Oil Economics and the Auto Industry

by Ruggles - from my Auto Finance News column

Drill Baby Drill has finally worked, but only because OPEC cooperated, at least temporarily. Until just recently, increased U.S. production hasn’t resulted in low fuel prices at the pump. There is no good reason for global oil market prices to have stayed so high for so long in the face of dramatically increased U.S. production UNLESS OPEC had curtailed its own production to provide price/supply equilibrium. That has been their modus operandi for decades. OPEC started off with 5 members and now has 12, yet they don’t produce any more oil now than they did in 1973. In that period of time, global population has doubled and oil consumption has almost tripled. It’s not because OPEC couldn’t or can’t produce more. They operate like a cartel, because they are.

Takata and The Quality Dilemma

revised version posted by Smitka at The Truth About Cars

The Takata airbag inflator problems illustrate a fine dilemma: quality standards across the auto industry are good, those for safety-critical devices very good. The result is that only things that occur very rarely get through the production process, and many of those either cause no problem or don't get reported. That makes confirming that there is in fact a pattern challenging, and figuring out the root cause (or causes) extraordinarily so. The number of known deaths (the media suggests 5) is a very small fraction of the number of lives saved by Takata airbags. So the other dilemma is that the fundamental robustness of the manufacturing process means the benefits of a recall are also very low, and the quality of work in your local dealer's repair bay is not equal to that in an airbag plant or vehicle final assembly plant. The cure can be worse than the disease.

Anyway, I spent a day this week with an airbag manufacturer, listening to engineering presentations on a new airbag design from the supplier's senior engineers, with a senior car company airbag engineer also in attendance. I won't name the companies, and what I write is based on information that should be available from public sources. (I spot-checked a couple of the points.)

1. First, globally there are tens of millions of Takata airbags on the road. I've not been able to find a number, but I would guess that over roughly 1 million such vehicles have been involved in a collision that led to an airbag deployment. Of those, to date there are 5 known fatalities and several more injuries. Actual problems are exceedingly rare.

2. The cause is as of yet unknown, as there are multiple failure modes. Which one(s) are leading to the observed problems? Small numbers mean (i) this analysis is intrinsically very challenging. It is complicated by (ii) the evidence going up in smoke when an airbag inflator explodes and (iii) other evidence going up in smoke because documents in Japan were sent to the incinerator. The concentration of incidents in very high humidity locales suggests deterioration of the ammonium nitrate "propellant" due to hydration, wich could cause the sheets of material to turn into clumps (sheets go "whoosh," clumps go "boom"). However there are several incidents in areas not known for high humidity. So there could be two different problems, or one systematic problem and the random one-in-a-million manufacturing defect, or all random problems some of which just happened to be clustered geographically. So last week automakers who use Takata airbags got together to decide how to jointly collect and analyze disparate data in the hopes that the combined data would allow meaningful analysis. This was a meeting cleared by the Dept of Justice as not violating antitrust because it was limited to engineers discussing a narrow set of issues. Almost every car company uses Takata for at least a few airbag applications, so it was basically a meeting of the global customer-side engineering community.

3a. If the actual problem is not systematic, then a recall may do nothing at all except cost lots of money, because the same one-in-a-million bad inflator ratio won't change. If anything, a rush to increase production will make monitoring production process compliance more challenging and could lead to a higher number of (idiosyncratic) random defective airbag inflators in cars.

3b. Again, other manufacturers cannot substitute their inflators for a Takata inflator -- they would have to design a product that matched the gas generation profile needed to match the Takata airbag, verify their method of manufacturing produced parts that actually worked to design, test prototypes with the Takata airbag to make sure there was no unforseen interaction (vent angles or orientation slightly different, lots of subtle interactions). Then they would have to set up a production facility, run off a lot of parts coming through the actual production process on the machines and tooling and inspection processes that would be used (rather than the prototype build process), and have these tested and retested. This is necessary because the bag portion is very, very specific (the exact grade of material and how it is folded are all very carefully specified, tested and then monitored during production for exact replication). It would be very hard to do this in under 6 months, and production does not ramp up from nil to full overnight. It would be impossible to do this in 6 months across all of Takata's airbag-inflator-vehicle combinations, because each would need to be tested separately. Engineers can work 16 hour days for a while, but not for month after month. There isn't excess engineering and testing capacity just waiting for a recall to come along, and car companies want their engineers to continue working on new vehicles, they don't want to stop everything under development to re-engineer an old (perhaps decade-old) product.

If you need to find a needle in a haystack, maybe it's not worth finding the needle.

4. Nevertheless, of the inflator manufacturers, as far as I can tell Takata is the only one whose inflator operations did not start out as a division or factory of a rocket engine or explosives company. Instead Takata was a cut-and-sew operation that had expertise in fabrics that then added in-house pyrotechnic capabilities. That adds to the suspicion of a systematic albeit very rare propellant problem, but again, the number of incidents remains very small and there is essentially no ability to cull the necessary information from incident reports or (when they were kept) piles of shrapnel.

5. For reference, manufacturers of inflators include Autoliv (the other really big player), TRW, Key Safety Systems, Daicel and (making only inflators) ARC.

6. Finally, I want to reiterate that the numbers indicate you are much safer in a car with a potentially defective Takata airbag than a car without any airbag. The Takata airbag defect matters only in a frontal collision. Even if the inflator did spin off shrapnel, which is (order of magnitude) perhaps a 10 in a million chance, the chance you will be seriously hurt is lower. If you don't have an airbag, you'll be using your head -- to slow down the rest of your body. That story never has a good ending, and can readily have a fatal one, the latter at a rate much higher than 10 in a million.

mike smitka, from Toronto

How the Pre-Owned Market is Driving Economic Growth

An interesting theory inviting comments: http://www.cnbc.com/id/102186242

Waiting for the stars to align: Japan's Consumption Tax increase

Japan, as does much of the world, has long-run fiscal challenges. Its population aged faster than anticipated. No mechanism was put in place to automatically adjust pension and healthcare revenues.^{Note 1} In addition, the slowdown of economic growth and the late 1980s bubble and its collapse both meant that revenues plummeted, leaving the economy with a one-time buildup of debt as the aging process commenced. The result was a large initial buildup of debt, and an inexorable subsequent rise.

...right now the stars are aligned around the consumption tax...

Addressing the issue required however the proper alignment of stars. First, the political system had to be configured so as to allow decisionmaking. A long era of prime minister of the season meant that doing much of anything has been a challenge. Then there's the economic system: even deficit scaremongers recognize that raising taxes in a recession is a bad idea.^{Note 2} So Japan also needed to have the economic stars align. For the initial decade or so, the aftereffect of their bubble muted discussion of tax hikes. External shocks – the Asian financial crisis in 1997, worries about spillover from the end of the US dot.com bubble, then 9/11 and 3/11 [the Tohoku megaquake], and more recently the sharp recession touched off by what is known in Japan as the "Lehman Shock" provided excuses to postpone, from the perspective of politicians if not economists.

Then came Abe. He is only the second prime minister in many, many years to not face a constant risk of losing his majority support in the Diet; the political stars aligned. Likewise the economy has been recovering bit by bit from the Lehman Shock and 3/11. While the reality may be something less, weak labor markets that kept youth from launching careers, headlines trumpted the rise of GDP and diminishing deflation. The denoument was that on April 1, 2014 Japan increased the consumption tax (消費税) – its national sales tax – from 5% to 8%. That had a predictable negative impact on growth, and so it remains an open question which way Abe and his cabinet will lean for authorizing the next increase in the consumption tax, a 2 percentage point bump scheduled for October 2015. The legislation is in place, but there is still an opt out.

