Will the Auto Industry Go Down With Europe?

After their brush with death in late 2008, American automakers are back. After decades of losing ground on their home turf of North American auto sales, Ford (NYSE: F  ) and General Motors (NYSE: GM  ) are putting up big numbers, selling small and mid-size vehicles that consumers want, and actually earning money doing so. The new General Motors has just wrapped up its 10th consecutive quarter of profitability, while Ford has been hitting record profits since the recession. And yet, some spectators assert that the Detroit carmakers are again on the road to bankruptcy. What gives? In a word: Europe.

Though some commentators blame government ownership for GM's trouble, the real governments to worry about are on the other side of the Atlantic. Although government ownership doesn't seem to have hurt GM, the intervention of European governments on labor markets is hurting every automaker with production capacity in Europe. General Motors' European division, including the Opel and Vauxhall brands, hasn't turned an annual profit in over a decade. Ford recently announced that it expects to lose $1 billion in Europe this year as the company's losses in the region mount.

It's not news that demand in Europe is weak. Extreme economic uncertainty has prompted consumers to save instead of spend, while budget-cutting programs in the core economies have dampened income and job growth. Most global corporations, however, have managed this weak demand by either streamlining their operations in Europe or by exiting the area entirely. Legacy automakers, with massive plants employing thousands of Europeans, haven't followed suit.

In Europe, the highly unionized automobile workforce has a great degree of legal clout. In Germany, for example, the powerful trade union IG Metall isn't just limited to strikes or collective bargaining: By law, the union's "works councils" at each company appoint nearly half of the directors on company boards. This makes union approval a pre-requisite for any major restructuring effort. In France, the interventionist government is routinely a large shareholder in large corporations. When it is not, it is accustomed to demanding that large manufacturers preserve jobs, under pain of losing the generous web of subsidies, tax breaks, and low-interest loans the state provides to manufacturers.

Half measures
In the face of such pressure, the automakers have moved sluggishly to control costs. General Motors has announced that it will permanently close one German plant in Bochum -- but not until 2016. In the meantime, it has attempted to keep costs down through scattershot efforts at reducing hours and idling plants for a few days or weeks at a time. In many of these deals, such as the one announced on Tuesday to idle two British plants for one week, workers are paid throughout the period.

Ford has been even less aggressive. It has divested itself of some capacity through sales, such as in 2008 when Ford sold the Jaguar and Land Rover (JLR) brands, along with three assembly plants in Britain, to Tata Motors (NYSE: TTM  ) . However, Ford has not actually closed any plants. Worse, the JLR plants were relatively high-capacity plants, and under Tata's ownership have actually been staffed up as high-end JLR vehicles gain market share.

This just isn't good enough. According to analyst estimates, Europe's nearly 100 plants are running between 60%-65% of capacity, compared to the 70%-80% capacity needed to be profitable.

Time to sharpen the axe
These modest cutbacks are neither deep enough nor soon enough to stem losses in Europe. More decisive action is needed, as without a dramatic and sudden economic recovery in Europe, Ford and General Motors will continue to bleed over a billion dollars per year. Strong performances in North America and China cannot indefinitely offset that loss; eventually American automakers need to close the wound.

The math is stark: To get Europe's 98 auto plants operating at around 75% capacity, about a fifth of them must close permanently, the sooner the better. Ford and General Motors should both consider the permanent closure of two factories each.

There is hope that such a move would actually be allowed to go through. While governments and labor unions have historically successfully squashed such efforts, the depth and severity of the recession in Europe has changed some minds. Even Francois Hollande, the President of France and leader of the historically pro-labor Socialist Party, has stated publicly that the influence of unions must be curbed, and companies must be allowed to cut costs, if Europe is to remain competitive.

The automakers themselves have been reticent to even publicly contemplate such moves, perhaps out of fear of stirring up opposition. No averse government or union reaction, however, could really be worse than the losses the companies are enduring due to inaction. They must be their own strongest advocates, rather than waiting around for politicians to stand up for their interests.

As critical as the situation Europe is to Ford and GM's future, however, it remains just one of many factors weighing on the global companies' prospects. To get a complete understanding of the challenges and opportunities facing Ford, in particular, check out the Motley Fool's premium research report, complete with a full year of analyst updates. This report is available only for a limited time, so get your copy now.

Daniel Ferry owns shares of General Motors. The Motley Fool owns shares of Ford Motor. Motley Fool newsletter services have recommended buying shares of General Motors and Ford Motor. Motley Fool newsletter services have recommended creating a synthetic long position in Ford Motor. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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