Lanka Harness joins the elite tier of auto suppliers

The company that makes impact sensors for airbags and seatbelts will get a boost when it acquires its Japanese parent company in 2017, consolidating its position as a tier-one automotive supplier

Lanka Harness, a $40 million export revenue company making impact sensors for airbags and seatbelts, will acquire its parent company Ito Springs Japan in 2017, giving it a significant boost to grow its business by supplying directly to carmakers in Europe and the US.

Lanka Harness Chairman Rohan Pallewatta says the acquisition will help him aggressively grow exports to the US and Europe, and is unfazed by the wave of protectionism there—the company operates a small factory in Mexico, supplying to several carmakers based in Motor City, Detroit, USA. Donald Trump is threatening to slap high import duties on vehicles manufactured in Mexico for the US market, and on the very first day in office pulled out of the TPP (the Trans-Pacific Partnership trade pact involving 12 Pacific Rim countries), which benefited carmakers. “I am not too concerned about any of this, as I see opportunities for growth,” Pallewatta says.

Sensors are a critical component of deploying airbags on impact to protect people. That’s probably why robots don’t make them.

There are three reasons why he is optimistic: First, Lanka Harness is increasingly supplying directly to carmakers in an industry that has a three-tiered global supply chain. Second, carmakers focusing on safety have seen the number of airbags in a single car increasing from two to around 18. Third, protectionism may place barriers to large scale assembly across borders, but suppliers of specialised components and parts cannot be easily substituted. “Sensors are a critical component of deploying airbags on impact to protect people. That’s probably why robots don’t make them,” Pallewatta says. “Making them requires skilled hands and quality-controlled processes that could take years to replicate and perfect.”

The global automotive industry, which made nearly 90 million cars in 2016, is a web of complex relationships: Carmakers sit at the center, directly sourcing parts and components from several companies called tier-one suppliers. Lanka Harness’ parent company, Japan-based Ito Springs is a tier-one supplier of airbag and seatbelt sensors to Japanese carmakers including Toyota, Nissan and Honda. Next come tier-two suppliers who make parts mostly for tier-one suppliers. The outer ring comprises tier-three suppliers making one or two specific parts or components for tier-two suppliers.

The company’s early purpose was to supply parts to Ito Springs, but it will join the elite tier of auto suppliers when its acquisition of its parent is concluded in 2017. The deal will establish a tight integration with the supply chains of Japanese automakers who rely on their tier-one suppliers for on-time delivery of small batches of products directly to the production floor.

The firm has already achieved this level of integration with non-Japanese automakers. “Sometimes, we are the first tier, supplying impact sensors direct to carmakers, and sometimes we are second- or third-tier suppliers,” Pallewatta says.

Ito Springs incorporated Lanka Harness in 2002, investing $8 million, with less than 50 people making around 350,000 sensors a month. Lanka Harness achieved high margins on cheap labour, and Ito Springs recovered its investment in two years. Pallewatta wasn’t content supplying parts to Ito Springs. Hungry to grow the business and widen the company’s exposure to the global auto industry, he looked for new orders elsewhere. “Connections matter in this industry. German carmaker Opel gave us the contract when I told them we supply to Toyota.”

The factory at Biyagama today employs over 300 people making 2.2 million sensors for airbags and seat belts for European and US car models from Aston Martin, BMW, Fiat-Chrysler, Ford, Saab, Volkswagen and Volvo. The company is the exclusive supplier of sensors for Toyota’s Lexus range. “I built the non-Japanese business on my own. When I acquire the parent company, I can be more aggressive. I will have the added advantage of negotiating from Japan, home to several giants in the industry, and heading a company that has been a tier-one supplier for decades. Imagine what I could achieve,” Pallewatta says.

He will start by resetting Ito Springs’ focus. Incorporated 60 years ago, Ito Springs’ annual turnover is a little higher than its subsidiary Lanka Harness’ $40 million. Growth has been slow because the company is content with its present volumes, Pallewatta says, and supplies components to other non-automotive industries where margins are lower.

Lanka Harness makes better margins driven by high value addition averaging 55%. “When I ship sensors to Germany, the value addition is as high as 75% and 60% in Romania,” Pallewatta says. Ito Springs never repatriated profits, so Lanka Harness has enough cash to acquire the parent company. Pallewatta did not disclose valuations.

