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Malaysia's Proton struggles on
By Chee Yoke Heong

KUALA LUMPUR - Malaysia's national car, the Proton, owes its very existence to Mahathir Mohamad, the country's septuagenarian prime minister. In the early 1980s, when Mahathir first dreamed of putting the Islamic star and crescent badge on the front of what was even then an aging Mitsubishi Lancer and called it the Proton Saga, nobody, inside Malaysia or out, thought he could do it or would. They were wrong. In 1986, the Proton Saga hit the road.

Today, driving on the highways that Mahathir begat to handle them, it is hard not to notice how dominant the national car has become. Protons make up about two-thirds of all of the cars traveling Malaysia's roads.

In a rational world it would be questionable how long the car would survive Mahathir's 22-year reign, which ends in October when he retires. Proton, or Perusahaan Otomobil Nasional, as the government company is called that builds the cars, violates all of the rules of economics and carmaking. Because Malaysia's market is small, it would be difficult if not impossible to sell the half-million or so that are required for economies of scale to make manufacturing efficient.

The car, however, has a complicated hold on Malaysia's national psyche. To a great extent, it encapsulates the combative prime minister's vision for Malaysia. When he came into office, Malaysia was primarily an agricultural country whose income was founded on the triumvirate of rubber, oil palm and tin. Oil platforms in the South China Sea added to the mix.

But Mahathir was obsessed with industrializing what had been a somnolent tropical backwater. The country initiated disastrous experiments in steelmaking, cement production and other white elephants whose costs still have not been tabulated and won't be under what amounts for all practical purposes to a one-party political system. Proton's balance sheet debt is RM700 million (US$184.2 million) and falling, but that is because the capital construction costs for the car's two plants, estimated by analysts at as much as US$2 billion or more, don't appear on Proton's balance sheet. The costs were borne by the taxpayers.

Proton became the number-one car only because government intervention imposed a warped import tax regime that tacked tariffs ranging from 140 to 300 percent on to foreign cars and priced them well out of the reach of ordinary Malaysians. Thus opportunity costs - the money foregone by consumers who either have to pay the tariff on other brands they would prefer to drive or buy Proton - are estimated by analysts to be even higher. Proton has averaged sales of about 105,000 cars per year through the 1990s, analysts say, surviving on the high tariff rates. Consumers on average overpay by at least RM15,000 per Proton car, partly because of royalties paid to Mitsubishi (RM16 billion over the decade) and about RM20,000 per non-Proton car (RM17 billion over the decade), the analysts say.

Other industrialization projects were similarly costly and inefficient. But going to Malaysia today is very much entering a developed nation. Its roads are good, its cities are squeaky clean, its telephones work, its cargo-handling facilities are starting to rival Singapore's, its capital city features the world's two tallest buildings. Despite the failures and scandals, Malaysia is very much the country that Mahathir wanted it to be.

Still, Proton faces a dilemma. Vehicle sales volume dropped by 25 percent in the first half of this year compared with the same period of 2002. Total sales from January to June 2003 were 85,430 units, representing a 53 percent share of total passenger car sales, down from 113,680 units or 62 percent in the first half of 2002. Now, as Mahathir gets ready to leave office and World Trade Organization tariff cuts loom - and Malaysians get rich enough to buy other brands despite the high tariffs - the national car is in increasing trouble. Malaysia's consumers increasingly want something else.

Malaysia has compounded its problems by coming up with a second national car, the Perodua, to add variety for consumers but actually contributed to the problem because the two government-funded carmakers cannibalize each other. Undaunted, Mahathir is to unveil yet another, a locally assembled multipurpose vehicle MPV to be sold by Naza Kia Sdn, the Malaysian distributor of South Korean's Kia Motors Corp. The MPV will be priced at less than RM100,000.

Part of it is that competing non-national brands such as Toyota, Honda and Kia have cut costs to the bone, generated dramatic efficiencies and pushed promotions hard in order to get at Malaysia's lucrative car market.

"With non-national make cars hitting the market well due to attractive pricing and models, Proton is losing out," said Pankaj Kumar, head of research of OSK Research, adding that unless Proton bucks up, such as by introducing new models quickly, the company will see its market share slip further.

Proton's latest model, the Waja, is three years old. And in an industry where the average lifespan of a car before another new model emerges is two to two-and-a-half years, Proton is not producing new models fast enough to meet consumer expectations.

Despite its pricing advantage, Proton will soon face uphill technological and innovation battles in defending its dominant market share. In order to boost sales, analysts say, it must come up with more interesting models to compete with new non-national passenger cars that feature next-generation automotive innovations such as intelligent automatic gearboxes and variable-timing engines.

For a major part of its existence, the company merely assembled the Lancer and put the Islamic badge on the front. That has changed steadily as local content has risen. Once it unveils a new model with its new in-house engine, the Campro, that will rise to 95 percent. But that is not expected before next year and in the meantime consumers are looking elsewhere. Some analysts have projected a further drop in Proton sales this year as consumers await better, improved models and in anticipation of cheaper prices due to the advent of the ASEAN Free Trade Agreement (AFTA) in 2005. Under AFTA, Malaysia is required to reduce import tariffs on automobiles and auto-related products imported from other ASEAN nations to between 0 percent and 5 percent by 2005.

