‘In Favourable Spot': Aequs CEO Aravind Melligeri On India's Manufacturing Growth

In this week's The Core Report: Weekend Edition, Melligeri talks about why he ventured into toy making and transforming Belgavi into a manufacturing hub.

30 March 2024 5:30 PM IST

What does it take to make parts for commercial aircraft? The question couldn’t be timelier. As Boeing, once an American manufacturing icon, grapples with regulatory scrutiny, criminal investigations, and loss of confidence, the spotlight is widening to its supplier-partners too. Spirit AeroSystems, itself undergoing Federal Aviation Administration audits, is one such. The result is a cascading effect on the supply chain, unfulfilled orders and route expansion plans, and inevitably, higher costs passed on to passengers.

The global civil aviation market is estimated to make $964 billion in revenue this year, according to the International Air Transport Association. That target, however, cannot be met unless the backbone of the industry is strengthened. That backbone is component manufacturers.

As the world also adopts a China Plus One strategy, aviation majors are ramping up manufacturing and assembly in countries such as India. Airbus, for one, has over a 100 suppliers here. Aequs (formerly QuEST Global) is one of them. And it’s a vital cog in the machine.

A specialist in aerospace components, Airbus was Aequs’ first original equipment manufacturer (OEM) customer in India. It’s a partnership that’s lasted 10-plus years and counting. In 2023, Aequs and Airbus struck a deal for critical parts for the A320 family.

But aviation specialisation isn’t the only feather in Aequs’ cap. In an exclusive interview with The Core Report: Weekend Edition, company chairman and CEO Aravind Melligeri talks about why he ventured into toy making, the nitty-gritty of airplane wings, transforming Belgavi into a manufacturing hub, the concept of in-country value add, and much more.

Edited excerpts:

Tell us about contract manufacturing. We're going to talk about the journey from toys to aerospace, which anyone would admit is a very, very broad and wide spectrum and obviously represents a fairly significant jump in value addition and… being more, let's say, critical as opposed to toys, which are useful but not critical since they're not involved in, let's say, an aircraft and so on.

At what point did you start manufacturing toys as a contract manufacturer? What does that even mean? And what did it mean when you started out?

Thanks for giving me an opportunity to be here and talk about the contract manufacturing opportunity in India. I would like to correct a little bit. We started in aerospace manufacturing, then moved into toys over a decade.

The journey for contract manufacturing in what we call “build to print”, the manufacturing in aerospace, started as a progression of my earlier path of design of aerospace components and products at my other company, Quest Global. And that we saw as an opportunity. It was mostly happening in the West.

India was not doing much aerospace manufacturing. India was growing as a market in the early 2000s in the aerospace side, and (so) there was an opportunity for us to be a manufacturer.

Design was done by OEMs or “tier ones” in the aerospace industry, and manufacturing was happening mostly in the West. It was a high barrier to entry because it was built over three, four, or five decades in the West. India did not have all that experience. And that's where we saw (that) “Hey, we could talk to a customer like Airbus? If we were to do it, would you (too) be interested in doing it? He said, hey, you're pushing an open door, we want to do more in India if we can get solutions out of India.

So that's what it started as a journey for us. And what we saw in aerospace manufacturing was that the in-country value add was very small. By that, I mean the value of material, labour, and various other activities that lead to the final product. That was less than 20% when we started.

Compare that to the service industry, where there’s 100% value add Everything is labour, (and) driven by that. So we knew we cannot be competitive in the long run with a 20% in-country value add. That's when we took a step back and put a roadmap of “How do we go from this to 100% in-country value add, at least on some products?”

And that led us to building a Special Economic Zone in Belgavi, which was the first in the country to have an Aerospace Special Economic Zone in 2007. It opened in 2009, and further vertical integration was done through partnerships. We had three joint ventures, of which one was with Magellan Aerospace Ltd. for surface treatment, and another was with Aubert & Duval SA of France for the forgings.

Fast forward 15, 20 years, we are here today. We have products that are 100% manufactured in the country—all the way from raw materials to finished goods and getting them out of the country. That has been a long journey, with significant investments to achieve this journey.

I'm going to come to the 100% bit in a moment. But tell me about the very first product that you took to. Was it Airbus, you said? You said okay, this is what I can manufacture in India. When it comes to aerospace, there's a lot of trust involved, a lot of checking involved, diligence, and of course, the people who are doing it. So how did that process go?

