Acquire, Merge,
Rationalize — Survive Acquire, Merge, Rationalize — Survive

Auto industry executives have long
predicted that market forces would force the industry down to about a dozen remaining
automakers, and they were right. It’s already happened.

According to a new AUTOFACTS measure of
vehicle manufacturers’ size and importance, only 14 key automakers (See chart) now account
for 94% of expected light vehicle volume in the 1998-2005 timeframe.

This consolidation imperative (of the top
20 automakers in 1965, 14 have since merged or been taken over) 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 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 are stronger than ever.

cause of the industry’s low profitability and resulting consolidation pressure is excess
capacity. There is a huge, 20 million-plus unit gap between the global industry’s
productive capability and the global market’s ability to absorb that production. That
excess remains the key automotive planning issue, because it destabilizes markets, forcing
incentivization, protectionism, and lower returns.

The only
way automakers will be able to successfully overcome their market difficulties is to
achieve a degree of scale that allows them to remain profitable, which means

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consolidation cannot simply add capacity; in an already glutted market, that would be
self-defeating. True savings from consolidation no longer come from the traditional
industrial age assumption of increased production scale and reduced unit costs. In an era
when 200,000 units may be the ideal size for a plant, and products proliferate to serve a
market split into dozens of niches, production scale it-self is not enough.
“Nimbleness” matters as much or more. The true economies of scale, and the
consequent savings, come in managing the costs of distributing and marketing vehicles, and
in platform development — maximizing R&D and parts volume, and spreading development
costs across more units of a flexible global platform. They also involve purchasing
savings. In an industry in which suppliers are increasingly designers and manufacturers,
and VMs assemblers and marketers, it is vital to spread the enormous environmental and
safety costs. Only consolidation — carefully planned consolidation — offers the
potential for that kind of 5-10% cost reduction.

there are still some 250 firms engaged in the final assembly of light vehicles. But very
few have global significance. To give a true picture of the industry, our research went
beyond what a corporation directly makes or owns and instead tracked corporate control,
corporate-controlled brands, and corporate relationships, gathering in all the vehicles
truly associated with the
manufacturer either through sales or production relationships. Cutting through the tangled
webs of international business relationships, this method sums how many vehicles — by
brand — can actually be attributed to each of the 14 key vehicle manufacturers. This
method not only highlights the major VMs but gives a true picture of each automaker’s full
strategic spread and global footprint.

First, we counted production by automakers
in which a VM has a “controlling interest”. So Mazda is included in Ford and
Isuzu in GM, since by Japanese law, a 33.4% share gives an automaker an effective
“controlling interest”.

Second, we tracked production by brand,
allowing licensed, cooperative, and JV production (very common in emerging markets) to be
included in a VM’s total. So all GM brand volume is counted, from Buicks made in its
Chinese joint venture to Opels built under license by GM Egypt.

THE GLOBAL SIX. Six automakers (including
the recent Renault-Nissan alliance) have achieved “critical mass” — enough size
to separate them from the rest of automakers, to potentially achieve true economies of
scale — and to avoid becoming takeover targets themselves.

Size is important. But so is global
presence. The automotive world is essentially split into six markets, three of which are
high-volume, mature or maturing markets — North
West Europe, and Japan/Australia; and three developing or long-term growth markets –East
Europe, South America and developing Asia.

VMs don’t want to be in the emerging
markets in the near-term –too many economic crises, lack of scale in many markets,
regional protectionism, and volatility — but they absolutely need to be there in the
long-term, because those difficult markets will be the wellspring of future growth for
this industry — and a VM can’t be there then if it isn’t there now. It must be there now
to establish factories and supply and distribution networks — and brand equity — for
when the markets recover.

At the same time automakers are penetrating
emerging markets, however, they need to have strength in multiple regions to protect
against the legendary cyclicality of the auto industry — and the stock market penalties
this brings. Global automotive markets rarely move in lockstep: cycles may overlap, but
they rarely coincide. The best proof of the need for this strategy is that Honda and
Toyota, thanks to their multi-regional strength, are flourishing despite home-market

Two different kinds of markets — mature
and developing — call for two different strategies for establishing “global

I: GLOBAL BALANCE. With a global balance plan, a VM tries to match the percentage of its
production base dedicated to each of the six markets with the share of global production
that market commands.

The Renault-Nissan alliance illustrates
this strategy. The combined firm’s global production distribution — 1% of production in
Africa/Middle East, 6% in East Europe, 37% in Asia-Pacific, 3% in South America, 41% in
West Europe, 12% in North America closely matches the industry pattern of 1% of production
in Africa/Middle East, 7% in East Europe, 31% in Asia-Pacific, 5% in South America, 28% in
West Europe, and 28% in North America. This strategy allows a global VM to be in position
to take advantage of potential growth markets, yet spread wide enough to have
counter-cyclical insulation, so that when one (such as Asia at the moment) is facing a
cyclical downturn, the other markets keep the VM in the black.