One metric is inflation. Unfortunately a disadvantage of a large bump – in this case 3 percentage points – is that while it will produce a correspondingly large jump in the price level, the base effect will wear off if the underlying wage and other cost dynamics (and firm pricing power) remain unchanged. So we are now at the point where inflation is trending down. The depreciation of the yen helped hide that, particularly as higher import prices have been sufficient to offset lower global energy prices. But that effect too will wear off. Global headwinds now threaten; China, not the US, is Japan's largest trading partner. (Japan's exports to China of computer chips and the like are incorporated into iPhones and similar goods that are promptly re-exported to the US and ... whoops ... Europe. No out there!) So my sense is that if the economic stars are aligned, that is temporary.

All this begs one question on the nature of the tax increase: why large jumps? Instead of raising taxes by 3 percentage points in one fell swoop, why not raise rates by 0.75 percentage points every 6 months over two years? or (given the 10% end point) raise rates in increments of 0.5 percentage points every 6 months for 5 years?

That would have multiple advantages:

1. Incremental bumps would lessen the surge of big-ticket purchases just before the rate increase went into effect, and the subsequent negative rebound. Such volatility serves no good macroeconomic purpose.
2. Maxi bumps make sales data hard to interpret for the private sector – how much of the March 2014 sales surge was because the economy was doing well and how much was due to consumers pulling purchases forward? Such uncertainty serves no good business purpose.
3. Volatility makes macro data hard to interpret for us economists. Yes, readers are shedding crocodile tears in sympathy, but some economists do have politician's ears (such as Koichi Hamada, a friend of Abe and former University of Tokyo and Yale professor whom I've known for 30 years). If such economists are honest – Hamada is not a mere political hack – then they are surely tempering their advice.
4. Frequent mini bumps would add to inflation for some time to come. Surely that would be better if the goal of policymakers is to shift expectations away from deflation.
5. Mini bumps ought to be more robust politically. You can with good reason argue that, in the midst of a slowing global economy, now is not the time to bump the consumption tax to 10%. It would be harder to argue that going from 8.5% to 9.0% should be postponed.
6. Mini bumps ought to be easier to extend. From a fiscal perspective, even at 10% Japan's deficit will remain large, and at 10% the consumption tax is much lower than in many OECD countries. So why stop at 10%? That's surely much easier to sell if it's a continuation of mini bumps rather than a maxi jump.

Tightening loopholes through strict implementation of a national tax ID system may be the most desirable step. Right now though the stars are aligned around the consumption tax.

 

1. Money is fungible and there is no particular economic reason to run retirement programs on a stand-alone budgetary basis. Having separate retirement and healthcare accounts and taxes to match is however to my knowledge universal.
2. Cutting retirement benefits would have the same net budget impact and the same short-term contractionary impact as a tax increase, though with 25+% of the population already benefitting from Japan's programs, that's politically infeasible. It's also morally objectionable, as the twenty-five-percenters paid taxes during their working lives and so fulfilled their end the social contract. Extending the retirement age is a compromise: those near retirement may be treated unfairly, paying in more and taking out less than they anticipated, but at least the ex post adjustment is muted.

Michigan's Anti-Tesla Ban: Bloomberg is Off Base

Bloomberg has an op-ed "Detroit Fights Innovation -- Again" which in fact is not about the Detroit Three of GM, Ford and Fiat Chrysler [the merger was consummated on Oct 12th] or even manufacturers, but about Michigan and (indirectly) automotive dealers. It makes the very tenuous claim that state policy that blocks Tesla from running company stores (in contravention to existing state law) is tacit protectionism that represents a step backward. Indeed, the article implies that the restriction is ultimately aimed at preventing a Chinese invasion. In fact the policy is misguided because history shows that there's no need to fear factory stores, at least as long as they're not set up by a car company so as to undermine their own existing dealers.

First, there's the red herring: China. The editors – there's no by-line, though David Shipley is listed at the bottom – ignore that GM and VW are the biggest players in China, and that purely domestic firms are in a tailspin (Warren Buffett has thrown away a pile of money on BYD [比亚迪汽车]). Two firms less successful in China, Honda and Volvo, are however already exporting. The camel's nose is well inside the tent: all of China's major players are multinationals who already have dealerships spread across all 50 states. And protecting the Detroit Three? Don't they editors realize they have but 46% of the US market?

Second, multiple automotive firms in multiple countries across multiple decades have tried and failed with factory stores. If you read carefully, you'll even find Tesla talking about defects with their distribution model. A modern dealership is comprised of six interlinked businesses: new vehicle sales, used vehicle sales, used car wholesaling (trade-ins), finance & insurance [including warranties], repair services, and parts sales, both retail and wholesale. (Some add a seventh to the mix, body shops, which in practice are a very different business from service & repairs.) So a manager must handle trade-ins, push used car sales and otherwise place a priority on things other than selling new cars in order to make a profit. On top of that, dealers are in a constant battle over what sort of physical "store" is needed, how much and what kind of advertising is necessary, and many other decisions important from a financial or strategic perspective. All this requires an ability to say "no" to the factory. No company has ever granted the manager of a factory store that level of discretion.^Note

More important for potential new entrants, independent dealers provide billions in financing to a car company, because they hold inventory, not the OEM. The real estate is theirs as well. Any potential new entrant that needs a large distribution footprint -- that is, any company outside of the supercar niche -- can't afford to ignore that. If Elon Musk wasn't so good at bilkingmilking investors, he would need that money, too.

So the Bloomberg editors are accurate that Michigan -- which is far from being in the vanguard on this issue -- should not concern itself with Tesla's retail strategy. They are however accurate for the wrong reasons: factory stores have been a bloodbath for all who have tried, and will remain so. Indeed, they're critical to a car company's financial viability. Contrary to the editorial, it's not incumbent car companies that should be concerned, or existing dealers. It's Tesla shareholders and bondholders who should worry.

---

Note: The factory rep who has actually sold a car to a real customer is the rarest of creatures. To my knowledge there are none with the experience of running an independent dealership. Then there are incentives: a factory rep works for a salary, and their career depends on saying yes to their boss. They are not offered compensation commensurate with what the principal of a (successful) independent dealership can earn. So both corporate incentives and practical knowledge stand in the way.

Espresso and Pizza

photos fixed Jan 3, 2015

The base post lies at Espresso and Pizza on October 7, 2014 on The Truth About Cars.

I don’t normally post about vehicles themselves, but I am endlessly fascinated by the industry, and constantly surprised to learn of new niches. On the finance side, I’m amazed at the variety of vendors that show up at conferences such as those sponsored by Auto Finance News. One of these years I’ll make it to SEMA (the Speciality Equipment Market Association), which by reputation has both the credible and the incredible. But back to my topic: once in a while I do find products – or rather niches, I’m not a “car guy” – that intrigue.

I have fond memories of the local Good Humor trucks, which once made the rounds of Detroit. Then there was the lunch truck at the Chrysler Mack Stamping plant, where I worked some decades ago. Perhaps they’re still in business, but of late I see few such. Yes, the funnel cake van is a fixture at community festivals here in rural Virginia, and at least one of the local BBQs sell their pulled pork from a truck. The vendors of sausages and gyros unload everything from a trailer to set up under a tent, while the Ruritans sell hot dogs and burgers from a modified trailer. Other than the huge step vans on Constitution Avenue in DC, today I seldom see truck-based vendors, and the ones I do see are very utilitarian in their setup.

In Japan the historic model is the pushcart vendor (yatai 屋台). Going back to the 1800s, the Tokyo (Edo-mae) variety of sushi started out that way, a snack food sold on the streets, low not high cuisine. Into the 1970s (but now largely vanished) you could find yatai in the evening outside train stations, selling noodles or yaki-imo (sweet potatoes kept in hot gravel) or tako-yaki (octopus “donut holes”). It was in Tokyo that the phrase “chestnuts roasting on an open fire” first took on meaning for me, because that was another staple of street food. Such are not unknown in the US; you still find pushcarts in Central Park and elsewhere in New York [by which I of course mean Manhattan]. When I worked on Wall Street (well, actually Pine Street) I was fond of hot pretzels. But in Japan the modern version of the pushcart vendor is likewise relegated to the grounds of the local shrine during community festivals (matsuri).

