Further to my early post on Cash for Clunkers, see the blog on the Morgan Stanley Global Economic Forum of April 28, 2009. It adds the point that if the market value of a used car is already (say) $2000 and the "clunker" subsidy is $4000 then the net effect is smaller, similar to putting an extra $2000 rebate on a car. Plus it would be further muted by the various strings attached to the two main pieces of draft legislation winding their way through Congress. The bottom line is that it will cost a lot but won't boost sales much. Their blog includes methodology and estimates.
Thursday, April 30, 2009
Tuesday, April 28, 2009
Follow the Money
The news today is of efforts to cut the cost side of the OEMs, Chrysler of course but also General Motors. Is this good news? To frame that question we need to do two things. First, what of the revenue side? Second, what of the overall value stream? – after all, the OEM slice is a quarter or less of total, not including the aftermarket, consumer finance and so on. The way I read it, we do not yet have any good news, because focusing on costs while revenues slide is chasing a will-o'-the-wisp. And the upstream and downstream segments are on the brink of a deep precipice – but I'm not sure which side of the brink.
To my mind, the key variable at the moment is the residual (resale) value of a vehicle. As long as it remains low, it cuts into the arteries, and staunching the bleeding is hard. A low residual value means that purchasers are more likely to be "under water" on their current vehicle, with a trade-in value less than their loan balance. A low residual value means that leasing is dead, and a straight loan has to be priced higher, to cover the poor value of a vehicle as collateral (never mind the current recession-driven risk that the borrower's income may disappear). And a low residual value means that even if the buyer will pay cash (or has equity in their current car), they will shy away from a great vehicle in favor of one that because of its nameplate will hold its resale value. [I will post this before digging up sample numbers, say of a Toyota Titan and a comparable GM pickup – comments, please!] If the 4-year-out resale value of one vehicle is 50% of purchase price, and of another is 30% – well, no OEM can afford to discount their vehicles up front enough to offset the different.
So how to pull up residuals? Unfortunately the cutback in fleet sales at GM is too recent to have cut the flood of used cars that has depressed their residuals over the past several years. [Or so I assume -- ADESA or various used car guides could provide data.] In a year or two the impact would have been tremendous, had the recession not intervened. After all, GM has the car of the year and good ranking in the JDPowers quality surveys. (Ditto the combination of VEBA and retirees hitting age 65 to handle legacy costs on the cost side come 2011.) But luck was not with them. Maybe the biggest help the government could give is using its purchasing dollars not on new vehicles but on 2-, 3- and 4-year old vehicles to pull up their resale value.
Low residuals hurt other portions of the industry. If a dealer closes its doors, the normal franchise agreement obligates the OEM to repurchase inventory at cost. For the bank that finances this inventory ("floorplan") that is crucial. No bank is prepared to accept 200 cars on a lot when a loan forecloses. But if GM faces Chapter 11, it would no longer be obligated to make dealers (or their lenders) whole. Now if the residual value of GM vehicles was high, lenders could at least figure out what such collateral would be worth. As it is, no lender in their right mind would extend additional financing to a GM dealer (much less a Chrysler dealer). And no dealer would order a new car. That means that these companies will have zero revenue, because even if consumers flock to dealership lots, GM sells cars to dealers, not consumers.
That's of course the downstream viability story: GM may not have any dealers left, due to the collapse of financing, and they certainly won't have dealers buying cars. Costs cuts can never offset such revenue cuts. Of course if GM goes, and there is a massive firesale, Honda and others will face crisis, too, because consumers will have the choice of a new GM vehicle at 50% off – who knows? – and why in such a situation would you buy a used Honda? or a new one?
Now the upstream parts sector is in as bad of shape, maybe worse. While GM is closed they will be ordering no parts (remember that the factories of parts firms employ about 3x the number of manufacturing jobs at GM and its peers). With no orders, no revenue. Now the strategic imperative for suppliers the past decade was to diversify their customer base. But how can they keep their factories open if Honda and Toyota are 25% of their revenue, and GM and Chrysler 75%? And how can they fund the engineering effort on new vehicle models and basic R&D needed to garner orders for vehicles launched in 2012 and 2013, when sales will hopefully have rebounded? I don't think they can. My own feeling is that the downward spiral is not letting up. The tide is still building, and the whirlpool is getting harder to escape.
