The glitz, strutting and general hype of this month’s Frankfurt motor show hadn’t even climaxed before Volkswagen poured a large bucket of cold water reality on perceptions of the state of the European car market.
The motor show did its usual best to wow people with shiny new models, much singing and dancing, and large dollops of strategic bluster, with industry big-wigs talking up prospects for recovery in general and (of course) their own firms in particular. The general line was that the European market had bottomed out, was now on its way up and that they could all look forward to sunnier days (with climate control as standard of course).
Enter VW and its large bucket of cold water. “Basically it’s ten (European) 10 factories that could be closed” said VW’s chief executive Martin Winterkorn in an interview with Reuters. It was a rude reminder of the dismal state of much of the European car market where overall sales are now at a 20-year low. According to McKinsey & Company, last year the West European industry lost around $1.3 billion. This year will be as bad if not even worse.
Now $1.3 billion across a whole industry doesn’t actually sound that bad if you’re used to Blackberry-sized losses. But remember that the German firms of VW, BMW and Daimler all stacked up huge profits (and JLR did well as well), so that means that the mass middle was bleeding copious amounts of red ink. Think of GM Europe, Ford Europe, Peugeot-Citroen and Fiat. Meanwhile Renault managed to break even only because of its budget brand Dacia.
The same old problem persists in that there are way too many plants across Europe producing way too many cars – and the manufacturers themselves have exacerbated the problem by building huge capacity in central and Eastern Europe. Even before the most recent downturn, manufacturers could only make and sell three out of four cars profitably; the fourth one had to be sold at a loss. This 25 per cent over-capacity problem hasn’t gone away and if anything will get worse as new entrants come in.
Indeed firms from Korea, Japan, and soon China are attacking the mass car producers from below, while the premium producers (mainly German owned but also JLR) are squeezing them from above, making smaller premium cars.
Meanwhile industry analysts Alix Partners reckon that car sales in Western Europe have fallen to below 12 million a year. The key driver of course is European economic weakness and the lack of consumer confidence. But as Alix Partners have noted, other significant market changes underway. Cars are lasting longer thanks to better quality and durability, so people change them less often, with the average age of a European car now over eight years.
Younger drivers also seem happy to eschew car ownership per se and just rent cars by the hour. That’s for now at least – whether this is a longer term trend is not yet clear. And many cash strapped manufacturers are extending product lives by revamping older products, which in turn fails to boost demand.
As a result, Alix Partners stated in a recent report that almost 60 per cent of European car plants are operating at less than 75 per cent capacity, the rough rule-of-thumb measure of breakeven for a car plant. Operating below this level means sharply rising costs per unit of output. (It should be noted that overall, plants in the UK perform well on this score)
All of this reminds me of the dire US situation a few years ago when GM and Chrysler went into Chapter 11 and emerged slimmed down and generally in better shape after US government nationalisation and restructuring. But in contrast I can’t see such government intervention on the European side of the Pond given the austerity drive.
It’s true that Ford, GM Europe, Peugeot-Citroen and Volvo have all announced plant closures. And there is more pressure on both Renault and Fiat to take do the same. But there is still a long way to go with overcapacity; some has been taken out but not nearly enough. At some point there will have to be further cuts in capacity or we face the same old muddling through with veiled government support.
Strictly speaking, state intervention to support national champions goes against European Union State Aid rules. But in practice governments often find ways around the rules. During the last downturn France managed to lend Peugeot and Renault funds worth around $4 billion.
And earlier this year it gave Peugeot an €8bn loan guarantee. Such interventions have helped both firms avoid making some pretty tough decisions. Meanwhile, Fiat is under so much pressure that at some point it may be forced to sell off its Alfa Romeo brand, which VW has been eying up for some time.
Indeed Fiat and Peugeot have both slashed capital expenditure as sales fell off the cliff and losses stacked up. That in turn may impact on longer-term product development; their new product shelves may start to look a bit empty by the time the next motor industry jamboree comes along in Geneva in the spring of 2014.
Of course, that’s not how Fiat or Peugeot see things – publicly at least. It’s possible that through cooperation – Fiat with Chrysler and Peugeot with GM – they can develop platforms more efficiently. But it is remarkable how much spending they have nevertheless cut. The proof of the pudding will be when the new models arrive.
In fact, much the European car industry is now so desperate to turn things around that some firms, including Ford (with its Vignale take on the Mondeo) and Renault, came up with new offerings at the Frankfurt show which they claimed would move them into the premium territory occupied by the likes of Audi, BMW and JLR. Peugeot-Citroen is thinking along the same lines.
Ford reckons that this is in response to consumer demand and that they expect 10 to 15 per cent of sales to be Vignale variants. That may or may not be the case, but these firms are living in cloud cuckoo land if they think this will bring BMW-style premiums.
All previous efforts by the mass firms to get into the premium sector have failed dismally – witness for example Ford’s offloading of its premium car division. In short, I doubt very much whether mass producers like Ford and Peugeot are capable of competing with quality premium cars like the BMW 3 series, at least in the short and medium term.
And therein lies the problem, as entering the premium sector takes long-term commitment and investment – something that Audi did over many years. It doesn’t just happen overnight. I doubt if Ford or Peugeot can make that sort of commitment when they are under such short term pressure.
Overall, European car sales may have stopped falling off a cliff and like others I hope that the European car market has hit bottom. But how long we have to wait before it takes off again really is anyone’s guess despite all the Frankfurt hype. All the problems from before are still there, especially in terms of over-capacity. Frankfurt may be remembered as a showcase of over-optimism as to prospects in the European mass market, especially as more competition is about to arrive from China.
* Professor David Bailey currently works at Coventry University. He starts work as Professor of Industrial Strategy at the Aston Business School on October 1
