Wheeling and Dealing: Economics of Prices in Automobiles - Essay Example

Wheeling and Dealing: Economics of Prices in Automobiles With the current market trends around the world, the automobile industry has suffered slumpsdue to the rising prices, taxes, competition and most of all, the recent skyrocketing oil price hikes. As the modern global automotive industry traverses the paths of principal manufacturers, Ford, General Motors, Honda, Volkswagen, Toyota and Daimler-Chrysler, which all operate in a global competitive marketplace, it is seen that there's still much hope to alleviate economic conditions that affect them. It is suggested that the globalization of the automotive industry, has greatly accelerated during the last half of the 1990's due to the construction of important overseas facilities and establishment of mergers between giant multinational automakers (Hiroaka, 2001). And, there's no reason that they could repeat that achievement. Globalization and the current mergers in the automobile industry has been correlated with today's controversies over high petrol prices and fuel-guzzling SUVs in the huge American market. According to The Economist (September 8, 2005), this picture of the automobile industry only offers a partial detail of what future holds for industry as a whole: It may well be fully mature in markets such as North America, Europe and Japan, where over-capacity continues to sap profitability. But globally the industry is set for huge expansion with the motorisation of China and India. Within a few years China will replace Japan as the second-largest national market after America. Some experts predict that over the next 20 years more cars will be made than in the entire 110-year history of the industry. In the same report, Garel Rhys, director of the Centre for Automotive Industry Research at Cardiff University in Britain, enlightened that this growth will create the need for 180 new factories, each producing 300,000 cars (and light trucks) a year-in effect, almost doubling the production capacity of the global industry to over 110m units annually. Thus, today's car plants will need to be "renewed, retooled, refurbished and replaced to remain competitive. There is nowhere for the inefficient to hide." Automobile manufacturing is an industry in which it is difficult to achieve optimized procurement, production and sales on a global scale. Yet in the period from 1998 to 1999, major assemblers began to form strategic partnerships based on capital relationships, and since then there has been an accelerating trend toward the creation of structures that allow manufacturers to supply a diverse range of vehicles tailored to consumer needs in markets throughout the world. For vehicle assemblers to develop their global operations efficiently, they need to balance the merits of centralization as a strategy for achieving economies of scale, with localization, which is the key to the supply of products that match national and regional needs. Three additional requirements for the development of global strategies are the clustering of internationally competitive suppliers, the establishment of management systems to support global operations, and the use of IT networks. To note, great achievements have been copped by the European automobile industry. According to the Trade Issue Website, in 2001 alone, the European - Automobile Industry achieved a world wide turnover of 452 BN , of which 271 BN in Western Europe, providing direct employment to 1.1 Million people in the EU (1.6 Million world wide) to which another 11 to 12 Million directly or indirectly supported jobs can be added. Thus the sector involves roughly 8.5% of the EU's active workforce. The EU-15 motor vehicles industry (manufacturers and suppliers) represents about 9% of the EU manufacturing sector in terms of value added (operating profit). EU-15 exports of motor vehicles reached 59 BN in 2001, representing 6% of the value of total extra EU-15 exports. Tax revenues from the motor vehicle industry amount to about 334 BN , i.e. 15% of EU governments revenues and 4% of EU GDP, excluding oil products that indirectly add another substantive volume of revenues. The European Automobile Industry is a frontrunner in the global automotive market with integrated automobile operations (research, design, development, production and sales) and a dense world wide network of joint ventures, cooperations, production and assembly sites. In 2000 the EU-AI invested over 33 BN , R+D spending amounted to 19 BN . In closer analysis, today's established big producers, many of which have merged their way to giant status, but remain chronically hampered by legacy costs and operating problems and could now be beaten by new entrants and competitors shunned the merger game. Potential industry competitors in China and India also loom to account most of tomorrow's extra production. With the globalizing car industry, the prices of automobiles have been an important issue in determining the condition of the car industry. In the study of economics, there are several factors that drive the price of goods like cars. With this, we could study the importance of controlling these factors as it would determine the future fate of the automobile industry. In 1992, the European Commission published the Intra-EC Car Price Differential Report, based on a study by Motor Industry Research Unit (MIRU) and Computer Industry Research Unit (CIRU). The study covered the period 1988-1991 in Belgium, France, Germany, Italy, the Netherlands, Spain and the UK. The report lists the following explanations affecting car prices: (1) exchange rate fluctuations; (2) the differences in taxes; (3) differences in market access, in particular Japanese penetration rates; (4) fleet purchases, i.e. purchase in bulk by leasing firms or large companies; (5) the number of dealers in some markets; (6) transportation costs; (7) consumer arbitrage costs and the existence of a selective distribution system. In addition, the Monopolies and Mergers Commission (MMC, 1999) categorized the role of exchange rates, taxes and residual values as "factors affecting comparisons of average prices in the long run." The MMC discussed the role of exchange rates in conducting international price surveys, in part based on the views expressed by the suppliers. The MMC began by noting that there appears to be no relation between domestic prices in the UK and exchange rate changes. In particular, car prices did not fall following the appreciation of the pound; the price decreases did not even occur after two years of relatively stable exchange following the peak of the pound obtained in August 1997. The suppliers' reactions to the role of exchange rates were that one could not use current (contemporaneous) exchange rates in an international price comparison because exchange rate fluctuations, such as the appreciation of the pound, may be unanticipated. Many manufacturers argued that a key factor of price differentials is given by the tax differentials between the countries. Denmark, Finland and Greece have very high rates of car taxation, whereas the Netherlands and Portugal also have high rates. They explained that manufactures would lower their margins a little to cushion some of the effect of the tax rather than lose