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Despite Record Sales, BMW Faces Fight to Increase Profitability
14 Jul 08
BMW is facing an uphill struggle to hit financial targets set by its own "number ONE" strategy.
Global Insight Perspective | | Significance | BMW is facing an increasingly difficult task in implementing its number ONE strategy to increase return on sales to between 8 and 10% by 2012. | Implications | Rising global commodity prices, increasing research and development costs and difficulties in finding the staff will to take voluntary redundancy or early retirement to fulfil the company's targeted job losses of 8,100 jobs are all putting the target under threat. | Outlook | BMW has grown in the last decade to become the world's largest manufacturer of premium passenger cars. However, while the company's independence has been a key strength and factor in this rise it also needs to form R&D alliances and component synergies to reduce costs in a period of record price rises. |
BMW Needs to be Number One Financially as Well as in the Sales Charts BMW has a fight on its hand to hit its key financial targets over the next few years and have its financial performance match its immense sales success in recent years. The BMW Group, which encompasses the BMW, Mini and Rolls Royce brands, has become the world's best-selling premium carmaker after overtaking Mercedes-Benz in 2005. The company sold 1.5 million units in 2007 and wants to increase this figure to 1.8 million units by 2012. However, while its success in increasing sales volume and global distribution network has been immense, this has not been matched by profit margins or investor dividend returns. BMW's management, headed by CEO Norbert Reithofer, pinpointed this issue as a key weakness last year and vowed to implement a new corporate plan called the "number ONE" strategy. The programme included an efficiency drive to save 6 billion euro per annum by 2012 through efficiency savings and increased supplier value. The company also wanted to generate a return on sales of between 8% and 10% on its passenger car sales by 2012, up from the current level of 5-6%. BMW also planned to extend its currency hedging programme and analyse all cost structures, while other targets included a reduction in cost and capital expenditure per vehicle in development, production, sales and administration. However, BMW is facing increasing challenges in trying to meet its goals. Despite a successful 2007 financial year (FY) which saw net profit rise by 9% 3,134 billion euro, BMW said it had to contend with high costs resulting from the weak U.S. dollar and rising raw material costs; best defined by the rising cost of steel, which by the end of May had almost doubled to US$900 per billet. However, other commodities that are intensively used in the automotive industry such as galls and rubber have also risen sharply. BMW is also facing increasing difficulties in generating the kind of staff cuts it was looking for through early redundancy packages and natural wastage. As part of its cost-saving strategy, it is looking to cut around 8,100 jobs, mainly from its German production operations (see Germany: 28 February 2008: BMW Executive Details Planned Job Cuts). However, it was hoping to avoid compulsory redundancies in order to achieve this target. Speaking earlier this year, the company's head of personnel Ernst Baumann said the company was hoping to generate cost savings of about 500 million euro in from 2009 onwards. However, BMW has been left disappointed by the response to its voluntary redundancy plans. According to a Dow Jones report, Manfred Schoch, Deputy Chairman of the supervisory board and head of the workers' council said, "The company was surprised that not as many people wanted to leave the company as it had been expected." BMW is also facing rising cost bases from component acquisition while the cost of research and development also continues to rise, despite BMW stating that it wants to generate cost savings in this area. As a result of this BMW announced last week that it had signed a memorandum of understanding (MoU) with Fiat Automobile to investigate potential cost savings involving component sharing and the possibility of joint vehicle platforms (see Germany: 9 July 2008: BMW and Fiat Sign MoU on Sharing Components and Platforms). Outlook and Implications Despite BMW having made huge progress in terms of sales growth and brand development over the past decade, profitability has failed to keep pace. Despite Norbert Reithofer and his board colleagues taking proactive steps to increase profitability, the company still faces an extremely difficult operating environment in which to achieve this goal. BMW is countering the weak U.S. dollar with enhanced currency hedging while also planning to ramp up production at its Spartanburg plant in the United States to 240,000 units from 140,000. Spartanburg will become BMW's sole production base for sport utility vehicles (SUVs), with the X3, X5 and X6 all scheduled to be built there from 2010 (see United States: 11 March 2008: BMW to Spend US$750 mil. on Expanding Production at Spartanburg). However, despite the ongoing sales success of the X5 and the immense initial interest in the X6 sports activity vehicle (SAV) this strategy may prove flawed if there is a wide scale downturn in global premium SUV demand as a result of record high oil prices. The company's MoU with Fiat has a sound basis in terms of lowering the cost structure with regards to component supply and platform R&D costs. While BMW has always seen its independence as a key asset, it has also left it unable to compete with rivals like Audi and Mercedes-Benz that are, or have been, part of much larger vehicle groups and are better able to amortise vehicle development costs as a result of bigger economies of scale. However, it remains to be seen what tangible benefits come from this relationship. One area where BMW must be careful in cutting costs is its R&D department. For a company that has built a solid reputation as a technical innovator and is renowned for the engineering integrity and drivetrain technology, it would be a massive mistake to cut development costs too far. At the same time, BMW faces being squeezed by rising raw material costs, detailed above, and by its own pledges to increase shareholder dividends, which it must continue to do the placate the investment community and maintain its share price. This is the high wire act that BMW needs to pull off successfully if it is to achieve the goals outlined in the number ONE strategy.
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