Car sales around the world dried up in the last quarter of 2008. What are the prospects for an industry so reliant on credit and consumer confidence?

Correction to this article

Bloomberg News

THE symbolism of the freezing temperatures in Detroit this week was lost on no one. The mood at the annual motor show was sombre, the razzmatazz noticeable only by its absence. Nobody needed reminding that General Motors (GM), normally the dominant exhibitor and until recently the world's biggest carmaker, would be in the bankruptcy courts but for emergency federal loans just before Christmas. GM's plight is only the most dramatic expression of the bleak state of the global car industry. Sales figures published the week before the show confirmed what everyone already knew: the second half of 2008 saw the most savage contraction of demand since the modern industry was formed after the second world war.

No company or country has been immune from the collapse. Last month sales of cars and light trucks in America fell by 35.5% compared with a year ago (see chart 1). In France, despite government incentives designed to prop up the market, sales were down by 16%; in Spain they fell by almost half; in Japan by 22.3%. Even in Brazil and China years of double-digit growth turned into sharp declines in the last quarter of 2008.

The woes of Detroit's Big Three carmakers have received most attention because of the toxic cocktail of factors that has made them especially vulnerable. They relied too much on mammoth pickup trucks and SUVs, which no one wanted when petrol prices hit $4 a gallon. Their finances were already strained after years of restructuring. And they were the most exposed to the American market, which was hit first and hardest by the financial crisis.

Beyond Detroit

But in the past few months the agony has spread to just about every other leading firm. Judged by American sales over the whole of last year, the Big Three suffered most. Ford and GM dropped by more than 20% in 2008, and Chrysler by 30%. Toyota, number two in the market, fell by 15%; Hyundai, Nissan and especially Honda (down by 8%) did a little better. However, the year-on-year figures for December show that the pain was more evenly distributed by the end of the year (see chart 2). Except for Chrysler, where sales dived by 53%, almost all the big carmakers suffered percentage declines in the low to mid-30s. Toyota and even Honda did slightly worse than both GM and Ford, which may have discounted prices more heavily in the run-up to Christmas.

Prestigious brands have been clobbered as much as volume manufacturers. BMW's American sales fell by 40% in the year to December and those of Mercedes by 32%. Rolls-Royce, whose customers might be thought impervious to hard times, sold 29 cars in December 2007, but precisely none last month.

The cause is no mystery. It all began more than a year ago in America with the subprime-lending crisis and then the doubling of oil prices. Buyers with below average credit ratings found it increasingly hard to borrow to buy cars, new or used. Dearer pump prices set off a scramble to swap gas-guzzlers for smaller vehicles, which in turn led to a collapse of residual values. By the second half of 2008 the contagion of tightening credit and waning consumer confidence was spreading to other mature markets in Europe and Japan. Even the BRICs (Brazil, Russia, India and China), the great hope of the global car industry, slowed from a sprint to a limp.

However, the real trouble came only in November, in the financial meltdown begun by the failure of Lehman Brothers. As the credit system seized up and stockmarkets panicked, global car sales buckled. According to different estimates, the volume of world car sales in November fell by between 20% and 24%. Nigel Griffiths, the head of automotive forecasting at Global Insight, describes the “highly synchronised nature” of the collapse in light-vehicle sales at the end of 2008 as “completely without precedent”.

That view is shared by Sergio Marchionne, the blunt-speaking architect of the near-miraculous revival of Fiat. In an interview last month with Automotive News Europe, he declared: “What we are seeing is unprecedented. I have never seen the failure of so many systems at once.” Asked for his sales forecasts for 2009 and 2010, Mr Marchionne, who has a reputation with analysts for keeping his promises, confessed: “I honestly do not know. It's not that I refuse to make a projection. I just don't have a reliable context in which to make the projection…I abstain.”

Mr Marchionne can at least be thankful that Fiat (except Ferrari and Maserati) is not exposed to the American bloodbath and is in its strongest financial condition for many years. Nonetheless, he makes no bones about the priority for the coming year: survival. He says: “We're just going to slam the brakes on, use as many temporary lay-offs as needed, cut everything back to essentials. It's like going swimming but never knowing if you can stand up because the bottom is so unstable you simply can't tell when you have reached it.”

Almost every carmaker has a similar plan. Toyota, the world's biggest and most profitable, expects its first-ever operating loss in the financial year that ends in March. It said on January 6th that it would cease production for 11 days in February and March at all 12 of its factories in Japan, and that it would sack half its temporary workers and negotiate wage cuts with permanent staff. It had already decided to halt work for three days this month and to reduce output by 27%. GM and Ford have cut back by a similar amount.

