The Road Narrows For Hyundai

With the rising won and runaway costs choking margins, it has to regroup fast

Hyundai Motor Co. hardly seems like a manufacturer in distress. At a time when Detroit is barely hanging on, the Korean auto manufacturer's global sales last year climbed 10.8%, to 2.5 million vehicles. In the U.S. they were up 8.7% after surveys showed that new Hyundais match the best Japanese brands in quality. So why has Hyundai Chairman Chung Mong Koo suddenly put his company into "emergency" mode, saying Hyundai's very survival is at stake?

The reason: a profit squeeze. Even as Hyundai's sales have soared, operating margins narrowed to 4.1% in the latest quarter, down from 9.9% in the second quarter of 2004. For 2005, profits fell by nearly a third, to $1.43 billion. Hyundai executives blame a strengthening currency as Seoul has stopped intervening to hold the won down. The won now stands at around 970 to the U.S. dollar, 22% stronger than two years ago and nearly double what it was in 1998. "We've met all the targets in our control: production, sales, and market share," says Senior Vice-President Hwang Yoo No. "But the revaluation of the won has been too fast."

The won's strength comes at a bad time. U.S. carmakers are offering discounts of up to $4,000 on each of their cars, and the Japanese are enjoying a relatively weak yen. Hyundai, meanwhile, is spending like crazy. It raised its research and development budget to $1.75 billion in 2005, more than double 2002's level, and has committed some $3 billion over five years to help parts suppliers improve quality. And its material costs have jumped 20% in the past two years, according to Samsung Securities Co. "The real test for Hyundai management is just beginning," says Samsung Securities analyst Kim Hag Ju, who sees a margin of just 3.1% for the quarter ending in March. "How Hyundai will control costs in the high-won era will make it go either the Toyota way or the Mitsubishi way," says Hyundai's Hwang.


Mitsubishi Motors, of course, almost collapsed. So Hyundai is taking a page from Toyota Motor Corp. (TM ), which has dodged high costs at home by manufacturing overseas. Of the 2.9 million cars Hyundai aims to sell globally this year, about a third will be built abroad, including 270,000 Sonata sedans and Santa Fe SUVs due to roll out of an Alabama factory Hyundai opened last May. It's boosting output in India and China, and also may open a factory in the Czech Republic.

Hyundai's strategic challenge involves more than ducking the effects of the won. "Hyundai has extremely aggressive sales targets," says J.D. Power & Associates (MHP ) President Stephen Goodall. "The targets are realistic if their quality improvements can hold up." But quality isn't cheap, and Hyundai still can't charge the same premium as Toyota. Today the Sonata costs about 10% less than Toyota's Camry, though that difference has shrunk from 15% four years ago.

The only way to close the gap is to spend even more buffing its image and improving its lineup. In the U.S., a revamped Sonata and Santa Fe, as well as a new $25,000-plus sedan called the Azera, are supposed to give the brand a boost. Hyundai might also create a new nameplate for its first true luxury model, a rear-wheel-drive sedan codenamed BH that's expected to make its U.S. debut in 2008.

The carmaker is attacking costs, too. In February it began renegotiating contracts with hundreds of parts suppliers in hopes of cutting prices by an average of 10%. On Feb. 22 its 8,100 managers accepted a wage freeze. Hyundai wants its powerful unions also to accept a freeze and greater work-rule flexibility. The union dismissed the demands as "ridiculous."

Hyundai, a distressed company? Not exactly. But with the won on the rise, the carmaker realizes it needs to act now.

By Moon Ihlwan, with David Welch in Detroit

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