The GCC’s automotive downturn

For a market known for its love of cars, cheap fuel and limited public transportation, the Gulf region’s automotive sector has been driving through something of a rough patch over the last year.

As consultancy Frost & Sullivan notes, 2016 was difficult for sellers across virtually all countries in the Gulf Cooperation Council as double-digit declines in new vehicle sales, overstocking of parts by distributors and a lack of clarity for the near future all weighed on the market.

And this feeling only continued into the first half of 2017 when many hoped the worst was over.

“Unfortunately, the market has not yet reached the point of balance. Even though we expected the market to start recovering only by the end of 2017, continuing sales drops seem to be following a pessimistic scenario in H1 2017,” says Vitali Bielski, senior consultant, mobility practice – MENA at consultancy Frost & Sullivan.

Most markets were down more than 20 per cent in the first four months of the year, according to Bielski, with other sources painting an even worse picture for automotive companies operating in the region.

In a recent report, Autodata Middle East said GCC new car sales were down 30 per cent in the first quarter of 2017 compared to the same period last year with the heaviest losses seen in Bahrain (41 per cent), Saudi Arabia (38 per cent) and the UAE (28 per cent).

The first quarter decline followed a 27 per cent dip in new car sales in 2016, according to the firm.

“We have already seen job cuts across the industry at all levels,” says Ian Batey, general manager at Autodata Middle East.

“There is a limit on how far those cuts go because if they go too deep you end up bleeding customers due to lack of service. This then compounds the problems and the business ends up in a downward spiral.”

Batey believes that showroom closures are “unlikely”, however the tougher environment is putting some expansion plans on hold and could see small independent dealers “fall be the wayside” if they fail to adjust.

In the meantime, economic uncertainty will remain the main challenge for the industry as consumers postpone purchasing decisions, forcing firms to up their marketing and promotional budgets to increase showroom traffic.

“That, in return, reduces profitability and forces dealers to focus on aftersales. Excess inventory and underutilised assets are also among the main challenges,” says Bielski.

Another side effect of the tougher environment has been that consumers are increasingly researching cars online before going to a dealership, according to Rahul Kulshreshtha, founder and editor-in-chief of Car Insight Solutions FZE, which has recently seen its site traffic grow to 300,000 visitors a month.

He says excess inventory due to higher supply than demand has placed retail prices under pressure and led dealers to carry out “heavy promotional activities” and “innovative financing schemes” like monthly payment personal contract plans (PCPs) to attract car buyers.

“If someone is looking to buy a new car, then this is the right time,” he adds.

Indeed, customers who took the plunge into the market around the traditional Ramadan sales period were met with some of the most generous offers to hit the market in recent years including ‘buy now, pay next Ramadan’, 0 per cent finance, zero deposit, extended warranty and three-to-five-year service contracts, according to Autodata.

But outside of these marketing actions and an optimisation of their asset base most dealers are “simply waiting for the situation to improve”, according to Bielski, and Batey argues more dramatic change will be needed to weather the current slump.

“As we have been stressing throughout the first half of this year, this is the new normal. The industry needs to adjust its operating methods to suit the new market,” the Autodata general manager says.

And as we move into 2018 it will be up to GCC market leaders Toyota, Nissan, Hyundai, Mitsubishi, Ford, Chevrolet and Kia to maintain their appeal for motorists.

“The current market standings are being driven by the strength of the consumer offer and it will be interesting to see if anyone can challenge this group to gain market share,” Batey adds.

Going electric

Despite the wider downturn in the Gulf’s automotive industry one element that has caught the media’s attention has been the entrance of electric vehicle (EV) manufacturer Tesla into the UAE.

In February, the company announced that it would begin accepting UAE online orders for its Model S and Model X vehicles alongside plans for stores and service centres, super charger stations for its cars and a deal for 200 limousines with the Dubai Roads and Transport Authority.

Following this, it opened a showroom in Dubai in July ahead of the global launch of its cheapest vehicle to date, the $35,000 Model 3.

Should the vehicle maintain this price point in the region, Bielski believes Tesla will be able to attract its share of GCC customers from the e-segment where vehicles like the Dhs125,000-130,000 ($34,000-$35,400) Toyota Avalon are currently available.

But there is still a long way to go for electric vehicles to reach anywhere near mainstream adoption.

Batey believes Gulf countries will need to introduce similar incentives as other markets, where direct subsidies can sometimes cover 25 per cent or more of the cost of a vehicle, to increase adoption.

Although he suggests one trend that could be to the market’s benefit is a shift towards downsizing engines and vehicles as emissions regulations in other parts of the world forces carmakers to rethink their production.

“Although fuel is cheap in the region and drivers love big, thirsty engines, the manufacturers cannot keep building large cars and big engines for a diminishing market,” he says.

“We are seeing the big gas guzzlers being phased out to be replaced by smaller cars with more efficient engines and the growth of alternate fuel and hybrid power units.”

This trend will see the large sedan segment shrink and engines in full size SUVs also get smaller, which could drive consumers to look at alternatives, he believes.

But this may be more long-term potential than short-term sales.

“As the technology improves and battery range gets longer they will become more attractive if the pricing is competitive. In the short term it will remain a niche segment.”

Local manufacturing

Another potential upcoming trend in the GCC automotive industry is local manufacturing.