Actually, that trust came from a customer. Magellan Aerospace was my first customer, who turned out to be my future JV partner in the surface treatment. They were already working on the engineering design side of it. So there was trust between us. We said, “Hey, we want to get into manufacturing, here is one component”, and they gave us the most difficult one to do!

Which one was that?

It was a portion of a titanium wing component for a Boeing 777 aircraft. They were a Tier-1 supplier to Boeing but they gave us this and said okay. It was obviously challenging. Hardly anybody was cutting titanium in the country. But we delivered that and they were very happy with what we had done.

And then the work started. It took little more than three years before Airbus engaged with us because although Airbus was a customer from a design perspective, they did not come on board for manufacturing until three more years.

But the first component that you made, and I'm going to go a little deeper into that, was for a Boeing 777, not Airbus.

Yeah, it was a Boeing 777.

Right. Okay, so now on the wing, can you go a little deeper? Which part of the wing was this?

This component sits inside a wing, where it holds the actuators. It encloses because wings hold the fuel. So it needs to sit in an enclosed, controlled environment, which is the inside of the wing box.

So the actuators are those (components) that sort of shut off and on…?

More of the flap control and other things you see while landing… actuator pumps sit inside some of these things. Sometimes there are fuel pumps also sitting there. The wing might look simple from the outside but it's internally very complex. It has wing spars, several wing ribs are there, and also the fuel tank is there inside. The wing is actually a fuel tank if you look at it. And actuations are there to flap controls and everything.

The titanium that you needed to make this actuator, where did you get it from at that point in time?

It came from Russia. Russia is a big player in titanium and has historically been so. This came from Russia to the US to India. That's how raw material flow typically happened.

What was the size of the first order?

It was small. The value add was only about $500 per part… as long as that part is there, you are going to be manufacturing only this. Typically at that time, they were manufacturing five per month, if I remember right, for 777s. So basically it's a $2,500 value add, but that material itself was worth $2,000.

You were making this in Belgaum?

We were initially making this in Bangalore. We had a very small facility of 20,000 sqft in Bangalore before we moved to Belgaum in 2009 to establish a much larger 250 acre zone, because we saw this opportunity. But also, at same time, we saw challenges in developing and retaining the talent in a big city like Bangalore on a long-term basis. And sustaining manufacturing in big cities was also a question mark for us.

Globally, manufacturing, especially aerospace manufacturing, happens in the hinterlands. Like Toulouse, France; Wichita, Kansas; it used to be in LA, New York, and Paris, but not anymore. London is cost-prohibitive, and real estate and all these things are players. We didn't want to do this again and again in India, so we had to start from scratch anyway. We had to develop the talent. So we went and picked a place where fundamentally good, capable people existed, but we needed to train them for aerospace requirements.

What was the second product?

We had a very large package coming out of another customer called SABCA, which gave like 200 different parts for Airbus—the A-380, which is no longer under production. We ended up with a very complicated part, then with a large number of parts. How do we industrialise this?

That's where engineering capability came into picture. It was 200 parts industrialised over a six month or one-year period for each part. And they were aluminium parts. It was not complex material wise, but it was a large number of parts that had to be managed, and for which there had to be a quality setup. Processes have to be established.

The machines, the CNC [Computer Numerical Control] machines that you were using for this, were you buying them within India or were they imported?

They were all imported from day one. Even now, I don't see anybody doing aerospace grade titanium machining in India that much. Almost all our machines are imported, but most are from Germany. Deckel Maho [Deckel Maho Pfronten GmbH][and we established a long-term partnership early on, and we are pretty much an exclusive facility in Belgavi. There needed to be proven machines because we are entering a new vertical and building new capabilities. We didn't want to have another variable of machines that we don't know about yet.

I'm going to come back to that point where you've reached 100% value add. But most of your efforts also predate the China Plus One thesis. Tell us about going on that path, and whether China Plus One has changed anything because you're already plugged into an aerospace supply ecosystem.

Certain customers were very clear. They don't want to go to China big time in aerospace.

That was always the case is what you're saying?

Yeah, that’s always the case in aerospace because the IP was the biggest concern. They had aspirations about which country they wanted to be in because they were worried about IP. That basically kept an opening for India. They also knew that India is a large aviation market.

