Thursday, September 27, 2012

Cost Competitiveness, Unions, Italy and Car Companies

When sales are expanding and the economy is growing, even poorly run businesses are able to make money.

Conversely, when sales are tough to come by, even well run businesses will have trouble staying profitable. As the old saying goes, we can't save our way to prosperity. We need to grow sales to increase profits. It's that simple.

As a result, in the private sector profit is indeed the cost of doing business. No profit = no investment = no business.

So when business has been growing for years and capacity has been increased to accommodate that growth in business, it comes as a shock to the profit making capability of the company and industry involved when a downturn in sales occurs. Think recession.

That's what is happening to the global auto industry today. Too much capacity for the sales base.

And that's where unions and government tend to really screw things up, since they're playing the growth is good game when the game has changed to staying alive in a slow to no growth operating environment.

Fiat's Auto Job Problem is illustrative of this situation and will help explain why GM and others are by means out of the woods with respect to their future viability:

"For Fiat, home is where the heartache is.

The auto maker is under huge pressure to re-affirm its commitment to Italy, where its 90,000 employees make it the largest private sector job provider. The problem is that Italy isn't much of a draw. Its auto market is suffering the most in Europe: Car sales there fell 20.2% year-on-year in August. And Fiat's efforts to improve workplace efficiency are being stifled by Italy's still-powerful unions.

Luckily, Fiat's purchase of a 62% stake in Chrysler in 2009 has paid off, thanks to the U.S. auto industry's improved fortunes. But its Italian woes are threatening Fiat's ability even to make the most of that opportunity.

Indeed, Fiat could justifiably have given up on Italy already. Beleaguered Chief Executive Sergio Marchionne has suspended a €20 billion ($25.74 billion) investment program at Fiat and sister company Fiat Industrial's Italian operations, after spending only €2.5 billion. That decision saw the Fiat boss called into talks with Italian Prime Minister Mario Monti last weekend, after which Fiat committed to maintaining its industrial presence in Italy.

Yet closing down more Italian operations would make more financial sense. Fiat's auto-making plants in Italy are running at around 50% of their capacity, well below the 78% level needed for the company to break even, Goldman Sachs estimates. To return to profitability in Europe by 2014, after an expected €700 million loss this year, Fiat would need to cut 5,400 jobs, Goldman says. . . .

Closing plants would likely cause even more of a firestorm around Fiat in Italy. It already faces substantial resistance from unions to even minor workplace changes, such as a recent plan to cut workers' coffee breaks by three minutes. Adjustments such as shifting workers on production lines for poorly-selling cars to new operations can take months to negotiate, according to one person familiar with the matter.

Fortunately, things look better abroad for Fiat. Its low-cost operations in Serbia, Poland and Turkey mean it has the lowest labor cost per hour among European auto makers, Goldman says. Moreover, the Chrysler investment has proved a master stroke: It contributed 92% of Fiat's first-half trading profit. Take out Chrysler, and Fiat burned through €1.6 billion of cash in the first half, three times as much as its similarly troubled French peer Peugeot.

But under the terms of its investment, Fiat can't get its hands on Chrysler's healthier cash flow until it owns more than 80% of the U.S. company. A bid for the remaining stake is theoretically possible now, but Fiat needs to keep enough cash to tide it through the European market woes. Italy is not just Fiat's problem; it's the stumbling block to pursuing an American solution."

Summing Up

The auto industry is a global industry. Capacity is far in excess of both current sales and any interim term projections for auto sales as well.

Thus, the weak companies will fall by the wayside while the strong will get stronger.

Interfering governments and recalcitrant unions will hasten the day when the weak ones disappear.

So let's all hope our big remaining U.S. players (GM and Ford) make the right moves, that our government bureaucrats don't interfere, and the UAW's union leadership doesn't make an already bad situation even worse.

It's tough enough out there without the government and auto unions "helping" out.

Thanks. Bob.

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