So, even if a bailout is arranged that temporarily keeps GM out of bankruptcy, if the downstream and upstream both collapse, well. I want to avoid thinking about what that might look like, and how the industry could start up again. But my quick attempt to follow the money suggests it's flowing down the drain, and the flow is slowing to boot.
To my mind, the key variable at the moment is the residual (resale) value of a vehicle. As long as it remains low, it cuts into the arteries, and staunching the bleeding is hard. A low residual value means that purchasers are more likely to be "under water" on their current vehicle, with a trade-in value less than their loan balance. A low residual value means that leasing is dead, and a straight loan has to be priced higher, to cover the poor value of a vehicle as collateral (never mind the current recession-driven risk that the borrower's income may disappear). And a low residual value means that even if the buyer will pay cash (or has equity in their current car), they will shy away from a great vehicle in favor of one that because of its nameplate will hold its resale value. [I will post this before digging up sample numbers, say of a Toyota Titan and a comparable GM pickup – comments, please!] If the 4-year-out resale value of one vehicle is 50% of purchase price, and of another is 30% – well, no OEM can afford to discount their vehicles up front enough to offset the different.
So how to pull up residuals? Unfortunately the cutback in fleet sales at GM is too recent to have cut the flood of used cars that has depressed their residuals over the past several years. [Or so I assume -- ADESA or various used car guides could provide data.] In a year or two the impact would have been tremendous, had the recession not intervened. After all, GM has the car of the year and good ranking in the JDPowers quality surveys. (Ditto the combination of VEBA and retirees hitting age 65 to handle legacy costs on the cost side come 2011.) But luck was not with them. Maybe the biggest help the government could give is using its purchasing dollars not on new vehicles but on 2-, 3- and 4-year old vehicles to pull up their resale value.
Low residuals hurt other portions of the industry. If a dealer closes its doors, the normal franchise agreement obligates the OEM to repurchase inventory at cost. For the bank that finances this inventory ("floorplan") that is crucial. No bank is prepared to accept 200 cars on a lot when a loan forecloses. But if GM faces Chapter 11, it would no longer be obligated to make dealers (or their lenders) whole. Now if the residual value of GM vehicles was high, lenders could at least figure out what such collateral would be worth. As it is, no lender in their right mind would extend additional financing to a GM dealer (much less a Chrysler dealer). And no dealer would order a new car. That means that these companies will have zero revenue, because even if consumers flock to dealership lots, GM sells cars to dealers, not consumers.
That's of course the downstream viability story: GM may not have any dealers left, due to the collapse of financing, and they certainly won't have dealers buying cars. Costs cuts can never offset such revenue cuts. Of course if GM goes, and there is a massive firesale, Honda and others will face crisis, too, because consumers will have the choice of a new GM vehicle at 50% off – who knows? – and why in such a situation would you buy a used Honda? or a new one?
Now the upstream parts sector is in as bad of shape, maybe worse. While GM is closed they will be ordering no parts (remember that the factories of parts firms employ about 3x the number of manufacturing jobs at GM and its peers). With no orders, no revenue. Now the strategic imperative for suppliers the past decade was to diversify their customer base. But how can they keep their factories open if Honda and Toyota are 25% of their revenue, and GM and Chrysler 75%? And how can they fund the engineering effort on new vehicle models and basic R&D needed to garner orders for vehicles launched in 2012 and 2013, when sales will hopefully have rebounded? I don't think they can. My own feeling is that the downward spiral is not letting up. The tide is still building, and the whirlpool is getting harder to escape.
So, even if a bailout is arranged that temporarily keeps GM out of bankruptcy, if the downstream and upstream both collapse, well. I want to avoid thinking about what that might look like, and how the industry could start up again. But my quick attempt to follow the money suggests it's flowing down the drain, and the flow is slowing to boot.
thanks to DR and JJH and TK for stimulation
I will try to add numbers later
Monday, April 20, 2009
Downsizing
While interrupted from time to time by the business cycle – exceptionally so at the moment – automotive demand has expanded steadily since the end of WWII in the US, Japan and the EU. As a consequence the normal challenge for auto companies has been expansion. That process was not always orderly, as the different divisions of the larger firms fought for product for their dealers. Such product overlap is particularly severe at Toyota and GM, with the most sales channels. For dealers there is modest downside; additional models mean additional inventory. But each dealer hopes to pick up some incremental sales. Unfortunately that includes sales cannibalized from other sales channels – Pontiac sales robbing from those of Chevrolet – and so the benefits to the manufacturer are smaller. Overall however the bias (as in most franchising systems) is to have too many sales points and too many products from the standpoint of the system as a whole. As disorderly as the expansion path may appear, with firms responding to "hits" by their rivals with product that may mesh poorly with the overall vehicle lineup, reversing that process is much more difficult. Doing it in an orderly manner is well-nigh impossible.
