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Subsidised Europe Faces Traumatic 2010 Fighting Reality

Car Scrapping

Scrapping Schemes Simply Brought Sales Forward, Delaying Pain
Except If You Are Germany’s Angela Merkel, Of Course

Sometimes you have to be cruel to be kind. That’s a truism that politicians don’t find easy to live with because allowing a failing enterprise to die can look insensitive, despite the fact that attempts at resuscitation are often futile, cripplingly expensive, and take scarce resources away from projects that offer real payback.

European politicians, faced with economic meltdown and impending elections, have done almost anything to avoid allowing automotive factories to shut. This year in Europe, and led by Germany, governments spent huge amounts of money to fund so-called scrapping schemes – cash for clunkers – to subsidise and prop up mass car makers faced with haemorrhaging sales as the worst recession for 60 years bit huge chunks out of gross national product.

Germany spent about five billion euros ($7.4 billion) this year with its offer to give 2,500 euros ($3,700) to those junking cars that were over nine years old if they bought a nice new one. Not surprisingly, this resulted in a huge boost to sales, of mainly cheap, small cars often made in Korea, and stolen from next year. (In the middle of this bonanza, Chancellor Angela Merkel was comfortably re-elected.) It doesn’t take any special powers of clairvoyance to predict that next year this policy will end in tears, as sales in Germany, Europe’s biggest market for cars, dive by up to 30 per cent or perhaps one million. This will hit Germany’s Volkswagen hardest, courtesy of its towering market share lead in Western Europe of over 20 per cent.

Stable in 2009
Deutsche Bank thinks Western Europe’s sales will be more or less stable this year at 13.4 million, thanks to subsidies, but dive 12 per cent in 2010. IHS Global Insight projects that sales in 28 European markets will drop four per cent in 2009 to 14.2 million, and the downward momentum will accelerate to nine per cent in 2010 with sales falling to 12.9 million. U.S. agency Fitch Ratings forecasts Western European sales will fall by six to eight per cent in 2010, after slipping five per cent in 2009. Americans can afford a smug smile, as sales in the U.S. rally a bit in 2010 after the recent precipitous drop.

While sales slid in Europe, and not content with funding clunker swaps, France also pushed six billion euros ($8.8 billion) of tax payer’s money in the form of cheap loans at its national champions Renault and Peugeot-Citroen as they chalked up massive losses. Peugeot-Citroen had said that its future health could only be assured if production was progressively moved to low cost economies in eastern Europe. That had to stop if French government help was to continue. So the company’s short-term lifeboat jeopardises its long-term future.

GM Europe’s Opel-Vauxhall is seeking help from Germany, Britain, Spain and Poland as it nails down its $4.85 billion restructuring plan that will slice more than 8,000 jobs from its 50,000 workforce. But the severity of that plan has been watered down; three plants across Europe were originally lined-up for the axe. None now are likely to be shuttered.

Long term failure
As Europe emerges from the recession, in a sensible world you would expect some positive payback from the pain. Most experts agree that Europe’s automotive industry has between 25 and 30 per cent of over-capacity, that costs are too high and if burgeoning competition from Korea, China and India is to be faced down, efficiencies and rationalizations are unavoidable. The alternative is long-term failure for the European mass car manufacturers.

According to Sergio Marchionne, CEO of Fiat-Chrysler, nothing has happened, and it’s all the fault of governments too eager to placate voters.

“In Europe, structural overcapacity has not been addressed, and nationalistic interests continue to prevail over the overall health of the industry,” Marchionne said.

“The need for rationalization is now undeniable,” Marchionne said in a speech in Washington this week.

Marchionne praised the Obama administration’s automotive actions, which had forced restructuring in the U.S. This slashing of capacity raises the prospects for decent returns on investment in the U.S., which is currently denied to those operating in Europe. Marchionne said his operating profit margin target of seven to 7.7 per cent of revenues in 2014 for Chrysler in the U.S. compares with a target of 4.5 to 5.3 per cent for Fiat Auto next year.

“Is that (seven to 7.7 per cent) possible in the European marketplace given what exists as an industrial landscape? The answer is no,” Marchionne said in an interview with Automotive News.

End to subsidy
But Europe’s economic problems may force an end to this subsidy mindset, according to Karel Williams, Professor of Accounting and Political Economy, at the University of Manchester.

“The car industry has established the idea that it is a special case which requires subsidy instead of restructuring; when things go wrong you ask the government for help. My feeling is that this is going to get much more difficult because public spending cuts in most western European countries mean that as the money runs out car companies will have to compete head-on with schools and hospitals. It’s one thing to say you support car companies, but when they compete with schools and hospitals it’s much more difficult to justify keeping car factories open,” Williams said.

Williams is amazed at the lack of action in the face of what he called the worst downturn in high income markets since World War II.

“This has not led to substantial restructuring. It is utterly bizarre that GM is persevering with GM Europe and not a factory will close, not even the Belgian (Antwerp) factory. Saab remains in intensive care with tubes connected to its body but nobody prepared to switch the life support machine off,” Williams said.

Premium makers ok
Professor Ferdinand Dudenhoeffer of the Center for Automotive Research at Germany’s University of reckons that there is over-capacity in Europe of about 3.5 million cars a year; that’s more than 25 per cent of total sales.  But Dudenhoeffer doesn’t expect much in the way of restructuring soon, even though the important German market faces a “serious downturn” that won’t impact on premium makers like BMW and Mercedes which didn’t profit from the cash for clunkers scheme.

There will eventually be serious consequences from this lack of action on profits, according to Dudenhoeffer, as car manufacturers are forced to slash prices to move output and keep production lines running at economic rates.

“So what happens is obvious. We will see fierce price competition. Every month we publish discounts that are offered by dealers and the average is now about 18 per cent. On average car buyers receive about 4,000 euros ($5,900). It’s unbelievable, but true. U.S. discounts are now lower than German discounts. And this will go on into 2010, when we expect an average discount of more than 20 per cent; that’s more than 4,400 euros ($6,500) per car,” Dudenhoeffer said.

Dudenhoeffer also blames the politicians, but says the day of reckoning can’t be put off forever.

Long run pain
“The rules of the free market still exist. Heavy discounting will lead to more losses, and we will see dealers running into bankruptcy and carmakers gradually reducing capacity. GM-Opel will get some money from governments. We can’t stop our politicians from doing that. The European car market will be hurt in the long run, thanks to the politicians,” Dudenhoeffer said.

Manchester University’s Williams agrees that Europe faces tough times, probably triggered by heavy losses which will block access to credit markets, the life-blood of the recent boom times.

“I think we are going to see a very nasty judder in the market,” said Williams.

The automotive business faces a similar future to the airline industry.

“Airlines are also serial loss makers, another industry that doesn’t restructure in the face of losses,” Williams said.

Dudenhoeffer does have some cheering news though, saying that although there might be problems in Europe, there are growth areas still.

“We need capacity in Asia and Russia/Eastern Europe so the car industry will remain a growth industry. The winner of the game will be the carmakers which rapidly shift capacity from old Europe to the merging markets,” Dudenhoeffer said.

Given that every automotive CEO will be saying just that, the long-term winners are not yet obvious, although thanks to the terms of its government bail-out, France’s Peugeot-Citroen is starting the New Year with a big handicap. That cheap government loan had unintended consequences.


Neil Winton – December 20, 2009 

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