Source: Annual reports and SEC filings
The European Automotive Industry
FINANCIAL STATEMENT ANALYSIS
In this chapter we shall seek to quantify, some of the factors we
have discussed earlier in the report. For this we shall use the
consolidated annual reports of Ford, GM, BMW and Volkswagen.
Unfortunately the annual reports of Fiat and Renault has not been
available.
It should be stressed that this is not a financial statement
analysis in the traditional sense, and hence the objective is not
to evaluate the performance of these companies. The purpo-se is
merely to examine some of the factors we have discussed earlier
in the report.
LIMITATIONS
Obviously there is a number of limitations in using the companies
annual reports for em-pirical data. These are discussed below.
First of all there are differences in the amount of information
given in the annual reports. Thus it is not possible to examine
all factors for all companies. Further the companies are
registered in three different countries, and are thus subject to
different accounting rules. For example is it likely, that the
companies follow different rules for consolidation of re-ports
from subsidiaries. Another example is rules for the period over
which assets can be depreciated.
Another problem is that book value does not always represent
actual value of an asset. This is a problem when using
depreciations in value added calculations. However it is
impossible to evaluate the real annual cost of using these
assets, as it would require, both an actual value of the asset,
as well as an exact measure for expected lifetime of the asset.
Hence we shall use depreciations as an estimate.
Thirdly it is often difficult to separate different business
areas. In our analysis below we have attempted to separate the
automotive business from the other business area of the
companies, to the extent allowed by the data in the annual
reports.
Finally we face the problem, that we only have the needed data
for one year. Thus the cyclical nature of business in the car
industry may affect the results of the analysis. This is a
problem in the value-added analysis, in the case where a firm has
faced low sales in a year. In such a situation sales are lower
than usual, but value added expenses like depreci-ation is
unchanged, and thus value added will seem higher than it actually
is. The same problem arises in the analysis of fixed costs, where
fixed cost ratio will be higher in years with low sales.
All in all using financial statements are not an exact measure,
and thus there is some inse-curity linked to the analysis.
However, the analysis will give us a general idea of the
ma-nufacturers situation with respect to different industry
features.
VERTICAL INTEGRATION
As discussed in chapter 3 vertical integration on the supply side
is likely to occur as a consequence of highly specialised assets.
We shall now measure the amount of vertical integration in the 5
companies in question.
One way to measure the amount of vertical integration is through
a value added to sales ratio. Firms that have a very high ratio
of value added to sales, add a lot of value internal-ly, and are
thus vertically integrated. Value added is in this respect
defined as the amount of capital and labour, that a firm has used
to produce its output . Thus we shall calculate value added as
labour cost, depreciation and net income as a percentage of
sales.
The table below shows these figures for the 5 companies in
question.
Table 7.1
Source: Annual reports and SEC filings
From the table it appears that BMW and PSA are much less
vertically integrated than Ford and Volkswagen. However, in all 4
cases the figure shows the importance of subcontracting in the
car industry. If only between 25% and 40 % of total value is
added internally, the rest is added through suppliers. Thus
little changes in supply prices can have dramatic effect for the
car manufacturers.
Another interesting aspect of the value added analysis, is that
Japanese manufacturers add significant less value as a ratio to
sales, compared to European manufacturers . Conse-quently
Japanese manufacturers must be less vertically integrated than
the European firms. This probably has to do with the special
structure of Japanese industry, where firms are closely linked in
a Keiretsu system. This system poses an alternative to vertical
inte-gration for avoiding the transaction costs connected to
specialised assets.
FIXED COSTS
Fixed costs have been discussed both in chapter 3 and 4. A high
amount of fixed costs, allow relatively low marginal costs. Thus
high fixed costs can sometimes be an incentive for price cutting
as firms struggle to increase sales to cover their high fixed
costs. Further we have argued in chapter 4 that demand changes,
can have severe effects on companies that are not geared with an
appropriate fixed to variable cost ratio.
It is difficult to find a good measure for fixed costs relative
to valuable costs. The prob-lem is that fixed costs are usually
related to assets, which cannot be distributed accurately across
several years, unless we know the exact lifetime of every asset.
Instead we can use depreciations as an estimate for fixed costs.
Table 7.2 
Source: Annual Reports
This percentage may seem rather small for an industry that is
usually perceived as having high fixed costs. However one must
keep in mind, that the percentage is calculated rela-tive to
total costs of sales, and not relative to value added. Thus this
percentage would be much larger if calculated only for the
manufacturer, in didn't include costs of supplies and raw
materials. Thus fixed costs are very important in the automotive
industry, but depreciations are still much smaller than labour
costs.
Another way to measure fixed against variable costs would be by
comparing the value of production plants to the amount of
workers. Such an analysis assumes that workers are relatively
variable, while capital is fixed. It does not take variable costs
like materials into account. In the table below we have conducted
the analysis. Value of plants has been de-fined as historical
costs of land, buildings, equipment and machinery. This equals
book value plus accumulated depreciations and adjustments.
Table 7.3 
Source: Annual reports and SEC filings
As we can see Table 7.2 and 7.3 are closely correlated, with
respect to the relative posi-tion of the companies. This suggests
that in spite of their limitations, our measures are not
completely off.
It is clear, that BMW has the highest fixed costs, followed by
PSA. Volkswagen and es-pecially Ford have significantly lower
costs. As we have argued in section 4.2, it is un-fortunate to
have high fixed costs in a low growth market. Further we have
argued, that there is little chance of booming demand in the
European market. However, the cost ra-tios above are calculated
for the world as a whole, so it is not significant, whether
growth in Europe alone is stagnating. We shall not discuss world
automotive outlook in this re-port, and thus we will not
consider, which of the manufacturers are best positioned for the
future, with respect to cost structures.
One important implication of high fixed costs is that it may lead
to price cutting (As ar-gued in section 3.2.3). Hence initiation
of price reductions, that may lead to price wars, are more likely
to come from BMW or PSA. Therefore other members of their
strategic groups should watch these two closely.
R&D AND MARKETING
Only Ford, GM and Volkswagen provide data regarding R&D and
marketing. These are shown in the table below.
Table 7.4 
Source: Annual Reports
The figure demonstrates the vast amount of R&D that is
used in the industry. We have already discussed the effect of
marketing and R&D in section 3.5.2 and 3.5.3, where we have
also argued, that a reason for these heavy investments in
R&D, is the special structu-re in the automotive industry.
SECTION SUMMARY
In this section we have analysed Ford, GM, BMW, PSA and
Volkswagen with respect to vertical integration, cost structure,
R&D and marketing.
Our analysis shows, that the companies add between 25 and 37
percent of value, relative to cost of sales. This shows, that
supplier relations are still very important, as more than half of
the vehicles total value is contained in supplies. Further this
analysis revealed, that costs related to labour, far exceeded
costs related to plants (depreciations).
Further we have discussed fixed costs. This analysis has
demonstrated the enormous amount of capital required among the
large players in the industry. Further we have shown, that there
are large differences in capital to labour ratios among firms.
This may lead some firms to cut prices.
Finally we have quantified R&D and marketing where possible.