A leading London-based securities firm Arbuthnot has predicted that the current environment in the global automotive industry is a “toxic cocktail that is a catalyst for a radical reshaping of the automotive industry on a global and unprecedented scale”.
The firm’s automotive research wing firmly believes that tomorrow’s winners are not necessarily today’s big players. “We expect five to six mainstream OEMs (car manufacturers) to emerge,” said Xavier Gunner, head of research of London’s Arbuthnot Securities Ltd. Speaking to Autocar Professional, Gunner felt that the way in which vehicles are put together could change and that new technologies would need to be embraced. There would also be a significant change in the automotive component industry, he said.
According to CLEPA, the European suppliers organisation, around 500 automotive component manufacturers will go out of business in the next three months.
In spite of a gloomy outlook for the global automotive industry, Gunner continues to be optimistic about the growth potential of countries like India and China. India, he believes, has the potential of becoming a global manufacturing destination provided it gets its act right especially on the transport and energy infrastructure front. Gunner observed that global light vehicles sales experienced their worst downturn with demand slipping by 10 to 11 percent in 2008.
He noted that the outlook for global volumes is challenging on a 12-18 month view at least, and “this is the first time we have had a significantly coordinated downturn, driven not least by falling consumer confidence and rising unemployment.” But he was quick to add that vehicle volumes have a tendency to swing quickly in both directions. For example, he pointed out that US vehicle volumes fell 11 percent in 1991 but rose more that eight percent in both 1993 and 1994.
“Swings in smaller markets tend to be even more pronounced. Industry observers tend to underestimate the movement both on the downside and the upside,” he added.
Ultimately, volumes should be supported by a combination of underlying replacement demand coupled with longer term new demand from emerging countries like India, he observed. Gunner said that the new sources of global auto demand would come from countries which have a low vehicle population (parc) per thousand and whose per capita GDP too is very low. The US, which has a per capita GDP of more than
$ 40,000, has a parc of 740 cars per thousand while countries with a per capita GDP of less
than $10,000 include Russia, Mexico, Brazil, Thailand, China, India and Phillippines that
have a parc of less than 200 cars per thousand, with India having far less than 50 cars per thousand.
“The challenge for the Indian auto industry is ensuring the right product quality. It is also important for players in the market to establish relationships with some of the other international players. The volume implicitly has to grow here in India and the need for the industry is not to be complacent. Made-in-India products are not readily accepted in some of the developed markets like the US and Europe as yet, but as development takes place in India, this too will happen. A number of companies are looking at producing cars in India because it is a low-cost production base. So, if the quality and product is right, there is no reason why it should not be purchased elsewhere. It may not start with premium products but the strength lies in small cars,” noted Gunner.
The different pressure points
According to Gunner, the global auto industry is renowned for its excess capacity. Arbuthnot estimates that capacity utilisation rates in the industry are less than 70 percent are heading for 65 percent. “You’ll never run a plant at 100 percent capacity. In a typical plant, it is the paint shop that struggles. The nature of production cycles and model diversification strategies mean that net utilisation rates rarely go above 80 to 85 percent. Historically, this has been the rate for capacity utilisation," he added.
Gunner agreed that in India, which is an emerging market, utilisation levels in car plants are much better. “A model typically lasts eight years. That is the production cycle. Year one is the ramp-up year. In year two, you get the maximum volumes and in years three and four it slows down and then the last couple of years are the run-out phase,” he said. He noted that flexible model lines help plants like in the case of Mahindra & Mahindra which produces the Scorpio and the recently-launched Xylo on the same lines at its plant in Nashik.
Globally, the industry is also highly dependent on vehicle leasing and customer financing. Now that consumer credit has dried up, the vehicle industry has been impacted adversely. In India too, the credit squeeze has led to a major slump in the passenger car segment as well as the two-wheeler segment. Coupled with this is the high legacy costs of US car majors like GM, Ford and Chrysler, while the Japanese are struggling with the Yen-US dollar exchange rate.
Increased outsourcing,
globalisation of platforms
According to Gunner, most of the action and restructuring in the last 25 years has focused on increased outsourcing and globalisation of platforms and production. The increased outsourcing, he said, has been evidenced by lower labour costs as percentage of sales and lower invested capital for OEMs. “This has the effect of increasing the variability of the cost base (and lowering the volatility of
margins), but the pricing dynamic means continued structural pressure on margins,”
he added.
Speaking on globalisation of platforms and production, Gunner noted that what was a multi-regional industry has embraced globalisation in a bid to reduce complexity and cut costs. But in effect this has led to an increase in vehicle complexity (platforms trying to meet all regulations maximising the number of variants) and increasing parts tourism. The parts industry has remained highly fragmented.
“Back in 1993 Ford spent $6 billion for the development of the Mondeo. It was one of the most expensive new car programmes. It was supposed to be a global car and was expected to sell in Europe, US and a whole bunch of other countries. Because of the different regulations in different countries, you start engineering a complicated product and one platform has to serve different sizes like station-wagons, saloons, coupes, etc. So having a global platform ends up increasing complexities.
A particular component criss-crosses the
globe before reaching the end user,” he said.
Gunner felt that the current actions taken by automotive players worldwide are simply not radical enough. “The problem has been brewing for over 30 years and the current action is too little too late,” he reiterated. He was referring to the legacy costs being borne by the three major car makers in the US and their seeking emergency funds from the US Congress. He also noted that most other
OEMs are pursuing the traditional course
of production cuts, aggressive cost cutting, plant shutdowns and increasing pressure on supplier base.
Future trends
Gunner observed that five or six global mainstream car makers would emerge after the current turmoil in the auto industry. That list could include at least two from Japan, one from the US and a couple from Europe, he predicted. He also noted that the way in which vehicles are put together could change. “Parts tourism is sheer madness. It is best to have local production,” he said. On the new technology front, he said innovation on the energy front, safety and intelligent traffic data and management would need to be embraced.
“The top 10 parts makers currently account for less than 10 percent of the US $ 1.2 trillion global parts industry. We estimate there are in excess of 3,000 significant parts makers in Europe alone. Once credit defrosts, there is a huge potential for mergers and acquisitions. While many suppliers will not survive in their current incarnation, ultimately this is likely to lead to a better and stronger supply base,” he said. These were some of the opportunities that Gunner thought would emerge for the automotive industry.
As for India, he said, there is already strong governmental support for the sector as is evident from the Automotive Mission Plan (2006-2016) relating to the development of the industry in India. The Plan envisages India emerging as the destination of choice of the world for design and manufacture of automobile and auto components with output reaching a level of $145 billion and accounting for more than 10 percent of the GDP and providing additional employment to 25 million people by 2016.
“But India is a big country and the transport and energy infrastructure needs further development and the credit markets are tight,” he concluded.