Global Economics

German Auto Industry Facing the Abyss


Carmakers in Germany are facing their worst crisis in decades, with hundreds of thousands of jobs at risk. BMW and Mercedes are especially vulnerable

It was time for Martin Winterkorn to relax. The exhausted chairman of the VW Group was sitting in a leather seat on the company jet, coming from a conference in Berlin where he warned attendees of the consequences of the financial crisis. It had been a long day. It was 9 p.m. and he was still in the air.

"We have never before seen this kind of a crisis," Winterkorn, 61, said at the conference. The German auto industry, he told his audience, must prepare itself for a "tough, prolonged dry spell." It would not be possible to avoid "difficult cuts" and "painful" measures, Winterkorn said.

Even after the conference, sitting in the company jet, the head of VW was still preoccupied with the question: "How bad is it really?" Winterkorn has been in the industry for decades, and he has weathered many a crisis. But now he too is baffled. "I don't know what else is going to happen," he said.

According to Dieter Zetsche, the CEO of Daimler, there are those in the industry who believe that "up to 100,000 jobs will be lost in the German auto industry in the next 10 years." Some, says Zetsche, are even suggesting that this is "the worst crisis since World War II."

The Daimler CEO has already concluded that Mercedes-Benz will produce more than 150,000 fewer cars than planned in 2009. Management is negotiating with labor representatives over the possibility of Mercedes reducing the workweek to 30 hours, with a corresponding wage cut for workers, or introducing part-time work at the company. Daimler may have to cut several thousand jobs. How many? Zetsche, 55, is not even willing to venture a guess.

Sharp Decline in Sales

Norbert Reithofer, the 52-year-old chief executive of BMW, is similarly baffled. He believes the company is "in the biggest crisis in its history." BMW has already cut more than 8,000 jobs this year. Production in its plants is shut down for several weeks at a time, a step that Volkswagen and Mercedes-Benz have also taken. But this will not be enough to offset the sharp decline in sales. In some markets, auto sales have not dropped by this much since the 1973 oil crisis.

In October, car sales dropped by 32 percent in the United States and close to 15 percent in Europe. Sales are also down in former growth markets India and Brazil, while economic growth in China is weakening.

This crisis is different from the ones before it. Opel is fighting for its survival, because its parent company, General Motors, is on the brink of bankruptcy. Mismanagement at Ford and Chrysler has driven the two companies into similarly dire straits. This was predictable.

But now even VW, Mercedes-Benz and BMW are at risk, companies that were considered the most stable in their industry. Even executives at Japanese carmaker Toyota are worried. According to Executive Vice President Mitsuo Kinoshita, "the current situation is an emergency, of a magnitude we have never seen before."

There is reason for this massive, general uncertainty: The auto industry is being assaulted on several fronts.

Sales are declining rapidly worldwide. If there is one thing anxious consumers can postpone, it is the purchase of a car. Economic crises normally affect one major market, which allows large car companies to make up for the difference in other countries. But this time the financial crisis is shaking North America, Asia and Europe at the same time.

Suppliers are likewise threatened. Banks have cut off funding for necessary investments. Some suppliers are already on the verge of bankruptcy. If the biggest manufacturer of rear-view mirrors or door locks fails, carmakers will be forced to stop production, and it will be difficult to quickly find replacements.

Tens of Thousands of Jobs at Risk

Providing consumers with financing is also becoming more difficult. Part of the reason VW, Audi, Mercedes-Benz, BMW and Porsche have enjoyed such phenomenal sales growth in recent years is that they have offered customers attractive leasing and financing packages. Now the carmakers' lending divisions must pay high interest rates to obtain the necessary funds on the capital markets, if they can borrow at all. As a result, they can no longer attract customers with low-interest car loans.

Ultimately, the entire business model of VW, Mercedes-Benz and BMW is beginning to falter. It is based on the assumption that carmakers can constantly increase sales by constantly introducing new models. This is the only way they can guarantee jobs. For car companies, standing still is in effect moving backwards. Companies that are not increasing sales are in fact shrinking, because productivity in their plants grows by 5 to 10 percent every year. Declining sales can potentially lead to the loss of tens of thousands of jobs.

Opel is not the only German carmaker seeking government assistance. VW, Daimler and BMW have also submitted their requests. They want Berlin to issue government loan guarantees on the loans taken out by the carmakers' financing divisions. They are also asking the German government to pay a premium to anyone who replaces a car more than 10 years old with a new one. And they want to see Brussels cancel its plans to impose penalties on manufacturers for failing to meet their CO2 emissions targets.

