Leading Industry Insight, with Monty Meghjee, Chief Financial Officer at Majenta discussing the Post-COVID Economics of Car Manufacturing.
From our unique vantage point across the automotive industry, senior directors in the company consider the impact of Covid-19 on an industry already in the grips of systemic change. This week’s article addresses the broad economics of car manufacturing and asks whether current business models are likely to change as the production lines start to move again across the world.
Until January 2020, the progression of the UK car industry from the 1970s was a model of improvement that had shifted a heavyweight manufacturing sector dominated by toxic industrial relations, reliance on public ownership and invariably produced poor-quality cars to today’s efficient, privately funded and largely profitable industry that makes a large claim on consumer spending.
While so much has improved, from assembly processes becoming highly efficient or sector design engineering vastly improving the product proposition, certain structural factors have proved stubbornly resistant to change.
Majenta’s CFO, Monty Meghjee has been observing the macroeconomics of the sector for his entire career and observes that
“…one of the most challenging financial dynamics that has persisted in car manufacturing is the conflict between short-term decisionmaking and the long term investment cycle.”
Monty suggests that this dynamic remains one of the structural flaws in the industry, with management decision-making focused around quarterly management accounts and short-term metrics. One of the casualties of this tendency to manage by short-term decision making in the UK automotive sector has been the paucity of investment in areas such as automation.
Despite impressive productivity gains that has seen a tripling of worth per worker from £32,000 to £100,900 in 20 years, the UK industry is poorly prepared for what is seen as the next quantum shift to automated production using smart production lines.
UK automation levels currently stand at less than a quarter of robotic automation rates per 10,000 employees compared to Germany and less than half of the current levels across manufacturing generally in Spain.
Covid-19 pulls this reality into sharp focus. The current bottleneck for carmakers to ramp up production is limited by the physical constraints inherent in factories that do not allow workers to maintain social distancing. Automation has the capacity to solve this problem at a stroke and so says Monty Meghjee, may at last re-prioritise investment over short-term decision-making. While the lead time for more smart production lines to build our cars may be measured in years, what is certain is that all OEM Boards are overwhelmingly focused on new strategies and long-term investment plans to build an industry fit for the post-COVID era.
A second feature of OEM macroeconomics that has come under considerable stress during the pandemic has been the combination of typical car company operating profit margins and their average cash holdings.
OEM operating margins typically hover in the single-digit range, with strong performers such as BMW returning 10% average operating margins (2006-2017) and Ford towards the bottom of the table returning around 2.7% operating margins for the same period. However, even top performers like BMW fail to reach the average operating margins more generally across UK manufacturing. This reality adds a degree of additional vulnerability to the sector’s fragility that has been compounded by an assault on the OEMs’ cash positions driven by plant shutdowns.
According a recent Society of Motor Manufacturers and Traders (SMMT) industry questionnaire in May, 56% of industry respondents highlighted liquidity as a key problem, with commentators reporting that some UK car manufacturers only held cash reserves sufficient to manage overheads for two months.
As a consequence, the automotive sector has been an active participant in the government-backed Coronavirus Job Retention Scheme (CJRS) and a number of OEMs are in ongoing consultations with the Treasury in order to secure fiscal stimulus packages.
Monty feels that the reliance on the Chancellor will be a double-edged sword for the carmakers.
“Whether the government will accede to the requests for funding from the car industry is moot. There are plenty of sound economic reasons to do this, equally, there are cries for help are coming from every corner of the economy. It remains to be seen which sectors of commerce will benefit,” he said. “However, what is abundantly clear is that if the automotive sector is a beneficiary of grants from government, the money will come with extensive caveats. It is likely that OEMs will be forced into electrification further and faster than the industry would have progressed under its own steam. It will be interesting to see if the demand side from the public will keep up with the volumes of EVs the government will want to see rolling off production lines in exchange for their money,” he added.
The financial fragility of the automotive sector, certainly by the measure of its liquidity, will force some companies into the arms of government in order to navigate the post COVID landscape.
By extension, the economics of these car companies will have unwittingly given the government’s policymakers a proxy seat at their board room table.
Majenta Solutions are an enabler of intelligent supply chains, bringing proprietary digital solutions to build knowledge, enhance efficiency and deepen integration between OEMs and their suppliers. The company has enabled supply chain digitisation in industries from automotive and construction to aerospace and manufacturing. With deep expertise in enabling digital transformation for automotive design engineering, Majenta helps engineers across the tier suppliers to integrate seamlessly with OEM primes to drive efficiency, quality and productivity.