Frost & Sullivan estimates the GCC market could reach annual sales of two million units over the next seven to eight years, creating a large enough local customer base for manufacturers to take notice.

Even today some carmakers like Toyota, which sells 500,000 units in the GCC alone, may have sufficient volumes to justify a factory, according to Bielski, and there have been several efforts to encourage production.

These have mainly been led by Saudi Arabia, the region’s largest importer of cars and car parts, with trucks from several companies already produced there including the first Volvo Truck at the industrial valley of King Abdullah Economic City in June 2015.

Before the current slump, Saudi Arabia was forecast to hit one million new vehicle sales a year by 2020 from 770,000 in 2014, according to a report by Oxford Business Group.

This forecasted demand saw Saudi National Automobile Manufacturing Company (SNAM) and Saudi Arabian Public Investment Fund sign a deal with South Korea’s Daewoo International in May 2015 to build a $1bn vehicle manufacturing plant capable of producing 150,000 cars a year by 2018.

At that time other manufacturers including Ford, GM and Chrysler also reportedly expressed an interest in local manufacturing operations. However, there have been few updates since, outside of an agreement announced in February 2017 that saw SNAM partner with Sadara Chemical Company for an automobile manufacturing cluster.

The cluster, within the PlasChem Park in Jubail, is planned to span one million square metres and will host tier one, tier two and tier three automobile part manufacturing companies as well as basic facilities like a press, body, paint and general assembly shops, a logistics warehouse, test track and administration building. Another one million square metres next to the cluster have been allocated to automotive part suppliers.

Yet, despite these efforts, the path to cars made in the GCC may not be an easy one, with over capacity meaning most manufacturers would not invest in a new plant unless they have to.

“Opening a new manufacturing facility means lower output in existing plants and such decisions are usually made very carefully,” Bielski says.

“Additionally, the supplier base in the GCC is highly limited as of now. So if governments prepare the right mix of incentives to attract original equipment manufacturers into the region, it will become possible – but in no way easy. And that’s where a clear roadmap for the automotive industry is required as it would indicate direction for the industry.”

The VAT factor

With widespread electrical vehicle adoption and the development of significant local manufacturing still deemed to be some way off, car manufacturers and dealers are instead expected to focus on more pressing concerns as we move into 2018.

One factor that is hoped to encourage a surge in sales growth to the end of 2017 is the upcoming implementation of a 5 per cent value added tax rate across the GCC.

Some analysts believe the tax, which comes into effect on January 1 next year, will lead consumers to push forward their buying decisions to save money.

“This trend was not visible in the first half of 2017, but as we move along and more details are made clear, it can support sales in the short term,” says Bielski.

“Additionally, we expect some dealers and importers to try to absorb price hikes triggered by VAT introduction, at least initially. However, that strategy might not be sustainable in the long term.”

Others suggest the tax may also create more interest in previously owned cars, which are not subject to the same tax calculations.

“We forecast that this will generate more consumer interest in ‘nearly new’ cars e.g. those up to six months old,” says Autodata’s Batey.

“Our reasoning behind this is the VAT on a used car will be calculated on the margin – the difference between the price paid for the car and the price it is then sold for – whereas the VAT on a new car is levied on the full price. This will make a used car more appealing to a consumer.”

For new vehicles, however, he suggests the current offers in the market like free insurance and servicing for a set period will be replaced by ‘we pay the VAT’, meaning the transaction price for a new car will not change.

But outside of a potential increase in sales linked to VAT there are mixed forecasts for new car sales in the months to come.

Bielksi suggests the restoration of government benefits to workers in Saudi Arabia in April after they were taken away in September 2016 could lead to a swifter recovery in the kingdom than other markets, which are likely to see further pressure until the end of the year.

“We expect the market situation to start gradually improving by the end of 2017,” he says, adding a focus on maintaining current vehicles could see the parts market bounce back earlier.

“If future macroeconomic conditions do not change significantly, we expect sales to witness a moderate growth and reach around 1.3-1.4 million units by 2018, which is close to the 2016 result.”

Kulshreshtha too is optimistic that a market upturn is imminent.

“Positive factors like low cost of ownership, affordable fuel prices and the under developed public transport system in the GCC will continue to drive automobile sales,” he says.

“After a market correction in 2017, I am optimistic that automobile sales in the GCC will increase next year, World Expo 2020 being one of the key drivers. “

In contrast, Batey believes automotive firms should prepare themselves for a longer recovery period with Autodata forecasting no market growth until 2019 when a modest 5 per cent increase in sales is expected.

The company’s estimation for 2017 sales remains at one million vehicles across the GCC as a whole, including 450,000 in Saudi Arabia, 233,000 in the UAE, 134,000 in Oman, 103,000 in Kuwait, and 29,000 in Bahrain.

But despite this outlook, he believes the current downturn may create opportunities outside of the market’s traditional ‘new car’ focus.

“The industry has to change and mature in order to maintain or try to grow market share. The skill set and processes have to improve within the distributors and dealers,” he says.

“The days of not wanting to deal with a ‘trade in’ car has gone. The consumer is looking for and expecting total service. If you tell a customer you do not want his car as a trade in they will simply find another dealer to do business with.”

Regardless of which forecast you believe, it is clear that automotive firms can expect at least some uphill driving ahead as they pursue a return to growth.