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Friday, December 9, 2011

From whence will they come? -- profits, that is.

In North America the pricing umbrella created by the need of the Detroit Three to fund retiree health care is unwinding, while the Europeans are fleeing the Euro to add capacity here; the Japanese began diversifying out of their yen cost base 15 years ago. In the short run, that may improve profits for the Detroit Three and the Germans at the expense of the Japanese, but will ultimatlely enhance rivalry and lower profits for the industry as a whole. Europe remains in the doldrums, and the excess capacity in China will become more apparent as sales slow to a merely torrid pace. Ditto India. Brazil? South Africa? Sure, there will be markets that grow, but will they grow faster than new capacity is added? I can't think of an exception.
That pressure is obscured by shifts among market segments, particularly in the move away from small cars in the US and China that boosted profits for some firms. It is also obscured by exit, the role of which is inadequately recognized. In Europe VW snapped up SEAT, Skoda and others while Ford and GM consolidated formerly autonomous UK and German operations. In Japan Toyota absorbed Hino, Isuzu, and Daihatsu and now has a large though not yet controlling stake in Fuji Heavy Industries, Subaru's parent. Meanwhile foreign partners have unloaded their stakes in Mazda and Mitsubishi, which face a shrinking domestic market and a yen whose value makes exports unprofitable. No one is likely to value them solely for their engineering capabilities; their demise is only a matter of time. The US looks different partly because of large capacity adjustments by the Detroit Three, but we've also seen the demise of AMC, Suzuki, Isuzu, and Mazda while Mitsubishi's plant continues to run at unsustainably low capacity. If we include the elimination of brands such as Saturn and the cessation of exports by various firms, exit is significant. Inside Korea, Hyundai gobbled up Kia while GM purchased Daewoo and Renault picked up Ssangyong. The survival of brand names makes it hard to know what operations remain. Ditto Australia, where the Ford and GM affiliates were at one time stand-alone companies.
You might say "but China." Few outsiders are aware that there were 120 firms in that market, which was dominated by a host of minuscule operations owned by the governments of provinces and large cities. They had captive markets -- the models made in Shanghai couldn't be found on the streets of Beijing, and vice-versa. Of course some of these firms and subsequent private entrants (Geely, Chery and BYD) continue in business. But the market is dominated by those Chinese firms that poured their efforts into joint ventures; they've created jobs and been able to keep a slice (as a first approximation, half) of the profits, and some of them have quietly gobbled up failing regional firms. That's important because, while the central government in Beijing has been able to eliminate the domestic trade barriers in industry after industry that impeded the creation of a national economy, the legacy of local fiefdoms remains visible in the vehicle market. VW and GM, strongest in Shanghai, have done very well. Who will "own" Sichuan Province, with a population of over 100 million? It won't be a local firm, because their exit continues.
So as I look across the world (OK, on a good day I can only see 40 miles from my mountain ridge home), well, what strikes me is the likelihood that in the aggregate profits will continue to erode. Consumer preference for choice offsets that, allowing an amazing diversity of product to survive in the marketplace. From time to time individual firms will themselves with the right vehicle in the right place, and do quite well. But that will be offset by poor profits elsewhere. In the background, there's the pressure to invest in new technologies. No one can risk not pouring resources into R&D, as regulatory pressure for safer products, lower emissions and higher fuel efficiency keeps raising the technology bar. But with expensive new and less expensive old technologies continuing side-by-side in the marketplace (and typically the dealership), it won't be possible to raise prices sufficiently to generate generate commensurate profits.
With lower industry profits, the losses for those firms that fail to hit a sweet spot will be worse. It will thus be much harder for firms that find themselves on left tail of the distribution of profits to survive. Chances are Saab won't be the last manufacturer to fold in the 21st century's second decade.
Followup: For a story focusing on this issue from that standpoint of one product, see"Toyota Threatened..." by Alan Ohnsman at Bloomberg.
Mike Smitka

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