Light vehicle production on a global basis slipped a bit during 1998 calendar year, declining nearly 2% to 51.6 million units. This decline from 1997 stems from the collapse of the economies of the Asia Pacific region, where automotive output declined by 11%, to 14.5 million units, as well as a knock-on decline in South America, where light vehicle production tumbled by over 17%, to stand at just over the two million unit mark. Production of light vehicles in North America went sideways during 1998, holding at approximately 15.6 million units, thanks partially to an unexpected 54-day strike versus General Motors during the summer months. These regional declines were partially offset by strong 8% growth in automotive production in West Europe, where production topped the 16 million unit mark, and near 5% growth in East Europe, where output totaled 2.8 million units.

While these sorts of market dynamics are tame relative to the go-go worlds of high-tech, internet and telecommunications, the global automotive industry remains in the bleeding edge of transformation. Indeed, the relative and apparent stability of the marketplace disguises the ever-increasing level of competitive intensity in the global automotive sector and the wrenching structural changes that continue to transform the competitive landscape.

The state of the global automotive industry can be summarized by three interrelated themes:

  • globalization,
  • excess capacity, and
  • consolidation.

In its most basic form, the story is as follows: the globalization of the industry has resulted in significant levels of excess capacity, which, when combined with other market factors, is resulting in the ongoing consolidation of the sector's players.

Globalization of the Industry

There is no issue more fundamental to the automotive industry than "globalization." The reasoning is straightforward: economic development and demographic trends virtually guarantee that tomorrow's growth is going to come from outside the maturing, replacement-demand-driven North American and West European markets, market needs are converging (though considerable differences remain!), capabilities and intentions are finding more common ground, technology is easily transferred around the world, product, process and system simplification has gained added significance, and globalization offers efficiencies and economies of scale achievable through no other route.

As a result, the rallying cry in today's automotive sector is "Go Global or Go Home." Issues such as global strategies, global mergers, global platforms, global powertrains, global technologies, global sourcing, global pricing and global integration have become the core drivers, enablers and constraints -- in effect, the backbone -- of the current and next phases of the automotive industry's evolution.

Globalization presents the industry with an almost overwhelming array of new opportunities and challenges and a pace of change never seen before. But as with any prospect of great reward, there is complicitly high risk. With all of these new dimensions come increased complexity and the emergence of some fundamental paradoxes. For example, while there is no denying that it is a global industry, it also is certain that the world is not a single marketplace.

Structural Excess Capacity

Of all the industry risks, none is more serious than excess capacity.

1998's worldwide light vehicle production total of just under 52 million units compares to an established capacity base of nearly 75 million units, resulting in a straight-time global utilization rate of just under 70%. This represents a four million unit increase in global light vehicle capacity from 1997, and a decline in utilization by five percentage points. On a regional basis, North America and West Europe turned in the best performances, running at 81% and 78% capacity utilization, respectively. At the other end of the spectrum, capacity utilization in Asia slipped to below 60%. Plants in South America assembled vehicles at 64% of capacity, a steep drop from 1997's near-85% rate. And despite growth in output in East Europe, utilization there remains stuck in the 50% range.

Looking ahead, global capacity is slated to expand by another eight million units between 1998 and 2005. Meanwhile, production is anticipated to expand by ten million units, which will result in an improvement in the world's capacity utilization rate. However, it will remain stuck at 75%, meaning that the world's capacity overhang will remain above 20 million units, the equivalent of over 80 North American-style vehicle assembly plants. Looking at it another way, the global system already has more than enough capacity today to build our expected 2005 production volume of 62 million units.

Without question, some of the world's excess capacity is cyclical and will modulate with demand patterns across markets. However, the greater concern is that a large portion of the world's excess capacity is in fact structural, built-into the sector's competitive fabric as the industry rushed to implement global strategies.

Simply put, much excess capacity is the unintended industrial by-product of the industry's collective urge to globalize. Though certainly appropriate for some manufactures in some situations, the widespread adoption of the "build-where-you-sell" globalization model and the corresponding rise in foreign market capacity has contributed to structural excess capacity. Too often, import-substitution capacity has been added in developing foreign markets -- the direct result of regional protectionism -- without a proportional decline in traditional home-market capacity. In addition, capacity growth has significantly outpaced production growth, reflecting unprecedented investment based on corporate objectives, not market reality.

Consequently, the current excess capacity problem is largely structural, not cyclical, and is an unintended consequence of industry globalization. Though cyclical downturns exacerbate the situation, it is the non-cyclical component of excess capacity that most seriously destabilizes the marketplace, threatens profitability and in fact calls into question the very survival of some automakers and suppliers. In an underutilized world, automakers face a chronic need for new markets. Worse, in today's increasingly inter-related industry, excess capacity knows no geographic borders, allowing disruptive contagions to spread rapidly.

As a result of this state of extreme competitiveness, the industry is well aware of the consolidation imperative.

The Consolidation Imperative

Auto industry executives have long predicted that market forces such as globalization and excess capacity would force the industry down to a dozen remaining automakers, and they were right. Though some deals remain to be done, the world's automakers have already consolidated to a significant degree.

Consider the following: according to a new AUTOFACTS measure of vehicle manufacturers' size and importance based upon corporate control, brands and strategic relationships, only 14 key automakers now account for 94% of expected light vehicle volume in the 1998-2005 timeframe.

Further, though technically there still are over 200 distinct vehicle assemblers in the world, six automakers (including the recent Renault-Nissan alliance) have achieved "critical mass" -- enough size to separate them from the rest of automakers. These six have the potential to achieve true economies of scale -- and to avoid becoming takeover targets themselves. And while agility, nimbleness and global presence are as important success factors as sheer size, these select manufacturers and brands will continue to dominate the automotive sector.

In addition to industry-specific conditions such as excess capacity, the consolidation imperative (of the top 20 automakers in 1965, 14 have since merged or been taken over) partially is the result of the capital penalty the auto industry faces in a shareholder-driven era, when less capital-intensive high-tech firms offer far greater returns than large industrial firms. For example, GM was #1 in 1998's Fortune 500 ranking by revenue, but #42 in ranking by market value; by market value Microsoft was first, and its US$14.5 billion in revenue was rated as worth six and a half times more than GM's US$161.3 billion in revenue. All automakers are now challenged to justify their existence as a low rate of return industry, which ensures that the effort to increase and leverage size, and hence to consolidate, will continue.

Last year's burst of merger activity is a clear indication that the factors driving consolidation, most specifically globalization, excess capacity, the need for economies of scale and the hunt for improved profits, are stronger than ever. In the final analysis, the globalization of the automotive industry is not a fad, it is real. With few exceptions, the attitude of those driving the development of the industry is that size and reach do indeed matter, and that companies need to get big fast, or they will become small even faster. And though the outlook for the industry is positive, this sector certainly is not the place for those fearful of a little relentless, non-discriminating competition.

Chris Benko, PricewaterhouseCoopers