Blog: Dave LeggettEmerging markets: how far does 'hollowing out' of the economy go?

Dave Leggett | 24 April 2006

‘Globalisation’ is a word that it is hard to get away from these days. Two things in the news last week caused me to reflect on what it means in the auto industry. One was PSA Peugeot Citroen’s decision to close its Ryton, UK, car plant. The decision needs to be seen against an international backdrop and PSA’s business strategy within that.

Leaving aside the factors specific to the plant that made it relatively uneconomic for the company, it is clear that PSA, like other automakers, is investing where it believes that investment will get the greatest return. A big plant in Slovakia makes sense: low-cost with ease of EU market access. And more capacity in China is a long-term no-brainer (though one that is not exempt from risk), so it is investing there.

PSA is not alone. The move to emerging markets for reasons of low-cost manufacturing for global sourcing and because they have good demand growth prospects is looking like a stampede; suppliers are following the OEMs. Get on the bus or get left behind seems to be the operating mantra for many.

And last week I also took a Brazilian-built Volkswagen Fox out for a drive (the city car is only now coming to the UK, replacing the unloved and expensive Brussels-built Lupo). Using Brazil as a base for global supply on a fundamentally low-margin product makes sense because of overcapacity down there, a cheap currency and genuinely low manufacturing costs.

But does that mean that it is all over for Western Europe and North America as automotive manufacturing locations? Is Western Europe destined to become a kind of Disneyland tourist destination for the Asians who become the manufacturing powerhouse of the world economy?

No, I think not. Two reasons. Firstly, as countries develop economically, wages tend to rise. It’s already happening in central Europe where the costs differential with Western Europe, though still sizeable, is beginning to narrow. Also, the ‘losing’ countries tend to take remedial actions to become more efficient. The cost differential narrows further.

Added to this is what might be termed ‘cultural location inertia’ that makes companies want to be near their customers; it can also manifest in industrial clustering and overlaps with cultural factors and things like available skills: heck, companies like to be near to their customers and they are always reluctant to quit their home market.

For example, if you are an engineer in a car company, being physically close to engineers in key supplier companies is often a benefit. You may regularly meet up with ‘old Harry’ in the Tier One who you have known for years. You may play golf with him; your kids go to the same school; you share common values; it’s a club of sorts. Not always a good thing, perhaps, but it is not to be discounted. That’s not to say there is not a role for global sourcing, especially on commoditised parts, maybe bought through online auction, but on high value engineering projects face-to-face contact may be invaluable. Suppliers want to be near to their customers and dislike massively complex logistics and high transport costs. There are limits to how far companies will go with offshoring.

Of course, emerging markets will remain a focus in the auto industry for some time. Being cute with low-cost manufacture and being where demand is strong can be the difference between surviving and going under. The auto industry is cutthroat and some of today’s players will fall by the wayside. But that doesn’t mean that North America, Europe and Japan will dwindle to nothing.

The big question is where things will eventually settle and how long that will take.


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