The Peugeot–GM tie up in the context of Brexit

The merger between PSA Group, owner of the Peugeot, Citroen and DS brands and General Motors’ European division (which includes Opel and Vauxhall) will usher in significant change in the European car industry. A combined PSA-GM will be the second largest car maker in Europe behind Volkswagen, and the merger will trigger significant restructuring and efforts to cut costs at PSA-GM.

That in turn raises potential closure risks for plants and workers in the UK especially given the nature of the UK’s flexible labour markets. Uncertainty over the whether the British car industry will be inside the Single Market or even the Customs Union in a few years’ time increase that risk.

GM and PSA already share production of sports utility vehicles and commercial vans, as part of an earlier attempt to cooperate. GM sold its stake in PSA back in 2013, a move which paved the way for a bailout of the then ailing PSA by the French government and investment by the Chinese firm Dongfeng Motor Corp. Both hold 14 per cent stakes in PSA (as does the Peugeot family). Combined, PSA and GM Europe would have a 17% share of the European car market, second only to Volkswagen’s 24% (2016 figures).

PSA has done relatively well of late, bouncing back with French state support from a ‘near death’ experience in 2013-14 to post a decent 6% margin last year, and paid out a dividend for the first time in years. The firm sold 3.15m units last year. Its CEO Carlos Tavares – like Sergio Marchionne of Fiat Chrysler – had previously indicated a desire to tie-up with other car firms to increase PSA’s scale and be better placed to invest in new technologies set to transform the industry in Europe (think electrification, hybrids, connected and autonomous cars) especially in the wake of VW’s ‘dieselgate’ scandal.

Meanwhile, GM has for years struggled to make a profit in Europe, losing some US$15bn there since 2000. It had previously looked at off-loading its European operations during the global financial crisis but eventually decided to hang on to them as it saw them as strategically important in developing new technologies.

That has now changed. GM Europe failed to meet its own breakeven target last year, losing over US$250m, citing a $300m-400m financial headwind from the post Brexit vote depreciation of sterling last year. A weaker pound makes importing both cars and components to the UK (GM’s second biggest market in Europe) more expensive. These extra costs from Brexit-vote currency movements may have been the final straw for GM.

Given such losses at GM Europe, why is PSA taking it over? It hopes to achieve economies of scale, gain access to GM Europe’s technology (its engineering centre at Russelsheim in Germany has played a key role in GM’s powertrain development work) and to achieve cost savings of some €2bn a year.

The latter will likely come through joint procurement, technology sharing across models and brands, and plant closures and job cuts. That in turn raises the question of where the axe will fall. On first inspection GM plants in Germany might be vulnerable owing to high costs but GM has already closed a plant at Bochum, and the German economy minister Brigitte Zypries recently stated that maintaining plants and research capacity in Germany is the government’s “top goal”.

Rather, it’s the UK plants that look most vulnerable to cost cutting moves. That’s not because they are inefficient. Far from it; workers and management at both Ellesmere Port and Luton have pulled out all the stops in recent years to work flexibly, get costs down and win contracts to build new models, beating competition from across GM’s European plants when ‘locational tournaments’ have been held to decide where to assemble models like the Astra and Vivaro van.

Rather, it’s the combination of the UK flexible labour markets (it’s easier to fire workers here), uncertainty over the UK’s trading position with Europe and the post-Brexit referendum sterling depreciation that leaves them especially exposed.

On the latter, major components such as engines are imported to GM’s UK plants from the continent. As noted, the post-referendum weaker pound makes such imported components more expensive, pushing up assembly costs in the UK.

PSA of course, shut its (profitable) Peugeot plant at Ryton, near Coventry almost ten years ago, shifting production of small cars over to Slovakia as the EU expanded. If the deal goes there is a serious risk it will axe UK operations all over again.

Vauxhall’s Ellesmere Port plant was anyway arguably the most vulnerable in the context of uncertainty over the future of the UK’s trading relationship with Europe (Bailey and De Propris, 2017). The Astra model assembled there is due to be replaced in 2021, with a decision on where to base production to be made sometime in 2018, right in the middle of Article 50 negotiations.

So key investment decisions will be made in what looks to be at least a two-year window of uncertainty. PSA/GM, like other car makers, will ask questions like: Will the UK car industry have access to the Single Market? Will WTO tariffs apply? Is investing in UK production worth the risk?

This risk is greater for ‘mass market’ producers who operate on low margins, are reliant on exports and have new models (like the next Astra) at the planning stage. Cue much speculation as to whether a ‘Nissan-style’ deal could be offered to PSA to encourage investment in the UK.

Nissan’s decision late last year to base Qashqai and XTrail model production at Sunderland from 2020 was clearly good news for the UK car industry and reflected the underlying competitiveness of the Sunderland plant.

Yet the bigger battles in securing foreign investment in UK auto lie ahead – at Honda, Toyota and Vauxhall – all of which are more at risk of switching production from the UK to Europe if uncertainty over the UK’s trading relationship with Europe is not clarified sooner rather than later. This has been amplified in the Vauxhall case by the PSA-GM tie up with its implications for plant closures somewhere in Europe.

In summary, the combined PSA-GM will look to cut costs, with potential closure risks for plants and workers in the UK. Uncertainty over the whether the British car industry will be inside the Single Market or even the Customs Union in a few years’ time increase that risk when key model location decisions are made in 2018, right in the middle of Brexit negotiations.

Professor David Bailey works at the Aston Business School.

Disclaimer:
The views expressed in this analysis post are those of the authors and not necessarily those of the UK in a Changing Europe initiative.

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