Actually, the whole thing was driven initially by offsets to a certain extent. When Air India first purchased [merged with] Indian Airlines, there was an offset clause in 2022 for commercial purchase. And that drove Airbus and Boeing to work in India… manufacturing work. Earlier whenever the offset was there, they would buy tea or coffee and meet those offsets.
Direct offsets were implemented only in 2002 under the UPA-I regime, I think, when the order was placed. And to fulfill that, they had to buy from India. That is why initially they pushed their Tier-1 suppliers to go to India, to buy and give them the credits. They started coming to India later.

That and the IP protection aside, they were comfortable giving the design activities to us. Manufacturing is a lesser IP concern compared to the design side. That combination helped us. With China, they have always been cautious. It's not like they're not doing anything there. Whatever they have, a lot are their own facilities. Especially engine makers, they set up their own facility instead of having a contract manufacturer. Because they were getting enough credit and investment subsidies from provincial areas. So they could control their IP better, and that's how it evolved.

But when it came to India, people like us were happy to invest and set up contract manufacturing for them, and they were able to work with us and do that.

It was never a China Plus One strategy for them. Very early on, the chief procurement office of Airbus, Klaus Richter, took on two paths for Airbus. Airbus used to buy a whole lot from within European countries [since it is a consortium]… they had a give and take. That's how it was between 2009 to 2020. When he [Richter] was CPO, his two paths were dollarisation and globalisation.

Dollarisation because their contracts were in Euro but all their sales were in dollars. So it was an inherent risk for them. They needed to convert supplier contracts into dollars.

As for globalisation, they were buying locally within Europe and even US buying was not that high. So they saw India was a sweet spot. They could achieve both dollarization and globalisation [with us] because we would sign a dollar contract and they would get a lower cost structure also. So that propelled their thought process. Then the focus on India as a manufacturing base, which has paid off well for them… they are the largest today from among the OEMs who source from India on the manufacturing side.

I'll now come to the 100% value add. You said you're essentially sourcing raw material, designing, adding value, or manufacturing machining, and then exporting the final product. So what are those products typically?

I know it could be in the thousands, but at this point of evolution, after more than a decade in this space, are you positioned as someone who says, “I can do anything… for [various] components in the aerospace industry”? Or do you say “I specialise in the wing or fuselage”... or some other aerospace need?

I would segment this into three areas. One is aerostructures, like [for example] a fuselage wing, things on the structure side. Then you have actuations, which control… which are basically hydraulic actuators or pumps and that kind of thing: systems and equipment, landing gears. The third is engines. Then you have electronics and all those things. Flight controls are a separate area…

When we started, there were aerostructures. [Now] we also do actuation components, the machining side, manufacturing, and the engine component… though mostly in India, we are doing non-rotating engine components. We make rotating components in a French facility. Our progression now is to do more rotating components for aerospace engines. [With respect to] materials and size, [what accounts for] the most volume in what we do today is titanium and aluminum, though we also do steel and various other alloys. And most of our parts are under two metres, specifically, under one metre a cube. About 95- 98% of what we make fits under a two metre cube, lengthwise…

After machining, you also have to do coating and various surface treatments, and that's a whole another infrastructure you require. Tank size needs to be defined. All those things are much longer lead items to set up and establish, you need approvals. Then comes forging… so you have to think through the whole ecosystem. How much can you support? That's how it gets driven.

When you said engines, would that mean that you're working with GE or Rolls Royce or CFM?

We work with Safran, they are old customers. We're continuing dialogue with Rolls Royce and various other people. Again, we are focused on higher value vertical integration and we look at forged machined products.

You know, having a certain capacity for forging… though it’s a 10,000 ton hydraulic press, it’s still small from the large engine perspective. We can do more business jets than large engines.

All these components—and I'm going to come to toys, because we've almost forgotten about that—but how do you ship them out from Belgaum?

[They are] airlifted [from] Belgaum to Bangalore or Mumbai, then airlifted from there too. We are delivering 100% on time with zero defects for Airbus for the last 40-odd months. Our ability to meet the schedule is extremely good from India. During Covid also, we were able to support them, even though globally [things were] disruptive.

They go by road to Bangalore and then via air from there. And we deliver on a drumbeat every 48 hours to their line there from Belgavi.

And it takes roughly about 15 to 20 hours to reach Bangalore from…

It is an 8-9 hour drive by truck, then it goes into the belly of an aircraft and lands there. Within 48 hours, actually after, we ship from Belgavi, [where] it is in a customer facility.

Okay, so it's going in a commercial aircraft?

Cargoes are going every day right from Bangalore. So it can be both… depending on how DHL and FedEx manage their logistics.

