Institute for Prospective Technological Studies

Advanced technology and the competitiveness of European industry:

The cases of textiles, steel, motor vehicles and aerospace.

A report prepared by the IPTS for the Committee on Economic and Monetary Affairs and Industrial Policy of the European Commission.

Eamon Cahill & Ken Ducatel

Joint Research Centre-European Commission IPTS(TEC) Seville

September 1997

SUMMARY MAIN REPORT

1 Introduction 2 Competitiveness - a slippery concept 3 Textiles, clothing, leather and footwear 3.1 Overview 3.2 Sub-sectoral issues 3.3 Technology and skills 3.4 Integrating the value chain 3.5 Regional issues 3.6 Strategies and policies for the sector 4. Steel 4.1 Overview 4.2 Technology and skills 4.3 Overcapacity and rationalisation 4.4 Strategies and policies for the sector 5 Motor vehicles and components 5.1 Overview 5.2 Technology and skills 5.3 Strategies and policies 6 Aerospace 6.1 Overview 6.2 Technology and skills 6.3 Strategies and policy 7 Conclusions 7.1 Diversity and similarity: general lessons from the sectoral stories 7.2 Outlook and Policy Prospectives

1 6 6 6 8 8 10 12 13 15 16 16 16 18 20 21 23 23 25 28 30 30 32 34 35 36 40

APPENDICES: SECTOR DESCRIPTIONS

1 Textiles,Clothing, Leather and Footwear (TCLF) 1.1 Introduction 1.2 Growth in the Sectors: 1.3 Profitability of Companies: 1.4 Trade and International Structure: 1.5 Labour Costs: 1.6 Employment 1.7 Strategic responses 1.8 Summary 2. Steel Sector 2.1 Introduction 2.2 Steel Markets and Trade 2.3 Technology 2.4 Research and Development: 2.5 Profitability 2.6 Costs 47 47 47 48 51 53 53 54 56 56 57 60 61 61 62

2.7 Outlook: 2.8 Summary: 3 Motor Vehicles and Components 3.1 Production 3.2 Competitiveness: 3.3 Profitability: 3.4 Exports and Imports: 3.5 Research and Development: 3.6 Capital and Other Costs: 3.7 Human Capital and Skills Base: 3.8 Key Strategic Issues: 3.9 Summary 4 Aerospace Industry: 4.1 Production 4.2 Research and Development 4.3 Profitability: 4.4 International Trade 4.5 Costs 4.6 Productivity 4.7 Employment 4.8 Some Key Issues 4.9 Summary

64 65 67 67 68 70 70 71 72 72 73 74 77 77 79 80 80 81 82 83 83 85

Summary
The report examines the competitiveness of European industry in four sectors: textiles, clothing, leather and footwear; steel; automobiles and aerospace. It provides a concise overview of each sector which concentrates on the major competitive challenges facing them, an interpretation of the current implications for technologies and skills in competitiveness and a short set of policy proposals.

It concludes that, the main drivers affecting these sectors are similar: low to moderate growth in demand in EU markets, increasing pressure from low-cost commodity producers in Asia and the increased use of labour saving technologies. Overall,

although employment in these industries can be expected even where the competitive position of the industries is good. We three see main trends which are important in all three sectors: 1. Increased specialisation and concentration on higher value more technically demanding markets or sections of the value chain. 2. Value chain integration and the streamlining of the supply chain will change the calculation of costs and benefits of moving production activities out of Europe. 3. Global-localisation will mean that production capacity will remain in Europe. The question is whether it will be owned by European firms.

However, in each sector technological strategies have to relate to the specific challenges which the industry faces: the very low cost and growing capabilities of Asian manufacturers in textiles; very low cost Eastern European producers sitting on the margins of the EU (in automobiles and steel); the need to internationalise production capacity and develop stronger international alliances (in textiles, automobiles and aerospace); etc.

Against these intra-industry challenges pressures are being created by broader changes which are taking place in the economy and society. The most important changes which are looming relate to: the increased liberalisation of markets; the more stringent environmental regulations and issues surrounding governmental spending plans. This

points towards the need for clear signalling of policy intentions, with sufficient lead times for industries to respond and a match between the regulatory agendas and feasible technological trajectories. This can only be achieved through co-operation between policy makers and industrialists on short and most of all, longer term planning, co-operation and experimentation.

Main report
1 Introduction This report examines the competitiveness of European industry in four sectors: textiles, clothing, leather and footwear; steel; automobiles and aerospace. The report provides a concise overview of each sector which concentrates on the major competitive challenges facing them, an interpretation of the current implications for technologies and skills in competitiveness and a short set of policy proposals. For each sector an empirical appendix is provided which contains more detailed tables and figures from which the main points in the overview were derived.

The overall aim has been to provide the basis for an informed debate on these specific, and rather different, sectors. Nevertheless, we do see some general trends in the emerging competitive position of European industry which are common to all these sectors. In a concluding section, therefore, these are drawn out in order to try to contribute to a more general debate on industrial policy and prospectives.

2 Competitiveness - a slippery concept Although competitiveness is a much discussed subject and is a major focus of policy concern it is rarely defined or used in a consistent way. Whilst the idea of competition between firms is relatively orthodox, it can be questioned whether the term has any meaning at the national or regional level, where it is often deployed.

Sectoral studies of competitiveness suffer from a similar problem, in that it is not clear exactly what comparison is being made when statements are made about the competitiveness of European industry. Does it mean that they are suffering growing (or declining) markets, that the products are of higher (or lower) quality or lower (or higher) price, that more (or fewer) Europeans are being employed in that sector, that firms are being formed (or closing down), that the productivity rates of European firms are higher (or lower) than those in other countries, that the technologies deployed are older (more modern) or perform better (less well)? Most of the time such issues

remain implicit in the discussion and this leads to major misunderstandings about the future prospects for European industry and misplaced policy debates.

In fact, as we can see from the questions we have just asked, competitiveness is a multi-dimensional concept, and one on which there is unlikely to emerge a consensus. Recently, there have been some major efforts to understand the main dimensions of competitiveness as part of an overall attempt to map out industrial performance. These include the growing numbers of benchmarking studies - which have also been undertaken at national as well as firm level. Most of the time, therefore,

competitiveness reports are assemblages (whether in the form of an index or an argued rationale) of indicators of firm performance, such as: market share (changes) profitability return on investment levels and directions of inward investment flows turnover (rates of growth) labour costs and labour/capital cost ratios growth in jobs productivity qualification levels of the workforce training expenditures rates of investment in new capital equipment and technologies investment levels in formal R&D patenting activity levels of regulatory rigidity etc.

Most of these indicators are unsatisfactory. Some reflect only short term performance. Others are only input indicators. Overall, it is usually necessary to make a composite story from all these factors. The problem with such stories, of course, is that they are open to interpretation (or theorisation) especially as regards the projection of current trends into future performance.

In constructing this report, therefore, we deliberately adopted an empirically grounded approach to the issue, based upon the idea that competitiveness relates to the prospects for retaining market share in Europe and of expanding market share abroad.

In developing our accounts of competitiveness, therefore, we were mainly interested in trying to explain overall changes in the structure of international markets, and particularly to examine the role of technological changes in explaining the changes which are taking place. Clearly, in order to do this we had to develop some kind of notion of the key pressures of globalisation which are taking place at the moment (another term which is open to widespread misuse). We were particularly interested to try to understand the role of innovation in building up European industrial performance, even though direct effects are rather hard to identify. In addition, we wished to examine the role of policy as it affects the evolving competitive position of European producers. 3 Textiles, clothing, leather and footwear

3.1 Overview The Textiles, clothing, leather and footwear (TCLF) sector continues to be an important industry in overall employment terms despite fairly flat or slowly growing demand and falls in employment to just under 2 million. Its importance resides in the fact that these four industries represent a complete production chain which extends from the processing of raw materials to the supply of large consumer and intermediate markets. In fact, Europe is the world largest market for TCLF and so, in blunt s terms, the competitiveness issue is if Europe does not produce the goods, they will be imported from elsewhere. Indeed, the negative trade balance in TCLF in 1994 had reached 14 billion ECU. Section 1 of the Appendix provides more detailed quantitative data on the sector.

A cursory examination of the competitive position of European TCLF indicates that European producers face one major disadvantage - labour costs (see Table 1.3 in the Appendix). Wage costs in Europe are between ten and fifty times those some Even compared to

emerging industrial nations, especially China, India, Pakistan.

relatively developed countries in Eastern European, South East Asia, Japan and the US labour costs in northern Europe can be quite high.

In the commodity end of the industry, which is highly sensitive mainly to price, relatively high labour costs are competitively unsustainable. The extreme wage

differentials strike hardest at the labour intensive areas of production particularly cutting and assembly operations in the clothing and footwear industries, and dyeing, printing and finishing components of the textiles industry. But in the commodity areas of TCLF, generally, strategies of increasing capital intensity in order to offset high labour costs are confounded by the sheer size of the market which would be needed to achieve a (competitive) economic scale of operation.

However, in other parts of the industry where non-price issues are more important there is some scope for retaining the competitiveness of European producers. The issue can be conceptualised as a competitiveness continuum (Figure 1). At the

commodity production end Europe may retain some residual manufacturing capacity, but the scope for growth is negligible. Europe retains a competitive advantage only in areas where factors other than price are important such as: textiles and clothing which meets specialised requirements, such as high performance materials for use in certain leisure activities, the automobile industry or in the hospitality trade; differentiated consumer tastes and fashion awareness

Even here there are vulnerable areas. Lower cost producers are increasing their ability to contest higher value markets as their quality standards rise, as the sophistication of their methods increases, as their workforces become better trained and as they become more tightly integrated into global logistical chains (as a result of the use of information technologies). Also, some European producers are currently protected under the continuing provisions of the Multifibre Agreements. In these parts of the sector we expect there to be a dramatic lowering of prices as low-labour cost producers enter the European market, with products which are not significantly lower in terms of quality. The best hope for European producers in these vulnerable areas is

to use the remaining period of protection to strengthen their presence in relatively defensible specialised areas of the market.

3.2 Sub-sectoral issues The TCLF sector is very diverse, and in order to bring into focus the competitive challenges facing European producers it is necessary to look in more detail at some of the sub-sectoral and regional issues surrounding the prospects for the sector.

The key point is that the main area of competitive weakness is in the labour intensive assembly and finishing operations. This means that in parts of the industry where there is scope for labour substitution and where import penetration is more difficult competitiveness might be retained. A number of sub-sectors potentially have these features. First, Europe remains a major producer and processor of wool as a raw material and, because many woollen garments are knitted rather than cut, there is a foundation for a continued European presence even in the commodity end of the wool trade. Secondly, non-woven materials based on synthetic materials and those which are made up into articles which are pre-formed, moulded or which are bonded and stuck rather than sewn, present opportunities for removal of the major labour intensive stage.

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Figure 1

The Competitive Position of European TCLF Products

Type of Market: Demand Pattern

Commodity
Long runs of basic yarns, cloths and products. Mass production, mass assembly of standard products.

First Stage Specialisation

Medium/long runs of standard products with minimal design content. Large batch production in quick changeover equipment mode. Higher Product quality standards

Advanced Specialisation
High design content with specialised and innovative materials. Niche markets and fashion. Technology intensive production, quick response and flexibility. Emphasis on high product performance

Production Pattern Opportunities

Increasing Specialisation of Markets

Threats
Uncompetitive by reason of Costs

Increasing Contestability of Markets

Vulnerable by reason of costs and the developing capability in emerging low cost economies. Capital investment in product development and in productivity improvement based on technology. Increased emphasis on quality. Scope to compete successfully

Competitive Position

Strategic Response

Limited scope for capital investment in selected areas to defend existing markets

Concentration on product development in collaboration with customers. Emphasis on R&D for improved product performance and attributes.

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The handling of such materials also tends to require a higher level of technological input than in the basic commodity sector, even though the production runs might be quite long and the products themselves quite cheap. Thirdly, bulky products or those which are cut or finished in the final markets such as carpets, soft furnishing materials, etc may also be possible to retain in Europe, again because such products are relatively capital intensive and they are less prone to cheap importation. The implication of these points is that policies concerning the TCLF sector should be tuned to its inherent diversity. In

addition, the fact that as competitive strategies are increasingly based upon specialisation that this diversity is in itself a potential avenue of competitive advantage that should not readily be discarded in favour of traditional industrial policies to encourage centralisation and integration. 3.3 Technology and skills Overall, however, the future of European TCLF production depends to a large extent upon how effectively it can build strengths in the high performance, higher margin areas of the sector. These are the areas which are skill and/or technology intensive

(increasingly they are both). There are three levels at which we can see an increasing role for technology and skills: high performance products - either where the basis for the product depends on new materials which are themselves high technology inputs to the production chain (new fabrics), or where the final product has to meet high levels of technical performance or finish such as in special applications in intermediate goods; high skill/technology processes - where handling the materials or the final assembly requires special technologies, environments or skills on the part of operators; customisation and service - where customers are either very exacting in their requirements or where the market is characterised by variability in specification, meaning that production is best located near the final demand in order to match needs. Here high quality and technical mastery may be very important to service the market.

In practice, these levels interact one with another to provide a set of forces which may allow Europe to retain a strong presence in specialist markets. The scope resides in the fact that the labour cost component of the overall value is relatively low. We can see

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these kinds of effects most clearly in the case of the so-called technical textiles, which are intermediate products for use in sectors such as transportation, geotextiles, technical garments, health care, construction, and so on. In these applications, performance and service may outstrip pure price issues by a long way. Also at 30 billion ECU (1993) this market is significant and certainly worth pursuing, even if it cannot be regarded as the saviour of all of Europe textile producers. s

In order to service these kinds of demand, however, it continues to be necessary to upgrade both skills and technologies in the TCLF sector. There has been a long term upgrading of spinning machinery ( as shift to open-end rotors), weaving (shuttless looms) the introduction of computer aided design and manufacturing in clothing Assembly processes,

(especially in cutting, but also to some extent in assembly).

however, remain quite labour intensive, which is one reason why the clothing industry is more susceptible to pressures international competition than say textiles. Increasingly important, also, has been the development of information networks in order to achieve downstream integration with suppliers. These technologies increase the ability of

producers to meet customer needs in a very flexible and timely manner, and thus could be seen as a means of pursuing a specialisation strategy, However, such technologies are also the backbone of a global information system which permits the integration of producers all around the world into a single logistical chain, thus, perhaps, increasing still further the exposure of European producers to lower cost competitors. 3.4 Integrating the value chain The perspective that economics of production can be seen in a holistic way as a complete value chain is a relatively recent approach, and certainly relates to the trend towards logistical integration, JIT production and the use of information technologies. The question is whether, taken from this viewpoint, there is a potential change in the economic calculation about where to locate production activities, and, more precisely, whether there will be scope for the retention of employment in TCLF in Europe.

