China’s Consolidating Auto Industry Can Learn From DaimlerChrysler

November 21, 2009

In an increasingly competitive and globalized automotive industry, companies that lack scale or a global production footprint are believed to be at a significant disadvantage. Many automotive companies have launched plans to address this “organically” by introducing new brands, developing new products and entering new markets. However, in an industry characterized by high capital investment and long technology and product development lead times, it may not be feasible to proceed organically. As a result, many automotive companies have sought to address their needs “inorganically” via M&A or a strategic alliance.

While auto sales in 2009 indicate a bright future for China’s automotive manufacturers, one must look deeper into the facts before drawing quick conclusions. In fact, there are numerous structural problems in the China automotive industry. While light vehicle sales stand at historic highs, overcapacity and lack of scale remain major problems. This is true largely because of the highly fragmented and scattered OEM landscape. China’s auto industry today includes over 150 registered automotive manufacturers. The top 10 OEM’s account for 83% of vehicle sales and the top 20 OEM’s account for 95% of sales. Additionally, approximately 60% of vehicles sold carry a foreign brand, which makes it very difficult for Chinese domestic brands to generate sufficient volumes or profit margins to remain economically viable. This fragmentation is mirrored in China’s automotive component supply base, where a significant percentage of auto suppliers face severe liquidity issues in 2009.

As a result, the Chinese government has pulled-ahead its plan to consolidate the OEM landscape in order to achieve economies of scale for the remaining manufacturers. Prompted by the economic crisis, the China government in early 2009 published revitalization plans for its key industries including automotive. The plan clearly articulates the vision for industry consolidation, technological upgrade, export, and brand development.

The most sweeping proposal in this plan is the intention to consolidate the industry into a “top 10” group organized into 2 distinct “tiers”: the Tier 1 group consisting of companies with an annual capacity of 2 million units that are encouraged to acquire smaller automotive companies throughout China, whereas Tier 2 consists of companies with an annual capacity of 1 million units that are encouraged to drive regional consolidation. Earlier this month, a major step was taken towards implementing this plan with the announcement that Changan Automobile Group Co. agreed to take over the auto operations of Aviation Industry Corp of China (AVIC).

Deals like this are just starting and there will be more. While it may be relatively easy to put together a deal to consolidate assets, there is enormous risk and the vast majority of acquisitions ultimately fail. The most recent case of SAIC’s acquisition of Ssangyong ultimately failed because the interests of both parties were not aligned. SAIC was: unable to secure concessions from Ssangyong’s labor union to lower costs, unwilling to inject billons of RMB incremental capital to fund the business, and unable to manage the loss of leadership at Ssangyong. Ultimately, SAIC decided to dissolve the deal. Sadly, automotive acquisitions are rarely successful.

One of the most famous cases was the failed 9-year marriage of Daimler-Benz and Chrysler. Announced to the world in 1998 as a $38 billion “merger of equals”, the deal was ultimately dissolved in 2007. The causes of failure are noteworthy:

1. Strategic Mis-Alignment: While each company had a sound rationale for partnership, there was a lack of alignment between the architects of the deal and the organizations they led. Juergen Schrempp was seeking to build scale and elevate the prominence of the automotive business in the Daimler-Benz portfolio of companies. Bob Eaton was seeking to expand Chrysler’s global reach beyond its core North American market. While on the surface it appeared compatible, this vision lacked sufficient top-down direction needed to build a globally integrated automotive enterprise. The target for achieving “synergy” resulting from achievement of a cost-savings target became the sole objective of the post-merger integration team, and meaningful integration of the core automotive business was never established as a concrete target.

2. Brand Tension: The brands of Daimler and Chrysler do not overlap, however the struggle over brands cut to the heart of the merger integration challenge. In many ways, the brands of a company define the image and aspirations of both its customers as well as its companies. For this reason, the idea of sharing any product, technology, or even resources used in the development or distribution of the product was viewed as a risk of compromising the value proposition of the brands. Daimler was concerned that a direct association with Chrysler would damage the Mercedes-Benz “premium” image. Chrysler was concerned that Daimler’s higher cost structure would make Chrysler’s mass-market brands less cost competitive.

3. Lack of Core Business Integration: The “Chrysler Group” essentially became a division within Daimler-Benz, which was renamed “DaimlerChrysler AG” in November 1998. The only functions that were integrated were the Financial Services division and several corporate staffs including Human Resources, IT, and Corporate Finance. Staff reductions in these functions accounted for much of the “Synergy” of the merger. The core business functions were left unchanged. As a result, the complex decisions of how to share development costs, develop new technologies, share product platforms, cross-load manufacturing plants, and combine marketing and sales functions were completely avoided. As a result, the automotive businesses failed to realize any benefits from the partnership.

4. Brain Drain: It is often stated that the majority of senior leaders of an acquired company leave within a two-year period after the merger. While efforts were made to retain Chrysler’s top leadership, it became very difficult once it became clear that this was never actually a “merger of equals”. Starting with Bob Eaton’s decision to step down as co-CEO, the leadership "flight" at Chrysler accelerated. Within two years, a significant percentage of Chrysler’s top 100 managers had left the company. While it may be difficult to avoid completely, it is critical to plan for the retention of the key leadership, or company performance and employee morale will suffer.

5. Culture Shock: This issue is often mistakenly attributed to differences in language, culture between Germans and Americans. However, this is not the root cause. The challenge is to achieve a true understanding of the respective needs of each partner. This tends to get oversimplified by assuming that language and culture are the problems. Language and cultural misunderstanding creates “resistance” and adds friction among the partners – which makes it difficult to develop a common understanding, but this is not the most fundamentally challenging issue. If this were the case, it would be impossible to explain why similar problems occur when companies merge within the same country. The most difficult issue is to establish a common understanding of what each partner wants out of the relationship – and finding a way to work with that.

Businesses hoping to grow “inorganically” would be wise to learn the lessons from the causes of the failed DaimlerChrysler merger.

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