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