Summertime in Gothenburg has the same relaxed feel found around the rest of Scandinavia — the days are long, nights are short; tourists flock to its open-air festivals, while locals escape for their holidays that start in June and often stretch into August. But this year, the mood has been different in Sweden’s western port city as the fate of one of its biggest employers hung in the balance.
On August 2, months of conjecture and negotiations came to an end when Chinese regulators approved the sale of Volvo Cars — which has been producing automobiles in Gothenburg for more than 80 years — to Hangzhou, China-based Zhejiang Geely Holding Group for an estimated US$1.8 billion. Despite assurances from politicians and corporate executives alike, Volvo’s 10,500 Gothenburg workers — who produced around one third of its 334,000 cars last year — are wondering whether it’s just a matter of time before their factories are shuttered, making way for low-cost sites in Geely’s home country, whose OEMs are said to have a cost advantage of as much as 35% over those in developed markets.
Beyond such immediate concerns, however, auto-sector experts are also asking what the deal means for not only China’s fledgling automakers with global ambitions like Hong Kong-listed Geely, but also the car giants in developed markets — like Ford, Volvo’s former owner — which are struggling to hang on to their former glory days? And ultimately, can Geely succeed where other cross-border mergers and acquisitions in the auto sector have stumbled?
Geely’s M&A gambit is an unusual one. “There haven’t been too many examples of exactly this, where a company from an emerging economy has the wherewithal to purchase a company that’s been around for a long time,” as John Paul MacDuffie, Wharton management professor and co-director of the International Motor Vehicle Program, observes.
But with hindsight, Volvo’s acquisition wasn’t as unexpected or audacious as many thought it was when the mid-sized Chinese startup — rebuffed initially — began talks in earnest last year with the troubled Big Three U.S. auto giant, which owned Volvo cars since 1999 and would eventually sell it for less a third of the price it paid back then. Geely’s acquisitions “would have been unheard of 10 years ago, but we shouldn’t be surprised,” says Ian Fletcher, a U.K.-based auto industry analyst with IHS Global Insight. “Geely wants to grow on the back of Volvo’s established brand, which has a lot of aspects that Geely’s doesn’t, such as a [track record] of safety and quality. And it gives the Chinese automaker a stepping stone to becoming part of the establishment.”
Geely and China’s other private, listed rivals — Chery and BYD, to name two — are following in the footsteps of the global automaking giants, says Pedro Nueno, professor of entrepreneurship and president of China Europe International Business School (CEIBS). As the U.S. automakers found in the 1960s, the Europeans in the 1970s and the Japanese in the 1980s, going global can give them much-needed economies of scale, supply chain flexibility and greater market access than if they remained domestically focused. “The market in China is huge and they are doing everything possible to maintain or increase their market share there,” Nueno says. “But their ambition is global.”
Leading the charge has been Li Shufu, the chairman of Geely and now Volvo Cars, Nueno adds. “Three or four years ago, he told me his international strategy was that by the year 2015, 60% or more of his production could either be done or sent abroad.” By many measures, that’s a bold dream, but coming from an entrepreneur like Li not unbelievable, says Nueno, approvingly.
The son of a farmer, who in 20 years built a refrigerator-parts company into a fast-growing car maker, Li is an industry maverick. Charismatic and indefatigable, the 47 year old has turned Geely — which means “lucky” in Mandarin — into China’s 10th largest car company by sales, and is known for launching unusual designs, including a luxury sedan with a single chair in the back (with a built-in massage device), with unusual names, such as King Kong, Urban Nanny and Beauty Leopard.
And it’s not just eye-catching names, but also low prices for which Geely is known — its cars sell for as little as RMB 40,000, compared with Volvo’s top of the line XC 90 price tag of $205,000 in China. As for overseas expansion thus far, Geely has been exporting its cars, mostly to other emerging markets such as Algeria and Iran, and bought a 23% stake in London black cab taxi maker Manganese Bronze four years ago.
Despite its phenomenal growth, Geely is still a small fry in the global context. Last year, it produced 330,000 cars, compared with Ford’s 4.7 million (and 7.2 million at world number-one Toyota), according to the International Organization of Motor Vehicle Manufacturers. Even locally — in the world’s biggest auto market, with nearly 14 million units manufactured there last year alone and some 16 million expected to sell this year — it has catching up to do. Local rivals moved aggressively ahead– in 2009, Beijing Automotive produced 685,000 cars, Chery 508,000 and BYD 428,000.
A Double Win
Against this backdrop, the Volvo deal looks even more enticing. “To enter the global market, a much tougher and discerning market, Chinese auto manufacturers need technology, and a global production and marketing platform. This purchase gives Geely both,” says John Zhang, a Wharton marketing professor.
Indeed, just getting the deal over the finish line means Li has succeeded where other car companies have failed. The bid of Tengzhong, a little-known Chinese heavy equipment company, to buy the Hummer brand from GM was struck down by Chinese authorities earlier this year, reportedly amid concern about Tengzhong’s inexperience. A consortium including Beijing Automotive Industry Holding Corporation, China’s fifth-largest automaker by sales, failed in its bid to buy Volvo’s domestic rival Saab from GM, and settled for some SAAB design assets.
But now Geely also has a company under its wings that is weak financially. Though turning a small profit in the first two quarter of this year, its last full-year profit was in 2005. Revenue on sales of 334,000 cars for last year was US$12.4 billion, down 18% from the previous year, and its pre-tax loss totaled US$653 million. In contrast, Geely sold nearly the same number of vehicles in 2009, generating a sixth of Volvo’s revenue but posting a net profit of US$200 million.
