Big Week for the Big Three!
Tuesday, 2 December 2008
Khaled Aziz
THIS week is likely to mark a defining moment for the century-old US Auto Industry. The Chief Executive Officers (CEOs) of GM, Ford, and Chrysler will be making their second trip, beginning from Monday (December 01, 2008) to Washington, their second trip in two weeks, to plea for $25 billion in bailout money from the US Federal Government.
The money is badly needed to keep the industry afloat. During their fist visit, the three CEOs were thoroughly grilled by the members of House Financial Service Committee and were asked to return in two weeks with a detailed plan on what the industry would do to turn things around. Surprisingly though, immediately after showing a cold shoulder to the Big Three, Washington had no problem coughing up $20 billion for the ailing Citigroup.
So, have the US policymakers become more concerned about Wall Street than the Main Street? There seems to be no shortage of bail out money for the Financial Sector, but when it comes to helping out an industry that is directly or indirectly responsible for one in ten jobs in USA, the tone of policymakers seems to be quite different. But the fact of the matter is the Auto Industry needs help. More importantly, the US economy needs a healthy Auto Industry.
So, how bad is the situation? Is the end in sight for the once mighty US Big Three carmakers? The question would have been an absurd one even two years ago. Yes, the ride has been bumpy for General Motors, Ford and Chrysler for the past a few years, but the possibility of bankruptcy? That would have been considered a stretch in imagination even for an extreme pessimist. After all, what's at stake here is an industry which has been in the forefront of innovation for over a century and has firmly established itself as the backbone of the US economy. The subject under discussion involves world renowned brands like Cadillac, Chevrolet, Pontiac, Saturn, Buick and GMC (US franchises under GM), Lincoln, Ford and Mercury (under Ford) and Dodge, Jeep, and Chrysler (under Chrysler). We are talking about an industry which has put the world on wheels, has been responsible for almost all of the major innovations found in modern day cars, conceived the idea of moving assembly line and mass production (Ford), and set the foundation of modern marketing theories by popularizing the concept of segmented marketing (GM). Until recently, it was kind of taken for granted that if any of the big three faced any serious financial difficulty, the US Government would never allow it to go out of business. But all of it seems to have changed with the latest economic turmoil.
It wasn't too long ago when just the brand value (goodwill) of these names was much more than the combined market cap of the Big Three today! The industry was at the pick of profitability during the nineties. Quite a few foreign brands were purchased by the Big Three with the cash they had, including Volvo, Aston Martin, Jaguar, Land Rover and Mazda by Ford, Saab, Hummer and Suzuki by GM, while Chrysler merged with Daimler Benz of Germany (later de-merged). General Motors and Ford had the No 1 and 2 footings in the Fortune 500 list for many years as the biggest revenue earners among all US companies across all industries.
Automotive is a cyclical industry and therefore when times are good, it is customary for the companies to build up cash reserves to survive through the next downturn. During late nineties, each of the big three automakers had 15 to 30 billion dollars in cash reserves. With that kind of liquidity, surviving the next downturn seemed like a non issue. Ford even went as far as returning almost 20 billion dollars in cash payments to its shareholders, declaring it wouldn't need that much cash to survive the next down turn. Gasoline prices in US were among the lowest in the world. US Consumers were purchasing huge gas guzzling SUVs and Pick-up Trucks, some of which were yielding as much as ten to fifteen thousand dollars in profit per unit. Multiply that by two hundred thousand to half a million units sold per year for the popular models, and it won't be hard to imagine how profitable the car business was even just a few years ago. During mid nineties, the US market had an annual demand of roughly 16.5 to 17 million vehicles (for reference, compare that to about 50 thousand cars sold per year in Bangladesh) and 70% of the market share was enjoyed by the big three. That market share has dropped to below 50% now and the annual industry sales is expected to drop below 14 million units this year.
