Car manufacturing

Ripe for revolution
Sep 2nd 2004
From The Economist print edition

New kinds of cars are about to produce a new kind of car industry

AMERICANS are queuing up to add a Prius, a new petrol-electric hybrid car, to the trio of gas-guzzlers parked in the average suburban driveway. There is no doubt about it: this car is cool. It is not only fashionable in the usual way—the favourite model of Hollywood movie stars—but also in a new and startling manner. The Prius serves not only as a green credential for its owner, but also as an exciting high-tech gizmo. Yet for anyone watching the fortunes of the car industry closely, the Prius represents something else as well—the quiet revolution that is about to engulf the car industry itself.

Leading that revolution is Toyota, manufacturer of the Prius. It is no accident that Toyota, Japan's biggest car firm, is now pioneering the industry's move into new kinds of environmentally friendly vehicles with a cleverly marketed and commercially viable product. Toyota is a relentless competitor which has overtaken Ford in terms of sales and is now tailgating the industry's leader, General Motors (GM). The widespread use of all-electric, non-polluting vehicles, using hydrogen fuel-cell systems (like GM's concept car above), is probably still 20 years away. The Prius, with its little electric motor performing as a supplement to its petrol engine, is just a small step in that direction. But it is significant, because it represents two things that promise to transform the entire car industry—new technology and new production methods.

So last century

The car business is ripe for revolution. As our survey of the industry in this issue describes, it has chronic problems. Once it epitomised 20th-century capitalism, but today it looks poorly equipped to thrive in the 21st century, or even to survive in its present form. Many of the world's biggest car firms are destroying wealth rather than creating it. About half of the industry is regularly incapable of earning a decent return on its invested capital. Although it still accounts for about a tenth of economic activity in rich countries, it has been virtually shut out of stockmarkets for the past 20 years, accounting for a mere 1% of total market capitalisation.

Only the support of governments and the patience of founding families keep many companies going. Even this has often not made car making profitable. For years companies such as General Motors and Ford have relied on their finance arms to stay afloat. Laden with gold-plated pension and health schemes from an earlier, more profitable age, Detroit sometimes seems like a Swedish-style welfare state paid for by a consumer-finance business specialising in cars. This is unsustainable. Long-term liabilities are being met by repeated financing via the corporate bond market, the only part of the capital markets that most car companies can tap.

But there are plenty of ideas knocking around for how the industry might transform its fortunes. Ambitious mergers are no longer regarded as the answer, especially after the disastrous acquisition of Chrysler by Daimler-Benz in 1998. Instead, the focus is on ways to adapt the mass production system invented by Henry Ford to the realities of today's markets. All car firms have learned from Toyota how to use just-in-time, lean production to make cars much more efficiently. A continuous flow of parts arrives from the other side of the world (increasingly from China) just when they are needed. But, oddly, the finished cars then sit in parking lots for up to 90 days before they are sold, usually at a discount because they are not the colour or do not have the optional extras that the buyer wants. The whole industry is straining to find ways of making cars to order rather than producing them for inventory.

The industry is also trying to respond to changing tastes. As consumers become more choosy, the market is fragmenting into a bewildering array of niches. As a result, car manufacturers are struggling to make their assembly lines flexible enough to produce, say, roadsters in the morning and pick-ups in the afternoon. But as the market fragments, flexibility alone may not be enough. Smaller production runs, smaller factories and new ways of assembling cars are likely to be needed as well. Henry Ford could one day be history, to borrow one of his own famous put-downs. Economies of scale alone used to dictate the industry's shape, but changing markets could be more conducive to smaller, less capital-intensive companies.

Such changes are already lowering the barriers to entry to new entrants. Some parts suppliers have taken over the role of final assembly of niche models for big car firms, and others are doing more of the development work on new cars. The virtual car company could be in sight: perhaps one day some firms will own only technology, design and a brand, while a contract-manufacturing industry, born of today's suppliers, springs up, a path already taken by the consumer electronics and computer industries.

