‘Blind Curves Ahead’ For Auto Industry, As Europe Remains Spotty, America May Be Peaking, China Cools, Japan Gears Up And Regulations Loom, According To AlixPartners Study
The global automotive industry, having survived a very bumpy road in recent years, now finds itself facing at-best uncertain times ahead, including a recovery in Europe that has been slow, uneven and marked by continued overcapacities; a post-restructuring American market that, while still strong, could be nearing its peak, with a conservative-side AlixPartners forecast of 16.7 million units to be sold next year; a growth rate in China that’s forecast to fall to 6.3% over the next five years, from 17.6% in the previous decade; a situation where Japanese automakers, buoyed by a weak yen, appear to be gearing up for a global product onslaught; and, overarching all, a push from regulators and consumers to almost totally reinvent the automobile in the next few years in order to address environmental and other demands. Those and many other industry challenges are outlined in a new study, “Caution: Blind Curves Ahead: The AlixPartners Global Automotive Outlook” by AlixPartners, the global business-advisory firm.
Overall, the study paints a picture of an industry globally that has entered a brave new world in which some regions and players seek to sustain post-crisis growth while others still struggle to find it, and yet all are forced to move at warp speed to accomplish the seemingly impossible, from unprecedented engineering feats to satisfying customers who, in some cases, don’t seem to like cars as much as they used to.
“The good news is the global auto industry made it through the financial crisis, recession and a whole lot of pain,” said Stefano Aversa, President of EMEA at AlixPartners and head of the firm’s Automotive Practice for the region. “The bad news is what’s ahead is uncertain and unprecedented, could be painful as well and suggests that now is certainly not the time for anyone to think about coasting.”
Here is an overview of the study’s findings, by region and issue:
Europe: A Job Not Finished
Though industry sales in other global regions have largely recovered from the financial-crisis era, Europe’s market last year was still down 19 percent from its historical sales peak of 2007. Moreover, the AlixPartners study shows that markets in southern and South-eastern Europe are still down more than 35 percent vs. 2007, with some countries even experiencing drops of over 50 percent. That compares with declines of 5 to 15 percent in heavily industrialized Western Europe. Meanwhile, finds the study, the biggest growth markets in Europe are Turkey, up more than 25 percent compared to 2007, and Russia, up 10-15 percent. The study points out, however, that Russia, like some other growth markets today, is also a volatile place, and therefore that its continued growth shouldn’t be taken for granted.
For the period until 2020, AlixPartners expects European light vehicle sales to remain virtually flat within a band of 18-19 million vehicles sold, due to still-unresolved economic problems in the Eurozone including stagnating wages and high levels of unemployment and longer-term macro trends such as urbanization, together with the decreasing role of the car as a status symbol and Europe’s ageing society.
While the total number of automotive plants has been reduced by 10 in the US since 2007, the net number of plants in Europe has actually grown by one. Consequently, according to the study, the share of plants in Europe operating below breakeven level went up from 40 percent in 2007 to 57 percent, down only slightly from 58 percent in last year’s study. Meanwhile, average plant utilization in Europe, says the study, is at a dangerous level of 70 percent, vs. 92 percent plant utilization in the US. According to the study, most of the underutilized European plants can be found in Italy, Spain and Russia, whereas Czech Republic, German and UK plants have less unused capacity.
In total, the study shows that Western Europe has closed seven plants since 2007, while Eastern Europe has opened eight new plants.
“The European car market is not likely to recover soon, thus near-term growth is unlikely to cure the underutilization issue in Europe,” said Stefano Aversa. “Those waiting for the tide to rise enough to lift their boat may be waiting forever.”
The US: Is This As Good As It Gets?
Unlike Europe, the US auto market has been very strong and, since the industry’s true restructuring there of a few years ago, automakers and suppliers alike have on average been enjoying high revenues and profits. However, whereas some other forecasters see industry sales climbing to peaks of 17 million or more units per year in coming years, the AlixPartners study forecasts industry sales in the US of a more-modest 16.3 million units this year and 16.7 million units in 2015.
Among the reasons, says the study, are that, when taking into account “pulled-ahead” sales in the decade of the 2000s, the U.S. industry is actually on track to pass its long-term sales trend line this year—and that long-term trends are, despite what some may think, still very meaningful in the auto industry. In addition, the study points out that the vehicle-renewal rate in the U.S. has been on a long-term decline, and that vehicle-usage rates are also declining—both in part due to aging Baby Boomers on the one end and on the other younger Americans, including Millenials, whom AlixPartners has dubbed “Generation N,” for neutral about driving.