Financial implications aside, trimming capacity presents formidable strategic challenges. First, the menu of vehicle programs must be developed with a 6-8 year time horizon. The allocation of engineering resources is a complicated dance, and has to also mesh with assembly capacity. A firm can work on only 1-2 vehicles in a size class at a time, and delaying a program until later then means some future program must be moved forward or otherwise shifted. So the dance has to position the players with a vision of where the firm wants to be 8 years down the road. That is hard enough when most vehicles programs are merely (?!) developing a replacement to existing product. Downsizing will almost inevitably mean that a firm is set to develop the wrong vehicles in the wrong order.
Second, if products are located rationally in consumer space, canceling one model creates a hole in the overall product lineup. That means that there are greater benefits from moving adjacent vehicles to the head of the development queue. So one less model increases the pressure to re-engineer two or more adjacent vehicles. Doing that of course costs money rather than saves money, so a hole must remain. Such a hole affects dealerships; if a particular sales channel is starved for product, then it will be more difficult for the dealers to maintain the presence in the market in overall staffing and advertising needed to support vehicles that ought to sell well. Downsizing, in other words, can amplify an initial decline in sales. And that's without taking into consideration any negative publicity from media coverage of the process.
Third, developing vehicles entails teamwork; downsizing means breaking up teams. Trying to "cherry pick" the good engineers is hard, and hurts morale – and of course a team without spirit is not much of a team, as is a team that has never played together before, even if (especially if?) it is composed of all-stars. Voluntary buyouts may force a company to "buy back" workers if too many in a give area quit. And in either case a firm will find it difficult to continue recruiting young engineers and other functions where learning the trade takes time.
Fourth, uncertainty looms large. CAFE (fuel efficiency) mandates skew incentives for where to allocate resources, with an impact that varies from firm to firm depending on their mix of domestic and imported vehicles. "Green" incentives that accrue to vehicles that may in fact not be very efficient, the lack of an energy policy that creates uncertainty in the path of energy prices (and which in the US makes diesel more expensive rather than cheaper than gasoline), and the presence of state and local economic development incentives that make a new plant for a company with an expanding market share cheaper than an old plant for a firm with a declining share all make life more complicated.
Then there are legacy costs. Incumbents in the US already had large number of retirees, due to the cumulate impact of increases in longevity and increases in productivity, that left them with an unfavorable ratio of retirees to workers. Downsizing makes things worse. New entrants have no such problems. They have virtually no retirees, their healthcare costs are further lowered by the relatively young age of their workforce, and they have "modern" benefit plans rife with deductibles and co-pays, things that were of little or no concern when such benefits were negotiated by the incumbents in the 1950s.
Finally, what scale is needed for survival? Electric vehicles, hybrid diesels, hybrid gasoline vehicles, natural gas vehicles, fuel cell vehicles – it is unclear which of the next generation of propulsion plants will prove fruitful. All require significant expenditures now that will not generate revenue in the near term. A large firm can have multiple platform teams, very small cars in Korea, small cars in Germany, midsized-cars and light trucks in the US, real-wheel drive projects in Australia, and so on. There are potentially large benefits from that, though to date the track record of "world" cars is poor, in part because regulatory barriers and variations in manufacturing infrastructure make it expensive and time-consuming to adapt a European car for the US market.
Of course there is excess capacity in the market alongside too many models. The ease of entry means that will not change in the medium term – remember, there are 14 producers in NAFTA, not to mention importers. Dealers face their own problems, particularly for those in urban areas, as the internet undermines the value of a large, expensive physical footprint. Downsizing individual firms affects suppliers in an uneven manner, but few suppliers depend on a single customer. Viewed from the other end, a Toyota or a Honda is reliant on the health of suppliers for whom one or another Detroit firm is a major customer.
In short, downsizing can unravel along multiple dimensions. And probably will.
