Buyer Beware at Chrysler

With the entrance of billionaire Kirk Kerkorian into the bidding for Chrysler Group, the struggling carmaker is starting to look like a hot property. But buyer beware. Whoever ends up purchasing the U.S. company from German parent DaimlerChrysler (DCX) might find themselves a few parts shy of a complete car company.

If a deal gets done, the new Chrysler may prove the ultimate test case for outsourcing. Chrysler is far from being a turnkey company and lacks some of the most basic components of a successful automaker. Its new owners would either have to continue to rely on Daimler—which may keep a stake in Chrysler—or find new partners for such vital disciplines as research and development, engineering, even writing car loans. Tougher yet, Chrysler lacks economies of scale that rivals like Toyota Motor (TM) and General Motors (GM) enjoy by selling variations of the same car across the globe.

Winning the bidding war is just the beginning. The new owner of Chrysler will have to find innovative ways to make this small, regional company compete like a big global one. "We did the merger with Daimler because we didn't think we could make it on our own," says former Chrysler President Thomas T. Stallkamp, now a partner with private equity firm Ripplewood Holdings. "If the merger is unwound, you have to find a new partner or partners to make it work."

That's the bad news. But in a perverse way, it's also the good news. Sure, any of the bidders—which include Kerkorian, private equity firms Cerberus Capital Management, Blackstone Partners, Centerbridge Partners, and parts maker Magna International (MGA)—will need to forge some key strategic links. But that gives a new owner the opportunity to rethink the way Chrysler has managed itself. It could scrap some existing relationships and find new partners to develop cars, technology, and even purchase parts on the cheap. Chrysler's new owner could also find creative ways to team up with other carmakers that make mainstream models in a way that produces real synergies and saves billions. "If I'm one of these private equity players bidding on Chrysler," says David E. Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich., "I'm talking to China Inc., I'm talking to GM, or any other automaker."

Partnering Up

To see how badly Chrysler needs partners, look at its passenger-car business. The underpinnings of the popular 300 sedan came from Mercedes-Benz. Mitsubishi Motors, which was DaimlerChrysler's partner for passenger cars until recently, developed the core frame and structural components that lie beneath Chrysler's Dodge Caliber and Jeep Compass compacts and the Dodge Avenger and Chrysler Sebring midsize cars. A new Chrysler would have to either redevelop small and midsize car engineering capabilities, or more likely, find a new partner. Except for the Caliber, the new cars developed with Mitsubishi are also-rans in a crowded market. Three decades of on-and-off ventures with Mitsubishi have produced few winners.

That means it's time for Chrysler to pick a new partner, one with better engineering and even greater global sales volume than struggling Mitsubishi. Fiat (FIA) and France's PSA could be candidates. So, too, are Korea's Hyundai and Kia, as well as Chinese carmakers. Chrysler has already signed a deal to develop subcompacts with China's Chery Automobile. The company needs other deals like that to offer cost-competitive cars.

A stronger partner could also help Chrysler overcome one other big disadvantage: Its small size and overexposure to the U.S. Chrysler sells maybe 200,000 midsize cars a year—a fraction of what Honda, Toyota, and GM sell worldwide. Those giants spread costs over sales of 1 million to 2 million family cars, reaping huge advantages in parts-buying and factory use. That pays off development costs quickly and boosts margins. Add a partner like PSA or one of the Koreans, and they can combine sales to push down costs for parts, engines, and engineering work. That's something that Mercedes, whose luxury cars can't easily share parts with Chrysler vehicles, rarely gave its American partner.

Then there's the lending business. Daimler and Chrysler married their finance units thoroughly. A new owner could split out Chrysler's portion of the loan business. But the company would still need to set up back-office and underwriting operations, Stallkamp says. Daimler could keep the financial-services business and charge Chrysler fees for writing loans. Or Chrysler and Daimler could jointly run the finance company, but then they would have to share the profits—which are big on this side of the business. One other possibility that could be a boon for Chrysler's buyer: The new owner takes all of DaimlerChrysler Financial Services and charges Daimler for loans.

Bigger challenges loom on the R&D front. Chrysler closed down its research unit in 2004, turning over most advanced work in hybrid-electric cars and hydrogen fuel cell research to Daimler. Again, Chrysler could rely on Daimler for fuel-cell development and continue to use the GM-BMW-Daimler hybrid joint venture. That's no big deal—many companies are pairing up to share the expense of developing clean, fuel-efficient cars.

But there's the catch. Chrysler has a hybrid partnership, but it's one of the last carmakers to bring a hybrid to market. Daimler has 100 fuel-cell vehicles on the road globally, though most of them carry the Mercedes name. A new partner might work faster. In any case, says Stallkamp, "the Daimler merger answered a lot of questions for Chrysler. Now that it's going away, someone needs to answer those same questions."