For an industry with a very high proportion of fixed costs, such a significant drop in annual sales means excess capacity, price wars and huge losses. And for records, it is not just the Big Three who is suffering; Asian rivals like Toyota and Honda are also facing difficulties. Only the European brands like VW, BMW, Audi and Mercedes are doing better with Euro losing strength big time against US dollar, making these nameplates much cheaper to import.
So how did the industry end up in mess like this? The Big Three has a number of problems that need to be addressed:
Credit Crunch: With banks not willing to lend that generously, it is becoming increasingly difficult for potential car buyers to arrange financing for their vehicles. In USA, very few people buy cars with cash!
Consumer Confidence: For those who qualify for credit, there is the uncertainty factor. The outlook on economy is prompting prospective buyers to delay their next purchase as long as possible. Hence, the consumers who are used to changing their cars every three to five years are now holding on to their rides for a few more years.
Perceived Quality: For many years, the Big Three produced inferior quality vehicles compared to their Japanese counterparts. The latest Consumer Reports ratings show that Ford is now at par in quality with Toyota and Honda. GM also has made significant progress and even Chrysler is not lagging that far behind. In terms of vehicle safety, most recent rankings put Ford on top of Toyota and Honda. Unfortunately, perception doesn't change overnight and the Big Three is still not getting the benefits they deserve from these improvements. But if they can keep things up, the perception will change, slowly but surely.
Labour Unions: Like it or not, the unionized labour force of Big Three represented by United Auto Workers (UAW) for decades have negotiated contracts which are probably the most generous in any standard. In many instances, a blue collar worker earns more than an entry to mid level engineer. In addition to high wages, healthcare, unemployment and other benefits enjoyed by the union members would be a matter of envy for highly educated white collar professionals in many other industries. As a result from labour alone the big three has an estimated cost disadvantage of $1500 per vehicle, compared to their Asian and European rivals with manufacturing plants in USA. Foreigners have chosen to set-up plants in states with less stringent labour laws. Moreover, because their workforce is younger, they don't have any legacy cost for their retired workforce. It is estimated that GM alone has to spend $3.0 billion per year in retiree health costs.
Fortunately, UAW is becoming more sensible these days and their recent contracts are far less generous. But once again, there is a lag time before which these changes will begin to pay off.
Product Mix: For many years, the Big Three were totally focused on producing SUVs and light trucks, which were more profitable. They kind of took their eyes off of the passenger car segment and their shares were quickly eaten up by their Asian and European rivals. With rising gasoline prices and tighter economy, consumers now seem less interested in expensive gas guzzling SUVs. But product mix changes take years in the car industry. Big three will continue to lose their market share as they retool their assembly plants to make cars instead of SUVs and Light Trucks. The only good news is the gas prices have fallen significantly in recent months, which may partially reverse the consumer preference back to SUVs and Pick-up trucks.
Cost Structure: The fixed vs. variable cost ratio in the Automotive Industry is disproportionably biased towards fixed costs. Even when a plant is shut down, the depreciation of assets continues. The workforce in many cases still has to be paid more than 90% of their regular wages (thanks to the contracts negotiated earlier by UAW). As the annual industry wide demand plunges from 17 million units to less than 14 million, the fixed costs associated with the idle capacity for 3.0 million units which had to be shed still must be borne by the manufacturers in the short term.
So how will things play out? That depends on how long this turmoil lasts. A few more years of annual volume below 14 million units is bound to force some players out of business.
The only hope is, this is a century-old industry which has faced difficult times in the past and survived. One can only hope that this time would be no exception. However, when the turmoil is over, the Big Three will probably emerge out of it much smaller in size, but leaner and more flexible. The possibilities of further consolidations and mergers can't be ruled out. A few of the money-losing brands will probably be discontinued.
But in order to survive until things start to improve, help is needed in the short term. Industry watchers are now reasonably confident that the US Congress will ultimately work out a package for the auto industry. Because no matter how much they chose to grill the three CEOs, everyone probably understands that bankruptcy for even one of the big three is not an option, unless the US wants the current recession to become a depression. The cost of inaction would simply be too high.
