Changing Economics, Tastes, CO2 Rules, Tougher Competition
Audi Looming Large In the Rear View Mirror
“BMW most at risk without the scale of Audi, Lexus, Acura, and Infiniti”
Germany’s premium car manufacturers have weathered the recession without taking on too much water, but the long-term prospects for Mercedes, Audi, Porsche, and particularly BMW are starting to sound alarm bells.
European mass car manufacturers like Renault and Peugeot-Citroen of France have piled up huge losses and relied on cheap government loans and subsidised car scrapping schemes to keep their heads above water. GM Europe owned Opel-Vauxhall’s problems have been well aired. Ford Europe has performed strongly by managing its business well and selling lots of little Fiestas and Kas. Fiat of Italy, with its newly arrived sibling Chrysler, looks safe for the time being. Market leader VW has rolled on making money relentlessly.
When the recession ends (and in Western Europe minus Britain that process seems to be starting), mass car makers have proven business models to plug into.
But premium car manufacturers face shifting sands as traditional markets whither, according to a report from Bernstein Research. Harsh fuel consumption rules in the name of saving the planet will soon kick in and destroy traditional boy-racer profit centres. People are losing interest in fast cars and driving. New competition, mainly from Audi, is making life more difficult for the traditional premium manufacturers.
Lack of scale
BMW is seen as most at risk because it hasn’t the scale of production to compete with Audi, Lexus, Acura, and Infiniti, which use much output from VW, Toyota, Honda and Nissan to cut costs using cheap components the source of which is hidden from prying eyes. Mercedes has its truck and bus businesses to cushion its luxury machines and make money when cars are in trouble.
The German premium model is under threat, according to the report, authored by Max Warburton of Bernstein Research in London.
“We continue to have great concerns about the long-term strategic challenges of Germany’s premium producers BMW, Mercedes, Porsche and Audi,” Warburton said.
“We see the business model of BMW (and indeed its close peer Mercedes) as fundamentally challenged in the face of “Anglosphere” currency and consumer weakness and restrictive CO2 legislation in both the E.U. and U.S. We do not believe BMW or Mercedes’ returns and earnings are likely to return to historical peaks and do not see BMW’s 2012 targets of 8-10 per cent margins as realistic,” Warburton said.
BMW has traditionally sold about 25 per cent of its cars to the U.S. and just over 10 per cent to Britain. Both countries’ currencies have been weak in recent years, as governments print money to stave off financial crises and economic sluggishness. This forces exporters like the German premium companies to cut prices and therefore profit margins to compete.
Rules in the U.S. and E.U. forcing higher fuel economy will force premium car makers to stop selling high-performance vehicles with huge engines carrying massive profit mark-ups, in favour of smaller cars with less potent engines and profit margins.
“We see 5-6 per cent margins as a more realistic (for BMW), and still a very ambitious target for 2012 and beyond. The BMW business model, and that of other premium brands, is under siege from structural pressures on U.S. and U.K. currencies from budget deficits and printing money, structural pressures on premium brand consumers’ disposable incomes from taxation, wealth redistribution, limited capital gains; structural pressures on mix from fierce CO2 legislation, and structural pressures on consumer taste as interest wanes in driving and in performance cars,” Warburton said.
David Bailey, Professor of International Business Strategy and Economics at Coventry University in the English Midlands, isn’t so sure about this doom and gloom scenario for BMW and its premium sector brethren.
Foreign exchange problem
“We have seen this before. There were similar forecasts back in the early 1990s, but BMW managed to do well. Certainly, tough new CO2 rules will push up costs, and this will hit BMW more than its rivals because it doesn’t have the resources of VW or Toyota. But it can produce all over the world to avoid the foreign exchange problem,” Bailey said.
“In environmental technology, BMW will have to cooperate with other companies (it is already producing engines with Peugeot of France for its Mini and little 1 Series). As for consumer sentiment shifting away from conspicuous consumption, that may be true in the West, but it’s certainly not the case in Russia, India, China, or Brazil where there are big emerging middle classes. People have said before that BMW is too small to be able to hack it long-term, but it always seems to manage,” Bailey said.
