The huge potential of the automotive industry in the Asean region cannot be denied. The emerging economies, with a combined population of 550 million, present a huge market for automakers.

However, the impending implementation of the Asean Free Trade Area (Afta) rules is a challenge to both automakers and parts manufacturers.

But judging from their annual reports, many already know what to expect. 'It's going to be very competitive. Growth will be correlated to growth in automotive sales but at lower margins,' Chin Jit Sin, executive director of parts maker New Hoong Fatt Holdings Bhd (NHFHB), tells Malaysian Business.

Reduction in tariff barriers, including policies on local content, are leading the region's auto industry to undergo a major transformation. The move by automakers to increase production capacities and operational efficiency demands that suppliers do the same.

Technological advances and diversity in auto makes mean short product life cycles that prevent automakers and suppliers from achieving economies of scale in design and manufacturing.

To get around this problem, homogenisation of car characteristics and processes are being instituted by automakers to lower production cost and gain market share, but it is leading to a much tougher operating environment, with downward pressure on prices and margins.

The chain of suppliers is becoming smaller, with automakers preferring a smaller number consisting of first-tier producers to whom automakers are passing on part of the responsibility of manufacturing and development.

National carmaker Perusahaan Otomobil Nasional Bhd (Proton), for instance, is demanding that distributor Edaran Otomobil Nasional Bhd (EON) put up 30 per cent of the development cost of new models as a condition for the renewal of EON's distribution agreement.

'All car manufacturers are demanding a cost down by 20-30 per cent over a few years,' says Kit Lew Lin, managing director of Sunchirin Industries (M) Bhd, a tier-one and tier-two supplier.

He says the 20 per cent target could be very difficult to achieve. 'There is a limit to the cost down we can do as raw material pricing is independent. If material prices rise, there is no way we can make parts cheaper. The only way we can cost down is to reengineer the processes to become more efficient and try to cut down on production processes. If you are talking about a cost down of 20 per cent we need to cost down by 40 per cent'.

The move is part of Proton's efforts to face up to impending competition. Japanese automakers, which have a built a commanding presence in the region, are expected to take advantage of the Asean Industrial Cooperation (AICO) programme under Afta that provides preferential treatment regardless of capital affiliation or participating companies to trade parts and components.

The removal of the local content policy by Thailand in January 2000 will allow automakers to source parts globally from more efficient and established suppliers.

In Malaysia, the government is worried that Afta would see Malaysian parts suppliers lose market share. The decline in profits would spiral into lower investments, which would affect the competitiveness of the parts industry, not to mention likely closure and job losses.

It has thus sought a two-year delay in the implementation of the Afta plan to reduce tariffs to between zero and five per cent, scheduled for January 2003.

Industry players say most local parts producers are competitive and credit the national car projects for that.

'Malaysian auto component producers are as competitive as those in Thailand, especially for passenger cars, due to the higher researh and development capabilities demanded by Proton, and technical cooperation with foreign companies,' says Annuar Jalaluddin, a research analyst (automotive, industrial technologies) with Frost & Sullivan.

Flipping through company reports will reveal a host of export markets for the local parts and component producers like APM Automotive Holdings Bhd, NHFHB and Sunchirin.

The Thai parts industry's advantage over Malaysian producers is their lower labour cost of about US$1.50 an hour compared with US$2 in Malaysia, according to a study done by Toyota Motors.

The bigger threat, however, comes from Chinese and Korean producers, the former with their cheap products and the latter their large and strong auto industry. 'The only advantage we have is our quality standards which are more consistent than our competitors,' Sunchirin's Kit told Malaysian Business at the company's annual general meeting recently.

Korean suppliers are the preferred choice of Koraen automakers but for Japanese and non-Korean makes, Malaysian manufacturers are well positioned.

The plastic-based and metal-based parts market, which uses lower levels of technology, is expected to come under pressure most under the Afta regime. For long, the auto parts industry in Malaysia has been a beneficiary of the growth of the national car projects, replacement parts market and the local content policy.

The industry's main customers are Proton and Perusahaan Otomobil Kedua Sdn Bhd (Perodua) which together account for about 85 per cent of the local passenger-car market.

The immediate outlook for local parts suppliers remains bright. A growing domestic market and long established ties with Proton and Perodua will continue to see local suppliers benefit from old associations.

The Malaysian Automobile Association has forecast auto sales to grow by four per cent this year but sales for the first quarter rose by 10 per cent on the back of low interest rates and strong domestic consumption.

Annuar says the impact of Afta would be felt after 2003, when sales are forecast to drop a little as consumers postpone purchases in anticipation of cheaper prices.

Over the longer term, local parts suppliers would need to enhance design and engineering capablities and have strong financial capabilities to maintain their strong presence.

'Local parts manufacturers need to get the QS 9000 certification to bid for contracts with international automakers. Companies could also diversify into manufacturing other parts using current capacity," says Annuar.

Sunchirin is moving into supplying piping parts not related to the air conditioner market, says Kit, while NHFHB has moved into plastic parts from its traditional metals parts business.

The prospects of Afta and industry-wide changes are also leading some local component suppliers to locate production facilities in regional bases of automakers. This is because the marketing of component parts generally requires direct contact with automakers and established suppliers.

Sunchirin has set up a company in Thailand to be closer to its customers such as Sanden and Denso and Denso, and automakers who have made Thailand the auto hub for the region.

Ingress Corporation Bhd has done the same by venturing into Thailand in a joint venture with Mitsubishi Corporation and Katayama Kogyo Co Ltd to supply engine gas return pipes and bellows to the Honda and Isuzu regional manufacturing centers in Thailand.

Another local original equipment manufacturer (OEM), Delloyd Ventures Bhd, has acquired a 10 per cent stake in parts manufacturing operations in Indonesia and set up a representative office in Thailand. Executives at the company say they are bidding to become a supplier to automakers there using the QS 9000 certification as proof of its engineering capabilities.

Non-dedicated Proton or Perodua parts or component suppliers with a strong presence in the market say they will not branch out into the region with the lifting of tariffs. NHFHB, for instance, says it will work in its present locality but with an emphasis on becoming more efficient through automation, diversifying of product portfolios and improving of logistics capabilities.

Relocating could be avoided as automakers have established an e-commerce marketplace for suppliers and potential customers. The bigger trend noticeable is the move into thriving areas of distribution and after-sales service.

Proton itself has moved into the two activities through Proton Edar Sdn Bhd. 'There is a huge service-related market,' says Annuar. Moves by automakers to reposition themselves into the services business rather than manufacturing will see the outsourcing of greater manufacturing responsibility to suppliers. This could see a consolidation in the chain of suppliers.

If Proton were to take on a foreign supplier-partner, the industry could see even more changes. Tier-one suppliers could get relegated to tier-two and financially weak suppliers unable to carry out research and development could be taken over by competitors.

Still, the main beneficiaries of Afta are likely to be the customers as automobiles are likely to become cheaper, theoretically. The availability of major makes in the region will also see more choices for customers and better quality vehicles.