Then I spent a year in suburban Japan. There you encounter a modern version of the yatai of old, imaginative and entrepreneurial. These are (often) young couples in “kei” trucks (mini minivans) fitted out to be one or another sort of mobile restaurant. You encounter them in suburban parks and other places families frequent, or in urban plazas. [In most of Japan parking along the street is not an option. In the areas I frequented the police made no exception in the late evening, when streets were only occupied by the occasional taxi and by drunk sarariman tipsying towards their train home.]

Here and below are photos by Smitka

Entrepreneurial, imaginative. First, the imaginative. To be practical, imagination must be constrained, not given free rein. Keeping things small(er) is one such constraint, pushing creativity in much of the world in directions irrelevant to the US environment. In Japan you find many adaptations to narrow streets and small lots. There are the local restaurant delivery services. At one time that would have been a Chinese restaurant or sushi shop, but tastes have changed and now that niche is dominated by contemporary sorts of foods. In the US delivery is done by employees in their own car. Not so in Japan – it’s by company scooter. In Chiba (a city of 900,000 just east of Tokyo) that might be the local Pizza Hut franchise. [I was never tempted to sample their fare...] Similarly, the backhoe that as I write is digging a trench to improve my driveway’s drainage is small, but it’s a monster compared to the construction equipment at sites in urban Japan.

So I should not have been surprised at vendors in their “kei” minivans, laid out to take advantage of every cubic centimeter. I unfortunately don’t have a photo of my favorite, a “kei” that a couple fitted with a wood-burning oven appropriate for two small pizzas. Not a viable business? Actually, it was about right – they didn’t have much workspace to toss the dough and lay on the toppings, and with the very thin crust they used – something I’ve seen in Milan and Tokyo but not the US – a “pie” didn’t take long to bake. The wait wasn’t bad. Theirs was a one-off, a personal project, but it looked something like this:

My most recent encounter was with a mobile coffee shop. I had a chance to chat with the owner/barrista in between customers. He had designed the layout himself, and helped do the fitting. Water, propane for heat, a grinder, an espresso machine, a sink, a fridge … the whole works, and he roasted his own beans [his logo proclaims that: 自家焙煎]. He wasn’t however in the suburbs but instead near Tokyo Station, taking advantage of real estate laws that set fairly restrictive floor-area ratios forcing newer office buildings to include an off-street plaza. He had a rotating schedule of such locations where he’d negotiated access (presumably for a fee). While he had an awning and some seating, most of his business was take-out. That sultry summer day he was busy enough, though he’s inclined to take the day off in truly inclement weather. Here is the van, with the “master” at work. (Click to enlarge!)

Home Roasted Beans	Master at Work	Service Counter

In my experience restauranteurs are quite finicky about their setup. This entrepreneur may have been willing and able to take a hand in finishing off his creation (see his 大月珈琲店 Facebook page for photos). However, welding and fitting are not part of the typical Japanese skill set, where “do-it-yourself” does not include even the most basic of household repairs. So with a little bit of digging I found several companies that specialize in such, including ZECC, Maku, Aian Cook ["Iron Cook"], and (winner of the best name) Mobil Cafe Mom’s: Production of Customized Car. The used car page on GooNet lists 104 “mobile retail” vehicles for sale, with prices from around $12,500 for a used truck to $25,000 for a brand new one, albeit none of these have appliances. An example from carsensor.net lists one with already equipped with sinks, plumbing and exhaust fan at $17,000. Yahoo Auctions Japan likewise lists numerous vehicles, so it appears to be an active segment. (I didn’t check Rakuten; in Japan eBay botched its initial entry and is not a player.)

Now I’m sure there are similar specialized firms in the US, and maybe on the West Coast mobile vending remains a lively business model. Yes, there are unusual promotional vehicles, such as the Oscar Mayer Wienermobile – there’s one on permanent display at the Henry Ford Museum in Dearborn. But I’ve not seen such whimsical “mobile kitchens” outside of Japan.

Links to (Japanese) pages with photographs:

1. Pizza Boccheno
2. ZECC, which specializes in making “mobile retail” vehicles. Lots of photos.
3. Pizza Ci Vediamo [note the Coleman brand tent!]

[Note: max "kei" dimensions are 3.4m x 1.48m x 2.0m with an engine of 360 cc - a Smart is too wide and has too big an engine.]

Labor Market Update: little bad news, but no acceleration

I post below a series of graphs on the US labor market updated through September 2014. As I read it, the latest CES (Current Employment Survey) and CPS (Current Population Survey) releases from the Bureau of Labor Statistics show more of the same – job growth a bit above population growth, little bad news, but no hint of an acceleration in the economy that might soak up what I estimate to be a 7.6 million shortfall in total employment, and 8.7 million gap if we subtract the rise in those working involuntary short hours. All this is calculated correcting for demographic effects including baby boomer retirement. As the graphs indicate, there's been no drop in participation by older Americans; the brunt of our recession was born by prime-age workers and especially new school leavers.

Warren Buffet's Berkshire Hathaway buys auto retailer VT Inc.

From Slate Magazine: "Warren Buffett's Latest Deal Has Officially Made Car Dealerships Cool"

I don't think so. I have a LOT more to write on this as someone who has spent a career life in the retail auto business AND worked in the van Tuyl organization. This time, Warren might have bit off more than he can chew

This is a REALLY BIG DEAL!!!!

Ford Poised to Realize an Upturn in Margins?

http://seekingalpha.com/article/2538735-is-ford-on-the-cusp-of-an-upturn-in-margins?app=1&uprof=53

A good piece from Seeking Alpha on Ford, instructive in the importance of margins, or as we call it in the retail auto business, "Gross Profit," what consumers hate to pay. "Success for any company begins with gross margins as this tells you how much it costs a company to make whatever it's selling. This is a pure look into a business' ability to show pricing power with its suppliers and demand from its customers."

In For The Long Haul

The original for this post is at TheTruthAboutCars.com, which in turn draws upon a post by Alexander Dawejko done for my Economics 244 course. I have added another paragraph here.

ZF Friedrichshafen is buying TRW; JCI sold its automotive business to Gentex and Visteon. Are we in a new era of supplier M&A activity? The previous wave didn’t work out well – Dana, Tower, Dura, Lear and others ended up in Chapter 11.

So how about Federal-Mogul? They too went on an acquisition binge in the late 1990s, including the British firm T&N. In the process they took on debt, with a $2.75 billion package just for the T&N purchase. As with others, they bit off more than they could chew. Federal-Mogul’s downfall however wasn’t operational issues but one T&N factory that had used asbestos. The accompanying $1 billion-plus in costs tipped them into Chapter 11, and it took until 2007 – 6 years – for them to emerge. So where are they heading?

Now back in 1999 Carl Icahn, a corporate raider, started buying shares in Federal-Mogul. The value of his initial holdings vanished in Chapter 11, but he also bought Federal-Mogul debt, a lot of it, and in 2007 emerged as the dominant shareholder in the new firm. Icahn’s modus operandi had been to acquire a majority stake in a company – the list includes Viacom, Marvel Comics, Blockbuster and Time-Warner – and then replace management with his own associates. They then would dismember the company in search of cash, with Icahn unloading his holdings as soon as practical, to make way for the next target.

Obviously 2008 was not a good time to unload anything automotive, and overall profits have since been spotty. But by 2012 profits were looking up, and Icahn split the firm into two pieces, separating powertrains (a $4.2 billion business) from aftermarket ($3.1 billion). This made sense only as a prelude to Icahn’s selling one or both of pieces. Consistent with preparing for a sale, he appointed an associate, Daniel Ninivaggia, as co-CEO of the aftermarket portion. [See a Sept 3rd Automotive News story.]

In a visit to a Federal-Mogul R&D center in Plymouth, Michigan we [Dawejko and the rest of the class] saw how focused their people were on designing and manufacturing new products. Most of the class had never heard of the test equipment we saw. Unlike the tribology labs, some of the products under development were self-explanatory, such as the corona discharge spark plug about which TTAC reported in 2011. What became clear is that Federal-Mogul is in fact a high-tech operation that spends 5% of revenue on R&D. They have been a PACE supplier innovation finalist 32 times, and an award winner 11 times. In the context of the automotive product cycle, however, technology is not a route to quick profits.

