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Ripe for retail revolution

Automotive markets across the world may look different, but competition is always tough. With purchasing and production already lean, retailing is in for a change.The performance of the auto industry will very much mirror the economic performance of the different regions of the world. In the United States, economic growth is projected to slow. Nonetheless, most economists project the industry will see the fifth straight year of car and truck sales exceeding 15 million units. In Europe, economic growth is expected to pick up steam and certain markets, especially in eastern Europe, will witness double-digit growth. The Japanese auto market, still reeling from the lingering recession, consumer uncertainty and last year’s consumption tax increase, will continue in the doldrums. The Southeast Asian markets, which showed strong sales growth throughout the decade, have virtually collapsed and show no signs of improving this year. The debacle in Southeast Asia has crippled the Brazilian market, and it in turn is negatively impacting the economies of South America.

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Summary

Everybody’s talking
More than 30 years ago, when Fiat of Italy and Citroën of France discussed a merger, Fiat’s CEO Giovanni Agnelli predicted that the world’s car producers soon would be reduced to six or seven players.
      The Fiat-Citroën merger was vetoed by President Charles de Gaulle – and we still have more than the predicted seven car producers. But Agnelli was partially on target in his forecast. Since then acquisitions and alliances have been the critical issue for every automotive company around the world. Today, while the companies may be separate, the platforms on which they build their cars are often transcorporate. Development costs are shared; more model variations are built on every platform; and purchasing costs are reduced through volume purchasing of components.
      Earlier this year a merger was announced between Daimler-Benz of Germany and Chrysler of the United States. Despite the differences in company cultures, this is a logical merger. It would be even more logical if they took in a Japanese partner as well. None of them is particularly strong on the Asian markets. Now, whatever rumours are denied, industry executives are clearly talking to each other.
      So more megamergers may well be on the horizon for the automotive industry.
by Jan Hökerberg business editor

Automotive markets across the world may look different, but competition is always tough. With purchasing and production already lean, retailing is in for a change.The performance of the auto industry will very much mirror the economic performance of the different regions of the world. In the United States, economic growth is projected to slow. Nonetheless, most economists project the industry will see the fifth straight year of car and truck sales exceeding 15 million units. In Europe, economic growth is expected to pick up steam and certain markets, especially in eastern Europe, will witness double-digit growth. The Japanese auto market, still reeling from the lingering recession, consumer uncertainty and last year’s consumption tax increase, will continue in the doldrums. The Southeast Asian markets, which showed strong sales growth throughout the decade, have virtually collapsed and show no signs of improving this year. The debacle in Southeast Asia has crippled the Brazilian market, and it in turn is negatively impacting the economies of South America.

Global economic outlook
While western Europe’s economy is projected to grow 3 to 5 percent overall, certain regions will underperform others. Britain, for example, will likely see sales slow as interest rates rise, the result of a deliberate move to slow growth and avoid inflationary pressures. The Italian market is expected to fall as much as 17 percent as the government abandons a car scrappage programme that helped propel Fiat to all-time sales records in 1997. German automakers are expected to boost sales, largely thanks to strong exports. The outlook for eastern Europe looks very promising. Poland is absolutely booming and could see double-digit sales increases. Economists project Russia will also enjoy a strong year, as long as the crisis in Asia doesn’t hurt it.
      In Southeast Asia, the collapse of the currency markets brought car production to a screeching halt. While moves by the International Monetary Fund (IMF) may shore up confidence in these economies, no one expects vehicle sales or production to improve during the year. The strength of the dollar and European currencies is luring Western automakers and suppliers to shop for bargains. Suppliers are finding easier entry into markets from which they had been shut out. Even so, as the Pacific Rim countries see their economies slow or even contract it will create even more overcapacity in the region.
      In Japan the seven-year recession shows no sign of easing. About 40 percent of Japan’s exports go to Southeast Asia, which will hurt its economy’s ability to recover. Car sales will likely fall this year, and the stock prices of Japanese automakers, which enjoyed strong increases in 1997, are no longer benefiting from the weaker yen. Japanese automakers will increasingly look to North America and Europe for sales and profits.
      In Latin America, the repercussions of Southeast Asia’s currency problems will continue to reverberate in the Brazilian economy. A steep hike in interest rates, combined with a new tax on automobiles, designed to shore up the Brazilian real, brought growth to an end in what had been one of the strongest markets in the world. Virtually all automakers there have cut back production and are operating on short work weeks. As Brazil is the largest economy in South America, the slowdown there is adversely affecting the rest of the region’s economies.

