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The New Face of the Auto Industry and Its Affect on Offshore Manufacturing

Interview of George Magliano, Director of Industry Research North America–IHS Global Insight Hosted by Doug Donahue, Vice President of Entrada Group The Entrada Group is proud to bring you a series of informative interviews with leading authorities on some of the essential aspects of offshore operations. These free, educational programs, hosted by Doug Donahue, Vice President of the Entrada Group, cover current topics important to companies operating offshore or looking at moving operations. In an interview recorded June 5, 2009, George Magliano, Director of Auto Industry Research North America at IHS Global Insight, analyzes the short- and long-term future of the global auto industry. He also discusses its affect on supply-base manufacturers operating offshore.

DOUG
Welcome ladies and gentlemen to Entrada Group’s ongoing series of audiocasts related to manufacturing in low-cost countries. For those of you that this is your first audiocast, Entrada Group is a service provider dedicated to assisting manufacturers in establishing and maintaining operations in Mexico and Central America. Today, we have George Magliano of IHS Global Insight joining us. IHS Global Insight is recognized as one of the leaders in economic forecasting, covering more than 107 industries in over 200 countries. George is a director of industry research North America. In this role he is the group’s auto economist responsible for relating the overall economic and market environment for North American light vehicle sales.

I think it’s important to note that these audiocasts typically have a shelf live of two to three months. So, giving the rapidly changing environment of our subject matter today, let’s let our audience know that this interview is being recorded the week that GM has officially entered into Chapter 11 and it appears that some form of agreement between Chrysler and Fiat looks likely. I think it’s good to give some of that background because some people might be listening months from now.

So George, without making you or Global Insight project the future, can you tell us what you’re hearing out in the marketplace regarding the next six, twelve, eighteen months and maybe speculate about a longer outlook over the next 36 months?

GEORGE
This is a really fluid time. I’ve never seen anything like this in my 20 years in the automobile industry. You’ve got two major auto manufacturers, what used to be two of the Big Three – now it’s the Detroit Three – Chrysler and GM in bankruptcy. And it looks like they’re going to go smoothly, if we can judge by what’s happening with Chrysler. The government’s put them into bankruptcy and the government’s used all sorts of muscle to get this to move and move very quickly. They are steamrolling the unions and the bondholders in an effort to get Chrysler out of bankruptcy. The state of Indiana has appealed the court ruling on the deal on the bonds for Chrysler and the sale of the assets. This could slow thing up quite a bit. And this could be used as a precedent to slow up the GM bankruptcy proceeding, which will go much more slowly than the Chrysler ones.

DOUG
I’ve notice today and I’ve noticed in the last couple of weeks that they are going to attempt to sell some of these brand names to buyers – particularly GM with Hummer and Saturn. I guess there’s a Chinese group and I hear today the Penske group has interest in Saturn. Do you see this strategy continuing or do you see these as one or two-time deals coming off and that’ll be the end of it?

GEORGE
I think the interesting thing here is that the only brand that appears to be dying, out of the GM stable, is Pontiac today. The Opel operation in Germany was acquired by Magna. GM is still holding a piece of that. So is the German government. Today, I believe, Saturn has sold to the Penske group. It’s been reported that they’ve reached an agreement. And over the last couple of days, the Chinese deal to acquire Hummer surfaced. But, that one might take a while because they’re afraid the Chinese government will not okay this deal because the Chinese government has really set it’s sight on higher fuel economy and better fuel economy standards and emissions. This would fly in the face of the new policy. So, that one is a little bit in doubt. But I think it will go through anyway. It may take a little while longer. Those operations will acquire a second life and will be reborn in some different ways and will continue doing business.

DOUG
Most of the people who subscribe to these interviews are owners or working for medium-size first-tier and large second-tier suppliers. How will the break up of these companies affect these suppliers? Speculating obviously, how do you see this affecting the supply base?