Financial implications aside, trimming capacity presents formidable strategic challenges. First, the menu of vehicle programs must be developed with a 6-8 year time horizon. The allocation of engineering resources is a complicated dance, and has to also mesh with assembly capacity. A firm can work on only 1-2 vehicles in a size class at a time, and delaying a program until later then means some future program must be moved forward or otherwise shifted. So the dance has to position the players with a vision of where the firm wants to be 8 years down the road. That is hard enough when most vehicles programs are merely (?!) developing a replacement to existing product. Downsizing will almost inevitably mean that a firm is set to develop the wrong vehicles in the wrong order.
Second, if products are located rationally in consumer space, canceling one model creates a hole in the overall product lineup. That means that there are greater benefits from moving adjacent vehicles to the head of the development queue. So one less model increases the pressure to re-engineer two or more adjacent vehicles. Doing that of course costs money rather than saves money, so a hole must remain. Such a hole affects dealerships; if a particular sales channel is starved for product, then it will be more difficult for the dealers to maintain the presence in the market in overall staffing and advertising needed to support vehicles that ought to sell well. Downsizing, in other words, can amplify an initial decline in sales. And that's without taking into consideration any negative publicity from media coverage of the process.
Third, developing vehicles entails teamwork; downsizing means breaking up teams. Trying to "cherry pick" the good engineers is hard, and hurts morale – and of course a team without spirit is not much of a team, as is a team that has never played together before, even if (especially if?) it is composed of all-stars. Voluntary buyouts may force a company to "buy back" workers if too many in a give area quit. And in either case a firm will find it difficult to continue recruiting young engineers and other functions where learning the trade takes time.
Fourth, uncertainty looms large. CAFE (fuel efficiency) mandates skew incentives for where to allocate resources, with an impact that varies from firm to firm depending on their mix of domestic and imported vehicles. "Green" incentives that accrue to vehicles that may in fact not be very efficient, the lack of an energy policy that creates uncertainty in the path of energy prices (and which in the US makes diesel more expensive rather than cheaper than gasoline), and the presence of state and local economic development incentives that make a new plant for a company with an expanding market share cheaper than an old plant for a firm with a declining share all make life more complicated.
Then there are legacy costs. Incumbents in the US already had large number of retirees, due to the cumulate impact of increases in longevity and increases in productivity, that left them with an unfavorable ratio of retirees to workers. Downsizing makes things worse. New entrants have no such problems. They have virtually no retirees, their healthcare costs are further lowered by the relatively young age of their workforce, and they have "modern" benefit plans rife with deductibles and co-pays, things that were of little or no concern when such benefits were negotiated by the incumbents in the 1950s.
Finally, what scale is needed for survival? Electric vehicles, hybrid diesels, hybrid gasoline vehicles, natural gas vehicles, fuel cell vehicles – it is unclear which of the next generation of propulsion plants will prove fruitful. All require significant expenditures now that will not generate revenue in the near term. A large firm can have multiple platform teams, very small cars in Korea, small cars in Germany, midsized-cars and light trucks in the US, real-wheel drive projects in Australia, and so on. There are potentially large benefits from that, though to date the track record of "world" cars is poor, in part because regulatory barriers and variations in manufacturing infrastructure make it expensive and time-consuming to adapt a European car for the US market.
Of course there is excess capacity in the market alongside too many models. The ease of entry means that will not change in the medium term – remember, there are 14 producers in NAFTA, not to mention importers. Dealers face their own problems, particularly for those in urban areas, as the internet undermines the value of a large, expensive physical footprint. Downsizing individual firms affects suppliers in an uneven manner, but few suppliers depend on a single customer. Viewed from the other end, a Toyota or a Honda is reliant on the health of suppliers for whom one or another Detroit firm is a major customer.
In short, downsizing can unravel along multiple dimensions. And probably will.
Friday, April 3, 2009
Too Big To Fail
A quick line, a take on Paul Krugman's latest (April 2, 2009) NYTimes Op/Ed on China and the US:
Their stance -- and that of the rest of the world -- is that they don't like what they see [US macro fundamentals], but we (the US) are too big to fail.
Thursday, April 2, 2009
Zero (Economic) Profits
Previously I analyzed GM's decline and the rise of new firms in the US market. It was simply (but ironically) sound short-run strategy for all involved. Some time soon I extend that, arguing that downsizing in the auto industry presents almost insuperable challenges.
