Pestel Analysis: Economic Factors

By taking into consideration the PESTEL analysis, the Economic Factors

play a crucial role in the assessment of external macro-variables impacting
industries. These factors need to be addressed as they indirectly affect
businesses performance.
The automotive sector, and more specifically the FCA Group, has been
chosen in order to provide a concrete example on how to implement such
analysis. The following critical items have been identified in order to
assess the degree of impact each one has on businesses success.

1. Disposable income

The income effect may have positive or negative consequences as it relates

to how a consumer spends money based on an increase or decrease in
his/her income. Therefore, an increase in income results in demanding
more services/goods and vice versa a decrease results in a lower demand.
Obviously, this depends on the size and the type of business, in other
words a small business specializing in goods or services that are bought
when income has decreased may register high profits (for example
discount stores or wholesalers). However, this does not influence the
automotive sector. The disposable income of potential car buyers has
decreased after the past decades economic crisis and forecasts confirm
this trend. The middle class is FCA groups main target market and it is
specifically them who have been affected by the decrease in disposable
income. Therefore, this item significantly affects the business.
(fcagroup.com)

2. Foreign exchange rates

The exchange rates play an important role for businesses exporting goods
and importing raw materials. In other words:
A depreciation (devaluation) makes exports cheaper and exporting
businesses benefit from this;
Although businesses importing raw materials face higher cost of
imports;
 An appreciation makes exports more expensive and decreases
competitiveness of exporting businesses;
Although, raw materials are cheaper as a consequence of
appreciation.

Foreign exchange rate is significant for the profitability of the industry,

for FCA group exports are a great part of its total sales so it is likely to be
affected by the exchange rate volatility.

The following graph shows that the US dollar has a tendency to be

somewhat depreciated against most of the other major countries
currencies, meaning that exporting from USA has been profitable for car
manufacturers, at least until 20081.

1 Graph source: Avsar, V., & Turkcan, K. (2013). Exchange Rate Volatility and US Auto-Industry
Exports: A Panel Cointegration Approach. International Journal of Economics and Financial
Issues, 3(4), 773.
 3. Interest rates

Interest rates are significant and dictate whether a business should expand
or withdraw. When interest rates increase, banks charge more for business
loans, that is companies need to use their earnings to pay loans while
decreasing their profits. Of course, this has consequences on the growth of
the company. In fact, businesses may earn more from new ventures to pay
for rising interests. As for customers, they will have to pay more for car
loans and this will decrease their buying power.

The trend of interest rates for vehicle loans and their demand are different
in each country, in Mexico for instance 68% of the new cars sold were
purchased using some form of financing in 20152. In USA, the growing
demand for new vehicle loans was driven on by a decrease in interest rates.
Bank rates dropped from 5.17% to 3.76% between 2010 and 2014. This
had benefited FCA because USA represents a significant share of its sales.

4. Trade flows and patterns

Freer trade enables the acquisition of greater market shares and new
opportunities for Mergers and Acquisitions (M&A), this allows companies

2 http://www.jato.com/wp-content/uploads/2016/06/JATO-Global-Car-Sales-2016-Q1.pdf
to benefit from economies of scale, economies of scope, gain profitability
and defeat rivalry.
The automotive industry is characterized by over-capacity, resulting in a
situation where weak firms often exit the economy, not only for
bankruptcy, but for acquisition purposes. When mergers take place
between companies located in different countries, national economies
become more integrated.3

The board of directors of FIAT S.p.A have approved the merger plan with
Chrysler, renaming the company FCA; the company has significantly
benefited from synergies and has promoted innovation4. Innovation has
derived from the interaction with customers starting from the product
concept phase up to the participation in virtual networks and also
contributions from suppliers, public and private institution, research
centres and universities.5

5. Unemployment trends

Unemployment in an economy increases the supply of labour creating a

negative pressure on wages, as labour is less scarce and more people are
willing to get a job at a lower wage. This will have a positive effect on
businesses as their variable costs decrease.

