After the exit of Suzuki from a joint venture, TVS Motors took many years to find its bearings. Will this be the case with Hero too?

The exit of Japanese Honda Motor Corp from a joint venture with the Hero group may open new avenues for India's number one two-wheeler maker. Although the experience of another Indian company which had gone through a similar experience, has not been so good. In fact, after Honda exited from another joint venture, Kinetic Honda, the Firodia group failed to cope up and ended up selling Kinetic Engineering Ltd to Mahindra & Mahindra (M&M) in 2008. In another instance, the TVS group struggled for many years to develop new products and launch them across the country after its breakup with Suzuki. So what will happen to Hero without Honda?

"One big differentiation between Hero Honda and other automobile companies is the scale and strong brand recall," said Deepak Jain, assistant vice president and research analyst, Sharekhan. "Hero Honda's Splendor is a decade-old motorcycle brand. However, automobile divorces are very challenging. Retaining core customer group will be the incremental challenge for the Hero group apart from cut-throat competition."

As per the new licensing arrangement between Hero Honda Motors Ltd and Honda, the Indian entity will be free to start its own research and development (R&D) capabilities and exploit global export and manufacturing opportunities. The Hero group, promoted by the Munjal family, will buy Honda's entire 26% stake in the joint venture for an undisclosed sum.

With both companies deciding to end their 26-year old partnership, the question being asked is what may have caused the split? There are two likely reasons. One, the increasing cost of royalty and technology (R&T) and second, the growing presence and market share of Honda Motorcycle & Scooter India (HMSI), a 100% subsidiary of Honda.

R&T payments are the third biggest expenses for Hero Honda after raw materials and employee cost. However, even as it has to pay more to Honda under the R&T head, its margins are actually falling. This coupled with higher input cost means that Hero Honda was left with marginal revenues; on the other hand, Honda was walking away with a bigger chunk, year after year.

Even Hero Honda's product development cost (PDC) is much higher than that of its competitors. The PDC for Hero Honda is over 2.7% of its net sales, while it is 1.4% and 2.3% for Bajaj Auto Ltd and TVS Motors Co Ltd, respectively. Hero Honda pays about 90% of the PDC as R&T cost to Honda, while there is no R&T cost for TVS Motors.

"Royalty deregulation received the government's nod only in December 2009 which was earlier capped at 5%. Maruti's parent, Suzuki, took the lead in hiking royalty charges. We were anticipating Honda to do the same," Mr Jain said.

HMSI, which is the market leader in the scooter segment, is increasing its presence in the motorcycle space. The motorcycle segment in India is divided into three broad categories, entry-level bikes, executive segment and premium segment. Currently the entry-level motorcycles (defined by engine capacity as 75cc to 125cc) caters to about 72% of the market, while the executive segment (125cc to 250cc) and premium segment, constitutes 27% and 1%, respectively.

Hero Honda is the market leader in the entry-level segment while Bajaj dominates the executive segment. During April to November 2010, Hero Honda sold 29.5 lakh units, a growth of 9.6% over corresponding period last year, in the entry-level segment. At the same time, HMSI sold 1.2 lakh units in this segment, a phenomenal growth of 4,34,703%, over the corresponding period a year ago!

In the executive motorcycles segment, Bajaj's sales continued to grow at 47%, while HMSI achieved a growth of 27% during the eight-month period till November 2010. Hero Honda's sales increased 30% to about 2 lakh bikes in the same period. The rapid rise of HMSI and its pricing policy may have become a cause of concern for Hero Honda, especially the Hero group.

Although, Honda will continue to provide support to Hero Honda, the Munjals have a very short time to get their bearings right. The Hero group has two options, either to go for in-house R&D or choose a domestic/foreign partner for technical collaboration. However, analysts do not see the group going in for a partnership with anyone.

Mr Jain from Sharekhan said, "Creating an alliance with a domestic partner is not value accretive or a possibility for Hero Honda. A new foreign alliance would never substitute Honda as a brand.  We do not see this as a possibility in the short term."

"Even if the agreement (with Honda) is not renewed, the fact that the current agreement is in place till 2014 provides the Hero group sufficient time to beef up its R&D capabilities. In fact, this also alleviates our concerns on any premature termination of the contract," said Kaushal Maroo, auto analyst at Religare Capital Markets.

Echoing a similar sentiment, Mr Jain said, "Manufacturing entry and executive segment bikes would not be much of an issue (for Hero Honda). We believe that the company would have already internalised the technology so far. However, manufacturing, marketing and delivering premium bikes would be a challenge."

In the 1980s, Hero Honda grabbed everyone's attention with its campaign 'Fill it - Shut it - Forget it', which emphasised fuel efficiency of its vehicles and helped the company grow at a double-digits. Now, Hero may have to revise the 'Forget it' part, to re-invent (especially, its R&D capabilities) and refill (the euphoria, once attached to it), to survive in the coming years.