[In autos] technology is not a route to quick profits

Back to Icahn. The new co-CEO of the aftermarket half of Federal-Mogul may be an Icahn executive, but unlike the people Icahn installed on the board, Ninivaggia previously spent 6 years at Lear. He is an industry person, and not just an M&A specialist. In the same vein, Rajesh Shah, named CFO in 2013, has a long career working for auto suppliers, and came from another supplier rather than from Wall Street. Looking forward Ninivaggi noted, “There’s been a significant consolidation in the industry and as our customers have become very large companies, we need to do the same thing; we need to grow fast, improve our capabilities and expand our product lines”. It will take some years to show that the newly autonomous aftermarket operations are firmly profitable.

M&A may be a useful tool as major suppliers work to adjust their portfolio to match their global footprints, selling pieces that don’t fit to erstwhile rivals and buying similar operations from their competitors. Federal-Mogul is itself an assemblage of such pieces, cobbled together over the past 20 years. (An aside: one engineer the prof knows worked for five different firms, while never changing his desk at what is now a Federal-Mogul facility just outside Ann Arbor.) At the Plymouth tech center we were presented with their R&D roadmap, shared with their customers. They’re looking a decade down the road, 3 product cycles, for what future drivetrains will require. If they get that right, they will be one of 2-3 global players left in each of their product segments, with profits to match.

Pension fund managers operate on a 60 day cycle; the customers of hedge and restructuring funds take longer to get restive. Neither is compatible with the auto industry. History suggests that buying and selling automotive firms is not a quick route to riches for anyone but the lawyers and investment bankers who participate on a fee basis. Wittingly or not, Icahn is in this one for the long haul.

...there's irony when corporate raiders turn into stable shareholders...

Icahn isn’t alone in holding onto things; Wilbur L Ross with International Automotive Components has been “in” for a long while as well. Is there not irony when corporate raiders turn into stable, major shareholders, so that these firms look more like privately held firms investing across the business cycle than ones whose strategy is driven by the stock price of the moment?

By Alexander Dawejko ’17 and Michael Smitka, Economics Department, Washington & Lee University

Does Car Racing Make Cents?

Here is a post that draws upon questions posed by students that appears on the Economics 244 Auto Industry blog. However, instead of posting it in full here, I encourage you to go to it on The Truth About Cars item Does Racing Make Cents?, in part for the occasionally thoughtful comments that appear on that site.

Mike Smitka

Interest rates, inflation and growth

I go through US data periodically for a weekly radio show on W3Z - WREL in Lexington, Virginia. Unfortunately they don't stream their locally-produced content, probably because most of what they broadcast is syndicated and they aren't licensed to do so.

I've talked in recent weeks about the low returns available on savings. Let me trace that logic in more detail. In the end, I'll tie this to the discussion going on in economics circles about secular stagnation. (Since this is a blog, here's a link to VoxEU, which has just released a free eBook with essays by 19 economists, arguing the empirical strengths, weaknesses and implications of "staganation.")

Long-term rates are generally down since December: 30-year bonds fell from 4.0% to 3.2% and 20-year bonds from 3.0% to 2.4%. Those are drops of 0.8 percentage points and 0.6 percentage points, respectively. (Meanwhile-year rates are flat at 1.6%.) That is not necessarily good news, as it means that the serious money crowd think that growth will be weak for years to come.

Let's look at the numbers over time and see what they imply. If you're an investor, you can buy a 1-year bond today and another 1-year bond a year from now. Or you can buy a 2-year-bond today. Since there are lots of players in this market trading minute-by-minute, those two returns ought to be comparable. Here are calculations of future rates consistent with today's bond prices. (There are other corrections, such as for risk, but I don't think that changes my results in a qualitative manner.)

Who is Number One?

Auto sales are not the only measure to assess an auto OEM's relative health. This piece from the Detroit Bureau lays it out:

• GM slid to third when it comes to units sold for the first half of 2014. And focusing on just the most recent quarter, the Detroit maker fell to fourth when it comes to gross revenues.
• GM reported gross sales of $39 billion for the April to June quarter, noted Autoline: Detroit Editor John McElroy, putting it well behind Germany’s multi-brand Volkswagen AG, at $68 billion. That was well ahead of even the industry’s leader from a unit sales standpoint, Toyota, which managed a still-hefty $62 billion in revenues.
• The big surprise was Daimler AG, which managed to nudge past GM with $42 billion in second-quarter revenues. GM, in turn, managed to squeak past the Euro-Asian Renault-Nissan Alliance by just $100 million.
• Ford Motor Co. delivered $37 million in revenue, with fast-growing Korean siblings, Hyundai-Kia reporting $33 billion. The newly merged Fiat Chrysler had combined revenues of $31 billion. Rounding out the list of major global plays, Honda revenues came in at $29 billion, with BMW in the industry’s 10th spot at $26 billion.

Auto Finance Sub Prime Bubble?

I don't think so. For some reason, the New York times jumped on an Equifax report, cherry picked data to suit a sensationalistic agenda, and published the piece on Dealbook (link). Many have weighed in since, including myself – see below! Other examples are Marketwatch and a NYT Op-Ed

Written for Auto Finance News

By David Ruggles

A recent report from Equifax Inc., which noted that originations and total outstanding balances for subprime auto loans have hit recent highs, triggered an alarmist article on subprime lending in The New York Times. In the July 19 piece, authors Jessica Silver-Greenburg and Michael Corkery cited anecdotes that leave the impression that fraudulent practices are widespread. They castigate the “high” interest rates on subprime loans without mentioning the high rate and expense of default and repossession. Repos can reach a third of originations, and collection practices ― which are expensive to begin with ― are a challenge on these loans.

Through April, 2.6 million subprime loans were originated, representing 32% of all auto loan originations, according to Equifax. The outstanding balance of those subprime loans totaled $46.2 billion, an eight-year high. Equifax defines “subprime” as loans to customers with credit scores of 640 or below. As a matter of record, though, in some circles, a loan is deemed subprime when the credit score drops to 580.

The American Financial Services Association and other industry professionals have since weighed in on the NYT article, noting that it enflames already-riled regulators. And Derek Kreindler, managing editor of TheTruthAboutCars.com blog, writes: “Don’t expect that 32% figure to let up anytime soon. The glut of credit available for auto financing ― driven by securitized subprime auto loans being sold as investment-grade instruments ― is going to keep the auto financing business alive and kicking for the foreseeable future.”

Mitsubishi Motors Future: Summer Guest Post #1

This post was written May 12, 2014 by Anton Reed '14 for Economics 244. The Prof edited it and appended comments by others in the class.

Nissan acquired MMC and is now in the process of redesigning product to share components and rethinking product lineup and factory utilization. See ongoing coverage by Hans Greimel in Automotive News. the prof, Mar 2017

For my own analysis see Mitsubishi Motors: Going-going ... gone? on this site.

In April, when they released their FY2013 annual results, MMC (Mitsubishi Motors Corp) reported record profits. Don't get too excited.

Mitsubishi Motors' North American operations are struggling; MMC sells far less than any other Asian car company in North America. The next smallest, Mazda, sold almost three and a half times as many vehicles in April 2014. Only six firms sold fewer cars, and of those only Volvo is not a niche luxury marque. (The other five, in decline order of sales, are Jaguar/Land-Rover, Porsche, Tesla, Maserati and Ferrari.)

There are positive signs, with April sales up 46.6% over 2013 and year to date sales up 29%. Only Maserati had a larger increase, but they sold 753 vehicles last year, so that shift represents only a few additional cars. On the other hand, among manufacturers building cars for mainstream customers, Mitsubishi sells the least, so its percentage increase likewise represents only a modest absolute change. Nevertheless Mitsubishi has been improving its North American operation, with net sales up 53% from 2012 to 2013.