In broad terms the answer to this question depends upon the specifics of the sub-sector, and the decisions of industrialists. However, as we note above, it does mean that non-

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price factors such as timeliness, customer service performance and so on are likely to rise in importance, which can only create opportunities for European production.

To take as illustrations the contrasting patterns of development in the German as opposed to the Italian TCLF sectors. In Germany, the more vulnerable labour intensive stages of production have been outsourced to lower-cost Eastern European producers, whilst German producers have invested heavily in upgrading the capital (and technology and skill) intensive activities which have remained at home. In this case, a lot of effort has been expended on the development of high quality logistical competences in order to manage the complexities of an internationally outsourced production activity. Of course this means that certain (mainly lower skilled) production activities are delocalised. Taken together with the increasing focus on high performance intermediate products for German industries (for instance upholstery for automobiles, etc), there has been a shift in emphasis of the industry towards higher skilled workers in ancillary trades such as: customer service, technical development, logistical support, marketing, etc. In essence, the German story is that although the lower skilled labour intensive operations are delocalised, the overall production is still controlled by German firms creating higher skilled jobs in Europe. Moreover, the production stages which remain in Germany are likely to have higher multipliers into other local sectors because they call on greater technical support, training facilities, design services, and so on.

The Italian example is structurally somewhat similiar to the German case in that the labour intensive steps are also outsourced, but here the outsourcing has followed the traditional TCLF industry patterns of using networks of small scale workshops, with low overheads, to take on the labour intensive stages of production. Again, the competitive focus of the industry has shifted towards more design intensive markets (particularly the fashion industry). This must in part reflect that no European assembly operations can compete on price with Asian competitors. However, the higher fashion sector tends to demand shorter batches and more technical features on garments such as finish details can reduce price sensitivity. In addition, it has to be mentioned that much of the putting out system still relies heavily on cheap and relatively unprotected female labour operating in lower quality work environments. The Italian story is that the value chain as a whole can support the continued presence of labour intensive processes in Europe by both 14

aiming at less price sensitive (and fast changing) items, where physical proximity to the design and fashion centres is important so that close social networks between designers and producers can be maintained. At the same time, as is traditional in this sector, there is a constant pressure to reduce the costs of craft stages in production - even in the high fashion sectors of the market. The important thing is that the retention of a viable production capacity nearby is a support to the vibrant Italian clothing and textile design industry, because it permits the direct experimentation with new ideas and interaction between the producers and the designers. In essence the point is once again that the attractive high skilled jobs to some extent rest upon the continued presence of the practical industrial culture in Italy, and thus the multiplier effects of the retention of TCLF manufacturing are probably more significant than would appear at first glance. 3.5 Regional issues Given that the employment implications of the TCLF sector depend upon the important multiplier linkages between the production activities and the higher margin links in the value added chain, it is worth recalling the twilight stage which a large proportion of the TCLF sector has reached in Europe. Although TCLF production is found in all parts of Europe, in some regions there is a high level of specialisation and dependence on the industry. For example, Bavaria (D), Veneto and Lomardia (I) for clothing; and

Lombardia (I), Catalunia (E) and Norte (E) for textiles; Tuscany (I), Veneto (I), Campania (I), Calalunia (E), Valencia (E), Murcia (E) for leathergoods and so on. Also, whilst the larger European economies (Germany, UK, France and Italy) represent a larger share of the industry the TCLF sectors can be much more significant to the national economy in Portugal, Spain and Greece. In some of these regions there may be little alternative forms of employment other than the TCLF.

We make this point because it underlines the indirect significance of retaining some areas of the TCLF industry. First, the survival of a TCLF industry in some less favoured and less diversified regions is necessary to the maintenance of the local economy. This is a particular challenge, given that many of these regions lag behind in terms of innovation, technological investment and skill development and are therefore most vulnerable to low wage competition. In essence, therefore, there is a critical challenge in these regions somehow to integrate themselves into the higher value links in the production chain

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(either by building on links with design and fashion intensity by working closely with customers which demand high technical specifications and customisation ). If not, they will in head to head competition with lower cost regions outside of Europe (which, with the aid of ICTs, are coming ever closer). This inevitably means working to improve their technical performance, their technology and skill base. 3.6 Strategies and policies for the sector As we note above, the TCLF sector is diverse and no simple ready to wear policies can be prescribed for the sector as a whole. Rather, our main overall policy prescription is that that a strategy exploiting diversity and specialisation should be pursued.

This would require the reinforcement of competences in the sector in areas such as: 1. increased awareness of how to meet differentiated and fast changing demands, especially establishing close working relationships with downstream intermediate customers and retailers and upstream relationships with designers and fashion houses; 2. greater search for and exploitation of the possibilities of new materials, designs of garment and techniques of manufacture, and as this is a sector which has traditionally depended on upstream (e.g. petrochemicals) and downstream industries for its R&D. 3. building up the complementary assets to the core industry such as design houses, research and laboratory facilities, technical advice services, industry liaison office, marketing and publicity services, etc with the aim of creating a value added chain which might generate new jobs in based on an increasingly productive manufacturing sector (but one which probably employs fewer and fewer people).

4.

Steel

4.1 Overview World-wide demand for steel is static, expected to grow at only 1.5 to 1.8% per annum. At the same time there is rapidly growing capacity in developing countries, particularly in Asia. The industry as a whole, and particularly in Europe, therefore, faces a considerable problem of overcapacity. Section 2 of the Appendix provides more detailed quantitative data on the sector.

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However, a key feature of competition in the steel industry is the high level of localised consumption of production. That is roughly 80% (or more) of the production of any major trading block is consumed within its own territory (Figures 2.3 and 2.4 in the Appendix). Thus, whilst European producers do face competition from the rapidly expanding capacity in developing countries and Eastern European countries they are by no means subject to the level of import penetration seen in some other sectors (such as TCLF discussed above).

One of the reasons why there is relatively low import penetration in the sector is that steel production is already capital intensive, even though much of the technology is only at a medium level of sophistication. There are exceptions to this such as in castings which still can have a labour input cost of up to 50%. However, the generally high labour intensity in the sector means that direct competition from low labour cost countries is less marked because cost differentials are less extreme, except in very basic commodity steels such as flat steel. Here, there is exposure to, for instance, extremely cheap but low quality commodity production from countries such as China and Eastern Europe. However, the more sophisticated products are not particularly vulnerable to incremental improvements from such sources as the only route upwards in to higher quality steels is by adopting the same capital intensive methods as the west employs, thus eroding their cost advantage. Although such producers still benefit from subsidies and other artificial advantages such as the lack of environmental protection costs and the zero depreciation of plant, which may give them a window of opportunity for expansion into more technically demanding markets.

In fact, the most significant source of competitive pressures on European steel manufacturing are indirect ones related to the volume and structure of demand in Europe. There are two sides to this issue. First, steel products are under constant threat of substitution by alternative materials such as plastics, aluminium, timber, etc. Thus, it has to compete for its intermediate markets, possibly against non-European producers. Second, as a locally produced intermediate good the level of demand for its products

depends on the level of demand in steel using industries based in Europe such as canning, automobiles and construction. The steel sector, therefore, is directly affected by the competitive performance of its purchasing industries (in European 17 markets and

overseas). Or to put it another way, the competitiveness of these major steel using industries depends to a significant degree upon the ability of the steel industry to meet international standards of performance, product quality and price.

An example of this last point is the competitive response of European steel producers to the large volumes of semi-finished low alloy steel which have been globally available from China since 1995. The European response has been to develop markets in areas where the Chinese producers cannot meet the quality thresholds, such as in high alloy specialised steels and components. In particular, there is an attempt to lock engineering industries into European production through the supply of complete critical subassemblies, which are designed and marketed in collaboration with a downstream customer. Such consortia have allowed European steel producers to compete, through the internationally sales of their customers.

In summary, the most important issue facing the European steel industry is how to deal with the overcapacity/slow growth in demand. On the one hand, this is being met by ongoing processes of rationalisation and restructuring in the industry to eliminate the spare capacity. On the other hand the industry is also expending considerable effort to

strengthen their linkages with its downstream customers, especially those based in Europe, in order to strengthen markets for its products. 4.2 Technology and skills The essential backdrop to the recent development in the steel industry has been the emergence of the electric arc furnace (EAF) and the minimill. Taken together, these two technology systems have set a new production paradigm in the industry which diverges significantly from the traditional patterns associated with the blast furnace or basic oxygen furnace and large integrated steel plants.

Integrated steel plants are associated with a limited number of big companies aiming at economies of scale through large plants and long production runs. The trend in the industry, therefore, was towards a strong centralisation of production with relatively inflexible capacity. The EAF/minimill technology which has emerged over the past twenty years has increasingly challenged the integrated plants (Figure 2.5 in the

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Appendix). The challenge was strongest first in special steels, with shorter production runs. However, they have increasingly penetrated the traditional markets integrated plants, so that their share of the crude steel market has grown from 14% (1970) to 33.5% (1996).

There are several reasons why the minimills have advanced so strongly.

The

technological set up is more flexible allowing steel producers to work closely with consuming industries in order to tailor products to exact specifications in short production runs. Secondly, the flexibility of the technological system allows a more cost efficient matching of demand cycles (which can be quite severe in this industry) whereas integrated plants have to be operated at a high capacity all the time in order to achieve their minimum efficient scale. Also, the EAF can use scrap as its feedstock

which lowers energy demands and is more consistent with environmental pressures. For these reasons it can be expected that most of the new capacity in Europe will be created be of the EAF/minimill type.

The basic technological trend towards smaller, more flexible plants relates also to changes in the demand structure for steel products. In recent years, the industry has invested heavily in R&D in order to meet increasingly sophisticated demands from the major steel using sectors. For instance: the automobile industry now demands very high uniformity and reliability of supply, and the steel industry has responded to competition from aluminium products by producing stronger and lighter body panels which are coated against corrosion trends in the canning industry towards the use of aluminium and plastic have been met by innovations in tinplate to reduce the weight of metal required by 20%, which whilst reducing the demand level for the volume of metal has helped to fend off the substitution effect.

Other major technological innovations include: continuous casting, near net shape casting, improved computer control of bright steel bars, low pollution manufacturing techniques (including techniques for the recycling of scrap as feedstock). Most of these improvements are aimed more at improving the quality of the steel products, to higher

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reliability, closer tolerances, reducing secondary processing and scrap and so on rather than cost control per se.

The overall impact of these changes on skill levels is that the industry as a whole is now highly professionalised, with almost comprehensive use of process control, and science rather than craft based techniques. The sole exception is probably foundries where production often still takes place in small plants (of around 50 employees) providing a jobbing service to the industry. The increased stress on R&D in order to meet

increasingly discerning customer demands leads to complex developments involving advanced metallurgy, engineering and process control techniques. Also, the shift

towards small production facilities with the minimills has stripped out layers of hierarchy, leading to a greater emphasis on multiskilling of all levels of employees, while the emphasis on quality has led to efforts to improve the skills of even lower level workers. Finally, the greater emphasis on customer needs is the shift towards service activities, such as a growth in marketing, management, distribution, and logistical support functions.

In summary, the important technological issue to note, therefore is the way the steel industry is the way that the growth in EAF/minimill reflects the demands for increased performance in the steel using industries. Indeed, a significant proportion of the growing demand for speciality steel has depended upon quality improvements, higher flexibility, lower level of efficient scale and tighter control over production which is possible in the minimills.

4.3 Overcapacity and rationalisation It is tempting to concentrate on the relative robustness and competitiveness of the EAF/minimill based markets for steel and to ignore the fact that integrated mills still dominate the industry in quantitative terms (share of the overall value created in the industry, employment and so on). And it is in this area where integrated plants retain their major importance (such as steel tubes) where there is declining demand in Europe, lower export performance and increasing imports of low-cost commodity production (especially from low technology Eastern European producers).

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For illustration of the weak position of EU producers of such steel products, we can look at steel tubes production, which dropped by 12.74% or 1.645 million tonnes between 1989 and 1994. Mostly under pressure from lower cost imports. The average price per tonne for imports dropped from 887 ECU per tonne in 1989 to 714 ECU per tonne in 1994, leading to rise of 18% or 232,000 tonnes. Within this figure, Japan, US and Turkey took an increasing share of EU imports, but Eastern Europe increased its exports to the EU fourfold from 55,000 tonnes to 226,000 tonnes.

The unavoidable conclusion is that in this sector of the steel market Europe faces a loss of competitive performance, which against stagnating demand adds up to an overcapacity problem of some significance. That this problems persists, despite

continuous reductions in labour force and output, partly reflects the view that steel is a strategic industry, so that capacity has been highly influenced by political pressures. The recent trends towards privatisation and the increased competition from minimills and non-European producers has certainly driven up productivity, but in this highly regulated market this has made little impact on profits. Further rationalisations of the integrated plants are foreseen by industrial analysts and it is an important question how this process should be managed on an international (European) level in order to preserve a coherent structure for the industry as a whole and the integrated mill capacity in particular. 4.4 Strategies and policies for the sector The steel industry faces low growth and increased competition especially in commodity markets remains a strategic industry in Europe. It is unlikely to generate much new direct employment but is crucial to the continued presence and competitiveness of the major steel using industries in Europe. It is also worth prefacing these comments by pointing out that overall the European steel industry is a highly dynamic and competitive industry in global terms, even if it continues to face international pressures. Thus these proposals are supportive of trends already to be seen in the industry rather being radical in intent.

1. The steel industry, particularly the concentrated integrated mills, will inevitably face further rationalisation. The process of negotiating these cuts should take place on

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the basis of supporting the longer term competitiveness of the European-based steel using industry rather than any vested national interests; 2. The key potential avenue of growth for European steel producers will be through increased demand for the products of the steel using industries operating in Europe. Many steel producers are already working closely with the major purchasers not only to define higher performance steel products but to develop international markets for critical sub-assemblies. This type of collaborative strategy is however still quite alien to the industry, so support in building the awareness and competences in such approaches will be important not just for the steel industry but European producers more generally. In addition, it might be appropriate to provide aid to help such consortia in defining, meeting and servicing emerging needs for such steel-based products. 3. The shift towards EAF/minimills and the increased quality demands has encouraged led to many incremental innovations which have made the steel industry much more science-intensive. It is unclear to what extent the smaller scale of production which is found in such plants can support the technical know-how necessary to take this process further especially as it will require the integration of scientific, technical and management disciplines. It is possible that the technology transfer services might be valuable to support the further quality advances which are needed if Europe is to maintain its technical superiority in specialist steels. 4. The greater flexibility of EAF/minimills may also permit steel producers to meet the specific demands of smaller customers more closely than has been possible in the past. It might be that efforts to complement this reduction in the minimum efficient scale in the market by steel producers (or brokers) taking a proactive approach to helping smaller steel using firms to specify their needs better might both lead to a higher performance of the steel using industry and the possibility of stronger growth in the longer term.