GEORGE
Right now, the small suppliers are one of the entities that is bearing the major brunt of these bankruptcy proceedings. The supplier base, in general starting with the big tier ones, has been in a real bad way for an awful long time – longer than let’s say GM or Chrysler. If you look at Delphi, Visteon, Lear and a few other people out there, these people and really been struggling because of the problems with the auto assembly base – the problems with Detroit.

But right now, the tier-two and smaller suppliers aren’t getting any money. They’re not getting paid. We’re seeing more and more, in the news, incidents of bankruptcies on the small supply base – the tier twos and on down. While the government has committed five-billion dollars to support the supply base, it’s been largely taking it to tier ones, the bigger guys. And that money really hasn’t been flying very rapidly right now.

So we have an issue with the supply base. We’ve got an issue that could spin out of control. I think the government better get its act together, and will get its act together to shore up these little guys.

DOUG
In the short term do you see any new assistance, either directly or through the OEMs coming to these suppliers and what form might it take?

GEORGE
I think it’s probably going to go through the OEMs. The GMs and Chryslers have to make sure the money goes through and gets to them and these guys get paid. That’s the issue right now. They’re not getting paid. So the money, the cash flow, is not there and they’re burning through cash just like GM and Chrysler burned through cash. Unless somebody steps in you’re going to see a raft of bankruptcies and you’re going to see something that could have the potential of spinning out of control and hurting the economy. Something similar to what happened to Lehman Brothers on the financial side. The government doesn’t want that. But I don’t think the government is going to take an active role in putting money directly into the small supply base. So it will have to go through the third party and this third part would be the OEM assemblers.

DOUG
I realize it’s hard to project the details, but if they’re not purchasing parts you can obviously pay what you owe them in the past. But if you’re not purchasing parts, will they be paying for research or tooling? How do you see that money flowing?

GEORGE
The question has been asked ‘GM and Chrysler, are they going to be able to do their investments? Are they going to be able to continue business?’ I think the object of the reorganization is to shrink these guys down. But they have to be funded on a day-to-day basis. They have to continue doing those things that they would normally do in order to survive every day in business. They can’t cut back on the research. They can’t cut back on the tooling. They can’t cut back on how they’re working with the supply base. And it’s just going to reorient itself to a smaller base because both GM and Chrysler are getting out of brands and getting out of product. So, you’re going to see less volume coming out of these OEM assemblers. That will restrict the business they do with the supply base.

DOUG
Let’s venture a little bit into not only the manufacturing arena but where it crosses over into the political arena. Entrada’s business is assisting the first- and second-tier suppliers in Mexico and other low-cost countries. How do you see any of the current assistance efforts affecting those suppliers with operations in Mexico or other low-cost countries?

GEORGE
Well, this becomes a very delicate case right now. The issue is that the United States government has put a lot of money into Chrysler and GM. The Canadian government is putting money in. They’ve gotten concessions from the United Auto Workers in the U.S. They’ve gotten concessions from the Canadian Auto Workers. All these entities are looking to keep the plants and the jobs in their countries. And so the risk here to Mexico is that there’s going to be a backlash. We’ve seen a backlash in general politically. This ‘buy American’ campaign and ‘keep the jobs here.’ And there could be a backlash against plants and operations in Mexico.

But working in Mexico’s favor, first, the Obama administration has publicly come out and said that they don’t want to block free trade. That they don’t want to move into a protectionist mode. Two, Fritz Henderson, CEO of GM was asked outright whether he was going to close any operations in Mexico and he said, “No” at the last press conference he gave. He said, “We’re committed to operating down there.” And three, the government knows that in order to be profitable, in order to be successful, both GM and Chrysler have to keep those low-cost plants and facilities operating. They have to have access to low-cost components and they have to keep the plants down there operating assembling cars and trucks in Mexico in order to be profitable. So the bottom line is “Do we think that the plants in Mexico will suffer and be closed?” No. It might slow the growth of the auto base in Mexico, which over the last couple years it’s really taken off again. There is an issue in the future where we’re going to have to balance out Canada, U.S. and Mexico – balance out the assemble plants and component base in all three countries.

