10 June 2015

Europe's Profit Conundrum Continues

GM is finding profit elusive in Europe

In the mainstream area of car sales in Europe, profit is illusive. The continent is affluent so you would think it would be easier to stay in the black. Added to that is the fact that it is several years since the last economic fall, so plenty of time for conditions to improve. Sometimes car makers have to renege on predicted dates for a profit turnaround. Is it that difficult to work out, or is it a case undue optimism when these predictions are made? There are three reasons I can think of.

1) Tight margins. Mainstream car makers are on a knife's edge on pricing, volume and desirability of the product. Get those three right and profit will be there, albeit modest. Fail and the balance sheet can slip into minus territory quickly.

2) Delayed recovery. Pundits felt that things would have recovered by now. However, there is still uncertainty and issues that have not been resolved and they are keeping a full recovery somewhere in the future. Just as things appear to be coming right, another hiccup occurs.

3) Overcapacity. Because sales have not fully rebounded, many factories are still underutilised. A facility that is half idle is one that is unprofitable. The simple answer would be to close some plants down. However, governments quickly move to pressure car makers not to close a manufacturing plant for political reasons. Added to that, if things did improve then no one wants to be caught out with insufficient production volume to take full advantage of the upturn.

Summary: All of the above leads European car companies to try and keep their facilities busy. They may discount and/or preregister cars to move stock. That hits margins and undermines perceived value and therefore desirability. They can cheapen their own product going down that route. Still, if they refuse to chase sales and then appear overpriced compared with those discounting, they lose volume as a result. A catch 22 situation.

The answer: Be product driven, making desirable cars. Then they can ask a fair price for the car and still get the volume needed, with sufficient margin to make the accountants smile. There is nothing car makers can do about the economic situation and mainstream cars will always be price sensitive. Nevertheless, by designing vehicles that people desire to own - with a sound reputation of quality - and profit will be made. Building that sort of reputation and product takes years, and requires a well run company to get all those things mentioned sorted. The problem is most are not at that level and for them the profit conundrum continues.

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