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The Daimler Chrysler Merger And The Automobile Industry Finance Essay

The Daimler-Chrysler merger was announced on May 7th, 1998 as the largest trans-Atlantic merger ever. The combined company was supposed to be a giant in the auto industry. At that time, Chrysler was the most efficient of America's "Big Three" car producers with strong position in the SUV and minivan markets. Its profitability was achieved by low R&D investments and a comparatively well-established product portfolio that generated high profits. In 1998, Chrysler sold three [i] million cars and trucks, having Dodge Neon as the cheapest, selling for $12,000 [ii] . After a long history of financial difficulties (including a Government backed loan in 1979) Chrysler had finally become the leader in “low-cost, high-volume auto production [iii] ”. More than 90% of Chrysler’s 120,000 employees were based in USA, earning $22 [iv] per hour on average. Market analysts described Chrysler as “daring, diverse, and creative” [v] .

Several years prior to the merger, Chrysler was close to bankruptcy and survived a failed hostile buy-out. The company’s advisers saw the need to merge with another player in order to survive in the cutthroat industry.

On the other side, Daimler-Benz was the most profitable car producer, owning Mercedes brand, recognized for its high quality, state-of-the-art engineering. In 1998, Daimler-Benz sold about 920,000 [vi] cars, with price ranging from $31,000 (C230 model) to $135,000 (S600, the company’s top model). Daimler-Benz had one of the industry’s highest production costs due to high labor costs in Germany (average salary of $28 per hour). Daimler-Benz had 320,000 employees, many of which worked for other businesses such as aviation and financial services. Market analysts described Daimler-Benz as “conservative, efficient and safe” [vii] .

Automobile industry analysts were expecting only 10 of the 30 existing car makers to survive and that companies would either merge or acquire. They believed that sales of 4 million cars would be crucial to be one of these big players.

DaimlerChrysler merger created a $92 billion market cap company with 440,000 employees and sales of about $130 billion. Most importantly, DaimlerChrysler’s projected sales were greater than the four million car threshold set by analysts. The companies projected $1.4 billion savings in synergies in 1999 and $3.5 billion within three years [viii] .

Synergies were expected from combining purchasing and other operations, like distribution (selling Mercedes products through Chrysler dealerships), sharing the R&D costs over a larger production base and reducing total R&D investments by jointly developing mid-sized cars. Daimler’s growth was slowing because of a saturated luxury market, and they viewed Chrysler’s growth as very attractive. The cost reductions would improve DaimlerChrysler’s competitive position and strengthen the company’s financial position. They also believed that a larger, more stable, multinational company would find cheaper financing and better exchange rates. Finally, Daimler’s market share in Europe was three times more than that of the US, while Chrysler sold almost all their production within the United States. The analysts predicted that combining Daimler’s European strength with Chrysler’s US sales would create a truly global company [ix] .

More cynically, we can also view the merger through agent theory and note that Daimler and Chrysler management had large personal incentives to complete the deal. Chrysler management contracts contained a clause where their stock options vested upon an acquisition. Daimler executives were paid significantly less than their American counterparts (CEO pay was $14 million versus $2 million,) and their pay was likely to increase with the addition of a large, American division [x] .

Although the merger was considered a bold strategic move and the biggest merger up to that moment (it was a model for the Renault-Nissan alliance), the integration of the two companies was not as smooth as anticipated. Many advantages were touted for the combined company, but their cultural fit was completely wrong. Daimler was a luxury manufacturer who leveraged only two models for sales volume, while Chrysler was a mass producer who sold more that 20 types in many different categories. German executives analyzed issues to death, "they aimed so much they forgot the shooting" while Chrysler executives were used to synthesizing data and making quick decisions. Their approach to customers was also completely different, Mercedes appealing as a rational brand and Chrysler as an emotional one. Decisions were also muddied by Co-CEOs and confusions over who was ultimately in-charge. Executives predicted shared components would provide savings, but in reality the companies purchasing had no overlap. Mercedes components were high cost/high quality, while Chrysler required lower cost/lower quality parts. For similar reasons, their distribution channels couldn't be integrated, either. High-end Mercedes customers won't go to a mass-market Chrysler dealership, nor vice versa.

Complications also arose from listing the stock in Germany, because the S&P 500 dropped DaimlerChrysler from the index and many US investors didn’t want to hold a stock listed in Germany causing a drop in the premium enjoyed by Chrysler. German shareholders also found US pay packages unacceptable. Eventually establishing the headquarters to Germany and emerging with one, German CEO made DaimlerChrysler priorities clear: Mercedes was most important.