DOUG
I sat in on a presentation of yours a couple of months ago, in which you did project: the overall number of light vehicles produced in North America, which is going to drop in the medium term, you thought the overall production in Mexico might increase. Are you still thinking that might be the path?

GEORGE
Short term – we will see a contraction probably in all three countries. That’s a function of the fact that the recession has gotten so bad and the auto volume, both sales and production, will be off by 30% in the United States this year. That’s what controls North American production. Mexico, in the short run, will gain share. Longer term, they will gain share and volume will increase. As the overall volume in light vehicle sales increases in North America and production follows with that.

DOUG
A lot of people who listen to and subscribe to this audiocast series are in the process of moving an operation, for the first time, offshore. Somebody who is a first-tier or second-tier supplier, who needs to move offshore, typically looks at Mexico as their first choice for product being delivered in North America. Do you see that backing away just a little bit? Do you see the suppliers going to other low-cost countries or analyzing other low-cost countries to supply the North American market?

GEORGE
They’re always looking for a source of supply. They’re always looking to go global. I think the trend a couple years ago was to look at China. Look at China ahead of Mexico and anything else ahead of North America. I think that’s changed. I think Mexico has come back as a key place to assemble cars and trucks. Obviously if you’re building them down there, assembling them down there, you need to source those components down there. The component base has benefited from that. I think the issue of proximity to the U.S. market, I thing the labor force down there and the reputation for quality that is going up quite a bit. And I think those will continue to serve Mexico very well. I believe that Mexico has really come alive again and will continue to grow despite the issues, the extraneous environmental issues that everybody’s wrestling with in the United States right now.

DOUG
Let’s switch a little bit on the subject. Before all this hit the fan last September, I was having conversations with numerous European first- and second-tier suppliers. Basically, the thrust of the conversation was: Our OEM clients have North American operations and manufacturing operations and they’re placing a lot of pressure on us to set up a North American operation to reduce transportation costs, which were high then because of the cost of oil as well as the strong Euro. Obviously, since September, that conversation has subsided in general with a lot of the economic activity. Did you see that also as a growing trend and do you think that that trend will return once production picks up again?

GEORGE
Yes, definitely. But if you look at it, the Euro has gone to new highs again. The dollar is going to remain weak and it will continue to put pressure on the European manufacturers in order to find a way around the strong Euro. Oil prices have gone up. We don’t think they’re going to sustain themselves and I don’t think we’re ever going to get back to that $120, $140, $150 a barrel at least not in our lifetime. But the cost of transportation, the cost of doing business, along with the cost of oil and the economy’s picking up, inflation’s picking up, that would make the operations in Mexico look that much more attractive.

DOUG
On that same theme, obviously most of the attention today and what we’ve been talking about has focused on the Detroit Three. Can you spend a few minutes talking about the North American future for some of the Japanese and European OEMs?

GEORGE
Right now, the recession has put some of this on hold. But if you look at it, every body outside of the Big Three, the transplants as we call them or the new American manufacturers, before the recession were expanding again and expanding very rapidly. Volkswagen has put a plant up in Chattanooga in Tennessee. And they have very aggressive plans to build cars and trucks out of that facility. The Kia plant has just opened up, or is close to opening up down in the Southeast. Toyota was moving extremely aggressively with opening up a plant in Canada and Mississippi. They put the Mississippi plant on hold. They thought they were moving too fast. The recession has hurt their volume. So they’re rethinking it. Once the industry comes back, these manufacturers know that to be successful in the world, they have to be successful in the United States. And to be successful here they have to make the vehicles here. They are all looking to expand and they are all looking to expand at the expense of Detroit.

DOUG
What we have not discussed in all of this conversation is Ford. Ford is getting a lot of attention because it has not talked about taking money from the government or bankruptcy. With the restructuring of Chrysler and the restructuring of GM, can they continue down this path and compete? Or at some point, are they going to need some assistance?