Still, its difficult not to think that some manufacturers are merely trying to divert attention away from their own mistakes. Many of the problems are homegrown. The companies placed too much emphasis on growth at all costs, while at the same time neglecting to develop fuel-efficient cars earlier in the game.

Nevertheless, the appeals for help show how serious the situation is. Some senior executives already question whether Daimler and BMW will survive the crisis as independent companies. And close examination reveals that both companies significant Achilles heels.

The biggest risk for BMW stems from its successes in recent years. The Munich-based company risked almost everything for its goal of finally overtaking rival Mercedes-Benz. BMW has almost doubled its car sales since 1999, and since 2007 the Bavarian carmaker has been the world's top seller in the premium class.

BMW has achieved this mainly by expanding its model line downward, with the 1 Series and the Mini. This weakened the company's profitability. But BMW has also boosted its sales by offering customers attractive leases and car loans; today this approach is used to sell every second car the company moves off its lots. This has increased risk.

While Daimler has only about €11 billion ($13.8 billion) on its books for leased vehicles, it is almost €20 billion ($25 billion) at BMW. That is BMW's major weakness.

BMW based its leasing calculations on an estimated residual value for the cars when customers return them after three or four years. But this value has little to do with reality these days, because used car prices fall during an economic crisis. Besides, more and more customers who purchased a BMW on credit can no longer afford their car payments. In the first nine months of this year alone, BMW had to establish reserves of more than €1 billion ($1.25 billion) to make up for the difference, and more reserves are likely to follow.

The second risk for BMW lies in the fact that customers are increasingly buying smaller models, or at least are opting for smaller engines in the larger 5 Series and 7 Series. Because of this, Munich-base engine factories have slid into the danger zone this year.

Waste of Money

"We are producing the wrong engines," Manfred Schoch, the chairman of BMW's works council, warned. The plant can satisfy the demand for eight-cylinder engines in single-shift operation over a four-day workweek. Six-cylinder engines are also becoming less popular, so much so that production could be shifted to the company's engine plan in Steyr in the future. This would "mean the death of BMW at the Munich location," said Shoch.

By introducing new working hour models, Schoch managed to reduce wage costs so that more four-cylinder engines can be assembled in Munich in the future, thereby saving the plant. But BMW still has the problem of having to achieve adequate profits with smaller models in the future.

The company is poorly prepared for this. Building the 1 Series with rear-wheel drive and the Mini with front-wheel drive is a complete waste of money, because it means that the two cars need different engines and transmissions, eliminating the savings that could be achieved with identical parts.

BMW CEO Reithofer and Daimler CEO Zetsche have long agreed that the two companies must work together. Daimler has the same problem with its A and B Class models, which are produced in numbers that are far too small. What would be more obvious than joint development of the platform for the next generation of entry-level models?

Engineers from both companies have been searching for possible joint projects for more than a year now. But everything they have turned up has only served as proof of why cooperation is impossible. Each of the partners is convinced that his development is the best. The companies have agreed to joint purchasing of windshield wipers, batteries and other parts, but nothing more.

'I Want to See Results'

In a recent board meeting, Reithofer was visibly irritated by this relative lack of cooperation. He told the group that he was no longer interested in hearing why things were not working. "I want to see results," he said.

The mood in Munich is tense, as layoffs have led to discord between the board of directors and the works council. Manfred Schoch, who heads up the BMW works council, complains that employees were simply left with no work to do, so that they could be bullied into signing a termination agreement. Schoch asks: "How low have we sunk?"

Ironically, BMW has probably the most flexible working hour models in the industry. Employees can accumulate up to 300 hours of overtime in working hour accounts or work up to 300 less than normal—and consistently receive the same wages. Only after an extended period of time are they required to balance out the working hour accounts. The result is that BMW can shut down a factory for two months without adverse effects on employees. Only after two months do workers face the threat of short-time work and further layoffs.

According to one senior executive, BMW would already have slipped into the red without this year's savings measures. The Quandt family, which owns a little less than 50 percent of shares, knows that this would immediately fuel speculation over a sale of BMW. To dispel such speculation, the reclusive Stefan Quandt appeared with BMW CEO Reithofer at a ceremony to award the "Golding Steering Wheel" at offices of the tabloid Bild am Sonntag. The clear message was that the family is sticking to BMW—for now, at least.

Daimler CEO Zetsche would welcome a major shareholder like Quandt. Zetsche's company, too, has a large Achilles heel: Daimler's shareholder structure. Because it lacks a major shareholder, the company is constantly at risk of being bought up and dismantled.

For this reason, the Stuttgart-based carmaker has to be managed using the same criteria that led General Motors to the brink of ruin: It must earn high short-term returns and pay large dividends. This is the only way to bring up the share price and thus prevent a takeover. But, under these conditions, how can the company be expected to continue designing cars that lead the world in technology, design and quality? And how can Mercedes-Benz justify its high prices in the long term?

