The transformation of the automotive industry is happening at an incredible pace. In today’s world, three powerful forces are rolling the auto industry, which is the shift in the consumer demand, strict regulatory requirements for safety and fuel economy, and the increasing necessity for the automation of the manufacturing processes.
In a continuous dynamic environment, a strong financial performance as an automobile manufacturer entails rapid technology adoption and frequent introduction of new models and revision of the existing ones. Moreover, besides the aforementioned, car makers need to be extremely focused on their cost structure to sustain several volatilities faced within the industry. The direct manufacturing costs, in this industry, generally account for c. 80% of all cash operating expenses, with raw materials accounting for c. 70%-90% of direct manufacturing costs. Furthermore, steel makes up roughly 50% of the raw material cost allocation. Considering the fact, that steel prices have been volatile over different quarters of 2012 to 2015, companies have selectively adopted hedging of steel to contain raw material price volatility to broadly match their order book.
Additionally, labour is another major cost for the automobile manufacturers after raw materials. Televisory compared the labour cost for GM and Toyota. The GM’s total hourly labour cost was c.$70 which included wages, pensions and health care for active workers. Further, it paid the pension and health care costs to more than 432,000 pensioners and their spouses. On the other hand, Toyota’s total labour cost was c. $48, in addition, they had fewer pensioners to support coupled with the benefit of lower pension and health care benefits.
As a result of higher costs like the ones above, GM has a lower net profit margin than that of Toyota. In spite of this, GM’s ROE was the highest amongst the four players mentioned in the below table. This is attributable to GM’s lower capital base which has led to a higher equity multiplier in comparison with Toyota’s (as stated below in the Du-Pont Analysis).
The following table displays the breakdown of the ROE and GM ROE Vs. Toyota ROE.
Source: Televisory’s Research
Source: Televisory’s Research
Over the past decade, regulatory compliance has gained significance in the industry. The Stringent Corporate Average Fuel Economy (CAFÉ) regulations, as well as mandated safety equipment requirements, were imposed in the US and the rest of the world, this subjected automakers to incur higher costs for complying with the standards. For instance, the directive from the US Department of Transportation to have backup cameras as a standard safety equipment in the new models has further pushed up the costs. CAFÉ regulations state that by the year 2021, all vehicles in the US are mandated to have a sales-weighted average fuel economy of 45mpg. Similarly, vehicles manufactured in the EU region should not emit carbon dioxide in excess of 95 grammes per kilometre. In response to stricter fuel economy standards, a few car makers are now attempting to use the aluminium body for the vehicles as opposed to the earlier usage of the metal which was restricted to the engine parts and heat exchangers. Further, with every 10% reduction in the weight, the fuel economy increases by 5 to 6%. Although aluminium is two times more expensive than steel, it is lighter with identical strength. In the recent years, an all-aluminium body model was launched by Ford to reduce weight and thus, enhance fuel efficiency. In addition to the utilisation of lighter manufacturing material, automakers such as BMW, Fiat Chrysler and Mazda are meeting stricter fuel economy mandates via a combination of better performing turbo engines and improvement in the aerodynamics.
The regulatory requirements have assumed greater importance with the revelation of the Volkswagen emission scandal in 2015. VW recalled millions of cars worldwide and set aside around € 6.7 billion to cover the costs, this resulted in posting the first quarterly loss in 15 years of about €2.5 billion for the company. In 2015 and at the end of the financial year ending in the same period, its peers, on an average, observed a healthy sales growth of c.16%. Volkswagen’s sales, however, grew by c.8% YOY, albeit this was a higher growth as compared to 2014, but lower than that of the industry. In spite of this, Volkswagen’s return on equity nosedived to minus 5% in 2015 from 36.6% in 2014 (as can be seen in the below chart) due largely to the write off mentioned above.
Source: Televisory’s Research
Therefore, to conclude, the automotive industry, despite being highly competitive is going through a phase of extreme turbulence with each player trying to increase their market share. Automakers are fighting on distinct fronts which includes volatile macroeconomic factors, challenges of newer technologies such as battery operated or self-driven cars and increasing environmental regulations. The automotive companies continue to pour a huge amount of money into research, development and launch of new models employing enhanced and environment-friendly technology. This implies that only those automakers who continuously monitor and improve their operational efficiency and meet the ever-changing dynamics of the sector will manage to survive and thrive in this competitive industry atmosphere.
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