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.