Euro crisis are you prepared?

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Unlike foreign carmakers, Chinese OEMs are not prepared for the potential crisis that might start from a euro-zone collapse

The world’s economic and political tension is tied-together closely with future trends of the automotive industry. The Arab Spring uprisings drove up energy prices, which created even more pressure on governments around the world to encourage and promote fuel efficiency vehicles and alternative energy vehicles in addition to the already existing demands due to global warming and CO2 pressure. The connection here is quite clear: fuel price directly and immediately impacts the automotive industry and future development.

To make the situation even worse, nowadays worries about the financial health of European nations are scaring the world. At a time when USA, Europe and developing countries are still fighting the aftermath of the 2009 recession the world economy suffered setbacks throughout the whole year 2011.

Until recently, Greece, Ireland and Portugal were the main troubles for Europe’s economy, which only account for about 6% of euro-zone GDP. But growing financial strains in Spain and Italy are adding to the euro-zone worries. If the Euro crisis explodes, the world economy will suffer even stronger and deeper problems than the recession in the past 2 years. Take the US as an example: Obama pushed through an $800 billion economic stimulus plan in 2009 and has set out a new $447 billion plan to create jobs and cut taxes for small business and faced opponent from Republicans. Given the current political climate in Washington it is unthinkable that similar measures could be taken when a new crisis occurs.

But this is not only limited to the US: governments around the world depleted their funds to create incentives for e.g. job-creation. One of the most important reasons that China could take over the US as the biggest car market was thanks to its generous government incentive package, which this year officially ended. Furthermore tier 1 and tier 2 cities are facing traffic problems; the local governments are already putting restrictions to the numbers of new car registration. All of the factors above lead to a situation that makes it much more difficult for carmakers to sell their cars.

One lesson learnt from the Chinese market in the last 2 years is that in good times market share competitions are basically production capacity competitions. Therefore from last year, just 1 year after the biggest global recession in recent history, almost all carmakers invest in new plants to increase their production capacity even further.

In a recent survey of global auto executives by research firm KPMG, a quarter said that they expect China to have 20% more automotive capacity than needed within the next five years. Overcapacity, the impact from Euro crisis and tight government incentives policies are landmines that Chinese carmakers might easily step on!

On the other hand foreign carmakers are not only already aware of the problems the Euro crisis might bring, they have also learnt their lessons from the 2009 recession. BMW’s CEO for example recently stated that his company is fully prepared for another global crisis and can still be profitable due to an improved cost and organization structure.

Today European carmakers have a leaner cost structure, broader diversification and higher liquidity than in 2009 when the economic downturn hit. They can now manage their working capital cycles much more efficiently. Due to the experiences from the 2008-2009 economic downturn, carmakers have spent the past two years saving costs, downsizing or cutting production capacity in Europe, working on more efficient processes and increasing the share of flexible staff between 10-15 percent of car manufacturers’ total workforce, leading to an easier adjustment if necessary.

Chinese carmakers were very lucky compared to their overseas competitors because thanks to government incentives they could still grow. Actually while all major markets were contracting China became the world leader in both sales- and production numbers. Unlike foreign carmakers, which had the last years to learn their lessons in fighting an economic downturn, Chinese OEMs are not prepared for the potential crisis that might start from a Euro-zone collapse.

What can the Chinese government do to save the automotive industry again? First of all China is an export-driven economy: a Euro crisis together with an RMB appreciation would continue to deepen the problems for smaller and medium sized OEMs around China for export. Local government debts would put additional pressure on the Chinese government as they would require financial intervention that otherwise could be used to give incentives to the automotive industry and other industries.

In my opinion this is the right time to push for a consolidation in the local automotive industry; the government should allow some carmakers to go bankrupt or encourage them to merge into healthier companies. Following Darwin’s evolutionary theory this is “the survival of the fittest”. In the long run this is not only a risk but a huge opportunity for the Chinese automotive industry to become more competitive- both in China and globally.