Google's Autonomous Car: Don't Drink the Kool-aid

Google's senior executives are busily touting the wonders of autonomous vehicles. There's the technological marvel, at least in the eyes of Silicon Valley. There are the economic benefits - no more congestion, no more accidents. Wonder of wonders! – and great for the Google empire, and for its stock price.

The PR machine is a marvel to behold, and the gullibility of the audience – well, it's Google! Is their part in this really that much of a marvel? Will economic benefits be as great as they claim? Will they even be a player in future vehicle technologies? Their PR machine is not paid to probe such issues, much less point out that alternative technologies may bring almost all of these benefits more quickly and at a very modest cost.

First, the core innovations necessary for an autonomous vehicle are already on the road, the result of decades-long engineering efforts alongside which Google's investment and expertise pale in comparison. Blindspot detection, lane departure warnings, backup "assist" (outside the US that is surely called a safety feature) and adaptive cruise control are all necessary for an autonomous car. Now some of these aren't cheap, but they're falling in price. So we don't have to await an entirely new generation of vehicles to begin reaping the benefits. Crucial to Google's vision is that these are all partial solutions. However, I am not at all convinced that what Google offers will be a sufficiently big increment to offset the additional costs of full autonomy. Nor is it at all obvious that Google will have any role short of autonomy – their presence is not needed for these existing tools.

Second, Google's is not the only approach. In particular, connected vehicle technologies promise most of the benefits at a far lower price point and with a faster rollout. Such systems are inexpensive because they can use the copious computing power already in car, while the hardware consists of inexpensive RFID transponders (though not as inexpensive as the tags retailers use to deter shoplifting). The pieces of such systems are now being tested on the road, with a large test facility – the Michigan Mobility Transformation Center – an artificial cityscape – under construction in Ann Arbor, adjacent to the University of Michigan Transportation Research Institute. Such systems don't require the panoply of sensorts of an autonomous vehicle. Indeed the core components could be sold as an aftermarket item, albeit with lower functionality. Such connectivity could be rolled out in the course of years.

Call for Entries: 2014-15 PACE Supplier Innovation Competition

Time for suppliers to apply for the 2014-15PACE COMPETITION! (Links to PACE web site)

Autosaurus Rex: Car Death in Japan (revised)

Iwao Corp: After the last auction

Thanks to Prof. Shioji of Kyoto University for arranging this tour in conjunction with the 22nd GERPISA Conference, June 2014

Car's don't last forever. Auctions provide one intermediate step, helping set a market in used car prices and facilitating the reselling from the original owner. But what happens after that? One place is the Mogitori Center of Iwao Corporation [リサイクルセンター有限会社イワオ] in Yawata City, Kyoto.

Now as noted earlier this June in the post on auctions, the average life of cars was at one time extremely short, driven by the escalating costs of vehicle inspections, which included mandates for replacing items that might fail with age, at least when the system was set up in the 1950s. Until 1995 inspections were annual from the 10th year, and since they were costly (US$1,000 at a dealer, including biannual vehicle taxes), the result was that few cars were kept longer than 10 years. Indeed, through 1997 the average life of a passenger car was stable at 9¼ years. Thereafter it rose steadily to hit 10 years in 2000, 11 years in 2005 and 12 years in 2010. (The chart in the post on auctions gives a stable 4.7 year average age through 1995, then rising monotonically to 8.1 years in 2013. I do not know the source of the difference – given the context I think it is age at auction, but the underlying source does not make that clear - literally, in that the relevant footnote is too blurred to read.)

Still, cars don't live forever. Accidents happen; depreciation is inexorable. So while about a third of cars sold at auction are exported, most eventually are scrapped. That's what Iwao does.

Disassembling a car takes less time that putting one together. The key is to extract value – and stay legal. Typically the tires and wheels have been removed before Iwao receives the car; sometimes the engine and other replacement parts have already benn removed. For what they do get, they pay by weight – trucks hauling in cars get weighed before and after unloading. Once that's done, the fluids must be removed. The gas tank gets emptied, and cut open to release residual vapors and prevent an explosion. The freon (or other refrigerant) gets recovered, to prevent the release of greenhouse gases. Then the airbags are set off – once the appropriate wire harness is exposed, all that needs to be done is to run a current through it, from a safe distance. The battery's removed, oil and other fluids drained. That all takes maybe 15 minutes, at least for an older car that only has a basic battery and a driver and a passenger side airbag. (Modern cars must be more challenging, with more airbags, multiple batteries, and plastic gas tanks. But for the time being most predate that era.)

Then the fun begins. A forklift is thrust through the windows, and the car moved to the initial disassembly location. A quick flick and it's on its side, so the axles and gas tank can be cut loose with a torch, any underbody wire harnesses cut, and bolts holding the engine removed. Another couple torch cuts and the engine flops out, and is moved to another station where the various appurtenances attached to the block are pulled off, leaving a large chunk of aluminum. The exhaust system (and particularly the catalytic converters) are then cut off and put in the relevant pile, and if they're still in the vehicle, the radiator and air conditioner condensor are removed. (Of course they'll also salvage parts from recent vintage vehicles, but so few remain on the road after year 10 that Iwao makes no particular effort to resell individual pieces of older vehicles.)

Meanwhile, the body is lifted over to face the jaws of death. This tyrannosaurus rex of the automotive world punches through the roof and rips it away. The monster might shake and throw a recalcitrant car around, playing with it until can rip enough roof off. Then in a couple gulps it dispatches the instrument panel, tossing those bites aside. It then punches through what's left to grab the main wire harness: copper's valuable. Once that's done it tosses it to one side for a quick scan for any other easy-to-remove wiring. Then it's to the crusher, and the cube stacked with others awaiting its turn in the shredder. [In Japanese it's a "nibbler" crane [ニブラ重機], though the bites it takes are pretty big! – here's a YouTube link, though it's not the same facility.]

What goes on in the shredder isn't visible, but the noise and dust make it clear that violence reigns. (I didn't ask whether it is a toothed roller or hard steel balls swinging on chains.) Not everything gets shredded sufficiently; a crane picks up big pieces and stacks them for reshredding. For the remainder, a magnetic separator pulls out the steel; a "cyclone" uses air to separate out lighter components, such as the fabric and foam in the seats, carpets and headliner, that then gets compressed into burnable chunks that can be sold as an alternative to coal. Two workers in full suits and breathing units pick out rubber tubing in an enclosed shed through which what's left. Of course that's a function of the resale price of various types of scrap. At present about 20% remains as "shredder dust" headed for a landfill; potentially that could be reduced, if Iwao can find a market for additional types of material.

Back to cars as durable goods. For a given rate of depreciation, the higher the value of recycled components, the sooner a car will get scrapped, by Iwao Corp or one of 3,000 other small-scale operations. However, the advent of auto auctions facilitated more used cars being exported, driving down the number scrapped domestically. At it's peak Iwao handled 150,000 vehicles a year; it's the largest and most vertically integrated firm in the industry. But now it's down to about 70,000 per year, or 50% of peak, though most it buys already compacted; only about 10 per day start as complete vehicles. Still, the scrapping facility we visited generates about US$5 million a year in revenue, with 10 workers, 2 bookkeepers, 2 truck drivers and Mr. Iwao.

In Europe environmentalists have seen that OEMs face mandates that cars be made capable of recycling. Despite high prices for steel scrap, copper and aluminum the labor involved means that only some can actually be profitably culled. Of course if the workers know the layout and composition of each and every model they face in their dirty, noisy shops – but these are not the sort of jobs to attract those with analytic skills and an attention to detail. Watching this operation suggests less may become recycled, because the mix of materials – aluminum bodies, magnesium liftgates, and a wide array of plastics – will be harder to sort through.