greater volumes. Increasing global trade has enabled the growth in world commercial distribution systems, which has also expanded global competition amongst the automobile manufacturers. Japanese automakers in particular, have instituted innovative production methods by modifying the U.S. manufacturing model, as well as adapting and utilizing technology to enhance production and increase product competition (Degryse &Verboven, 2000). At the question of determining the car prices, negotiating the prices have transformed into ways for dealers with market power to discriminate their customers. Given the high price of a new car, it would not be surprising if the cost of gaining information about a consumer's willingness to pay is, in comparison, small enough to make the dealer's effort to assess a consumer's valuation and negotiate individual prices more profitable than posting a fixed price. Because car supply is fixed in the short term at the inventory on the dealer's lot, and demand is volatile, the opportunity cost of selling a car of a specific make, model, options, and color is constantly changing with demand for that particular car within the geographic market. Even if inter-dealer vehicle trades mean that supply is not absolutely fixed, this trading is limited because of the transaction cost of bartering with other dealers and thin markets due to the large variety of cars. Thus there are effectively new, dealer-level optimal prices each day - or perhaps more frequently - for each car. Not posting a price, and instead negotiating with the consumer, allows the dealer to incorporate the latest information on inventory levels and demand into the offered price. As a result, the opportunity cost to the dealer of selling a car-and therefore transaction price-is likely to vary across two consumers who purchase the same car on different days, even without differences between them in willingness to pay or bargaining ability According to the Sloman & Norris (2005), economies of scale are increase inefficiency of productionas the number of goodsbeing produced increases.Typically, a company that achieves economies of scale lowers the average cost per unit through increased production since fixed costs are shared over an increased number of goods. For an oil refining company, the economies of scale are: lower input costs of chemicals used in refining petroleum; costly and specialized inputs like the machines the refinery needs, specially skilled laborers and the like; and the learning processes needed to know about the things that would make their work efficient in the oil refinery. In case of the automobiles, economies of scale could be place with the local distribution costs incurred in the country of sale. When the European Commission (Bouckaert & Verboven, 2000) inquired about the sources and the magnitude of the local distribution costs, the European car manufacturers mentioned the following sources of local costs: - pre-delivery inspection; - transport from the factory to the dealer or from the importer to the dealer; - marketing and advertising of vehicles parts and accessories; - personnel and management of the dealer; - inventory; - recruitment and training of staff; - administration of policy and warranty; - administration of recall and rework campaigns; - information systems; - import duty and port handling; - insurance, warranty, etc Unlike other sectors, automobile manufacturing is characterized by a comparatively small number of producers, most of which are multinational firms. This is due to the required size of fixed capital investments necessary to be able to produce cars. Assembly plants require smaller production volumes and investments than sites producing car engines, whereas sites for engines require smaller fixed investments than the production of car bodies in a body stamping site. Under the conditions of an industrial mass production, the international market for automobiles is characterized by its economies of scale: an industry with a relatively large number of multinationals which move high financial volumes with any production decision they take, amounting to sums which can easily distort the balance of a national trade (Gual, 1993). In view of the widespread mergers in the automobile industry, The Economist report informed that car companies "remain chronically hampered by legacy costs and operating problems and could now be beaten by new entrants and competitors", despite their giant status. Mergers and acquisitions, the search for new markets, raw materials and labor, the transmission of technology to developing countries and the integration of world economies have all helped further the trend toward globalization, especially in the car industry. Stohl (2001) notes that "globalism refers to the interconnected nature of the global economy, the interpretation of global and domestic organizations, and communication technologies that blur temporal and spatial boundaries" (p. 325). The environmental and technological pressures on contemporary organizations to become more and more similar clash with the proprietary pull of cultural identifications, traditional values, and conventional practices of social life" (p. 326). These tensions may be particularly evident in the case of a multinational merger where the merging organizations have strong individual identities. With so many lessons learned in the past, these mistakes should be a reminder on how they could strive to be better corporations. As prices of cars go down with the current spate of competition, they have no choice but to join the bandwagon and be wary about the economic factors that will greatly affect their industry in the hands of globalization. The prospects are daunting but these are challenges the automobile industry has to face that will make them reshape the global industry to their advantage. Bibliography Bouckaert, J. & Verboven, F. 2000, Price Differences and Price Setting in the European Car Market, Chapter 12 in: F. Heylen, H. Ooghe and R. Vander Vennet, The challenge of the EMU. London: EMU. Degryse, H & Verboven, F. 2000, November. Car Price Differentials in the European Union: An Economic Analysis. London: Centre for Economic Policy Research. European Automobile Industry. 2004. Trade Issues Website. Acquired online last November 25, 2005 at http://europa.eu.int/comm/trade/issues/sectoral/industry/auto/index_en.htm Gual, J. 1993, An Econometric Analysis of Price Differentials in the EEC Automobile Market. Applied Economics, vol. 25, p. 599-607. Hiraoka, L.S. 2001.Global Alliances in the Motor Vehicle Industry. Westport, CT: Quorum Books. Monopolies and Mergers Commission (MMC). 1999. New Cars - A Report on the Supply of New Motor Cars within the UK, London: TSO, 737p. Sloman, J & Norris, K. 2005. Principles of economics, Prentice Hall, Australia. Special Report. Extinction of the predator: How merger mania has been a disaster for the world's great car manufacturers. The Economist. 8 September 2005. Acquired online last November 25, 2005 at http://www.economist.com/business/displayStory.cfmstory_id=4369762 Stohl, C. 2001. Globalizing organizational communication, In F. M. Jablin & L. L. Putnam (Eds.). The New handbook of Organizational Communication (pp. 323-375). 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