eurosif-sr_automombiles

Automobile

Sector Report - 3rd in a series

This Eurosif sector report has been compiled with research by SAM. It describes the major social and environmental challenges facing the European automobile industry and the associated risks and opportunities these pose for long-term returns. Notwithstanding the significant potential environmental risks and opportunities highlighted in this document, the car industry has achieved significant improvements in terms of transparency over past years. Although the auto parts makers are an integrated part of the value chain, specific issues uniquely relevant to them are not addressed here.

Automobile Features Production volumes in automobile companies have grown by around 2% per year over the last 20 years; however, its relative importance in terms of market value compared to other industry sectors has decreased significantly.

Today the automobile industry represents less than 2% of the total European market capitalisation, while 20 years ago the sector was almost double in relative size.

Only about 1/4 of over 50 car manufacturers who were operating 40 years ago have been able to retain their economic independence. Despite this consolidation, overcapacity in the industry is a constant issue, keeping pricing and the return on invested capital under pressure when the cost of capital can often not be covered. A high fixed cost base ensures that companies follow a growth strategy. However, this does not mean more jobs in the sector, but rather that fewer employees in lower-cost countries have to produce more.

As a result of tough competition, product cycles have become shorter which creates a crowded market place with newer and fresher products. This also means that 1) the competitive advantage period of a model, or technology, decreases, and 2) research & development costs have to be covered more quickly.

Recognising market movements first, or even creating them, is a key success factor for automobile companies. For 100% example, early detection of the rising demand for hybrids Europewas an important marketing move for Toyota, while other 87% 90% 88% Americas is already quite intense. companies may be launching their hybrids when competition 80%

50% 40% 30%

60%

72%

50%

0%

58% 53%

34%

21%

20% 10% 8% 4%

8% 10% 4% 2%

Renault SA

Peugeot SA Renault SA

15% 10% 13%

2%

21%

15% 24% 13%

9%

13%

9%

33%

24% 13% 13%

8%

Fiat Spa Volkswagen AG BMW AG Porsche AG DaimlerChrysler AG Peugeot SA Fiat Spa Volkswagen AG BMW AG

53%

52

Number of independent automotive manufacturers

52

34%

Only one-quarter of all car manufacturers has retained its (economic) independence since 1964

33%

30

30

13% 8%

12 12

1960 Porsche AG DaimlerChrysler AG

Regional Sales Figures of European Automobile Manufacturers

Automobile Trends

Only one-quarter of all car manufacturers has retained its (economic) independence since 1964

58%

63%

30%

0%

63%

70%

40%

20% 10%

Europe Americas Others

Today

1960

Today

Consolidation of European Automobile Manufacturers since1960’s

The industry is mature, especially in the European and American markets, while some Asian markets (e.g. China and India) still offer some growth. Overall, demand growth is likely to stay below the nominal GDP (Gross Domestic Product) expansion rate.

In all consumer markets, whether they are low-priced household goods, food, apparel, or cars, a clear polarisation exists. On one side there are people who can afford to buy very expensive automobiles, while on the other, demand for low-cost vehicles is increasing. This trend can be expected to continue and car manufacturers have to ensure that they are not going to be lost in the middle.

The regulatory focus on greenhouse gas emissions, as well as the increasingly tight regulations on air pollutants, is creating pressure for automakers to reduce fuel consumption, as well as emissions from internal combustion engines.

The trend is moving towards developing drivetrains based on new technologies such as hybrids and fuel cells.

Branding, technological leadership (especially in fuel efficient propulsion technologies and safety) and consequently differentiation, as well as good supplier relations will be the key success factors for the automobile company of the future.   Deutsche Bank, Global Automotive Industry, The Drivers: How to navigate the auto industry, 27 August 2004.

Source: Deutsche Bank

70% 60%

Number of independent automotive manufacturers

70%

87%

90% 88% 80%

Others

72% 70%

Source: Company’s Annual Reports 2004

100%

Key Challenges SEE Issues The ability of people and goods to move and to be moved in an efficient way is essential for economies to prosper.

