business >> economy
Fiat-Chrysler Merger With GM?
F
iat Chrysler Automobiles (FCA)
chief Sergio Marchionne is propos-
ing a potential merger with General
Motors. In light of the conditions in today's
auto industry, his reasoning is well-grounded
in business strategy and economics.
The automobile indus-
try has many firms —
none with a dominant
market share. Firm strat-
egies are quite similar,
as each company strives
to serve all market seg-
ments by offering a full
line of products — small
Jonathan
and midsize cars, SUVs,
Silberman
trucks, etc. — around the
globe.
Companies compete for customers based
on product differentiation, quality and brand
identity. Innovation yields only temporary
gains as competitors replicate the new prod-
uct or feature.
The competitive landscape is influenced by
a range of factors, including:
• Government regulations (e.g. safety,
emissions, and mileage standards).
• Gasoline prices.
• Rapidly changing technology (e.g.
autonomous driving, infotainment services,
connected cars and car sharing).
• Potential competition from other busi-
ness sectors (Google, Apple and Uber). As
mechanical engineering gives way to comput-
er-driven innovations, barriers to entry are
falling.
• Cyclical customer demand: Purchases
can be postponed in an economic downturn,
leading to revenue volatility for automakers.
The automobile industry also requires a
lot of capital. Manufacturing automobiles
requires substantial investment in factories,
equipment, and research and development.
These costs are increasing due to the reduced
cycle time of bringing new models to market,
the rapidly changing technology landscape
and increasingly automated production pro-
cesses to reduce reliance on labor.
As a consequence of the large capital
requirements, economic profits are less than
other industries and tend to be negative.
Economic profits adjust accounting profits
by subtracting the costs of capital. This rep-
resents the difference between the profits
earned in a particular activity, and the profits
that could have been earned by investing the
same resources in the most lucrative alterna-
tive activity.
The low economic profits can make it diffi-
cult for automobile companies to attract new
capital by issuing stock or borrowing funds.
Automakers tend to fund capital require-
ments from internal operations and maintain
large cash reserves. Ford Motor Co. in 2014
reported accounting profits of $6.3 billion but
had an economic loss of $2.8 billion. The last
time Ford had a positive economic profit was
in 2004. In contrast, Apple has had a positive
economic profit in each year since 2004 and
an economic profit of $26 billion in 2014.
Against this challenging business environ-
ment, Marchionne's consolidation strategy
is smart. A combined FCA-GM can realize
economies of scale and scope, thereby reduc-
ing costs. An economy of scale occurs when
average costs decrease as output increases.
Cost savings are achieved by spreading
product-specific fixed costs, purchasing, and
research and development.
Kirk Kerkorian in 2006 urged GM to
pursue a partnership with Renault-Nissan
to save on purchasing costs. Companies can
also combine support services such as human
resources, legal, information technology, and
accounting and finance.
An economy of scope is the cost savings
a firm achieves by increasing the variety of
activities it performs. For original equipment
manufaturers (OEMs), this is having more
components in common and making vehicles
on a global architecture.
While this would be advantageous, the
execution will prove problematic. Merging
two large organizations is challenging due to
potential differences and conflicts in orga-
nizational culture. Successful integration
requires great leadership, people skills and
change management.
Combining complex IT systems presents
many challenges. Streamlining operations by
closing factories in Europe or dealerships in
the United States will face resistance.
GM is resisting the consolidation overture
from Marchionne. GM CEO Mary Barra
said, "We are merging with ourselves; we
have scale; we have leveraged the appropriate
opportunities."
Strategies to confront the challenging
business landscape for OEMs will develop.
Consolidation will take place as competi-
tive pressures increase and the costs savings
become more critical.
In the next five years, the number of
auto companies will decline in the face of
an increasingly dynamic and challenging
business environment. *
Jonathan Silberman is a professor of economics at
Oakland University. Contact him at silberma@oakland.
edu.
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