Mike Smitka

Janet Yellen's Dashboard

Once a quarter, Federal Reserve Chair Janet Yellen and her colleagues on the Federal Open Market Committee take a thorough look at where the U.S. economy has been and then make projections for where they think it’s going. The next batch of those predictions—for unemployment, inflation, growth and interest rates—will be released on June 18. Ms. Yellen will discuss them at her quarterly press conference. (Brookings link)

David Ruggles

Auto Auctions, Japanese Style

Here're just a few notes on a visit to the Kinki branch of Toyota Auto Auction on a day when they were offering 1,700 vehicles (of which 10% or so might not hit the reserve price). This was arranged by Prof. Shioji of Kyoto University who helped host the first meeting in Japan of GERPISA, an international consortium of (mainly social science) researchers on the global auto industry. Now I've yet to see a Manheim or an Adesa auction so I can't compare and contrast. Perhaps later this summer I can rectify that...

At the Kinki site there's a massive multi-floor garage; land's too valuable close to Osaka for a massive open-air parking lot. We watched one of their evaluators go through a vehicle with a long checklist, from spots of corrosion to paint that suggests a repaired ding, including pulling away the fascia in a couple places. Most purchasers don't look at the actual vehicle but rely instead on the (target) 7 minutes that an inspector spends on a car.

Indeed, when we moved inside it was apparent that many purchasers are remote. While there is a large room of people bidding, many others are at computer screens elsewhere, while those at the Kinki site are watching simultaneous auctions held at other TAA sites. For that matter, Kinki TAA itself runs two lanes simultaneously; each computer in their bidding room has a red button on the left, a blue on the right. So first the screen updates as pre-bids are sorted out, and then the live bidding begins as those sitting in the auditorium or elsewhere click the bid ¥1,000 higher. The screen changes color once the reserve is hit – most of the cars are from trade-ins at Toyota dealers – and sellers can negotiate with the highest bidder when the reserve isn't hit. (I will check my notes later, but recall the no-sale rate is about 10% or, to put it the other way, the conversion rate is 90%.)

Now several larger trends in the Japanese market and in used cars showed up in our discussions. One is the role of cars as durable goods. Japan raised its consumption tax from 5% to 8% on April 1st and given that processing paperwork for a new car purchase takes several days (you have to file proof of a parking spot, which must be vetted by the relevant local government), sales plummeted in late March and are only now starting to recover. The result was a short-run dearth of vehicles coming to auction, and a modest bump in prices. Now at one time cars were kept but a few years, typically being scrapped before vehicle inspections became annual in year 10. That in turn meant low prices for used cars in year 8 ... so the prospect of even a minor repair could lead to a vehicle being scrapped. However, in the early 1990s the vehicle inspection system was relaxed, with less frequent inspections, fewer mandatory parts replacements (reflecting the abominable quality of Japanese cars in the 1960s, brake lines were one mandatory item), and allowing non-dealers to do the inspections. As a result the average age of vehicles is higher, and with a more vigorous resale market, well, that's when TAA switched from a way for Toyota to help dealers by buying trade-ins at an artificially high price as a quiet, off-books subsidy to a real entity. Of course the fact that one friend drives a 13-year-old vehicle that he's in no hurry to replace is not necessarily good news for those selling new cars. Even so, the market remains thin at older ages, where roughly one-third of cars are bought by foreign traders (many in evidence at TAA that day) for export to Russia, Pakistan and West Africa.

The group also visited a shredding operation; more on that later. The key link to TAA is that their business is down by about 50% as vehicles are on the road longer and more are exported (including some apparently exported to be scrapped). As noted in earlier posts on this blog (The Decline of the Japanese Auto Industry), it's going to be really interesting to see how all of the loss of a large domestic market interacts with the product mix of Japanese car companies and particularly the survival of Japanese parts makers.

The Supplier Auto Parts Fixing Scandal is Just Getting Started

Auto parts price-fixing probe rattles industry Star-Telegram, May 16 By Eric Tucker, Associated Press

WASHINGTON — An investigation into price-fixing and bid-rigging in the auto parts industry has mushroomed into the Justice Department's largest criminal antitrust probe ever, and it's not over yet.

As noted in the article, we're 4 years into the price-fixing investigations, with total fines to date (including ones levied in Japan and Germany, not just the US) of $2.3 billion. On the criminal side it's not clear whether there's much left in the pipeline.

The more interesting part is what whether any private anti-trust suits. In the US antitrust law provides for treble damages to private parties. My strong assumption is that antitrust settlements are set high but well below the maximum to garner guilty pleas and fines paid without chewing up staff time – otherwise the Department of Justice doesn't have enough people to prosecute everyone. If that's the case, then actual losses to consumers are far higher than $2.3 billion ... and the private penalties are thus $10 billion or more. That would be enough to push some suppliers into Chapter 11 (or its Japanese equivalent).

Now ... because all cases have resulted in guilty pleas without trial, no evidence has been made public. That may stymie the ability of lawyers to pull together a plaintiff or two and pursue a case. In any event, if private suits move forward, we're looking at years more. But if they go nowhere, then we may finally be nearing the end.

I know lawyers involved in one or another manner in these cases, and they take confidentiality very seriously. None have been willing to give me "deep background." Knowing how strict the rules are, I now don't ask. the prof

Summers and Marchionne on 2009 Auto Bailout: No Alternative

http://www.brookings.edu/blogs/brookings-now/posts/2014/05/summers-marchionne-2009-auto-bailout Discussion by some of the players in the GM and Chrysler rescues, which also "rescued" North American auto production and military procurement at a time of two wars.

Transparency, and Some Retail Auto Industry History

Ruggles

“Transparency” is one of the new buzz words in the retail auto industry these days. Dealers are urged to be transparent with their consumers because vendors tell us that’s what consumers want. These vendors tell us being “transparent” is the best way to win them over, as if all consumers think the same and all consumers mean what they say. Let’s take a look at transparency in the context of some retail auto business history.

First, there are a variety of definitions of “transparency.” True transparency is when the seller and the consumer have the same information as well as the equal ability to interpret that information.

I broke into the retail auto business in 1970 in a Chrysler dealership in Rock Island Illinois, Learner’s Sales and Service. Chryslers and Imperials had a 22.5% markup with a 2% “holdback.” Furys had an 18.5% markup with the 2% holdback while Valiants and Dusters had 14.5% with 2% HB. There was very little “trunk money” or incentive money paid to the dealer by the OEM back of “hold back.” There might have been some “stair step” programs around “build out” but as a general rule, gross profit was made ABOVE invoice with the “hold back” retained by the dealer. Some dealers took “hold back quarterly, some took it yearly. Our dealership had a $125. “pack” on new vehicles and none on preowned. The dealership used “washout method” accounting, where the new vehicle profit wasn’t shown until all trades on it had been sold. This was considered to be a good method of tax deferment, but was otherwise not such a smart program. All one had to do was lose track of where one was in the trade chain and it was easy to make a mistake if one wasn’t mindful of the true market value of a piece of inventory versus what the dealership actually had in it. But I digress. Everyone doesn’t find these things as interesting as I do.

From this point in in 1970, where gross profit was largely made ABOVE invoice less holdback, lets move forward in history. In 1970, sales were slow. The economy entered recession. The 1971 vehicles were awful. It was the first year for lowered compression ratios and unleaded gasoline. Not only did we lose most of the high compression ratio vehicles in model year 1971, we lost the 5 year 50K Chrysler warranty. Insurance companies had killed the popular performance cars, the Viet Nam war was underway, and the country was in the doldrums. Richard Nixon imposed a wage and price “freeze” which later came back to bite Jimmie Carter and the national economy in the ass. I worked for a salary and a commission of $10. per car sale. The gas for my demo was paid for by the dealership. We referred to ourselves as “Moral Motors” as we thought it was smart to charge everyone the same margin. We lost a lot of gross profit by offering up the standard discount to everyone, and “walked” a lot of deals when we turned down cheaper deals, eagerly gobbled up by our competitors. We thought we made it up in volume. The dealership had been in existence since the 1920s, and had long been paid for. And we had a large repeat clientele due to excellent customer service on the decidedly crappy quality Chrysler product as well as a robust leasing operation. Yes, we leased cars in 1970. In fact, the little Rock Island dealership was the largest Imperial dealership in the Chicago Zone and 5 guys would deliver over 100 vehicles some months. In 1972 Nixon repealed the “Excise Tax” on cars and the retail business exploded until the Oil Crisis of late 1973, when things went back in the tank. But let’s get back to the “transparency” issue.

