The Industry in the face of the Euro's (partial) demise

...Eurxit and beyond...

The Euro as currently configured is not sustainable, from both an economic and from a political perspective. Spain cannot possibly deflate its way back to balance, and 20% overall unemployment and 50% youth unemployment is not politically tolerable. The only way out – forcing German banks to write off their Spanish debt now, matched by stimulus sufficient to turn Germany into a net importer – is not on the policy horizon, though in due course German banks will in fact have to write down debt.

If Spain falls, so will other parts of the Euro zone. Greece of course, and Portugal, and Ireland but not Italy? – I'm not euro-centric and don't know enough to create my own list. I assume France, Spain, Benelux, Austria and Finland will remain. To highlight issues, however, it is sufficient to focus on Spain.

The Euro exit process – I've seen the term "Grexit" used for the likely initial case – is not clear-cut. I would hope that central bankers and pan-European financial institutions are (quietly) working on possible scenarios. If so, in our leak-prone world, they really have been quiet. At the moment, a sensible assumption might be a three years of chaos in those exiting, since there seems to be no planning to support a quick and clean break (cf. the 1997 Asian Financial Crisis). In the interim, those remaining on the Euro would face a corresponding period of deep recession. Then would come two years of recovery that would leave economies below peak, followed by an era of more gradual reconstruction. The total: five lean years, less than what drove Israel to Egypt, but potentially just as devastating to the European heartland.

Not all auto firms are equal. For several – Fiat, Peugeot and Renault – Europe dominates their operations. So far VW appears exceptional, because its German sales base has escaped the current crisis and it is larger outside Europe. Then there are BMW and Mercedes, in the upper segment of the market, about which I know little, and so will hazard no guesses.

Other firms have a footprint in Europe, but are not dominated by what happens there: Fordwerke and Opel are but one part of the global operations of Ford and GM. Europe is peripheral for Toyota, Nissan, Honda and Hyundai. Their parent companies may or may not decide to tough things out – GM will have the hardest time –but unlike Euro-centric firms they have the option of exiting. That would matter if both Ford and Opel/GM leave the market, but otherwise would not remove enough capacity to change the equation.

Then there are automotive suppliers, the larger of which have substantial bases in the Americas and Asia, but still have their core in the Euro zone. My sense from visiting suppliers on a regular basis is that they've done a good job of geographic rebalance, to the benefit of firms headquartered in Europe and the detriment of those headquartered in the US. Asian suppliers are on average relatively weaker in Europe, and so will be less affected. Catastrophic failure of any of the large European suppliers would be catastrophic to the industry, the equivalent of Lehman Brothers in the financial world. Renault would (quietly) cheer the failure of PSA or Opel. All would lose in a meltdown of the supplier base.

Shifting gears from firms to geography, Eurxit (pardon the neologism) would bring a large devaluation to Spain. That is most obvious relative to the Euro; imports from Germany and France [Grance? Framany? – the new Europe will need new jargon] would be much more expensive. However, I would also expect the (new) peso to depreciate relative to currencies in peripheral Europe, since Hungary, the UK, Russia and Turkey already reflect a more sustainable level relative to the Euro.

If it could avoid collapse during the transition, Seat as a local firm (albeit also a VW subsidiary) would benefit from a large shift in relative prices that would improve its strategic position. It could become a true value brand in Europe, with increased exports and (due to the higher cost of imports) would have a near-unassailable position in its home market. Seat might still be Skoda's poorer brother, but its place in the VW family would be more secure. Now the labor cost component of local [Spanish] assembly is modest, and many parts and components are imported, muting the initial benefit. Over the space of a few years, however, local content would rise and with it the peso component of the cost base.

In contrast, firms remaining in the Euro cost base would see their export markets shrink, and the burden of the zone's excess capacity is already heavy. Who has deep pockets? VW, yes, but (potentially) Ford, Opel, Toyota, Nissan, Honda and Hyundai. Chrysler isn't big enough to fully balance Fiat, nor Nissan to balance Renault. Absent government intervention, it is hard to imagine all of these small firms surviving five lean years. In addition, GM's pockets aren't deep; Ford is still rebuilding its balance sheet. Eurxit won't help the US economy and it won't help China, so won't help either firm. So it is conceivable that one of them would exit. It is almost inevitable that the European market would witness multiple bailouts, given a greater political sensitivity to unemployment than in the US. This would be to the detriment of VW, and to any of the branch operations of US and Asian-based firms that remain.

