The news from Europe is like a broken record: cut costs; cut costs; cut costs…and cut them again. And issue profit warnings, as BMW did last week, warning that pre-tax profit is set to drop 10% or more, on the heels of an earlier warning about a month or so ago. Ford is cutting 5,000 jobs in Germany; Volkswagen is cutting 7,000 just at its VW brand. Everyone is talking to everyone else about platform, technology, engine and component sharing.
What’s driving this latest round of cost cutting? Before we get into the specifics, let’s remind ourselves that the automobile industry has been cutting costs…forever. The earliest cars were extremely expensive, and Henry Ford saw a huge opportunity. As did Alfred Sloan. And the opportunity for competitive advantage—or just trying to keep up with the rest of the industry—by cutting costs faster has never ended, although there have been periods of complacency. Real (adjusted) labor costs have grown faster than other costs, and thus the perpetual and relentless drive for efficiencies.
But this current crisis in Europe is being fueled by a number of factors that didn’t exist before, making this an unprecedented event.
The issues are manifold; an unwelcome convergence of geopolitical and regulatory disruptions and a technological revolution. Brexit, China-US trade/tariff issues, China’s economic slowdown, the diesel’s death sentence, CO2 standards, WLTP (the new EU emission testing scheme), mobility alternatives, a demographic decline, and of course the real elephant in the room: the transition to EVs.
The last one is the biggest single drain on manufacturer’s capital: they see no choice but to commit billions to EVs, without knowing if the market will be there, or develop quickly enough. Or profitably. Almost certainly not, at least for the first some years. Battery costs are still well above the cost of an IC engine. And a huge efficient and profitable supply chain making IC drive trains is going to be deeply impacted, if not largely destroyed. Developing a whole new industry for battery production on a comparable scale will soak up vast amounts; over $100 billion in commitments have already been announced.
If there was any remaining doubt about EV’s being the way forward for the German manufacturers, it was dispelled this past week. From electrive.com:
During a (joint 40 minute) call, executives of VW, BMW and Daimler have agreed on a common approach towards electric mobility following Volkswagen’s recent demand for technological clarity. Insiders report the trio being in agreement that the future belongs to battery-electric vehicles.
In the coming decade, battery electric mobility will be the only technology to enable carmakers to comply with environmental laws in the EU, claim the Germans. Apparently now, the bosses of the big three, VW, BMW and Daimler jointly agree that the focus will be on battery-electric cars. The trio do not think fuel cell cars will be ready for market in the next ten years.
VW’s “demand for technological clarity” is a push to get the VDA, Germany’s powerful automobile industry association behind EVs and lobby for a change in the German incentives for EVs, to increase them for shorter EVs, like VW’s upcoming ID cars, and reduce them for longer sedans, like the Tesla Model 3. VW wants as much federal support as possible for its huge investment.
Speaking of Tesla, European deliveries of its Model 3 started in mid-late February, and it quickly became the best selling EV in Norway and the Netherlands, and was trending to the #1 spot in Germany as of mid March.
But without yet having any confidence in being able to build EVs profitably for the initial ramp-up period, which may take some years, manufacturers have no choice but to slash costs associated with their existing IC-related operations in order to free up necessary cash and maintain some semblance of a decent profit margin.
BMW’s profit margin for 2019 will be in the 6 – 8% range, well below their stated target of 10%. Ford is struggling to just break even, and is looking at its ever-deepening alliance with VW to jointly build two different vans and for Ford to use VW’s new EV platform. And for VW to share Ford’s autonomous technology (Argo). From an autonews.com article:
VW Group CEO Herbert Diess said the joint development is worth the effort for both sides: “It’s mitigation against potential cost increases because of the new drivetrains we need for the electrification in this segment and also the CO2 penalties we are facing,” he said.
The Ford-VW alliance could extend to combining autonomous vehicle development while Ford is considering whether to use VW’s MEB platform for EVs. “It’s an attractive area,” Ford CEO Jim Hackett said. “Both the EV and AV are big costs for investment. Both are really important to both companies’ future. That is part of the incentive to find ways to cooperate.”
One way costs are being cut is by eliminating complexity, whoever possible. VW plans to drastically reduce the various stand-alone options and bundle them, as has become the norm in the US.
VW brand COO Ralf Brandstätter cited the Golf as an example in an interview last November. “In 2018 [so far] we have sold about 84,000 Golfs in Germany of which more than 58,000 had a different configuration. Fewer than 400 models were identical,” he said.
By bundling options and increasing the number of identical models, you need less logistics space, optimize your supply chain and reduce lead times, he said. Under the VW brand’s Future Pact, the company targets 3 billion euros in cost cuts through 2020.
