Global challenges and strategies in the automobile industry

Internationalization

The automobile industry is one of the most globalized industry in the world. Yet, it is still subject to a considerable amount of fragmentation. The industry features global giants (Ford, Toyota, Volkswagen) but many nations also have local automobile industries to compete with the global firms (SEAT in Spain, Proton in Malaysia, Tata in India, for example). The industry is faced with a number of challenges as well. In the long-run, higher oil prices is changing the types of vehicles that are being demanded, and the global economic slowdown also impacted the auto industry. Two of three major U.S. automakers -- among the world's largest -- have been the recipient of significant government aid that has strengthened firms that only a few years ago were ripe for the taking by aggressive competitors. A high-volume, low-margin manufacturing industry, the automobile industry is one of the world's largest and most important, so the strategic implications of the internal and external environmental changes that the industry is facing are significant.

This report will outline and analyze both the environment and the impacts that these changes will have for automakers. An understanding of international business theory and the implications of that theory on the industry will also be undertaken. The firms competing in the auto industry utilize a number of different strategies, and there will be some discussion of those strategies. Finally, some conclusions will be drawn with respect to what the key success factors in the industry.

Industry Environment

There are a couple of different frameworks that can be used to understand the industry environment. The PEST analysis covers some of the basics with respect to the external environmental forces that can have an impact on a company's operations around the world. Porter's Five Forces analysis examines an industry through the profit drivers of the business, with the intent of understanding how profitable a business is.

The political environment is generally favorable to auto industry firms, as cars are viewed favorably by virtually every nation. There are a couple of major challenges that can emerge in certain nations, however. The first is environmental regulation, which can drive innovation but also change the economic structure of the industry, forcing automakers to discontinue previously successful models or make dramatic alterations to vehicles in order to meet stringent new requirements. An example would be emissions laws -- for example in the large California market auto makers were compelled to launch legal action against the state in order to protect themselves from the impact of new emissions standards (Egelko, 2007). The second is protectionism. Many nations that have domestic auto industries protect those industries with duties, taxes and other trade barriers, and this presents a challenge to foreign players attempting to break into that nation (Chrysler, 2007).

The economic environment is today generally favorable for automakers. While auto sales slumped during the global economic downturn, rapid economic growth in Asia combined with slower recoveries in Europe and North America have resulted in an encouraging environment for auto sales. The major economic consideration is the current high oil prices, and in particular the long-run trend in oil prices. This makes larger vehicles, which carry higher margins, less economically viable (Human, 2011). It will also necessitate a continuing shift towards more efficient vehicles, and this necessitates a greater investment in research and development.

The social environment is generally favorable towards automakers. Billions of people, especially in the developed world, are dependent on automobiles and this gives tremendous advantage to automakers. That manufacturing facilities are a major source of jobs in the regions where they are located also gives advantage to manufacturers because this gives them bargaining power with local politicians. There is a broader social trend towards environmental consciousness, but this trend is moving relatively slowly, so that automakers can also move slowly in order to take advantage of the trend. Only if they completely ignore the trend will automakers suffer negative consequences, as happened to American automakers in the 2000s.

The technological environment has reduced the need for labor in automobile manufacturing. This has resulted in more efficient production and lower defect rates. In addition, it allows for automakers to negate one of the traditional disadvantages faced by the large American companies -- a large retiree force whose benefits must be paid for. Technology may one day present a threat to automakers with respect to a substitute product for automobiles, but that is not a significant threat at present and is not expected to be at any point in the near future either.

The Five Forces model analyzes the forces that impact on the profitability of companies. For the auto industry, the bargaining power over suppliers is high. Many auto industry suppliers are entirely dependent on the industry. The industry is often aware of the cost of inputs and uses that to drive down prices. Automobiles are a high-volume, low-margin business so there is significant incentive for automakers to leverage this power. The one exception to this is the auto unions in the U.S. And Canada. Their past high bargaining power has left the American auto industry with massive retiree obligations that have crippled the industry and forced government intervention to save two of the three companies (Brower & Johnston, 2010) the industry's bargaining power over buyers is low. Buyers are price sensitive, and will often delay purchases if need be to get the deal they want. Buyers are often well-informed about the competition on the marketplace, as automobiles are a high-involvement purchase. Buyers often bargain, in addition to being sensitive to list price.

The threat of new entrants is relatively high. For a long time, there were no entrants in the industry. Despite the high costs of entering the industry, many sovereign governments support auto industries in their countries, and this allows new competitors to flourish. Eventually, these new competitors will arrive in international markets. Japan and Korea have both become major players in the U.S. market in the last forty years, after not being in the market at all for the previous sixty. The threat of substitutes is moderate. There is a relatively low threat from alternate modes of transportation such as public transport and bicycles, largely because most of the world's human settlements are built around the automobile and roadways. In emerging markets, the strongest substitute threat is from motorcycles, because they are cheaper and in tropical countries they can be used year-round. In developed markets, the most significant threat comes from used cars -- strong secondary markets are a significant threat to the new car industry.