Across the world carmakers are mothballing factories and dropping shifts. They are postponing or aborting the launches of new models. They are offering huge (and unaffordable) incentives to lure bargain-hunters into empty showrooms. But even these drastic measures may not be enough to save large parts of the industry.

The reason is chronic overcapacity, exacerbated by a recent binge of factory-building. CSM Worldwide, an automotive-market consultancy, estimates that the world could produce about 94m cars a year—about 34m more than it is buying. In North America alone, capacity exceeds demand by around 7m vehicles. In the seemingly insatiable BRICs, the lag between the burgeoning demand of the past few years and the investment to meet it means that dozens of new factories are coming on stream at precisely the wrong moment.

Struggling with closed credit markets and insupportable operational gearing, carmakers are going cap-in-hand to governments to plead for loans to get them through the next few months. Some, such as GM and Chrysler in America and possibly Jaguar Land Rover in Britain (bought last year from Ford by Tata Motors of India), need state loans just to stay in business; others are demanding money to stave off the permanent closure of factories. Nearly all are urging governments to provide them with the cash to allow them to carry on lending to customers.

Liquidity and lubrication

How much of the downturn in sales can be attributed directly to the freezing of credit is hard to say. But credit is the lifeblood of the car business. More than two out of three sales in Europe are credit-financed. In America more than 90% of new cars are bought with some form of financing. For most customers, no credit means no new car.

Credit is the carmakers' most potent marketing tool. Finance is made available to dealers to ensure they hold adequate inventories and to give them an incentive to “move the metal” (support is withdrawn for cars that remain unsold for too long). It also allows them to offer loans at low interest rates or leases on attractive terms, perhaps packaged with insurance or maintenance. Cheap finance is often a better tool for carmakers than a straight rebate on the purchase cost would be, because it helps maintain both the prices of new cars and residual values.

What has made the credit crunch so painful for carmakers is the almost total dependence of their captive financial-services subsidiaries on wholesale funding, which has become scarce and expensive. In May Daimler's finance arm paid 5% on a bond issue; in December it had to pay 9%. Late last month GMAC (attached to GM) received $6 billion from the American Treasury's Troubled Asset Relief Programme; almost at once GM and its dealers offered 0% interest on five 2008 models and relaxed their lending criteria.

State backing can help for a while, but unless other sources of funding reopen soon, the future will remain grim. According to Exane BNP Paribas, the five largest European captive finance businesses will need to raise €10 billion ($13 billion) in medium- to long-term debt this year. They will also have to absorb rising losses on bad loans to customers and dealers, as well as the cost of returned lease cars that are now worth far less than once assumed.

All the signs are that governments in Europe as well as the new administration in Washington will help their national carmakers—at a price. The president of France, Nicolas Sarkozy, has made it clear that support for PSA Peugeot-Citroën and Renault will depend on production staying in the country. Other governments are likely to impose similar conditions. However, because of their relative financial strength, European and Asian car firms will be better placed than the Big Three to resist political interference in the running of their businesses once the crisis is over.

That is why Ford is still hoping (with some prospect of success) to get through the year without having to ask for a handout. It has indicated it would like access to a $9 billion short-term credit line if there is no improvement in the market during the second half of the year, but it is desperate to avoid being cast as a basket case as GM and Chrysler have been.

Of all the 11 big volume carmakers, Chrysler is the most likely to disappear this year. Customers are deserting it in droves; its product quality, according to the latest Consumer Reports survey, is so far below its competitors' that the magazine could not recommend any of its vehicles; its pipeline of new models is almost empty; unlike Ford and GM, which have successful foreign subsidiaries, it is almost entirely reliant on the brutal North American market; and its majority owner, Cerberus Capital Management, would love to be shot of it. The best that Chrysler can achieve with the $4 billion lent to it by the federal government is either to engineer an orderly bankruptcy or to attract a bottom-feeding buyer by dressing up the bits that could be sold—the Jeep brand and possibly Chrysler and Dodge minivans.

GM's position is more complicated and will prove a test for the new administration and Congress. For a start, it is bigger than Chrysler: so big, indeed, that its failure could bring down hundreds of parts suppliers on which Ford and the Asian “transplants”—Toyota, Honda and Hyundai—also depend. That almost systemic risk to America's light-vehicle industry persuaded the reluctant Bush administration to stump up $13.4 billion to keep GM going until Barack Obama's team decides what to do with it.

GM, unlike Chrysler, contains a profitable business struggling to get out. Its products have been improving rapidly and it has the technological resources to be a leader in low-emission powertrains. The Chevrolet Volt, a plug-in hybrid, is due to be launched next year. Despite its difficulties at home, it is strong in most big markets abroad, especially China, which within a few years will be the world's largest.

