Twenty years on from its formation as Malaysia's 'National Car' manufacturer, Proton is facing a crisis of direction. And unless it finds an international partner, it could collapse, says the man who set it up in the first place. That man is former Malaysian Prime Minister Mahathir Mohamad, who told local reporters earlier this month: "At the rate it is going, it's not going to last long."

Mahathir has an axe to grind. He handed over power to a carefully selected successor, Abdullah Ahmad Badawi, in 2003, but has seen the new Malaysian PM forge his own path rather than continue with Mahathir-sponsored projects. A plan to build a bridge between Malaysia and its neighbour Singapore has been scrapped. And Proton has found its favoured position seriously undermined as Badawi has opened up the market to greater competition.

The rise of local rivals, plus the growth in imports, has seen Proton's market share slump from more than 60% a decade ago to below 40% today. The government cut import taxes to 5% from 15% in March 2006, which has hit Proton hard. And in particular, Badawi has appeared to favour upstart Malaysian automaker Naza, lending high-profile public support to Naza's new plant under construction in north-western Malaysia - it's not entirely coincidental that Naza is based in the region of the country from which Badawi hails.

Meanwhile Malaysia's other national automaker Perodua has made strong progress in the domestic market, eating into Proton's market due to an improved model line provided by Daihatsu, its technology partner. Perodua's Myvi hatchback is basically a rebadged Daihatsu Sirion, and has proved a strong seller.

While Perodua has a strong partner - effectively Toyota, Daihatsu's owner - Proton doesn't. Its long-running relationship with Mitsubishi, which has provided it with technology and designs since its inception, crumbled in 2004, when Mitsubishi was going through a crisis of its own in Japan and trying to extract itself from an alliance with DaimlerChrysler.

Proton, meanwhile, had been moving away from Mitsubishi for some years. In the mid-1990s, before the collapse of the Asian "Tiger Economies" in 1997, Proton had outlined a plan to become a self-sufficient car maker, building a range of cars of its own design at a new factory complex, called Proton City.

The opportunistic purchase of Lotus of the UK in 1996 gave it the R&D abilities to develop cars, but the economic situation meant progress was slow. Proton City is only partially built; and only one totally self-developed car, the Gen2 hatchback, has appeared.

The move to self-sufficiency was premature, and for the past year or so, Proton has been hunting for a new partner. Volkswagen, PSA Peugeot Citroen and even China's Chery have entered the equation - but no big deal has been struck.

Volkswagen broke off talks with Proton about an alliance in January 2006 - but is not completely out of the picture. PSA is still talking, and a loose Letter of Intent (LoI) has been signed with a view to investigate collaboration. This will study collaboration potential and will report back before the end of the year.

Proton Holdings group managing director Syed Zainal Abidin Syed Mohamed Tahir said talk of PSA taking an equity stake in Proton was premature: "For the next three months we are just focusing on how Peugeot can help us improve," Syed told Malaysian reporters last month.

But the LoI has not stopped PSA from hiring Naza to assemble 206 and 307 models from CKD kits for sale in Malaysia. And PSA's own woes in Europe, compounded by the looming departure of Chairman Jean-Martin Folz, have pushed the need to strike a bigger deal in Malaysia down the agenda.

The Malaysian government believes the local car producers will not survive without partners, and protectionism is not an option. Deputy premier Najib Razak said in May 2006: "'To continue shielding our domestic market indefinitely is not a viable long-term strategy. The solution is to have a powerful foreign partner that will open the door for Malaysian-made vehicles to larger markets."

For this to happen, the Malaysian Government will probably have to let the prospective partner buy a meaningful - probably controlling - stake in the business. Syed Zainal Abidin said Proton was "prepared to talk" about equity sharing when the time was right.

However the lack of progress in finding a big partner has resulted in Proton managers looking at doing other deals. Proton wants to expand into other parts of Asia - particularly the huge growth areas of India and China.

Najib Razak has revealed that Proton has had talks with said two Chinese companies, Chery Automobile and Jinhua Youngman Automobile Group, with a view to setting up production in China. Similar talks have been held with Mahindra & Mahindra about assembling Protons in India. In return for providing market access, Razak said companies could be allowed to buy a minority stake in Proton.

Former PM Mahathir believes this is the wrong way to go. "The new management wants to work with China and India, thinking that they can enter these markets. I don't think they are going to get very far," he said, according to a Bloomberg report.

Rather than a majority shareholding, the issue was management control, he believes. That's why talks with Volkswagen collapsed, and why Proton won't reopen discussions with the German company. VW sees Proton as potentially an Asian Skoda - but in order to turn Proton round, it would assert its control - just as it did so successfully with the Czech car maker.

Mahathir told Bloomberg he thought VW was still willing to talk, and did not want a controlling stake in the business, but the problem was Proton, whose management "seems to be not keen at all to have anything to do with Volkswagen".

So for the time being, Proton ploughs on. Not all links with Mitsubishi have been lost, and new models using Mitsubishi components and technology, are under development. Proton has outlined plans to introduce six models, including its first MPV, by 2008 in a bid to reverse slumping sales.

But in global terms, Proton remains a little fish. Its position in Europe as a budget Asian brand is much weaker than its Korean rivals, largely through poor distribution and weak residual values. For a time, Proton's UK subsidiary was resorting to buying up used cars and exporting them in a bid to prop up Proton's rock-bottom used car values.

And coming up on the rails are the Chinese - less experienced, but with greater critical mass from a much bigger domestic market. If, as expected, the likes of Chery and Geely get their act together as exporters, Proton may find its meagre export sales squeezed even further.

Proton's position is not all gloom - Malaysia is a strong market, and well-placed within the ASEAN trading region as an automotive powerhouse to rival Thailand. And that makes it attractive to a foreign partner. Mahathir is almost certainly right - but the Malaysian government remains reluctant to remove the protection from its "National Car" makers. But it may find it has no choice.

Mark Bursa

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