Bad News for Toyota? – the Detroit 3 are Back

...the Detroit 3 are returning to the midsized-car segment...

I'm tossing out back issues of Automotive News to try to fit into a corner office with more windows but less shelf space. I know, crocodile tears for this academic with his shelf-filling collection of books and journals. Anway, one headline caught my eye: "What can save the Detroit 3? Cars!" [a John K. Teahen, Jr. editorial from Sept 18, 2006, p 16].

The context was the near-exit of GM, Ford and Chrysler from the car market, which decreased monotonically from 89% of their sales in 1965 to 35% in 2005, while (correspondingly) trucks went from 11% to 65%. Now admittedly trucks were incredibly profitable on a unit basis, while small cars were a necessary evil, intrinsically unprofitable but needed for CAFE (the Corporate Average Fuel Economy mandate). But the decline at the Detroit 3 was disproportionate to the shift towards light trucks in the over US market.

One point is that ambitious designers, engineers, and senior managers all want to be associated with halo the ka-chenk of good bottom-line vehicles. Teahen argued that the Chevy Impala remained a potential money-earner, with hoped-for sales a bit above the 296,000 of 2006. In fact, on a platform basis, output was higher – 500K – reflecting the multiplication of nameplates that were in fact the same basic car, but the implication of the editorial was that it wasn't making much money. And even with the shift of the overall vehicle market towards light trucks, such sales pale besides the 1-plus-million mark hit of 1965. GM wasn't putting its heavy hitters on car projects.

I've argued before on this blog that Toyota lavishes undue attention on the Prius and on the Lexus marque, again reflecting the status of these projects within the company as a whole. Reputedly Toyota's working to correct that bias, devoting more effort to the 2012 version launched in December 2011. Time will tell if it is better executed and better selling.

Today, however, the Detroit 3 are a factor. They have very different cost structures, with the removal of the millstone of legacy costs from around their neck, a function of the aging of workers "retired" under pre-2007 restructurings, the impact of the VEBA and (for GM and Chrysler) additional costs shed under bankruptcy. Labor is no longer a fixed cost. They thus no longer need to maximize revenue [which for you economics junkies is also implied by the low marginal price of labor]. Instead they can aim to make money from cars. We see that in reduced incentives, reduced fleet sales -- that is, higher prices -- and a normalization of residuals. (I can't speak of leases -- I lack knowledge and suspect that option continues to suffer from the aftershocks of the financial upheaval of 2008-9.)

What does that imply for those who remain focused on cars, particularly Toyota, Honda, and Nissan? On the one hand, they ought to benefit from less discounting. On the other hand, they are hurt by reinvigorated Detroit 3 products. The latter, I believe, dominates: from Toyota's perspective, they have two new, heavy-weight competitors in GM and Ford (and in some product categories, a 3rd in Chrysler), and while Hyundai has been around for a while, sales of the Sonata are only now such as to represent a major slice of the mid-size segment of the Camry and the Accord. If you've become a bit sloppy dare I say arrogant? the sudden appearance of new competitors can be very painful.

My prediction thus is that Toyota (and Honda) will resort to greater discounts and higher fleet sales. That should be good news for new car buyers. (Car renters will have greater choice, but price may not budge much, better residuals will work against higher initial acquisition costs for Enterprise and their rivals.) But since Toyota relies on exports from high-yen Japan for Lexus and (to a lesser extent) the Prius, they've taken a major hit to profits on that front. I'll leave it to financial analysts to pour over segment results of the major players, particularly Toyota, to see if the new competition means their US profits take a hit as well.

Mike Smitka

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