods and services, further attracting foreign exporter and investors. With the achievement of the Bilateral Trade Agreement between Vietnam and the United States in 2001, two-way trade has increased by a decade. The BTA was the result of President Clinton’s elimination of the trade embargo on Vietnam. The U.S saw new opportunities in Vietnam after reducing tariffs and deletion of market barriers. Not coincidentally, the U.S. is among the top ten investors in Vietnam. Furthermore, majority of Vietnamese products are exported to the U.S. U.S.-Vietnam trade relations have been increasing rapidly within the last decade. “Two-way trade revenue rose from $1.2 billion in 2001 to $10 billion in 2006. This boom in trade is thanks to Vietnam’s strong economic growth and the US companies’ provision of equipment, materials, technology and management skills to developing industrial establishments of Vietnam.” This increase in trade between the two countries should create a rise in domestic disposable income, as well as make Vietnam a convenient stepping stone into the U.S. market. These are both potential benefits to TTM. Culture and Workforce The Vietnamese culture is one of the oldest cultures in the Asian Pacific. Its cultural heritage dates back to the ancient Dong Son culture during the Bronze Age. The Dong Son people were known to be skilled in cultivating rice, farming buffaloes and pigs, fishing, sailing and bronze casting. This history has positioned the Vietnamese as an agrarian civilization, concentrating their crops on rice. Vietnam’s history includes a millennium of domination by China (part of the “East Asia Culture Sphere” / “Chinese Cultural Sphere”). Much later, Vietnam was dominated by French colonial influence, where the Vietnamese were influenced by European merchants. The spread of Catholicism and the Latin alphabet also came through the European merchants. Currently “Vietnam is the only non-island nation of Indochina which uses the Latin alphabet to write the national language.” Whether through research or direct interactions with expatriate business owners, Vietnamese are portrayed as kind, hardworking people with the capability of creating good quality products. They are said to value their time away from work, so they rarely work overtime. In the event where overtime is a necessity, Vietnamese prefer working Saturdays, allowing their Sundays free of work, to “enjoy life”. The majority of Vietnamese do not volunteer for a seven-day work schedule. Vietnamese take pride in their work and expect respect. “You cannot treat them very strictly, and you cannot scold them or shout at them in front of other workers,
said Tsai of Return Gold.
They will feel ashamed. You have to respect them. If you treat them well, they will do their best for you.
This attitude, observers say, comes from the sense independence and pride gained during the French rule. In discussions with factory owners and tour guides, it was clear that many Vietnamese in urban areas tend to work more than one job to support themselves and their families. The working conditions appeared deficient with respect to American standards of safety. As TTM’s mission and values articulates a concern for social responsibility, this may be disconcerting to management. Strikes are common, especially with respect to compensation and overtime. Strikes may last for a couple hours or a few days depending on the negotiations through labor union and the government mediators. These strikes impinge on the work schedules that cause frustrations among foreign companies and customers. To avoid these issues, foreign companies start Vietnamese workers at higher rates than nationally required. Further, companies try to avoid these issues by motivating workers through daily meetings that discuss goals, quality and any concerns from the employees. This additional overhead erodes margins that companies attempt to achieve by targeting a lower cost of production nation. Both strikes and upward spiraling wages destroy profitability for companies like TTM that produces low-cost, low-margin products. Approximately two-thirds of Vietnamese are under the age of 35, with a national literacy rate of 90-95%. The country has a large young and educated workforce. Many of the expatriate managers visited stated that the young Vietnamese workforce is comprised of dedicated workers, but with some complications. Observed in the factory tours were issues with the quality of the labor market that were not revealed by research. The culture tends to be tolerant of stealing and cheating, requiring increased security costs. This was demonstrated in the form of security guards at the factories and the discussion of surveillance cameras installed by Apple-Tree Group. Turnover is extremely high (50-60%), increasing onboarding and training costs. A domestic management pool is almost non-existent; almost every location visited used expensive expatriate management. Intel clearly demonstrated the problems in their efforts to bring in local Vietnamese that were properly skilled. They needed to significantly invest in internal and external training. Also, workers lack an appreciation of workplace etiquette since they move from jobs frequently—especially in the management tier. One manager described a behavior as “no safety culture” in plants. “They aren’t used to the quality and safety levels,” said Bruno Le Roy, of France-based Technip. Several of the factory owners referenced these problems as serious issues related to labor and the costs. Further, as Mr. Merlin noted, workers will continue to steal from their employer until they are caught (through surveillance or any other kind of evidence), admit to the crime because they see no wrong in it, and move to another job. Naturally, high turnover, safety issues and pilferage are not conducive to the smooth operations of an automotive plant. While the labor pool has great potential, it appears to be a huge negative for the automotive industry when compared with other neighboring countries. Vietnam vs. Malaysia Economically and politically, Malaysia has a pro-business focus consisting of regulations, commercial laws and economic policies that facilitate foreign direct investment. Malaysia is ranked one of the easiest places in Asia to do business by the World Bank. Malaysia’s commercial