Life After VW- Proton Survival Game

"Malaysian pride, at home and abroad"

It is officially over. After months of negotiations, the second round of talks between German based automobile company Volkswagen and the national carmaker Proton have finally collapsed. The announcement made by the Second Finance Minister was not entirely surprising as many international analysts have predicted this outcome since the start of the talks. The failure of Proton to offer a more lucrative partnership deal was cited as the primary reason for the failure of the second leg of negotiations which started June this year. Ironically the same reason was behind the fruitless talks between the two companies in 2005. The general Malaysian public would think that Proton was stupid and incapable of making good judgments while presenting their offers. That is a fair remark, given one completely ignores the realm of deal brokering. However, my hats are off to Proton for their remarkable ability to keep playing along with the German automobile firm. It was indeed an achievement for Malaysian thinkers to remain in a competitive psychoanalytical finance game with arguably the smartest race on earth. If you are puzzled as to why I am praising a firm which has failed to close a deal with its potential savior, it is a good sign- I have your undivided attention on this article.

I have always been interested in the studies of bounded rationality in economics. In laymen’s term it is about the behavioral patterns of two competing firms, how they will react strategically to maximize their benefits given that they consider the other firm’s move and at every movement there is definite rationalization of ideas. This was the “game” that Proton was beaten flat at by the established German firm. The tactical and strategic movements of Volkswagen were unpredictable, which sent mixed signals to the national carmaker’s management team. Misinterpretation of information is very costly in international business, which involves immense risks. This is as Joseph E. Stiglitz rightly pointed out- is the product of globalization. Proton miscalculated the risks on both sides and assumed that Volkswagen had written off their initial plan to set up its strategic base and production plant in Indonesia due to factors such as geographical stability. However, the charm of investing in our neighboring traditional economic rival is that the market is under-regulated for international firms excluding Malaysian businesses. This is what historians would identify as Javacentric ideology, the thought of Java as the natural leader of Nusantara and hence the notion that it should remain better than the rest of the cluster Malay islands. Indonesia will never accept Malaysia’s economic leadership in this region which the politicians believe strongly as violating Javacentric optimality position, evident in their eleventh hour hijacking of the proposed merger of PNB’s plantation businesses late last year. Simplifying the situation, Indonesia made a better offer to Volkswagen, which includes a lower tax rate- guaranteeing cost minimization for the German firm hence meeting its primary objective of global expansion. Proton clueless about the ruthlessness of our neighboring economic rival was left to face a bleak future alone, as Volkswagen ended their strategic business game by a full withdrawal. It was like a hard slam on the door for Proton as their German counterpart did not drop any analytical hint of disinterest. One painful chapter in Proton’s short history, but it has to be tightly shut as life has to go on. This reminds me of the famous quote “I can’t go on. I’ll go on,” by my personal favorite contemporary playwright, Samuel Beckett. Can our national carmaker turn over its business fortunes?

It is not surprising why there is little faith in a Proton turn over, it has been promised before but not delivered. This is practically revisiting the MAS dilemma in 2005. Efforts for turnover will be dampened as the share market has been hostile towards Proton upon receiving the news of the deal breakdown by slashing its share value by 19 percent, to its lowest price in seven years, standing at RM 4.80 per unit. It is predicted that the price will be floating around the range of RM 4.50 to RM 5.00 until the share market breaks for Christmas. The lowering share value will lessen the treasure chest which Proton needs very much at this point to expand. Why expansion when finances are unstable? The fundamental problem with Proton is the failure to reach the economies of scale. With the introduction of AFTA, Proton witnessed its monopoly power over the domestic market-the only market it is surviving in, sliced by half, to 30 percent in 2006. Today, it stands at only 25.5 percent. There is insufficient demand to supply cars at the competitive prices, with lower costs. That was why Proton wanted badly to tie up with Volkswagen, as the German firm will provide Proton with a springboard to dive into the Euro car market. Proton wanted to infiltrate the Eastern European market in particular, which it has potentials to be a competitive automobile firm. The deal collapsing is an opportunity loss for Proton, a big one. Nevertheless, Proton must expand for its strategic benefits, and its tactic for the time being is to abandon the profit and loss sheets. Financial stability is secondary now and all efforts must be directed towards expanding the firm. With liabilities for the financial year ending March 2007 standing at nearly RM 1.5 billion, can Proton continue expanding?