Expected R&D synergies were unobtainable, Daimler had expertise in diesel engines that are not popular in the US. Car platforms were technologically different and Daimler executives said “never will a Mercedes-Benz platform be shared with Chrysler or other brands [xi] ”.

After their large payout (almost $17 million each) American executives became disinterested in the company, “they stopped working as hard and if you called on Friday afternoon they were out golfing. By 2000, they would complain if we scheduled a meeting after 5pm [xii] ”. Chrysler problems surfaced quickly: low productivity levels, high fixed costs, inefficient purchasing systems, and constant quality issues and inefficient investments (which accounted for 10% of the sales figure). German executives stepped in closing factories, laying off 45.000 workers, cutting budgets and trying to develop new models in a more efficient manner. For a short period of time Chrysler seemed to recover, and even made a “shy” step into Europe with the newly developed 300C model.

In 2006, Mercedes lost market share and Daimler experienced heavy losses with the Smart brand in Europe. DaimlerChrysler executives recognized Mercedes needed to undergo important structural changes, and diverted funds and attention away from Chrysler, pushing it into a downward spiral, that was hastened by surging oil prices that made US customers lose their appetite for the gas guzzling cars that made up an important part of Chrysler's sales.

The merger was a bitter experience for both parties. It demonstrated that just by adding two companies under a single corporate umbrella, value is not created. In this case value was destroyed, since the market cap of DaimlerChrysler was lower than the sum-of-value pre-merger. Even though some synergies were achieved by integrating parts sourcing and shipping in the US, and corporate financing, other objectives like sharing R&D costs and investments related to new products proved unrealistic since high end technology and low costs cannot be achieved simultaneously.

Organizationally they were actually two independent entities with different goals, directions and most importantly cultures. Daimler-Benz is an efficient and safe company, while Chrysler is a dynamic and innovative company with strong marketing. Looking back, one wonders if the merger was not necessarily triggered by the need to create a scale within a consolidating market. Both companies’ management, investment bankers, and consulting firms had high personal interest in seeing the merger completed.

Fiat and Chrysler

In 2008, following the industry’s trend of further consolidation, Fiat’s CEO Marchionne was searching for a way to ally Fiat with another manufacturer (or group of manufacturers) to ensure its long term survival.

The financial crisis decimated Chrysler. After the failed marriage with Daimler, Chrysler was taken over by the private equity fund Cerberus Capital. Cerberus never seemed to gain traction with the investment and even claimed that Daimler misled them during the initial purchase [xiii] . Private equity firms are not required to disclose performance, but its rumored Chrysler burned over $1 billion of cash per month under Cerberus management [xiv] . US auto sales dropped dramatically from 16.1 million cars in 2007 to 13.4 million in 2008 and 11 million in 2009 (see appendix 3). An already weakened Chrysler couldn't survive, weighed down by high fixed costs and $18.6 billion pension liabilities [xv] .

The US government was forced to step in and give a politically unpopular loan to Chrysler in December 2008. Chrysler continued to falter throughout the spring and in April 2009 the US government finally pushed them to first declare bankruptcy and then sign the deal with Fiat. The US government wouldn't accept a licencing, a joint venture or other non-ownership market solution between Chrysler and another manufacturer. The US has strong separation of public and private enterprises and the US population would not accept long-term government ownership of Chrysler. This context gave Fiat two choices: accept some Chrysler ownership under extremely favorable conditions or miss-out on the opportunity altogether.

Marchionne and Fiat decided to accept the deal (see appendix 4). Under the new structure, however, Fiat-Chrysler are under high political pressure to achieve these milestones and relieve the US government of their ownership stake.

Chrysler has a reputation in the USA of an innovative designer who is not afraid to take risks. They were the first company to introduce the mini-van, and consistently pushed design limits launching the PT Cruiser, Prowler, Crossfire, and Viper. Chrysler is probably the only US manufacturer who can credibly borrow Italian designs from Fiat and Alfa Romeo. Furthermore, their history of performance cars fits well with Alfa Romeo. It is also an excellent marketing company, providing character and strong position for its cars. Chrysler's weaknesses are in international markets and manufacturing quality and efficiency.

Fiat positions Alfa Romeo cars as born from high performance racing, especially F1. Its mission is "to build cars with attractive styling and exciting engines, cars that are accessible and improve the quality of everyday life [xvi] ". The company has also rapidly improved its perceived quality and popularity within Europe.