However, if current trends continue, the growth in transport activity will lead to an increase of greenhouse gas (GHG) emissions to a level that is not sustainable. There will be a substantial negative impact not only on social and environmental values, but also on economic growth.2 The automotive sector is a major source of CO2 emissions, representing approximately one quarter of global anthropogenic GHG emissions. In order to follow the Kyoto protocol, several of the world’s major automotive markets have adopted policies to reduce vehicle-related CO2 emissions. In the typical life cycle of an automobile 75% of automotive-related emissions occur during vehicle use (19% during fuel production, 4% during the production of materials/components, and 2% during assembly work).3 Thus, fuel economy and CO2 emission standards offer the best prospect for reducing vehicles’ contribution to climate change.

In the European Union, a dialogue between regulators and the automotive industry trade association (ACEA) inspired a voluntary commitment from the industry to reduce CO2 emissions from passenger cars to a level of 140 g CO2/km by 2008. Depending on progress, ACEA may extend the target to 120g CO2/km by 2012.

According to the Clean Air for Europe (CAFE) programme the pollutants of most concern for human health from road transport are airborne particulate matter (PMs) which are precursors of smog and other poor air quality problems, as well as the ozone that is formed by the reaction between hydrocarbon (HC) and nitrogen oxide (NOx).

While the ACEA voluntary agreement (see key challenge “Fuel Efficiency & Climate Change”) targets the reduction of CO2 levels, Euro 4 and Euro 5 aim to regulate the vehicular emission of PMs, HC and NOx. The Euro 4 standard came into effect in 2005. Euro 5, which could be introduced by mid-2008, has been submitted by the European Commission, although its final form is still unclear. The main priorities are to further reduce emissions of PM and NOx with the introduction of a limit value of 5 milligrams per kilometre for PM (-80%) and a NOx limit value of 200mg (-20%) for diesel cars. The commission is also considering proposing reductions in the emission limits for petrol cars (a 25% reduction in NOx as well as in hydrocarbons).

In 2000, approximately 1.2 million people worldwide died as a result of road traffic injuries, and another 7.8 million were seriously injured.5 In Europe, every year road traffic accidents kill more young people aged 5 to 29 than any other cause of death.6 The number of road deaths by inhabitant sharply rises in the early stages of motorization when people can afford to buy motorcycles first, and then cars as is happening in India and China.

The World Health Organisation in Europe considers speed as the single most important determinant for safety in road transport systems. They call for new road safety thinking that builds safety into the transport system, and improving implementation mechanisms and tools to achieve this.

Automobile companies are very large employers. Some major companies in Europe have over 300,000 employees worldwide.

A strong workforce provides the basis for a successful company. In order to foster their commitment, automobile companies must continually invest in training and development of their employees.

Labour costs represent on average only about 10% of the sales price of a car while material costs are responsible for around 50%. R&D expenses will rise with increasing technical complexity of the product as well as with tougher safety and environmental regulations. Additionally, marketing costs are likely to go up as the need for differentiation will persist. Pressure to make cost elements, like labour, more flexible and to continuously restructure or even outsource part of operations is likely to increase.

As car manufacturers are becoming assemblers, instead of manufacturers, the integration of suppliers into vehicle development and production is increasingly essential and a decisive factor in competition.

A potential issue for car manufacturers is their rising dependence on their suppliers for innovation and quality. It is therefore necessary for the car company to integrate these criteria into the selection process.

2 Mobility 2030 : Meeting the challenges to sustainability (World Business Council for Sustainable Development – WBCSD).

3 Source : WRI & SAM. 4 K.Blok, N.Höhne, A. Torvanger, R. Janzic: Towards a Post-2012 Climate Change Regime - Final Report; European Commission, DG Environment, Directorate C - Air Quality, Climate Change, Chemicals and Biotechnology http://unfccc.int/cop4/misc01aw.htm.

SEE Risks & Opportunities

Fuel Efficiency & Climate Change

Air Quality and Public Health

In the context of climate protection the western industrial nations would have to lower their GHG emissions by 60% to 80% by 2050 in order to limit global temperature increases to no more than 2°C of pre-industrial levels.4 This means that GHG emissions would have to be reduced by 2%-3.5% per year. On the assumption that car traffic increases by 2% per year, efficiency would have to increase by around 4%-5%, which is significantly higher than the commitment from the European automotive industry of 140 g CO2/km by 2008.

