Costs drive car-giants east

Eastern Europe is fast consolidating its new-found reputation as a global powerhouse for automobile production as manufacturing in the west continues its steady decline.

According to a recent report by PwC, the Czech Republic currently has the highest annual growth rate (13%) among the top 20 car-producing countries in the world, thanks to investments by companies including Hyundai, Peugeot-Citro‘n and Volkswagen. This, at a time when Germany has been wallowing in misery following Volkswagen's recent announcement that it would eliminate up to 20,000 jobs.

The misery in the west is not confined to Germany. France's Renault and Peugeot-Citro‘n also plan to cut their labour forces. The latter is closing down its Coventry plant in the UK next year, a move that will produce savings of _90 million. "I'd say for definite that there can no longer be high-volume car production plants in western Europe," says analyst Toby Procter, director of Trend Tracker, an organisation specialising in automotive industry research. "All high-volume production is shifting to central and eastern Europe. The UK has already borne most of the pain. Germany and France will suffer a lot."

A look at industry supplier Mittal Steel's website reveals some frightening forecasts: in 30 years, the number of major global car manufacturers has shrunk from 57 to 13 - by 2010, only six to eight are expected to remain. European manufacturers grappling with virtually non-existent sales growth on their home turf are desperately trying to cling onto their sliding market position while waging increasingly fierce price wars with relatively new market entrants such as Korea's Hyundai.

The situation faced by VW in Germany, where it is saddled with the highest labour costs in the industry and stringent employment regulations (half of the seats on its supervisory board are held by union leaders), contrasts starkly with its operations in Slovakia. Its Bratislava plant is the most profitable of all its factories worldwide, thanks to a combination of low costs and flexible working conditions.

Peugeot is going to the trouble and expense of moving engines to assembly plants in eastern European countries by truck, so the advantages of shifting production processes eastwards must be worthwhile. But, Arthur Maher, European forecasting head at automotive research firm JD Powers, points out that, even in low-cost countries, production processes will have to become more efficient. "From a manufacturing perspective, to be more competitive, companies will have to use plants more effectively. They will need flexible plants with one line able to deal with different models. The overall ethos will be to have increasingly flexible car plants working different shifts."

Joint ventures between car manufacturers will also be used as a survival strategy. The trend for joint ventures aimed at producing economies of scale in the high-volume manufacture of shared components has already begun. Fiat, for example, announced last week a joint venture agreement with Shanghai Automotive Industry Corporation and Chongqing Heavy Vehicle Group, involving an investment plan of _120m. The Italian carmaker is already allied with Severstal Auto in Russia.

At one point, troubled US company General Motors (GM) would have regarded an alliance with Renault Nissan as a vital lifeline. The heat is now off chief executive Rick Wagoner since last week's announcement of better-than-expected second-quarter profits for the company, but a joint venture this October should not be ruled out. Collaboration between companies in areas such as research and development can produce substantial savings.

With labour costs sometimes accounting for only a tenth of total production costs, the move eastwards in itself will not be enough to save companies battling to protect their market shares. Still, the question remains just how far eastwards production will go. By 2010, when eastern production plants in the EU will have reached full capacity, EU manufacturers offering more competitively priced cars might have to contend with new imports from markets like China.

"Further down the line, all this will be affected by investments in Russia by companies like Volkswagen, which is happening faster than people think," says Procter. "You can't contain this industry within continents any more. The EU car industry will not only have to get cheaper, it will have to get cleverer. There's plenty of evidence that it's very good at that."

Maher predicts big changes in current supply chains feeding the industry. The structural shift in component supply chains from the high-cost west to the low-cost east that is already happening is likely to pick up speed in the not too distant future. "It's changing the rules of the game," Maher says. "It's like we're starting with a clean slate."

Eastern Europe is fast consolidating its new-found reputation as a global powerhouse for automobile production as manufacturing in the west continues its steady decline.