Premium sector strength
Walt Madeira, Manager, Europe Vehicle Sales Forecasts at CSM Worldwide, agrees that the German premium sector faces tough problems, but insurmountable they’re not.
German premium manufacturers will gain market share not lose it, at least in Western Europe, benefitting in part from the failure of mass car manufacturers who have tried to push their brands a little too close to the sun, he said. The premium high ground is littered with attempts by companies like Ford, with expensive versions of the Mondeo, the Renault Laguna and Opel/Vauxhall Insignia which tried to mix it with Audi, Mercedes and BMW.
Between 2009 and 2015, Madeira expects the premium sector’s market share to rise from 15.3 per cent to 19.5 per cent – that’s sales of 2.9 million versus four million. BMW will also show solid sales gains in the period, from just over 708,000 in 2009 to a smidgen over one million in 2015, Madeira said.
This solid increase in sales though could mask a serious deterioration in mix, with few M5 V10 supercars, and lots of underpowered and cheap 1.6 litre I Series cars.
Madeira also doubts the demise of premium brand power.
“Entrepreneurs and wealthy buyers will still be looking around for a brand which meets their image. They won’t be buying brands which mean nothing to them. Audi, BMW and Mercedes have invested heavily in creating this image. When the wealthy get to the top they won’t be looking back (at Fords and Renaults),” Madeira said.
Madeira and Bailey both agreed that profits will be harder to come by, as Mercedes pushes cars like the little A class and BMW its 1 Series and increased range of Minis. But even though the cars will be smaller, they will still command a bigger premium than mass car manufacturers. The huge mark-ups now seen on go-faster BMWs, Mercedes and Audis will certainly disappear.
Bernstein’s Warburton points out that BMW’s move to downsize its fleet has coincided with a drastic drop in profit margins. As small cars like 1 Series and then the Mini moved from zero to today’s just over 30 per cent of BMW sales, operating profit margins have been on the slide, dropping from just under nine per cent in 2000, to about eight per cent in 2005, and on down to one per cent in 2008.
This also coincided with the weakness of the dollar. Warburton points out that BMW profit margins have been under pressure, even as premium car sales zoomed. Its two biggest export markets, the U.S. and Britain remain barely profitable because of exchange rate weakness. The devaluation of the dollar which began in 2003 has cost BMW more than 2.5 billion euros ($3.8 billion) in earnings before interest and tax.
Cynics might also point out that there is also a rough correlation of profit weakness with the tenure of controversial stylist Chris Bangle, famed for the Bangle butt on the 2001 7 Series, and “flame-surfacing”. Bangle left the company early this year.
Sales in the U.S. and Britain have been boosted by the property boom, according to Warburton, who pointed out that in 1986 a BMW top of the range M5 cost 82 per cent of an average British house while by 2007, this had fallen to 36 per cent. Sales of premium cars were boosted by wealth inequality generated by dynamic, entrepreneurial economies – the percentage of total wealth taken by the top income group. The property boom became a bust, and this will lead the German premium brands in general and BMW in particular to change its tactics. The heady days are over.
“In our view, BMW probably saw returns peak earlier this decade and it is very unlikely it will return to previous levels. BMW’s brand and profit model has been built around selling powerful, large-engined vehicles to “Anglosphere” customers at favorable exchange rates. This has allowed BMW to be historically very profitable by auto industry standards despite low scale and high costs.”
“However, tightening CO2 legislation and changing customer taste will drive a decline in average engine power and force BMW to expand its small car offer. We believe structural weakness of the U.S. and U.K currencies will mean BMW’s two largest export markets remain barely profitable. Audi is an ongoing destructive force. Emerging markets may provide some offset, but insufficient to return BMW to peak earnings,” he said.
“BMW is going to have to continue to head downmarket, selling smaller cars with smaller engines and competing more directly with mainstream products and brands,” Warburton said.
Neil Winton – December 5, 2009
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