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European Financial Aid Could Be Long-Term Negative

    If you are wandering around the Detroit Car show later this month, it’s a fair bet that you won’t detect any superficial signs of crisis. General Motors and Chrysler and to a lesser extent Ford might be on the brink of financial Armageddon, but the showbiz glitz and hype will surely still be there. The Europeans will also be putting on a brave face, even as the market meltdown across the pond starts to cause pain.

    When the dust settles after the economic crisis most European automakers will survive, but long-term profitability strategies may have been weakened by government interference, while the luxury sector will have to spend heavily on new technology to meet tough emissions standards and cultural changes.

Like in the U.S., European manufacturers are facing severe problems financing their sales and supply chains, as economies crumble and consumer confidence craters. But the comparisons start to falter when you consider the relative health of the European industry compared with America’s.

Until the credit crunch crisis started, Europeans were in pretty good financial shape. The U.S. Big Three though were already wallowing in much red ink, as their gas-guzzling products fell out of favour with buyers chastened by soaring gas prices. Gas prices have fallen sharply over the last few months, but this came too late to bail out General Motors, Ford and Chrysler.

“The U.S. big three are in far worse shape than much of the industry in Europe, but there will still be a rationalization, and the severe recession will force mergers and cooperation agreements  to reduce costs and to reduce capacity,” said Professor David Bailey, director of the Birmingham Business School.

    Rescuing the undeserving
Governments, particularly in Europe, are likely to get involved trying to save jobs, even if this means rescuing the undeserving and undermining healthy companies. After all, getting votes has always outweighed economic rationality for politicians.

“Governments will try to retain activities within their home countries through support, but even with a relaxation of European State aid rules, there are limits to what government can do when the market is effectively in free fall,” Bailey said.

The European Union imposes strict rules on government subsidies for industry, but these are often ignored when economic or political crises flare up.

Late last year, French President Nicholas Sarkozy let it be known that he would look favorably on requests for financial assistance from Renault and Peugeot-Citroen as their sales disintegrated. But the reported offer came with strings – future production must stay in France. Unfortunately, these French companies planned to move much production to low-cost eastern European or third world sites, to face down competition from new Asian players like South Korea’s Kia and Hyundai and upstarts from China. Short-term fixes won’t look so good when medium to long-term higher costs in France ruin the business plan.

Dr Wolfgang Bernhart, partner at automotive experts Roland Berger Strategy Consultants in Stuttgart, Germany, doesn’t think the E.U. will allow outright protectionism, but agrees that moves to curb outsourcing will hurt future profitability. Second-guessing of corporate strategy by bureaucrats can’t help either, but he concedes that Germany’s Volkswagen, because of the veto power of its minority owner the state of Lower Saxony, has had to negotiate this for some time.

According to Peter Cooke, professor of Automotive Management at the University of Buckingham, government help doesn’t have to result in negatives for the future, although he says governments find it difficult to remain aloof.

“Certainly there is an almost political knee-jerk response to try to keep production at home, but often this is mere assembly work which might necessitate importing workers in any case. The key is to keep the manufacture of sophisticated value added sub-systems in the high cost/high productivity economies and ship those to (eastern Europe/3rd world) for final assembly,” Cooke said.

Cooke said governments should help the most vulnerable part of the industry – the supply chain – with credit guarantees. The big manufacturers should be helped to retain their highly skilled teams until demand returns, and consumer credit should be underwritten or created. Support should be given because industry problems, except in the U.S., have been created by outside forces. Action should not be as deep as day-to-day management though.

    Regulate, but don’t direct
“The historic business model has been damaged by an external force (the banks and the credit crunch) rather than the motor industry business model which had, apart from the USA, started to evolve rapidly. Bureaucrats should look after regulation, not direction,” Cooke said.

Europe’s profits have been boosted by its success in the premium sector, and the likes of BMW, VW’s Audi, Mercedes and Porsche face more problems than just crumbling economies. The E.U. has just enacted a new crackdown on carbon dioxide (CO2) emissions, although the manufacturers managed to engineer a less harsh regime than originally suggested, and a delay from 2012 to 2015 for full implementation.

The economic crisis also presents a new problem, according to Bernstein Research analyst Max Warburton, who says the German premium manufacturers have become successful because of what he calls increasing wealth inequality. The long boom in the West has created a new class of higher earners with enough disposal income to buy fast, sporty, luxurious cars, rather than utilitarian runabouts.

    Thanks to wealth inequality
“We remain concerned that even after the recession, returns for the German premium automakers may struggle to return to previous peaks, due to structural long-lasting changes in wealth distribution and consumer spending patterns,” Warburton said in a report called “With Global and National Wealth Inequality Set To Moderate, Is The Premium Brand Model Broken?”

Professor Ferdinand Dudenhoeffer of the Center for Automotive Research at the University of Duisberg-Essen believes the premium sector has the power to accelerate back to the good times.

“After the crisis ends – let’s say after 2010 in the U.S., Western Europe, in China, India, Russia. Porsche will be the most important player in the worldwide premium market. With Audi, Bentley, Porsche, together with the communalities with VW products, they will have the best cost structures in the premium world of tomorrow,” Dudenhoeffer said.

Porsche now owns just over 50 per cent of VW, which in turn owns Bentley of Britain, Lamborghini of Italy, and Audi.

    Hybrids, plug-ins
Roland Berger’s Bernhart believes the German premium makers will soon be able to slash CO2 emissions with new gasoline-electric hybrids, and plug-ins able to rack up at least 20 miles on battery power alone. This won’t mean the end of high-profit margin performance cars.

Bernhart doesn’t see the end of “wealth inequality”.

“This has only limited effects on the question of whether people buy more premium/high margin cars or cheaper/less expensive cars. Compare France and Germany for example. People in Germany spend much more of their disposable income for cars than French people who spend more for better food than Germans,” Bernhart said.

Another possible curb on luxury sales is political calls to curb CO2 on the grounds that cars cause global warming. This might make it increasingly difficult for high-flying corporate leaders to be seen driving expensive cars that theoretically are contributing to rising seas and environmental destruction.

    Hide the corporate jets
Meanwhile, European governments will no doubt want to be seen to be trying to help the industry with large amounts of money. According to University of Duisberg-Essen’s Dudenhoeffer, this could be useful if carried out intelligently.

“The challenge of bailout programs must be to avoid the big crash, which would hurt everybody. However, uncompetitive companies and excess capacity must not be saved. My fear is that the Sarkozys of this world will do the latter,” Dudenhoeffer said.

The Europeans might not be looking to learn how to improve their strategies from the likes of GM, Ford and Chrysler. But one important item of intelligence will be on their joint radar. They will have learned from last month’s public relations debacle in Washington to park the corporate jets, discretely, out of sight of prying eyes at Detroit’s Metro Airport.

Neil Winton – January 10, 2009

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