Abstract
The financial crisis of 2008–2009 was devastating for most of the car manufacturers around the world. Many of them lost their competency and market position in the global car market with unprecedentedly low sales volumes and negative financial performances. However, Tofas, the biggest car manufacturer of Turkey, turned the financial crisis into an opportunity through its international alliances, credit subsidiary and research and development (R&D), while increasing its profitability and market positioning during the midst of the financial crisis.
Discussion Questions
How did Tofas Fiat partnership change strategically throughout the years?
What is the importance of research and development (R&D) in Tofas’s strategy?
Explain the strategic role of ToP contracts during the 2008-2009 crisis? Why do you think the purchaser accepted these contracts?
Do you think the ToP Contracts are sustainable? Why or why not?
What is the importance of the Tofas and Fiat partnership? Please consider the effects of this partnership by considering joint ventures and foreign entry for both sides.
Having adapted to changing conditions rapidly, we were able to respond to our customers’ expectations agilely, with numerous models and various payment options. As a matter of fact, we transformed the crisis into an opportunity. 1
In 2008, one of the vital growth engines of the global economy, the automobile industry, was shrinking, and each day the market was overwhelmed by the news of production volume contractions, missing sales revenue targets and the net losses of the global automobile giants. The global automobile industry was suffering from the contagious impacts of the so-called ‘subprime mortgage crisis’ started in the United States (US), and caused the housing prices to decline, creditors to fail for their debts and deteriorated the economic environment throughout the world as a result. The crisis forced leading car manufacturers to take immediate actions to sustain their businesses. Meanwhile, a contract automobile manufacturer in Turkey, Tofas, succeeded in turning the crisis into an opportunity for growth through an effective crisis management by efficient governance of strategic tools, such as research and development (R&D), take-or-pay (ToP) contracts and owning a credit subsidiary. This growth strategy was established mainly on two pillars: international market expansion through the support of its partnership and owning an exclusive consumer credit channel, which eased the car ownership for the domestic market. These two pillars are supported by consistent investment in R&D that cultivated high-quality manufacturing for the company. In addition to that, the international market growth was also reinforced by the profitability provided through the long-term ToP contracts.
The structure of the case is organized as follows. The first section indicates the company background. The second section focuses on the export-oriented business strategy. The third section highlights the domestic market strategy.
Company Background
It was the year 1968 when Tofas 2 was established by its venerable founder, Vehbi Koc of Koc Holding, to manufacture national passenger cars (PC) with its Italian partner, Fiat Auto SpA, 3 in Turkey. Koc Holding, which was the largest industrial organization, with investments in other car manufacturers in Turkey, and Fiat, the largest automotive enterprise of Italy, with operations throughout the world, controlled 75 per cent of Tofas. Both of them had equal shares of 37.856 per cent as a joint venture, while the remaining 25 per cent were held by the public.
Along with manufacturers in Brazil and Italy, Tofas was one of the three major manufacturers and one of the R&D centres of Fiat in the world. Fiat partnership made Tofas the main contract manufacturer and the distributor of its vehicles in Turkey. Tofas produced approximately 11 per cent of total sales of Fiat in 2014.
The business strategies and the strategic decisions for the future of the company were decided by Fiat and Tofas together. In terms of business strategy, the story of Tofas had three distinct stages: from establishment to 2000, 2000–2005 and the period after 2005.
The Initial Period: A Mere Assembler of Fiat
Due to Fiat’s sales strategy, before the year 2000, the main export markets of Tofas-manufactured vehicles were in Asia. Most of the cars exported by Tofas were made in Italy, and distributed internationally by that time. Although the company manufactured some PC models for the domestic market under its own name, Tofas was mainly the assembler of car parts, such as doors, mirrors and engines.
We were pursuing exports more than our competitor Renault was, but our foreign partner Fiat chose Russia, India and China as Tofas’s export markets, and all of them were hit hard by the global financial crisis. 4
The Co-chairman Gokce Bayindir in 2000 was indicating the 1997–1998 Asian Crisis, which started as a currency crisis 5 in the summer of 1997 and caused many economies in Asia to contract enormously. As Tofas exports were mainly to Asian markets, its profitability and competency had been affected negatively. On the other hand, the Asian crisis had limited effects on the European countries due to the lack of direct trade between them. It is for this reason that the Asian Crisis was a turning point for strategic positioning of Tofas. In 2000, in order to counterbalance the impact of the Asian Crisis, the company needed to shift its international sales destinations and manufacturing strategy.