Germans have typically ordered their new cars; that’s bound to change. It’s inefficient, as the Japanese showed the Americans back in the late 60s. Volvo is at it too:
“The XC40 [compact crossover] is essentially a one-spec, high-price car,” Lex Kerssemakers, head of Volvo in Europe, told journalists in January. “We don’t want to go back to the days of Henry Ford and say, ‘The only color is black.’ But I think we are at a turning point. People don’t buy complexity any more. It also brings our cost down.” Volvo is planning to reduce options further later this year.
Volvo, along with PSA, have become low-cost leaders in Europe.
“Circumstance forced us to reinvent ourselves when the Ford era ended [in 2010 and Ford sold the company to Zhejiang Geely Holding],” he said. “Geely did not come in with a bag of gold. We had to finance it [Volvo’s revival]. And when you are poor you become very inventive,” he said.
When it created its Compact Modular Architecture it saved by co-developing the platform with sibling brand Geely Automotive.
Volvo also made sure there was plenty of carryover from its larger Scalable Product Architecture. “With one engine bay, one firewall layout and the same engine family, you start to be extremely efficient,” Kerssemakers said.
Platform and engine sharing is expanding drastically, as automakers seek to cut back to just one or two flexible “building blocks”. This was the key to Opel’s rapid turnaround after being bought by PSA. Opel is dropping from nine platforms and ten powertrain combinations to two platforms and four engines.
Engine sharing is rapidly on the rise. PSA’s 1.2 L turbo gas engine is being built in six countries all over the globe. And PSA is eager to sell it to anyone who wants it. Evercore ISI analyst Arndt Ellinghorst says;
“With the exception of certain sports cars, full-size pickups and larger premium offerings, we believe that the powertrain is of diminishing interest to the vast majority of consumers,” he said.
Continuing to invest in combustion engines on a stand-alone basis is a “flagrant waste of capital,” Ellinghorst said. By treating engines as a commodity and buying from suppliers, the industry could save $30 billion a year, Evercore ISI predicted.
Speaking of shared platforms: the hot story as reported by the German Sueddeutsdche newspaper was that BMW and Mercedes are in talks to develop common platforms. The potential saving for each firm would be some seven billion euros each. From electrive.com:
The German report also states that cooperation is notably driven by Mercedes’ development director Ola Källenius, who will be taking over from Dieter Zetsche as the new Daimler boss in May. One of the reasons is that the cost structure at Mercedes is significantly less favourable than at BMW. As is well known, the Bavarians are relying on a so-called convergence architecture for their electric offensive, according to which cars of different motorizations are produced on one platform and also on one production line. Mercedes’ strategy, on the other hand, is split into an electrical construction kit for electric branch-offs of existing models and one for independent (premium) electric vehicles. Both approaches could quickly reach their limits as demand for the vehicles rises, which would explain the cooperation intentions.
What will be left to distinguish a Mercedes from a BMW? The exterior skin, the interior, and the software, presumably?
However, it is also clear that parts of the savings potential would probably have to be reinvested in differentiation so that future BMW and Mercedes-Benz models based on the same platform would be sufficiently different. The preservation of the respective brand cores is an issue for both companies. Because despite the different approaches, both manufacturers are still courting the same target groups.
I would not be surprised if within 10-15 years, BMW and Mercedes merge their automobile operations. Germany Inc. will do whatever it takes to stay competitive.
Meanwhile, PSA, the undisputed champ at cost cutting, has announced that it is ready to swallow bigger fish after having digested Opel so well. CEO Carlos Tavares has the backing of the Peugeot family to pursue other acquisitions.
“We supported the Opel project from the start. If another opportunity comes up, we will not be braking, Carlos knows that,” Robert Peugeot said. There were no concrete projects at the moment, he said. “The Opel operation is an exceptional success, we didn’t think that the recovery could be as fast,” he told the paper.
The primary candidates? JLR and FCA. JLR is struggling currently, but just how good a fit it is with PSA is a question, as its luxury platforms don’t offer the obvious synergies as did Opel’s. Meanwhile, FCA would give PSA a huge opneing into the US market, which it has already committed to re-entering. And although FCA didn’t comment, there was some indication that FCA is reluctant to increase its exposure in Europe, as it’s seen as a difficult and shrinking market. Maybe PSA should knock on GM’s door instead?
Who could have foreseen that PSA would be the company all the Europeans are having to chase after, in terms of cost-cutting? And what of the old saying “You can’t cut your way to prosperity”? Actually, the long history of the automobile industry shows otherwise, and PSA is clearly proving it to be the case currently.