The majority of FCA's employees are located in "NAFTA" and "EMEA":

in "NAFTA" the unemployment estimated levels show a slight decrease,
as for "EMEA" there's an opposite trend, in general the balance seems to
not be significantly affecting the group as a whole.

Labour costs vary significantly by country. A large portion of the

automotive industry expenses come of labour costs. As a result, it is very
important for companies to be able to control wages.

3 Serdar Dinc, I., & Erel, I. (2013). Economic nationalism in mergers and acquisitions. The Journal of
Finance, 68(6), 2471.
4 https://www.fcagroup.com/en-

US/media_center/press_release/2014/june/Pages/Fiat_S_p_A_approves_merger_plan_for_the_f
ormation_of_Fiat_Chrysler_Automobiles.aspx
5 https://www.fcagroup.com/en-US/innovation/Pages/open_innovation.aspx
 6. Cost of raw materials

Increasing cost of raw materials translates into increasing prices for

customers. There are four major cost drivers in the production and sale of
an automobile:

- raw materials (47%)

- labour

- advertising

- R&D (research and development)

Competition makes it difficult for companies to pass on increases in raw

material prices to the customer. Due to high operating leverage, a slight
increase in input prices negatively affects margins by a significant
percentage6.

7. Inflation Rate

Inflation rate may affect the purchasing power of customers if the increase
of prices is higher than the inflation rate. This is because inflation rate has
been stable and the trend has matched the price increase for the sector in
the past years, maintaining the real price stable over time and the same is
expected for the coming years inflation will not be a threat for the
sector and for the FCA group. During periods of increasing inflation, car
manufacturers have defended themselves by extending bill payment plans
from 24 months to 36 months7.

8. Foreign economic trends

This item impacts significantly businesses as it offers opportunities for

businesses, if the trend is a market growth as it has been reported by
forecasts. In fact, companies can invest in growing market in order to gain
market share and sales. China represents the best opportunity for the sector
because of its highest market growth.
Following are the most important geographical markets for the automotive
sector will be analysed8:

1) China: the market soared (+10% in 2014 and +8% in 2015) but it is
perhaps becoming too profitable, selling price will have to fall for
competition purposes.

2) United States: the market has boosted profitability and marked a 20%
fall in the workforce. There has been a growth of 4% in 2014 and 3% in
2015 a trend which has continued in the following years (17 million units
were sold).

6http://marketrealist.com/2015/02/intense-competition-leads-low-profit-margins-automakers/
7From: http://www.fcagroup.com
8
From: http://www.eulerhermes.com/mediacenter/Lists/mediacenter-documents/Economic-
Outlook-The-global-Automotive-market-Sept14.pdf
 3) Japan: despite the flexible monetary policy and protectionism 94% of
Japanese cars were sold between 2014 and 2015, VAT on sales was about
5% in 2014 and 2% in 2015 and it has slightly increased in the following
years.

4) Europe: The automotive market recovered by +5% in 2014 and 2015,

but has not recovered its pre-crisis level yet. Cannibalism among European
manufactures is increasing, reducing margins due to overcapacity.

5) France: the market has been recovering and sales have grown by 3% in
2015. However, production has been moving offshore and is positioned
particularly in entry-level products.

6) Italy: The market is registering unprofitable rates and production

capacity continues to be underutilised showing no improvement.

7) Germany: Manufacturers are trying to absorb the increase in operating

costs and investments through efficiency gains and internal synergies. The
market has grown by 3% in 2014 and 2015.

8) Spain: automotive production has grown by 10% and contributes to the

countrys trade surplus (EUR 12.5 billion in 2013) after wage adjustments
and increased working hours.

9) United Kingdom: the pre-crisis level of registrations, at 2.4 million

units, has been regained, and the market has grown by 10%.

10) Belgium: The market should remain stable while production faces a
chronic crisis (halved by the crisis) and there is no prospect for growth.