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Motor vehicles and components

5.1 Overview Production of automobiles is dominated by the US, EU and Japanese production, accounting for 80% of world production. Between these three blocs, however, the automobile manufacturing firms industry are increasingly operating on a global scale. At the same time within each bloc production is taking place inside the consuming region. In other words, in the auto sector a pattern of global localisation of production is emerging. Section 3 of the Appendix provides more detailed quantitative data on the sector.

Once this global-local pattern of competition is recognised it becomes clear that a distinction has to be made between the competitiveness of European producers and the competitiveness of producers based in Europe. Given that Europe will remain a large, if slowly growing, market for cars we can be certain that a large production capacity will remain in Europe. However, this capacity may not be European owned. Given that there is slow growth in demand there is little choice for European based producers except to compete intensely for a share of a relatively fixed market. It is important not to overstate the effect of new Asian competitors entering the market, for even today Japanese auto firms still take only a small share of the total European market. But in an increasingly crowded market the ability to gain market share from competitors in Europe is the crucial issue confronting European based producers.

For European owned firms the scramble for a share of the relatively fixed EU market creates a particular challenge in that several of them are in a weak competitive position because of they are too small to be able to guarantee their presence, even in the EU markets, in the longer term. The economics of the industry is shifting so that smaller manufacturers are at risk in two ways. First, they do not have the large funds needed to keep up a flow of new models. Second, they also are insufficiently large to be sure of surviving the failure of a new model in the market place. In short, industry analysts suggest that only the biggest and richest auto firms will survive in the medium term future. In turn, as many European auto firms are still dependent on relatively small

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national markets (and eroding levels of national loyalty) the message is simple, get bigger in international markets or decline at home.

This European owned industry has responded to this message to varying degrees. Some European producers, particularly German manufacturers such as VW, Mercedes and BMW, have traditionally had a strong presence in international markets, particularly the USA. However, other firms such as the French (Citroen, Peugeot, Renault) and the British (Rover) have traditionally been quite weakly internationalised outside of Europe. The recent trend has been for the international traders to seek to secure their presence in non-EU markets by setting up transplants in the third country markets. Here again the German producers have been at the leading edge, although FIAT has also had long term globalisation strategies. In the past FIAT mainly concentrated on emerging country markets and based its strategy on licensing models to local producers for foreign markets, rather than internationalising its own capacity. This has now changed with the purchase of the Polish firm FSM and investments in the Russia VAZ. s

Investments in foreign transplants, therefore, may be important in maintaining the competitive position of European owned producers in European markets. The industry is increasingly characterised by joint development and production activities between producers who are operating in different geographic markets. A major trend in this regard has been the increasing investments and co-operation of Japanese firms in producers in Korea - where Hyundai has collaborated with Mitsubishi, Mazda has been working with Kia, and Nissan with Samsung - and in Malaysia - where Mitsubishi has ties with Proton. Such developments may provide a model for European manufacturers wishing to benefit from the strongly growing markets in developing countries.

At the same time, transplant investments (whether by European owned producers or not) in Eastern Europe may represent one serious threat to the future location of manufacturing production in the EU15. With the privileged market access of some of the Eastern European countries (or indeed their potential membership of the EU), their geographical proximity to EU markets and their much lower labour costs they are extremely well placed to supply complete vehicles straight into the European market.

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This is certainly a situation which should be monitored, although at the moment most of the new capacity in these countries has yet to come on stream. 5.2 Technology and skills Beneath the discussion of global-localisation strategies in the auto industry lie two broad sets of technological issues which help to shape the international patterns of competitiveness. First, competitive auto firms have to be able to bring out successful new models on an ever shorter timescale (even while the complexity and technical demands on new product development is increasing). This requires not only large cash resources, but very high levels of technological competence in design, testing, production planning and so on. All major auto manufacturers have this capacity, but they vary significantly in their abilities to manage this process efficiently and successfully. Key pressures have been to introduce concurrent engineering practices, along with the use of computer design tools in order to manage the development process. At the same time, the major manufacturers are increasingly trying to access niche markets (e.g. four wheel drives, multi-purpose vehicles, etc) and so are seeking to make savings by cost sharing on product development and by building a wider range of model variants on the same platform.

The issue of integrating emerging technologies into the design of vehicles is also a major challenge in the development phase. The main emerging technologies concern emission control, lighter and stronger materials (steel, plastics, etc) and ceramics which are being developed for use in the engine. Some of these technologies are being explored in relation to consumer preferences (more fuel efficient cars, cars with multiple functions, etc). The key point here is that with the sheer costs involved manufacturers take a big risk every time they launch a new model. As we note above, a model which is not accepted in the market can hurt a manufacturer very hard and so the integration of new technologies into the design is usually quite conservative and incremental in order to risk a major flop.

New technologies are also being introduced to make the car more people and environmentally friendly. It is in this area that there important interactions between the auto industry and policy. Clearly, whilst regulations usually confront all producers

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equally (and are not immediately a competition issue), there may be differences in the ability of different manufacturers to respond given previous investments in R&D, the existence of a supply industry or other technical resources and so on. For policy makers the critical requirement is that regulatory changes should be introduced in phased in steps, which can be accommodated within the incremental development cycles of the industry

The other side of the technology issue is that all manufacturers have to have the tools and skills to actually construct the cars. This also has been a major area of development, and has been heavily debated in recent years as firms try to introduce concepts such as flexible production systems, total quality management, just in time(JIT) techniques, lean manufacturing and so on. One of the important findings of these debates has been that automation by itself is insufficient to maintain competitiveness in the production processes. Making cars is as much about high quality management of the supply chain and the work organisation processes in the plants as it is about technologies themselves. As a result, much effort has been expended in recent years on: improving workforce skills; the introduction of automation in areas where it can improve quality in a critical ways (the location and reliability of rivets, the finish of paintwork, etc); more effective work processes which eliminate defects and waste; control over inventory to reduce stock in progress and expose inefficient practices; re-evaluating the quality of bought-in sub assemblies and equipment and so on. Of course, it has also been important to integrate the development/design stage and the production stage through an emphasis on design for manufacture and the active search for incremental improvements. In the process of working out this new manufacturing paradigm the automobile has made large strides forward in terms of its technological and skill intensity.

There are important implications for European competitiveness from these technological trends. Taking first the issues surrounding innovations in production processes, the European industry has risen to the challenge. For the most part, the upgrades in

technology and worker competence/productivity in the car plants have largely been achieved. In this sense at least European producers are, for the moment, internationally competitive, although there are still areas of relative weakness, particularly in work organisation, as compared to say leading Japanese producers such as Toyota. 26

The major challenge now is to upgrade the quality and performance of the first and second tiers in the chain of industries which supply the main automobile assemblers. Here, also, there has been much progress. European component suppliers have

upgraded their technologies, quality level and overall performance, particularly through co-operation with Japanese auto firms, but also as European producers have imitated the more co-operative style of product development and service relationships.

These trends in the components industry are important for several reasons. First, the management of the supply chain is still the major area in which European owned automobile firms have yet to achieve international performance levels. So these relations will be an increasing focus in the next few years. Second, the components industry represents a growing slice of the value added in motor manufacturing as vehicles become better equipped, and equipped with more sophisticated components (with items such as fuel injection, air bags, air conditioning, engine management systems, etc) and as the trend towards outsourcing gathers pace. Third, the Japanese experience has shown that it is hard to transplant component suppliers. Although a few major Japanese firms have made the transfer into Europe (e.g. Calsonic and Nippodenso), most of Japanese components have been sourced from local suppliers or joint venture operations. The reason for going to local industry partly reflects the relatively low volumes demanded by a single transplant and partly the need to appear to be good Europeans. But, it also reflects the increasing trend away from supply chains which involve shipping components over very large distances. Modern auto production techniques are very often time critical and require close and direct co-operation between the supplier and the assembler.

As a result, Japanese producers have worked with European component suppliers to upgrade their performance and in the process have helped to build up a technological capacity in these industries, which in many cases were often dependent for their innovations on the main auto producers. Thus, it seems that the auto component

industry is increasingly important in terms of its value contribution, its technological autonomy is growing and, yet, its international tradability is relatively low. If this configuration of factors holds true the implications are that industrial policies for the sector need to concentrate strongly on building up the links and learning effects between 27

assemblers and suppliers in existing areas, and to attract inward investments a technologically vital local supplier base will surely be a strong attractor to the location of new transplants.

In terms of international competitiveness, therefore, two issues arise.

First, the

difficulties of internationalising the supply chain to transplants will probably reduce or defer the threat to European auto assembly from Eastern European transplants. The problems of finding local sources of high quality components will certainly raise a barrier to such imports. Second, an emerging trend is the internationalisation of this industry, especially as the suppliers increasingly become technologically autonomous and as the supply chain itself is rationalised into first and second tier suppliers. Under these

circumstances, a critical challenge will be for the components industries themselves to establish transplants in emerging markets, whilst working with local second tier supplier to improve local sources of sub-components.

Moving to the other major technological issue, a different set of competitiveness issues are at play in the technological and skill aspects of product development. Here, the traditional strengths of Europe in research and development, in engineering and in design are important competitive issues. And, recent trends point towards an

internationalisation of these knowledge intensive activities. But, these core strategic activities are still mostly located in the countries of origin of the major manufacturers. Moreover, if Europe is to maintain its reputation as a leading area of technological and design expertise it is essential that these activities continue to take place in Europe. Arguably, then, it is here where there is greatest long term risk from the increased penetration of transplants into the European car market, in that the loss of European owned producers from the scene could weaken the important high value activities and services which support the model design and development stages of auto production. 5.3 Strategies and policies The auto industry is one of the most globalised of all industries and yet still carries out its production activities on a regional level. This means that fears of a complete loss of production capacity in Europe are greatly exaggerated. Rather we have to distinguish

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between the consequences of competitiveness as it is played out in the European market and its effects on European owned firms.

1. The critical trend in the vehicle assembly industry is towards transplants being set up in all the regional markets in order to assemble the vehicles of each of the global players. To stay competitive in an increasingly capital hungry business, European producers will have to achieve a similar scale of internationalisation and market size as the leading US and Japanese firms. This implies both that further mergers and rationalisations of European automobile firms are in prospect. In addition, the

European survivors will have to have an active internationalisation strategy to take them into emerging markets either through transplants, co-operation agreements or both. This is particularly important for the least internationalised of the big

automobile producers. 2. The biggest area of competitive weakness of the European industry is in its component suppliers, particularly the second tier component manufacturers. This industry stands to gain from the new management approaches which have been introduced in the industry in recent years, especially along with the Japanese transplants. But the industry is increasingly opening up to international competition which means that there is a window of opportunity during which time the industry has to upgrade its quality, performance, technologies, skills. Industrial development policies should be concentrated on this sector to build its strengths and to develop regional industrial strengths as an attractor to inward investors. In particular, as some of the critical new technologies which are emerging are likely to be in critical sub-assemblies policies to aid European component suppliers to incorporate these technologies into their products may be needed, especially where the industrial segment is populated by smaller firms with lower formal R&D capacity. 3. The automobile industry is particularly exposed to regulatory changes and to decisions about investments in infrastructure, particularly in respect of issues such as safety standards, urban planning, traffic congestion and the environment. Whilst, policy has to meet the wider needs of the European people, the manner of introduction of changes could important in its influence on the ability of the European automobile industry to respond. Broadly, policies need to be phased and set against realistic timescales. However, it is also important that the policy is 29

consistent with the incremental changes and path dependency which faces the automobile market. Large sudden changes are hard to achieve by the industry not least because the automobile operates in a complex setting of social, legal and economic practices which have to be complementary to the car to achieve the desired policy outcome. In such complex circumstances changes are often slow and hard to drive in the desired direction, even if there is goodwill on all sides.

Aerospace

6.1 Overview The growth outlook for aerospace is good, given emerging demands especially in the Pacific Rim countries and China. Nevertheless, it faces considerable demand cycles which relate not just to business conditions but to government expenditure decisions, especially in military markets and as they affect national airlines. In this industry the main players by a long way are the US and European producers. Japan and other Asian firms are far in the background. The Soviet air industry certainly has had the technological competencies to compete in the past, but it is unlikely to be able to establish a presence in the market without a substantial upgrade of its products, skills and management competences. This would be a costly process and it is hard to see where they would get the large sums of money which would be needed. Thus, European producers are well placed in an important industry with growing export potential. The question is whether they can maintain and build on their existing competitive performance. Section 4 of the Appendix provides more detailed quantitative data on the sector

Competitiveness in the aerospace industry, however, is complicated by the sheer size of the investments involved and the long periods over which they are depreciated. The business is built on selling systems rather than products and the development of aircraft takes place over many years involving many different partners. Thus competition is based around the activities of the main prime contractors, which are the airframe manufacturers. In international terms this reduces down to two main players: Boeing (now together with McDonnell Douglas) and Airbus Industrie.

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Other sub-sectors of the industry are smaller but still important. They include engines, equipment, space and guided weapons. The markets for engines exists largely

independently of the airframes industry in that most of the major firms (Rolls Royce (UK), Pratt and Whitney (US), General Electric (US) and SNECMA (F)) can supply engines for any of the main airframes. However, clearly the engine and airframe

manufacturers have to collaborate quite closely in specification and design integration in order to meet demand. The equipment market is largely dependent upon the activities and market success of the airframe and/or engine manufacturers. Whilst the civilian space industry is dominated by the European Ariane rocket systems and the US facilities based at Cape Canaveral. Military systems (guided weapons, military aircraft, etc) are of course highly influenced by strategic and political issues, although there is an increasing focus on open competition even in this sector.

Looking at airframes, which is the main area of competition, European aerospace is a strong industry and has made considerable gains in both market share and competitiveness in past years. The main basis for these gains has been the (heavily subsidised) emergence of Airbus Industrie from the four main European partners of Arospatiale, British Aerospace , DASA and CASA. Even though it is only about half the size of Boeing, Airbus is regarded as an equal player in the market place in terms of its products and technologies.

Direct subsidies were crucial to the establishment of Airbus.

In an industry with

extremely high barriers to entry due to the very high costs and high risks, subsidies were the only way to the find the sustained investment necessary to break into the market. However, although the A300 was entirely subsidised the level of subsidy has been steadily reduced so that the most recent aeroplanes have been funded entirely from the internal resources of the consortium.

The crucial point, here is that aerospace whilst being a highly competitive industry is not subject to open competition. First, the industry is highly concentrated with most of the attention focusing on the activities of the two largest players (Boeing and Airbus). Second, entry to the market is difficult, given the high costs of developing a product and the long term relationships which are entailed in purchasing an aerospace system. Such 31

contracts involve complex financial, leasing and servicing agreements extending over many years. In many cases, as each aircraft is to some degree customised for the individual order, the choice of sub-components may reflect the carrier preferred s supplier. Such choices may be driven by national interest or by the wish to streamline the number of different types of equipment in the fleet. This is an important

consideration in the competition in the market for engine. Third, the industry is highly influenced by governmental policy. This is an industry where military and civilian

production are very closely allied and so there are shared learning effects. Similarly, governmental decisions about subsidies, support for national airlines and so on can all influence greatly the rate of market growth. 6.2 Technology and skills The aerospace sector is incontrovertibly a high technology-high skill sector.