My question is that by sitting in Belgaum, you're not necessarily at a disadvantage because you're at least eight to 10 hours away from, let's say, any big city.

Yeah, absolutely. We can do Mumbai. We can do Bangalore… And by sea also. We do emergency doors for the Airbus A321 that go by sea, by container. We pack containers every week and we ship it out of Mumbai.

So these are the latest A321s, which we have in India. Of course. We've just seen them come in. Thanks to IndiGo.

Yeah.

I'm going to come back to aerospace in a moment, but tell us about toys. Actually, I got that wrong. I thought you started from toys and then went to [aerospace].

No, we started with aerospace

Why would you do this?

We never thought we'd enter the toy business. But in 2015-2016, Hasbro came to us saying, “We have significant spending in one country, and we want to diversify to the other Asian countries. India could be one option, but we don't want to go to traditional toy manufacturing companies in India because they don't have an understanding of global quality expectations. And you are in the aerospace industry. So would you be interested? You have built an ecosystem here.”

They came and saw what we have done in aerospace from scratch. And this is what needs to happen in the toy industry also. Ultimately, to get the most value out of the country, out of the product, [you need] value add…

We looked at it. That was the first time we saw a China Plus One strategy. Nobody talked about China Plus One, but that’s what it was.

Yeah. Terms usually come later.

Yeah. so we looked at it. I said, I don't even know how we can compete with China… [but] we dug deeper. We saw there was a 20-25% [and even] up to 30% labour content in these products. And China has three times the labour cost of India. We ran the calculations and were able to show them at least 5-7% cost savings.

Polymer was [readily] available in India, since material is a significant portion. Packaging was available and could be developed, all these things. Almost all the material was there. Almost 80-90% of the purchase bill for materials was local.

Then it was using unskilled labour. What we always saw was engineering talent, which had leverage for IT services, engineering, design services, and aerospace manufacturing. But there is a large pool of unskilled labour, predominantly in farming. They could easily be trained for a week or two and get onto a shop floor assembly line. We saw an opportunity to leverage the second leg of this, India's strength. It was already an in-country value add…
So customers said we are willing to support you if you want to develop this. That's how we ended up entering the proof of concept with an about-50,000 sq ft facility in Belgavi itself. And set it up. Today we have a 600,000 sq ft facility in Belgavi making toys.

Then we set up a brand new cluster in Koppal for toys because we couldn't do more in Belgavi. Aerospace also was growing and toys were also growing. We needed a unique ecosystem where the labour pool was much larger, available, unscaled. We picked Koppal because Koppal is one of the least developed districts in the state of Karnataka. It doesn't have any water resources. Only depends on four or five rain spells a year for any kind of farming. And it was only an hour and a half away from Hubli with the new roads and everything coming in. We [also] looked at it from a hub and connectivity perspective. Bangalore and Belgaum and Hubli are like only an hour, one hour, ten minutes drive [from one another].

We have a 400 acre zone in Koppal—a first in Indian toy manufacturing. Fortunately, Covid was a good time. In aerospace, we took a big dip [during Covid], but toys were booming. But post-Covid, [because of] inflation in the US, toy [sales] in the West have come down, while aerospace continues to shoot up. We're able to balance these economies because one is very consumer focused, while the other one is a very long term B2B business.

The challenges are different today in the toy business because China's economy is in a challenging situation. The price points they are offering to customers is much, much lower today. And competitiveness has come back. You know, they're just trying to use depreciated assets and trying to compete. Our competitive situation is a little challenging right now, but it is what it is, right? China plays with its strength of capacity, invests in capacity, and we need to work through and figure [things] out.

We are focused on the domestic market too. We have introduced some products with some partners in the Indian market. We feel that with India, restrictions on a QC, through the QCO and various other import restrictions… tariff side 70% duty is there. But we need more toys in India. We didn't even have a domestic manufacturing facility until recently, when we opened one in Koppal. Otherwise it was only export-oriented. So it's evolution. That's what I would say

For the company that's Aequs, what's the split between revenue from…

Eighty percent of our revenue is aerospace, and 20% comes from toys and consumer. We also have a small cookware business which we started in Hubli, and we entered a new vertical called Advanced Technology products, which is focused on consumer electronics. Again, precision machine products for the consumer electronics industry. This is bringing a little more diversification on the precision machining side, which we feel is the biggest strength of India because of the engineering capability and capacity. These are two verticals that play with mechanical materials and metals, whereas plastics is where toys and other consumer business work.