This is my first pass at the implications of Eurxit. Additional differentiation would come from breaking down market shares of individual firms between Eurxit and Euro countries; who is strong in the Mediterranean periphery, and hence more vulnerable? Who has the weakest balance sheet among OEMs and among suppliers? On which side of the divide will Italy lie? Who has a stronger base in the non-euro periphery (Turkey, Hungary, Poland, Russia) and so may be better positioned to pick up pieces of the market via exports?

We can always hope for a miracle European unity, that France and Germany can act as one. So far the fear factor is failing to force fraternity. The initial Eurxit – Grexit? – may change that, but my hunch is that by the time it will be too late.

Finally, this places a fundamental strategic choice in front of firms not irrevocably committed to Europe: do you marshal resources for a long and expensive slog there, or do you prepare to retreat and instead concentrate on the Western Hemisphere and Asia? Even with a reconfigured "euro" divide Europe will remain on average prosperous, and with a population larger than the US will remain potentially profitable. But is every current participant willing to wait until 2018 to realize that potential?

...Mike Smitka...

Is there a GM without Opel?

Can GM sell off assets such as Opel and remain a going concern? I have my doubts.
At one time, while GM assembled cars in most major markets, these operations were largely autonomous. After all, GM expanded outside the US more by acquisition than by organic growth. For example, it entered the UK market through the 1925 acquisition of Vauxhall, which had started producing cars over two decades before, in 1903. Similarly the core of its continental operations is Opel, which began producing cars in 1900 but was not purchased by GM until 1929, while it acquired the Australian firm Holden in 1931. The most recent such acquisition was in 2002, when GM took over the core operations of the Korean-based firm, Daewoo (which turned out its first motor vehicle in 1937, during the Japanese colonial era).
That is no longer the case; GM is now a global firm, rather than a collection of national operations. Beginning in the mid-1990s it began to focus more carefully on developing a set of core platforms to serve as the basis for the vehicles it manufactured around the world. The next step was to lessen duplication, reducing the number of platforms, and then creating engineering centers that concentrated on specific products. Holden in Australia worked on rear-wheel-drive cars (though those programs are currently in abeyance); Opel in Germany worked on compact and mid-sized cars. The US focused on light trucks and larger front-wheel-drive vehicles. Finally, Daewoo focused on subcompacts. And consistent with that, Vauxhall in the UK no longer develops its own product; instead its vehicles are all engineered in Germany.
The geographic lines reflect in part the nature of the markets in which the engineering takes place; Europe, not the US, is the core market for compact cars, while subcompacts are more important Asia, Eastern Europe and the developing world, where Daewoo's strengths lie. In the current global structure each of these design centers then works with the various regional and national operations (such as North America) to develop vehicles specific to those markets. In the US the new Aveo is from Daewoo, which now handles the Gamma II platform, while in 2005 the engineering of GM's Delta platforms (e.g., the Malibu) was centralized in Germany. Paralleling this development of "world" platforms is the globalization of GM's supply chain; companies that wish to sell parts to GM need to be able to work with the relevant engineering centers, and to be able to produce their parts in multiple regions.
So, can GM then sell off Opel, and remain an ongoing operation? GM will be beholden to the new owners for core vehicles, as it will lose all independent ability to engineer small and mid-sized cars. Opel's products are a real strength to GM; they are one core of its surge in China, where sales jumped 50% in April 2009, and are essential in the US as well if (when!) high gasoline prices return. Unless the purchaser of Opel cooperates wholeheartedly with GM — grudging fulfillment of a contractual obligation won't do the trick — then, sooner rather than later, GM will collapse.
Now such cooperation is not impossible. Fiat's revival under Marchionne was dependent on product engineered jointly with GM's Opel subsidiary. They can and have worked together successfully, culture clashes or no. Second, Fiat has no presence in North America, and so can only gain from continuing to develop vehicles for GM in its home market; Fiat is also weak in China, where GM is the market leader. (They do compete head-to-head in Brazil, where Fiat is the market leader.) Should Magna, the other bidder for Opel end up carrying the day, there in fact are no such conflicts, as it has no independent OEM operations.
Losing Opel does not necessarily spell the end of GM as an ongoing business. But any car company that ceases developing new product has in effect declared that sooner rather than later it intends to close its doors. GM truly is a global business, and splitting itself up puts all of the pieces at risk — including Opel — because they are no longer standalone operations. The German government is nervous contemplating Fiat as the new owner of Opel. It should in fact be nervous about anyone other than GM owning Opel — and Obama's car czars should be as well.