Many factors explain Volvo’s financial struggles — not least its failure to adapt to changing consumer tastes for smaller, more economical cars. Analysts say Volvo’s cars sit in an awkward niche – too expensive to win the mass volume needed to compete in the budget end, but not advanced or stylish enough to be in the luxury strata.
Ford is also partly to blame, despite its attempts to invest heavily in an R&D center in Sweden and improve its cost base by sharing production platforms, technology and intellectual property (IP) where it could. “[Ford] was pretty good and had a bit of a standoffish approach. It wasn’t meddling that much in day-to-day business,” says Aleksander Zuza, an analyst for IFMetall, a union that represents Volvo workers. “But as Ford’s problems got bigger, it got harder to give money to Volvo, which meant that it wasn’t as easy to develop new products, bring things to market and be as innovative as they would wish.”
By the time Ford put Volvo on the block, suitors were few and far between. “Geely was really the only option for them to take,” says Fletcher of IHS, despite Ford’s reservations about the transfer of IP and technology to the Chinese company. “Ford has been quite brave and really took a pragmatic approach.” In a press release published on August 2, Ford made a point of stating that it “has committed to provide engineering support, information technology, access to tooling for common components, and other selected services for a transition period” and that various agreements within the deal — which ran to a hefty 10,000 pages, according to Reuters — will “establish the proper use of each other’s intellectual property.”
It’s not just how Geely handles the untangling of Volvo’s ties with Ford in Europe that will be critical for the acquisition’s success. All eyes will also be on what Geely does with Volvo in China.
When it comes to working closely with foreign companies at home, China’s automakers have had a steep learning curve, over a relatively short period. From 2004 to 2005, according to consultants at McKinsey, China went from being a net importer to a net exporter of automobiles; by 2007, they were exporting — often in joint ventures with western OEMs — more than half a million cars and trucks, the majority of which are Chinese-branded vehicles for other developing markets.
But in a 2008 paper, McKinsey’s consultants questioned the readiness of China’s OEMs to expand abroad, citing common novice missteps such as failing to prioritize target markets sufficiently so that resources and management were spread too thin, and not paying enough attention to marketing and distribution. As McKinsey consultants concluded, “Such quick-and-dirty approaches risk permanently damaging brands.”
Today, as automakers in developed markets continue to struggle with their flagging balance sheets, McKinsey is more optimistic about China’s automakers prospects. In a paper published in July, McKinsey analyzed various scenarios for growth for China’s auto makers, including buying established, high-quality rivals in a developed market (“one larger than Volvo”). In doing so, it says a Chinese company could gain a market share of 3% to 6% and a profit pool of between US$1 billion and US$3 billion by 2020.
Nueno of CEIBS adds, “This is a particularly good moment [for China’s deal-making OEMs] because they are strong, and [those in the developed markets] are weak.” Indeed, in the U.S., 10.4 million cars were sold in 2009, compared with 14.8 million that had been sold on average every year between 1980 and 2008. In contrast, China’s auto sales to end customers in the first half of 2010 rose 30.45% year-on-year to 7.2 million units, according to Tianjin-based China Automotive Technology & Research Center. Unlike in the U.S., even greater growth is predicted for China over the next few years.
That’s good news for Li and his plans for Volvo. The Swedish manufacturer currently makes its S40 and S80L models for the Chinese market at a factory co-owned by Ford and Chongqing Changan Automobile Company, which is said to be under contract to run for the next few years. Building on the 15,000 cars Volvo currently sells in China, Geely wants to ramp that up to 150,000 by 2015, according to Reuters. Citing local newspaper reports, Reuter also says Geely wants to start making Volvo’s XC60 SUV in China this year and has a shortlist of sites for a new factory to manufacture other Volvo models in the future, including Beijing, Chengdu in the southeast and Ningbo in the east.
But for the most part, auto-industry experts aren’t expecting any immediate, radical overhaul of Volvo, which might throw either company off course. Volvo has just undergone nearly two years of restructuring to bring it back into the black, and Geely currently looks set to hit its 2010 target to increase year-on-year sales 23% to 400,000 units. “I don’t think they’ll do anything to shake up the brand massively in the next five years,” predicts Fletcher of IHS. “Volvo will run as a separate organization for now.”
But beyond operations, Geely won’t be able to downplay the “softer” post-merger challenges it faces, including integrating a vastly different Northern European corporate culture with its Asian one. For sure, Li’s every move will be watched closely in Gothenburg and Volvo’s other major sites, including Belgium. “Cultural differences are often underestimated or underplayed when these sort of things are announced,” asserts Wharton’s MacDuffie. In this respect, experts regard the recent appointment of outsider Stefan Jacoby — Volkswagen’s former U.S. chief — to be Volvo’s new CEO as an astute move, both culturally and operationally.
Some experts reckon the Volvo sale was a one-off — or as Fletcher puts it, “the stars were aligned” — and that it will be difficult for Geely and China’s other automakers to snap up other companies that will help them grow globally. Others — like Nueno of CEIBS — predict that Geely’s acquisition is just the beginning of a new wave of global growth in the auto sector. “The fact that Geely is ambitious is perhaps the beginning of a process that’s going to be very important in this decade,” he says.
Either way, Geely wins. “Even if it fails [with Volvo], the Chinese manufacturer learns some good lessons out of the experience and should not mind too much about paying the tuition,” says Wharton’s Zhang.