Uphill battle for car makers

Motor vehicle manufacturers are having a tough time. Over the five years to 2010-11, industry revenue is forecast to contract by 6.1% annually to reach $11.91 billion. The woes of car manufacturers started when consumers began switching to smaller, more fuel-efficient vehicles due to environmental concerns and the skyrocketing price of petrol.

This proved to be an issue for domestic manufacturers, particularly for Holden and Ford, as their core market consists of powerful, big fuel-inefficient vehicles. Truck manufacturers also noticed the shift towards cleaner trucks, but their troubles lie more in the slowdown of truck-freight demand than in environmental factors.

When domestic manufacturers continued to manufacture cars that consumers were demanding less of, car buyers had no choice but to turn to imported vehicles. Import penetration has been rising in the past five years, with Toyota’s imported cars leading the pack. To make matters worse, the Australian dollar has appreciated dramatically, which has led to a fall in the price of imported cars. Faced with falling demand, domestic manufacturers have been struggling to make profit over the past five years. In March 2008, Mitsubishi gave up entirely and exited the market after years of trying to prop up production and efficiency.

Car production fell by 27% in 2008-09 due to the global financial crisis and the cancellation of the Pontiac export programme, which saw Holden’s production levels plummet. Ford and Toyota also cut manufacturing during that year due to lower demand across the board. Production continued to decline in 2009-10 but is forecast to rise again in 2010-11 due to improving economic conditions. The next five years will be more positive for manufacturers and all three car makers will be producing at least one fuel-efficient vehicle; Toyota is already manufacturing the hybrid Camry domestically. Over the five years to 2015-16, industry revenue is forecast to grow by 1.9% annually to $13.09 billion.

Industry outlook

The already fragile Motor Vehicle Manufacturing industry really did not need an economic crisis added to its list of problems. Even if operating conditions are expected to improve over the next five years, the industry will be growing off a low base. Demand for cars will pick up, but domestic manufacturers will continue to face tough competition from imports. Revenue is forecast to grow by 1.9% annually over the five years to 2015-16 to $13.09 billion. However, there is some bad news ahead. Oil prices have been playing havoc on the industry over the past five years. After rapidly plummeting in the second-half of 2008, oil prices are forecast to rise over the five years to 2015-16. However, the price of steel is expected to grow minimally, which will help keep production costs in check. The Australian dollar will appreciate over the next five years, which could cause some more trouble for domestic manufacturers.

Going green

Motor vehicle manufacturers are looking at an eventful five-year period. In 2010-11, demand will rise again backed by the production of fuel-efficient cars and fleet sales, but domestic manufacturers will feel the heat from imports due to lower tariffs and a strong dollar. Manufacturers will be better equipped to deal with import competition. All three major car makers will be manufacturing a fuel-efficient vehicle by 2011-12. Domestic manufacturers will no longer ignore the shift in preferences from large petrol-guzzlers to cars that are a better fit to the environment. However, the shift in production towards green cars may be too late for domestic manufacturers. More fuel-efficient vehicles (than those made locally) have been available on the global market for years. As a result, imported green vehicles may be more price-competitive than domestically made cars. If it goes ahead, the cleaner car rebate will benefit both exports and domestic cars, as long as they meet the emission target. IBISWorld believes that imported vehicles will benefit more from the rebate than domestic vehicles.

The bright side

Producing green cars is not an easy decision to make, as it requires a significant amount of investment and high costs. Domestic manufacturers were reluctant to manufacture small cars at first for various reasons, including the fact that it would have been difficult to make profit out of green cars without proper government support. Fuel-efficient vehicles are relatively more expensive, and there is not a mass-market for them yet. Manufacturing will be slow at first, which radically diminishes any hope of profit as large-scale production is crucial to make money in this industry. However, the good news is that the Australian Government is willing to help make the industry more green.

The Australian Government will continue to support the Automotive sector over the next five years, which will work to stimulate growth for this industry. However, the full benefits of government intervention and assistance can only be reaped if producers can achieve industrial harmony, reduce employee turnover, and invest in automated production equipment. Industry players should also strive to have reliable supply links with specialist component producers and to contain costs through economies of scale in production runs. Cost reductions should then be passed on through efficiencies to model pricing for domestic consumption and exports. By pumping money into the pockets of motor vehicle manufacturers, the government will ensure a rise in production over the next five years. Volumes will also be supported by financial incentives (as opposed to outright handouts) to generate investment schemes for green-car manufacturing.

Government intervention alone will not be enough to jump-start the Motor Vehicle Manufacturing industry. However, it will encourage manufacturers to start producing the right type of motor vehicles: cars that consumers actually want to buy. Manufacturing smaller cars and fuel-efficient vehicles will help to drive industry demand. The industry will also see limited growth in the SUV and large-vehicle segment as the price of petrol will be high, but still lower than it was at the start of 2008.

Restructuring for a greener future

The assistance packages announced by the government in 2008 contain restructuring programs that aim to make the industry profitable again. With the reduction in industry protection already announced, there is going to be a shake-out among vehicle producers that will be under pressure to become competitive or exit the industry. IBISWorld believes that some consolidation will occur over the next five years, as companies eliminate inefficient units. Establishment numbers will fall by 1.6% annually over the five years to 2015-16.

As manufacturers strive to become more competitive, labour productivity will be one of the first issues to be addressed. IBISWorld believes that industry operators will be investing in state-of-the-art production machinery over the next five years as well as improving labour productivity through leaner production methods. Employment is forecast to fall by 1.3% annually, while wages are expected to rise due to government incentives to train staff and employ a better-skilled labour force. These restructuring measures, along with the development of green car production and a shift away from manufacturing big cars, will lead to a rise in industry profitability over the next five years. IBISWorld anticipates that by 2015-16, the manufacture of small and fuel-efficient vehicles will be well-established in Australia, which will drive profit margins. However, losses will continue at first as it will be difficult for car makers to make profit when they first launch the vehicles in the market.

