The Rise of Subscription Business Models in the Auto Industry

Today we take a look at the rising Subscription Business Models in the Auto Industry. We take a look at the traditional model and then head on to talk about the new “Subscription model” – finally, we conclude with the help of the numbers and understand why this model, is appealing to the auto Industry.

Let’s jump right in the piece!

Traditional business model of the Automobile Industry

The Millennials and Gen-Z have become the hotties that corporates are trying to woo. Their behavioural tendencies have even been cited by India’s Finance Minister as causes of a downturn in the automobile industry. Whether that is true, is debatable, but the folks born after the late 80s are certainly making corporates rethink their business models.

If we look at the automobile industry, traditionally, it has had a straightforward business model. The auto manufacturers (OEMs) use factors of production i.e. labour, capital (machinery and raw material) and management to make an automobile.

Traditional Business model

The revenue comes in by selling the product (the car) and the costs outflow is for purchasing raw materials, salaries of workers and employees, selling and administration expenses, and other expenses. What remains is the shareholders’ profit. Easy-peasy right?

But here comes a twist in the tale. The rising student debt burden, traffic congestion in cities, availability of shared mobility options and commitment issues have forced Millennials to buy lesser automobiles as compared to Gen-X or Boomers.

Related: Take a look at the rise of Kia motors in India
Rising Subscription Business Models in the Auto Industry

To address this change in consumer behaviour, OEMs (or Original Equipment Manufacturers) have started adopting a new business model based on subscription. Just as Netflix provides access to all the content available on the platform for a monthly fee, OEMs now allow customers to subscribe to their cars for a monthly fee. The monthly subscription amount includes the vehicle cost, routine service and maintenance, roadside assistance and sometimes even insurance. Only the fuel cost has to be borne by the customer just as the internet data cost in the case of Netflix.

Further, no down payment is required but only a refundable security deposit. This model is being used to attract the customers who scout for low capital expenditure, on-demand use and flexibility in changing vehicles. The cumbersome process of finding the right insurance and maintenance is done away with, easing the customer onboarding process.

However, the adoption of a new business model comes with a host of new complexities. Unlike the traditional business model in which the OEMs manufactured a product and sold it, in the subscription model the companies use labour, raw material and machinery to create a fixed asset i.e. the automobile. This asset will be owned by the company and used to generate staggering revenue.

Subscription business models in the auto industry

Let’s take the example of Hyundai India. If it sells one Santro Sportz today, it will earn ₹5.46 lakh straight away, and the amount will be recorded in the profit and loss statement. The company will use this revenue to bear the costs of the next car. However, if it provides access to the car through a subscription fee of ₹ 14,320/month starting today, in a year it will only earn ₹ 1.72 lakh as revenue from the car while retaining the car as an asset on its balance sheet.

This is a drawback, as the costs for manufacturing the car will remain the same in both cases, while the cash inflow will be spread out over a longer time period in the subscription model. Resultantly, the working capital days will increase and debt will be required to bear the costs of making the next car.

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Will the model work, though?

If so, why would a company adopt this model? Let’s try and understand. Assume that Hyundai will continue to offer one car for 5 years on subscription. This would result in an inflow of ₹8.6 lakh for the company. At the end of 5 years, it sells that car for half its original value. Therefore, the total inflow at the end of 5 years will be ₹11.33 lakh. The average cost of debt for the automobile industry is 8%.

Now, since the company would be funding its operations through debt, the returns it would be expecting will be at least equal to the cost of debt. Therefore, by using the cost of debt as the discounting factor to all the future inflows, the present value in the first year comes to be ₹9.42 lakh, which is higher than ₹5.46 lakh

YearTraditional ModelSubscription Model
15,46,0001,72,000
21,72,000
31,72,000
41,72,000
54,45,000
Present Value in Year 15,46,0009,42,349

We see that the revenue obtained from a car in the subscription model is higher than in the traditional model and this business model may fetch a higher return on capital employed while addressing changing customer needs.

However, there are some operational problems. The OEMs will have to build fleet management capabilities since they will have an entire fleet of cars. Good IT infrastructure, repair and maintenance centres, and storage places will be required in which the companies will have to develop expertise and employ additional resources. Despite these challenges, the auto manufacturers can benefit by adopting this business model through the acquisition of new customers, building a revenue stream out of it and venturing out for forward integration.

Author

The piece was written by Shivam Ghule, a co-author at Casereads. If the piece added value to you, how about you share this with your best friend on WhatsApp?

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