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  • irishtimes.com - Posted: July 27, 2012 @ 10:45 am

    Discounting the obvious

    Neil Briscoe

    The European car industry is tying itself in the same knots as US car makers did back in 2009, offering deep discounts and incentives in a desperate attempt to keep expensive factories turning, despite the fact that it’s clear there are not enough buyers for the cars that are being built.

    It’s a position that we have been slowly drifting towards for many years now. Over-capacity, the fact that there is space and investment in the factories to build more cars than there are people to buy them, has been hovering, shadow-like, over volume western European car makers for well over two decades now, but until the current financial crisis hit, there was always just enough heat in the national economies to keep sales flowing and the money coming in.

    Now, though, the European car market is continuing to contract, and it’s leaving the ‘traditional’ volume makers badly exposed to chilly economic winds. So, out come the discounts because in the minds of some makers, it’s better to be selling something, anything, even at a slim profit or even a loss, as long as it keeps those expensive factories, with their high-cost labour, working and turning out metal.

    But it’s a honey trap and deep-down, the car makers know it. Offering juicy incentives and price cuts might appeal in the short term to buyers, but such actions have serious consequences. An impact on residual values is just the start of it, but there’s also the subsequent raised expectations of customer value. After all, if you can buy a car for 10% off this year, why not 15% or even 20% next year? And cars aren’t like sofas or televisions. Whatever the blaring ads from the retail park superstores may tell you, the discounts on TVs and furniture don’t amount to much when the cost of making them is so low. Cars aren’t cheap to build, and profit margins in the broader car industry are as low as 3-5%. Knock a few discounts off of that and suddenly everyone, from the dealer right the way back up to HQ, is making a loss.

    Mark Fulthorpe is an analyst at industry watchers IHS, and he told me that the succession of discounts is a worrying sign in the European car market.

    “It’s becomes slightly nuanced. In the short term, discounts can be a positive in keeping those fixed assets, the factories, moving. There’s a danger if the industry becomes reliant on it. Effectively that’s what happened in the US market. We saw the passenger car market starting to slide and when the heat went out of the light truck market, we saw massive and unsustainable incentives being introduced.

    “If it becomes ingrained, it’s a weakness. Discounting is a plausible response if it’s to ride out a short term problem, but given some of the fundamentals, we would see at as potentially, as you put it, ‘floundering around’ unless restructuring is also part of the plan.”

    Restructuring is a dirty, unuttered word in much of the western European car industry, with car makers caught between a devil of falling sales and plummeting profits and deep blue seas of national pride, political pressure and expensive labour contracts. So far, only Fiat (which has already closed down one factory, and may do so with another) and PSA Peugeot Citroen (which is currently wrangling with the French government over its restructuring plans) have begun to grasp the nettle of making their operations leaner and meaner. Fiat boss Sergio Marchionne reckons that everyone is waiting for the others to blink before committing to costly (both in the financial and political sense) restructuring plans and that it may take the bankruptcy or collapse of a major player to trigger the broader process.

    If a major car maker, went to the wall, would that be a relief valve for the rest of the industry? Not so, says Mark Fulthorpe: “If a major OEM (Original Equipment Manufacturer – analyst speak for a large car company) went to the wall, it would alleviate the problem in the short term, but it wouldn’t be a panacea. I think there’s something deeper, the over-capacity is more deeply ingrained, across the board. Anecdotal evidence suggests that if a major player went bust, that would only account for about 25% of the over-capacity in Europe.

    “We see 2013 as still being very much a pinch-point. There’s the potential for a lot of volatility up to the middle of next year in the Eurozone, but we would hope to see a pick up in demand by certainly the latter quarters of 2014.”

    And even if the over-capacity issue could be tackled, there would still be the issues of increased competition for the once-mainstream players.

    “Some of these problems have their roots in ’09, and then there’s the trend of the premium brands moving into volume sectors” says Fulthorpe. “They’ve essentially taken over the D-Segment (cars of the likes of the Ford Mondeo and Toyota Avensis) and now they’re moving into sectors below that and that will continue to apply pressure to what we would traditionally have called the volume brands.

    “As will the growth of the Koreans. Their capacity investments have been primarily made in central and eastern Europe, where the labour costs are much lower, so they’ll continue to enjoy that benefit, and continue putting pressure on factories in western Europe, where thanks to legacy issues, costs are much higher.

    “As well as discounts applied by OEMs, don’t forget that both Italy and France have been effectively supporting their national car markets with incentives for around 15 years. It makes us nervous about incentives.”

    So while a car buyer today will be delighted that you can currently get up to €5,000 off the price of a new car, even one from brands that are actually doing well right now, including Volkswagen and Skoda, the price for the economy as a whole may be a steep one to bear, not least because of the highly-skilled and paid jobs that would be lost in the process, and the subsequent brain-drain that would be more or less inevitable. Europe has already lost so much of its ability to build ships and aircraft. If we let cars go too then what hope for economic growth? Service economies are all well and good, but to make real money you have to make real things.

    Yes, it’s nice to be able to buy a new Renault Laguna and get a free Twizzy electric car thrown in (a current deal being offered in the Spanish market) but it’s all just a desperate attempt to paper over major cracks in the foundation of the European car industry. And all of the big players are about to find out that ruthless, Darwinian economics doesn’t pay any heed to fripperies like discounts. The value of a product lies only in what people are prepared to pay for it, not in what they could save.

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