Fiat to the Rescue?

Chrysler, heavily dependent on light trucks (jeeps, minivans, pickups), was whipsawed by the spike in gasoline prices in summer 2008. Then came the credit crunch; when its access to lease financing disappeared, it lost 20% of sales overnight. As cash drained, it attempted to work out a deal with its many creditors, and failed. Assuming the firm emerges from Chapter 11 – rather than collapsing into liquidation as dealers and other creditors play "chicken" in hopes of a bigger slice of a rapidly shrinking pie – what will it need to survive?
First, Chrysler has neither the cash – nor after a mass of white-collar buyouts, the people – to develop new cars. It strikes me as unlikely that it will receive an infusion of cash and the stability to rebuild its famous design and engineering capabilities. Fiat doesn't have the money. Nor does it have the people, because it has no expertise in large cars, SUVs and light trucks to supplement whatever remains of Chrysler's historically famous but leanly staffed product development organization. Chrysler thus faces a long 2 years, until new product arrives via Fiat.
It will then face the challenge of selling Fiats. The new product will consist almost entirely of small cars, because as a company firmly rooted in southern Europe and strong in Brazil and other developing markets, that is Fiat's core strength. But neither Chrysler, nor any other company operating in the US, has been able to make a go of that on a consistent basis.
On paper we have policies to encourage a domestic market for small, fuel-efficient vehicles: CAFE, or Corporate Average Fuel Efficiency requirements, in place since 1977. Under CAFE, in order to sell a large car, firms must sell small cars, or they will exceed the average "mpg" standards that legislation imposes. The problem Americans have not bought into that policy: they want power. Given separate, less stringent standards for trucks, the entire market shifted towards light trucks (which for CAFE includes jeeps and minivans, and not just pickups). Small cars remain a small slice of the market, but in 2012 Chrysler's jeeps and minivans and pickups will be dated; small cars will be the only "new" product they will have on offer.
Absent a polar shift in American politics, to enable a stiff gas tax, Chrysler will not survive to 2015.
Now in the longer haul they need to not just survive, they need to gain back at least a modicum of market share. To stay in the auto business will require the cash to continue funding new product develop. That is in itself not an insuperable barrier. But in the background firms also need to be able to fund supporting research and development so that they can bring a range of new technologies to market, particularly electric vehicles (whether they run off of batteries, small "hybrid" engines or fuel cells). At present Chrysler is wholly incapable of doing that by itself. Fiat is probably too small as well. A beefy combination of the two might be another story, particularly as a smaller company has greater leeway to buy technology from independent suppliers. (Larger companies want to withhold core technologies from larger rivals, but Fiat-Chrysler may be viewed as a way to leverage their own investment, rather than as a threat.)
That too appears unlikely. Over the past 15 years vast improvements in engineering tools -- computer design and simulation, specifically -- have enabled car companies to spin off vehicles from their core platforms more quickly and at lower cost than ever before. And the U.S. market is so large that it supports a plethora of firms -- 14 at last count. From how many varieties does a consumer need to choose a minivan? Or mid-size car? Or whatever type of vehicle? Hundreds of models are on offer. There is no reason to assume Chrysler cars will improve so markedly that they will be able to pull away from the field and secure more sales than the company does today. Or that they will make money: given the competition, profits were falling across the industry even as sales boomed. There's no reason to think they'll recover.
And no sales pitch from President Obama will change that.

Thanks to JJ and DR for the back-and-forth behind this.