jurisprudence is based on English common law and an independent judiciary, therefore a “fair” outcome is more likely. Contract law is enforced efficiently, compared to other Southeast Asian countries (Global Insight) and especially Vietnam. This is an advantage when committing large amounts of capital to build a plant, hire workers, and sell a relatively expensive consumer product. The Malaysian government is concerned with price stability and economic growth, pursuing fiscal policies to keep deficits and currency fluctuations. The economy has a higher proportion of middle-class consumers and is growing faster than the population. If TTM chooses to invest in Malaysia, they would be placing a manufacturing operation in a nation where all of the major political parties are focused on price stability and economic growth, maintaining a pro-business environment. On the other hand, Vietnam’s annual inflation rate runs between 6-10%. Their skilled labor wage rates are increasing at a high rate, according to the business owners visited during the residential. The dong is unofficially pegged to the U.S. dollar, meaning that Vietnam will likely import inflation as the dollar continues to devalue. Manufacturing inputs and the overall cost of business will likely get more expensive in Vietnam. Mr. Burke from Baker Mackenzie discussed how these are still significant issues in Vietnam, particularly that commercial law jurisprudence is still developing and venue shopping for judges does not ensure a reliable outcome. Without judicial consistency, enforcing laws and creating a culture of compliance requires a lot of time and enforcement. If TTM chooses Vietnam they would face many challenges. The Vietnamese government has sent mixed messages in the automotive industry for foreign companies. While the government has announced a long wish-list for infrastructure improvements, little has been accomplished. The government has reduced the auto-component import tax while increasing the luxury tax and driving domestic demand off a cliff. The Vietnamese auto market is extremely competitive (red ocean) with many existing auto-manufacturing currently operating in the country fighting over 180,000 potential sales per year. The workforce of Malaysia is a better fit for TTM because of the quality of their education and the large percentage that already have experience in the auto industry. Manufacturing TTM vehicles requires great attention to detail and precision to ensure durability and reliability. This implies a need for an educated, skilled labor pool at both the manufacturing and management level. Malaysia has a well-educated workforce, one-third of whom work in the manufacturing sector. English is the lingua franca for Malaysia and the government has started promoting English as the country’s primary language in schools. There are very few Malaysian unions and strikes require government approval, meaning that in practice they are very rare. In addition, there is no minimum wage and no unemployment insurance so labor costs are reduced, although overtime and the length of the work week are highly regulated by the government. The Vietnamese workforce, while young and educated may not provide TTM with an appropriate labor pool. While the Vietnamese worker is consistently described as hard-working, they have several disadvantages. They require extensive in-house training, turnover is extremely high, pilferage is a problem and safety regulations are followed with the same compliance as traffic law. All of these factors drive up cost while driving down quality. Both Malaysia and Vietnam are springboards for exports based on their bilateral trade relations and both are ASEAN Free Trade Area (AFTA) signatories. However Vietnam still has extensive gaps to fill in its infrastructure before facilitating the level of exporting for which Malaysia is known. Malaysia has a bilateral free trade agreement with Japan and is negotiating free trade agreements with Pakistan, Chile, the United States and other nations. Free trade agreements, while generally positive in aggregate for consumers and countries, can present difficulties for specific companies. Free trade creates downward pressure on prices in the local market, although it creates more opportunities for exports abroad. Within ASEAN, tariffs are capped at 5% by AFTA so regional competition would still be a factor. However, tariffs do help to price out European and American offerings, giving TTM some time to develop its production before being beset by a truly global competitive landscape. Vietnam has entered into WTO and bilateral trade agreements with the United States. It is a signatory to AFTA (http://www.us-asean.org/afta.asp) but will not be required to implement lower tariffs until 2012. Between the two countries, Malaysia has the mature infrastructure and shipping environment for exports that can be leveraged to supply AFTA signatories. Conclusion Low wages do not make up for a lack of infrastructure, poor domestic demand, high labor turnover and whimsical government policy. To choose Vietnam would mean that TTM commits a great deal of time and treasure to leverage country’s long-term potential. However, that is a very uncertain future. If the Vietnamese domestic market is the target, export to it. If the goal is to choose a country as an export platform, choose one that offers the best infrastructure and relatively low-cost workforce in the region. From the analysis above, Malaysia provides TTM with better opportunities to realize a return on its investments. Malaysia offers a welcoming business environment, a stable government, a slow but steadily growing economy and an excellent distribution system. Vietnam has a booming economy, a nascent (but growing) automotive market and requires extensive work on its infrastructure. Within a few years, AFTA will take effect between Thailand, Singapore, Malaysia, Philippines, Indonesia, and Brunei, lowering the cost of exporting to those countries. By 2012, AFTA will spread to Myanmar, Cambodia, Laos and Vietnam. It is the conclusion of this paper that investing in Malaysia to build automobiles for export will augment Tata Motor’s investment in Thailand and position the company to take advantage of the increased demand for small and midsized cars in Asia and beyond. References