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The Global Car Industry in 2004[1]
Introduction
In early 2000s, the car industry occupied a position of strategic importance in many countries. However, with increasing maturity, the industry’s average profit margins had declined from 20% or more in the 1920s to around 10% in the 1960s and less than 5% in 2004. The car industry represented just 1.6% of Europe’s stockmarket capitalization and 0.6% of USA’s[2]. About 20 years back, the corresponding figures had been 3.6% and 4.0% respectively.
In recent times, the automobile market in America, Europe and Japan, where over 80% of the world's cars and trucks were sold, had stagnated. Supply had increased vis-à-vis demand for several reasons. In countries like Germany and France, rigid labour laws had inhibited the closure of redundant factories. In America, the arrival of European, Japanese and South Korean makers and their aggressive plans to expand market share had also created overcapacity. Effective capacity had increased slowly but steadily as carmakers continued to improve their productivity.
The car industry also seemed to be undergoing a structural transformation in the early 2000s. Many players were trying to move towards a build-to-order model that could serve niche segments efficiently. As new electronic control devices emerged and concern for the environment grew, new players with new competencies were likely to enter and challenge the incumbents. Under these circumstances, the leading car makers wondered what they had to do to revitalize themselves and strengthen their competitive position.
Background Note
The car industry was born in Germany more than 100 years ago. Early development of the industry began in France in the 1900s. It was in America that the industry came of age thanks to Henry Ford, who introduced the assembly line production system.
The car industry pioneered many innovative business practices. For example, the industry introduced the concept of “planned obsolescence,” i.e. frequent changes in design to induce customers to switch to a new model every other year. At the same time, by virtue of its sheer size and ubiquity, the industry attracted wide public attention. In the 1960s, consumer activist Ralph Nader attacked the safety record of the ‘Big Three’ Detroit manufacturers, General Motor, Ford and Chrysler. In the 1970s, as oil prices quadrupled, the industry found itself under attack from environmentalists. The industry also attracted government scrutiny on account of safety concerns, antitrust worries (in the days when General Motors had 60% share of the US market) and pollution. But in view of its size and the number of jobs it created, the industry continued to receive strong government support. When small, fuel efficient and reliable Japanese cars started to eat into the market share of the Big Three, the American government resorted to protectionism.
The global car industry had been consolidating almost since its birth. In the late 1920s, there were 270 car companies in the world, most of which were based in America. From these, the Big Three - G M, Ford and Chrysler emerged. In 2004, the global car industry comprised seven big groups and three smaller ones. In volume terms, six groups - GM, Toyota, Ford, Renault/Nissan,Volkswagen and DaimlerChrysler and their affiliates accounted for about 70% of global sales.
Since the 1980s, car makers around the world had been trying to emulate the success of Japanese companies in lean manufacturing. Most car factories had been revamped more or less along Japanese lines. Consequently, the productivity gap between Japanese and western producers had become much smaller. But still many analysts felt that Toyota, the leader in lean manufacturing, was well ahead of the pack.
In recent times, the automobile industry appeared to be undergoing a transformation. Fragmentation of the market had led to lower production runs. With the system of building cars based on projected demand proving costly, companies were attempting to move towards build-to-order systems. Many companies were embracing innovative modular construction, in which a large section of the car was put together by parts suppliers. There was also a trend towards electric cars with electronic and electrical rather than mechanical controls.
Traditionally, economies of scale had been important in the car industry. This went back to the 1920s when the pressed-steel monocoque body shells (that were in use then) could be made only by huge, expensive press tools. Large production runs were needed to recover the heavy investment.
In the early 2000s, car makers continued to look for ways to improve operational efficiency. Some of the alternative business models being explored would dramatically change the industry. Some players had turned to alternative manufacturing methods, using what was known as space-frame construction rather than pressed panels for strengthening the vehicle. The body panels were riveted on to frames. This method was particularly attractive for production runs of less than 100,000 units a year, obviating the need for large numbers of huge presses to stamp out expensive floorpans. The method also facilitated the easy modification of the shape of cars.
The US
In the 1980s, America's car markers had been in deep trouble. While the Ford family (which had a controlling stake in the Ford company) had bailed out Ford Motor, the federal government had given a loan guarantee that enabled Lee Iacocca to rescue Chrysler. In the early 1990s, GM ran into trouble, losing a total of about $15 billion in its North American car business. GM was saved only by profits in other markets, mainly Europe. GM quickly got back into the black under a new chief executive, Jack Smith. Chrysler emerged from near-bankruptcy for a second time in ten years under the leadership of Bob Eaton, aided by efficient product development and leaner manufacturing practices. In the 1990s, a boom in sports-utility vehicles (SUVs) and import tariffs gave Detroit’s Big Three a respite from the Japanese onslaught.