The writer is a banker and former Manager at Ford Motor
Company, USA
THIS week is likely to mark a defining moment for the century-old US Auto Industry. The Chief Executive Officers (CEOs) of GM, Ford, and Chrysler will be making their second trip, beginning from Monday (December 01, 2008) to Washington, their second trip in two weeks, to plea for $25 billion in bailout money from the US Federal Government.
The money is badly needed to keep the industry afloat. During their fist visit, the three CEOs were thoroughly grilled by the members of House Financial Service Committee and were asked to return in two weeks with a detailed plan on what the industry would do to turn things around. Surprisingly though, immediately after showing a cold shoulder to the Big Three, Washington had no problem coughing up $20 billion for the ailing Citigroup.
So, have the US policymakers become more concerned about Wall Street than the Main Street? There seems to be no shortage of bail out money for the Financial Sector, but when it comes to helping out an industry that is directly or indirectly responsible for one in ten jobs in USA, the tone of policymakers seems to be quite different. But the fact of the matter is the Auto Industry needs help. More importantly, the US economy needs a healthy Auto Industry.
So, how bad is the situation? Is the end in sight for the once mighty US Big Three carmakers? The question would have been an absurd one even two years ago. Yes, the ride has been bumpy for General Motors, Ford and Chrysler for the past a few years, but the possibility of bankruptcy? That would have been considered a stretch in imagination even for an extreme pessimist. After all, what's at stake here is an industry which has been in the forefront of innovation for over a century and has firmly established itself as the backbone of the US economy. The subject under discussion involves world renowned brands like Cadillac, Chevrolet, Pontiac, Saturn, Buick and GMC (US franchises under GM), Lincoln, Ford and Mercury (under Ford) and Dodge, Jeep, and Chrysler (under Chrysler). We are talking about an industry which has put the world on wheels, has been responsible for almost all of the major innovations found in modern day cars, conceived the idea of moving assembly line and mass production (Ford), and set the foundation of modern marketing theories by popularizing the concept of segmented marketing (GM). Until recently, it was kind of taken for granted that if any of the big three faced any serious financial difficulty, the US Government would never allow it to go out of business. But all of it seems to have changed with the latest economic turmoil.
It wasn't too long ago when just the brand value (goodwill) of these names was much more than the combined market cap of the Big Three today! The industry was at the pick of profitability during the nineties. Quite a few foreign brands were purchased by the Big Three with the cash they had, including Volvo, Aston Martin, Jaguar, Land Rover and Mazda by Ford, Saab, Hummer and Suzuki by GM, while Chrysler merged with Daimler Benz of Germany (later de-merged). General Motors and Ford had the No 1 and 2 footings in the Fortune 500 list for many years as the biggest revenue earners among all US companies across all industries.
Automotive is a cyclical industry and therefore when times are good, it is customary for the companies to build up cash reserves to survive through the next downturn. During late nineties, each of the big three automakers had 15 to 30 billion dollars in cash reserves. With that kind of liquidity, surviving the next downturn seemed like a non issue. Ford even went as far as returning almost 20 billion dollars in cash payments to its shareholders, declaring it wouldn't need that much cash to survive the next down turn. Gasoline prices in US were among the lowest in the world. US Consumers were purchasing huge gas guzzling SUVs and Pick-up Trucks, some of which were yielding as much as ten to fifteen thousand dollars in profit per unit. Multiply that by two hundred thousand to half a million units sold per year for the popular models, and it won't be hard to imagine how profitable the car business was even just a few years ago. During mid nineties, the US market had an annual demand of roughly 16.5 to 17 million vehicles (for reference, compare that to about 50 thousand cars sold per year in Bangladesh) and 70% of the market share was enjoyed by the big three. That market share has dropped to below 50% now and the annual industry sales is expected to drop below 14 million units this year.
For an industry with a very high proportion of fixed costs, such a significant drop in annual sales means excess capacity, price wars and huge losses. And for records, it is not just the Big Three who is suffering; Asian rivals like Toyota and Honda are also facing difficulties. Only the European brands like VW, BMW, Audi and Mercedes are doing better with Euro losing strength big time against US dollar, making these nameplates much cheaper to import.