As we can see from their positioning, Chrysler and Fiat evoke the same image - passion, speed, aggression and proud history. They both leverage emotional ties to their consumers and identify strongly with their countries of origin. Their brands are also fairly complementary - Jeep, Ram, and Fiat all target different groups. Only Chrysler-Lancia and Alfa Romeo/Maserati-Dodge may see some overlap. Their dealer networks are already being integrated: for example, Chrysler dealers will start selling the Fiat 500 in the US later 2010. Fiat and Chrysler products are integrating now - sharing power trains and platforms.

Marchionne is key for the Fiat-Chrysler relationship: since he was appointed CEO in 2004, he turned Fiat around and built a successful story. As we saw in the DaimlerChrysler failure, cultural mismatches can destroy synergies. Marchionne understands this and has been assigning Fiat’s team to Chrysler’s core executive positions, thus ensuring an integrated strategy. He spent much of his youth in Canada and seems to be an excellent bridge between the American and Italian cultures.

Conclusion

Based on our research (see also Porter’s Five Forces and SWOT analysis in Appendices 1 & 2) , we believe that the ongoing merger between Fiat and Chrysler is much more likely to succeed than the DaimlerChrysler one. This new alliance can enjoy complementarity in terms of products, markets (geography and segmentation) and brands. On the other hand, it can benefit from achievable synergies in R&D, platforms, manufacturing, supply chain management and distribution. To make this work though, the biggest challenge is on the organizational and cultural sides.

In January 2010, while addressing his audience at the Automotive News World Congress in Michigan, Marchionne stated: “There are those who say a trans-Atlantic alliance is bound to fail-that Chrysler cannot Americanize Fiat and that Fiat can’t succeed as a schoolmaster in Detroit. Were that our intention, they’d be absolutely right”.

These words can be the key for the success of this strategic alliance.

Therefore our recommendation is that Fiat should complete the merger by reaching the milestones set by the US government and using the option to own up to 51% of the shares of Chrysler. In the mean time, the management should work on spreading the shared corporate values that will form the base for the long term sustainability of the new entity.

Stronger and stronger synergies in the key areas mentioned above should be aimed at ensuring the viability of businesses. Marketing strategy should be focused on preserving the brand identities and complementarity. We recommend an approach similar to the one of the Volkswagen Group with its brands Skoda, Seat, Volkswagen, Audi and Lamborghini.

After freeing Chrysler up from the US Government loan, the company should return on the capital markets to gain back confidence in the company internally. In order to send a strong signal that Fiat and Chrysler want to be linked to their countries of origin, we recommend that the respective shares should be traded separately on Italian and American stock exchanges.

Appendix 1 – Porter’s Five Forces evolution over time

1998 - Porter’s Five Forces [xvii] 

2009, US market at crisis - Porter’s Five Forces

Buyer Power (High)

Many cars are available in the market, from many recognizable brands with worldwide reach

Buyer Power (High)

More products available than in 1998, plus new Asian imports (like Kia) are gaining traction in the US market

Supplier Power (High)

Dependent upon a supplier for the life of the design, as manufacturers & suppliers design together

Everything from steel, aluminum, dashboards, seats, tires, etc. are purchased from suppliers; modern auto manufacturers are used to manage concurrent design and assembly of many component parts

High labor cost due to unions

Supplier Power (High)

Dependent upon a supplier for the life of the design, as manufacturers & suppliers design together

Everything from steel, aluminum, dashboards, seats, tires, etc. are purchased from suppliers; modern auto manufacturers are used to manage concurrent design and assembly of many component parts

High labor cost due to unions

Threat of Subs (Low)

No real substitute for cars (especially when oil prices are cheap in U.S)

Threat of Subs (Low)

No real substitute for cars (especially when oil prices are cheap in U.S)

Barriers of New Entrance (High)

Need to reach economy of scale in U.S

Barriers of New Entrance (High)

More foreign players have entered

Chinese players are starting to rise (Geely)

Industry Rivalry (Medium to High)

Intense / saturated market

Margins are under intense pressure from competition

Industry Rivalry (High)

Saturated market

Global players consolidating

Overall industry declining, sales in US falling quickly during the financial crisis and credit markets are freezing exactly when the auto industry needs access to them

Appendix 2 – SWOT Analysis for Chrysler

STRENGTHS

WEAKNESSES

Strong US market base

Well known brand

Dealership network in US

Innovative

R&D

High debt

UAW

Out of date models

OPPORTUNITIES

THREATS

Access to Fiat’s cutting edge technologies; economies of scale

Access to Fiat’s dealership networks in Europe and Latin America

Fiat’s managerial style

Unsuccessful global record of mergers

Clash of cultures

Cannibalization of certain products

Appendix 3 – Global car sales 1990-2010 (forecasted):