2000–2005: Transitional Period for Change in Business Strategy
Fiat and Tofas mutually agreed on shifting Tofas’s export and manufacturing position. To support this new direction, although Tofas had an R&D centre established in 1994, a new R&D centre project was started and more investment on R&D was approved to enhance production capability. As a result of its new business strategy, the company started to focus more on the European Union (EU) market to benefit from its location advantage, such as decreasing the logistics costs and benefiting from the high income per capita of the EU countries. The main export markets for the transitional period became Italy, France, Spain and Russia, which together represented 80 per cent of the total exports of the company. As a subcontractor of Fiat, through the help of increasing investments on the R&D, Tofas, for the first time in its history, started manufacturing the light commercial vehicle (LCV) model, Doblo. This model would later become a legendary export vehicle in both domestic and international markets sold under the Fiat brand with patent rights belonging to Fiat. Later, in 2002, Tofas also started manufacturing a new PC model for Fiat, Albea. The patent right of this model also belonged to Fiat. In the same year, Doblo LCV model received ‘export champion’ award in its segment, and Tofas became the sector leader in Turkey based on its performance in exports and manufacturing. The acceleration in export levels enabled the company to produce two million vehicles by 2003, which made Tofas an experienced vehicle manufacturer. As a result of its strategic change, Tofas was becoming a mass contract car manufacturer of Fiat rather than a distributor and assembler of its imported vehicles.
2005–2009: R&D-oriented Production and Strengthening Domestic Sales
The year 2005 was a milestone for Tofas as the company was selected to produce a new LCV model, mini cargo vehicle (MCV). The related model would be produced for both Fiat and Peugeot and Citroen (PSA) until 2015. The manufacturing contract with PSA was launched through an agreement between Fiat and PSA. The agreement was important not just because it provided another world-scale producer, but because it was also the first time for Tofas to have the patent rights of an LCV model through its own R&D process. Moreover, a profit protector, ToP contracts were used for the sale of this new LCV. Adding a new global automobile brand to its manufacturing portfolio increased the international recognition of the company and increased the confidence in Tofas as a manufacturer. The production quality of the automobiles through the company’s own R&D process grabbed the attention of international bodies. The ‘New Doblo’ LCV model received one of the most prestigious awards at the Amsterdam Commercial Vehicle Fair, the LCV of the year award, 6 which was also an indication for future awards to come (Exhibit 1).
Linea Model
Following this success, a new manufacturing contract was signed with Fiat to manufacture a new PC model, Linea, through Tofas’s own R&D centre with patent rights belonging to Tofas. In 2005, the company also made an agreement with Fiat to become the distributor of its luxury brands—Ferrari and Maserati—in Turkey.
To support its new position as a major producer in 2006, the company established a fully owned subsidiary, Koc Fiat Credit (KFC), to provide credit to its domestic customers for retail sales. Tofas was the only domestic automobile manufacturer having its own credit supplier, which successfully supported domestic sales in the 2008–2009 financial crisis. In 2008, the company celebrated its fortieth anniversary with an increased production capacity of 400,000 units annually, and a record level of exports reached at 209,456 vehicles. In addition, Linea received the ‘Autobest’ prize. The company was also honoured by the World Class Manufacturing (WCM) 7 auditors with the silver quality production award, making it the only silver level WCM manufacturer among Fiat’s 170 facilities around the globe in 2009. In the meantime, it also produced its three millionth vehicle in the midst of the financial crisis.
It was not known whether the founder, Vehbi Koc, had expected Tofas to become one of the most important Turkish automobile manufacturers. However, by 2009, the company accounted for approximately 27 per cent of total automobile exports and 29 per cent 8 of total automobile production with 7,014 employees, while sales revenue and net income reached TL 5,098 billion or US$ 2,883 billion and TL 360 million or US$ 200 million, 9 respectively.
Export-oriented Business Strategy
Despite shrinking demand and the deep economic recession that began in the second half of 2008, especially, in Southern European Countries, its key export markets, Tofas managed to boost export income for 2008 by 43.3% year-on-year. 10
The adoption of an export-oriented manufacturing process sustained the company through 2008, a year in which the catastrophic results of the financial crisis resulted in the overall contraction of the Turkish automobile market by 17 per cent. Tofas increased exports by 18.7 per cent in 2007, and 48.9 per cent in 2008, through its ToP contracts with Fiat and PSA. The number of exports in units increased from 146,194 in 2007 to 168,359 in 2009 during the crisis. Although Tofas had exports to more than 80 countries from East Asia to South America, a large proportion, 28 per cent, were to Fiat in Italy in 2007 (Exhibit 2). However, the company increased its exports to France through its agreement with PSA, which allowed it to diversify its portfolio before the crisis, and increased the share of France in its export portfolio from 8.6 per cent in 2007 to 17.6 per cent in 2008. As a result of this export diversification, in 2008, the company was able to increase its total exports to 69 per cent of total sales, up from 57 per cent in 2007 (Exhibit 3).
