Made In Iran
Whether or not Iran is building nuclear weapons, its auto industry, the largest in the Middle East, is learning how to cope with privation - and planning for worse.
By Eric Ellis, Fortune Magazine

(Fortune Magazine) -- Earlier this year, as the rhetoric soared between Tehran and Washington over Iran's nuclear program, the country's two biggest carmakers, Iran Khodro and Saipa, did something executives at Ford, Toyota, and BMW probably haven't contemplated: They commissioned a study of how to run their businesses in a war zone. That may have been prudent.

Government-owned and military-linked, Iran's carmakers presume they are in Washington's cross hairs, and neither the White House nor President Mahmoud Ahmadinejad shows any sign of backing down. "We now have three scenarios-green, yellow, and red," says Hadi Malekan, Saipa's general manager of business development, a portrait of the late Ayatollah Khomeini staring over his shoulder in an office on the baking plains west of Tehran. "We have shared these scenarios with 100 of our top managers to make them aware of what could happen."

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Green represents normalized relations between Iran and the U.S. This assumes that embassies are reopened, that Iran is able to access the world's biggest economy - both its financial markets and its automakers - and that non-U.S. manufacturers would no longer have to tiptoe around U.S. sanctions. In other words, a return to the market freedoms Iran had before 1979, when the mullahs came to power. "We would like this situation very much," says Malekan, whose state-owned company claims about half of Iran's auto market.

Yellow is a variation of the status quo, in which Iran remains off limits for the U.S. and bilateral relations are nonexistent. "This scenario would effect the buying patterns of customers," says Malekan, "and there would be a problem with the sourcing of parts."

Red, of course, means war-"attack and invasion, even nuclear," Malekan suggests. "We might increase the volume on the commercial-vehicle side," he says, hinting at military clients. This scenario comes in shades: darker for devastated factories; a pinker hue for an international sanctions regime tighter than what already exists. "We would operate," he explains, "but we would decrease some of the lines because of the lack of customers."

Worst-case scenario planning

There's a similar sense of fatalism at Iran Khodro, the country's oldest and largest carmaker, best known for the Paykan, a discontinued knockoff of the Hillman Hunter, a 1960s British marquee formerly owned by Chrysler and Peugeot.

"We believe that a war could destroy everything," says Alireza Mirzaei, the company's deputy president, a 37-year-old veteran of the 1980s Iraq-Iran war that shaped so many Iranians of his generation. "We are a people [born] of war, and in a special situation maybe war is the only way. We hope for the best, but our plans also include the worst."

But even with such dismal scenarios looming, Malekan and Mirzaei both embrace an optimism typical of businesspeople anywhere. "So maybe they attack," Malekan says. "This would be a challenge for a short period of time, but then the company would go to a normal situation very soon."

Agrees Mirzaei: "We can work with European companies, even with Americans. Business is business, and they don't like to lose the benefit of the Iranian market, or the region. The past is past, and after five to six years, I believe we will be producing Chevrolets."

The largest automaker in the Mideast

This nation of 70 million people has much at stake. Its auto industry has boomed in recent years to become one of the biggest sectors outside of oil, employing 150,000 and accounting for about 4% of GDP. With nearly one million vehicles produced last year, as many as in Australia or Thailand, Iran boasts the largest car industry in the Middle East and Central Asia. "We're not talking small numbers here," says industry analyst Jonathan Poskitt of J.D. Power Automotive Forecasting. "There is a huge aspirational population under 40 in Iran, with money, and they want the same stuff as everyone else."

Iran was once a playground for U.S. automakers - the first car in Iran was a Ford (Charts), and GM (Charts) produced Chevy Novas, Buicks, and Cadillacs there in the 1970s with a Saipa subsidiary - but production of American marques ceased in 1981 after the embassy siege. Today the only U.S. models visible on Tehran's traffic-clogged streets are 1960s and '70s Chevys and Cadillacs, driven mostly by aging Iranians.

The revolution and the U.S. boycott hit the Iranian car market hard. The Islamic rulers nationalized the industry, and many foreign automakers went along with the boycott, not wanting to jeopardize their more valuable U.S. operations.

As a result, plants are dated, and parts, often imported through third countries, are expensive. Engineers complain that assembly lines often break down. The best evidence of this pariah status: the Paykan, a car regarded by Iranians as both a national treasure and a national joke. Some 40 years after they were introduced, Paykans (the name means "arrow" in Farsi) still ply Tehran's streets, accounting for about one car in three, belching pollution, lacking air conditioning, and burning gasoline at a high rate - the last not a big issue in a country where a liter of gas costs only 10 cents, one-third the price of a bottle of drinking water.

Iran Khodro finally phased out production last year, when the Paykan failed emissions tests. Giving up on the nation's best-selling car wasn't easy. But when Iran Khodro ignored the government's directive, Industry Minister Eshaq Jahangiri said he would go to the plant and shut it down personally. Says Iran Khodro's Mirzaei: "The Paykan lasted so long because the U.S. would not permit us to trade."

American overtures?