The

technological systems are not only leading edge they are integrated into complex systems which have to perform in hostile conditions with extremely high levels of reliability. As a result the industry is characterised by very high costs which are directly related to the R&D stages of production.

In practice, this means that the aerospace industry cannot operate without some form of public subsidy. In the US case this has normally taken an indirect form through crosssubsidies from military purchasing. In the European case, as we have seen above, substantial (if repayable) subsidies were allocated to the launch of Airbus. subsidies were almost entirely used to support technology development. These

The design/development intensity of the industry means that we might expect further concentrations of effort to take place, even within the current oligopolistic market structure which already exists. Already, Boeing are sharing the highly advanced windtunnel which was constructed to permit Airbus to design airframes which have a world beating aerodynamic performance. In addition, there are many instances where US or European producers may act as a sub-contractor to its main rivals, simply because it has the technological capacity needed to fulfil the contract. In future projects,

particularly areas supersonic aircraft and the space industry, the high level of capital investment which is required will probably require collaborations on a global scale. The

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issue here will no longer be competition for market share, but what the European producers can bring to the project in terms of technological competences and resources in order to negotiate a significant slice of the activity.

Below these overall considerations there are two areas in which technology will affect competitiveness. The first concerns innovation in the technological systems and

equipment. The second relates to the ability to manage the complex process of coordinating the design and construction of the aircraft.

In the first case there are a series of areas of technological challenges which dominate in the industry these mainly concern fuel efficiency and noise reduction. One side to these issues lies in engine technology, where there are major efforts in lean burn and cleaner fuels (possibly hydrogen), better turbine design, the use of ceramics and other new materials in the engine and so on. The main effort in the design of airframes has been to reduce drag factors and to reduce weight (through new laminar flow vertical fins, new carbon fibre wing designs, new fuselage designs, etc). In addition, control systems have been a major area of improvement such as reduced crew requirements, fly-by-wire technologies and so on.

In these component systems European technology is at least as good as the main competitors in the US. It is an important area in which the strong science and research base in Europe seems to have been converted into effective innovations. However, if there is a weakness here it lies in the fact that the European industry is still based on small to medium sized nationally orientated producers. This reflects the continuing concerns by national governments to retain a defence capability. In terms of

international competitiveness, however, the capital intensity of even the sub-technologies means that smaller firms are likely to be at a disadvantage as compared to the larger US producers as the sophistication of technologies escalates ever upward.

The second main area of effort is in the co-ordination of the design and assembly of these complex systems. Here, as a single firm, Boeing has a major competitive advantage over Airbus. Whilst Airbus has competitive designs and component technologies it faces a much bigger challenge to introduce effective lags behind in the procedures and 33

methodologies of concurrent engineering to compete on product development cycle times given it devolved consortium structure. A significant part of the problem is nontechnological in that decision making is separate between the consortium members (and still reflects national priorities). This is an area which will require close attention and probably some rationalisation if Airbus is to continue to match Boeing in the introduction of new aircraft which meet the operating demands of customers, changing environmental demands and so on. 6.3 Strategies and policy The European aerospace industry is currently highly competitive with its major competitors in the US. In some areas it has a design and technology lead. However, it is smaller and, in an industry which requires massive capital investments in R&D in order to develop new models, is therefore exposed to a much greater degree of risk from a product which performs poorly in the market place. The critical challenge therefore is to expand its market share as far as possible to match the US producer.

In support of this overall aim, the aerospace industry will have to make further structural adjustments in order to strengthen its competitive position.

1. The major challenge is to integrate Airbus into a single firm, in order to eliminate operating inefficiencies, to raise levels of internal control and to increase its performance in bringing new products to market rapidly and effectively. This will probably lead to further rationalisations in the production capacity and the workforce in order to match recent restructuring in the USA. 2. The main growth markets in the industry will be in the emerging economies of Asia/ Pacific Rim/China. Clearly it will be here if anywhere that Airbus has a chance to make gains in its market share. Thus, processes of technology transfer and

collaboration with producers in these emerging economies will be crucial to its market position in the future. As in the auto industry, processes of global

localisation in order to develop these markets will be important. 3. Future trends towards a global scale of production in some areas (supersonic planes and space) imply the need to build technological strengths and production resources

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in anticipation. There may also be issues here which will require rethinking of competition rules on an international level. 4. New developments by engine manufacturers are an important area in which technological advances may improve the European competitive position especially given demands for quieter more efficient power units. One issue is whether the relatively small SNECMA may find its position under threat from the capital intensity of the industry. Here collaboration between firms on development may be important. 5. In the equipment industry the relatively small size and national orientation of the firms supply chain, which can often extend to three or four tiers, may be a cause for concern. Given the complexity of the aircraft design and assembly there may be scope for streamlining the supply chain and for greater support for the firms in this industry to meet the ever rising quality and technological sophistication.

Conclusions

In this report we have examined the competitiveness challenges facing a number of key manufacturing sectors. The first point to make is that whilst the main drivers affecting these sectors are similar (globalisation and internationalisation, increasing concentration on non-price competition, etc) there are also major differences relating to the nature of the product, the openness of the market and the level of technological intensity of the sector.

In this conclusion, we first briefly summarise some the main competitiveness issues affecting each of the different sectors at the moment and then use this to construct an overview of competitiveness issues. We then try to take a look into the future to see what major technological and competitiveness questions may be on the horizon for these industries over the medium to longer term, before pointing to some discussion of the wider policy questions which arise from our review of the competitiveness of these sectors.

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7.1

Diversity and similarity: general lessons from the sectoral stories

There are major differences between the industrial sectors which we have examined in this report. Table 1 provides a brief summary of some of the main directions of change in the overall industrial structure. The main messages in the chart are that all of the industries confront low to moderate growth in demand in EU markets. High growth in demand is only to be found in emerging markets particularly in the Asia/Pacific Rim/China region. With the low growth in demand, increasing pressure from low-cost commodity producers in Asia and the increased use of labour saving technologies this means that direct European employment in these industries can be expected to fall.

It is important to recognise, however, that falling employment and even the loss of some market share in Europe does not mean that European industry is uncompetitive. Rather it reflects changing international systems of production. First, this leads to a greater degree of globalisation of production. Second, it results in shifts in the international specialisation of activities, so that more of the European centred activities are upstream or downstream of the direct manufacturing processes, especially the more routinised labour intensive processes.

We can illustrate this general point through an examination of each of our sectors in turn (see Table 2). The textiles, clothing, leather and footwear (TCLF) sector in Europe is increasingly abandoning commodity textile manufacturing and labour intensive make-up and assembly of clothing. However, given its wealth, Europe will always continue to be a major market for such goods. Thus, there will continue to be good prospects for the higher value fashion and design stages of production and the distribution, marketing and retailing steps (stages which are often not counted in the statistics of the industry). Given intangible issues such as brand loyalty, the cachet of certain design centres and so on there remains considerable scope for the retention of much of the value created in these industries in Europe. In addition, even in the manufacturing and assembly stages, there will continue to be demands for products which are made to meet tight technical tolerances, high performance uses, delivery to tight deadlines and so on. The retention of these markets depends upon the ability of European manufacturers to innovate in the use of new materials, to operate to high technical standards and so on. Finally, there is a

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trend in the industry towards the integration of production into seamless chain. With such moves the economic calculation of competitiveness shifts because the costs of production are taken over the whole value chain and so the outsourcing of low value components may not be particularly significant as compared to say timeliness of delivery, lowering of overstocks and so on.

In terms of the overall TCLF sector, therefore, the important step is that European TCLF producers have to gain control the overall production chain so that the design and distribution ends remain in Europe, even if some of the intermediate steps are outprocessed to third countries. A secondary, but increasingly important issue, is that technological leadership is necessary not only in the design, development and distribution stages, but in production as well. If the production stage of specialist TCLF

manufacturing is lost then much of the practical know-how necessary to continue to bring innovative materials and designs through to the market will be lost.

The easiest way to understand the European steel sector is as two overlapping sections. The most troubled part, which is still the largest segment of the sector, is populated by integrated plants. It has overcapacity, faces further rationalisations and is subject to competition in commodity markets from cheaper imports. In comparison to textiles and clothing, the intensity of international competition in steel products is less severe, if only because even commodity products are bulky and relatively capital intense. However, commodity production in primary processing and some areas other areas which demand relatively low grade steel, such as canning, steel tubes and so on are vulnerable, particularly from low cost Eastern European producers located on the borders of the EU15. On the other hand, the growing minimill sector which is better equipped to meet the growing demand for specialist steels is highly competitive, even though much of the competition is actually directed at other materials which might be substituted for steel rather than other non-European steel producers. Here the trend is towards very close co-operation with steel using sectors (especially the automobile, consumer goods and construction industries) to improve the performance and marketing, not only of the steel components but the sub-assemblies in which they are used. In order to meet these

demands the steel industry is having to become much more technologically (and

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scientifically) dynamic as well as providing ever higher quality and performance characteristics.

From the first two sectors we can clearly see two important features of the competitiveness strategies which European producers are pursuing. These are, first, the importance of strategies of specialisation, often based on enhanced technological performance and; second, closer integration of the value chain in order to build up links with downstream purchasers of products or indeed to gain control over the high value stages of production in design, development and delivery. Exactly the same features can be observed in the other two sectors, but here there we see an additional feature which is the growing globalisation of manufacturing firms through regional production facilities.

The motor vehicles sector is probably the most globally distributed in its production capacity. The leading global firms are present in all the major markets. This is an essential step for all firms hoping to remain serious players in the industry. Only by achieving the kinds of volumes which are available to global producers can firms hope to find the cash to develop increasingly costly new models. At the same time, assembly facilities have to be located in the consumption markets because of a combination of political pressures, economics of distribution of such bulky consumer products and so on. For some European producers their competitive weaknesses resides in their

relatively low level of internationalisation: a lack of transplants in emerging markets; and relatively slow entry into co-operative agreements with emerging market auto producers. However, they also lag some way behind in terms of the streamlining of the supply chains and the quality standards and technological performance of sub-assembly producers.

Aerospace has the least conventional market structure of all our sectors. The barriers to entry to the industry are very high, the risks of developing products extremely large and the relationships with customers long term. The market is effectively restricted to a few leading US and EU firms, but nevertheless there is a high level of competition between the prime contractors involved. And much of this competition revolves around the technological capabilities of the leading players both in terms of their ability to develop 38

extremely high performance sub-systems and in order to integrate these systems to create aircraft which meet extremely exacting performance requirements. In terms of the

component technologies it is clear that Airbus, the European leader, is fully competitive if not slightly ahead. However, its ability to manage the complex processes involved in bringing forward a new model of aircraft is undoubtedly hampered by its fragmented organisational structure and the relatively small size of the partners in the consortium. Airbus will have to rise to this structural challenge if it is to gain market share from Boeing, its main rival. However, at the same time, like the auto manufacturers, it will also have to seek out international alliances (possibly even transplants) in the merging Pacific Rim countries and will probably have to streamline its rather complex and deep supply chain.

Thus in arriving at an over view of these sectors we can see three main trends taking place which will form the focus of competitive strategies for European producers in the next few years (although to different extents in different markets). These are:

1. Increased specialisation and concentration on higher value more technically demanding markets or sections of the value chain. This may mean that much of the real growth happening in industries which are not statistically part of the sector itself (for instance the growth might be in an ancillary producer service firm). However, the retention of technology intensive manufacturing capacity is of strategic importance because only through practical experience acquired in production can the know-how necessary to undertake the value added services be retained in Europe. 2. Value chain integration will change the calculation of costs and benefits of moving production activities out of Europe. The auto industry provides an example where there is an increased co-operation between suppliers and assemblers down the production chain. These close associations are not based on freely traded market transacting based on price, but on long term collaborations to achieve quality, performance and joint technological advances. Similar close relationships can be seen in the steel and aerospace industries, and may also be emerging in noncommodity areas of the textile industry. Price remains important, but it is relegated to one amongst many factors. The other side to value chain integration is the

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streamlining of the supply chain that has been seen in the automobile industry and which is probably also needed in aerospace. 3. Global-localisation gives some relief from the fear that the vast majority of manufacturing capacity will migrate out of Europe because of relatively high labour costs. With rising technological sophistication and growing capital intensity, relative labour costs are less important, especially in large consumer and intermediate products. For this reason it is fairly sure that large amounts of production capacity will remain in Europe. The question is whether it will be owned by European firms. The risk is that if it is non-European then much of crucial the high multiplier, high value added activities (the ones that will create jobs in the future) will mostly take place in the home countries of the globalised firms. Rather counter intuitively, this seems to imply support for a strategy of delocalisation of European producers, certainly co-operative arrangements with foreign producers should be sought.

7.2

Outlook and Policy Prospectives

The general lessons which emerge from our survey of these four quite different sector certainly points towards an increased role for technologies and skills in the competitiveness of European industry. The challenges are clear: to pursue more

specialised and technically demanding market segments; to build on the European strengths in the high skill activities which are complementary to manufacturing such as in design, development and logistics; to put greater efforts into innovating with new materials science and technologies; to put greater efforts into co-ordinating and streamlining the value added chain; and so on.

However, in each case the technological strategies have to relate to the specific challenges which the industry faces. These challenges come from a variety of sources, for example: the very low cost and growing capabilities of Asian manufacturers in textiles; very low cost Eastern European producers sitting on the margins of the EU (in automobiles and steel); the need to internationalise production capacity and develop stronger international alliances (in textiles, automobiles and aerospace); etc.

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Against these intra-industry challenges we have also to place pressures which are being created by broader changes which are taking place in the economy and society. For these industries the most important changes which are looming relate to: the increased liberalisation of markets; the more stringent environmental regulations and issues surrounding governmental spending plans (Table 3).

Across the sectors, TCLF and steel are those most exposed to increasingly open market structures due to their weak position with regard to competition in commodity markets. However, the automobile industry is also facing challenges due to the greater openness of markets, if only in terms of declining consumer loyalty to the national marque. The question here seems to be how best to use the time during which the markets are becoming more internationalised in order to build strengths in speciality sectors and those areas of the market where technological advances (especially for steel and TCLF in new materials) can provide the basis for longer term competitiveness. In all these sectors it will be important to increase the efficiency and integration of the value added chain in order to raise the efficiency of the innovation process.

Of course, the process of liberalisation of markets is strongly related to the timescales of political decision making. In this area, therefore, coherence has to be sought between the competitiveness trends and the trade policy issues. The same is true in the other key policy areas of government spending plans and environmental regulations. As regards government spending the main issues concern the control and distribution of subsidies and government contracts. In particular, here, we need to consider the consequences on very technology intensive industries (such as aerospace) of contractor choices on the future viability of the sector. The tradition of choosing national champions in support of strategic industries is no longer viable at an EU level, even if it is still necessary at a global level. Even here, however, new rules will have to come into play as the level of internationalisation of production increases through transplants, co-operative research and development, inter-continental sub-contracting and so on. The extreme case of course are global projects such as the supersonic plane and space projects. In these cases current conceptions of markets and competition seem to run out of credibility.

