Proton’s Dilemma / Malaysian Car Industry

Proton’s Dilemma

Whatever the circumstances faced by all three of the national carmakers, there seems to be an obvious dilemma faced by Proton. Vehicle sales volume dropped by 25 percent in the first half of 2003 compared with the same period of 2002. Total sales from January to June 2003 were 85,430 units, representing a 53 percent share of total passenger car sales, down from 113,680 units or 62 percent in the first half of 2002. As Malaysia’s prime minister, Mahathir left office and World Trade Organization tariff cuts loomed, Malaysians got rich enough to buy other brands despite the high tariffs, causing the national car to be faced with increasing trouble. Proton was faced with increasing trouble as it competed in the 1.6-2.0 litre segments, which is basically the most competitve segment in the market. In addition, Malaysian consumers wanted something else, with increasing variety offered from the Koreans (Kia & Hyundai) and Japanese (Toyota & Honda). Undaunted, Mahathir unveiled yet another vehicle, a locally assembled multipurpose vehicle MPV sold by Naza Kia Sdn, the Malaysian distributor of South Korean's Kia Motors Corp, which was priced at less than RM100,000. Part of it is that competing non-national brands such as Toyota, Honda and Kia have cut costs to the bone, generated dramatic efficiencies and pushed promotions hard in order to get at Malaysia's lucrative car market. According to Pankaj Kumar, head of research of OSK Research, with non-national make cars hitting the market well due to attractive pricing and models, Proton lost out, adding that unless Proton bucked up, such as by introducing new models quickly, the company would see its market share slip further.

Proton's latest model, the Waja, is almost four years old. And in an industry where the average lifespan of a car before another new model emerges is two to two-and-a-half years, Proton is not producing new models fast enough to meet consumer expectations. Despite its pricing advantage, Proton is facing uphill technological and innovation battles in defending its dominant market share, which continues to drop. In order to boost sales, analysts say, it must come up with more interesting models to compete with new non-national passenger cars that feature next-generation automotive innovations such as intelligent automatic gearboxes and variable-timing engines.

For a major part of its existence, the company merely assembled a rebadged clone of the Mitsubishi Lancer as the Proton Saga. That has changed steadily as local content has risen. After unveiling the new Gen-2 model in 2004 with its new in-house engine, the Campro, that is expected to rise to 95 percent. A further drop in Proton sales in 2003 was projected by some analysts as consumers awaited better, improved models and in anticipation of cheaper prices due to the advent of the ASEAN Free Trade Agreement (AFTA) in 2005. As stated earlier, under AFTA, Malaysia is required to reduce import tariffs on automobiles and auto-related products imported from other ASEAN nations to between 0 percent and 5 percent by 2005.

If implemented, Proton and Perodua, the other national car maker, are expected to lose market share dramatically unless the government comes up with other non-tariff barriers to protect the two national companies, which is likely. Minister of International Trade and Industry Rafidah Aziz has said that higher excise taxes for cars are likely to be introduced to offset lost revenues from lower import tariffs. Malaysia, however, also needs to liberalize its market under the auspices of the WTO, to which the country is a party. Under the WTO, participating countries are required to abolish unfair trading practices, including rules and policies in the compulsory usage of locally produced inputs for manufacturing of traded goods. Malaysia, therefore, is required to phase out several measures that are considered unfair trading practices to protect the local automobile industry. That includes a local content requirement policy by 2003 - but which was extended for two years.

Most analysts believe the government will seek to preserve the car. Apart from being the four-wheel symbol of Malaysia's industrialization, a number of government-owned entities have stakes in both Proton and Perodua and employ significant number of people both directly and indirectly through its network of dealerships and auto-parts manufacturers. Hence, to ensure that the dual goals are achieved - the realization of the vision to turn Malaysia into a developed country by 2020 and the protection of thousands of jobs - the survival of both companies will probably be ensured.

Based on an analysis by a major multinational investment bank, the government’s decision to back the new multipurpose vehicle clearly shows the Malaysian government's lack of seriousness in complying with the issue of AFTA. But despite the protection, Proton continues to struggle with high production costs and a lack in economies of scale, making local cars relatively more expensive than many foreign cars without tax and tariffs.

Proton spends a significant amount on research and development (R&D) and royalties paid to Mitsubishi for the use of its engine. Still producing only 200,000 units after 15 years, its volumes are too low to support stand-alone operations, according to an analyst. The company has been trumpeting the development of its own engine, the Campro, since 2001, which analysts said would likely cut its cost by about 30 percent. But in the meantime, the big global firms are designing engines with target production volumes of at least 750,000 units per year, while investing billions of dollars on hybrids and fuel-cell systems. Some analysts disagree, saying that Proton is relatively new on the block whereas other giant motor companies have been around much, much longer and therefore Proton should be given time to catch up. A Maybank Securities analyst, for instance, has said that Proton is taking steps to streamline its operations, referring to the restructuring that took place recently that allows each division to offer its expertise and services to other firms and evolve into a profit-making centers. According to Proton's chief executive officer, Tengku Mahaleel Tengku Ariff, Proton today is not just about selling cars but selling its expertise, capabilities and resources combined with that of the UK-headquartered Lotus Group (of which it has an 80 percent controlling stake), also presents the company with the opportunity to sell these services. 

Meanwhile, Kim Eng Research points to the initiatives Proton has taken to defend its domestic market share and grow its export markets. Firstly, it plans to cut cost by 30 percent by designing its own car, using its own Campro engines for all future new models and procuring quality components from cheaper sources. This is in addition to annual savings of over 200 million Ringgit a year on payment of royalties to Mitsubishi for their engines. The use of its own engines also reduces the effect of yen fluctuation on its earnings. Kim Eng estimates that every 1 percent appreciation in the yen translates to a 1.4 percent drop in Proton's earnings. The engine and transmission (which typically account for about 25 percent of the cost of a car) are currently imported from Japan. With the use of the Campro engines, the transmission will be the only major imported component, thus reducing its yen exposure drastically. 

The establishment of Proton's Tanjong Malim plant (coined as Proton City) is also expected to cut costs and improve quality. The plant has the initial capacity to produce 100,000 units annually with the potential to churn out as many as one million cars, hopefully providing Proton the ability to reach the economy of scale it needs. This is in comparison to just 230,000 units produced by its plant in Shah Alam yearly. The lower cost per car also fits into Proton's export strategy, which most analysts agree is crucial to its survival beyond 2005. Proton is currently losing money on its exports, which account for only about 9.2 percent of total sales. This is not surprising given its outdated models and high cost structure. With lower cost and newer models, it is Proton's intention to boost exports. The company has identified China, the Middle East and North Africa as key export markets, and is currently negotiating for joint ventures. It has entered into a joint venture with Goldstar in China and hopes to start produce 30,000 and 100,000 cars in 2004 and 2005 respectively. While all these plans seem promising, all eyes will be on Proton when it rolls out its state of the art models in the next couple of years, and on how the market, both at home and abroad will take to them.