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‘Blind Curves Ahead’ for Auto Industry, as America Nears a Peak, Europe Remains Spotty, China Cools, Japan Gears Up and Regulations Loom, According to AlixPartners Study
July 01, 2014

The global automotive industry, having survived a very bumpy road in recent years, now finds itself facing at-best uncertain times ahead, including a fully recovered American market that, while still strong, could be nearing its peak, with AlixPartners forecasting 16.3 million units to be sold this year; a recovery in Europe that has been slow, uneven and marked by continued overcapacities; a growth rate in China that’s forecast to fall to 6.3% over the next five years, from 17.6% in the previous decade; a situation where Japanese automakers, buoyed by a weak yen, appear to be gearing up for a global product onslaught reminiscent of the late 1980s and early 1990s; and, overarching all, a push from regulators and consumers to reinvent mobility and the automobile in the next few years.

Those and many other industry challenges are outlined in a new study, “Caution: Blind Curves Ahead: The AlixPartners Global Automotive Outlook,” from AlixPartners, the global business-advisory firm.

Overall, the study paints a global picture of an industry that has entered a brave new world in which some regions and players seek to sustain post-crisis growth while others still struggle to find it, and yet all are forced to move at warp speed to accomplish the seemingly impossible, from unprecedented connectivity, powertrain and active-safety engineering feats to satisfying customers who are increasingly neutral about driving.

“The good news is the global auto industry made it through the financial crisis, recession and a whole lot of pain,” said John Hoffecker, co-president of the Americas at AlixPartners and head of the firm’s Automotive Practice globally. “The bad news is what’s ahead is uncertain and unprecedented, and could be painful as well.”

Here is an overview of the study’s findings, by region and issue:

The US: Is This About As Good As It Gets?

Since the industry’s restructuring of a few years ago, the US auto market has been very strong and automakers and suppliers alike have on average been enjoying ever higher revenues and strong, if flattening, profit margins. However, whereas some other forecasters see industry sales climbing quickly past 17 million units annually in coming years, the AlixPartners study forecasts industry sales in the US of a more-modest 16.3 million units this year.

Among the reasons, says the study, are that, when taking into account “pulled-ahead” sales in the decade of the 2000s, the U.S. industry is actually on track to pass its long-term sales trend line this year—and that long-term, fundamental trends are, despite what some may think, still very meaningful in the auto industry. In addition, the study points out that the vehicle-renewal rate in the U.S. has been on a long-term decline, approaching replacement levels, and that vehicle-usage rates are also declining—both in part due to aging Baby Boomers on the one end and on the other younger Americans, whom AlixPartners has dubbed “Generation N,” for neutral about driving. These factors have increased each year in recent years, says the study, even as the economy has improved.

Overarching all of this, the study also points to what might be a current “QE Bubble,” or a liquidity bubble underpinned by the Federal Reserve’s current quantitative-easing actions, a program many economists are predicting will begin being unwound in earnest starting next year —which would likely lead to an increase in interest rates. If consumer interest rates were to rise three percentage points—about the normal historical increase when rates go up in a managed fashion after a prolonged downward trend—that would translate into $2,500 less purchasing power for car buyers, according to the study. If they were to rise seven points, which is far less than the rise in the early 1980s recession, that would mean $5,250 less purchasing power.

“The auto industry in North America is in what you might call a ‘perfect calm’ right now, but this remains very much a cyclical industry,” said Mark Wakefield, managing director at AlixPartners and head of the firm’s Automotive Practice in the Americas. “If there’s a perfect unwinding of QE and its many international brethren, interest rates might rise moderately, which would likely dampen demand; but if it’s not done perfectly—and that’s a tall order—we could be looking at a steep sales downturn, and increased debt costs sooner than many are planning for.”

Europe: A Job Not Finished

Though industry sales in other global regions have largely recovered from the financial-crisis era, Europe’s market last year was still down 19 percent from its historical sales peak of 2007. Moreover, the AlixPartners study shows that markets in southern and southeastern Europe are still down more than 35 percent vs. 2007, with some countries down more than 50 percent. That compares with declines of 5 to 15 percent in heavily-industrialized Western Europe. Meanwhile, finds the study, the biggest growth markets in Europe are Turkey, up more than 25 percent compared to 2007, and Russia, up 10-15 percent. The study points out, however, that Russia, like some other growth markets today, is a volatile place, and therefore that its continued growth shouldn’t be taken for granted.