9. Taxation level and taxes on products/services

Taxation levels and taxes on specific products/services are likely to affect

the performance of the industry and the purchasing tendency of potential
customers to buy a new car. In fact, if the general taxation level is high
businesses in the industry will suffer a decrease in profitability because of
higher purchasing costs. As for the customers, higher taxation on products
(such as fuel) will have a negative impact on sales, because they are likely
to switch to substitute products (for ex. Public transportation, car sharing,
etc.). Taxation levels change according to geographic areas and countries,
the majority of the FCA group's plants are located in " NAFTA" and in
"EMEA"; this could lead to economic disadvantages in the instance that
taxation levels in these areas increase. Tax burden is still growing. Cost of
fuel is at its highest in Europe, costs for insurance, tolls and VAT are
rising. Taxation policies, especially in Europe, confirmed this trend, for
instance, fuel is likely to increase in the future as it has done in the past
years.

10. Credit Availability9

Easy access to finance, availability of credit and cost of service foster

financial development. Credit finances, production, consumption and
capital formation improve economic activity. The availability of credit
signals growth of the banking and financial sector.

Domestic credit to the private sector refers to financial resources provided

to households and businesses by financial corporations in the form of
loans, purchases of non-equity securities, trade credits and other accounts
receivable. Moreover, in some countries, credit to the private sector may
sometimes include credit to state-owned or partially state-owned
enterprises.

Regarding the relative size of total domestic credit and credit to the private
sector as percentages of GDP in low- and middle-income countries in the
World Bank's six regions, it can be observed that East Asia and the Pacific
region has provided the most domestic credit to the economy and private
sector, at 141% and 122%, respectively, of its GDP. Therefore, this item
significantly affects the FCA group, as business benefits in that area
because the population has easy access to credit to purchase new cars.

11. Stage of business Cycle

Business cycles are characterized by alternating periods of prosperity and
depression in the economic activities of a country. These fluctuations are

9 https://blogs.worldbank.org/opendata/data-show-rise-domestic-credit-developing-countries
called phases of business cycles. The intermediary phases are:
expansion, peak, trough and recovery are.

The upward and downward fluctuations show variations in different

economic activities in terms of production, investment, employment,
credits, prices, and wages.

The different phases of business cycles are shown in Figure 1:

As shown in Figure 2, the steady growth line indicates prosperity as the

economy lacks alternations between periods.

The line of cycle that moves above the steady growth line represents the
expansion phase of a business cycle. In the expansion phase, there is an
increase of various economic factors, such as production, employment,
output, wages, profits, demand and supply of products, and sales.

In addition, in the expansion phase, the prices of raw materials and output
increases simultaneously. In this phase, debtors are generally in good
financial condition to repay their debts; therefore, creditors lend money at
higher interest rates. This leads to an increase in the flow of money.

In expansion phase, due to increase in investment opportunities,

organizations or individuals use their funds for various investment
purposes. Therefore, in such a case, the cash inflow and outflow of
businesses balance out. This expansion significantly affects the
automotive sector in general and it will continue until economic conditions
are favourable.

As mentioned above, many geographical automotive markets are growing,

this is especially true for China where FCA group has great opportunities
to invest and conquer new market share.

CONCLUSION

Items 1 2 3 4 5
Disposable income X

Foreign exchange X
rates

Interest rates X
Trade flows and X
patterns

Unemployment trends X
Cost of raw materials X
Inflation Rate X
Foreign Economic X
Trends
Taxation level and X
taxes on
products/services
Credit Availability X
Stage of business X
Cycle

Tot. 47/55

Overall, having analysed the automotive sector and assigned the scores to
each item, it may be stated that the automotive industry constitutes one of
the most important market sectors, is one of the largest sectors in terms of
revenue and is considered a bellwether of both consumer demand and the
health of the overall economy. Businesses to be successful need to be
aware of the items identified pertaining the economic factors. The items
which significantly affect the automotive industry and more specifically
the FCA group are: disposable income, interest rates Trade flows and
patterns, Inflation Rate, Foreign Economic Trends and credit availability.