A diabtribe on the car industry (or F1 meets the real world...)

I don't know about the rest of you, but I am not good at sitting around doing nothing. Having some time off between races is nice but I am not very good about knowing what to do with it. The result is that I spend a lot of time reading. And it is from doing this that I have concluded that the current state of the world's automotive industries should be a source of worry to Formula 1. The car industry, you see, is not doing as well as it should be doing and that is actually quite important to Formula 1.

In very basic terms this is because there are too many cars being built for the number of people who are able to afford them. There may be big new markets to be opened up in Eastern Europe and Asia but at the moment people in these countries do not have the money to buy cars.

The over-capacity of the industry is best seen in the US and European markets. In the year 2001 the big three car companies in the United States (GM, Ford and DaimlerChrysler) sold 17m vehicles. But they all lost money because the profit on each vehicle was very small and production costs were very high because the companies are using old techniques, old machinery and have old fashioned attitudes. The terrorist attacks on September 11 2001 had a further effect as people stopped buying new cars and that forced dealers to offer special incentives to keep cars moving through the showrooms. That worked but because of the incentive schemes profits dropped even further.

According to Ford's head of US operations Jim Padilla there are now five to six million more cars in America than there are people who need them and unless production is cut the big three firms are not going to make profits.

The big three have been shedding staff as fast as they can but they are losing money all the time, particularly as the sale of foreign imports is now increasing as other more efficient car companies aim for the huge US market. In 1990 the big three sold 66% of the cars in the US. In 2000 this was down to 57%. If the current automobile sales trends in the US continue for the rest of this year Toyota is going to finish the year having sold more cars in the United States than Ford, GM and DaimlerChrysler, the first time that a foreign company has outsold America's industrial giants. The big three continue to dominate overall vehicle sales thanks to strong sales of light trucks and sports utility vehicle markets but all the major Asian car companies are expanding their US manufacturing and developing new models for the US market.

As a result of the stagnation of the markets, the trend in recent years has been for the industry giants to take over smaller firms. This has left GM, Ford, DaimlerChrysler, Toyota, Volkswagen and Renault-Nissan as the big players in the world market with only a few middle-ranking firms left. Of these BMW, Peugeot-Citroen, Honda, Hyundai and Suzuki are the most notable.

In Formula 1 terms, this means that there are fewer companies in a position to invest the hundreds of millions of dollars which are nowadays needed to create a competitive F1 program. Estimates of the costs vary a lot but an accepted figure is around $200m a year and with success taking so long to achieve because of the competition involved that means that companies must be willing to spend perhaps as much as $2bn if they wish to make it in F1.

Of the companies involved in Formula 1 Toyota and Honda are doing very well because of their efficient production techniques and high quality products. The rest of the companies are not doing as well.

Mercedes-Benz is the best of the western companies with first half sales in 2003 just below the levels of 2002. Mercedes made a profit in the second quarter of around $900m but its sister company Chrysler lost $1bn in the same period as a result of the weak dollar and a five percent drop in sales.

It is also worth noting that DaimlerChrysler has a major lawsuit hanging over its head from billionaire investor Kirk Kerkorian who is claiming $9bn and trying to break up the 1998 merger between Daimler Benz and Chrysler. He is accusing the German management of falsely telling Chrysler stockholders that the deal would be a merger of equals, something which Daimler-Benz boss Jurgen Schrempp admitted in an interview with The Financial Times was never intended. Kerkorian is seeking over $2 billion in actual damages, $1 billion in damages for the drop in value of the DaimlerChrysler stock since the merger, and punitive damages of at least $6 billion. That could have a dramatic effect on the fortunes (and indeed the future) of DaimlerChrysler although the company is trying to play down Kerkorian's hopes of success.

Mercedes-Benz rival BMW is in good shape but is also reporting being hit by currency fluctations and its first half revenues are down 8.3% compared to 2002 although sales remained stable. The company's net profit in the first half of the year was down 14.5% to $1bn.

The Ford Motor Company has made a series of losses in recent years but recently announced a small first half profit, largely due to cost-cutting measures. Sales, however, are down with the second quarter seeing a drop of seven percent over 2002. Profits from Ford's vehicle sales are down from $403m in 2002 to $3m, in part because of heavy losses at Ford Europe ($774m in the first half of the year).

Ferrari has posted a slight increase in revenues but profits are down because of investment that is needed in Maserati while its parent company Fiat came close to breaking even in the first half of the year but only when the sale of non-core subsidiaries was taken into account. Revenues have declined by eight percent and the company is dragging around debt of $4.8bn.

The European car market as whole is expected to end this year with sales down by three percent but France is the worst performing market. In recent months sales have been down 15% compared to the same period last year. Peugeot-Citroen has done well in recent years and was challenging Volkswagen to be Europe's number one manufacturer but that momentum now seems to be weakening, while Renault's unsuccessful new models have taken a toll although sales of its new Megane have strengthened recently. It is worth noting also that the French government has been selling off its shares in Renault.

If the current trends continue (and that looks likely to continue until supply is outstripped by demand) there are going to be more and more questions about the value of F1 to the car manufacturers. The sport may help them to win customers but that is only valuable if the costs are kept in check. The problem is that the big F1 teams do not want to cut costs because this is where they gain their advantage.

Somewhere along the way some bright spark pointed out to the car companies that they could reduce their investment in F1 if they took a bigger share of the revenues generated by the sport.

Nice idea.

They then established a company called the Grand Prix World Championship company (GPWC) as a potential replacement for the existing Formula One group when the current Concorde Agreement runs out at the end of 2007. At the moment, however, none of the Formula 1 teams has expressed anything more than a vague interest in the GPWC as it has not provided any long-term financial guarantees for the sport. There may be talk of attractive new profit-sharing schemes but this will have to be backed up by long-term guarantees if the GPWC wants teams to commit to a new series. Unfortunately a 10 or 15 year deal involves a massive amount of money and offering a guarantee means that the car companies would have to declare billions of dollars of guarantees on their balance sheets.

And in the current financial climate that is not going to be easy.

Bernie Ecclestone's Formula One group may not be as a generous as the GPWC when it comes to sharing out the profits of F1, but he is willing to give guarantees and in the multi-million dollar world of F1 such things are essential these days...

If you follow through that argument you will see that in all probability the big car companies will not gain control of the sport and that means that they will look at their investment in F1 and wonder whether it is all worthwhile and, after losing for a number of years, some are going to conclude that they are wasting time and money. If they own teams these will then be closed down, sold on or given away to the people who run them. But these organisations will have trouble competing with the remaining manufacturer teams and will struggle. The danger is that this will leave the sport without enough viable teams.

And when you stop for a coffee and a sandwich and think it all through, you reach the conclusion that the one thing that the sport needs more than anything is cost-cutting whether the manufacturers like or it or not...

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