Is Europe’s car industry teetering on the brink?
The European car industry is, by common consent, at a crossroads. Shrinking sales, pressure to discount list prices,
In cold cash terms, the plight of the mainstream carmakers looks terminal. Hundreds of millions of pounds were lost last year, and it’s a situation that will get worse this year as the European new car market continues to contract. This cannot continue. Many analysts regard 2012 as the calm before an inevitable storm that will force the European car industry to undergo its most brutal restructuring since the Second World War.
WHAT’S THE PROBLEM?
TOO MANY CARS chasing too few buyers. That adds up to what’s called ‘over-capacity’ – factories designed to manufacture a certain number of cars each year but building far fewer, causing the factory to run at a loss.
If that wasn’t serious enough for the mass manufacturers, there is the added problem of high assembly costs in the EU and, as a result of too many cars being farmed out through dealers, the inevitable issue of cut-throat discounting as makers and dealers struggle to ‘shift the metal’.
Europe’s car industry has grown to be a significant part of the EU economy. According to the ACEA (the European Automobile Manufacturers’ Association), the 16 members of this association operate a total of 208 plants in 25 countries, including facilities producing engines and commercial vehicles. Factor in nearby countries such as Russia, Ukraine and Turkey, and that total rises to 297 plants.
ACEA claims that the European industry provides direct employment to more than 2.3 million people and, indirectly, supports another 10 million jobs in Europe. It also says its members “invest over £21 billion (Rs 168,000 crore) in research and development.” However, this is all increasingly at risk as the mass makers are caught between high production costs, rising research and development costs, and a forecourt price war.
According to a report by a Parisian financial research company, uncovered by an industry newspaper, Carlos Tavares, Renault’s chief operating officer, told a hearing at the French senate that building a Renault Clio in France cost about £1,100 (Rs 88,000) more at factory prices than building the same car in Turkey.
Denis Marti, manufacturing chief at PSA (Peugeot-Citroën), reportedly told the senate commission that his company was suffering in a similar way. The supermini segment is not profitable in Europe for PSA, and the situation is “even worse” in France, Tavares is quoted as saying.
Pressure to move European production of mass-market cars to low-cost countries is becoming overwhelming, especially for middle-market models. This is because mass makers are trapped in a vortex of declining volumes, sliding sale prices and increasing production and engineering costs. They’re also under growing pressure from South Korea in the form of Hyundai and Kia. To cap it all, the European car market has not recovered from its nosedive following the deep global recession of 2008. Indeed, the core western European new car market in 2011 was at a lower volume than in 1997. Even with the addition of the new central European markets, volumes, at 15.629 million, are only just above the 1997 core market volume of 15.193 million.
WHO’S IN THE BIGGEST TROUBLE AND WHY?
THE ONLY MASS carmaker to make money in Europe last year was Volkswagen. The premium brands – which also generally sell their cars around the globe – did very well, too.
In 2011, across what the industry calls the ‘EU27+EFTA’ (the 27 countries in the European Union plus those in the European Free Trade area), VW sales were up nine percent to 1.684 million. Ford sales, by contrast, were down by 2.9 percent to 1.077 million, while Renault’s fell by nine percent to 1.044 million. Peugeot’s sales were down 9.4 percent and Citroën’s by eight percent. Fiat’s fell a whopping 17 percent.
But it’s not just the European mainstream that is suffering. Honda was down 20 percent, Mazda 25 percent and Toyota eight percent.
A large part of the problem is the intense competition in the mainstream new car market and the fact that mass-market cars are generally sold at a discount. At the turn of the century, Renault embarked on a drive to push itself upmarket with the new-generation Mégane and Laguna, which were designed to allow Renault to achieve higher showroom transaction prices.
At the launch of the Mk2 Laguna, then-Renault boss Louis Schweitzer told UK journalists that his company suffered in comparison with VW in that the German firm could typically charge about £1,500 (Rs 1.2 lakh) more for a Golf than Renault could for a Mégane.
If the two model ranges sold about 400,000 units per year, that meant VW’s small family hatchback was generating £600 million (Rs 4,800 crore) more each year than Renault’s. Over a model’s typical five-year lifecycle, that’s an additional £3 billion (Rs 24,000 crore) in VW’s coffers. Such a vast cash pile could pay for the R&D costs for the next-generation Golf platform as well as contributing £400 million (Rs 3,200 crore) a year to VW in profits.
Today, after its abortive move upmarket, Renault’s Mégane sells about 250,000 units per year in Europe and has not, it seems, achieved a more premium pricing position. By contrast, the Golf sells about 500,000 units in Europe. Much greater sales volumes and more efficient factories are now compounding Volkswagen’s pricing advantage.
And that’s the Golf’s second big advantage. Not only does it command a price premium, but higher volumes also mean the cost of producing each car is potentially lower. That advantage can also be flipped so that, in theory, the Golf can offer higher-quality parts (such as a multi-link axle) for a similar factory cost to a less expensively engineered rival.