In my opinion, it can continue chartering its expansion path, but it has to do so within a stipulated framework. There must be a realistic time frame of expansion, say for instance three years. Defining the timeframe has been the main problem for the Proton management. There is an ongoing argument between the management and the major shareholders on the timeframe of the business turnover plan. Official losses reported for this year is a staggering RM 550 million, and if this is taken as the average, Proton has less than five years to survive, on basic accounting principles. It is losing RM 1.5 million on a daily basis and given other things remain constant, five years is the expected date of demise for Proton. Ironically, despite being in the red for the last three financial years, Proton remains an asset rich firm. It has its current and fixed assets portfolios in good shape. This is the reason it is able to expand. The monopoly power for twenty years was fully utilized in accruing assets for rainy days. However, the amount of assets could not be stretched beyond another five years, which is discounting inflation. All in all, Proton has a good ten years of life. Its priority now is tackling the South East Asian market and the Middle East. The launch of Pesona which was well received in the domestic market, will improve the firm’s financial standing. Furthermore, the reported production of “halal” cars- extreme labeling I guess, will be appealing to the Iranians and other Middle Eastern countries. Proton is taking it one step at a time now, surviving in the wilderness on its own. Why on its own?

After Khazanah consolidated the position as the major shareholder of Proton from Petronas, it has been trying to assume more control over the national car maker. This led to an internal rift which witnessed the departure of Proton’s long time leader, former CEO, Tengku Mahaleel. An autonomous Proton is a better Proton, wouldn’t you agree? As we speak, the current CEO is having a tough time dealing with the turnover plan as it has to be authorized by Khazanah. The assurance from the Second Finance Minister that the management team will be given “time” to sort its own house out has an underlying political tone. The government will not bail Proton out anymore. The EPF was the last contributor to Proton funds by acquiring 830 000 shares of Proton in January 2007, and I can assure you, the national carmaker will not receive further assistance from the government. This is primarily because Khazanah is tied down managing all the economic regions launched by the government at various stages in 2007. Khazanah will not make further capital available for Proton, as it believes the economic regions have better potentials of reaping higher returns for the investment arm. It leaves Proton to fend for itself. Is Proton that unimportant in Malaysian economy? Well, the government views that since Proton does not bring in tax revenues for the country, it should not be given priority. Well, this is untrue. Proton provides 10300 job opportunities to the economy, with a further 5000 dealers nationwide. If Proton is allowed to fall flat on its feet, how is the government going to ensure that the mouths of these employees and their dependents are well fed? Proton has come to the point that it has to expand or face the possibilities of shut down within the next decade. If MAS sold their headquarters, what can Proton sell? Nothing, because they need all they have now to efficiently produce. Proton needs to find the market. And they have to find it fast.

In a nutshell, Proton’s future is not as bleak as many believe. There is still a ray of hope for Proton to successfully turn around its business and prove the analysts wrong. Product differentiation and management autonomy are two key issues which have to be addressed before Proton goes on the expansion path. The government must not abandon Proton at this juncture as it is the point where Proton could simply make or break. However, the government itself is facing financial difficulties due increasing fuel subsidies in the world where price per barrel is nearing USD 100. Moreover, the commitment towards building the economic regions further aggravates the government’s financial position. Nonetheless, one could never dismiss the notion that there is an equivocal agenda by certain political powers to drown Proton now, and drive its share prices down, setting the scene for a perfect takeover of the asset rich firm. Is there an attempt to politically take over Proton? Think and you might just find the missing link.