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The European Automotive Industry

Problem Statement

PROBLEM DESCRIPTION
This project focuses mainly on the level and nature of competition in the car industry. Especially we are concerned with the market power of car manufacturers. Market power is closely related to the slope of the demand curve, which determines the discretion a company has over its prices. The reason for this is that in competitive industries, substitution within the industry is more likely. Thus companies cannot charge prices significantly above its competitors prices. This leads to elastic demand.

Firms with monopoly power face a downward-sloping demand curve, which means that to sell an extra car the manufacturer must lower the price on all cars produced (Disregarding the ability to price discriminate). Thus the marginal revenue of selling an additional unit will always be below the price of that unit. The firm will produce at the level where marginal costs equal marginal revenue. Since marginal revenue is always below price, the firm will gain monopoly rents.

Besides these static effects of competition vs. monopoly power there are also dynamic effects of competition. A major concern for many policymakers is the effect of the automotive industry on the environment. In this respect the combination of government policy and competition in the car industry, might provide a powerful incentive for invention of more environmental vehicles in the industry. E.g. if government increase taxes on fuel, the competitive industry will adjust and provide cars with better fuel economy, whereas the manufacturer with high monopoly power can more easily pass taxes on to consumers.

As mentioned the objective of this report is to describe the nature and level of competition in the European car industry. This is of great importance both to government and to individual producers, as the level of competition is closely linked to both economic efficiency and industry profitability. A clear perception of the industry drivers are also important for the manufacturers, both in order to make rational decisions, but also in order to understand the strategic interactions with competitors.

PROBLEM DEFINITION
Thus the main focus of this report is on describing the factors that influence the industry and the corporations within it with the purpose of:

Identifying and describing the most important market structures and drivers of the industry, and determining the effect these structure have on the conduct of corporations in the industry. Further we will discuss how the above affects the level of competition in the industry.

It should be stressed that we do not assume that the relationship between structure and conduct is unilateral, and thus conduct may affect structure as well.

We will also examine how market structure and the industry drivers are likely to change over time, and how this will affect the conduct of car manufacturers and performance of the industry.

In order to answer this question and the ones mentioned above we need to examine the following subquestions:

# What are the main features of the industry?
# How does these features affect the level of competition in the industry?
# Who are the main actors in the industry, and what are their distinctive features?

# Are there strategic groups in the industry?
# How are the industry drivers likely to change over time?
# How does that affect the industry?

As mentioned this is a rather complex subject, and therefore a rigid structure is needed for the report. This structure is described below, together with a section regarding the methodology used and a section on the limitations of our investigation of the European car industry.

STRUCTURE OF THE REPORT
After the introduction and preliminary considerations, we will move on to a discussion of industry features. Here we will present facts about the industry, and discuss their effects on competition and conduct of market actors.

Next we move on to discuss the factors that determine long run competitiveness in the industry in chapter 4.

Thereafter we will describe the major car manufacturers in the European market, with respect to product lines, brands, market share, presence in different European markets etc. We have chosen to concentrate on the following manufacturers: Volkswagen-Audi, General Motors Europe, PSA, Renault, Fiat, BMW, and Ford Europe since they are the 7 largest manufacturers in the European market.

Next we will divide the market into segments, and the actors into strategic groups. Further we shall combine the two, by using the diversification across segments as a criteria for strategic groups.

In chapter 7 we will conduct an analysis of the financial statements of these companies. Here we will focus on vertical integration, cost structures and R&D. The purpose is to quantify some of the factors discussed in the preceding chapters. Thus this is not a traditional cash flow oriented analysis, with the intent of evaluating company performance.

Next we turn to the future of the industry. Here we will discuss how some of the basic industry drivers are likely to change in the future and how this will affect the structure and conduct in the industry.

Finally we will write a conclusion summing up our findings in the previous sections. In addition to this each of the chapters will finish with a section summary summing up the findings in that chapter.