The export-oriented business strategy was one of the key factors that helped the company manage the crisis period of 2008–2009 by increasing its market share for the sales. Additionally, ToP contracts-based manufacturing during the crisis also helped the company to remain profitable and competitive for that time period.
Fiat Partnership for Exports
As Koc Group, we have a very harmonious partnership and friendship with Fiat which dates back to more than 40 years and which enables us to reach all targeted results in every field. 11
The long-term partnership strategy with Fiat enabled the company to benefit from Fiat’s distribution network throughout the world. This allowed Tofas present its LCV and PC models at international markets at no extra costs. Tofas was also able to use Fiat’s strategic partnerships with other automobile brands. For example, Tofas’s sales to the PSA group in 2007 were facilitated through Fiat’s business network.
The production contract with Fiat involved substantial manufacturing levels over long-time periods. For instance, Tofas was to produce one million LCVs before 2015 according to its agreement with Fiat. Especially, long-term contracts enabled Tofas to exploit its production capacity with an average of 73.25 per cent 12 of its annual full capacity, 400,000 units, between 2006 and 2009. Additionally, the Fiat partnership allowed the company to have long-term exports through ToP contracts, which were vital for the company’s profitability during the crisis period.
Individual and Total Market Share of Tofas-Fiat Cars in Turkey
Take-or-Pay (ToP) Contracts
Take-or-Pay contracts were the contracts that allowed Tofas to receive the ‘cost plus profit’ payment of the importer depending on the number of automobiles that the importer required annually. Once the order was received and ToP agreement completed, Tofas received all the cost plus profit payment and the counterparty had no right to cease or decrease the number of production. This ensured that the company received the cost plus profit amount for the annually contracted number regardless of the importer’s actual order amount. Thus, the company was able to protect its profitability under unfavourable economic conditions, as indicated by the former CEO:
We have an agreement with Fiat, Peugeot and Citroen for our exports through take or pay guaranteed contract. Even if the counter party does not have any orders, we get our fixed costs plus the agreed profit amount written in our contract. That’s why current financial crisis will have the minimum effect possible on our financial results.
13
Tofas achieved successful bottom line results for 2008 and 2009 as a result of these agreements. The company’s operating margin, an important indicator of operating profitability, remained at high levels during the midst of the crisis in 2008 and 2009, with 5.3 per cent and 5.5 per cent, although the number of sales decreased. Additionally, these results were also very strong when compared with the world average of the automotive industry as highlighted by former CEO Ali Pandir in a 2008 speech:
Our operational profitability is at record levels when compared with the world average of approximately 3%.
14
In terms of profitability, ToP helped Tofas improve on the performance of some of its globally known Asian peers during 2008–2009 financial crisis, such as Honda Motors, Hyundai and Mazda. Although each of these outperformed Tofas in terms of total sales, the company’s profitability and operating and profit margins were superior to each of its Asian competitors during the crisis. In fact, after the crisis, only Hyundai was in a better position than Tofas in terms of profitability margins (Exhibit 4).
Company Profitability-International Peer Comparison
Details of ToP Contracts with Fiat and PSA Groups
The MCV, an LCV production project, was initiated on 31 March 2005 with Fiat and PSA, and the first production started in 2007 covering an annual production level of 165,000 units per year until the end of 2015. In other words, Tofas would be secure in terms of cost plus profit receivables until this time. Additionally, in accordance with this agreement, 90 per cent of annual production would be covered by ToP contracts. Fiat would receive one third of this production, whereas PSA would take two thirds. 15 The name of the LCV for Fiat was ‘Fiorino’, whereas it was ‘Nemo’ for Citroen and ‘Bipper’ for Peugeot. This agreement also made an important contribution to company’s record export levels in spite of the financial crisis in 2008.
As a result, the ToP contracts had strategic importance for Tofas’s profitability during difficult times. However, it was important to note that Tofas was able to convince its customers, Fiat and PSA, for the ToP contracts due to its quality in R&D which reinforced improved manufacturing process.
