Seismic Shift in Store for Europe's Car Industry

An article in the Economist entitled Small Isn’t Beautiful examines the current state of the car industry particularly in Europe but with reference to North America and Asia as well. The article examines the over-capacity in the European car industry but what is really interesting is the analysis of longer term structural changes that the writer believes have been accelerated by the events of the last 12 months.

Light vehicle excess capacity is estimated by PriceWaterhouseCoopers to be somewhere in the region of 5 million units in Europe and nearly 4 million in the US, figures which could rise to 7 million in Europe by 2010 and over 4 million in the US where plants have been closed quicker due to GM’s descent into Chapter 11. In Europe’s fragmented car industry, every country protects its plants and producers, much like the way GM plays one government off against another to get state aid. Consequently, no car plants have been closed because of the credit crisis. In both markets, scrap schemes have temporarily boosted demand but mostly from private buyers of small fuel efficient cars. Company car buyers have stayed out of the market and the lease business has dropped dramatically due to a combination of low residual values and lack of finance. BMW for example has cut back its lease contracts by a third this year.

Europe is also facing a demographic shift. Credit Suisse is quoted as saying that by 2020 some 40% of new car buyers in developed markets will be over 60 compared to less than 30% today. Older buyers tend to favor smaller cars as they don’t need as much carrying capacity and the over 65’s drive 45% fewer miles than the average. So their cars last longer.

The third change is a gradual increase in legislation around emission standards which will force the average car to be lighter in order to achieve improved mileage and lower CO2 emissions.

For the steel and related metals industries that supply to automotive the drop in volumes has been as bad as the decrease in car size. For the automotive manufacturers the profit is in the large vehicles. The article illustrates the point by explaining that the fixed costs of producing a sub compact Fiat 500 are about the same as a SUV 7 seat Audi Q7. The variable costs (labor, materials etc) are maybe $15,000 more for the Q7, but the Fiat sells for $15,000 and the Audi sells for $60,000. The same is true of metal content. A Fiat 500 has a curb weight of about 2,400 lbs, the Q7 over 5,100 lbs. Much of that difference is metallic in nature, steel, aluminum, even copper etc. If the car industry is making fewer cars and those cars are on average smaller and lighter, longer term both car manufacturers profits and metal demand will suffer.

This will also pose a challenge for manufacturers trying to return to profitability. The manufacturers approaches vary. GM is quoted as saying the answer is not to load cheaper cars with unnecessary technology. Ford on the other hand believes you should load small cars up to as high a spec as possible to make them feel more luxurious. Which approach is right remains to be seen but for the time being, Ford is finding half the sales of its smallest car, the Fiesta, are in the top of the range, and it is proving both profitable and popular. But how will luxury brands like BMW and Mercedes cope? There will be a limit to how far you can downsize your range before you cease to be perceived as a luxury brand. If the car industry really does go through the changes outlined in the article the ramifications will be felt far beyond the car makers themselves. Steel and aluminum suppliers in Europe will also have to downsize or find new markets for the capacity that has been installed in the belief that big was beautiful.

–Stuart Burns

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