The result of low transaction prices and failing volumes is red ink. Last year, it is thought that the Fiat brand made a European market loss of about £418 million (Rs 3,344 crore), similar to PSA. GM Europe was down about £447 million (Rs 3,576 crore), and even a tightly run Ford Europe lost £17 million (Rs 136 crore). PSA’s debts doubled in the second half of 2011 to £2.8 billion (Rs 22,400 crore) and it is currently raising £800 million (Rs 6,400 crore) in cash, presumably to help pay for new model development.
Mass-market cars – not significantly cheaper to design or produce than premium models – are sinking through a mix of low volumes, under-used factories and low transaction prices.
WHO’S WINNING AND WHY?
THERE ARE PLENTY of car makers – mostly premium brands, admittedly – that can manufacture at a profit in western Europe.
Across 2011, in the 30-country EU market, Volkswagen sales were up nine percent, Audi up nine percent, Mini up 19 percent and Land Rover up 11.5 percent. There were rises for mainstream winners, too. Hyundai and Kia were both up 11.5 percent (thanks to their high-value propositions) and Nissan rose 13.7 percent as its bet on the urban SUV market continues to pay off so well. In simple terms, premium makers are selling higher-value vehicles that attract showroom prices close to quoted retail prices. You cannot walk into a BMW dealer and haggle much of a discount, for instance. BMWs are in demand and superior residual values mean buying one makes sense for private and fleet buyers alike. It is a virtuous loop. But the premium advantage is not just about convincing new car buyers to pay list prices. It is also about competing at list prices well above £16,000 (Rs 12.80 lakh).
It may seem counter intuitive, but it does not cost much more to design and develop a BMW 3-series from scratch than it does, say, a Ford Mondeo. The factory build costs are also not so wildly different, especially as sophisticated suspension systems, expensive high-tensile steel bodies and extensive electrical equipment lists are expected on both premium and mainstream models.
Making a profit from selling Mondeos in Europe is much, much harder than making money from a premium German executive model, especially as the 3-series and Mercedes C-class are sold globally, which helps realise bigger production volumes. Which is one of the reasons that the next Mondeo will also be a global product.
A UK source tells us one compact German premium executive model averages a profit of £5,000 (Rs 4 lakh) per car sold. If that were repeated across all the model’s global markets, the retail profit would be £2 billion (Rs 16,000 crore) per year for just one model line.
Premium makers are also making big financial gains through optional extras being specified by buyers. Xenon headlights, bespoke navigation set-ups and upmarket sound systems have very significant margins.
Early supply delays suffered by the Range Rover Evoque were caused, it is rumoured, by a huge proportion of buyers specifying the panoramic sunroof – the numbers were well beyond what was estimated by Land Rover’s marketing experts. Early Evoque buyers gorged on expensive extras, with the average transaction prices rumoured to be as high as £40,000 (Rs 32 lakh). This kind of premium success is one of the reasons that Land Rover’s recent profit margins have been as high as 20 percent.
IS THERE ANY ECONOMIC HOPE OVER THE HORIZON?
NO. THE ON-going crisis with the eurozone countries – and the very real possibility that Greece could yet default on its debts, causing Portugal to go the same way – is putting a huge damper on consumer confidence. Austerity measures from most European governments are also turning people away from expensive consumer durables. The demographics are also against selling new cars in Europe, with high youth unemployment in many countries. The average age of a private new-car buyer in the UK is 53.
Fiat-Chrysler boss Sergio Marchionne (also head of the ACEA) expects the European car market to remain becalmed until 2014. But in the first two months of 2012, the new car market took another nosedive, dipping by nearly eight percent. The total 2012 market is expected to come in at just over 12 million units.
Again, mainstream makers are taking the biggest hit (Fiat down 18 percent, Renault down 20 percent and PSA down 16.5 percent). For these makers, and GM Europe, the situation is critical, and two more years of losses look virtually certain.
WHAT NEEDS TO BE DONE?
QUITE A FEW things, and some of them very quickly indeed. In the first instance, reductions in capacity need to be executed. According to one industry estimate, the European car market has excess capacity of three million cars per year, or about 10 typical factories. That’s 20 percent of today’s production capabilities.
Sergio Marchionne has been calling for a coordinated response to factory closures, executed at the level of European government. He figures that the French and German governments will probably prevent plant closures, but that the EU could probably force a solution in order to prevent the mass-makers cutting each other’s throats.
In the medium term, more platform sharing is needed, much like the recent PSA-GM tie-up, which could allow the two to share small, medium and large platforms. But the benchmark is set by VW’s new MQB platform, which stretches from the Polo to the Passat and will be made in identical factories around the world. Six million cars per year could come from the same components set.
Ultimately, mass makers have no choice but to get involved in serious, long-term, alliances, sharing platforms and component sets at volumes well north of one million per annum. And all factories will have to be running at or near full capacity. Whether they can achieve this medium-term goal without collapsing depends on how willing they are to close factories over the next 24 months.
HILTON HOLLOWAY, AUTOCAR UK
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