Focus on Research and Development
Making R&D and manufacturing of important models like Fiat Fiorino, Linea and Doblo, Tofas’s place in the Fiat’s world as is very strong without any dispute. Tofas’s success globally is a true example of discipline, quality and success in this period when Fiat and Chrysler factories are in common action in terms of production in world class. 16
In 2009, The Chief Manufacturing Officer (CMO) of Fiat, Stefan Ketter, emphasized the importance of Tofas’s quality manufacturing for Fiat, which increased the strategic position of Tofas against other Fiat contract producers in Brazil and Italy. Moreover, as indicated by its former CEO Ali Pandir:
Through its investments on R&D, today, Tofas is able to produce a new model in every two years. We are one of the largest producers of Fiat due to our R&D centre. Our R&D expenses reached 4% of total sales, nearly $100 million, in 2007 which is well above the world average.
17
Tofas also increased its model development capability, which enabled a rapid response to the changing demands of customers, while protecting its market share with high-quality innovative automobiles in a challenging market. The emphasis on R&D enabled high-quality production, which was awarded the ‘Silver Level World Class Manufacturing (WCM) Award’, the second best quality production level for carmakers around the world, and Tofas became the most successful producer among Fiat subcontractors around the world in 2009. All these successes supported the company’s aim of becoming one of Fiat’s strategic innovation centres for long-term production, as indicated by former CEO Ali Pandir:
We have taken some important steps to satisfy the requirements of being one of the three R&D centres for Fiat as recently indicated by Chairman Mustafa Koc. Especially, the models that we have developed so far are very successful in the market, for instance, Doblo became a legend and we would like to increase our product range by winning new production licences for new Fiat models.
18
The R&D contributions to the company were also seen during the 2008–2009 crisis. Especially, between 2006 and 2009 Tofas’s spending on R&D reached approximately US$ 400 million, which put the company among the top 1,000 companies worldwide in terms of R&D investments. The R&D-based manufacturing contributed to the Turkish economy, especially through LCV and PC production as emphasized by Chairman Mustafa Koc:
In 2009 more than 84,000 Fiat cars were purchased by consumers. This also made a significant contribution to employment and the economy, since 90% of these cars were domestic models.
19
The success of R&D-based manufacturing was also supported by the Turkish government as emphasized by the Minister of Science Nihat Ergun in 2012:
‘All the support is behind native car and the supported R&D projects in Turkey are within the scope of strategic investments…’ Ergun continued his speech, saying that strategic investment is an issue that is mostly about Turkey’s fight against the current deficit and the investment of the projects that is supported by R&D is also in the scope of strategic investments
20
In line with the government’s expectations, Tofas’s R&D-based manufacturing was also important for the Turkish economy. In fact, in 2008, the government authorized new legislation, making R&D expenditures 100 per cent tax deductible, which reinforced the increase for shareholder value and profitability, especially during the financial crisis. In addition to that, the Turkish government also supported the manufacturing process of electric engine automobiles which supported the production of the electric engine for the Linea model.
The R&D orientation contributed to indispensable strategic positioning of Tofas for Fiat as a contract manufacturer, as well as for the Turkish economy as a domestic producer. The R&D investments brought returns concurrently for export and domestic markets during the crisis, while enabling Tofas to successfully manage crisis impacts and maintain competitiveness. In the following years after the financial crisis, Tofas sustained R&D investments and became the most prominent R&D centre of Fiat. The silver quality WCM was promoted to gold level and the company’s international customer portfolio had consisted of Fiat, Peugeot, Citroen, Opel, Vauxhaull and Chrysler by the end of 2015.
Domestic Market Strategy
Almost 90% of our domestic sales consisted of locally produced models in 2009. This is an important success that none of our competitors is even close to achieving. 21
As indicated by former CEO Ali Pandir, Tofas made most of its sales in domestic market through its own production by 2009. In 2009, the company sold 93,517 units, an increase of 39 per cent compared to the previous year, and as a result of the success of the eight previous years, the company became the market leader with 15.3 per cent of the domestic market share (Exhibit 5). 22 It was seen from the results that Tofas was becoming a market leader during the crisis. In particular, the two most important factors in this success in domestic market strategy were its own consumer credit channel, KFC, established in 2006, and the strategically located dealer network. On the other hand, when compared with domestic peer performances, it was obvious that Tofas’s key performance ratios, return on equity (ROE) and earnings per share (EPS), were superior. For instance, the major listed competitor of Tofas was Ford Otosan, a Turkish American joint venture, which had an ROE of 0.25 in 2008, that decreased to 0.20 in 2009. In contrast, Tofas’s ROE increased from 0.16 to 0.25 in the same period. Similar results were also observed for EPS performances: Ford Otosan’s 2008 EPS was US$ 0.69 which decreased to US$ 0.53, whereas Tofas’s EPS increased from US$ 0.08 in 2008 to US$ 0.4 in 2009. The related per share increase was unprecedented for Turkish automotive market during the crisis (Exhibit 6). Additionally, the strength of Tofas’s financials for crisis period could also be detected on its financial statements (Exhibit 7).
