In India, a Big Push Into Small Cars

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He is known to be working on a multiutility vehicle, but hasn't ruled out a small car.

This represents a big move for Bajaj Auto. The company has been the second-largest player in the Indian two-wheeler segment, and investors have long been grumbling that the company was giving up a lucrative market of buyers who wanted to get a vehicle that was more than a scooter but less than a car.

Bajaj's fiercest competitor, the New-Delhi-based $3 billion Hero Group, India's largest bike and cycle maker, has also stirred the car pot, but won't give details. The group's 23-year-old joint venture with Honda Motor (HMC) for motorcycles, Hero Honda, has been one of the most successful in Indian auto history, but now Hero is looking at making vehicles with four wheels rather than just two. "We are exploring avenues but it's too early to talk," says Pankaj Munjal, managing director for Hero Motors and Hero Cycles.

For these players, entering the car market is yet another opportunity, say analysts. If the Tata car succeeds, it could eat into the 65 million-per-year two-wheeler market in India. The most affected would be premium two-wheelers with 35% of the market and 16% operating margins, double the average for bikes. Already, rising interest rates have hit consumer spending on two-wheelers, with many consumers pushing back purchases at least until the Indian New Year festival season in September. In the most recent quarter, domestic two-wheeler sales for the major players fell between 6% and 13%. "That's because of the inventory buildup and nonavailability of finance," says Ramnath Subramaniam, vice-president of research at SSKI Securities.

Up from the Bullock Cart

The transition away from two-wheelers makes the small car's success seem inevitable. Despite India's increasing wealth and the multiple auto offerings, small cars continue to dominate Indian roads, with 70% of the 1.4 million-car annual market. That's likely to double by 2008. Spurred by a growing demand for compact and low-cost cars, auto sales are expected to soar from $34 billion last year to $145 billion by 2016. According to the Strategic Foresight group, between 2001 and 2007 about 100 million Indians moved up the ladder from being bullock cart-users to being two-wheeler users. The next move is a car—an affordable one, which bridges the gap between the $1,450 average scooter to the $4,800 small car currently on the market.

That's why the upcoming Tata car is aimed at the first-time car buyer, or the two-wheeler user wanting to upgrade. The space is wide open, says McKinsey's Mangaleswaran. "Manufacturers are looking to capture this."

It wasn't always so, not even a year ago. Tata's small-car venture was pooh-poohed by many in the industry as a mad idea by a dreamer. Earlier this year, Maruti Chairman Osamu Suzuki dismissed the Tata car as "impossible." But now there's talk in the market that Maruti Udyog, the Indian subsidiary of Suzuki Motor (which is now changing its name to Maruti Suzuki), may slash prices of its 800cc, $4,800 car and spruce it up for a relaunch. "The game is about volumes," says Amit Kasat, auto analyst at Motilal Oswal.

But profitability is a big issue, and the critical factor is making the car at the lowest possible cost. Tata is confident: Says Ravi Kant, Tata Motors' managing director, "It is not just pure price play, but a lot to do with innovation and effective use of resources." This is not idle talk, as Ratan Tata produced India's first indigenous car—the Indica—in 1999, helping Tata Motors emerge as the second-largest carmaker in India. And that's why everyone wants to be in his game.

For more on India's push into small cars, see BusinessWeek's slide show.

Lakshman covers Indian industry for BusinessWeek from Mumbai

Lakshman covers India business for BusinessWeek .