41

In the environmental areas all the sectors are affected by changing regulations, especially in the areas of industrial pollution control. Of course the two transport sectors

(automobile and aerospace) are also affected through policies on issues such as noise pollution, congestion and pollution from the combustion of fuels.

As the recent DGIII (1997) report on competitiveness suggests, regulations are not in themselves inhibitors of competitiveness or innovativeness regulations . It depends on how they are conceived and implemented. Industrially efficient regulations should:

1. focus on outcomes rather than forcing firms to adopt particular technologies or approaches to solving problems 2. provide a stable, predictable decision making environment in which delays, transaction costs etc are minimised, this raises transparency and reduces risks in innovation; 3. be realistic about the speed and timing of new regulations, so that firms can adopt the new approaches without putting competitiveness into jeopardy; 4. get industrialists involved proactively in setting the standards 5. make sure that regulators understand the constraints and possibilities facing industrialists especially regarding economic and technical aspects.

The key issues, for these transport sectors at least, are the clear signalling of policy intentions, with sufficient lead times for industries to respond and a match between the regulatory agendas and feasible technological trajectories. This can only be achieved through co-operation between policy makers and industrialists on short and long term projects. In the short term at least, this implies a pragmatic search for areas of complementarity between policy fields, which incrementally move policy in more environmentally friendly directions. In the longer term greater challenges may have to be confronted where environmental policy may by pushed in directions which are detrimental to the continued existence of major transport industries (i.e. in some respects there is a fundamental conflict of interest between different fields of policy action). We suggest therefore that here, most of all, longer term planning, co-operation and experimentation is needed between industry and policy makers.

42

Table 1 The status of the sectors: summary table Sector Market Structure Intense international competition, especially in commodity markets Market Growth Employment change in the EU Low growth in Substantial EU. Expanding continuing markets in Asia decline Technology intensity Low to medium (except in new material sciences)

Textiles, clothing, leather and footwear

Steel

Local consumptionproduction. But growing international competition

Low growth in EU. Expanding markets for speciality steels

Some further rationalisation in integrated plants

Low to medium (except in speciality steels and metallurgy sciences)

Motor vehicles Global localisation and leading to a few components big players

Low growth in EU, but expanding markets in developing countries

Further declines Medium to high due to mergers and a streamlined supply chain

Aerospace

Oligopolistic with high governmental intervention

Medium term growth in civilian sector, higher growth in Pacific Rim

Rationalisation of prime contractors and supply chain

Advanced

43

Table 2

Current position of Sectors Sector Strengths Fashion based products Specialist materials technological base large local market technological capability financial strength strong user markets restructured operations Good Engineering and Design large local market on which to support product development improving quality technological capability good product family political support Weaknesses cost structure deficiency in strategic management capability in many smaller firms Industry Environment commodity markets very competitive on price moderate to low growth Current Action rationalisation in textiles outprocessing in clothing increasing specialisation

Textiles, Clothing, Leather and Footwear (TCLF)

Steel

overcapacity in limited growth in local integrated operations markets low growth pattern increasing competition in basic products low level of internationalisation supplier system not effectively organised ability to fund model failure not assured structure of Airbus Industrie is weak military/civilian link less than in US defence spending declining moderate local growth potential growing competition from transplants increasing regulatory impositions oligopolistic and highly collaborative growth prospects good very high risk and capital intensive

continuing restructuring shift to minimills close co-operation with user markets emphasis on streamlining product development improvement of supplier networks increasing collaboration across industry structural reform promised for Airbus

Motor Vehicles and Components

Aerospace

45

Table 3

Future position of Sectors Sector Opportunities Emerging fashion markets Specialisation of materials, products new Asian markets improved steel for motor vehicles reduced complexity of organisation improved user collaboration Emerging market alliances strong component supply networks with transplants based on quality Threats Prospective developments Policy Actions Adequate response to changes to Multi Fibre Agreements encouragement of demand led innovation planned phasing of changes in regulation in harmony with shifts in usage patterns industry wide rather than nationally based restructuring phasing of regulations on personal transportation to be harmonised with adoption of technological developments. Increased linkages between military and civilian projects to make effective technology development. Harmonise national defence requirements

Textiles, Clothing, Leather and Footwear (TCLF)

improving capability rising sophistication of taste in Asian producers driven markets Competition from new materials and new Eastern Europe applications for materials general over capacity emerging Asian competition competition from other materials Existing global supply networks Model failures Failure to form international bases continuing shifts to flexible facilities more stringent environmental regulations metal composite materials impact of new materials Transportation policy decisions which disrupt mass markets regulatory change Problematic decisions on future of supersonic passenger air transport Increasing R&D spending likely

Steel

Motor Vehicles and Components

Prospects for growth Very strong US in civilian air transport competition Aerospace International collaboration in space Failure to join appropriate alliances

46

Appendix: Sector descriptions

1 Textiles,Clothing, Leather and Footwear (TCLF)

1.1

Introduction

In this section the situation in the Textiles, Clothing, Leather and Footwear (TCLF) sector will be explored. These four industries are classified as resource based, relying on many natural raw materials, and producing consumer or intermediate products. The clothing and footwear sectors depend significantly on economic development in general but their share of consumer spending decreases with increases in personal income. 1.2 Growth in the Sectors: In the EU, consumption of TCLF has been stagnant since 1990 although there are signs of a recovery recently. Growth in consumption over the period since 1985 was 1.9% per year in real terms. Production in the period since 1985 has grown at 0.7% per year in nominal terms and with growth in labour productivity of 3.6% per year, employment in establishments employing more than 20 persons has fallen from 2.6 million in 1985 to 1.95 million in 1995. The shortfall in production growth over consumption growth reflects the faster growth of imports(8%) over exports(2.6%). This reflects the competitiveness of these industries particularly in the lower priced commodity type products. In 1994 exports represented 23% of EU production while imports were 30% of consumption. The negative trade balance was almost 14 billion ECU. 1.3 Profitability of Companies: There is intense international competition in the TCLF sector, and this is reflected in the low levels of profitability which can be earned. In the textile sector the top ten largest companies in Europe averaged net profits of 2% of turnover in 1994 in a range from 4.7% to -1.9%. In the clothing sector the top ten largest European companies averaged net profits of 4.3% of turnover in a range from 9% to 1.2%. In footwear net profit figures are unavailable, because of the more fragmented nature of the industry, however the gross operating levels achieved by the footwear industry are comparable to those of the clothing and textile sectors, which would suggest that net profit levels are similar.

47

1.4 Trade and International Structure: There have been major shifts, in recent decades, in the location of textiles and clothing production. More than half of the world exports of clothing and one third of the world exports of textiles s s comes from developing countries, mainly in Asia. These countries have more than doubled their export shares of the late 1960 Even within Asia there have been migrations of textiles and s. clothing industries, first from Japan to Korea, Taiwan and Hong Kong and then to China and Indonesia and most recently to Bangladesh, Pakistan, Sri Lanka, Laos, Nepal and Vietnam. These migrations have been driven by rising incomes and wage rates and by developments in communications which have promoted greater specialisation of production with the labour intensive segments of production operations being established in low wage economies whose policies attract such development. Table 1.1 Textile and Clothing exports at current prices, 1980 and 1995 1980
($USm)
s Asia Chinab Taiwan Hong Kong (dom.prod)c Hong Kong (re-exports)c Indonesia Japan Korea Malaysia Singapore (dom.prod)c Singapore (re-exports)c Thailand Asiasub-total a Extra EU Intra EU US Others World Total

Textiles 1995
($USm)

Change
%

1980
($USm)

Clothing 1995
($USm)

Change
%

2540 1775 909 861 46 5117 209 161 143 225 330 13230 9428 16029 3757 12546 54990

13918 11908 1814 12001 2498 7178 12313 1132 263 1233 1648 52672 21814 39364 7372 31348 152570

448 571 100 1294 5330 40 457 603 84 448 399 298 131 146 96 150 177

1625 2430 4664 312 98 488 2949 150 354 73 267 13025 4924 10514 1263 10864 40590

24049 3256 9540 11757 3367 530 4957 2272 586 878 4620 53177 14596 33205 3757 53145 157880

1380 34 105 3668 3336 9 68 1415 66 1103 1630 308 196 216 197 389 289

Asia refers only to exports by those countries listed in the table. It excludes re-exports by Hong Kong and Singapore. b Includes significant exports from processing zones. Export processing zones are free trade enclaves in the customs and trade regimes of the host countries. c Hong Kong and Singapore are both sources of domestically produced exports and transhipment points for re-exports. To avoid double counting, re-exports are shown separately Source: WTO 1996

48

From Table 1.1 it can be seen that, while the value of world textile exports rose by 177% between 1980 and 1995, export value for Asian countries rose by 298%. The corresponding increases for clothing exports were 289% for the world and 308% for Asian countries. The clothing increase in Asia is largely attributable to the increase in China of $US 22 billion in the period and, to a lesser extent, growth in Korea and Malaysia. However the largest growth in clothing exports occurred in the othercountry category reflecting the global diversification of these industries. Table 1.2 Textile and Clothing imports at current prices, 1980 and 1995 1980
($USm)

Textiles 1995
($USm)

Change
%

1980
($USm)

Clothing 1995
($USm)

Change
%

AsiaChina a Taiwan Hong Kong (gross imports) Hong Kong (net. imports)b Indonesia Japan Korea Malaysia Singapore (gross imports) Singapore (net. imports)b Thailand EU US
a

1100 288 2967 2106 217 1663 409 298 853 629 174 8024 2542

10914 1792 16859 4858 1170 5985 3959 1539 2109 879 1360 18115 10441

892 522 468 131 439 260 868 416 147 39 682 126 311

n.p 6 695 383 n.p 1537 14 n.p. 142 69 n.p 9569 6943

n.p 882 12654 897 n.p 18758 1073 154 1644 766 n.p 43335 41367

n.a 14600 1721 134 n.a 1120 7564 n.c. 1058 1010 n.a 353 496

Includes imports into processing zones. Processing zones are free trade enclaves in the customs and trade regimes of the host countries.

Hong Kong and Singapore are both final destination for imports and major transhipment points. To avoid double counting, re-exports from Table 1.1 are subtracted from gross imports to give a figure for retained imports. Source: WTO 1995 and WTO 1996

From Table 1.2 it can be seen that the EU is the largest importer of textiles followed by China and the US. In the clothing sector the EU and the US dominate as importers with Japan the other significant importer. The EU and Japan were the largest exporters of textiles in 1980 with Germany being the largest single exporting country. In 1995, Germany was still the largest exporter of textiles in the world, 49

followed by China, Italy and South Korea.(see Fig. 1.2) Japan had slipped from second place in 1980 but part of the reason was investment by Japanese companies in production bases in low cost locations to supply Japan needs. s The share of textile exports in merchandise trade fell in the EU from 3.7% in 1980 to 3.0% in 1995 while the fall in the US for the period was from 1.7% to 1.3%. By contrast, in clothing export shares rose in both countries; in the US from 0.6% to 1.1% and in the EU from 1.6% to 1.9%. At the same time import shares have risen more; textiles - EU 2.0% to 2.9%, US 1.0% to 1.4% ; clothing- EU 2.4% to 5.9%; US 2.7% to 5.4%. From Fig 1.3 the emergence of China as a major force in clothing exports is clear, while the continued strength of Italy and Germany is also a feature.
Figure 1.2 Principal textile exporting countries, shares of world exports of textiles. 1980 and 1995

Ch in a 5%

German y 11% Japan 9%

China 9% German y 9% Japan 5% Rest of World 56% S. Korea 8% Italy 8%

Rest of World 56%

S. Korea 4% Italy 8% US 7%

US 5%

1980 Source: WTO 1995 and 1996

1995

Figure1.3 Principal clothing exporting countries, shares of world exports of clothing. 1980 and 1995

China 4% Germany 7% Italy 11%

China 15% Germany 5% Italy 9% Hong Kong 6% S. Korea US 3% 4%

Rest of World 57% US 3%

Hong Kong 11% S. Korea 7%

Rest of World 58%

1980
Source: WTO 1995 and 1996

1995

50

1.5 Labour Costs: A major influence on the competitiveness of European textiles, clothing, leather and footwear industries is the level of labour costs. In the following table it can be seen that European countries are at a severe disadvantage against Asian competitors and even against the US. Particularly in the labour intensive clothing and footwear this cost penalty is difficult to overcome in the low cost commodity product areas. Similar disadvantages exist with other areas of the world which have not yet entered the world markets but which will inevitably follow the established dynamic of industrialisation by developing textile and clothing production.