Company Financials
These performance indicators highlighted that the incremental levels of domestic sales through credit subsidiary also supported the profitability ratios of Tofas. In other words, the company outperformed its major competitor in the domestic market during the crisis of 2008–2009.
Percentage of Credit Sales in Domestic Sales
Consumer Financing Subsidiary
Especially, for the last two years KFC gave auto financing credit to more than 30 thousand customers and has made car ownership easier. Having KFC is vital for Tofas to sustain its market share. 23
Former CEO Ali Pandir indicated that KFC significantly contributed to domestic sales of Tofas counteracting the effects of the crisis on demand. The boutique crediting system which allowed flexible payment options to the customers not only prorated a fall in sales, but actually increased them. For instance, the credit sales percentage in domestic sales was 3 per cent in 2006 which increased to 23 per cent in 2008 and 17 per cent in 2009 (Exhibit 8). The cumulative annual growth rate of credit sales in domestic sales during the 2006–2009 period was 86 per cent—an indicator that Tofas was maintaining domestic market sales and increasing its market share through consumer crediting channel during the crisis. As also indicated by KFC General Manager Pinar Kitapci in 2010:
KFC approximately covered the 50% of total retail sales of Tofas in 2009. KFC played a distinct role in Tofas becoming the market leader in 2009.
24
Percentage of Domestic Sales and Exports in Total Sales
The variety of customer credit options enabled Tofas to dominate the domestic car market in 2009. Especially, the credit campaigns attracted the customers through flexible credit conditions, such as minimum possible down payment combined with long-term payback options of up to five years. These credit options were offered through Tofas’s strategically located dealer networks throughout the country. In addition to that, customers could explore credit options over the KFC website before visiting Tofas showrooms.
Dealer Network Strategy
Tofas had significant customer appreciation with more than forty years of experience in implementing strong sales network in the domestic market. The company practised push system sales principle with its dealers – and since none of the dealers were owned by Tofas, it allowed Tofas to pass risks on to the dealers during crisis. In 2008, Tofas had one of the largest dealer networks in Turkey facilitated to reach customers and allowed to support sales network through after-sales services with 74 major dealers, 111 sales points and 133 workshops, in which the dealers of the company had right to sell exclusively Fiat automobiles.
What Lies Ahead
Tofas had significant growth through Fiat partnership during the financial crisis which was also reinforced with the efficient governance of R&D, ToP contracts and its credit subsidiary for domestic market sales. However, the engine of growth had the potential to move the company into international markets. Over the years, the company shifted its international focus from Asia to Europe. The contagious effects of the financial crisis in the European market after 2010 led Tofas to consider extending its international reach to other markets. The US market was one of the primary focuses of the company for its future LCV sales, and the exports to the US totalled 11.7 per cent of its total exports in 2015. 25 The US was the world’s largest car market by 2015 with an annual expected compounded growth rate for LCV sales of 5.9 per cent up to 2020. On the other hand, the global auto sales in units expected to reach 29.1 million by 2020 (Exhibit 9), 26 which would be an opportunity for Tofas to increase LCV sales. By the end of 2014, the company entered the US market through adding Ram into its customer portfolio—Ram being a prominent light-and middleweight auto brand in the US—a subsidiary of Fiat and Chrysler. The Doblo model production line was renewed for its sales to Ram, and the new model was given the name ‘Ram ProMaster City’ in the US. The Ram ProMaster City model was also able to satisfy the green consumption demand of the US auto market, and received the ‘2016 Commercial Green Car of the Year’ award at San Antonio Auto & Truck Show in Texas. This model was hailed as important for enabling the company to penetrate the US market for the following period in which the sales were expected to be 22,500 units for 2015 and 175,000 units in total by 2021. 27 In addition to that, the Fiat and Chrysler 28 merger in 2014 increased their dominance in the US market, and this partnership became the fourth greatest auto manufacturer in the US by 2015 while dominating 13.2 per cent of the total market share (Exhibit 10). 29 The recent developments of 2015 indicated that Tofas had great opportunity to benefit from the Fiat and Chrysler merger and expand into the world’s largest auto market while becoming the manufacturer of two giant auto brands.