You've done some fundraising from institutional investors in recent years—three different investors, or at least three lead investors—and others in two rounds from what I could see. My question is not so much on the fundraising, but what do investors see in this? Because I can see that some of those investors are typically investing in technology bets where they're looking for eight and ten times returns, like tech companies and so on. This is a contrast from that. This is not going to deliver 8-10x returns, at least from what I can see. But at the same time, I can see the consistent and steady nature of this business in the long term and or the medium to long term. What's your view?

We have invested ourselves for more than 15 years. We brought in external investors because we wanted to feel comfortable in our ability to scale and drive profitability and all these things. It is very difficult to have very short-sighted investors [with] a 3-5 year view when I'm making an investment call for 15-year ROI on a 10,000 ton forging press. It's very difficult for them to, you know, meet that expectation. So I had to really manage this.

We have done all long-term investments. We are done. We have three clusters. We have three verticals. The base is all set up. That's why we felt we could bring investors and demonstrate the return on capital employed…
Ultimately we see each of these verticals growing 20% to 30% every year for the coming years, through to 2030, at least. The opportunity for India, whether you call it China Plus One strategy or overall diversification, is very good. No other country in the world has the volume of both engineering talent and unskilled labour that India has. It’s a demographic dividend, as they call it. In the foreseeable future, we don’t see any other country able to supply that number of people as a workforce…

None of the investors who came in are short term. They're all public market investors. They will be there after we go to be a public company, for years to come. That was the commitment for me to bring them on board. I want somebody with me in my boat to be there longer term. I don't want people to just exit post-IPO or anything. And we ended up splitting the round into two pieces because one, we brought in somebody [from] private equity, who will have a shorter, five year window. But other ones are public market investors or family offices who have a much longer term horizon. They believe in the thesis. Thesis and value creation are [what] we are [about]... They're permanent investors.

Everyone's talking about semiconductors, which is obviously a different thing, but also involves precision and very sensitive manufacturing conditions. Are you looking at other things either as an extension to aerospace or something completely different? Again, in the precision manufacturing space.

That was part of our expansion into the consumer electronics space. We [also] focused on housings and enclosures and that kind of stuff. On the electronics side, we focused on precision manufacturing rather than the electronics portion of the business, because there are enough players already established for decades. We have enough opportunities here… I can deploy my capital here very efficiently because we already have a large base…

Ultimately, again, when you look at in-country value add… [that] has to increase. So components had to be manufactured. We are more of a component manufacturer on the mechanical side, and it is very important for us to capture more value out of this. Just assembling them and [getting] some labour content will be 4 or 5% of the product value, versus [with what we are offering], we're going to get to 20, 30, 40, 50, 60%.

When you finally get a chip out, most probably the chip itself is 30-40% of the value of the product, especially newer generation products. The chip cost could be 30-40% of the total product cost. It's a journey for the country also. You start [with] assembly and then start industrialising. The government has done a good job by looking at PLIs. [When they consider] a full product, they're looking at component-level PLIs. Those things will help to bring these things into the country.

India is aiming to have a large manufacturing base at this point. Its share of manufacturing to GDP is lower than what it aspires to be. Critics would say it's quite low actually, given that we want to grow and bring people out of agriculture. You're doing some of that already. What is your sense [of things]? Can India become a much larger manufacturing economy or power than what it is today? And in your own journey, do you feel this can be replicated by others and therefore contribute to that target or objective?

I believe India has the best opportunity right now to make that transition because of demographic dividend and also global geopolitical situations. India is in a favourable spot.

The key… is not just domestic consumption; look for global exports also. It needs to be looked at holistically and capacity needs to be built to support that. When we look at other Asian countries' investments, capital availability and the cost of capital in the form of debt is our biggest as a country today. If there is a way to address this as an infrastructure type of investment, it could be accelerated very fast.

I absolutely believe the whole investment thesis we have is betting India to be manufacturing-based. Can we increase that versus services or other things? …I think we need to focus on the ability to employ people and also see what we can do with a lower capex kind of business. Toys for example have a much lower capex-to-dollar revenue compared to aerospace.

We need to drive some of these things not from the domestic market, because the domestic market in toys is a very small percentage of the global market of 80 billion. India is only a billion and a half. So we should look at the export side also, because then we can capture a lot more lakhs and lakhs [of rupees] and people could be working in this industry much easier. And that will automatically bring the portion of the GDP in my view.

Updated On: 30 March 2024 11:30 AM IST
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