U.S. economic outlook
In the United States, sales are expected to fall somewhat. The Asian crisis is projected to bring growth in the gross domestic product down to 2.5 percent, compared to the strong 3.2 percent rate reached in 1997. Many economists believe this is a good thing. A slower growth rate, they say, is likely to persuade the Federal Reserve to forgo raising interest rates, and that in turn will help the long-term growth in the economy. According to W. Van Bussmann, Chrysler’s chief economist, this and three other issues suggest the U.S. automotive market will run at the 15 million-unit rate for at least another two years because purchasers from the last cycle still have to buy in this cycle.
      First of all, the number of U.S. households is increasing. Household formation is growing at a rate of 1 percent to 1.5 percent per year. In the next 10 years the number of households will grow 14 percent. This translates into an increase of 12 million households, and they will need to buy new cars.
      Second, the number of vehicles per household, which grew briskly throughout the 1950s and the 1960s, is growing much more slowly. Even so, the number of vehicles per household could grow 9 percent in the next 10 years.
      Third, vehicle durability has improved so significantly that cars do not have to be replaced as frequently as in the past. In 1971, for example, it took seven years to scrap 85 percent of that year’s vehicle production. By 1976 that had increased to eight years and by 1990 it rose to nine years.
      As a result, the percentage of cars being scrapped each year is falling. However, because the total car fleet is growing, the total number of vehicles being scrapped is growing. Presently, the car fleet in the U.S. stands at about 225 million vehicles.
      Martin Zimmerman, Ford’s chief economist, says the economic fundamentals in the U.S. are very good. Even though the University of Michigan’s measure of consumer confidence fell recently, it is still at historically high levels. Consumers feel good because of low unemployment and an increase in income growth. This is remarkable, he says, because inflation is not rising. Low inflation rates lead to low interest rates and that makes it easier for consumers to buy new cars. While the drop in inflation has led to talk of deflation in the press, General Motors’ chief economist Mustafa Mohatarem says any effect will be negligible. Besides, he adds, if deflation becomes a problem the Fed can always lower interest rates. Both Zimmerman and Mohatarem expect 1998 light, medium and heavy vehicle sales in the U.S. to top 15 million units.
      However, there are some disturbing statistics that could spell trouble for the U.S. car market in the long run. Americans are starting to spend less of their disposable income on new vehicles. In 1997 the percentage of the gross domestic product devoted to the purchase of a new vehicle declined to 3.8 percent from the traditional average of 4.2 percent. Economists could almost always count on new cars sales going up as long as the GDP grew. But if less of the GDP is being spent on new cars, a healthy economy may no longer automatically translate into a predictable sales rate.

The retail revolution
Happily for the industry, truck buyers, including minivan and sport utility buyers, pay a greater percentage of their income on their vehicles than do passenger car customers. And the truck segment is a growing part of the market. While the Big Three – Chrysler, Ford and General Motors – are criticised for losing passenger car market share to the Japanese, they make US$4,000 to $6,000 profit per truck, while the Japanese earn $2,000to $3,000 profit per car. If the competition gets tougher, the Big Three can always cut truck prices to maintain their share and still make more money.
      Economists are also very bullish on Canada and Mexico, ensuring the North American market will do well. Mexico will have the highest economic growth rate in the world at 20 percent. Its economy will return to pre-1994 levels, and sales should hit 600,000 units. The Canadian market is projected to grow 10 percent in 1998.
      Automakers are focusing intently on the retail end of the business because it offers so much opportunity for cost reduction. While they have attacked their engineering, manufacturing and purchasing costs, the retail end of the business has barely been scratched. And yet, the post-assembly cost of a car comes to about 26 to 30 percent of the total cost. Post-assembly costs are in marketing, distribution and retailing, including handling and freight, field staff, retailers’ facilities and parts and service.
      The current system favors original equipment manufacturers (OEM) by using dealers as a buffer for excess inventory in the field. But that’s changing. The fact that there are too many dealers has virtually eliminated the profitability of retailing. So the system is ripe for consolidation.
      The OEMs are also trying to get more bang for their buck in incentives. According to Suzanne Kinsler of Autofacts, they’re now engaging in “micro bursts,” what she calls special incentives in specific geographic regions on specific models for short periods of time.
      The Internet is opening up new retailing opportunities. We may see retailers segmented by tiers, with the hottest products going to the best dealers in the best regions. This will precipitate a shift in power from the OEMs to the retailers. And once that power shifts to them, it may open the door for some suppliers to bypass the OEMs and deal directly with the retailers.

John McElroy  
(extract from his article) editorial director for Automotive Industries

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