Despite the cold war between Washington and Tehran, Iranian auto executives say there have been nibbles from Detroit. Hossein Momeni, Saipa's director of strategic planning, says his company negotiated in the early 1990s with executives from Chrysler (Charts), who told their would-be partners that U.S.-Iranian relations had thawed sufficiently to warrant exploratory talks.

He says Chrysler wanted to introduce a version of the Plymouth Acclaim to Iran and that vehicles were even tested for Iranian conditions. "The negotiations proceeded to a semi-advanced stage based on representations by Chrysler that it was able to follow through despite the state of political relations," Momeni says.

A former Saipa executive who was part of its negotiating team and who asked not to be identified backs up that account, saying that Chrysler fronted negotiations through its Canadian division and that discreet meetings were held in Istanbul and Dubai, with the two sides agreeing on price and production details. The talks petered out, and after George W. Bush made his "Axis of Evil" speech, lumping Iran with North Korea and Iraq, chances of rapprochement became as remote as ever.

Chrysler denies there were any such talks. "Neither Chrysler nor any of its subsidiaries has engaged in, or authorized anyone else to engage in, any meetings or negotiations with any state-owned or other automobile companies in Iran," says DaimlerChrysler spokeswoman Ursula Mertzig-Stein.

Washington's largely untested sanctions policy on Iran can seem vague, and it's unclear whether Chrysler might have broken any laws if it was negotiating with Saipa. "It's usually okay to talk," says U.S. Treasury spokeswoman Molly Millerwise, but "contracts contingent upon lifting sanctions or getting a license are verboten."

There are also accidents of history. Japan's Mazda, one-third-owned by Ford, has a joint venture with Iran's private Bahman group to make a version of the Mazda 323, and Chrysler parent DaimlerChrysler has licensed assembly of an E-class Mercedes-Benz.

The old company town

By world standards the Iranian car industry is primitive, much of its technology a holdover from the pre-Ayatollah 1970s. Iran Khodro's 25,000 employees toil in rundown plants at a massive complex that neighbors the Saipa facility. They make the Paykan's replacement, the Samand, as well as several Peugeot marques.

The plant is a city within a city, with its own postal code, train station, and apartment blocks. Street corners are decorated with Koranic exhortations that good Muslims work hard for the revolution. Mullahs in full clerical garb are common at the complex, alongside the Basij militia, Iran's religious police, who keep the faithful in order.

Production at both plants was recently upgraded to three shifts, running at 95% capacity and breaking only for religious holidays and the June 4 anniversary of Khomeini's 1989 death.

Distribution remains tricky. At Kerman Automotive, a small, privately owned Iranian carmaker that has joint venture deals with Volkswagen and China's Chery Automobile, it takes about a month for customers to get cars delivered. But, says Kerman vice chairman Bahram Shariat, that's a big improvement over when he was at state-owned Saipa, where it could take up to two years.

"A lot of foreign companies were scared of coming to Iran for a long time because they thought the U.S. could hurt their business in other countries," says Saipa's Momeni. If that's the case, at least some European and Korean automakers have gotten over such skittishness.

International carmakers ease in

With Iran awash in cash, thanks to soaring oil prices, international giants such as PSA Peugeot CitroŽn, Renault (Charts), Kia, Hyundai (Charts), and Fiat (Charts) have teamed with Saipa, Iran Khodro, Kerman, and Bahman, often licensing models for local production to avoid direct investment in Iran-and having to answer to Washington. "The Europeans and Koreans are meeting the pent-up demand," Momeni says, adding that their success is Detroit's loss.

But while most of them are showing annual sales growth of 30% to 40%, and their foreign marques are a status symbol to many Iranians, a corporate presence in Iran isn't something foreign carmakers want to talk about. Iran Khodro's Samand is based on a Peugeot 405 platform. It is regarded as Iran's new national car, with more than 300,000 cramming Iran's roads since its introduction last year.

Peugeot has a score of technical staff supervising production. It's a similar story at Saipa, where Momeni says PSA's Xantia model is "top of its class and has experienced growth in the double-digit range. We are now discussing further areas of cooperation." But neither is a success Peugeot wants to claim. Says PSA Peugeot CitroŽn director of communications Isabelle Cros: "Our group is not implanted, industrially or commercially, in Iran."

Momeni says Iran carmakers would like to wean themselves from foreign cooperation. After decades of government subsidies, Iran Khodro and Saipa are in better shape, adjusting as Tehran dismantles a heavy tariff regime to allow more foreign imports.

Iran Khodro turned a profit of $405 million in 2004, its last audited year, and was confident enough to open negotiations to buy Britain's struggling MG Rover group last year. The talks went nowhere, but now there are plans to export to Venezuela, Belarus, India, and China.

Mirzaei of Iran Khodro laments that Iran's stagnation as an auto power contrasts with the rise of Korea. "In the 1970s, Koreans regarded us as a developing-world model for their own new car industry," he says. "Now we are following them. If we did not have these problems with the U.S., we could have a car industry at least like Korea's, and we could all do well-the U.S. and Iran."

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.