Over time, the markup shrunk and the “hold back” grew to 3%. The OEMs shrunk the markup to allow them to raise their wholesale price without raising the retail price, figuring to take margin from the dealer and retain it for themselves. They did this under the guise of telling us real retail guys that consumers were suspicious of large markups and over allowances and that if we kept the shown numbers closer to the real numbers, consumers would be happier. Something else happened to transform the retail auto business in 1975. Joe Garagiola and Chrysler invented “Buy a Car, Get a Check.” The cost of the rebates and the eventual interest rate subventions, an eventual consequence of inflation that followed the Nixon Wage and Price Freeze, had to come from somewhere. OEMs included the cost in the dealer wholesale price while continuing to keep the lid on MSRP and the dealer markup to mitigate “sticker shock” to consumers. This was the first time consumers were taking delivery of a new vehicle for a price LESS than the dealer had to pay off at his floor plan bank.

Over the course of time we have seen dealer gross profit move from above invoice to below invoice based on a convoluted combination of “trunk money” that is earned from “stair step” sales incentives to purchase incentives as well as CSI payments and additional vehicle incentives based on OEM image programs. This “trunk money” system is FAR less transparent to consumers than the old system. Don’t get me wrong. I do NOT believe consumers have any right to know our true costs, even though vendors like TrueCar CEO Scott Painter say that hiding that true dealer cost information from consumers is costing the industry 4 million new vehicle sales per year because it creates “friction” in the selling process. Dealers often don’t know their true cost per vehicle until a particular program ends, and that is what grates Painter and others.

The “new” gross profit system is also designed to hide salient cost information from dealership staff who get paid based on a percentage of real gross profit. A cynical person might say that dealers aren’t likely to be “transparent” with consumers until they are first “transparent” with their own employees.

The information provided to auto retail consumers these days is vast. For them it is like drinking from a fire hose. There is so much “cost information” available even dealers and their staff have a difficult time interpreting it. It is anything but “transparent” to consumers. Its none of their business anyway any more than it is our business as consumers to know what our grocer paid for a head of lettuce. The system has evolved to the point it is designed like your cable TV or cell phone bill to be difficult to fathom while pretending to provide ALL the information. This is deceptive. It is FAR from “transparent.” In fact, it was NEVER meant to be “transparent.”

To be sure there has been distinct improvement in certain kinds of “transparency” over the last decades, in particular, in the area of Truth in Lending finance disclosure and with the FTC mandated pre-owned disclosure. Legal transparency should be followed to both the letter and the spirit of the law. No one should have a problem with either of these and other similar requirements.

Auto retail is the business of negotiation. For those who don’t have the stomach for it, I suggest they find another career path. There has always been artful negotiation and those who aren’t so artful. This allows those with polish and good technique to excel. It gives consumers the option of buying from the salesperson/dealership that provides them what makes them the most comfortable. To claim “transparency” while at the same time working within a system that is unnecessarily complex and designed to confuse to the advantage of the seller is duplicitous at best. I’d suggest we stop embarrassing ourselves by using the word. Consumers ain’t buying it. We don’t even buy it ourselves. Let’s get back to artful negotiation, sell some cars, and make some gross profit without claiming to provide something we’re not.

The Auto Industry: Journals from Detroit

My students have now a cumulative 150+ blog posts on the auto industry, plus 13 separate journals from our visits to firms and other events around Detroit. There are also scattered notes from our readings (Bill Vlasic's Once Upon a Car, Rudi Volti's classic industry intro, Cars and Culture, Tom Wolfe's The kandy-kolored tangerine-flake streamline baby and John Heitmann - Rebecca Morales' just-published Stealing Cars. Since I need to read and comment on what my students do, that's taken priority over generating new content here. I will repost roughly one post per student over the course of the summer, but take a look for yourself! You can find our Detroit schedule here and journals and all that as obvious when you visit the site.

Technological Surprises: PACE and PNGV at 20

I've test driven a number of cars the past week, and what I've seen is a cautionary tale on mapping technological trajectories. Two decades ago Automotive News launched the PACE Award to recognize innovation by suppliers. At the same time, the Partnership for a New Generation Vehicle (PNGV) set out to develop, well, the next generation of vehicles. What would be needed? Exotic materials, new propulsion systems, on and on. Yes, the steel industry came up with a light steel frame project, but the sense of the time was that aluminum, magnesium and fiber-reinforced materials would be central. On the drivetrain side, the future would lie with all-electric vehicles running on hydrogen fuel cells. Transmissions – well, electric motors wouldn't need one. For legacy combustion engines, however, the direction was CVTs (continuously variable transmissions).

Instead what we have are "standard" gasoline ICEs (internal combustion engines) that deliver 40+ mpg in a mid-sized car, with additional gains come each full model change. Turbos, direct injection, improved valve timing, all drawing upon sensor and computing power, have improved the combustion end. New bearings and friction materials complement that, alongside lots of little energy-saving steps – electric fans and eSteer that lessen parasitic losses are one example – cumulate to real savings. On the transmission side we will soon see 9- and 10-speed transmissions that use tried-and-true architectures and gear systems to deliver gains comparable to CVTs, enhanced by electronically-controlled shifts. Meanwhile metallurgy continues to advance, with hot stamping of "soft" steels into high-strength steel finessing the formability challenges to enable using lighter, stronger but still inexpensive steel. Finally, while not prominent in the US, at least for passenger cars, CNG and diesel (pervasive in Europe) and biofuels (ethanol in Brazil) provide greater flexibility and lower emissions alongside higher efficiency.

[Diesel, as a heavier product that needs less refining, should cost less than gasoline ... and in engines the new low-sulfur product can now run cleaner than gasoline. Sigh...]

Not all of this was wrong. What we see today is a greater palette of techniques and materials. The Ford F-150 will retain a steel frame, but shift to an aluminum body. Electrification of vehicles continues, as with eSteer. Start-stop systems bring much of the gains of hybrids at lower cost and complexity. Some companies have chosen CVTs over dual-clutch multi-gear automatic transmissions; they don't dominate, but haven't vanished. The one piece that seems wide of the mark is the (hydrogen) fuel cell, which with hindsight flies in the face of the economies of scale of electricity generation, while still requiring batteries: better just to use more batteries. At the same time, a totally new angle are connected vehicle and autonomous technologies that (as with adaptive cruise control) can perhaps improve traffic flow and save energy that way. Meanwhile, policies to lessen emissions and improve safety have gone much further than anyone imagined in 1993, when PNGV was launched. Both "cost" fuel efficiency, making the gains achieved to date surprising – in my Cruze I've peaked at 50.9 mpg over 25 miles.

Now in the long run I think battery electric vehicles will dominate. There has however been no breakthrough in battery technologies, only gradual improvements in power-per-weight and gradual reductions in cost. So as fossil fuel prices continue to rise – global growth dynamics are strong over the medium run, so higher demand will dominate improvements in extractive technologies – BEVs will gain traction. It will not however occur quickly. Meanwhile, as a perusal of PACE Award recipients demonstrates, lots of little steps continue that continue improving legacy ICE technologies.

Detroit Student Trip, Detroit Bankruptcy

I'm now back from a week on the road with students that provided an intense exposure to the auto industry and to the greater Detroit area. I managed to keep them busy, at the cost of my staying even busier, as I worked on logistics on top of taking part in activities. Before leaving preparations included a day-plus with Bill Cosgrove, a retired Ford executive who worked overseas, handling the Jaguar acquisition and the restructuring of Formula One racing, and in Dearborn under CEOs Jacques Nasser and Bill Ford. We also welcomed the author Tom Wolfe (W&L Class of 1951), whose mind remains razor-sharp and tongue eloquent. His discussion ranged from California car customization in the 1960s – a 1964 Esquire article thereon brought him to national attention as an author – and early NASCAR figures (interviews with Junior Johnson and with his father, then doing his 5th stint in prison for moonshining) to his own pimped-out white Cadillac.

