Normally, manufacturers fret about losing potential sales due to insufficient production volumes. In microeconomic terms, a profit maximizing firm should produce until the marginal revenue (MR) becomes just equal to the marginal cost(MC). It is being reported that Tata actually loses money on every Nano at the Rs. 1 lakh price point (the price of the cheapest variant). So, why would they still want to produce it?
Granted, the one lakh car has been a very successful branding campaign and has got them a lot of publicity both in India and internationally. But there might be a more economically rational explanation as well. Tata is going to manufacture only around 50,000 Nanos a year. But the demand is likely to be far higher than supply. Tata has come up with an innovative way to capitalize on this.
Booking for the Nano closes on 25th of April, and one must pay the full price up-front to book a car. At the close of the booking, a random selection will decide who gets the cars. The remaining customers can choose to get back the money or lend it to Tata at 8%. Tata seems to be betting on the fact that a lot of people will choose the second option. This is of tremendous use to Tata which gets cheap money to finance its acquisition of Jaguar and Land Rover.
4 Comments
That is interesting to know.
Btw, isn’t 8% a really high rate to borrow at?
8% is not all that high for a number of reasons including the fact that Tata’s credit rating has just been downgraded.
Typically, once a car is in production, the cost of sale to the manufacturer (publicity, lead generation and conversion) is in the range of 1-2%. This might be on the lower side (1%) for a small car but it does bring down the effective interest rate.
This is explained at http://www.economist.com/business/displaystory.cfm?story_id=13381522
“Tata is making the best of a bad lot by asking prospective buyers to place deposits that come close to the full price of the car. Someone ordering the basic model will have to find $1,875 to place an order for a car with an on-the-road price (including taxes) of around $2,500… In the rush to get their hands on the first Nanos, customers are expected to place deposits worth up to $1 billion—money Tata will hold on to for at least three months before the allocation is completed. Those wishing to be considered for the second batch of cars will be paid interest (at well below the market rate) after a year, but Tata will get to keep at least $200m interest-free while it ramps up production.
That is cash that Tata Motors could certainly do with… raw-material prices have helpfully fallen, a recent excise cut from 16% to 8% is not being passed on to customers and the majority of Nanos sold are likely to be the fancier, more profitable models. But… Tata Motors faces a funding gap this year of at least $3.4 billion. About $1.4 billion of that is in the form of short-term loans raised for working capital, and $2 billion relates to the bridging loan taken out last year to finance its $2.3 billion purchase of Jaguar Land Rover (JLR), a British premium carmaker, which must be either repaid or refinanced in June.”
Thanks for the link and the detailed explanation.