Also pushing the car industry in this direction is the fact that cars themselves are evolving into something akin to consumer electronics products, and this trend is likely to accelerate. Cars are already lighter than they were, and they contain growing numbers of chips and other electronic gear. Luxury models have features such as adaptive cruise control that keeps drivers from hitting the car in front. Electronic controls and little electric motors could soon be providing steering and braking as well, much as they do in aircraft. As electronics replaces clutches, steering boxes and other mechanical features, cars will become still lighter.

Thrill me

Those firms slow to innovate will surely exhaust even the patience of protective governments and founding families, and so fade away. Those that are successful at coping with the big technological, marketing and financial changes beginning to sweep the car industry, as Toyota has so far shown itself to be, should survive. But for the next few decades they, too, will have to scramble to adapt. And the car industry's privileged status as the pre-eminent example of the power of mass production looks finished. The industry of the future will look more like other consumer products businesses—crowded, fast-moving and a slave to the whims of customers.

SURVEY: CAR INDUSTRY

Perpetual motion
Sep 2nd 2004
From The Economist print edition

For much of the 20th century, carmaking was the “industry of industries”. Now it has to reinvent itself, says Iain Carson

IT MAKES nearly 60m cars and trucks a year, and employs millions of people around the world. Its products are responsible for almost half the world's oil consumption, and their manufacture uses up nearly half the world's annual output of rubber, 25% of its glass and 15% of its steel. No wonder the car industry accounts for about 10% of GDP in rich countries.

But the industry that has pioneered the forms and weathered the storms of 20th-century capitalism is now over 100 years old, and it is struggling. Average profit margins have declined from 20% or more in its youth in the 1920s to around 10% in the 1960s and less than 5% now, and some volume carmakers have actually been losing money. Despite its importance to modern economies, the industry has all but vanished from equity markets. “It is becoming a sunset industry, a has-been in financial terms—a flagrant contrast with its continuing social role, its share of employment and its political influence,” write Graeme Maxton and John Wormald in a new book, “Time for a Model Change”.

A study by Deutsche Bank two years ago found that the car industry represented just 1.6% of Europe's stockmarket capitalisation, and only 0.6% of America's. Two decades earlier, the figures were 3.6% and 4% respectively. Although firms such as Ford dominate the corporate-bond market, the car companies' debt is rated as close to junk, so they have to pay dearly for this kind of finance. In Japan the picture is different because of the unusual success of the world's mightiest carmaker, Toyota, and (latterly) the recovery of Nissan under the wing of Renault.

Invented here

A century ago the car industry more or less invented modern industrial capitalism. The car started life in Germany, and early development of the industry began in France (hence automobile, originally a French word) in the 1900s, but it was in America that it came of age. Henry Ford's adaptation for carmaking of the moving assembly line he had seen in Chicago slaughterhouses marked the birth of mass production.

But Mr Ford applied those techniques to a vehicle that resembled a horse-drawn carriage, with a body laid on to a separate chassis. Modern cars have a monocoque steel body in which the strength is built into the pressed steel floor, sides and roof. It was invented by Edward Budd, taken up by Dodge and then by Citroën in Europe, and then by all volume carmakers.

Toyota may have refined the process in the 1960s by its lean-manufacturing (just-in-time) techniques, but cars are still made by stamping, welding and dipping steel, then stuffing the body with engine, trim and seats. Factories have to be large to reap the biggest economies of scale: around 250,000 units a year for assembly plants and 1m-2m units for making body panels. So Mr Budd's legacy was not only a way of making a rigid integral car body; he also laid the foundations for a whole rigid industry that some experts think is now incarcerated in its own vast plants.

Around the same time as modern car manufacturing was born in the mid-1920s, Alfred Sloan's ideas for running General Motors provided the model for the great corporations that grew up to dominate the second half of the 20th century. GM soon swept past Ford as Mr Sloan revolutionised the young car industry, and Ford has never regained the dominance it enjoyed in the infancy of mass production.