Table 1.3 Hourly wage costs in the clothing industry ($US): wages + contributions. Country Europe Germany Belgium Denmark France Italy Netherlands Sweden UK Spain Portugal Eastern Europe Poland Hungary Russian Fed. Bulgaria 0.42 1.19 0.49 0.25 0.44 1.62 0.57 0.26 14.81 12.57 15.91 12.41 13.50 14.95 18.52 7.99 7.11 2.65 17.22 16.20 17.29 14.84 12.31 15.41 15.84 8.42 6.41 3.03 1991 1993 Country Asia Japan China S.Korea Hong Kong India Indonesia Malaysia Singapore Thailand Pakistan Others Israel South Africa Morocco US 5.73 1.12 0.99 6.77 7.44 0.24 2.75 3.39 0.25 0.18 0.62 2.72 0.59 0.24 1991

social 1993

10.64 0.25 2.71 3.85 0.27 0.28 0.77 3.06 0.71 0.27

5.54 1.12 1.06 8.13

Source: Werner International Inc. 1994 New York

51

The problems of the industries in the developed countries are highlighted in Table 4. Little data is available for the developing countries but, in the case of Malaysia, capital inputs as reflected by fixed assets per employee grew at a rate of 13.6% per annum in textiles and 5.9% in clothing in the period from 1986 to 1991. This contrasts sharply with the static or declining capital inputs in Europe. Table 1.4 Growth rates of Output, inputs and productivity (1980-1993) % per annum
Country or Zone Output Labour Input Capital Input Labour Productivity Cap.Lab. Ratio Total Factor Productivity

European Union US Japan France Germany Italy UK

-1.18 -0.51 -1.01 -2.84 -1.60 0.59 -2.00

-2.97 -2.95 -0.72 -4.09 -3.61 -1.10 -3.58

0.34 0.20 4.65 0.41 -0.79 2.48 -0.77

1.84 2.52 -0.29 1.30 2.08 1.71 1.64

3.40 3.24 6.37 4.69 2.93 3.61 2.92

1.33 1.82 -1.77 0.82 1.57 1.37 1.09

Source: International Industry Productivity Measurement and Analysis Study 1993 -IPC

Table 1.5 Employment levels in TCLF 1980 and 1992 Country France Germany Italy UK Japan US China India Indonesia S.Korea Malaysia Philippines
Source: ILO 1996

1980 (000s) 609.4 600.0 541.0 688.0 1216.0 2281.0 3281.0 1771.0 252.9 601.8 63.3 248.6

1992 (000s) 358.4 361.9 460.6 407.0 1108.0 1628.2 5280.0 1545.0 703.2 661.8 122.1 323.7

Change 1980-92 (%) -41.2 -39.7 -14.9 -40.8 -8.9 -28.6 60.9 -12.8 178.1 10.0 92.9 30.2

52

1.6 Employment Table 1.5 sets out the dramatic changes in employment which have accompanied the restructuring of these industries in the various areas of the world. In 1980 the number of employees in these industries was divided equally between G7 countries and Asian countries with just over 6 million in each group. By 1992 TCLF workers in the Asian countries outnumbered those in the G7 countries by two to one. The increase of 2.4 million workers in the Asia group was dominated by the 2 million increase in China. 1.7 Strategic responses

Four response to these competitive pressures have been discernible in developed countries: (a) Use of protection through the Multifibre Arrangement (MFA) and direct industry support programmes, (b) Capital investment to increase labour productivity, (c) Assistance to facilitate labour mobility and retraining for restructuring of the industries (d) Support for research and product development to increase competitiveness. The US confined its support to strategy (c) and then only for a short time. The EU has adopted a range of these strategies particularly programmes to limit capacity. Since 1993 there has been a specific programme to promote economic diversification in areas with high concentration on textile and clothing enterprises. The phasing out of the MFA under the Uruguay round of the GATT agreement has not yet had any significant effect on the industries but the later adjustments will increase the pressure for further rationalisation. One major adjustment strategy which firms have adopted has been outprocessing or the subcontracting of labour intensive elements of production to neighbouring low wage countries. This has allowed the developed country companies to concentrate on the high value added aspects of design and branding and innovations in distribution in the bigger markets. Germany has been relatively successful with this strategy. The case of Italy stands out as the country least affected by the dramatic shifts in production and employment in these industries. The success of Italy lies in its ability to combine the strategy of high value added from design with localised small company manufacturing with low cost. The establishment of networks of companies sharing expensive facilities in design systems and logistics has added to this strength.

53

1.8

Summary

The sector displays all the classic problems of retaining competitiveness in developed economies. Commodity production requires very low costs and technology has limited effects on reducing unit capital costs. Textile manufacturing and downstream subsectors such as carpetmaking are capital intensive and have not been subjected to the same level of competitive pressure as clothing manufacturers but all segments will be pressured as the removal of the protections, which existed under MFA, gains pace towards 2005. The main consumption markets remain Europe, US and to a lesser extent Japan. As suggested by the summary table (Table 6), the longer term challenge for European producers is to build on their strengths and leadership in high value areas and activities in the sector. For the moment, however, the main problem for Europe is to maintain the strength of those segments which have strategic competences until the markets in emerging countries gain the necessary level of development to constitute reciprocal markets for the sophisticated high design content products in which Europe might retain competitive advantage.

54

Table 1.6: Textiles: Key Challenges and Chances Production phase Commodity Fashion Design
Normally moderately important except when design of textile can be linked to specialised equipment fashion demands reduce commodity Cost the principal factor. The emergence of Asian companies who can acquire and use modern technology a threat Almost impossible for Europe to operate in this sub sector because of cost structure. Some use of outprocessing can help. linked with the overall product cost. has not protected European companies even in home markets branding is being used increasingly to sell concepts of quality in commodity type products Continued advance in technology linked to specialist attributes of products strong source of competitive advantage but when garment maker moves offshore failure to retain loyalty can be a threat for textile manufacturer Difficult to retain economies of scale in fashion fabrics but price competition is less at present integrated firms such as Benetton, can retain make-up and assembly in Europe. Other smaller fashion producers may send some work offshore Integration through the supply chain is an effective competitive strength for European manufacturers. development of brands is principal source of strength with other intangible assets embedded in service Further development of Integration and design led total service concept

Niche
presents opportunities for viable development of new fabrics which may be later adopted to mass or fashion markets

Rate of Change
fashion changes have increased from two per year to five or six. opportunities for design oriented supply firms

Main competition to Europe

USA. and some of the emerging nations.

Manufacture of Textiles

Opportunity to experiment with new fabrics.

Make-up and Assembly

Distribution

because of the nature of the market and the high innovative content companies in this segment can retain work in Europe. strongly linked within the overall supply chain.

overall rate of change in fabric types is increasing and may require product line rationalisation by individual firms fashion changes have increased from two per year to five or six. strong opportunities for suitably organised firms adoption of industrial practices for inventory control and lead time reduction have been used to compete. emergence of heavy discounting in major retail chains with retained quality image is increasing constant review and refocus in the face of intense competition from emerging areas.

Strong competition from Asia.

Retail marketing

not as important as industrial marketing but integrated service is strongly competitive Innovation in fabric use and product design and links with fabric producers

In commodity products Asia is the principal competitor. In the fashion and niche areas Asia will increase its competitive presence. Europe retains some advantages in this area but Asian economies are familiar with just-in time concepts too. US can compete on branding.

Strategy

55

2.

Steel Sector

2.1 Introduction The steel sector is undergoing substantial evolution. From the recovery of iron ore to casting and rolling of the final form, far reaching change is occurring and has been for some time. These changes have presented challenges and opportunities to firms in the industry which have been prepared to adapt. The pursuit of efficiency and cost containment has been particularly intense in the past ten years. The advent of new technologies, such as continuous casting, along with the economic difficulties at the end of the 70s and early 80s are reflected in the statistics. The growth in crude steel production since the mid 1970s has been only 0.5% per annum.(see Fig.2.1) Figure 2.1

WORLD STEEL PRODUCTION

900 800 700 600 500 400 300 200 100 0 1900

1910

1920

1930

1940

1950 YEAR

1960

1970

1980

1990

The demand for steel is not expected to grow at more than 1.5% to 1.8% per annum worldwide and when coupled with continuing improvements in steel processing yields the annual growth in the production of crude steel will be less than 1.5%. Of more importance to developed countries will be the developments in newly developing countries, particularly in

56

Asia. Despite the slow growth of steel consumption expected and the consequent slow growth of production, capacity increases, particularly in the newly industrialised countries, are predicted to increase the capacity available by the year 2000 to almost 1.2 billion tonnes. Figure 2.2 shows that virtually none of the increase is expected in the OECD countries while countries like India, China, Taipei, Malaysia and Thailand will be adding significantly to available capacity. Figure 2.2

Crude Steelmaking Capacity

1200

1000

800 million tonnes

600

400

200

0 1985 OECD countries Non-market economies 1989 1992 1994 Non-OECD Market Econ. Others 1996 2000 Central and Eastern Europe

2.2 Steel Markets and Trade It should be noted that the steel trade in most areas shows a strong tendency towards localised consumption of production. Figures 5 and 6 show that in each of the main trading blocs the bulk of local demand is met by local production. In the EU in 1994 76.6% of its steel production was consumed in the EU, in Japan 77.6% and in the US 94.7% were the equivalent figures for these blocs. The rest of the world market which is approx. 54% of total world demand was supplied by other producers to the extent of 87.5%.

The percentage of EU consumption met by EU production in 1994 was 83.3%, while the equivalent figures for Japan and the US were 72.1% and 94.8% respectively. The overall

57

picture is one of localised production but with significant markets to be competed for and a threat of increased competition from additional capacity being installed in newer developed and developing countries with lower wage costs.

Because of this localised phenomenon over supply in one area of the world and shortages elsewhere do not always lead smoothly to trade. Shortages of steel in Asia have been projected in the short-term while there will be over supply in the advanced countries. This should provide opportunities for efficient operators in the EU and US at least until new capacity in Asia comes on stream.
Fig.2.3
Percentage of Own Production Consumed by Country

18.26 12.06 5.59 1.09 0.24 77.63 0.16 Others 4.89 1.75 EU Japan Consuming Country US Others US 20.34 Japan 94.71 5.79 16.08 87.52 53.60 100.00 80.00 60.00 40.00 20.00 0.00 Total Cons

Percent

76.61

0.28

0.15 5.76 17.49

EU

Producing Country

Source: OECD World Steel Trade 1995

58

Fig.2.4 Percentage of Total Production by Consuming and Producing area

46.53 2.97 0.58 3.08 0.03

Percent

50.00 40.00 30.00 20.00 10.00 0.00

EU Japan

0.02 0.04 15.22 0.26 11.43

11.59 0.60 US 3.00

Others

0.03 1.14 US Others 3.47 EU

Japan Producing Country

Consuming Country

59

2.3 Technology The major technological development impacting on the shape of the steel industry in recent times has been the emergence of the electric arc furnace (EAF) and the minimill Although . the technology has been available for many years the EAF and associated minimill are significantly changing the industry in the 1990s. Facilities using EAF have encroached on the traditional markets of the large integrated steel plants and increased their share of crude steel production from 14% in 1970 to 33.5% in 1996. Planned capacity increases are mainly of the Blast Furnace(BF) or electric furnace type with many of the older open hearth furnaces being retired for environmental reasons. The development of the minimill on a smaller scale and with a modular approach to steelmaking has allowed synergy to be developed with the consuming industries and minimills to be tailored to specific market sectors. As a result, it is unlikely that integrated blast furnace or basic oxygen furnace(BOF) plants will enjoy more than very modest growth. Electric arc furnaces originally used 100% scrap steel as feedstock and their strong growth has led to an increase in the price of scrap. The latest technological advance, direct reduction iron (DRI), allows iron ore to be used thereby alleviating the problem. Figure 2.5 shows the pattern of technology use in steel production. Figure 2.5
WORLD STEEL PRODUCTION by Furnace Type
900 800 700 600 500 400 300 200 100 0 1975 EAF BF/BOF and OH

1980

1985 YEAR

1990

1995

2000

Source: OECD Steel Capacity Data (derived)

60

2.4 Research and Development: In Figure 2.6 the pattern of R&D expenditure in this sector for the three main trading groups suggest that the US which has recovered much of its competitive position has done so through purchase rather than development of new technology. European R&D spending is much higher than US spending but lags Japan significantly. This research effort needs to be increasingly focused on raising quality and enhancing value-added as a counter to lower cost imports. Europe has the capability to be a strong competitor in specialist property steel and should orient development towards that market with the co-operation of user industries.

Figure 2.6
R&D EXPENDITURE IN IRON AND STEEL 1985-1994
2000 1800 1600 1400 MILLIONS$ 1200 1000 800 600 400 200 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 JAPAN EU US

Source: OECD Science and Technology Indidcators 1997

2.5 Profitability The steel industry in Japan and in the EU, particularly Germany, shows behaviours that are typical of industries with little price competition and a low intensity of internationalisation. In Japan capacity and production are managed using demand forecasts from the government. Prices are kept in balance and profitability is optimised. There is strong inter-company cooperation and industry discipline. More recently the arrival of independent minimill operators and imports from other Asian countries have threatened this system by introducing aggressive price competition. The integrated producers have responded by increasing productivity and so far profits have been largely maintained.

61

The EU coal and steel treaties have had similar effects alongside large scale rationalisation. Preference for local production and local suppliers has kept the prices of steel to industries like the auto industry high and has helped to maintain profit levels. While Returns on Total Assets in the steel industry since 1980, in both Japan and the EU, have been low, they have at least been positive (Figure 2.7). By contrast in the US where price competition has been strong since 1980, profitability has been low with large negative levels of return on total assets(ROTA) from 1982 until 1989. The impact of new competition has increased the dynamism and innovation of the US industry as minimills continue to make inroads into the markets and weaker integrated players exit. Profitability has returned to US steel making since the early 1990s based on significantly improved productivity and new investment. Figure 2.7

Steel Industry Profitability 1980-1992

Return on Total Assets
8

% -4

-8

-12

-16 1980

1982 Japan

1984

1986 US

1988

1990 Germany

1992

Source: McKinsey Global Institute

2.6 Costs The principal cost elements in this industry are capital costs for facilities, energy costs and labour costs. Material costs can be variable, particularly scrap costs. Significant cost reductions

62

have been achieved by the minimills and newly restructured operations in the US where the industry average man-hour content of a finished ton of steel has been reduced from 10.1 in 1982 to 3.9 in 1995. Table 2.1 sets out the respective positions of the main trading blocs.

63

Table 2.1 Factor Markets Cost Category Inputs (material and energy) High cost of energy (electricity) Moderate cost of scrap Low cost of capital from banks Capital Less pressure to perform No venture capital Labour Relatively inflexible labour force Strict legal constraints Other Issues Management/ workforce relationship Strained /regulated Cooperative Adversarial in integrated production units Integrated mills resistant to change; opportunities for minimills Flexible workforce through subcontracting Lifetime employment Integrated producers face more constraints Minimills non-unionised High cost of energy (electricity) Moderate cost of scrap/ low availability Low cost of capital from banks and unrealised gains Low cost of energy (electricity) Low cost of scrap/ high availability High cost of capital High hurdle rates/ short payback requirements Europe Japan US

Resistance to change

Some Flexibility; able to change

2.7 Outlook: The outlook for the steel industry has to be seen from the standpoint of two different groups on the production side. Production will continue to shift from integrated mills to minimills or at least to less complex configurations of integrated facilities. This will occur for reasons of high productivity, better returns on capital investment and lower impact on the environment. New technological advances allow the minimills to compete in previously excluded areas such as flat products. The consequent reduction in the minimum scale of such mills to well below the one million tons level has opened up the competition for all areas of the industry. Integrated producers will have to respond by reorganising or closing. Reduction in complexity will be a major element in regaining competitiveness. One strategy being considered by many players in the integrated segment is the abandonment of primary ironmaking and purchasing

64

semi-finished steel to make final products. Such a strategy could be very viable in Europe with the availability of cheap blast furnace iron from former communist countries. However the employment reduction in the restructured companies would be high.

2.8 Summary: Steel making has undergone dramatic changes within the recent past with upheavals in world trade with the collapse of the former Soviet Union and in production with the growth of minimills and the emergence of China and Korea as major producers and users. The response of steelmakers in the US and Europe has been to restructure and improve dramatically labour and capital productivity and to invest in R&D to combat the technological advantage which countries like Japan and Korea had established.

The world market for steel will grow at only 1% or 1.5% per annum. Asian countries are developing capacity based on the most modern technology reducing opportunities in these growing markets. Investments in R&D are expected to increase in Asian countries and must be at least matched by Europe. For the moment, however, steel trade remains largely localised for reasons of transportation costs and exports rely on specialist markets and relatively nearby customers.

