Asians, Lean Economies Put Squeeze on European OEMs

Centuries ago, European winemakers learned to enrich their product by blending juices from several grape varieties.

Today, Europe's auto industry is undergoing a similar process as Asia-based competitors pour into the region. But while consumers benefit from more choice, the trend has diluted the profits of European auto makers.

This changing dynamic occurs as historically strong economies suffer from an increasingly hostile climate marked by restrictive labor agreements, stagnating populations and volatile currency exchange rates.

For these reasons, European auto makers do not expect 2006 to be a vintage year. Guardedly, they offer forecasts that call for flat to modest growth.

Sergio Marchionne

“Our friends from the east have taught us a number of things,” says Sergio Marchionne, CEO of embattled Fiat Auto SpA. “I think we need to be respectful of the direction they're taking. And I think it's incumbent on all of us to catch up.”

It won't be easy. With every passing month, juggernauts such as Toyota Motor Corp. and upstarts like Hyundai Motor Co. Ltd. and Kia Motors Corp. are gaining ground.

Through July, Hyundai and Kia held 3.3% of the lucrative Western European market, up from 2.0% in 2002, according to Ward's data. During the same period, Toyota grew its share 0.8% to 5.1%.

European auto makers still dominate their home market. But they have faltered, as heavyweights such as DaimlerChrysler AG, PSA Peugeot Citroen, Renault SA and Fiat have lost share, while sales leader Volkswagen AG struggles for cost competitiveness.

Industry insiders complain the story would be different if Japan and South Korea had the same open-market policies as Europe and North America. But Marchionne disagrees, believing the fight can – and should be – waged at home. “I just think we need to compete,” he says.

But the precise location of the battle for Europe is shifting eastward, as countries such as Poland and Romania use their low-wage structures to attract investment.

Hyundai is readying plans to build an assembly plant in Czech Republic, where production is expected to begin by 2008. And Kia already has a spade in the ground in Slovakia. (See related story: Hyundai to Build Plant in Czech Republic)

Ford of Europe CEO and President John Fleming says although his company is maintaining share in Europe's traditional 19 markets, much of the auto maker's anticipated growth is outside those countries, in such places as Turkey, Russia and Romania, where Ford once was weak.

“With Russia and Turkey, what we've proved is when we really start to focus in a market, especially if we think it's a growing market, we can really start to see some improvement,” he says.

Fleming says Ford will increase capacity in Russia from 40,000 units annually to 60,000, effective Jan. 1, to build the Ford Focus. And there is land to expand as Ford sales continue their exponential growth in Russia.

“Turkey's another significant success story for us,” he says. “We were No.1 in total volume and share last year,” he says of the auto maker's 15.5% share, with 115,000 deliveries in a 740,000-unit market.

He expects Turkey, overall, to reach 780,000 sales this year, noting Ford currently is up “by a bigger margin this year than last year.”

And as auto makers expand into Eastern Europe, suppliers are close on their heels.

“From a wage and benefit standpoint, it's a lot more competitive on a global basis,” says Mark Hogan, president of Magna International Inc. “So it's logical that the OEMs migrate there. We follow them.”

Magna already has plants in Romania and Poland, where it produces components such as stampings, body trim and suspension systems and soon will announce construction of a second plant in Slovakia, Hogan tells Ward's.

Though there is recent evidence to show the gap has closed slightly, labor costs in Eastern Europe are 75% cheaper than in Western Europe, according to a comprehensive study by global consulting firm, Mercer Human Resources.

“The enlargement of the European Union in May 2004 and the introduction of the euro as a common currency in a large part of Western Europe have significantly increased the momentum towards a more integrated European economy,” the Mercer survey says.

“These factors, in conjunction with growing economic globalization and increasing international competitiveness, have led to an increased focus on employment costs across the member states.”

Ironically, low wages also portend a troublesome bottleneck for Eastern Europe, which needs expertise in logistics to foster its manufacturing growth.

“Attracting logistics talent from the West will also be a challenge for the former Eastern Bloc nations,” says a study highlighted by consulting agency GlobalAutoIndustry.com.

“Wages are as much as 10 times lower, so some companies establishing Eastern European logistics operations are sending in western talent to develop and train a local workforce,” the report says.

“The labor cost advantage will gradually disappear as living standards improve in the East, but it should remain an advantage for about the next 10 years.”

