Is the Tata Nano recession proof?

Cheap is beautiful ...

The cheapest new cars in South Africa cost around R 64,000 and the cheapest five-year-olds at R 35,000. With credit drying up, and many people worried about the state of the economy, cars are looking unaffordable.

An opportune moment for an innovative company to change the game entirely. In New Delhi on Monday, 23 March, Tata unveiled the first commercially available Nano. At R 21,000, the four-door car is the cheapest on the planet.

Innovation over the past few decades has involved using technological improvements to offer ever more sophisticated products at ever-increasing prices. Over the past year, this has changed.

Netbook computers have used falling component costs to produce useable computers that cost less than R 2,000. Mobile phones are getting cheaper and more powerful. Now we have the Nano.

For consumers, this is a lifeline in an economy where their money is having to go further and further. For producers, it is a competitive shock.

Microsoft was caught by surprise by the exponential growth in netbook sales. Their Vista operating system is too heavy to run on them and so they had to dust off XP, first released in 2001 (an epoch ago in computing terms). The new version of Windows 7 is to be released later this year and was explicitly redesigned to work on these sub-notebooks.

Change drives innovation, after all.

Unfortunately, the incentive structure in South Africa has left the motor industry woefully unprepared for changing economic conditions. The Motor Industry Development Program (MIDP) was introduced in 1995 to replace previous protections that involved local-content rules and high import tariffs. These incentives have promoted export-driven production of high-end, luxury sedans, and import tariffs have kept the price of imported vehicles high.

In most countries, the Tata Nano is considered less of a threat to vehicle sales, because used car prices are still lower than that of the Nano. But not in South Africa.

Even with a 25% import tariff, the Nano will still be cheaper than equivalent five-year-old cars. The Chevrolet Spark, South Africa's current cheapest new car, is three times more expensive than the Nano. Any subsidy to promote this over the import would have to be ruinously expensive to a government already struggling to cope with a fall in tax revenue.

Let's be clear, the Nano still has to prove itself on the market. And it won't be for everyone. Its top speed is 100km/hour but it sips fuel at almost 17km/l. Cheap to buy, cheap to run.

These prices will put pressure on second hand car prices and expose the ludicrously high cost of South African motoring. Yet there is little room for local design improvement.

The major vehicle manufacturers are all foreign-owned. Innovation and design are set at head-offices in Europe and America. There is little the South African government (or taxpayer) can do to help Ford, GM, or VW to design and produce cheaper cars that people want to buy.

The credit crisis has focused innovation. Companies around the world are looking for the next ultra-cheap, high-end product. The $30 3G mobile phone may be upon us soon. India wants to release a $10 notebook computer. If the Nano is successful, other car companies in China and India will be looking to repeat that success and cut prices even finer.

And there is the nub of the problem of protecting businesses from low prices and innovation abroad through local subsidies and tariffs. It also stifles the need to innovate until, when new products eventually smash their way through, the difference between the products is so great that entire industries collapse.

It is a challenge to South African producers. Either you watch what has happened in the textiles and motor industries and hope that you are immune. Or you accept the challenge, and innovate.