European steelmaking has been consolidating and rationalising in the wake of a series of privatisations. Even in cases where full privatisation has yet to be undertaken mergers across national borders have been arranged. This is the only way that large integrated steel producers can achieve the reductions in costs that the challenge from minimill producers have mounted. The environmental requirements are steadily removing older open hearth production capacity and replacing it with electric arc furnaces. Specialisation in product performance and capability is one of Europe areas of potential competitive advantages in steel making (Table 2.2). s However, at an aggregate level, all these features are driving the rationalisation of European steel which will lead to significant loss of employment, particularly if integrated companies cease production of basic iron and purchase it from Eastern Europe.

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Table 2.2: The steel sector: key challenges and chances Sub-sector Growth Technology and R&D Primary Processors Overall Low Overcapacity in many areas such as tubes, investment confined to productivity and quality improvement Development of steel framing for housing and commercial buildings presents a future possibility Improvement in product performance capability is holding of challenge from other materials. Continued R&D investment needed. Diverse segment with competition from alternative materials very strong.

Skills Medium level skills with little new technology Medium level skills

Costs Costs currently competitive from restructuring. Problems with low cost imports Structural steel costs in Europe under severe pressure from Eastern Europe Specialist area with cost competitiveness based on technological capability Basic commodity steels are used and lowest costs prevail, severe competition Specialist area with cost competitiveness based on technological capability

Competition and Strategic Response Mostly Eastern Europe Further rationalisation and cross border mergers and cooperation Rationalisation and joint ventures with Eastern European partners Competition from Japan, particularly for transplant business. Strategic response lies in increased collaboration with Japanese auto makers on product development. Competition from low cost emerging economies. Product specialisation and innovation strategies based on niche markets. Competition more from alternative materials. Europe is competitive on tinplate but product improvement must be continuous based on R&D.

Construction

Moderate

Vehicle Manufacture

Moderate but cyclical

Higher level skills in terms of process control and monitoring Medium level skills

Metal Products

Low

Canning

Moderate

Investment in R&D has restored tinplate as preferred alternative to aluminium. Continued investment in product performance needed

Higher level skills in terms of process control and monitoring

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Motor Vehicles and Components

This industry sector covers not only the manufacture of motor vehicles and engines but also the manufacture of parts and components. Motor vehicles are dominated by passenger motor cars with a significant commercial vehicle sector traditionally segmented into light vehicles(less than 6 tons carrying capacity) and heavy commercial vehicles. The motor vehicle industry is a major industry with world wide sales of almost 35 million cars. Production is dominated by the EU, US and Japan who between them manufacture over 80% of world consumption. Manufacture of parts and components is a derived demand industry which moves in step with the motor vehicle sector.

3.1 Production (see Fig. 3.1 for passenger car production) The EU, as a unit, has been the largest manufacturer of motor vehicles, with Japan and the US closely grouped in second and third place. Since 1980 the respective positions have not changed significantly except for a period in the late 80s when The US production of cars fell below 6 million units and a large gap emerged with Japan. Since 1992 US production has recovered and has actually exceeded Japanese production in 1995. EU production grew steadily from 1981 to 1989 at a rate of 3.6% per annum. From 1990 to 1992 there was a slight decline of 1.1% per annum followed by a sharp recession in 1993 (-11.7%). Since 1994 production has been recovering steadily at about 4% . The recovery in the US production from 1991 arises from the sharp rise in competitiveness of the US industry as much of its reorganisation of facilities and practices has taken effect and from the reductions in unit costs as a result of the dollar /yen exchange rate in particular. Some of the shifts in production numbers are traceable to the transfer by the Japanese of production from Japan to Europe and the US.

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Figure 3.1
14000 12000 10000 8000 6000 4000 2000 0

Passenger Car Production 1980-1995

EU US Japan

The motor vehicle components and parts industry has demand patterns which reflect the demand for new vehicles in the first place and the vehicle life cycles and maintenance practises in the second. However the new vehicle demand is the principal factor. Production units tend to be located near the major vehicle assembly plants and, except in a few cases, exports are not a significant element in production. The recent practice of Japanese car manufacturers encouraging their domestic components suppliers to establish in the country where the new Japanese car plants are located has added to the competitive pressure on local suppliers. However, the practice is happening less in Europe than in the US. Japan is by far the largest supplier of components and parts with the output level increasing from 70 billion Ecu to 135 billion ECU in 1995. By comparison, the output of the US industry has remained static at approx. 85 billion ECU over that period. The EU industry has grown from around 30 billion ECU in 1985 to 64 billion ECU in 1995.

3.2 Competitiveness: In terms of technology the European industry is regarded as equal to the Japanese. However the European industry suffers adversely when the structure of the industry is examined. The Japanese industry has only 310 first line suppliers of parts and components who have close ties, organisational and financial, with the main vehicle manufacturers. These first line suppliers organise the up to 40000 sub contracting firms

68

who make up the bulk of the manufacturing capability of the sector. By contrast in Europe more than 3200 companies deal directly with the manufacturers.

There is also higher degree of specialisation and concentration in the industry in Japan than in Europe. European component manufacturers have traditionally had lower product quality, longer development cycles and lower labour productivity than the Japanese equivalents. This is beginning to change as Japanese vehicle manufacturers in Europe have chosen European suppliers and worked with them to reach traditional Japanese quality standards. The issues of productivity and development cycles are the focus of industry improvement efforts and the introduction of concurrent engineering and rapid prototyping techniques, again under the influence of new Japanese customers in Europe, is raising the performance of local supplier companies.

A significant element in the operation of parts suppliers in the different areas is the degree of responsibility placed on the supplier for the design of the component. traditionally in the US and Europe the motor manufacturer carried out the entire design of the part and ordered its supply. The supplier had no involvement in the design and had no discretion in terms of the specification. By contrast, as part of the new Toyota manufacturing system, parts suppliers like Nippondenso, which were part of Toyota, were given much more responsibility for design of products and therefore, could concentrate on ease of manufacture and assembly with consequent benefits to both parties. These changes are only recently being introduced by European and US suppliers.

In the motor vehicle industry while operational efficiencies are important components of competitiveness, successful marketing including matching overall product design and performance to consumer needs and preferences remains the cornerstone of success. Therefore, capability in these phases of the business provides a platform on which viable market shares can be achieved by individual manufacturers.

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3.3 Profitability: The profitability of companies in the motor vehicle industry has been variable over recent years. In all areas profit levels have been affected by the business cycle and consumer confidence which dramatically affects their readiness to purchase such a relatively costly consumer durable. Allied to periodic swings in popularity for product offerings individual companies can experience wide variations in profit (or loss) levels. The three major US manufacturers have had short periods of heavy losses during the years when large scale restructuring of the industry was taking place. Similarly all the manufacturers in Europe have had a period of profit seesawing. With the current recovery in demand, profit levels are recovering.

3.4 Exports and Imports: The picture in relation to imports of motor vehicles into the EU region is one of stability. In 1989 EU national manufacturers supplied 65.9% of the EU market, while US multinationals operating in Europe supplied 21.1%. Of the remaining 13% Japan supplied 8.9% and others 4.1%. By 1995 the proportions had changed little, with non EU based suppliers holding 12.9% of the market, the US multinationals holding 25%. However these figures disguise the shift the origin of the products in that Japanese transplant operations now appear as EU suppliers while Japanese imports have reduced. Nevertheless in production terms the EU has retained its share of its home market.

The export of motor vehicles from the EU has remained steady with losses in the mid 80s. However with the recovery in demand in the mid 90s there has been a sharp recovery. The trade balance has been restored. After shrinking from 18 billion ECU per year in 1985 to 5 billion ECU in 1992, it has exceeded 20 billion ECU in 1995. This achievement owes much to the competitive advantages of EU products in terms of design and performance.

A similar pattern is to be found in the components industries with a slow erosion of the trade balance as exports declined from 1985 to 1992. However the subsequent recovery in exports was matched by a surge in imports which has slowed the recovery

70

of the trade balance. The growth in imports is a consequence of the arrival of Japanese assembly plants and their insistence on sourcing key component supplies, with their traditional suppliers.

3.5 Research and Development: The technological state of the motor vehicle industry reflects the expenditure on R&D over the years. Fig. 3.2 illustrates the position.

When truck manufacture is added to car manufacture all three groups are of comparable size in terms of output with the EU some what the largest. however it can be seen that the investment in R&D in the US is regularly twice that of Japan and consistently 20% to 30% higher than Europe. This investment is not reflected in productivity higher than Japan, although recent measures would suggest that US levels may have significantly closed the gap which was 25% in favour of Japan in the early 1990s. Higher levels of R&D in Europe relative to Japan have not closed its productivity gap with Japan. This must raise questions about the focus of such research.

Fig.3.2
14000 12000 10000 MILLIONS$ 8000 6000 4000 2000 0 1985

R&D EXPENDITURE IN MOTOR VEHICLES 1985-1994

US EU JAPAN

1986

1987

1988

1989

1990

1991

1992

1993

1994

Some of this research is being focused on alternative solutions to the longer term problems of transportation such as environmental issues, traffic management and congestion issues and alternative sources of energy for transport equipment. The

71

solution to these problems will have little short term effect on the industry as it exists today.

It is not clear from the available data how much of this research is devoted to improvement of production processes and work organisation but EU levels of productivity are still about 25% below those of the US and Japan.

3.6 Capital and Other Costs: In a study in the early 1990s, McKinsey concluded that capital intensity as reflected in advanced labour saving technologies did not explain the differences in labour productivity between the US and Japan and that in fact the level of capital intensity for the industry in Japan was slightly lower than that in the US. This situation also applied within Japan where Toyota was the clear leader in productivity over its rivals but its level of capital intensity was similar. By the early 1990s the industry in Japan, the US and the EU had reached roughly similar levels of capital intensity and therefore little additional advantage was to be gained in that area.

In the case of labour costs, international comparisons indicate that Germany has the highest hourly wage cost when social costs are added, with Japan second and US third. A weighted average for the EU would place it between the US and Japan less than 10% below Japan and 2.5% above the US. Again these differences when combined with the productivity gaps suggest a cost competitiveness penalty which EU manufacturers must bridge.

3.7 Human Capital and Skills Base: The issue of the role played by work force skills in achieving higher productivity was examined by McKinsey and found not to explain differences in national productivity. The Japanese transplant factories in the US achieved productivity levels comparable to Japanese plants applying the same training techniques. However, they also used careful screening of new recruits and could bias the results in their favour. It was found, though, that equally good results were achieved by US companies who re-organised their existing factories with their existing workforces.

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In the components industry similar results are found. Japanese transplant factories using US staff achieved Japanese levels of performance. There were differences in the distribution of highly skilled personnel. In the US plants the highly skilled were evenly distributed over all plants whereas in Japan, they are concentrated in the large plants of the first line suppliers. The situation in Germany is similar to the US but this distribution of high skills does not translate into high productivity.

3.8 Key Strategic Issues: The response of EU motor vehicle manufacturers to globalisation will be an important factor in the retention of competitive advantage. Already the industry has followed market opportunities by building facilities in Eastern Europe and North America. Asia is likely to be a growth market and should be the focus of the next phase of globalisation by EU manufacturers. The same issues apply to the component manufacturers.

The current deficits in productivity will have to be eliminated in order to be able to compete on an equal footing. That this can be achieved has been demonstrated by individual manufacturers in particular plants. The main sources of improvement are organisational and in the production systems and structures adopted. This is particularly true of the components industry which needs to continue its moves towards the tiered structure of the Japanese industry.

The principal strength of the European industry lies in its design and innovation . This aspect needs to be supported heavily to allow the industry to shorten development cycle without compromising the excellence of the designs. The requirements of customers for more customisation in the specification of the product demands from the manufacturers more modularisation in design and an extension of the concept of building many product offerings based on the same design platform. An increase would be expected in this area in alliances between manufacturers formed for the purposes of particular types of product development. Niche market requirements at the interface between passenger cars and commercial vehicles are a good example of this (e.g. people carriers).

73

The move towards a restructured components industry will have major implications for existing producers. The main motor manufacturers will be increasing outsourcing of major systems and the suppliers of these in turn will be relying on specialist subsuppliers for much of their input. Improvements in quality and production flexibility will be top of the demand priorities. This in turn will require improvements in organisation and people skills. On top of this will come an increase in the responsibility for design and performance of the products being made at the various stages. This process of change is under way and will be continuous in its nature.

3.9 Summary The automotive industry in the EU, encompassing motor vehicle and component production is the largest of the Triad in terms of output. It has retained its competitive position by continuously improving its products and its productivity. Because growth in physical output has been only moderate, productivity improvements have led to reductions in employment. The principal source of competition has been Japan but now other Asian companies are joining the race. The EU based production situation has benefited from the investment by Japan in transplant manufacturing facilities in the EU and the consequent raising of standards in EU component manufacturers as they have competed to supply these transplants.

The indigenous EU manufacturers have adopted a range of strategies to maintain their positions in Europe as loyalty to national brands has come under severe pressure from high quality products from Japanese and other Asian manufacturers. Differentiation strategies continue to be important (such as the identification and development of niche markets, design and vehicle performance), and these continue to be strengths of the EU industry success in the past. Clearly, each of these sectors has slightly s different competitive tracks (Table 3.1).

In the future, however, it will be necessary to combine these types of approaches with an even more effective adoption of new techniques of organisation and management. Much has been done to raise productivity but much remains to be done to reach

74

Japanese levels in many European plants. More rationalisation and re-organisation is required, particularly in the component and parts supply industry which is still too fragmented to allow fully effective operation of the industry sector.

Research and development in the sector is being concentrated on improving efficiency of power units, improving safety and environmental impact and the use of new and advanced materials. The industry in the EU has established technological strengths in many of the development areas but will need to at least maintain its efforts to combat competition from Japan and the US.

75

Table 3.1: Automobiles: Key challenges and chances Sub-sector Passenger cars Growth
High in developing markets, Low in developed markets

Technology and R&D

Continuous product development based on improved performance, safety and environmental impact

Skills
High level design skills, Medium level assembly skills. High level production management skills High level design skills, Medium level assembly skills. High level production management skills High level design skills, Medium level assembly skills. High level production management skills High level design skills, High level cooperation and collaboration skills with original equip. manufacturers (OEM). High level production management skills

Costs
Cost levels related to productivity levels and adoption of modern production practice Cost issues similar to car section but new materials will be critical sooner.

Competition and Strategic Response

Competition is mainly local with presence of Japanese manufacturers in EU. Strategic response is based on product innovation and design. Competition for EU manufacturers will be from Japan and emerging Asian countries and from US. Strategic response will involve alliances Competition from Japanese and East Europe. Strategic response will be product development based with continuous improvement of production organisation also important. Competition is strongest from Japanese suppliers who have perfected supply chain management systems. Strategic response lies in restructuring companies to adopt similar practices and systems.

Light Commercial Steady growth based on expanding Vehicles

service markets and niches for personal use

Combination of technologies for ruggedness, reliability and comfort as well as performance will be the focus of development in this segment. European Industry has strong position technologically at the upper end of the product range but will need to improve its products in the mid range.