If implemented, Proton and Perodua, the other national car maker, are expected to lose market share dramatically unless the government comes up with other non-tariff barriers to protect the two national companies, which is likely. Minister of International Trade and Industry Rafidah Aziz has said that higher excise taxes for cars are likely to be introduced to offset lost revenues from lower import tariffs.

Malaysia, however, also needs to liberalize its market under the auspices of the WTO, to which the country is a party. Under the WTO, participating countries are required to abolish unfair trading practices, including rules and policies in the compulsory usage of locally produced inputs for manufacturing of traded goods. Malaysia, therefore, is required to phase out several measures that are considered unfair trading practices to protect the local automobile industry. That includes a local content requirement policy by 2003 - but which was extended for two years.

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

Indeed, says an analysis by a major multinational investment bank, "On a bigger picture however, its decision to back the new multipurposes vehicle "clearly shows the Malaysian government's lack of seriousness in complying with the issue of AFTA."

For instance, during the 1997-1998 financial crisis, most banks and finance companies were wary of giving out loans and consumer confidence had somewhat eroded. Government intervention came in the latter half of 1998 to relax some financing requirements, such as increasing the duration for hire purchase and increasing the percentage of car financing.

But despite the protection, Proton continues to struggle with high production costs that make local cars relatively more expensive than many foreign cars without tax and tariffs.

Proton spends a significant amount on research and development (R&D) and royalties paid to Mitsubishi for the use of its engine. Still producing only 200,000 units after 15 years, its volumes are too low to support stand-alone operations, according to an analyst. The company has been trumpeting the development of its own engine, the Campro, since 2001, which analysts said would likely cut its cost by about 30 percent. But in the meantime, the big global firms are designing engines with target production volumes of at least 750,000 units per year, while investing billions of dollars on hybrids and fuel-cell systems.

Some analysts disagree, saying that Proton is relatively new on the block whereas other giant motor companies have been around much, much longer and therefore Proton should be given time to catch up. A Mayban Securities analyst, for instance, said Proton is taking steps to streamline its operations, referring to the restructuring that took place recently that allows each division to offer its expertise and services to other firms and evolve into a profit-making centers.

Certainly, Proton is not going quietly. The company and the government intend to do their best to prove conventional auto economics wrong - in a time when there is a worldwide glut in automobile production. Proton ventured into Iran in July to make a series of sales presentations to Iranian institutions in a move to market its R&D and technical capabilities.

According to Proton's chief executive officer, Tengku Mahaleel Tengku Ariff, Proton today is not just about selling cars but selling its expertise, capabilities and resources combined with that of the UK-headquartered Lotus Group (of which it has an 80 percent controlling stake), also presents the company with the opportunity to sell these services.

Meanwhile, Kim Eng Research points to the initiatives Proton has taken to defend its domestic market share and grow its export markets. Firstly, it plans to cut cost by 30 percent by designing its own car, using its own Campro engines for all future new models and procuring quality components from cheaper sources. This is in addition to annual savings of over $50 million a year on payment of royalties to Mitsubishi for their engines.

The use of its own engines also reduces the effect of yen fluctuation on its earnings. Kim Eng estimates that every 1 percent appreciation in the yen translates to a 1.4 percent drop in Proton's earnings. The engine and transmission (which typically account for about 25 percent of the cost of a car) are currently imported from Japan. With the use of the Campro engines, the transmission will be the only major imported component, thus reducing its yen exposure drastically.

The establishment of Proton's Tanjong Malim plant (coined as Proton City) is also expected to cut costs and improve quality. The plant has the initial capacity to produce 100,000 units annually with the potential to churn out as many as one million cars, hopefully providing Proton the ability to reach the economy of scale it needs. This is in comparison to just 230,000 units produced by its plant in Shah Alam yearly.

The lower cost per car also fits into Proton's export strategy, which most analysts agree is crucial to its survival beyond 2005. Proton is currently losing money on its exports, which account for only about 9.2 percent of total sales. This is not surprising given its outdated models and high cost structure. With lower cost and newer models, it is Proton's intention to boost exports. The company has identified China, the Middle East and North Africa as key export markets, and is currently negotiating for joint ventures. It has entered into a joint venture with Goldstar in China and hopes to start produce 30,000 and 100,000 cars in 2004 and 2005 respectively.

In Iran, Proton's joint venture aims to sell 30,000 units per year. It has also submitted a bid to buy an assembly plant in Morocco to spearhead its thrust into the Northern African market.

While all these plans seem promising, all eyes will be on Proton when it rolls out its state of the art models in the next couple of years, and on how the market, both at home and abroad will take to them.

"We continue to believe that the survivaliability for Proton relies on two factors; (1) Continued government support and/or (2) The involvement of global majors in revitalizing its presence both in and outside the Malaysian market," says an analysis by a major investment bank. That sounds fairly ominous.

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Aug 26, 2003

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