DaimlerChrysler is also aiming for a
strategy of this sort: one of the key reasons both firms cited for the merger was their
respective over-reliance on the West European and North American markets, which left them
vulnerable to a cyclical downturn. This strategy is also behind DC’s drive to drastically
increase its presence in Asia, which it hopes will supply 10% of the firm’s revenue by

REACH. The essence of this strategy is to maintain at least significant, defensible
share in the home market to provide the cash flow and critical mass to underwrite riskier
globalization efforts. This is the traditional policy followed by GM and Ford, for
example, who leverage the revenue from their North American base to allow them to spread
globally, but still seek high volumes in at least one other global market (West Europe) to
give them a global presence and a strong measure of counter-cyclicality.

Toyota has been very successful with this
strategy: it has twice the manufacturing footprint in Japan/Australia as its next largest
competitor, and owns nearly 40% of its home sales market, and so has the volume, revenue,
safety, and product to underwrite R&D expenses and ventures into other markets.

VW is seeking to duplicate this pattern.
Long the leader in the highly fragmented West European market, VW has sought in recent
years to build a much higher level of market share to match the critical mass that GM,
Ford, and Toyota enjoy in their home market. Its tactics are acquisition (Seat, Skoda,
Bentley, Lamborghini, Bugatti) and product line extension to build up volume and profit

VW has taken the dominant home
market/global reach strategy to a new level, by seeking to have a dominant position in a
few key large markets. VW describes its current strategic targets as becoming #1 in
Europe, #1 in South America, #1 in China, and achieving a significant presence in the
large markets of India and North America, leaving the smaller markets for niche
manufacturers, or to be scooped up later.

Which is
the more promising strategy? It depends — on a VM’s performance and the next few swings
of the global market. The global balance strategy looks good on paper, but fails the
“GE Test”, which mandates that it is only worthwhile to stay in a market where
one is #1 or #2. Below that, the GE strategy advises getting out. Renault-Nissan, for
example, reflects the global production pattern, but is only #1 or #2 in a single one of
the six key markets — Japan/Australia.

It would seem, then, that the VMs pursuing
a “home market dominance, global reach” strategy may be better prepared to
weather the changes in the difficult global automotive market — but only if those home
market foundations are leveraged to create an ultimate “global dominance” to
pass the GE Test in multiple markets.

BREATHING ROOM. Whichever strategy
prevails, consolidation will continue. At the moment several factors allow VMs to put off
M&A decisions. One is the strength of the North American and West European markets,
which is masking the vulnerabilities of several automakers. Another is merger indigestion
among the Global Six, which has stalled acquisition activity. DC is distracted by merger
issues (the reason for its avoiding a Nissan stake); Ford is reorganizing again with its
new luxury division; GM is still struggling to make size an advantage with global
platforms and commonization; and VW is trying to leverage/differentiate its multitude of

CANDIDATES EIGHT. When consolidation resumes, which of the remaining eight automakers will
be the most attractive acquisition candidates? As CEOs Eaton and Shrempp noted in
announcing the DaimlerChrysler merger, there are only a limited number of good partners
left to choose from:

BMW is still the pick of the litter, with
tremendous appeal because of its profitability, and recognition of its eponymous brand.
Its own recent acquisition, Rover, has been a cash drain, which ironically makes courting
BMW a possibility for suitors.

Honda is valued for its production
capability and excellence, profitability, nimbleness and product innovation, and is highly
desired by some of the Global Six. But Honda has declared it has no interest in merging or
complicating its unique corporate culture. Nevertheless, Honda remains vulnerable because
it has not reached critical mass, and is over-dependent on the North American market.

Three of the Eight — Mitsubishi, Daewoo,
and Hyundai — are currently on the market, and offer the acquirer instant Asian market
presence. But they also face crippling debt loads and overcapacity. Although the Korean
automakers have been shopping for foreign capital for awhile, their terrifying balance
sheets, debt obligations, low utilization and nationalistic baggage have discouraged

Mitsubishi offers a wide-ranging and
solidly established presence in many key long-term growth markets; if a way can be found
around its debt, it is one of the most appealing automakers.

Most of the Eight say they are not
interested in a merger where they would lose control, but they may yield. For example,
Fiat and PSA are perceived as increasingly vulnerable. Neither has the scale or global
reach to compete against the Six, and both are taking drastic steps to survive. Fiat is
moving to low-investment-cost spaceframe platforms, while Peugeot is reducing its
platforms and drastically cutting costs. Either could be vulnerable in the next European

Suzuki is very attractive because of its
nearly unique ability to make money with small cars, and because of its JV with the Indian
government (Maruti), which grabs a dominant share of that key market. However, while GM
has no management control, its 10% stake essentially renders Suzuki taken.

WHEN? WHO? Consolidation will happen. The
next major recession in North America or West Europe could force a decision on automakers,
many of whom have neither the size, global spread, or cash to survive a serious downturn
in auto sales. The question is no longer if, but when? and who?

Paul T. McCarthy, Greg S. Bonner