This reality recently forced Volkswagen – Europe's largest auto maker – to seek wage concessions from the powerful IG Metall union, which represents the auto maker's hourly employees. (See related story: Marrakesh to be Made in Germany)

VW said it needed to address the high cost of manufacturing in Germany and brokered a deal with the union to shave about €850 ($1,000) from the cost of building the Marrakesh, a new cross/utility vehicles at VW's historic Wolfsburg, Germany, plant by not paying workers the expensive in-house wage structure.

Had a deal not been reached, VW was prepared to assemble the Marrakesh in lower-cost Portugal, another emerging manufacturing power.

VW has managed to keep its share of the Western European market fairly stable. Through July, it stood at 16.8%, an increase of 0.7% over the first seven months of 2004.

But the auto maker is preparing a turnaround plan for its very survival, with the focus on three areas: Germany, North America and China, all of which are struggling. (See related story: What Will it Take to Fix Volkswagen?)

Also in need of remedial work is DaimlerChrysler, especially its flagship Mercedes-Benz division, which has had quality issues resulting in a loss of reputation and sales, and the Smart unit that has been a money-loser since its inception.

These German stalwarts are addressing their problems – as is Germany, itself – which is crucial because the country is the engine for the rest of Europe.

“Germany, without significant reform, is going to continue to struggle,” says Mark Fields, former head of Ford of Europe, including the Premier Automotive Group.

“Nineteen ninety-eight was the last really good year in Germany,” says Fields, who left Europe recently to run Ford's North American operations. He says he observed an undercurrent of denial in Germany, which was eerily similar to his earlier stint as head of then-struggling Mazda Motor Corp. in Japan. (See related story: Management Changes Continue at Ford)

“It's been like the speeches I used to hear in Japan every year I was there, which were: 'Six months from now, things will start getting better.' That's the same speech I heard in Germany.”

Insiders expect labor reform to come more quickly as conservative Angela Merkel takes over as German chancellor from Gerhard Schroeder, who lost the hotly contested election in September.

Current law in Germany severely restricts employee-termination practices, fostering a climate that has ballooned workforces and compromised productivity, critics charge.

Rick Wagoner

“What we've learned here, over the years, is you have to run full capacity utilization to have a chance to get any kind of profitability,” Rick Wagoner, chairman and CEO of General Motors Corp., tells Ward's.

“And that's what we're driving to do,” he says. “Over time, we'll see the importance of having a balanced capacity footprint between the traditional markets and maybe some of the newer, lower-cost markets in the East.”

He tempers any overt optimism for growth in the European market by the reality that its population soon be will dominated by younger consumers, who, inherently, have less buying power.

“Basically, the growth rate is less than the decay rate, to put it in morbid terms,” Wagoner says. The CIA World Factbook estimates the European birthrate is 10 per population of 1,000. But its death rate is 10.1 per 1,000.

“You just don't have the vibrancy,” Wagoner says. “Over time, the market growth is going to be slowed because of that.”

That could skew heavily toward the B-car segment, where profit-making opportunities are scarcer. But it also could play into the hands of a resurgent Fiat, which is gambling heavily on the success of its redesigned Punto.

Meanwhile, Mercedes chief Dieter Zetsche predicts increased fragmentation. And damn the cost of product development.

“The customer asks for his or her favorite customized products, and you have to listen to that or you won't have a customer,” says Zetsche, who becomes DaimlerChrysler CEO in January. “So there's not much choice in increasing the number of offerings on the one side.”

Dodge Caliber

To this end, DC is expanding its Dodge lineup with the introduction next year of the Caliber, a 5-door hatchback built in the U.S. that will feature all-wheel drive and a 4-cyl. engine. Recent unveilings at the Frankfurt auto show also promise a pair of small Jeeps with the same powertrain as the Caliber, from the same AWD architecture.

Despite the potential these products represent, DC is keeping the champagne on ice. That is because there exists another threat to its profit margins.

“Incentives and discounts are going up in Europe significantly,” warns Thomas Hausch, the auto maker's executive director-international sales and marketing.

The only certainty in the European market is the strong ties that bind Europeans with their respective industrial landscapes. Like wine, those relationships endure and even flourish with the passage of time.

“The Italian market in Europe, as is the French market for the French producers and the German market for the Germans – there's so much of a national bias,” Marchionne says. “Not because of nationalism. It's simply because it's historical. It's got roots. It will take a long time to displace that.”

– with Alisa Priddle

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