The developers of the next A and B Class vehicles are feeling the brunt of this dilemma. Their investments must pay off at a planned sales figure of 350,000 vehicles a year. Of course, Mercedes charges higher prices for its models than VW does for its Golf. But VW sells almost twice as many Golfs, as well as using the same platform to build Audi and Skoda models.

"The Wolfsburgers can outfit the Golf with better equipment than we can provide with the A Class," complains one Mercedes developer. For this reason, Daimler's attempt to develop everything in the compact class internally could damage its brand image.

Distress at Daimler

VW has two major shareholders, Porsche and the state of Lower Saxony. Although the two are locked in a power struggle, they agree on one thing: Both are more interested in long-term development than short-term profits. In Daimler's case, pressure coming from the capital market prompted the company to buy back €5 billion ($6.25 billion) of its own stock.

The carmaker could have invested the money in the development of more environmentally-friendly cars. But this would only produce long-term profits, while reducing profits in the short term. It should thus come as no surprise that BMW has a small lead in the development of fuel-efficient technologies (including a start-stop automatic transmission and recovery of braking energy).

There is also another reason the crisis is causing such distress at Daimler. Normally, luxury cars like the world-famous sedans with the Mercedes star on the hood are not as sharply affected by an economic slump as mass-market models. But this appears to be changing. "The affluent still have the necessary money," says Daimler CEO Zetsche, "but some feel that it is no longer appropriate to drive a big car"—because of the crisis, but also in deference to the climate protection debate.

The mood is gloomy in Mercedes-Benz dealerships. At some dealerships, there are days when not a single new car is sold. When a customer does buy a car, it is more than likely a slightly used car with just 5,000 kilometers (3,100 miles) on the odometer—but already available at a 40 percent markdown.

Because many dealers also sell Mercedes trucks and this business has come to a virtual standstill, they are fighting to survive. Daimler has already provided its dealerships in Germany with €53 million ($66 million) to make up for losses, and €10 million ($12.5 million) for demonstration models. Now the company-owned dealerships, which expect combined losses of about €200 million ($250 million) this year, expect financial assistance.

In this crisis, CEO Zetsche is coming under growing pressure to search for a large-scale solution, in addition to the usual cost-cutting programs, to broaden the company's base. A joint venture with BMW would be one possibility. The second option, say experts, would be close cooperation with a technology company that could help the carmaker develop new drive technology. Under this sort of arrangement, Daimler could also be protected against takeover attempts through a capital investment by the new partner.

VW also at Risk

Volkswagen has already undergone a more or less friendly takeover. The new major shareholder, Porsche, whose sales have declined sharply because of a model changeover, secured its own technology by launching the takeover. The small sports car manufacturer now has access to Europe's biggest automaker.

But even the VW Group faces a serious challenge. The board must correct its model strategy. Until now, developers at VW headquarters in the central German city of Wolfsburg were fixated on developing more and more powerful engines. In addition to a 16-cylinder engine, the company has two different 12-cylinder engines—which not even BMW or Mercedes-Benz can offer. But this does Volkswagen little good, because smaller, fuel-efficient engines are now in demand.

It must have taken will power for Winterkorn, powerful engine enthusiast that he is, to see his company building three-cylinder engines. But the VW CEO has recognized that the future of the company depends more heavily on whether it can become the leader in this model class than on new, high-performance engines.

Winterkorn must also question his growth strategy, which involves almost doubling VW sales by 2018. This would have meant job security for the group's 330,000 employees. But because there is likely to be no growth at all in the next two years, VW has the problem of having too many employees, and company executives assume that VW will have to eliminate several thousand jobs. This will most likely affect some of VW's 18,000 short-term employees and its 25,000 temporary workers.

The board's initial goal is to prevent too many cars from being produced, since they could only be sold at a deep discount. The Christmas break at VW's Wolfsburg plant, already extended to last from Dec. 19 to Jan. 4, will likely be expanded even further.

For German automakers, the year 2009 will begin with eerie silence. It will be quiet in almost all plants, in Stuttgart, Munich, Regensburg, Rüsselsheim, Kaiserslautern, Cologne, Emden, Hannover, Braunschweig and Wolfsburg. All assembly lines will be shut down.

"We are about to face a serious test," says Daimler CEO Zetsche, and yet this does not make him pessimistic about the future of the German auto industry, not by a long shot. It is still more competitive than many other auto industries, not just from the United States, but also from France and Italy.

The crisis "is also a time of renewal," says Zetsche. "We will now see how well-prepared for the future our industry is."


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