*source: “The name of the game is survival!” (Fiat Group presentation to Bank AM Bellevue Investor seminar; Flims Jan 17th 2009)

Appendix 4 - The final Fiat-Chrysler Deal Structure:

Fiat acquires a 20% stake of the new Chrysler LLC (without paying)

No cash investment commitment to fund Chrysler in future from Fiat

Fiat will get access to Chrysler's dealers network in the US

Chrysler will get access to Fiat's technologies (especially engines)

Chrysler will get access to Fiat's dealers network in Europe and Latin America

Fiat can increase their ownership 5% for each milestone they reach:

1. Regulatory approval to produce Fire family of engines in US

2. Sales of Chrysler vehicles outside NAFTA

3. Regulatory approval to produce a Chrysler model based on Fiat technology

Furthermore:

Fiat gains a call option on a further 16%, exercisable between Jan ‘13 and Jun ‘16

Fiat can not take majority control of Chrysler until UST loan had been fully repaid

Appendix 5 – Chrysler and Fiat Product Lines and Brands

Chrysler Products [xviii] :

The Company engages the supply of passenger cars, SUVs, sports tourers, minivans, pickups, and also been experimenting with a Hybrid Diesel truck for military applications. Products are oriented towards lifestyle.

Dodge: capability and lifestyle. Durability, precision, safety and security (some models: Challenger, Grand Caravan, Journey, Viper and Nitro).

Jeep: 4X4, ruggedly refined. Capability to master any terrain. It represents peace of mind and confidence. (Some models: Commander, Compass, Grand Cherokee, Liberty, Patriot and Wrangle).

Chrysler: Car and minivan design. (Some models Chrysler 300, Chrysler PT Cruiser Classic, Chrysler Sebring Sedan, Chrysler Sebring Convertible and Chrysler Town & Country)

Ram: Trucks with turbo diesel. Safety for working and lifestyle (Some models: Dakota, Ram 1500, Ram 2500 & 3500 and Ram Chassis Cab 3500/4500/5500).

Mopar: Original equipment parts and accessories for the millions of Dodge, Jeep® and Chrysler vehicles.

GEM: Global Electric Motorcars (GEM) is a environmentally friendly alternative transportation.

Fiat Products [xix] :

Fiat makes cars with Italian design and stylish cars like Alfa Romeo, Ferrari, Maserati and Lancia. Fiat makes too trucks, tractors, agricultural machinery, construction equipment, motor vehicle engines and components through its sister companies Iveco, CNH, Fiat Powertrain Technologies, Magneti Marelli and COMAU.

Fiat: Practical and affordable technological solutions and Italian design. Environmental and technological innovation (New Panda, 500, Grande Punto, Bravo, Croma).

Alfa Romeo: Style sportiness, technology, comfort and elegance. Italian design, agility, spirit and charm (MiTo, 147, GT, 159, Brera).

Lancia: Class and exclusiveness. Elegance lifestyle and Italian designe. Innovative and stylish concept (Ypsilon, )

Abarth: sporting emotion and grit. Performance inspired by the world of motor racing

Fiat Professional: commercial vehicles (to partner small and large companies in growing their businesses). Productivity, ease of use and fuel efficiency.

Maserati: Technological derived from the world of competitive racing.

Ferrari: exclusive cars. Linked by Formula 1 without equal.

Agricultural and Construction equipment: Diversified businesses, 6 brands: IH, New Holland and Stey

Iveco: Trucks and commercial vehicules.

Components and production systems: FPT Powertrain Technologies, Magneti Marelli, Teksid and Comau.

Chrysler and Fiat products engage in different segments with their products.

Fiat and Chrysler Brands [xx] 

Fiat - Sometimes, to move forward you need to take a step backwards

Maserati - involves more than its glorious sporting achievements and the launch of great road cars

Alfa Romeo - With just a glance, Alfa Romeo allows us to discover a world of passion and engagement

Lancia - Faithful to tradition, attentive to new demands

Dodge - about grabbing life with intensity and passion, going full-throttle and exceeding expectations

Jeep - owning a Jeep® vehicle is about more than just ruggedly refined good looks

Chrysler - “I feel sorry for the person who can’t get genuinely excited about his work. Not only will he never be satisfied, but he will never achieve anything worthwhile.” Walter Chrysler

Ram - doesn’t take kindly to just standing idly by

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