Road narrows for merger ambitions

If the industry pundits have got it right, small automotive firms both vehicle manufacturers and suppliers should be quaking in their boots. The current wisdom says that in 20 years’ time there will be just six major vehicle manufacturers left and 20 first-tier components suppliers operating worldwide. Widespread consolidation is expected, both voluntary and involuntary. […]

If the industry pundits have got it right, small automotive firms both vehicle manufacturers and suppliers should be quaking in their boots. The current wisdom says that in 20 years’ time there will be just six major vehicle manufacturers left and 20 first-tier components suppliers operating worldwide. Widespread consolidation is expected, both voluntary and involuntary. If you make less than one million vehicles per year, then your days are numbered.

Globalisation, although nothing new to companies such as Toyota, Ford and GM, is becoming an increasingly important driver for component suppliers. The strategy is to grow big enough to supply not just components, but entire systems to vehicle manufacturers worldwide. This will entail expanded logistics, on-site manufacturing, R&D and a spreading of the costs burden from the manufacturer to the supplier.

According to consultants PricewaterhouseCoopers, the suppliers can afford it. In a report published last week, PwC claims that suppliers are among the most profitable players in the vehicle manufacturing, distribution and sales chain. With returns of 15.8% they far exceed those of the car makers themselves (11.6%) and dealerships (10%).

But to make the grade as global systems suppliers, regional players will have to start match-making with partners in other regions of the world. Only by doing this, the report argues, will they be able to afford the investment which lies ahead both in R&D carried out for customers, and in expansion of production.

For car manufacturers, though, over-capacity is the problem. PwC estimates that if this were removed, it could generate up to $70bn of profits across the industry the equivalent of a 2% increase in profits for every company. Within Europe, overcapacity and competition is at its fiercest (see chart). Consolidation, it seems, alongside vast cutbacks in capacity, is inevitable. Ford chief Jac Nasser predicted at the Detroit Motor Show this month that after the dust has settled, just two players will be left in Europe, two in the US and two in Asia.

DaimlerChrysler’s formation last year was the first of the big mergers, creating a firm with a strong upmarket presence in Europe and the US, and an equally powerful mass-market share in the US. It is an ideal marriage, according to industry experts, who point to it as an example of what is to come.

But there is a political dimension to job losses and plant closures that could hamper such moves. Ewald Merz, a former director of BMW, believes the 20-or-so car makers operating today will never be whittled down to a ‘magnificent six’ companies because of national governments’ opposition. Consolidation would be more likely to leave at least a dozen major players.

‘I cannot imagine the French government would allow it. And that would apply to other countries too,’ Merz says.

Merz’s argument is that car makers are too politically sensitive for consolidation on this scale. In countries with powerful trade unions, such as France, the redundancies involved in consolidation would be unpalatable. A line would be drawn in the sand.

Professor Garel Rhys, director of Cardiff Business School’s Centre for Automotive Industry Research, agrees with Merz that consolidation down to six players is unlikely, but for different reasons.

According to Rhys, competition authorities such as the DG IV in Brussels would be the major barriers to such a degree of consolidation. ‘DG IV would never allow one firm to control 40% of the European market,’ he says. ‘I suspect there will be over a dozen car makers, some with a semi-specialist view.’

Smaller volume manufacturers like Volvo look likely to be snapped up first. ‘What we’re seeing in Europe is a mopping up of smaller players and the end of national-based industries,’ Rhys says.

Extending this argument further, he also disagrees with the idea that national governments will be a long-term barrier to car makers’ consolidation. ‘In the world following Maastricht and the euro, national governments will not be willing to bail out firms with taxpayers’ money,’ Rhys says. Taking the French example, he argues that he would not merge Renault and PSA anyway.

‘You’d have to close too many plants. It would be easier for firms to contemplate merger with others outside of France and Europe. Any merger must be a geographical fit and product fit. That’s what made DaimlerChrysler so good.’

Rhys also disagrees with the extent of consolidation mooted for the supplier industry. Cutting the number of suppliers to 20 would make them as big as the vehicle manufacturers ‘and the manufacturers wouldn’t like that’.

Another barrier to true globalisation in the supply side is transport and distribution, Rhys says. But Richard Gene, leader of PwC’s automotive team, says that this could be avoided if suppliers set up production next to the car assembly plant.

But apart from the practicalities of operating a global supplier business there is also the cost of building it. At present, share prices of most engineering stocks are depressed. This could mean that mass merger and acquisition activity is unlikely until a recovery takes place. But apart from that, if consolidation in the supply industry is to be driven by the car makers, a point worth noting is that car makers only want fewer suppliers not just one supplier.

In vehicle manufacturing itself, Merz sees the trend towards vehicle platforms extending. Platforms consist of 40% of the cost of the finished vehicle. Producing many machines off the one platform reduces costs and allows work to be downloaded from VM to supplier. Bigger suppliers will become systems suppliers, which themselves will have suppliers. This, Merz points out, provides opportunities for specialisation. And specialists, he says, achieve greater returns.

But Rhys warns that the platform approach can only be taken so far. ‘You can’t have a common plan for your entire range,’ he says. ‘You could have around three and then mix and match chassis. If you relied on one, the consumer would eventually see through it.’

Platforms, Rhys argues, are not a new idea anyway. ‘From the 1930s to the 1960s, GM did this across its whole range but with sufficient differentiation in bodywork to convince the US public to pay more for each brand.’ In the 1970s-1980s Ford’s Capri and Cortina were built on the same platform. And in the 1990s, VW’s Golf and Beetle, the Audi A3, and Skoda Octavia are all built on the same platform too.

What works for Europe and the US, though, does not always work for Japan. Merz believes that the systems approach of suppliers might not be as necessary here as it is elsewhere. ‘Japanese culture has no problem with people working together. For example, Honda and Nissan have a joint manufacturing operation for making seats.’

But for manufacturers in all industries, pressure is mounting for consolidation. In oil refining, chemicals and other global industries, the collapse of prices and previously fast-growing east Asian markets, as well as rising costs of new product development, have sparked a tide of mergers and piled pressure on supplier firms to cut prices and costs. The automotive industry, in feeling these pressures, is not on its own.

But this latest batch of predictions for the industry has left Rhys with a sense of deja vu. He says: ‘In 1975 [in the wake of the oil price hike] I heard predictions that by 1995 there would only be eight car manufacturers. There are still more than 20.’