The intensity of rivalry in the auto industry is variable from country to country. The auto industry in most countries has a relatively high degree of fragmentation, but other factors increase the intensity of rivalry. These other factors include high exit barriers, industry overcapacity, high brand identity, high fixed costs and the relatively low diversity of rivals. All told, the auto industry is only moderately favorable. Despite high power over suppliers, there is low power over buyers. The other factors are only moderately favorable, which implies that the industry overall is moderately favorable, and industry players need to work hard to reduce the threats to their pricing power.

Strategy and Structure

Automakers have covered the globe using two main strategies. They produce primarily in a handful of countries -- usually major auto markets -- and do so either on the basis of wholly owned subsidiaries or joint ventures. The latter decision depends on the political environment of the country in question. This model allows automakers to reduce expenses in two ways. The first that they can avoid many of the duties and other trade barriers that are levied on automobiles by producing in the major auto consuming nations. According to OICA (2011), the top auto-producing nations are China, Japan, the U.S., Germany, Korea, Brazil, India…the major auto consuming nations. This implies that the size of the local market is of critical importance in determining where automakers will locate their production facilities.

That the type of market entry for these production markets varies indicates that the type of market entry necessary to enter is not a determining factor in the market entry decision, implying that trade barriers probably play a bigger role. Global automakers also undertake the production and exportation strategy. The way that this is conducted appears to be moving from a single production source model to more of a hub-and-spoke model that emphasizes regional production. For most of the 20th century, automakers produced in their local markets and competed in global markets largely based on exportation. Today's model still relies on centralized production and exportation, but the centralization aspect has been decentralized to regional centers of production rather than global centers of production. A nation such as Thailand has therefore become a production center for Southeast Asia, Turkey for the Middle East, Poland and Russia for Eastern Europe, India for South Asia and Brazil for South America. These regional production centers not only allow automakers to operate in the major markets, but to ship to the smaller nearby markets at a lower cost than would be possible with centralized production.

The next step in the strategy appears to be shifting production to low cost production centers and then exporting back to home nations. Should there be a shift in trade policy large enough to facilitate this, automakers would undoubtedly prefer to produce in low cost centers and then repatriate those vehicles to the home market. At present, the importance of auto industry jobs reduces the odds of gaining political acquiescence for such a strategy.

Key Success Factors

Automobile buyers are price sensitive, but firms can address this by lowering their own cost of production. They do this in part by lowering the barriers to entry with respect to key markets, usually by locating production in those markets. In addition, automakers can lower their cost of shipping by producing regionally rather than globally. This is a reasonable strategic response today because of the high volume of auto sales compared with decades past. Local production allows automakers to have better access to major markets, but it also allows in the long-run for automakers to shorten their supply chains. Suppliers are cultivated in the countries in which production is located, and the result of this is that the automakers have supplier arrangements around the world.

Another benefit of localized production that relates to the second key success factor is that the social environment is different in each country. With unique cultural traits, political/legal considerations and geographical/climatic conditions, the ability of auto companies to tailor their vehicles/lineups to each individual country is critical to appealing to the world's large variety of consumers. Some models are produced around the world, but for the most part models are tailored to individual regions and countries. In addition, there are sometimes substantial differences in consumer preferences from one country to the next and localized production allows for better management of production levels for different products. If this function was centralized, it would be difficult to estimate global demand for a given product, and the errors could be financially catastrophic.

Another key success factor for automakers is cost containment. This encompasses a number of variables, including labor costs and production efficiency. America's legacy automakers have very high fixed costs for labor and this has compelled them to move production to lower-wage countries. In addition, the use of production in multiple countries allows for more creative problem solving. Innovations in automaking today come not just from North America but Asia and Europe as well. For automakers, a presence in multiple countries around the world allows them to maintain competitiveness in production engineering by maintaining access to the industry's best thinkers.

Conclusion

Most automakers today are highly internationalized. They are all dependent on their domestic markets for financial strength, and usually operate with a geographic organizational structure with centralized head office and R&D. Most automakers have geographically diversified production, however. Parts markets tend to follow production, so that a Ford car made in Asia may not have very much American content at all. That many overseas automakers are the result of joint ventures only further adds to the international influence in the auto industry. That said, the major players in the industry do tend to come from one of a half dozen countries in the world, lending the industry a strong influence from those nations, regardless of how many other countries may contribute to the inputs.

It is interesting that the level of internationalization of automaking has actually changed little in the past several decades. The industry is still fragmented internationally, with a handful of global players and a slate of national producers. More countries have become powers in auto production, and some of them have done so by encouraging foreign direct investment rather than by building their own industries, but there are still examples of the latter. Government involvement in the industry is generally high in either case, and there is no expectation that that will change any time soon, especially given that the U.S. government remains heavily involved in its auto industry.

Works Cited:

Brower, K. & Johnston, N. (2010). Obama makes sales pitch for auto bailouts to skeptical voters. Bloomberg. Retrieved May 3, 2011 from http://www.bloomberg.com/news/2010-07-30/obama-trumpeting-success-of-automaker-bailouts-to-skeptical-u-s-voters.html