For the period though 2020, AlixPartners study expects European light-vehicle sales to remain virtually flat within a band of 18-19 million vehicles sold, due to still-unresolved economic problems in the euro zone, including stagnating wages and high levels of unemployment and longer-term macro trends such as urbanization, the decreasing role of the car as a status symbol and Europe’s aging society.

While the total number of automotive plants has been reduced dramatically in the US since 2007, that net number of plants in Europe has actually grown by one, notes the study. Consequently, according to the study, the share of plants in Europe operating below breakeven level went up from 40 percent in 2007 to 57 percent last year, about the same level as in last year’s study—which, at least, indicates what could be a bottoming-out in Europe. Meanwhile, average plant utilization in Europe, says the study, is at a dangerous level of 70 percent, vs. 92 percent plant utilization in the US. According to the study, most of the underutilized European plants can be found in Italy, Spain and Russia.

In total, the study shows that Western Europe has closed seven plants since 2007, while Eastern Europe has opened eight new plants.

“The European car market is not likely to recover soon, thus near-term growth is unlikely to cure the underutilization issue in Europe,” said Hoffecker. “Those waiting for the tide to rise enough to lift their boat may be waiting forever.”

China: What Will Its Slowing Economy Mean to the Rest of the World?

The study predicts that China alone will claim 44 percent of global growth within the next decade. Over the next five years the Chinese auto market is expected to grow by about 6.3 percent annually, and then drop to an annual growth rate of about 2.5 percent over the following five years.

The Chinese slow-down is even more apparent when compared to historical figures. In the 9-year period between 2004 and 2013 China’s light-vehicle sales experienced an average annual growth of 17.6 percent.

However, for most international manufacturers, the Chinese market will continue to produce more than one third of their future revenue growth and for some even more than half, says the study. It also notes that the Chinese market also still generates above-average margins for most manufacturers.

“Being big in China is a solid promise for future growth to automotive manufacturers,” said Hoffecker. “But it’s also an exposure that needs to be managed.”

Japan: Positioning to Take on the World Again?

Japan, says the study, has been quietly positioning itself for global expansion, perhaps not like that seen since the late ‘80s and early ‘90s. Buoyed by a weakened yen, Japanese automakers are sitting on a high level of retained earnings, and moving rapidly to introduce new products into markets from the US and Europe to Brazil, India and China, among others. And, notes the study, while the financial strength of Japanese OEMs varies, on the whole they are very strong and well-positioned to take advantage of their current situation.

Industry Perspectives: Growth Hurdles in Every Market

Worldwide, the study forecasts continued growth of light-vehicle sales from today’s 83 million cars per year to 109 million units by 2023. This equates to an increase of 31 percent within the next 10 years and annual compound growth of some 2.8 percent.

SUVs will continue to grow strongly in China, according to the study, but are close to their peak in most other markets. More than half of the expected upcoming growth will likely be in traditional cars, says the study. Another theory rejected by AlixPartners’ report is the advent of the age of the micro-car. Instead, close to 70 percent of the industry’s global growth in the next 10 years will be in small and medium-sized cars, it says.

However, all of the growth markets identified by the study also hold tangible risks for automakers and suppliers like -- from the possible “peak-car” scenario in the US to a Brazilian market endangered by rising taxes, inflation and currency devaluation to an Indian market that needs to prove that new political leadership can translate into sustained economic growth to a Russian outlook clouded by the current confrontation over Ukraine.

In China, says the study, the primary risks for future automotive growth are seen in possible regulatory interventions. Urban congestion and pollution may lead more cities to restrict car registrations. Seven major Chinese cities are already raffling car licences or parking lots, or hinge car licensing on the access to a parking lot. Six more cities have indicated plans to introduce similar restrictions. International players might have to face obstacles posed by various regulatory measures in the future. Such measures could, for example, come in the form of special privileges for electric vehicles and micro-cars (mostly domestic-made) in urban environments, says the study.