In the mid-1990s, the yen strengthened, putting the Japanese car makers at a disadvantage. Customers began to prefer made-in-America minivans and sport utilities. These big vehicles made money and the Big Three cashed in. In 1997, they reported combined profits of $16.4 billion. But instead of reinvesting the profits in successful new products, GM & Ford spent heavily on overseas acquisitions. GM bought a stake in Fiat, while Ford took over Land Rover in July 2000. Both had turned out to be money-losers. Their competitors, in the meantime, had made significant progress in the largest car market in the world. In 2003, Toyota passed Chevrolet and Ford to become the best selling passenger-car brand in America, while Mercedes and BMW (the German cars), seemed to be far more exciting than GM’s Cadillac and Ford’s Lincoln. The Koreans were also becoming more aggressive. Hyundai was outselling GM’s Buick, while Kia had sped past Mercury, also made by GM. By nearly every quantitative benchmark, such as defects per hundred, assembly hours per car, or time to market, Detroit’s Big Three still lagged behind manufacturers such as Toyota. In 2004, American car makers still had a lot of catching upto do. GM was making a profit of $178 per vehicle, but was still completely outclassed by the Japanese with Honda making $1,488, Toyota $1,742 and Nissan $2,402 per car.
Since 1999, total car sales in America had averaged around 17 million a year, (even through the mild recession of 2001) though it dipped a bit in mid-2004. After September 11th 2001, demand for cars had fallen. GM launched a wave of discounts and credit incentives. When GM's campaign succeeded, Ford and Chrysler were obliged to follow suit.
In the early 2000s, nearly half the cars sold in America were foreign brands, leaving the country's three native car manufacturers struggling. Japan's Big Three (Toyota, Nissan and Honda) and the European luxury brands (Mercedes, BMW and Volvo) recorded their best profit margins in America. The Americans steadily lost market share. In 2003, Detroit lost another 1.5 percentage points of the domestic market to foreign competitors. It accounted for only 60.2% of vehicles sold in the U.S., the lowest percentage ever. Detroit’s Big Three believed that by offering a larger variety of models at various price points they would regain market share.
Ford had reworked its lineup of passenger cars to reverse the decline in its market share (from 20.2% in 2002 to 19.5% in 2003). It added among other models, the spacious Five Hundred sedan; a van--station wagon crossover, called the Freestyle; and a new version of the Mustang.
Chrysler ended 2003 with a market share of 12.8% for its Dodge, Chrysler, and Jeep brands, down from 13.1% in 2002. Chrysler expected to launch nine new products or major redesigns that together would account for 60% of the 2.1 million vehicles it would produce in 2004. These included reworkings of its popular minivans, a new Jeep Grand Cherokee and Dodge Dakota pickup, and a pair of all-new rear-drive full-sized cars, the Chrysler 300C and Dodge Magnum.
U.S. auto makers had also been reducing their design and engineering costs. Earlier, it took four years and $1 billion to get a car from the drawing board to the road. Since the late 1990s, Ford had reduced its product development time by 25% and could produce almost a third of its new models in 30 months or less.
GM’s little sports car, the Pontiac Solstice, which would go on sale in late summer 2005, symbolized the new approach to product development. In the old scheme of things, the Solstice might never have been launched. With high costs, low sales volumes (20,000 units a year) and a base sticker price of less than $20,000, prospective returns on the two-seater were low. To get the car off the drawing board, GM worked hard to cut costs. The company slashed the cost of the dies used to stamp the body parts by $50 million through two process changes: use of computers to design and validate them, and a new technique called hydroforming, which eliminated half of the die. GM saved about $80 million because the Solstice had an uncomplicated body that could take advantage of existing tooling. GM used a simple architecture called Kappa, which could also be used as the foundation for other small rear-drive cars.
As the pressure for introducing new models increased, manufacturers were trying to develop models that looked different, though built from the same basic architecture. GM had attempted to generate global economies of scale by using its Epsilon framework for the Chevy Malibu Maxx in the U.S. as well as for the Swedish Saab 9-3, European Opels and Vauxhalls, Australian Holdens, and South American Chevys. Ford was trying a different approach by using the components of the XC90 sport utility/station wagon made by Volvo (which it owned) as the base for the Ford Five Hundred sedan and Freestyle crossover wagon. Since Volvos sold for higher prices than Fords, engineers reduced costs by substituting stamped steel parts for cast aluminum and magnesium. Chrysler was borrowing parts from its German affiliate, Mercedes. The 2005 Chrysler 300C sedan used a transmission and rear-suspension architecture designed in Germany.
American manufacturers were also adapting their factories for flexible manufacturing. Flexible factories could run five or more different kinds of cars on one assembly line. That helped balance production between fast and slow selling models. Flexible production lines were also cheaper to equip and to retool because welders and paint sprayers could be reprogrammed instead of being replaced.