So how did the industry end up in mess like this? The Big Three has a number of problems that need to be addressed:
Credit Crunch: With banks not willing to lend that generously, it is becoming increasingly difficult for potential car buyers to arrange financing for their vehicles. In USA, very few people buy cars with cash!
Consumer Confidence: For those who qualify for credit, there is the uncertainty factor. The outlook on economy is prompting prospective buyers to delay their next purchase as long as possible. Hence, the consumers who are used to changing their cars every three to five years are now holding on to their rides for a few more years.
Perceived Quality: For many years, the Big Three produced inferior quality vehicles compared to their Japanese counterparts. The latest Consumer Reports ratings show that Ford is now at par in quality with Toyota and Honda. GM also has made significant progress and even Chrysler is not lagging that far behind. In terms of vehicle safety, most recent rankings put Ford on top of Toyota and Honda. Unfortunately, perception doesn't change overnight and the Big Three is still not getting the benefits they deserve from these improvements. But if they can keep things up, the perception will change, slowly but surely.
Labour Unions: Like it or not, the unionized labour force of Big Three represented by United Auto Workers (UAW) for decades have negotiated contracts which are probably the most generous in any standard. In many instances, a blue collar worker earns more than an entry to mid level engineer. In addition to high wages, healthcare, unemployment and other benefits enjoyed by the union members would be a matter of envy for highly educated white collar professionals in many other industries. As a result from labour alone the big three has an estimated cost disadvantage of $1500 per vehicle, compared to their Asian and European rivals with manufacturing plants in USA. Foreigners have chosen to set-up plants in states with less stringent labour laws. Moreover, because their workforce is younger, they don't have any legacy cost for their retired workforce. It is estimated that GM alone has to spend $3.0 billion per year in retiree health costs.
Fortunately, UAW is becoming more sensible these days and their recent contracts are far less generous. But once again, there is a lag time before which these changes will begin to pay off.
Product Mix: For many years, the Big Three were totally focused on producing SUVs and light trucks, which were more profitable. They kind of took their eyes off of the passenger car segment and their shares were quickly eaten up by their Asian and European rivals. With rising gasoline prices and tighter economy, consumers now seem less interested in expensive gas guzzling SUVs. But product mix changes take years in the car industry. Big three will continue to lose their market share as they retool their assembly plants to make cars instead of SUVs and Light Trucks. The only good news is the gas prices have fallen significantly in recent months, which may partially reverse the consumer preference back to SUVs and Pick-up trucks.
Cost Structure: The fixed vs. variable cost ratio in the Automotive Industry is disproportionably biased towards fixed costs. Even when a plant is shut down, the depreciation of assets continues. The workforce in many cases still has to be paid more than 90% of their regular wages (thanks to the contracts negotiated earlier by UAW). As the annual industry wide demand plunges from 17 million units to less than 14 million, the fixed costs associated with the idle capacity for 3.0 million units which had to be shed still must be borne by the manufacturers in the short term.
So how will things play out? That depends on how long this turmoil lasts. A few more years of annual volume below 14 million units is bound to force some players out of business.
The only hope is, this is a century-old industry which has faced difficult times in the past and survived. One can only hope that this time would be no exception. However, when the turmoil is over, the Big Three will probably emerge out of it much smaller in size, but leaner and more flexible. The possibilities of further consolidations and mergers can't be ruled out. A few of the money-losing brands will probably be discontinued.
But in order to survive until things start to improve, help is needed in the short term. Industry watchers are now reasonably confident that the US Congress will ultimately work out a package for the auto industry. Because no matter how much they chose to grill the three CEOs, everyone probably understands that bankruptcy for even one of the big three is not an option, unless the US wants the current recession to become a depression. The cost of inaction would simply be too high.
The writer is a banker and former Manager at Ford Motor
Company, USA