At the Lanka Harness factory, 330 workers put together several small components including an electronic chip, wires and connectors—mostly imports—but the value addition is high because the process leading to stringent standards for accepted level of defects, one in a million, is complicated and not easily replicated. “Lanka Harness’ strength is no longer cheap labour, but smart labour,” Pallewatta says.

In the 1990s, Pallewatta had spent a year in Japan as a 16-year-old exchange student, which took him to Toyota on an educational visit. There was hardly a human being in sight and he remembers asking his guide if it was a holiday. “The production line a couple of kilometers long was entirely automated,” he recalls. “Suddenly, I saw a few hundred people working nimbly in a small room and asked what was going on in there.” He was told that the workers were assembling sensors for seatbelts. “When I was told how much each worker was earning a month, even at 16, I realised you could run an entire factory for a year with that kind of money in Sri Lanka.”

Lanka Harness Chairman Rohan Pallewatta

Pallewatta wanted samples to take back with him and they gave him four seatbelt sensors. A couple of years later, the Toyota official who was his guide— now promoted to mid-management— got a long distance call from Sri Lanka. It was Pallewatta telling him that he had made a few samples that he would like Toyota to look at. “Are you crazy? Don’t waste your time,” was the flat answer.

Pallewatta clearly never listened. Safety is critical in the automotive industry. Demand for impact sensors is growing, with cars equipped with up to 18 airbags cocooning the driver, and the front and rear passengers in the event of a collision, including two airbags forcing the bonnet to open outwards to prevent anything crashing through the windshield. Stringent regulatory standards in the US and EU lead to hefty fines and recalls to fix defects costing carmakers billions of dollars.

In 2015, eleven carmakers recalled over 30 million vehicles to fix defective airbags made by Takata Corp, a major global supplier. Lanka Harness won the contract to replace all the airbag sensors over the next two years. This doubled the company’s output to 2.2 million units a month. In 2016, Lanka Harness invested $5 million to set up operations in Mexico with 30 people to reduce lead times and costs, supplying to carmakers based in Detroit.

The small operation in Mexico presents an opportunity to build and consolidate relationships with carmakers across the border. And Trump’s wall? “I am not too concerned about this. Replacing suppliers is not easy. Despite six deaths and several injuries, Takata still continues to be a major supplier of airbags to several car brands because no one can fill the void; not even the biggest airbag supplier in the US can handle that kind of volume,” Pallewatta says.

“It’s not easy to replicate and sustain quality. You can copy a product, but the quality is a result of the process, which is not easily copied,” Pallewatta says. He started by copying. First, he replicated Ito Springs’ production line, not wanting to take a risk. Then, he improved and perfected it. “What took 100 seconds to do earlier takes 50 now,” he says. “There can always be emerging players, but it will take them a long time to build a sustainable process, and existing buyers will not want to risk going to a new supplier without credentials.”

Recently, a carmaker operating in Russia wanted sensors from Lanka Harness. They sent Pallewatta, who is an attorney-at-law, a tome detailing its terms and conditions, and a contract agreement for signing, which he carelessly did without reading anything. Lanka Harness’ first invoice didn’t impress the carmaker. The contract spelled out the terms: 90 days credit and the transaction currency is euros. Here was an invoice priced in Japanese yen and 30 days credit. The legal division called Pallewatta. It was embarrassing. He apologised for signing the contract without reading it. However, he couldn’t agree to the terms. Pricing will be in yen and the credit period 30 days. But they insisted that Pallewatta honour the contract, so he suggested parting ways. No harm was done, no transaction had taken place.

“A few days later, they sent me an amended contract. If they had other suppliers, they would have moved on. What gives us the edge is quality and purely that”.

Lanka Harness exports sensors to 12 countries including China, Germany, India, Indonesia, Hungary, Poland and Romania. Over the last two years, orders have been increasing from the US, Brazil and Mexico. Pallewatta is conservative in forecasting annual sales growth at 10% over the next five years. “We have enough orders for the moment. Increasing capacity is not easy as it requires a lot of thought and training,” Pallewatta says, “But I want to double the rate of growth”.