Once the shining star of Malaysia's industrialisation process, Proton is today seeing its grip on the domestic automotive market weakening.

To date, Proton`s local sales has hit an all-time low market share of 44 percent, almost 36 percent lower than its about 80 percent market share in the early 1990s.

Despite repeated denials from none other than the current advisor to Proton and former prime minister of Malaysia, Dr Mahathir Mohamad that there would not be any strategic alliances or tie up with foreign car makers, a deal with Germany`s Volkswagen AG has finally been inked on Oct 27 in Hanover, Germany.

Prime Minister Datuk Seri Abdullah Ahmad Badawi has confirmed that national car maker Proton has entered into a strategic alliance with Volkswagen AG, the world's third largest car manufacturer renowned for its long-standing beetle cars.

"I think certainly it is significant because Proton should be looking for a strategic partner and now Proton has found it (and) that is Volkswagen AG," he said when asked on the significance of Proton's partnership with the German car maker.

Proton's tie-up with Germany's Volkswagen AG heralds a new chapter for the Malaysian national car maker: In the interim, it has transformed Proton into a car assembly company.

Indeed, Proton announced that it would assemble and sell Volkswagen cars as part of a "long-term strategic partnership" that could lead to technology sharing and joint development of cars.

As part of the deal, Proton gets access to Volkswagen AG engines and other components. Volkswagen AG will develop a program to boost production standards at Proton plants and study opportunities to utilise Proton's technical expertise and facilities for the joint design and development of cars.

However, since there were no plans for Volkswagen AG to take a shareholding in the 38 percent state-owned Proton, it would appear that Proton has scored a commercial coup. At the right time too: the car market in the region should be liberalised by Jan 2005 under terms of the Asean Free Trade Area (Afta).

Trade liberalisation

Under Afta, import tariffs for most products in the region were cut to below five percent in the past year. Malaysia obtained a two-year reprieve for its auto industry until 2005, but has since said it would defer reducing duties to the required level until 2008.

Not withstanding the impending liberalisation of Afta, the timing of the tie-up with Volkswagen AG is crucial, as the price gap between Proton and non-Proton cars has already shrunk considerably over the last two years.

According to Clarence Ngui, writing in the Malaysian Business : "The shrinking price gap is attributed to the Malaysian government relaxing its control over new car prices in Malaysia. Interestingly, the government-approved selling price is now a thing of the past, and distributors can now price their cars according to market forces. This reason alone, has brought prices of new automotive models much lower in Malaysia."

In addition, five of Proton`s leading models have been around for more than a decade. From the Wira and Satria to the Iswara, the mainstream production models of Proton have aged beyond their newer competitors.

Indeed, if Proton is to survive beyond 2005, a fresh line-up is crucial to its bottom line. Necessarily, Proton plans is to produce 20 new models by 2010.

Perhaps for these two reasons, the market did not react too enthusiastically to the strategic pact. Prior to Volkswagen AG, for instance, Proton had worked with Mitsubishi for 21 years. Yet, the relationship could not venture any further, this in spite of heavy political support from the government of Malaysia and Japan.

Invariably, the response of the market to the new commercial relationship with Volkswagen AG has been lukewarm. Proton's shares rose a mere 15 sen to RM8.50 at the close on Bursa Malaysia on Monday.

A good reason for the tepid market reaction is clearly due to the lack of `realism` surrounding the new relationship at this stage.

Despite being the dominant partner, Proton has not allowed Volkswagen AG to take any strategic equities at all. Nor was there any reference to this issue in the memorandum of understanding signed on Oct 27. Yet, based on brand, volume and international sales, the stronger partner is clearly Volkswagen AG.

In 2003, the group brands delivered 5.015 million vehicles to customers in over 150 countries around the world with group sales amounting to 87.15 billion Euro (1 euro=RM4.84) and pre-tax profit of 1.53 billion Euro. To date, Volkswagen AG operates 45 manufacturing plants in 11 European countries as well as in the US, Asia and Africa.

The Volkswagen AG Group comprises the Volkswagen-Pkw, Audi, Seat, Skoda, Bently, Bugatti, Nutzfahrzeuge and Lamborghini brands.

Insignificant benefits

As such a report by AmResearch has affirmed that "without equity participation, it may not be in the best interest for Volkswagen to share its intellectual properties with Proton and vice versa."

Thus, while in the immediate term, AmResearch said Proton would benefit from additional earnings from the assembly and distribution of Volkswagen cars, such a commercial arrangement is unlikely to be significant. This is due to the relatively thin margins and small volume. Indeed, the contract will see an initial production of 15,000 Volkswagen units in 2006 only.

Although as part of the deal, Proton gets access to Volkswagen engines and other components, analysts have warned that the road ahead remains unclear. If anything, long-term benefits are hazy without any equity participation by Europe's top auto maker.

On the part of Proton, the management believed that the tie-up with Volkswagen AG will boost Proton's brand name internationally and create a global distribution link for it to sell its cars abroad, especially in China where Volkswagen AG is the top foreign car maker, with nearly 30 percent of the market.

But it is premature to determine if this could ensure Proton's long-term survival as Proton has fared poorly in international markets, selling no more than 1000 units a year.

Come what may, the clock continues to tick for Proton. Proton's RM1.8 billion new plant in Tanjung Malim, Perak is designed to produce a million cars a year by 2010.

The management of Proton, led by Mohammad Nadmi has confirmed that at least 20 new models must be introduced to allow Proton to venture into the Chinese, European and Indonesian markets within the next six years.

This is a tall order. Yet, with a local consumption of only about 200,000 units, exports are key to Proton survival.

Hence to make its international strategy work, Proton has to make a giant leap in performance, production and market penetration, all of which it hopes Volkswagen AG can help with.

So far, there is nothing in the deal to show that Volkswagen AG could be so generous. The latest deal is therefore the beginning of a series of tentative baby-steps for both partners to build their confidence and organisational rapport.

They will have to get to know the management culture and technological calibers of each other quickly though, without which the much acclaimed relationship could come to naught due to the narrowing window of opportunity.