BMW has Flexible Production but Inflexible Costs

The German luxury car maker did not shrink its operations to cope with the impact of Covid-19 in the way Detroit peers did.

By guest author Stephen Wilmot from Wall Street Journal

Caption and graphic courtesy by Wall Street Journal

BMW BMW talks a lot about the value of flexibility in dealing with the rise of electric vehicles. It has shown little flexibility in dealing with Covid-19.

On Wednesday, August 5, 2020, the German luxury car maker reported operating losses of EUR 666 million (USD 784.1 million) for the three months through June, its worst result since the 2008 financial crisis. Though losses were not a surprise, they were greater than investors were expecting, and the shares fell 3 % in morning trading.

Whereas Detroit’s auto makers all implemented radical austerity measures to conserve cash during this year’s pandemic-related lockdowns, BMW did relatively little to shrink its cost base. It delayed capital spending, which fell 32 % year over year for the first half, but operating costs weren’t much lower. This is something of a surprise given Germany’s Kurzarbeit or short-working program, which tops up the pay of workers whose hours have been reduced. BMW said in late March it had registered 20000 staff for the program.

As a result, BMW’s negative operating leverage—the profit lost for every lost dollar of revenue—was 43 %, more than for any of its big Western peers. The next worst offenders were its European rivals Volkswagen, Daimler and Renault. Germany has suffered less from the coronavirus than most countries, which may be one reason why its industrial titans have carried on as if things will soon get back to normal.

Sales are now recovering in BMW’s most important markets, to some extent validating its more relaxed stance. China is the brightest spot. BMW’s local joint venture with Brilliance Auto generated quarterly equity income of EUR 367 million—a new high, according to Bernstein. Just as important, BMW made revenue of almost EUR 2.6 billion, or 13 % of the group total, by selling parts and licensing its brand to the joint venture. The share of profit from these revenues is likely even higher.

Still, the apparent rigidity of BMW’s costs is a red flag. However, the pandemic unfolds, the coming years will be tough for traditional car makers as they sell more low-margin electric vehicles to meet European emissions targets and compete with Tesla.

BMW is betting on “flexible” production lines that can make traditional cars, plug-in hybrids or pure electric cars depending on demand. The logic is that the switch-over to new technology is based on unpredictable consumer choices. Dedicated electric-vehicle production, such as Volkswagen, GM and now Peugeot -owner PSA are investing in, is hugely expensive and could end up suffering from low capacity utilization if few consumers end up going electric.

But BMW risks being left behind if electric vehicles suddenly take off in the way Tesla’s market value has. In this scenario, the German company may need to be much more proactive about finding savings than it was during the pandemic-struck first half of 2020.

A flexible production system is one way to cope with the uncertainty inherent in the car industry’s technological transition. But a flexible cost base is arguably even better.

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