Why are auto firms outsourcing large engineering services deals? Devil is in the data. Examples of Renault and Honda.

The automotive sector is the biggest tailwind in engineering services. Auto enterprises are awarding large deals to engineering service providers, and the pace of large deals has increased in the last couple of years.

Why are auto firms outsourcing large engineering deals?

Devil is in the data. We take the examples of Honda and Renault as the two biggest automotive deals in recent months were awarded by the Renault Group and Honda.

Understand the chronology:

R&D Spend Needs to Grow.

• Disruptors have been raising the bar in the automotive industry. Tesla has taken a pole position in the EV industry and trying hard for AV. Software giants either have taken or are in the process of taking bets in the automotive sector. And these disruptors have been investing big in automotive R&D as they invest in software R&D.
• Incumbent auto firms need to spend more on new technologies such as connected, autonomous, shared, or electric (CASE). Simultaneously they need to continue investing in ICE technologies for efficiency, reducing emissions for a few more years. Also, they need to plan other technology investment as lightweight, hydrogen, more safety, security, and other new features and possibilities.
• Net-net all auto firms have to invest significantly more in R&D in the next few years to remain competitive.

Automotive Sales Are Down.

• The automotive industry has been facing one headwind after another. Even before the onset of the coronavirus pandemic, the global automotive market was slowing down and struggling. The sales in 2019 for Renault Group and FY20 for Honda were lower than the previous years' sales.
• Then corona lockdowns hit production and also consumption. Sales in 2020 for Renault Group and FY21 for Honda were further lower. 
• When automotive demand started recovering in 2021, there was a chip shortage, and sales went further down for Renault though Honda recovered to some extent. In 2022, Renault is still struggling with sales yet to reach the pre-pandemic level, while Honda has recovered.
• Renault Group and Honda faced challenges to keep investing in R&D while sales were down.

Constraint: R&D as % of Sales

• Renault and Honda need to invest more in R&D, but they face budgetary constraints in their operating model. Renault used to spend about 4.5-5.0% of Sales on R&D, while Honda's spending is between 5.0-5.5% of their sales in R&D.
• The R&D budgets got declined further when sales went down for Renault and Honda. R&D as percentage of sales started increasing outside their bands, creating problems for their operating model.
• This constraint created problems for Renault and Honda. They need to figure out how to achieve more in R&D with declining budgets.

Solution: R&D Outsourcing

• When R&D budgets are down, but more output is required, R&D outsourcing and offshoring are among the best solutions available to enterprises.
• Apart from the cost, partnering with engineering service providers can give automotive enterprises access to digital and software talent, which automotive enterprises lack.
• India is the best place to find quality automotive and digital talent at competitive price points. That's why many large deals are being awarded to India-centric engineering service providers.

Bottom Line:  Though this analysis is for Renault and Honda, it is true for most automotive enterprises. The automotive firms' need to achieve more with declining R&D budgets is driving this wave of automotive outsourcing. Earlier automotive outsourcing drivers were flexibility and time to market. Now dominant divers are cost and talent. The need for auto firms to navigate their challenges better, faster, and in a cost-effective way is creating a tailwind for automotive engineering services. A few engineering service providers capitalized on this automotive tailwind. There are opportunities for more engineering service providers to double down on automotive with investments and capability development to take advantage of this.