On Wednesday, General Motors Company (NYSE:GM) announced that it would end vehicle manufacturing in Australia in 2017. GM will still sell cars in Australia under its local Holden brand, but the vehicles will be imported -- most likely from South Korea. While shutting down local production was a tough decision for GM executives, it was absolutely the right thing to do. It has become virtually impossible to build cars profitably in Australia.
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GM's decision to stop building cars in Australia follows a similar decision from Detroit rival Ford Motor Company (NYSE:F) earlier this year. Both automakers were undone by the rise of the Australian dollar against other global currencies over the past decade -- and, to a lesser extent, the recent fall of the Japanese yen. These currency swings made Australian-built cars less competitive against imported models.
However, other factors also came into play, particularly the relatively small size of the Australian auto market and its ultra-competitive nature. GM's Holden unit manufactured just 82,000 cars in Australia last year, despite holding the No. 2 position in the country with 9.9% market share. Toyota Motor (NYSE:TM) easily leads the Australian market with a 19% share year to date.
It's not possible to build vehicles efficiently in such small numbers. The lowest-cost factories are set up to build one model (or several that share a common platform) at a rate of several hundred thousand annually. Given that Australia has minimal car import duties, and labor costs are much lower elsewhere, automakers are better off sourcing cars for the Australian market from larger factories in other regions.
The one thing that had been propping up Australian auto manufacturing was a government policy of subsidizing automakers for building cars in Australia. Ford made its decision to pull out of the market because even with subsidies, it was consistently losing money on locally built cars, while imported models were profitable.
For GM, a change in the subsidy climate may have been more significant. The new government has been eager to slash spending by cutting back on automaker subsidies. Holden has received an average subsidy of $180 million over the past 12 years, more than $2,000 per vehicle sold. Even with those subsidies, Holden lost about $140 million last year. Without them, the unit was not even within striking distance of profitability.
Aside from government subsidies, the only potential reason for continuing to manufacture cars in Australia would have been to create brand loyalty among patriotic Australians. Unfortunately, while Australians seem to have a soft spot for Holden, price ultimately won out with most car buyers. With imported cars selling well in Australia, it was very sensible for GM to move production to lower-cost countries.
Is Toyota next?
Ford's decision to end production in Australia may have been the first step in a chain reaction that will put an end to the Australian auto manufacturing sector. When Ford announced its plant closures earlier this year, many observers speculated that it would put pressure on parts suppliers, which could make it hard for GM and Toyota to soldier on. (A similar argument was used by Ford CEO Alan Mulally in support of the GM and Chrysler bailouts during the Great Recession.)
With GM now also planning to close up shop in a few years, it will be even harder for Toyota to continue auto production in Australia. Moreover, with the yen having plummeted more than 30% against the U.S. dollar and more than 40% against the euro since the fall of 2012, Japan is suddenly a much more attractive location to build cars. As a result, it's hard to imagine Toyota going to great lengths to keep its Australian factories open.
The Australian auto industry is an anachronism: In today's globalized economy, it simply doesn't make economic sense to produce cars in such a small, isolated, and fragmented market. GM's exit from Australian production was bound to happen eventually, and investors should be glad that the General isn't prolonging its pain.
Fool contributor Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.