Tuesday, April 26, 2011

Will Saab survive?

News reports indicate that Saab may not survive much longer. Spkyer Cars bought the firm from General Motors when the American automaker went bankrupt. By the time of the sale, Saab already had been experiencing years of decline. In North America, Saab had a small following in the northeast, but little brand presence elsewhere in the country.

Why will it be difficult for Saab to survive independently? First and foremost, the firm simply does not have enough scale. By most accounts, the minimum efficient scale (MES) for an automotive assembly plant is about 200,000 cars. MES is the point at which a firm has fully exploited scale economies. If a company operates below MES, its costs will be higher than more efficient competitors. Saab sold just over 30,000 automobiles last year - far below MES. It simply cannot remain cost competitive at these volumes.

Of course, some automotive experts believe that firms must be much larger than MES to survive in the auto industry. They argue that the development costs for a new auto platform often exceed $1 billion, and thus, firms need to be substantially larger than the simple MES for an assembly plant in order to be cost competitive. Fiat CEO Marchionne has argued that auto firms must achieve scale of 6 million units to survive in the long term. I believe Marchionne may be overestimating the need for scale. The economics seem suggest that firms can be quite profitable at below 6 million units. For instance, Ford became very profitable the past two years, operating below 6 million units of production. Honda also has been a very profitable automaker despite not exceeding 6 million units.

In the past, we have seen the drive for consolidation, based on a scale economy logic similar to that espoused by Marchionne. How did that work out? Well, the results of auto mergers and acquisitions in the 1990s look pretty ugly (think Daimler-Chrysler, Ford-Volvo, Ford-Jaguar, etc.). Apparently, consolidation isn't all that it's cracked up to be. For more on the risks of global mega-mergers, I highly recommend a classic article written several years ago by Pankaj Ghemawat, "The Dubious Logic of Global Mega-mergers."

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