Heavy Commercial Vehicles

Steady growth

Cost issues less important but still can be a source of competitive pressure

Components

Derived demand related to vehicle assembly. However, export opportunities exist for efficient producers with integration capabilities

Product innovation is the key in this segment and critical mass is important to sustain the investments required. EU component manufacturers need to consolidate to provide this dimension to the industry

Cost issues very important and so productivity improvement based on modern production systems and their organisation are critical

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Aerospace Industry:

The aerospace industry can be divided into sub-sectors covering civilian and military uses. Although the requirements in each sub-sector are different, the production systems and technologies are similar and therefore, the industry tends to be organised around a small number of major systems manufacturers who co-ordinate the output of a large number of manufacturing sub-contractors.

Military systems are normally purchased by national governments and for many years exporting companies have learned to accommodate the need of the purchasing nation for strategic involvement of its local industries in the programme to supply and manage the military hardware. As a result, even though there are a limited number of large integrated suppliers mainly in Europe and the US, there is a growing network of international companies spread throughout the world benefiting from alliances and technology transfer leading to a truly global manufacturing set-up in all parts of this sector.

The US is the dominant player in the sector, with the EU second largest. Japan is a distant third but with the potential to be significant. China too, will increase its involvement, particularly as Asia would appear to be where a large part of the growth in the sector will occur over the next decade. Russia, obviously has the technological capability to be a strong competitor, but reorganisation of the economy may slow their emergence.

4.1 Production Output world-wide for this sector has been cyclical and appears to be recovering from the most recent trough in the early 1990s. However output by the end of the decade (see Fig. 4.1) is only likely to reach the previous peak of 1989 at $160 billion US for the Triad of US, EU and Japan. Market shares have recently stabilised at 61% for the US, 34% for the EU and 5% for Japan. The effects of the recent mergers in the US of Boeing with McDonnell Douglas and Lockheed Martin with Northrup Grumman have still to be seen in the marketplace but they demonstrate that the US industry is

77

restructuring to face the new situation arising from the revised military environment in the post cold war era.

Figure 4.1
160

AEROSPACE INDUSTRY PRODUCTION 1985-1998

140

120

100 billions ECU %

Production EU

80

Production US

60

Production Japan

40

Triad total

20

0 1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

The main area of concentration in the EU is the civilian aircraft manufacture centred around the Airbus consortium. Airbus has developed to a point at which it has achieved 30% of the market for civilian aircraft. Recovery in airline companies profits has brought an end to the trough in aircraft orders and, more importantly, deliveries. The other main competitor in civilian aircraft is Boeing. The US company has consistently held 60% of the market and would appear set to increase this slightly with the merger with McDonnell Douglas. However the civilian aircraft arm, Douglas, is largely a spent force in the industry.

Production levels in the defence and space related areas of aerospace have been adversely affected by the adjustments in defence spending by the major governments following the end of the cold war. In the US, spending on defence and space has declined from $108 billion in 1992 to $90 billion in 1996 and is projected to remain at this level for the next five years. In Europe similar adjustments to defence spending are occurring but recent decisions to proceed with the Eurofighter project will provide a boost. Commercial based satellite operations in space will continue to expand the market in that sub sector. In the longer term the great unknown factor will be the

78

harnessing of Russian technology in a European context, particularly in aircraft manufacture and space.

4.2 Research and Development This sector is a high technology sector which relies on innovation and technical advance for much of its dynamism. The basic cost structure of the industry, with very high development costs and high risks, has a high reliance on public funding of its research and development. Figure 4.2
25000

R&D EXPENDITURE IN AEROSPACE 1985-1994

20000 MILLIONS$

15000

10000

US JAPAN EU

5000

0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

There exists an agreement whereby public funding to commercial aircraft development is restricted to 30% of development costs. Nevertheless, it is extremely difficult to monitor and control the situation in integrated civilian and defence companies. Fig. 13 above, shows the levels of R&D expenditure in the sector. In the US in 1994 R&D accounted for 15.8% of overall revenues in Aerospace while in the EU the figure was 15.2%. The significant drop on the actual levels of R&D expenditure since the peak years of 1988/89 in the US reflects cut backs in defence programmes and the revision of Department of Defence priorities in the 1990s. For major international projects such as the International Space Station R&D expenditures are expected to be trimmed in line with a longer lead time for the project. Europe has begun to reap the benefit of earlier heavy investment in wind tunnel facilities which are now the most advanced in

79

the world, to the point that US companies are utilising these facilities in their development programmes.

4.3 Profitability: The levels of net profit earned in this industry is in the range of 3% to 6% of sales revenue. Depending on financing structure and the scale of operations, the lower end of this range is the very minimum that can support internally financed growth. Steps to increase these profit levels have been made in the major manufacturers and their principal suppliers in both the US and Europe. Improvements in cost, product cycle time and quality have been achieved over recent years and further improvements are being planned. The US industry in particular has been increasing its competitive thrust along these dimensions of performance.

4.4 International Trade The industry sector has become a much more export intensive sector over recent years. Some of this development arises from the practice of including elements of component supply from the purchasing country in large scale sales contracts for aircraft and other significant aerospace contracts. While trade in aerospace products indicates that exports from Triad producers have increased to 38% of production in 1994 from 22% in 1985, extra-EU exports by EU producers have remained constant at around one third. However care must be exercised with trade figures in this sector because of the large trade in second hand aircraft. Countries such as China and Russia and others are seeking to develop or expand aircraft design and manufacturing capabilities by

teaming arrangements with each other and with current manufacturers. This is an emerging field of activity where existing manufacturers are seeking to position themselves to advantage with a global presence.

Exports of aerospace equipment represent between 3% and 4% of EU total exports. This is less than half the proportion of total US exports represented by US aerospace exports. The relatively high value of aerospace in US exports can be attributed to the strength of the US in all segments of aerospace and also to the fact that the majority of trade in the sector is denominated in US$ thereby sheltering the US from any currency

80

effects on trade. The US is the largest single export destination for EU exports taking over one third of the total and the EU is the largest destination for US exports taking over 50% of that total. International trade in aerospace is expected to grow and diversify as new producers enter the market.

In addition to the opportunities that are developing in the supply of aircraft to a growing market for mobility, the whole area of air traffic management systems

presents a significant opportunity for growth and development. The development and application of technologies for the reduction of delays in commercial air transportation is a segment of this sector which can deliver large savings to customers and airline companies. The area will be subject to fierce competition but many of the technologies are well advanced in both Europe and the US.

4.5 Costs There are no significant advantages in basic labour costs for either main bloc in the aerospace industry. Of much more importance to the overall cost competitiveness in the sector is the management of the time dimension to reduce the various process cycle times in the complex design, evaluation, testing and manufacturing processes. The application of developments in communications and computing, modelling, simulation and virtual reality, neural networks and intelligent systems, non-intrusive instrumentation, advanced flexible manufacturing, physics-based manufacturing modelling and lean production concepts hold the promise for overall time and cost reductions of the order of 30% + in the design, development and production of new systems in the industry. Europe is not as advanced as the US in these developments.

Another main cost category in the production of aerospace equipment is material costs. These are not commodity based materials but are high technology specialised materials which represent a complete range of technological problems on their own. Reduced size and weight combined with extreme ranges of functional capabilities tend to be demanded to meet the performance characteristics of the final products, while economics dictate that low price solutions are also demanded. The management of these functions in the overall process is also a key activity.

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The sector is also very capital intensive in its requirements for sophisticated facilities for design, manufacture, testing and for R&D. The enormous costs of developing major systems or aircraft require either significant public funding support or extensive risk-sharing partnerships which are now more and more a feature of the industry. Even the natural competitors of the sector are collaborating on major high risk projects. Annual Sales to Capital Employed ratios for the major companies in the sector are generally about 1:1. this represents very high barriers to entry although facilities sharing and risk sharing partnerships have helped to increase the levels of competition. The industry is currently working out a modus operandi within the new constraints which changed funding for defence projects imposes. In the US and to a lesser extent in Europe the spill-over from defence research into the commercial areas of business is becoming more difficult as the defence specifications change and provide less synergy with commercial requirements.

4.6 Productivity The productivity of the aerospace industry in terms of output per unit of labour input has shown a somewhat stubborn tendency to stagnate over the past five years in Europe. This reflects the shake out in the industry which has seen output levels fall by 4.3% up to 1995. Employment levels were reduced to match this drop thereby

maintaining productivity levels. Restoration of growth in production should allow further gains in productivity of 5% over the period from 1995 to 1998. Global productivity figures hide the widespread introduction in the industry of automation and sophisticated management practices aimed at streamlining operations and reducing cycle times and costs. These reductions have provided the latitude to offer competitive pricing and financing options to customers and are the hallmarks of competitive companies within the industry.

Productivity in the US aerospace industry has been increased in recent years as much by consolidation as by improved processes. Particularly in the defence related segment reductions in military spending and defence contracting are forcing further rationalisation among defence suppliers.

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4.7 Employment In line with the extensive re-organisation in the industry over the last decade, employment in the sector has shrunk. As the market dominance of the US has declined and as government spending has decreased The US has reduced employment in the sector by 600,000 in the decade. Europe by contrast has maintained its employment level at 90 % of the 1985 level, a reduction of approximately 10%, as against 45% for the US. Competitive pressures suggest that further reductions can be expected in the European industry but not at the level experienced in the US. The industry is a high skill industry relying on highly skilled personnel. Such conditions do not encourage frequent adjustments of numbers employed in response to variability of demand. Therefore, reductions in employment come about from significant restructuring.

4.8 Some Key Issues The Aerospace industry has some characteristics which, while they may be featured in other industries, are very pronounced. It is truly a global industry but this affects its various sub sectors in different ways. In the aircraft manufacturing segment on the commercial side there are emerging increasingly international business alliances. In particular in Asia the sale of commercial aircraft often has to be accompanied by business relationships which transcend the offset purchases common in aerospace transactions. Consequently to achieve sales in large developing markets the principals in the large aerospace companies are setting up joint ventures, and work-sharing arrangements.

At the same time the production of defence and military aerospace requirements still remains largely segmented on country lines. Retention of defence design and manufacturing capability is still considered a strategic necessity by many countries. This restricts the advantages which can be gained from collaborative work and can prevent the integration of the separate systems of production within the same company.

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The space segment of aerospace is developing towards an extensive regime of cooperation in the experimental area and in the interplanetary activity. The area of earth orbiting commercial satellite developments will continue to be highly competitive.

The potential for these areas of aerospace to overlap can be seen from the emerging need for technological developments in areas like air traffic control and management to permit the expected growth in air traffic to occur without the incidence of intolerable flight delays with their consequent cost effects. Much of the development profile of the aircraft industry is predicated on the assumptions of significant growth in traffic. Failure by another segment of the industry to solve the traffic management problems would restrict the development of new aircraft. The close involvement of public authorities as regulators and as stimulators of R&D in the overall interests of citizens can be encapsulated in the complexity of the aerospace industry.

The maintenance of competitive advantage by Europe while continuing to be the numerically smaller player(s) will depend on their skill in forging effective working relationships within the complex structures which the industry has embraced, including those with public bodies. In the defence related segment there would appear to be a need for further consolidation as defence spending is trimmed. However, in Europe further consolidation is hampered by national considerations concerning control over defence capability. This is a major dilemma for governments. A continuation in the reduction in spending for defence will quickly lead to the problem of being able to support a viable defence industry on the revenues proposed. Diversification by companies into export markets will simply disperse the capability with offset arrangements. At the same time, regulators of trade and competition will resist further rationalisation and weak competitive firms will result.

There is no easy answer to these problems. Governments will have to determine the minimum levels of spending needed to sustain design and manufacturing capabilities in defence industries or to decide to accept that they will be dependent on other countries for the supply of defence equipment. The issue of international consolidation of defence industries will remain on the agenda as long as the current trend of running down defence budgets continues. 84

4.9 Summary The Aerospace industry has to be considered in two segments, civilian and defence related. The major product groupings, aircraft and space have dual application in these segments. The synergies which large scale public funding of research has traditionally nurtured may be waning with consequent problems for technological advancement. Nevertheless this sector has a buoyant future and European manufacturers have capabilities which can be maintained and enhanced through appropriate strategic responses to change.

In the field of civilian aircraft Europe is currently competitive but must organise its facilities to allow speedier decisionmaking on major critical strategic issues such as the future of supersonic passenger travel. In the field of military aircraft Europe must face the reality that only as a unit can it have a viable supply industry and even then international collaboration will be a necessity.

Civilian space operations will continue to grow and opportunities in emerging markets of Asia and Africa will offer opportunities. The development of operations located in Europe will depend on the achievement of increased market shares in these areas.

Two major challenges face the industry in Europe: (a) Large scale rationalisation and consolidation of companies will be required to achieve the critical mass needed to sustain viable product innovation. This will have to be achieved across national boundaries in areas where governments see issues as nationally strategic and security based, (b) Companies have to work out modus operandi which allow for collaboration on some civilian projects while competing for military contracts and vice versa.

The requirements for research investment will remain highest in this sector, but Europe has demonstrated strengths in the critical areas of the appropriate technologies. High levels of public research funding will still be a feature of this industry on both sides of the Atlantic ocean and global alliances will be constructed to co-finance high risk projects. Table 4.1 outlines briefly the issues facing various segments of the aerospace industry in Europe.

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Table 4.1: Aerospace: Key Challenges and chances

Sub-Sector Civilian Air Transport Military Aircraft Space Growth High Technology Continuous High Investment Skills Advanced level Costs/Funding Cost reduction from improved manufacturing systems Questions of viability of product programmes arising from market size Pressure on costs as commercial application increase Reduction in defence spending putting downward pressure on prices and so on costs Similar pressures on costs as in civilian air transport. Product design and use of new materials are key factors. Products and systems are essential components of user facilities and cost pressures stem from total system cost appraisal Competition & Strategic Response Mainly US based. Corporate Restructuring Extended Product range Possibility of only one supplier in Europe with international partners. Exports important US, Japan and Russia. Political support for European capability US main competitor, Significant industry restructuring needed in Europe US competition is formidable and collaboration is commonplace. Need to ensure European base for engine capability. US competition with growing involvement of Japan. Industry rationalisation in Europe is needed to ensure critical mass for product innovation

Low

Advanced systems development, new materials, collaborative programs

Advanced level

Moderate

Leading edge technology, high levels of investment with substantial public funds Need for consolidation and harmonisation of systems even then viable European market not assured Environmental and performance demands require massive R&D investment. Collaboration important but European based capability strategic. Product innovation is key to survival in this segment of the industry, which can service a wider industrial base.

Highest level skills and qualifications Advanced level for design and manufacture Highest levels for research, design, manufacture and repair High skill levels in all phases of operations.

Guided Weapons Engines

Very Low

High

Equipment

High

86