Thus the report is divided into four major parts. The preliminary considerations contain the introduction and the problem statement, whereas the chapters 3 and 4 concerning level and nature of competition will conduct an analysis at the industry level. The firm level analysis will contain the chapters on market actors and financial statements. The future of the car industry and the conclusion make up the conclusive considerations.

This division and the general structure of the report are illustrated in the figure below.

 

METHODOLOGY
The underlying paradigm of the report is a standard structure - conduct - performance paradigm, like the one described in the figure below. The paradigm consist of basic structures (Nature of supply and demand), market structure, conduct of market actors and performance of the industry .

In its simplest form this paradigm suggests, that there is a causal relationship between the basic conditions and the market performance. However, as shown in figure 2.2 this is not always so. For example it is possible, that conduct of large market actors can affect the structure of the industry through mergers or acquisitions.

It is not the intent of this report, to make a complete analysis along the paradigm. Such an analysis is beyond the scope of this report, both with respect to size and available information.

As indicated earlier we will merely focus, on how the basic structures concerning the car industry affects the level of competition, and determine the factors that drive the industry.

In order to describe the industry we will use a modified Porters 5 forces, with emphasis on the factors we consider most relevant to the automotive industry. This theory has been chosen, as it is traditionally a model used for discussing industry competition. It does not provide answers or conclusions, but gives the section on industry features a firm structure. The model is based on the structure-conduct-performance paradigm, and thus assumes that competition is dependent on industry features. As mentioned above we modified the model slightly, in order to focus on specific aspects that are especially relevant to this report. These modifications are described in the beginning of chapter 3. To make up for the model's lack of conclusive determination, we shall use other theories for the individual issues of Porters model. These are concentration measures (HHI and CR4), theory of market power, game theory, transaction cost theory and theory of price discrimination. These are briefly described in relevant sections.

In order to describe the nature of competition we shall use Richard D'Avenis theory of hypercompetition and arenas of competition, as presented in the article "Hypercompetition: Managing the dynamics of strategic maneuvering". The basic content of the theory is presented in the beginning of chapter 4. The reason for choosing this model is its long run focus. D'Aveni believes that over time all competitive advantages are eroded. This naturally puts an emphasis on the factors that contribute to competitiveness in the longer term.

For the discussion of the industry future, we shall use some of the same theories as in chapter 3, since we in this chapter focus on how some single factors are likely to change in the future, and how this affects the level and nature of competition. Thus we merely apply the same theories, but under different circumstances. An exception is the theory of economies of scale, which is used to analyse the causes of increased industry concentration.

Textbooks used for background information on applied theories, are not referred to in the text, but are stated in the list of sources.

The report is based on public information. Thus we will not conduct a thorough investigation of the industry actors or the structure of the industry, but rather rely on the work of others. The main source of information is books from the Economist Intelligence Unit, that provide statistical facts of the industry like unit sales in different segments, sales in different countries, etc. Further we shall use facts on prices in different national markets.

Where available we shall also use the annual reports of market actors.

The individual theories that we use in each section can be seen in figure 2.2 above. When necessary these theories are presented and discussed in the relevant chapters.

LIMITATION
There are a number of limitations to this report, with respect to available information and scope.

We have chosen to focus only on the European car industry, and thus we will not discuss Japanese competitors in detail, although these firms contribute to the level of competition in the industry.

Further we shall focus only on the market for new passenger cars. Thus we shall not discuss used cars or commercial vehicles. This leads to some difficulties with respect to available information, since annual reports often do not separate passenger cars from commercial vehicles.

As mentioned above, we will not discuss short-term competitive advantage in chapter 4. The reason is that examining all the factors that contribute to competitive advantage is beyond the scope of this report. Instead we shall only discuss the long-term factors, that may help to build a series of short term advantages.

For the financial statement analysis, there are a number of limitations, with the respect to applying financial data. This is discussed in the relevant chapter. Unfortunately it has not been possible to obtain annual reports for Renault and Fiat.


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