Overarching all of this, the study also points to what might be a current “QE Bubble,” or a liquidity bubble underpinned by the Federal Reserve’s current “quantitative-easing” actions, a program many economists are predicting will truly start to taper off next year—which would likely lead to an increase in interest rates. In turn, says the study, that could lead to pro-cyclical decline for auto sales sooner rather than later.
China: What Will Its Slowing Economy Mean for the Rest of the World?
The study has identified five markets, which are likely to account for 71 percent of automotive growth within the next 10 years: Brazil, China, India, Russia and the US, and that China alone will claim 44 percent of growth within the next decade. Over the next five years the Chinese auto market is expected to grow by 6.3 percent annually, then drop to an annual growth rate of 2.5 percent over the following five years.
The Chinese slow-down is even more apparent when compared to historical figures. In the 10-year period between 2004 and 2013 China light vehicle sales experienced an average annual growth of 17.6 percent. This unprecedented growth has made China the No. 1 car market today with a share of 26 percent of worldwide sales as of 2013.
However, for most international manufacturers, the Chinese car market will continue to produce more than one third of their future revenue growth, and for some even more than half. The Chinese market also still generates above-average margins for most car manufacturers. “Being big in China today is a solid promise for future growth to automotive manufacturers,” said Stefano Aversa. “But it is also an exposure that needs to be managed.”
Japan: Positioning to Take on the World Again?
Japan, says the study, has been quietly positioning itself for global expansion in a way unseen in a number of years. Buoyed by a weakened yen, Japanese automakers are sitting on a high level of retained earnings, and moving rapidly to introduce new products into markets from the US and Europe to Brazil, India and China, among others. And, notes the study, while the financial strength of Japanese OEMs varies, on the whole they are very strong.
Industry Perspectives: Growth Hurdles in Every Market
The crisis of 2007/2008 is near overcome for the global automotive industry, with revenues last year up 11 percent since 2007, and average OEM EBITDA margins stable at around 10 percent. The study forecasts continued growth of worldwide light vehicle sales from today’s 83 million cars per year to 109 million units by 2023. This equates to an increase of 31 percent within the next 10 years and annual compound growth of some 2.8 percent.
SUVs will continue to grow strongly in China, according to the study, but are close to their peak in most other markets. More than half of the expected growth can be attributed to traditional cars. Another theory rejected by AlixPartners’ study is the advent of the age of the micro-car. Instead, close to 70 percent of the industry’s global growth within the next 10 years will be in the B and C segments, commonly known as small and medium-sized cars.
However, all of the growth markets identified by the study also hold tangible risks for car manufacturers. In the US signs are looming for a peak-car scenario that could prevent expected growth rates from becoming reality. Brazil’s economic development is endangered by rising taxes, inflationary tendencies and currency devaluation. The Indian market has proven to be an unfulfilled prophecy in the past, and growth will be mainly attributable to the low-cost car market. And in Russia the positive sales outlook could be clouded by a confrontation scenario with the West as the Ukraine crisis continues to be unresolved.
In China the primary risks for future automotive growth are seen in possible regulatory interventions. Urban congestion and pollution may lead more cities to restrict car registrations. Seven Chinese cities are already raffling car licences or parking lots, or hinge car licensing on the possession of a parking lot. Six more cities have indicated plans to introduce similar restrictions. The ubiquitous Chinese government plans to achieve a 50 percent inland market share for domestic auto brands – but current figures suggest it will reach only 40 percent. Thus, international car manufacturers might have to face obstacles posed by various regulatory measures in the future. Such measures could, for example, come in the form of privileges for micro-cars in urban environments under the pretence of lowering emissions and reducing the amount of urban space required. Chinese domestic car brands are strong in the entry-level segment, but weak in the middle and high-end segments.
“Participating in worldwide automotive growth will entail higher risks in the years to come,” says Stefano Aversa. “To mitigate these risks, international car manufacturers need to balance their exposure.”
Electric Vehicles: Gaining Traction Despite Questionable Economics.
Worldwide, the urbanization trend is unbroken. Air pollution remains a serious problem in many urban areas calling for zero-emission cars – as does the fight against climate change getting out of control. Last but not least, consumers are very positive towards environmentally friendly products if they can afford them. Thus, the cause for electric vehicles (EV) remains unbroken.
Although the 180,000 EVs sold in 2012 only represented 0.2 percent of the market, growth of the segment is strong. In 2013 EV sales doubled, with 405,000 units sold, capturing 0.5 percent of worldwide car sales. As of 2013, the five top selling EV models all came from Japanese or US manufacturers and captured over one third of the EV market while European manufacturers hardly played a role.