Here I argue that overcapacity and low profitability are intrinsic to the industry. Even if GM shuts down completely, removing a big block of production capacity, the overall impact will be fleeting. When the economy recovers, none of the volume OEMs will roll in profits, even Toyota. At core new entry is simply too easy. For years the new entrants – Detroit South – benefited from a pricing umbrella, as the Detroit Three priced to cover fixed costs. Henceforth, the volume players will have lost that last vestige of pricing power.
Caveats. First, I am less sure that the luxury producers will fall into the same trap; my instinct is they will. Second, this logic is specific to OEMs, not to suppliers or to distribution and finance. Third and finally, I avoid the jargon of a professional economist, but for any fellow members of the secret society of PhDs, this is a standard application of the model of monopolistic competition.
Bear with me while I explain.
Back in the bad old days of the 1960s, developing a new car was a long and costly undertaking, paling in comparison only to that needed to develop a new engine. As traced in Takahiro Fujimoto's Harvard Business School PhD thesis, and summarized in The Machine That Changed the World and elsewhere, firms in Detroit employed a sequential process that began with stylist sketches, then sculpted that into a clay model, and after concept approval moved to hand-crafting prototype parts. Once those checked out firms built tooling, which then was carted to an assembly plant for prototype production. Not everything would go right the first time around, and so some things would get thrown back into the pipeline, delaying the entire process. All in all it took 4 years and frequently more from initial approval to "Job One," ate up capital, and led to lots of incomplete fixes.
Meanwhile the market may have moved on. GM (and Toyota) were thus both explicit about it: if a model sold, tweak it but no more. Besides, with large market shares they had very little upside potential, and if the resulting car was blah, it should still sell OK. (If it was edgy, it could flop, which for a volume vehicle would be a true disaster.) Given all this, a car needed to be kept in production for 4-6 years to pay back up front costs, though perhaps it might be "freshened" midway with minor changes to the body and trim.
Japanese firms had grown up in a different environment: after the initial chaos of multiple firms entering and exiting in the 1950s, some 11 firms remained. Rivalry was thus more intense than in the US (or in Europe), and capital was scarce. A leisurely design process would be a route to failure, between the launch of new models by rivals and the sheer expense of the process. In addition, the same capital constraints (reinforced by the structure of the union movement in Japan) meant a greater role for suppliers in the process. Partly in response, the OEMs used an overlapping rather than a strictly sequential process. For example, you could begin work on structural components as soon as the attachment points of the sheet metal skin were fixed. Forcing cooperation across functions improved intrinsic design quality. But the real bottom line was speed.
During the 1990s such project management techniques diffused throughout the industry. Meanwhile the IT revolution was moving apace as was a revolution in materials science. For the former, CATIA, computer-aided design (CAD) software developed by the French aerospace firm Dassault Systemes, helped set the standard. CAD systems not only saved labor; they saved time while improving accuracy. Designs could be recycled, stretched, modified at the stroke of a light pen, and then sent electronically to suppliers or to a machine tool that could work on a prototype while the engineers slept. Eventually even the prototype was eliminated: structural testing and even mock assemblycould be done in a purely virtual world. Again, the real bottom line was speed.
Speed not only meant it was possible to better match market trends. Speed lowered costs. The "platform" concept pushed things further. Much of the engineering hours went to the brake-suspension-steering assemblies, and the design of the crush zones front and back, and other systems that were to some extent dependent on the size and weight parameters of a design. Once a new model was done, those core systems could be modified to create a whole family of vehicles in that size class, with some assurance that handling and safety performance and cost would be acceptable. That translated into more savings in development time and project cost.
So … in the 1950s there were around only 60 models on the road. There are now 60 new models a year. In extremis, a new vehicle can be designed in under 2 years; routinely, in under 3. Of course international trade complements these changes; it now makes sense to develop vehicles with modest shares in several markets, and a wider global palette of vehicles means a firm may be able to paint in a hole in a market that they would have ignored in the past.
