Richmond Times-Dispatch, Saturday, January 14, 2008; A15.
Detroit’s Drop Dead Day
When the good news is that Honda’s sales in the US are down by only 28% – and Toyota projects losses of only $5 billion – it’s clear the problems in the auto industry extend well beyond Detroit. Market projections by car companies for 2009 vary by 30%, while light truck sales are up – for now. Which cars will sell is no clearer than how many will sell. Yet in its December “bailout” to the industry Congress mandated that Detroit produce turnaround plans by February 17 and show progress in implementing them by March 31, or get thrown into bankruptcy.
The reality is that credible planning is impossible. And in an industry with high fixed costs, from parts producers – which employ three times as many workers as the car companies themselves – down to dealerships, a 40% decline in sales means everyone is losing money. Those without a cash cushion will go under. In the last few months 40 suppliers have declared bankruptcy; hundreds of dealerships have closed their doors. The entire “value chain” of the industry is in parlous health, but is so interconnected that if too many firms fail, the normally orderly process of bankruptcy will spiral into a chaotic shutdown of all manufacturing, taking with it 1 million jobs in short order.
Let’s be frank: there are no easy solutions. Improved engineering processes allow firms to launch new products more rapidly than ever. A vehicle that sells well soon faces competition from all sides. Even before the recession, chronic excess manufacturing capacity and bloated dealer inventories plagued the industry. One indication was the launch by the Japanese and Germans of SUVs and pickups, which they’ve found hard to sell. There’s been excess capacity across producers and product segments, and not just in Detroit.
Then came the bubble. During the four years leading up to our current downturn, the stock of vehicles expanded by 22 million units, leaving us with 248 million vehicles for 202 million drivers. Now population growth adds 2 million drivers a year, and expanding businesses top that off with another million units of demand. The market might more reasonably have grown by 12 million units – not by 22 million. The overhang created by the bubble isn’t just in housing.
One temptation is to try to pile on government-financed incentives. But as the industry well knows – and the Detroit 3 know better than most – artificially boosting demand with discounts and sales to rental car fleets carries a steep cost: it “buys” sales from the future and leads to an outpouring of used cars a few years down the road. So purchasers receive poor prices on their trade-ins. That, in turn, leads to a perception that these vehicles are low in quality when, in fact, poor trade-in prices reflect supply-and-demand. Incentives thus come back to bite the industry, but high levels of discounting are addictive, as sales plummet the moment they’re removed.
One policy that might help is a version of “cash for clunkers,” to help eliminate the market overhang created by the bubble to get rid of old cars rather than trying to pile on more new ones. To make sense, however, it must really be targeted at clunkers – and hence should offer more cash for older vehicles. It might start at $500 cash for a 10-year-old vehicle, bumping the payment up $100 per year, with $1,500 for vehicles aged 20 and above. The new Department of Transportation vehicle tracking system would help insure that these vehicles are recycled into scrap, and DOT and the EPA also have the expertise to jiggle the details to get rid of a target number of vehicles (say, 2 million).
This policy would be no panacea; if pursued too aggressively, it could make it harder for lower-income Americans to buy a vehicle. Nor are all old cars inefficient; the subcompacts of the 1980s got tremendous mileage, though owners of course might prefer to drive such clunkers rather that accept cash. But unlike other proposals, this policy would not distort new car purchasing decisions, and would thereby avoid another downturn in sales the moment the program ended. Improve access to finance for credit-worthy borrowers, yes! – and the recent targeting of TARP funds to the finance arms of General Motors and others has helped. But to offer an alcoholic strong drink – that is, to pile on more discounts – not only won’t work. It’s just plain wrong.
END
Michael Smitka, professor of economics at Washington and Lee University, has conducted research on the auto industry for more than two decades. He can be contacted at [email protected].
Michael,
To what extent do you believe that the restructuring for viability will include (1) a material scaling back of retiree pension benefits and (2) union pay cuts such that union and non-union pay scales are comparable? From what you are saying above it sounds like the “plan” will be more projected revenues rather than actual expense reductions.
Union wage cuts, interim purchase incentives, additional lending capital, and drastic product re-designs are the only salvation for this industry at this time in history.
I believe the UAW and GM negotiators are working through the night. Things seem unclear about recalcitrant bond holders. What IS clear to me is that GM just cannot wave a magic wand and make Saturn, Hummer, and Saab go away OR use the same wand to arbitrarily close dealerships. They don’t have the capital to buy dealers out and there are contractual franchise agreements and state and federal law that protects dealers. The dealers are quite well organized both on the state level and nationally with NADA carrying the torch in DC.
As I see who will be appointed to the over sight board in lieu of a “car czar”, I haven’t seen anyone with any auto business experience. I continue to hear conversation from the Obama administration that there will be pressure put on the Detroit 3 to build fuel efficient vehicles as if that is the key to their survival and long term success. What I HAVEN”T heard is their plan to get people to buy those vehicles in the face of cheap fuel. In short, where’s the energy policy the government is responsible for?
I am all ears too! What are the steps dealers are taking to comply with this law and how many dealers even know about it? Excellent question!