The Proton, Malaysia's national car, is losing market share. Can the company be weaned from its government subsidies?
by Eric Ellis, FORTUNE Magazine

(FORTUNE Magazine) -- Syed Zainal Abidin Tahir, the youthful new boss of Proton, Malaysia's state-owned car company, is clear on his priorities.

"I'm a Malaysian first and a businessman second," says the 44-year-old CEO, six months into the job. "I'm not a civil servant, but part of my job is a social and national obligation I have to adhere to."

Sentiments like those are a nod to Proton's 21 years as the most visible symbol of Malaysia's drive to developed-nation status.

They wouldn't convince the board at Ford, Fiat, or Toyota, and as noble as they sound, they won't help the ailing Proton either.

Although the carmaker is 42% owned by the government, Kuala Lumpur seems intent on withdrawing the subsidies that kick-started it back in 1985. It is also signing free-trade agreements that allow more imports of foreign cars.

As a result, Proton's market share - 80% at its peak and 60% as recently as 2003, when its founder, Mahathir Mohamed, retired as Prime Minister - tumbled to 40% last year. Profits dropped to $7.6 million, down from $113 million a year earlier, and revenue slipped from $2.3 billion to $2.1 billion.

How did it get so bad? In a word, politics.

Proton has become a football kicked between Mahathiristas, who believe the state must have a dominant role in advancing Malaysian industry, and those behind Abdullah Badawi, Mahathir's successor, who favor a progressive withdrawal of the helping hand.

Zainal, who came to Proton through a career in government-linked companies, is a man in the middle: "The government is saying, 'We will give you a good framework so you don't have to worry, but we want you to start operating like a business.' "

Mahathir is livid.

The man Zainal calls the "father of Proton" became a consultant to the carmaker after leaving office. Badawi was his handpicked successor, and the 82-year-old former Prime Minister pledged not to interfere in his government.

For Badawi's first two years that's how it was. But as Proton has sunk further, the two have fallen out over the carmaker's direction.

Mahathir recently told Malaysian journalists that "Proton is doomed" and that Badawi was selling out Malaysia's sovereignty.

For his part, Badawi is reluctant to talk about Mahathir's sniping; the former Prime Minister remains an influential figure in Badawi's ruling coalition. Badawi insists he won't allow Proton to go under.

"But they'd better work hard," he told FORTUNE recently. "Everything has to be improved. It has to be without the crutches. We can help to the extent that we can, but I have told them, 'Don't be too dependent on help without improving yourself.' "

That's fine by Zainal, who says success will come from production efficiency. Take the sourcing of parts.

"Some of the trucks load to just to 60%," he says, "compared with 90% at Toyota. We're paying for air." Zainal admits that Proton's three assembly lines have about 40% spare capacity.

Mahathirism has been a tough act for Badawi to follow, and its legacy shadows Badawi's rule.

Malaysians got used to the good times, but Badawi inherited an economy pumped up by state spending, which he's now attempting to dismantle.

"There seems to be new thinking in there," says ING Bank's chief economist for Asia, Tim Condon. "Under Mahathir, Proton was always a sticking point in free-trade agreements, but under Badawi that state lifeline is becoming more tenuous."

Mahathir believed in mega-projects - grandiose undertakings designed to fast-track Malaysia to economic development. Some of them were sound, but many were not.

The North-South Freeway cut travel time by two-thirds, and in the south, near Singapore, the Pelapas seaport has given its neighbor a competitive fright in its quest to be Asia's biggest port.

Putrajaya, Mahathir's administrative capital, is gathering urban mass, and Kuala Lumpur's international airport is one of Asia's best.

But other projects were pompous monuments to an autocratic ruler. Under Mahathir the national carrier, Malaysian Airlines, had one of aviation's most extensive schedules, because Mahathir liked to play the role of Third World champion.

That worked diplomatically, but who really flew from Kuala Lumpur to Tunis on a regular basis?

Now the airline is a money pit; it lost $88 million in the first quarter alone. Under Mahathir, Malaysia also built a $200 million Formula 1 track for one weekend's motor racing a year.

The Petronas Towers were the world's tallest buildings for six years but have never been fully occupied. And Mahathir's Multi-Media Super Corridor has generated just $2 billion in economic activity in a decade, missing the tech outsourcing boom, which mostly went to India.

But it is the Proton that has Malaysia in its deepest funk and that has given Badawi his most difficult challenge in de-Mahathirizing the economy.

Mahathir founded Proton to carry Malaysians to a shiny new industrial future, from rice paddy to factory floor. He even had a stretch version made as his official car.

Proton's models bore patriotic Malay names: Saga (seed), Wira (hero), and Putra (prince). Its logo incorporated the Malaysian coat of arms.

And a depiction of a Proton assembly line decorates the country's 100-ringgit note.

Mahathir made it a national duty to buy a Proton, and he helped Malaysians do so by providing for loans on easy terms. He signed up Japanese giant Mitsubishi as a partner, which built an assembly line in palm groves outside the capital.

There were jobs for 12,000, and despite slumping sales and excess capacity, Zainal says there are no plans to shed workers.

Mitsubishi sold its 16% stake in 2004. Now Proton is in a desperate search for a foreign partner to provide technical support and much-needed equity.

"We can't do this alone," says Zainal. "We must have a smart partnership."

There have been talks with Volkswagen and Peugeot, but it's a tough sell. With only 500,000 new cars sold a year, Malaysia's market is neither big enough nor cheap enough for foreign carmakers, which are focused on India and China. Ownership is also a sticking point.

Proton's major shareholder, Malaysia's state investment house, Khazanah Holdings, won't sell control of Proton to a foreign group. But few outsiders are willing to make the financial and management commitment needed without control.

Zainal acknowledges that Proton has major problems, but he says it's not a lost cause.

"We cannot be in a state of denial that we are producing quality cars, because the fact is we are not," he says. "We need to be brave enough to accept that. We have to face reality. We must no longer behave like the national car. We cannot behave like we will be protected forever."

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