The massive battery costs and range trade-off in combination with an inadequately developed infrastructure currently make EVs economically unattractive to rational buyers who do not fall for the environmental image or for the quiet and powerful electric drivetrains alone. This will not change unless there is a huge breakthrough in battery technology. “Most nations pay EV lip service but do not act decisively. Targets like Germany’s one million EVs by 2020 are unlikely to be achieved absent governmental investments in EV infrastructure and economics,” says Stefano Aversa. “Good examples are Holland and Norway, where EV sales have already reached an over six percent share of sales.”
Europe also needs to catch up on the technology side. “The most significant lag of the Europeans is their absence in battery technology,” says Stefano Aversa. “The battery today accounts for 35-40 percent of the total value of an EV, and all major suppliers are from Asia.”
Connected Cars: The Race Is On
According to the study the global market for connected vehicles will grow by 20 percent annually over the next three years and is expected to reach €34 billion by 2017 driven by sales of hardware, telematics services, data services and in-vehicle services and applications. In 2017 some 56 million cars will be shipped with telematics and infotainment systems – 53 percent of them will be embedded systems, 31 percent of them are tethered using an external SIM card, and 16 percent will run on smartphones. Regional penetration will vary, with China leading in absolute terms while North America and Japan experience the highest penetration levels, with connected cars over 80 percent of total sales.
Future connectivity will need to accommodate many aspects, from car-to-car and car-to-infrastructure communication, via driver information and entertainment, to advanced online services. Thus, car manufacturers and their suppliers will have to develop and test several technologies. As hardware will likely be commoditized, OEMs should focus on the user interface and experience, while tier-one suppliers could benefit from venturing into services.
“Betting on choosing the right system and partners for the connected vehicles delivery strategy will be a key success factor not only for OEMs but also for their Tier1 suppliers and technology providers,” said Stefano Aversa. “While a proprietary system offers more control, an open source platform might develop faster.”
Meeting the Regulatory Challenge: Mission Impossible?
With emissions standards and testing cycles converging globally, fuel consumption and carbon-dioxide emissions have become an even bigger topic for the automotive industry. Currently, says the study, the industry is on target concerning the 2015 standards, but meeting 2021 globally converging emission requirements will take breakthroughs not yet apparent. Overall, the AlixPartners study expects the 2021 emissions standards to produce additional costs of €600 to €1,200 per vehicle.
Downsizing has been one way to lower emissions. Between 2001 and 2012 the average engine displacement in Europe decreased from 1,710 ccm to 1,650 ccm, according to the study. Another way has been the use of stronger and lighter materials. Between 2008 and 2012, says the study, the weight portion of regular steel in an average US light vehicle has gone down 17 percent, from 1,627 pounds to 1,346 pounds. At the same time, the amount of high- and medium-strength steel has increased by 13 percent, and aluminium by 15 percent. For the next decade the study forecasts the use of high-strength steel to grow by about another 30 percent, at the expense of traditional steel.
“The high price of aluminium still prohibits its abundant use in the A and B segments,” said Stefano Aversa. “Here we will see it limited to engine blocks and wheels for the near future. The biggest aluminium growth we will probably see is in the C and D segments, where penetration rates still show upside potential compared to the E segment, which already as of today relies heavily on lightweight materials.”
Suppliers: From Antitrust Concerns to Demanding OEMs
The AlixPartners study finds that some suppliers have themselves become nearly as large as some international car manufacturers, and that the top quartile of suppliers generates more than 80 percent of the industry’s revenues and profits. Even several key components and systems have come to rest in the hands of a small number of large suppliers. That’s of course as large suppliers have been asked by OEMs to perform a much larger share of vehicle-development tasks.
Automotive suppliers begin to face limits in their striving for critical market shares, and for sweet spots with proprietary technology. This includes a rising number of anti-trust investigations, representing approximately 25-30 percent of the value of an average European compact car, according to the AlixPartners study. During the past five years, cumulative fines of €4.5 billion have been levied against suppliers in Europe, Japan, and the US. New EU anti-trust investigations are expected for ignition coils, starter motors, compressors, braking systems and other components that have been under investigation in the US.
“While tier one and two suppliers need to be careful in further consolidation moves, their overall role in the automotive industry will continue to expand,” says Stefano Aversa. “As complexity and diversity of cars continue to grow, suppliers will continue to grow their share of research and development, value creation, and risk-taking.”
About the Study
“Caution: Blind Curves Ahead: The AlixPartners Global Automotive Outlook” is based on expert interviews and financial analysis of more than 300 global suppliers and more than 50 global automakers.
AlixPartners is a leading global business advisory firm of results –orientated professionals who specialize in creating value and restoring performance at every stage of the business lifecycle. The firm’s expertise covers a wide range of businesses and industries whether they are healthy, challenged or distressed. Since 1981, we have taken a unique, small team, action-oriented approach to helping corporate boards and management, law firms, investment banks and investors respond to critical business issues.