The slow greening of the Automotive sector has already started, with an alternative fuel made up of 10% ethanol and 90% petrol (E10) being offered at various petrol stations. The E10 is cleaner than a 100% petrol fuel and is the first step towards the introduction of fuels with higher levels of ethanol. The higher the ethanol blend, the lower the emission. Car engines need to be manufactured specifically to run on ethanol-blended fuels that contain over 10% of ethanol. Consumers’ acceptance of ethanol-blended fuel is an important trend that car manufacturers need to look at in the next five years.

More trade

One of the reasons why Toyota’s financial performance over the past five years has been better than Ford and GM Holden’s is that Toyota derives a significant amount of its sales from foreign markets. Ford and GM Holden traditionally rely on domestic markets for sales. Ford and GM Holden will be following in Toyota’s footsteps by developing their export markets. Ford is already on the right track as it announced it would keep its Geelong engine plant open to manufacture export-bound engines. Holden lost the Pontiac export deal with GM in 2009, which has not left the company undeterred at all. Holden expects to continue exploring export markets, particularly for its engines and intellectual property regarding fuel-efficiency. Exports are forecast to grow by 2.8% annually over the five years to 2015-16.
Imports are also expected to rise over the next five years. Although domestic manufacturers will be doing their best to become more competitive by that time; restructuring is a long process. Importers of motor vehicles should be able to reap the benefits of a fall in tariffs fairly easily before domestic manufacturers start catching up on them. Over the five years to 2015-16, imports will rise by an estimated 3.0% annually.

Industry performance

Consumer Sentiment Index

End customers are very important to ensure the survival of the Motor Vehicle Manufacturing industry. Economic downturns and other events can affect expenditure decisions of households. When consumers are not happy or optimistic about the future of the economy, they tend to postpone large purchases (such as cars) until times are more favourable. Consumer sentiment was dismal during the global financial crisis.

Exchange Rates – Trade Weighted Index

Car manufacturers are significantly affected by changes in the value of the Australian dollar. Over the last five years, the Australian dollar has appreciated rapidly, almost reaching near parity with the US dollar in early 2008 before a quick depreciation. The competitiveness of domestic manufacturers is endangered when the dollar is too high as it makes imported cars cheaper.
World price of crude oil

The price of oil and petrol affect the driving habits of consumers and the type of car they buy. Over the past five years, the price of petrol has been causing chaos among motorists who have started switching to more fuel-efficient options. These include cars that run on liquefied petroleum gas (LPG), hybrids and small cars that achieve better mileage. The trucking segment has also been struggling with a rise in the price of fuel, which has put enormous pressure on production costs.

Import Taxes (Duties) – Motor Vehicle Tariff

Taxes on imports increase the price of imported motor vehicles, which makes domestic products more competitive on the market. The government reduced tariffs to 10% in 2005 and to 5.0% in 2010. Domestic manufacturers have voiced their concerns about the tariff reduction, believing that it will harm demand. A rise in the number of imported cars in the market could be detrimental to parts manufacturers, which would have a flow-on effect on the entire automotive supply chain.

Domestic Goods Prices – Metals – Iron and Steel

Steel is a major input used in motor vehicle manufacturing. Rises in the price of steel put cost pressures on manufacturers, which often leads to a fall in profitability. Over the past five years, the price of steel has been rising rapidly and manufacturers have not been able to completely pass on increased costs to customers.

Key success factors

• Effective cost controls: Close relationships with suppliers and good distribution channels will help manufacturers succeed. These will ensure that car manufacturers have access to relatively cheap car parts.
• Establishing motor vehicle export markets: Developing solid export markets with downstream motor vehicle buyers will help manufacturers secure demand and therefore income. Global expansion is also important due to the relatively small size of the Australian market.
• Having an extensive distribution/collection network: Good distribution channels will assist motor vehicle manufacturers succeed in this industry. The more networks a firm is involved in, the more opportunities exist for business.
• Use of most efficient work practices: Improved labour productivity, including industrial relations, will help manufacturers succeed.
• Ability to adapt to changes in consumer demand: Manufacturers need to adapt to new technology when consumer preferences change.
• Successful industrial relations policy: Manufacturers that use effective industrial relations policies will benefit from improved labour productivity.
• Access to the latest available and most efficient technology and techniques: The degree of investment into improving motor vehicle manufacturing technologies and product development will determine the success of a company in this industry.
• Optimum capacity utilisation: The level of plant utilisation of manufacturers in this industry will either help or impede business for motor vehicle production.
• Complying with government policies: Players that do not comply with government policies can be fined or have their products removed from the market.

Barriers to entry

Barriers to entry in this industry are high and are steady.

The Motor Vehicle Manufacturing industry is characterised by a highly cyclical growth pattern, high fixed costs, break-even profit levels and an excessive number of participants for the size of the market. Barriers to entry into motor vehicle manufacturing are formidable. Some barriers that need to be overcome by a new entrant include: the cost of developing high-volume production facilities, in order to benefit from economies of scale; and the ability of a company to gain access to technology from major global operators, as present incumbents include some of the largest multinationals that have considerable claims to new technology. The relatively small size of the domestic market, together with high import penetration levels, has already seen significant rationalisation in this industry.

Robert Bryant is the general manager of business information firm IBISWorld.