“Participating in worldwide automotive growth will entail higher risks in the years to come,” said Hoffecker. “To mitigate these risks, international car manufacturers need to balance their exposure.”

Electric Vehicles: Still-uncertain Economics

Will electric vehicles (EVs) ever really take off? Ultimately, it depends on economics, not environmentalism, says the AlixPartners study. And the key on that front is making a quantum leap forward on the cost of battery packs, which make up 35 to 40 percent of the cost of an EV, while at the same time also making big improvements in every other major system.

The study notes that while EVs captured just 0.5 percent of the market globally last year, in Norway and the Netherlands—both countries with heavy economic and infrastructure incentives toward EVs—market share for electrics stands at more than 6 percent. This suggests that economics really are the main driver in EV adoption. Absent such incentives or a battery breakthrough, says the study, EVs might stall.

Connected Cars: The Race Is On

According to the study, the global market for Internet-connected vehicles will grow by 20 percent annually over the next three years and is expected to approach $50 billion by 2017, driven by sales of hardware, telematics services, data services and in-vehicle services and applications. In 2017, predicts the study, some 56 million cars will be shipped with telematics and infotainment systems – 53 percent of those will be embedded systems, 31 percent will be tethered systems using an external SIM card and 16 percent will run solely on smartphones. Regional penetration is forecast to vary, with China leading in absolute terms while North America and Japan experience the highest penetration levels, with connected cars over 80 percent of total sales.

Future connectivity will need to accommodate many aspects, says the study, from car-to-car and car-to-infrastructure communication, to driver information and entertainment, to advanced online services. Thus, automakers and their suppliers will have to develop and test several technologies. As hardware will likely be commoditized, OEMs should focus on the user interface and experience, while changing the way they design and source suppliers in this area, suggests the study. It also notes that some OEMs are fighting to control and monetize these services, while others are more open and seeking to leverage other companies’ capabilities.

“Betting on the right systems and partners for connected vehicles will be a key success factor not only for OEMs but also for their Tier 1 suppliers and technology providers,” said Wakefield. “While a proprietary system offers more control, a more open-source platform might develop faster. This is not like designing and sourcing traditional components.”

Meeting the Regulatory Challenge: Mission Impossible?

With emissions standards and testing cycles converging globally, fuel consumption and carbon-dioxide emissions have become an even bigger topic for the automotive industry. Currently, says the study, the industry is on target concerning the current standards, but meeting globally-converging emission requirements in the next decade will take breakthroughs not yet widely adopted. Overall, the AlixPartners study expects the next round of emissions standards to produce additional costs of about $800 to $1,600 per vehicle.

Further downsizing is one way to lower emissions and cost, says the study. Between 2001 and 2012, the average engine displacement in Europe decreased from 1,710 to 1,650 cubic centimeters, according to the study. Another way is the use of stronger and lighter materials. Between 2008 and 2012, says the study, the weight portion of regular steel in an average US light vehicle has gone down 17 percent. At the same time, the amount of high- and medium-strength steel has increased by 13 percent, while the amount of aluminium has increased by 15 percent. For the next decade, the study forecasts the use of high-strength steel to grow by about another 30 percent, at the expense of traditional steel.

“The high price of aluminium still prohibits its abundant use in the A and B segments,” said Hoffecker. “Here we will likely see it limited to engine blocks, castings and wheels for the near future. In passenger cars, the biggest aluminium growth we will probably see is in the C and D segments, where penetration rates still show upside potential compared to the E segment, which already relies heavily on lightweight materials of all sorts.”

Suppliers: Challenged by Mega-platforms

The AlixPartners study finds that while automakers worldwide are forging ahead toward the widespread adoption of global “mega-platforms,” auto suppliers are in general far from being ready to effectively handle such platforms from their end. In particular, the study notes shortcomings in such areas as the ability to handle global quotes, cross-region modular designs and standardized operational processes across regions.

“OEMs are adopting true global platforms; that’s here to stay,” said Hoffecker. “Suppliers that don’t step up to that challenge, and quickly, will likely find themselves left behind in the not-too-distant future.”

About the Study

“Caution: Blind Curves Ahead: The AlixPartners Global Automotive Outlook” is based on an analysis of more than 300 global suppliers and more than 50 global automakers.