Prices of air-conditioners are expected to fall sharply in two years. According to a study conducted by consultants McKinsey & Co for the Refrigerator and Air-conditioner Manufacturers Association, prices will drop from Rs 18,000 for a 1.5 tonne AC last summer to Rs 15,000 in the coming season and to Rs 11,000 in 2004.

Such prices will mean the cost of manufacturing ACs in India will be at levels achieved in China, and convert India into a global sourcing (or export) hub, apart from driving volumes, the study says.

Additional volumes will help achieve economies of scale leading to more volumes, and the AC industry (all segments put together) turnover will grow from the current Rs 2,790 crore (Rs 27.90 billion)  to Rs 14,000 crore (Rs 140 billion)  in the next five years.

The observations assume massive cuts in pre- and post-production costs, and on the basis of an impending excise duty rationalisation.

"We have demanded a cut in excise duty on ACs from 32 per cent to 16 per cent in the coming budget. But even if the government reduces it to 20 per cent, we are sure that prices for a 1.5 tonne AC will be around Rs 15,000 when prices for the season are announced in the first week of March," Naishadh Parikh, managing director of Amtrex Hitachi Appliances and the president of RAMA, said.

A price reduction of Rs 4,600 on a 1.5 tonne will come as a result of cost reduction efforts by players through design, scale of production and anciliarisation, the study says.

If excise duties are reduced to 16 per cent (from the current 32 per cent), prices will drop another Rs 2,300.

Moreover, if indirect taxes and import duties are rationalised by implementing a single VAT of 15 per cent and a single import duty of 10 per cent across the value chain, there will be an additional reduction of Rs 3,100.

Though the retail price of a 1.5 tonne AC in 2002 was as much as Rs 21,000 for most players, some manufacturers brought it down to the level of Rs 18,000 by outsourcing assembling/production from tax havens like Silvassa, north-east and now Jammu.

Some other players also used global sourcing tie-ups to get a distinct price advantage.

Voltas tied up with Fedders as a result of which it sourced compressors in bulk, and cheap, from Fedders' Chinese factories, which brought down its production costs substantially.

Samsung and Electrolux are also adopting similar sourcing strategies, and LG is setting up its own factory in Greater Noida to be able to derive cost benefits.

McKinsey has found that a 30 per cent drop in prices will result in a 100 per cent increase in volumes.

Growth of residential segment will be driven by higher affordability, changing lifestyle in perceiving AC as need rather than luxury.

Residential segment is expected to drive growth of the retail AC and eventually increase its share to more than 80 per cent as in most markets.

A Voltas executive said that mere reduction of Rs 2,000 will breach the small gap between the organised and unorganised sectors, which means a bulk of the 20 per cent volumes being contributed by the unorganised sector will fall into the organised players' basket.

The changes in the tax structure over the past two years has already changed the ratio of the organised and unorganised sector from 30:70 to 80:20.

Tax sops split firms: The air-conditioning manufacturing industry is split down the middle with a section of the industry blowing hot and cold over the government's decision to grant tax exemptions to states such as north-east, Jammu & Kashmir and Himachal Pradesh, while removing similar exemptions in the case of Silvassa and Daman.

Several western India-based companies who had located their manufacturing units in Silvassa and Daman find themselves in the dock after the government removed the tax exemptions, on the plea that the exemptions will not hold good in a single VAT regime.

Several neighbouring states were imposing entry tax on goods manufactured in Silvassa and Daman to bring prices at par.

The decision has dealt a severe blow to companies such as Voltas, Blue Star, Amtrex Hitachi and Daikin.

But the government has in the recent past extended similar tax exemptions to the north-eastern states, J&K, Himachal Pradesh and Uttaranchal.

Northern India-based companies such as LG and Samsung are tying up with local contract manufacturers in the north-eastern states and Jammu to reap the benefits of the new extensions granted to these states.

Last year, LG was able to bring down costs by around 10 per cent last year through this modus operandi.

In its Budget presentation RAMA has said that the excise exemption in certain states such as Jammu, north-east should be repealed as they destroy value for government, players and consumers and confer none of the intended benefits to the system. LG and Samsung executives said they were against this resolution.

Run-up to the Budget 2003