German automobile manufacturers had been as soon as the envy of the world, however in the present day they’re a burden on the weakening financial system

On August 7, 2024, new cars of various brands will be parked for export in the parking lot of a car terminal in the port of Duisburg.

Ina Fassbender | Afp | Getty Images

The German car industry was once known worldwide for its high-quality, innovative cars with combustion engines. Owning a German car was a luxury and a status symbol. And the car manufacturers flourished and boosted the country's economy.

But the picture has now become bleaker.

The latest example is the developments at Volkswagen. The group announced at the beginning of the week that it could no longer rule out factory closures in its home country of Germany and that it was forced to terminate the dismissal protection agreement that had been in force in Germany since 1994.

“This is an unusual situation for German automakers, who have been the undisputed technological leaders in the industry for almost 140 years and have had little to worry about sales or competition,” Dr. Andreas Ries, global head of automotive at KPMG, told CNBC in translated comments.

The industry is currently experiencing its biggest upheaval to date, he added.

What about the German car manufacturers?

The mood in the automotive industry has been unsettled in recent years, as historical data from the Ifo Institute show. In August, the mood fell again to minus 24.7 points, as data published on Wednesday show. Business expectations for the next six months are “extremely pessimistic,” the Ifo Institute said.

Volkswagen is not alone with its problems.

In recent earnings releases, Mercedes' auto division cut its annual profit margin forecast, while BMW's automotive division said its second-quarter profit margin was lower than expected. Porsche lowered its forecast for 2024, but cited a shortage of specialty aluminum alloys.

Problems in the automotive sector can also have spillover effects In the German economy as a whole, which hovered around recession this year and last year – and found itself in it. In the second quarter of 2024, German gross domestic product fell by 0.1% compared to the previous quarter.

“The statement 'If the German car industry coughs, Germany has the flu' … describes the current situation well,” said Ries of KPMG.

The automotive industry includes not only the big companies, but also thousands of medium, small and micro companies across the country, he explained, describing it as one of the most important industries in the country.

“We are facing a variety of challenges”

According to experts and industry associations, various factors have led to the current situation and are putting a strain on the market.

“We are facing numerous challenges,” a spokesman for the German Association of the Automotive Industry (VDA) told CNBC. These still include the consequences of the Covid 19 pandemic as well as “geopolitical tensions and high bureaucratic requirements at national and European level”.

Car production also suffered from weaker domestic demand due to the general state of the German economy, the VDA added, pointing out that broader macroeconomic trends were also impacting the automotive sector.

But two topics that keep cropping up in the debate about the German automotive industry are China and the switch to electric vehicles – and their overlap.

“We are still in a very disruptive situation as electric vehicles are performing worse than expected,” said Horst Schneider, head of European automotive research at Bank of America, in a translated interview with CNBC. Demand is lower than expected while competition has increased, he warned.

While the car market in China is recovering, German carmakers are not feeling the effects of the recovery as competitors are gaining market share, says Schneider. It is also a question of price, he adds. German electric cars are simply too expensive, while Chinese products are better in some respects and also more affordable.

Tensions surrounding trade and import tariffs between the EU and China are also putting pressure on the market.

“German producers are very exposed to trade policy, previously it was 40 or 50% of the profits were made in China and the Chinese market is starting to close somewhat. … At the same time, we have a higher share of electric vehicles, which are nowhere near as profitable as combustion engine cars,” Schneider said, adding that this has created a “double problem.”

“If earnings in China were still as high as they used to be, the profitability dilemma of electric cars could be dealt with quite well. But that is not the case and Chinese profits are also declining. Therefore, there is general pressure on earnings and margins are shrinking,” he said.

The end of the subsidy program for electric cars in Germany also put a strain on the markets, said the VDA. A plan is currently being worked on to introduce new tax breaks to promote the use of electric cars.

What’s next for the German car industry?

Despite all the challenges, there are also glimmers of hope, says Ries of KPMG. Hybrid vehicle technology will probably be used for longer than expected, and sales of cars with combustion engines are also picking up again, he explained.

But politics, business and research must work together to create framework conditions to address issues such as regulation and place more emphasis on quality and regulation, he believes.

The VDA also sees a need for different production conditions.

“We need political reforms instead of regulation. Pragmatism instead of micromanagement,” said the association spokesman. “We need a modern mix of market-oriented economic policy and formative industrial policy.”

Market conditions will remain challenging at least next year, the spokesman added.

Many automakers still have forecasts that suggest their performance in the second half of the year could be better than in the first, said Schneider of Bank of America.

“There are doubts at the moment, investors don't fully believe it and that's why there are fears that there will be profit warnings in the third quarter,” he said. And that in turn leaves questions open about what that could mean for 2025, he added.