Ford's European Crisis

Even as it has seen a renaissance in North America and aggressively expanded its presence in Asia, Ford (NYS: F) has struggled to improve its performance in Europe. Though the Blue Oval has had a substantial presence in the Old World since Henry Ford's day, profits have recently been scarce: Just $176 million of Ford's $2.3 billion pre-tax second-quarter profit was contributed by its European division, despite sales of 422,000 vehicles in the region during the period.

Ford isn't the only one struggling in Europe. General Motors (NYS: GM) actually outsells Ford in the region but has recently seen even smaller profits -- just $102 million in the second quarter. And both Ford and GM have offered only guarded guidance for the near future, essentially aiming to break even.

What's the problem? And why are both automakers committed to staying?

Restructuring in slow motion
The story of mass-market automakers in Europe, particularly Western Europe, is a lot like the story of Detroit: High labor costs and too much manufacturing capacity have led to competitive disadvantages as lower-cost global competitors have entered the region. But unlike Detroit, parochial interests and complex laws among several different nations have made restructuring a slower-moving process.

There was a time when it looked like GM at least was going to cut its losses in the region. Following its bankruptcy restructuring in 2009, GM was actively seeking a buyer for Adam Opel AG, the deeply troubled subsidiary that represents the bulk of its European operation. A deal with Canadian auto supplier Magna International (NYS: MGA) was near completion when GM's board abruptly reversed course and decided to keep the troubled unit -- a fiasco that led to outrage in Germany and probably hastened then-CEO Fritz Henderson's downfall.

But GM's restructuring plan -- which involved reducing production capacity by 20%, closing a plant, and eliminating 8,000 jobs -- is finally progressing, and 2012's results should be free of restructuring charges, the company said recently. Meanwhile, GM's overall European operation -- which includes Opel as well as Chevrolet and a modest Cadillac presence -- saw a 7.7% year-over-year sales increase in the first half of 2011.

Still, GM's hopes for profits in the region remain modest, even after restructuring. Why did GM decide to keep Opel? And why is Ford committed to investing in and improving its European operation?

Why Europe matters to Ford and GM
Even if the region doesn't contribute significantly to the companies' bottom lines, Europe is tremendously important to both Ford and GM, for a few reasons:

  • Eastern European growth. Western Europe is a low-growth market, but Eastern Europe, including Russia, is still emerging. Ford and GM see their European operations as key to capturing enduring market share in the east.

  • Economies of scale. Ford's "One Ford" plan, in which it follows the Toyota (NYS: TM) and Honda (NYS: HMC) approach of building and selling essentially the same cars in different markets around the world, relies on global economies of scale to enable large investments in each product. Those large investments have resulted in superior, class-leading products that are profitable enough to fund large future investments and a high product-replacement tempo. That has been the key to Ford's turnaround. Simply put, Ford needs Europe's volume to pull this off. As does GM, which is following Ford's lead toward a streamlined global product portfolio.

  • Europe's engineering expertise. As gas prices rose, Ford realized that it needed top-notch new small cars for the United States. Old Ford would have developed those cars from scratch for the U.S. market, spending billions. New Ford simply adapted the excellent Fiesta and Focus that were already under development in Germany, the company's center of small-car expertise. Likewise, the acclaimed new Buick Regal started life as an Opel. (This goes both ways: The innovative Opel Ampera hybrid is close kin to the Chevy Volt.) My wife's new Focus was built in Detroit -- but it was engineered in Germany and shares most of its parts with the version of the Focus that's built in Europe.

Long story short, investors hoping that Ford and GM will start seeing significant profits from Europe are likely to be disappointed, at least for the next few years. But profits aren't the biggest reason for hoping for the continued success of these business units.

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