The tougher ACEA objectives will be substantially more difficult and costly to meet since it might require the hybridisation of the drivetrain and more dramatic shifts in the product portfolio. To meet the target by 2008, carmakers need an annual rate of improvement of 3.3%, suggesting that they may have to accelerate the introduction of expensive new technologies to boost fuel efficiency. Carmakers recognise that this will be challenging.

To meet current imposed carbon constraints, Original Equipment Manufacturers (OEMs) can turn to a wide range of carbon efficient measures, such as incremental technologies, alternative fuels, hybrid vehicles, and, in the more distant future, fuel cell technology. With rising oil prices, bio and synthetic fuels, which produce less GHGs than petroleum fuels, are becoming a viable alternative to gasoline and diesel. Leaders in these areas will gain competitive advantage and brand differentiation in the industry in the coming years.

Hybrid drivetrains are likely to provide an interim solution, although they do not significantly reduce emissions when driving long distances. Hydrogen-related technologies may represent a revolutionary but long-term answer as they are currently still too expensive and the infrastructure is not available yet.

Due to the characteristics of combustion engines (for petrol and diesel), it is not possible to reduce all emissions through improved engine efficiency alone. While diesel engines have advantages in terms of CO2 emissions compared to its petrol counterparts, they produce much higher emissions of PMs, HC and NOx. Thus, this can result in a trade-off between public health impacts and climate change.

Transforming a diesel engine into a cleaner powertrain requires sophisticated technology. The average cost of compliance for Euro 5 is estimated by the VDA (Verband Deutscher Automobilhersteller) at €800 per vehicle. Volkswagen puts the additional costs required at roughly €1 000 per vehicle. This is comparable to the higher material costs experienced in 2005 in terms of magnitude.

Some auto sector analysts, however, consider these costs to have been overestimated by the automobile lobby, and quote much more manageable figures closer to €140 per vehicle.

Companies that have market-ready, new technologies enabling compliance with tougher standards should be able to improve their short-term competitiveness.

Safety

In the developed and developing worlds, strategies should aim at achieving significant reductions of road traffic injuries from current levels and curbing the growth rate in deaths and injuries. Either through regulation or by market forces, car manufacturers are already facing pressure to make cars less dangerous, not only for the drivers and occupants of the vehicle but also for those on the street (e.g. pedestrians, bicyclists).

The following measures can be taken by car manufacturers to meet the EU regulations :7 1) creating more space between the front grill and the so-called hard points (such as the engine) to absorb the energy from a collision ; 2) redesigning the car’s hood to make it a better energy absorber and fitting the car with active safety systems such as airbags ; and 3) equipping the car with active safety systems such as night vision, adaptive lighting, active braking systems and run-flat tires to prevent accidents.

Human Resources Management

The automobile industry has one of the highest numbers of temporary workers as a percentage of the total workforce of any sector (often 10% of the workforce in a given year but representing up to 30% during peak production periods).8 Temporary work might in some cases be less stable and as such, this category of employee cannot afford to alienate automobile manufacturers and their subcontractors, which are often the sole local employers. The abusive use of temporary employment is now taken more into account by industrial tribunals, which do not hesitate to rule against companies that overstep the mark and impose fines.

The high number of temporary workers at automaker companies may also affect the quality and production of cars due to increased turnover of employees and lack of skills transfer.

To attract well qualified employees and maintain a high level of motivation, automobile manufacturers should offer a positive and safe working environment including: efficient work structures with flexible working hours, measures to promote young employees, part-time employment and child care.

Supplier Relations

The evaluation of the suppliers should not only be based on technical skills, quality of work and pricing, but also on environmental and social standards.

Suppliers have to be managed in the same way as subsidiaries in order to make work sequences and the interface between the supplier and the assembler as efficient as possible. In this respect, it is essential for the car company to set incentives for suppliers to guarantee not only a high level of quality but also access to innovation and state of the art technology. The car manufacturer has to make sure that the suppliers manage their people and talents in an appropriate way.

5 6 7 8

Source : WBCSD, Mobility 2030: Meeting the challenges to sustainability.

Source : World Health Organisation - www.who.int.

