Internationalization 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.

Growth and Development of the Auto Industry

The growth and development of the auto industry has been subject to a number of different dynamics over the years. Early growth internationally was led by the major firms that were located in developed nations. These nations had the right factor inputs -- notably in raw materials and production -- and the right conditions for rapid growth. Government policy, including road building and the wars of the early 20th century, facilitated heavy investment in research and development in the auto industry. Postwar peace and prosperity, along with the societal trend towards suburbanization, brought the auto industry into even greater prominence. From strong domestic markets, automakers were able to sell their products overseas. Eventually, this led to production overseas as well.

Local auto industries developed, and in some of the stronger nations these were given significant protection as infant industries, and but those protections remained after the industries had become large. Japan was the first new nation to begin exporting cars and they were followed by South Korea. Other nations began to adopt the model of heavy government protection in order to develop their own industries. Many of the newer nations focused on low cost production, leaving differentiated strategies to foreign firms.

The third major stage of the auto industry's internationalization came when the larger automobile companies began to set up production overseas. Some nations, due to their stability and access to factor inputs, became hubs of production. Thailand is one of the international hubs of auto production, attracting automakers from a large number of countries (Chrysler, 2007). Production is concentrated in a handful of major automaking nations. The largest of these is China, where most production is for domestic consumption (OICA, 2011). As with many protected markets, foreign automakers have only gained access to the Chinese market through joint ventures. Unlike with Korea or Japan, China's auto industry is not a home-grown enterprise but rather relies on foreign direct investment (Tang, 2009). Volkswagen, GM, Japanese and Korean companies have all entered the Chinese market through JVs with local concerns (Ibid). The trend towards consolidation is driven by the increasing dominance of the world's largest automakers. Smaller national automakers are becoming obsolete, and some nations have seen their automobile production decline to almost nothing (Finland, Serbia and Egypt for example, OICA, 2011).

Foreign automakers typically make use of joint ventures for a couple of main reasons. As the Chinese example illustrates, market access is a key factor. Many nations have highly protected auto industries or auto markets that make it difficult to set up greenfield subsidiaries. As a result, joint ventures with local firms are necessary to get around foreign ownership laws. In addition, joint ventures give the company better access to local parts suppliers, better access to local labor and helps them to overcome political and cultural barriers. The high risks inherent in the auto industry with its high fixed costs necessitate undertaking whatever strategy will reduce the risk. Automakers typically go greenfield when expanding to safe countries, for example Canada, but in the developing world most automakers seek the security of having a local partner.

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.