GEORGE
There’s a couple of issues here. Everyday you see another article that touts Ford, even with the restructuring and the cost restructuring of GM and Chrysler. Ford gets high marks for going out and getting its line of credit before GM and Chrysler. GM and Chrysler couldn’t get it after things tightened up. That put Ford in a very good light.

Ford has been extremely aggressive even though they’re not in bankruptcy, getting give-backs from the unions, getting their costs under control. Ford has a product portfolio today that suits the future here in this industry. They’ve downsized some of their vehicles and they’re bringing in a lot of vehicles from overseas – the Fiesta, the Focus. And they are sourcing these vehicles out of Mexico as well. They’re going to build smaller vehicles in Mexico, low-cost, fuel-efficient cares in Mexico and Brazil. They’re going to sell them in the United States. So they’ve got a lot going for them. They’re getting very high marks.

The issue in our mind with Ford is: they’re expecting a significant recovery in sales in the second-half of this year into next year – a lot more than we’re expecting. If we’re right and they’re wrong, that’s going to put more pressure on their cash flow and their cash burn. But the feeling is that Ford has figured out a way to get money and Ford is looked on in a favorable light by the financial community. As things loosen up on a credit basis from these big Blue-Chip institutions, they’ll be able to pull another rabbit out of their hat if they need it – if business stays sluggish longer than they expect.

DOUG
What have I not asked you that a first- or second-tier supplier should be thinking about today?

GEORGE
If you push all the stuff that’s happening together, the face of business in the global auto industry has changed. It was changing, now it’s changed drastically forever. So now, going down the road sort of speak, you’ve got other players. You used to rely on the Big Three, or rely on big assembly base, now you’ve got the possibility of a Chinese firm operating plants in North America. You’ve got Penske, which is a distribution group, they don’t have any manufacturing base and they’re going to have to look for a manufacturing base. They’re acquiring Saturn. You’ve got Magna who dabbled in vehicle assembly, now they’re going to run Opel. So that’s another player you have to deal with. And of course, you’ve got Fiat out there who’s looking to become a huge global player, trying to put together more pieces in this puzzle. So look for more of this. Look for Nissan/Renault to comeback and look for more alliances. Look for the Chinese to try to acquire other operation in North America, getting much more aggressive in trying to come back into the United States market, crack into the U.S. market. Look for a lot of other things, other players, other combinations. And to rob a term: think out of the box.

DOUG
We all know that the Hummer deal, whether it goes through or not, there is a commitment to continue to produce those cars in their current manufacturing locations for a period of time. Under the Saturn deal, am I wrong or aren’t most of the Saturn cars built on GM platforms? Their not at Saturn-only plants. Or is that incorrect?

GEORGE
That’s 100% correct. I think today, Penske’s got an agreement to keep the flow of vehicles coming and being produced out of the GM plants for a period of time. I don’t know how long. Then after that, he’s put his feelers out, number one to Nissan/Renault to source vehicles. I think the issue is Penske is a very smart operator. He is not going to leave himself high and dry, purchasing this operation and not have any vehicles to sell through the dealer network.

DOUG
George, we appreciate you taking the time to be with us today.

GEORGE
Thanks for having me on, Doug.

If you would like to listen to the audio of this transcription, or listen to other interviews regarding topics related to offshore operations, please click here.

These programs are offered as a free service by the Entrada Group. If you have any questions on these or any other topics related to offshore operations, email Doug Donahue at ddonahue@entradagroup.com

The Entrada Group provides offshore manufacturing services for the ultimate in efficiency and effectiveness. Entrada supports companies in quickly launching and maintaining manufacturing operations in Mexico without establishing a legal presence. Through powerful economies of scale, Entrada’s on-site shared-services center offers clients exceptional production control with long and short-term cost reductions.

Learn more at www.EntradaGroup.com