The car industry has been ahead of its time in many respects. Peter Drucker, a management writer who first made his name with a study of GM in 1945, coined the phrase “industry of industries”. The company was also the leader in “planned obsolescence”, the frequent changes in design that tempted customers to switch to a new model every year or so. It was the first to feel consumer anger, with the publication in the 1960s of Ralph Nader's attack on the safety record of the Big Three Detroit manufacturers, “Unsafe at Any Speed”. In the 1970s, as the oil price quadrupled, the industry found itself under attack from environmentalists outraged by its products' gas-guzzling habits.

It was also among the first to come under careful government scrutiny, from safety concerns to environmental issues to antitrust worries in the days when General Motors had 60% of its domestic market and could snuff out competitors with a few well-chosen price cuts. But it also received more welcome government attentions. When small, economical and reliable Japanese cars started to eat into Detroit's market share, the American government imposed restraints on those imports. Soon afterward, the industry in Europe came under similar pressures.

The car industry also found itself at the cutting edge of capitalism in another sense. As mass production techniques developed in the 1920s and 1930s, its workers increasingly pushed for unionisation. At times, it seemed as though the car factories of the Detroit area, the British Midlands or the huge plants around Paris were the main battleground of the class war. Even today, the United Auto Workers union (UAW) still dominates Detroit, even though trade union membership in America's private sector as a whole is well below 10% of the workforce.

Until last year the UAW's leadership seemed to have its head in the sand, oblivious to the competition that was hurting General Motors, Ford and the Chrysler end of DaimlerChrysler. Then it suddenly got the message, agreed to a moderate pay deal and accepted more closures. The union has seen its membership decline steeply over the past 20 years, but it can still make it hard for car companies to reduce overcapacity.

Today the motor car is the epitome of mass production, mass marketing and mass consumption, with some of the strongest brands in the world. For most households in rich countries, it is the second-biggest purchase after a house or flat. Few other consumer-goods industries depend so heavily on a thriving second-hand market for their products. And yet there are powerful forces at work that could profoundly change the industry.

One is the fragmentation of the market, leading to lower production runs. Another is dissatisfaction with the costly system of building cars for stock, not to order. A third is innovative modular construction, in which more of the car is put together by parts suppliers. And further ahead, a fourth force could be a switch to electric cars with electronic and electrical rather than mechanical controls.

A world falling apart

Right now, though, the biggest force for change is the fact that most of the volume-car industry is broke and needs fixing. The market in America, Europe and Japan, where over 80% of the world's cars and trucks are sold, has been running out of growth. In America the arrival of European, Japanese and South Korean makers has created overcapacity. Moreover, as America's own carmakers constantly improve their productivity to catch up on these new rivals, their greater efficiency itself increases capacity by about 3% a year.

In Germany and France, rigid labour laws have inhibited the closure of redundant old factories, although Renault has set a good example, and Ford Europe and GM Europe have been trying to follow it. In Japan, the close industrial partnerships known as keiretsu have proved too rigid for some manufacturers. Only Toyota and Honda remain in purely Japanese hands. The smaller Japanese producers make little or no profit at home and are struggling to get into the black in Europe. Even for the big companies America provides the best hopes for growing profits.

The rest of the world presents a mixed picture. In Asia the 1997 financial crisis dealt the South Korean car industry—always a rather artificial creation—a huge blow. Today only Hyundai survives as an independent. In South America economic collapse in Brazil and Argentina put a stop to the rapid expansion of the car industries there, leaving foreign investors such as Fiat to cut their losses.

The boom in China is getting everyone excited, but it needs to be kept in perspective. For all the huge percentage increases, the annual value of that market is equivalent to just about a month's sales in the rest of the world.

All the car companies think that if only they try harder, they can somehow regain growth at the expense of rivals. But in reality they are like Scott Fitzgerald's “boats against the current, borne back ceaselessly into the past”. Add the growing pension and health-care bills of traditional producers such as America's Big Three and the Europeans, and it is easy to see why the industry is feeling under siege.