GM led the US car markers in flexible manufacturing. It was poised to launch a record 27 models in 2004. Of those, 12 were either new or substantially redesigned, while the others had received sheet-metal changes or a different body style or powertrain. GM’s previous divisional structure, which encouraged bureaucracy, had also been scrapped. Engineers and designers switched from working on Cadillacs to Pontiacs in a flexible way. Duplication and overlaps had been eliminated. GM reported a rise in profits in the first half of 2004.
After recording a profit of $7.2 billion in 1999, Ford’s financial performance deteriorated and it posted a loss of $5.4 billion two years later. After Jacques Nasser, its charismatic chief executive, was fired in late 2001, the company seemed to drift as it sought to reverse Nasser’s ambitious diversification strategy. In 2003, Ford seemed to be on the verge of bankruptcy. Ford cut its excess capacity in America but somewhat later than GM. Still behind GM, Ford’s financial performance had been surprisingly strong since the start of 2004. Ford followed a profit of $1.95 billion in the first quarter of 2004 with one of $1.2 billion in the second (almost triple that for the same period in 2003).
After the merger between Chrysler and Daimler-Benz in 1998, effectively a takeover by the German company, the Germans had been slow to get a grip on Chrysler's management. Chrysler had made great strides, with efficiency rising by 16% in the past two years. But Chrysler’s revival coincided with the latest round of price-cutting, and effectively postponed any hopes of the company breaking, even in 2003. During the year, Chrysler was still losing $496 on every car it sold.
Europe
Through the 1990s, the European car industry had struggled. Volkswagen (VW) had been dragged down by the acquisition of the Spanish firm SEAT, and by its high production costs (especially high wages) in Germany. The company had struggled to manage its sprawling stable of brands, ranging from Bentley and Lamborghini to Audi, SEAT, Skoda and VW itself. Renault's attempted merger with Volvo had fallen apart. The French company, PSA Peugeot Citroën seemed too small and heavily dependent on Europe to survive as an independent player.Daimler-Benz’s merger with Chrysler in 1998 had not delivered results. In 2003, the combined stockmarket value of the two companies had fallen to about half the sum of their individual valuations at the time of the merger.
BMW, the German luxury car maker had struggled after the acquisition of Rover from British Aerospace in 1994. Six years later, when it divested the company, BMW no doubt had the successful Mini brand. But the Mini did not seem adequate reward for the $5 billion that the German company invested in Rover. However, the car helped BMW overtake the arch rival Mercedes (excluding Chrysler) in global sales in the first half of 2004, for the first time ever.
Fiat seemed to be in terminal decline. There had been frequent changes in Fiat’s top management. GM, which bought a 20% share in the Italian company four years ago, had reduced it to 10%. Fiat was nearly sold to DaimlerChrysler in 1999, but Gianni Agnelli, the patriarch of the controlling family, had not been in favor of the merger. An earlier attempt to form an alliance with BMW had also met with the same fate.
In 2004, the scenario looked far brighter for European car makers. Renault had made remarkable strides thanks to its alliance with Nissan. When the French group announced in early 1999 that it was taking a 37% stake in Japan's perennially loss-making second-biggest car company, few thought it would work. But within two years, Renault had made Nissan profitable through a multi pronged strategy, which included closing factories in Japan, streamlining product development and a revamp of management processes with an emphasis on cross-functional teams. Once things started improving, Renault increased its stake to 44%. But the two companies retained their separate identities in order to maximise brand loyalty and employee motivation. In 2004, Renault and Nissan pushed ahead with their plans to share car platforms, reducing the number across the two companies from 40 in 2000 to ten in 2010. This would lead to cost savings of more than €500m a year. On top of such operational savings, in 2004 Renault earned about a fifth of its profits from Nissan’s dividend payment.
Peugeot had strengthened its competitive position through a sharply focused product range. Instead of investing heavily in new capacity, Peugeot had achieved better utilization of assets and introduced various changes in working practices to achieve more flexibility. Peugeot had benefited from component sharing across complementary brands with very different customer appeal. Peugeot also had strong capabilities in diesel engines for small cars. It had joint ventures for engines, small vans and small cars with partners that included Ford, Fiat and Toyota. Peugeot shared a factory with Toyota, which made low priced cars in the Czech Republic. Peugeot was no longer so heavily dependent on France.
BMW and Mercedes had made impressive strides in global markets. VW had grappled with many of its problems and made progress in America and in China. Daimler-Benz's ambitious merger with Chrysler was at last beginning to show signs of working. With the exception of Fiat, the European industry seemed to be in good shape. Fiat was pressing ahead with a rescue plan drawn up with the banks. The company’s new Panda small car had been a hit. But Fiat still had a lot of hard work ahead.