Source : Supplement to Automotive News Europe, October 31, 2005.

European industrial relations observatory on-line. www.eiro.eurofound.eu.int.

Case studies PSA Peugeot Citroën’s diesel engine In its approach to eco-design, the PSA Peugeot Citroën Group aims to take environmental requirements into account at each phase in the vehicle life cycle, from design to use and finally to end of life. PSA Peugeot Citroën’s 1.4-litre diesel common rail engine complies with Euro 4 standards by managing fuel consumption more efficiently, in particular with

second-generation common rail systems, vertically positioned valves and valve drive with roller-type rockers, and by integrating emissions control technology.

CO2 emissions of cars equipped with these engines range from 90 to 120 grams per kilometre, depending on the model, compared with average CO2 emissions of 160 grams per

kilometre in 2004 in Europe. Wider use of this type of small diesel engine is therefore an effective means of reducing automobile greenhouse gas emissions. This will help achieve the ambitious targets European carmakers have set for reducing CO2 emissions.

Sources : www.psa-peugeot-citroen.com and www.developpement-durable.psa.fr/en

Toyota’s hybrids Toyota is leading the way in lowering emissions and improving fuel economy in gasoline powered vehicles.

They have created the world’s first mass-produced gas/electric hybrid car, and are also at the forefront of developing tomorrow’s fuel cell vehicles.

Toyota’s Hybrid Synergy Drive® vehicle is nearly 80% cleaner in terms of smog-forming emissions than Ultra Low Emission Vehicles (ULEV).

Even though the gasoline engine employed with Hybrid Synergy Drive® is a very efficient clean-burning engine, the less it is operated, the fewer emissions it will produce. Hybrid Synergy Drive® shuts the gasoline engine off and relies on the electric motor alone quite frequently: at a stop, in reverse, during initial acceleration, low-speed driving, coasting and normal braking. The gasoline engine is only used when necessary, thus

saving fuel and substantially reducing emission output. In addition, thanks to the special attention Toyota has paid to the design of the system, Hybrid Synergy Drive® vehicles emit zero evaporative emissions. According to Toyota, driving a Prius from Glasgow, Scotland to Athens, Greece and back again produces fewer smog-forming emissions than using one can of insect repellent.

Source : www.toyota.com

DaimlerChrysler’s fuel cells The DaimlerChrysler Group is making mobility sustainable through a number of initiatives based on alternative drive systems and renewable fuels.

In the past six years, the fuel cell drive system has been shrunk to such an extent that it presently requires no more space than a conventional drive system. The fuel cell uses the energy in the fuel almost twice as efficiently as a gasoline engine. The hydrogen carrier methanol – a liquid that can be sold in a manner similar to gasoline

through the existing filling station network – is the first fuel in the 115-year history of the automobile in Europe that isn’t derived from a fossil source and can be produced from renewable sources.

of a fleet of 36 buses DaimlerChrysler now has in operation in Europe, Australia and Asia in order to gain real world experience in day-to-day operation in its pursuit of viable emission-free mobility solutions.

In November 2005 three hydrogen-powered Mercedes-Benz Citaro fuel cell buses were delivered

by DaimlerChrysler to the City of Beijing at the opening of the 4th International Clean Vehicle Technology Conference and Exhibition. These buses are part

Fuel cells release energy from the reaction of hydrogen with oxygen.

The hydrogen-powered fuel cells emit only pure water vapour. Fuel cells are currently the only technology that can achieve zero emissions in vehicles.

Source : www.daimlerchrysler.com

Eurosif wishes to acknowledge the support and direction provided by the Automobile Sector Report Steering Committee: BNP Paribas Asset Management Crédit Agricole Asset Management Dexia Asset Management UBS Global Asset Management This sector report, created with the support of the European Commission, has been compiled by :

11 avenue de l’Opéra • Boîte 16 • 75001 Paris, France Tel/Fax : +33 1 40 20 43 38 contact@eurosif.org • www.eurosif.org

Seefeldstrasse 215 • CH-8008 Zurich, Switzerland Tel : +41 (0)44 397 10 45 • Fax : +41 (0)44 397 10 50 philipp.mettler@sam-group.com • www.sam-group.com January 2006