That said, GM has well-known problems: too much debt, too many dealers and brands, high labour costs, and crippling liabilities to pensioners. In its plea for bail-out funds last month, the company promised to shed up to 31,000 jobs, close nine plants and renegotiate a four-year labour contract which it signed with the United Auto Workers (UAW) in 2007. GM also wants to close 1,750 dealerships, possibly eliminate its Saturn brand and convince banks and bondholders to swap two-thirds of its debt for equity. Under the terms of the loan, GM must show that all this is in place by February 17th to qualify for the final $4 billion payment. Unless the Obama administration is more sympathetic than its predecessor, GM must win the approval of its stakeholders by March 31st or be forced into repayment of the loans and certain bankruptcy.

If GM misses the deadline—possible, given displays of reckless brinkmanship by the parties involved—or scrambles over the line but still needs more money to stay in business, it will be at the mercy of congressional Democrats who would like to make it an instrument of their environmental agenda. Nothing would damage its long-term prospects more than being forced by politicians to build cars for which the market is not yet ready. If Congress wants GM to make more fuel-efficient cars it has a far better remedy at hand: raising taxes on petrol, which is once again absurdly cheap.

Whatever happens to GM, the effects will be felt throughout the industry. Its competitors may fear its demise; but a weaker, smaller GM, which looks the likely outcome, would suit them just fine. Toyota, with its $50 billion pile of cash and marketable assets and its huge manufacturing presence in North America, stands to gain most. It has the financial strength to keep factories ticking over until the upturn, and a management culture that is comfortable playing a long game.

Honda would benefit too. It has won a lot of market share in the past couple of years, thanks to its bestselling Accord sedan and its economical small cars. So, perhaps more surprisingly, would Ford, which ranks third in America, just ahead of Honda (and behind GM and Toyota). If it can get through this year as the only indigenous carmaker not to need a bail-out, it will be well placed to appeal to patriotic buyers when demand picks up. It also stands to gain from whatever concessions GM can wring from the UAW.

Looming in the rear-view mirror

Among European carmakers, the Volkswagen (VW) Group, which includes Audi, Seat and Skoda, is best placed to emerge stronger from whatever horrors the next 12-18 months have in store. Last year it overtook Ford to become the world's third-biggest producer, and a shrinking GM may feel VW's breath on its collar before long.

VW boasts excellent products in every segment. It has unrivalled strength in emerging markets, especially China, where its market share through two joint ventures is 18%, and Brazil, where it has a market share of 24%. It has the fastest-growing premium brand, Audi, which broke through the 1m sales mark in 2008. And it plans to expand fast in the United States, tripling sales by 2018, thanks to several new America-only models that will be the first VWs to be built in the country for more than 20 years.

AFP

D is for Doomsday

Even the extraordinary takeover of the group by Porsche could turn out to be a help. The two managements appear to have reconciled their differences, and the addition of Porsche to the group's stable of luxury and sporting brands will bring scale economies in developing the technologies needed to make such vehicles environmentally acceptable. That may give them an edge over their German rivals, BMW and Mercedes.

For those two firms, the next couple of years are likely to be difficult. Their eager pursuit of lease sales in America and Britain has left them highly exposed to tumbling residual values. Between them, they have already written off more than €1.5 billion on lease returns, with more to come. They must also spend a lot on developing fuel-efficient models to meet European Union emissions rules that come into force in 2015, without sacrificing the performance their drivers expect.

Among Europe's volume producers, Renault is suffering not just from the extreme market conditions, but also from the cool reception for new models such as the Laguna and the Megane. And unlike PSA Peugeot-Citroën and Fiat, it is exposed to the bombed-out American market through its 44.4% shareholding in Nissan. Fiat has rediscovered the happy knack of making money from building the kind of small cars that are right for the times, but it is far too reliant on Brazil, which accounts for over 50% of its operating profit. Mr Marchionne sees the danger all too clearly, not just for Fiat, but for the whole industry.

He believes that to have any chance of making money in the future, volume manufacturers will need to produce at least 5.5m cars a year (Fiat, he admits, is not even halfway there). The only answer, he thinks, is rapid consolidation. “Our strategy of industrial alliances was a step to get there. But given where demand is now and what we see going forward, it is too slow.”

Many will quarrel with Mr Marchionne's view that in two years' time there may be room for only six global mass producers. But it is hard to argue with his contention that only the biggest firms can afford the €500m cost of a new car platform. Mr Marchionne says: “We need to bring people round the table and say, ‘Look guys, the party is over. Someone called our bluff and we're not all going to make it, so let's fix it.'” Unfortunately, the sad spectacle of GM is a sign that, these days, even size is no guarantee of survival.