At the project level the logic is inexorable. There are also lots of players. In order of US sales they are (subject at any time to Chapter 11!) the Big Three [GM, Toyota and Ford], the Middle Four [Chrysler, Honda, Nissan and Hyundai] and the ] and the Little Seven [VW, Mazda, BMW, Mercedes, Subaru, Suzuki and Mitsubishi]. And these 14 exclude firms that are solely importers! The chance that a vehicle will prove a hit is slim; the pressure to redesign and attack new segments immense. Almost everyone is optimistic at launch; almost everyone is disappointed. So on average there is everywhere excess capacity; it is better to be able to build more than to be caught short, and you don't want to drop margins. For years sales per model have trended down. And the irony is that while the improved economics of the design process has encouraged more vehicles, the aggregate effect is that overall costs haven't fallen in a commensurate manner; indeed, they may well have risen. And so another bottom line appears: red ink, or at least meager margins.
There is in my mind no way to reverse this process. No firm is large enough to take into account its impact on the overall market from model proliferation. So all continue to throw more models at the consumer. Of course the process built up a head of steam during the Greenspan-Bush Bubble; to date we've not seen many project cancellations. But to repeat, no longer is any single firm large enough in the market to mute the logic of this process.
Again, a bottom line, the bottom line: on a structural basis, an OEM is now and will remain a business that will barely manage a positive return on assets in good times and will bleed badly in poor times. It is a fundamentally bad business to be in and it will not get better, only less bad.
Here I argue that overcapacity and low profitability are intrinsic to the industry. Even if GM shuts down completely, removing a big block of production capacity, the overall impact will be fleeting. When the economy recovers, none of the volume OEMs will roll in profits, even Toyota. At core new entry is simply too easy. For years the new entrants – Detroit South – benefited from a pricing umbrella, as the Detroit Three priced to cover fixed costs. Henceforth, the volume players will have lost that last vestige of pricing power.
Caveats. First, I am less sure that the luxury producers will fall into the same trap; my instinct is they will. Second, this logic is specific to OEMs, not to suppliers or to distribution and finance. Third and finally, I avoid the jargon of a professional economist, but for any fellow members of the secret society of PhDs, this is a standard application of the model of monopolistic competition.
Bear with me while I explain.
Back in the bad old days of the 1960s, developing a new car was a long and costly undertaking, paling in comparison only to that needed to develop a new engine. As traced in Takahiro Fujimoto's Harvard Business School PhD thesis, and summarized in The Machine That Changed the World and elsewhere, firms in Detroit employed a sequential process that began with stylist sketches, then sculpted that into a clay model, and after concept approval moved to hand-crafting prototype parts. Once those checked out firms built tooling, which then was carted to an assembly plant for prototype production. Not everything would go right the first time around, and so some things would get thrown back into the pipeline, delaying the entire process. All in all it took 4 years and frequently more from initial approval to "Job One," ate up capital, and led to lots of incomplete fixes.
Meanwhile the market may have moved on. GM (and Toyota) were thus both explicit about it: if a model sold, tweak it but no more. Besides, with large market shares they had very little upside potential, and if the resulting car was blah, it should still sell OK. (If it was edgy, it could flop, which for a volume vehicle would be a true disaster.) Given all this, a car needed to be kept in production for 4-6 years to pay back up front costs, though perhaps it might be "freshened" midway with minor changes to the body and trim.
Japanese firms had grown up in a different environment: after the initial chaos of multiple firms entering and exiting in the 1950s, some 11 firms remained. Rivalry was thus more intense than in the US (or in Europe), and capital was scarce. A leisurely design process would be a route to failure, between the launch of new models by rivals and the sheer expense of the process. In addition, the same capital constraints (reinforced by the structure of the union movement in Japan) meant a greater role for suppliers in the process. Partly in response, the OEMs used an overlapping rather than a strictly sequential process. For example, you could begin work on structural components as soon as the attachment points of the sheet metal skin were fixed. Forcing cooperation across functions improved intrinsic design quality. But the real bottom line was speed.
During the 1990s such project management techniques diffused throughout the industry. Meanwhile the IT revolution was moving apace as was a revolution in materials science. For the former, CATIA, computer-aided design (CAD) software developed by the French aerospace firm Dassault Systemes, helped set the standard. CAD systems not only saved labor; they saved time while improving accuracy. Designs could be recycled, stretched, modified at the stroke of a light pen, and then sent electronically to suppliers or to a machine tool that could work on a prototype while the engineers slept. Eventually even the prototype was eliminated: structural testing and even mock assemblycould be done in a purely virtual world. Again, the real bottom line was speed.
Speed not only meant it was possible to better match market trends. Speed lowered costs. The "platform" concept pushed things further. Much of the engineering hours went to the brake-suspension-steering assemblies, and the design of the crush zones front and back, and other systems that were to some extent dependent on the size and weight parameters of a design. Once a new model was done, those core systems could be modified to create a whole family of vehicles in that size class, with some assurance that handling and safety performance and cost would be acceptable. That translated into more savings in development time and project cost.
So … in the 1950s there were around only 60 models on the road. There are now 60 new models a year. In extremis, a new vehicle can be designed in under 2 years; routinely, in under 3. Of course international trade complements these changes; it now makes sense to develop vehicles with modest shares in several markets, and a wider global palette of vehicles means a firm may be able to paint in a hole in a market that they would have ignored in the past.
At the project level the logic is inexorable. There are also lots of players. In order of US sales they are (subject at any time to Chapter 11!) the Big Three [GM, Toyota and Ford], the Middle Four [Chrysler, Honda, Nissan and Hyundai] and the ] and the Little Seven [VW, Mazda, BMW, Mercedes, Subaru, Suzuki and Mitsubishi]. And these 14 exclude firms that are solely importers! The chance that a vehicle will prove a hit is slim; the pressure to redesign and attack new segments immense. Almost everyone is optimistic at launch; almost everyone is disappointed. So on average there is everywhere excess capacity; it is better to be able to build more than to be caught short, and you don't want to drop margins. For years sales per model have trended down. And the irony is that while the improved economics of the design process has encouraged more vehicles, the aggregate effect is that overall costs haven't fallen in a commensurate manner; indeed, they may well have risen. And so another bottom line appears: red ink, or at least meager margins.
There is in my mind no way to reverse this process. No firm is large enough to take into account its impact on the overall market from model proliferation. So all continue to throw more models at the consumer. Of course the process built up a head of steam during the Greenspan-Bush Bubble; to date we've not seen many project cancellations. But to repeat, no longer is any single firm large enough in the market to mute the logic of this process.
Again, a bottom line, the bottom line: on a structural basis, an OEM is now and will remain a business that will barely manage a positive return on assets in good times and will bleed badly in poor times. It is a fundamentally bad business to be in and it will not get better, only less bad.
Wednesday, April 1, 2009
Supplier hiccup
Working on another installment of my "core" analysis. In the meantime, see the extended comment by David Ruggles on my second post.
Note too the closure of Chrysler main minivan plant (in Windsor Ontario, just across the river into Canada from Detroit). Automotive News reports that financial difficulties led a supplier of critical parts to stop shipments. Given "just in time" production, the assembly line stops pretty quickly. But if Chrysler isn't assembling vehicles, they aren't ordering parts from other suppliers (or shipping finished vehicles). So no money coming in, no money going out. For other suppliers who need cashflow, this is really bad news. And since suppliers ship to more than one auto company, this potentially could snowball throughout the industry. A couple more suppliers shut their doors temporarily, and more assembly plants shut, and a few more suppliers ... it would be very hard to stop once started, and very hard to get everyone back up producing. Unit sales are down roughly 60% from the 17+ million peak (2006?) to under 9 million. Not many firms can survive a sales drop of that magnitude. And of late banks haven't been eager to provide bankruptcy financing, while the government has only set aside a trivial $5 billion for suppliers. But suppliers employ far more the workers of the OEMs (nearly 3x more).
Note too the closure of Chrysler main minivan plant (in Windsor Ontario, just across the river into Canada from Detroit). Automotive News reports that financial difficulties led a supplier of critical parts to stop shipments. Given "just in time" production, the assembly line stops pretty quickly. But if Chrysler isn't assembling vehicles, they aren't ordering parts from other suppliers (or shipping finished vehicles). So no money coming in, no money going out. For other suppliers who need cashflow, this is really bad news. And since suppliers ship to more than one auto company, this potentially could snowball throughout the industry. A couple more suppliers shut their doors temporarily, and more assembly plants shut, and a few more suppliers ... it would be very hard to stop once started, and very hard to get everyone back up producing. Unit sales are down roughly 60% from the 17+ million peak (2006?) to under 9 million. Not many firms can survive a sales drop of that magnitude. And of late banks haven't been eager to provide bankruptcy financing, while the government has only set aside a trivial $5 billion for suppliers. But suppliers employ far more the workers of the OEMs (nearly 3x more).
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