From NYTimes March 12, 2006

Of course I did my professor thing, including working through books by Rudi Volti and by Bill Vlasic.

Thirteen students and I drove to Detroit, and began a round of visits. These included two trips to Ford World Headquarters to meet with executives, a meeting at the Detroit branch of the Federal Reserve, visits to suppliers Federal-Mogul, BorgWarner and Brose, presentations at UMTRI, and visits to the Ford Rouge assembly plant, the Henry Ford museum, the Detroit Institute of Arts and the Heidelberg Project, a Tigers baseball game and an alumni meeting that included a presentation by a top automotive industry lawyer. We even fit in a lunch with two retired Honda Manufacturing of America executives in Ohio en route home. [For a full schedule go HERE.]

Two presentations covered the Chapter 9 bankruptcy of the City of Detroit. One surprise is that the process is moving quickly. DIP financing (debtor-in-possession) is in place to provide operating funds, state contributions are penciled in and the hits to retirees worked out. Schools are already under state receivership; state oversight of the city itself will likely continue for 20 years. All involved realize that other municipalities will follow, and so courts and creditors view the process as precedent-setting. The other surprise (particularly for students) is that neither presentation mentioned the auto industry crisis. Detroit was an auto boomtown, and that was accentuated by World War II. By 1950, however, the city was losing population. Partly through lack of leadership, and not helped by battles with the state of Michigan (the capital is Lansing, not Detroit) and the worst race discrimination outside the deep South, corporate services and middle class residents left for the suburbs and the 1980s banking mergers left Detroit a backwater rather than a regional center. Yes, there was corruption, which may have been a small of immediate financial issues, but for three decades undermined the politics of the city.

The underlying story is however one of legacy costs. As the city shrank, so did its revenues, including property taxes and the modest city income tax. Its retirees refused to die at the same pace (and who is to blame them?!). Deficits accumulated, city services deteriorated, and a vicious cycle ensued. Today the city has a population of 0.7 million, down from a peak of 2.0 million, a 65% decline. Some neighbors remain intact in appearance, but the mansions of Indian Village and the Edison district give way in the space of a signle block to burned-out shells of formerly upper-middle-class homes. Nearly-free real estate is encouraging some entrepreneurs to re-enter the city; perhaps things are stabilizing. But little employment is to be found; all too many neighborhoods have but two types of businesses, liquor stores and churches.

Back to the auto connection. The North American industry's 2008-9 crisis mattered little to Detroit, because by that point little employment remained in the city, much less automotive employment. GM's headquarters is within city boundaries (with great irony, in the Renaissance Center constructed by the Ford family), but it is an enclave that helps local businesses little. Quicken Loans relocated to downtown, but again it's a drop in the bucket, and fails to offer opportunities to the local population. It doesn't help that high school graduation rates in the city are as low as 20%. So even before our Great Recession local unemployment was pervasive, and Chapter 9 restructuring inevitable.

Tom Hudson on "One Price."

Tom Hudson on One Price. The lede: No Haggle? No Problem. Or Not. The tag: The magazine’s legal wiz believes that dealers who advertise no-haggle pricing should be safe from legal action — unless, of course, they haggle.

Ruggles

A Perspective on Ford and the Automotive Business

Here is a student's perspective on a day spent with Bill Cosgrove, a retired Ford executive with experience at the senior level in Ford World Headquarters and in Brazil, South Africa and Europe. I will later move comments over from the Economics 244 blog where this was originally posted by Kade Kenlon on May 1st.

With more than 40 years of experience in the auto industry, Mr. Cosgrove had plenty of insight to share. Before he retired in 2003, after 31 years with Ford, he served as corporate vice president and the chief financial officer and chief of staff for the Premier Automotive Group (PAG). PAG was Ford's London branch that specialized in luxury cars including Jaguar, Aston Martin, Land Rover and Volvo. Although he retired from Ford, Cosgrove is still involved in the auto industry as he is on the board for Metalsa, an automotive supplier of structural parts.

Cosgrove began his talk discussing his fascination with the auto industry. There are so many resources needed to produce a car and getting everyone together on the same complex machine is truly amazing. The production of a car is so vast and so intricate, and it is not by any means an overnight process. Sheet metal takes time to produce and when you combine that with all the other necessary parts to a car it can take a very long time. The other point he makes about the auto industry is its uniqueness. You find everything in the auto industry including finance, economics, marketing, computer science, and so on. And, you can apply the knowledge you get from the auto industry to almost any other industry.

The complexity of the industry lead Mr. Cosgrove to develop a 5 step plan that, when followed, will bring success to an auto company. The plan is as follows:

1. Great Products

- It is impossible to survive without quality products. It seems like a simple and obvious step but it can definitely not be overlooked.

2. Competitive Costs

- Mr. Cosgrove stresses that this does NOT mean the LOWEST costs! Costs must be comparable to other cars from other companies that are on the same level.

(Steps 3,4 and 5 are sub-steps of 1 and 2. Without success in the first two steps, the next three are useless.)

3. People and Process

- This step demands strong leadership, the best engineers, the best IT guys, the best marketing guys, etc.

- Process refers to high discipline. An example of a bad process would be not knowing cash flows.

- GM exhibited poor process techniques when they refused to recall a flaw in the ignition switch that was causing accidents with their vehicles.

4. Strong Balance Sheet

- It is good to have lots of cash

5. Running Scared

- Always worried about what is on your back. When you think you have the answers, that's the beginning of the end.

- You have to realize that you need to change.

Running scared is the most important step. Cosgrove says that the reason that the Big Three all faced difficulty was because they weren't running scared. There was a change in the market, new players were introduced and legacy costs became a huge problem. These companies never expected to lose their enormous shares in the market. In the heart of their troubled times, they were spending more money on medical costs than they were on steel. "The key to running scared," says Cosgrove, "is having leadership in the company that encourages opposing views and doesn't allow the status quo."

Here's where other industries tie into the auto industry. To be any type of successful entrepreneur, you need to be running scared. It is necessary to be able to take a step back and look at the future and understand the bigger picture. You need to be uncomfortable, you're either growing or you're shrinking, status quo can't be an option.

After lunch with Mr. Cosgrove we came back to hear his predictions on future market share. He showed the most confidence in his prediction for Toyota that they would be losing market share. He thinks that because of legacy costs catching up with them, and a recall that has destroyed their public perception, they will go down.

Other Predictions from Cosgrove:

• GM-down. Although their products are majorly improving, the competition is also so he expects them to struggle.
• Chrysler- down. He is shocked that Chrysler is still around today, and believes they are at the top of their cyclical market share right now.
• Honda- flat
• Ford- Up and down
• BMW- slight increase

The day finished with a lovely dinner at the Chinese restaurant Canton in Buena Vista, VA. A long conversation over dinner gave us more insight on what it is like to be involved in such a large corporation and other ideas about the auto industry and where it's going. A large part of the conversation focused on the advancements we are seeing from Tesla with the completely electric cars. We discussed the logistics of a car like that and the potential it has in the market.

After a long day with Cosgrove you can gather a lot about the auto industry. But, you can also learn more about an interesting man, and so I will leave you with the most interesting facts I learned about Bill Cosgrove.

• He is an avid Jacksonville Jaguars fan. Being from the nearby area I guess it makes sense, but really the Jaguars!? He wouldn't be opposed to drafting Johnny Manziel, but right now he's just trying to get over how terrible Blaine Gabbert was.
• The luxury car he would purchase for the quality: The Volkswagen Phaeton. He says it is beautifully constructed but it doesn't sell because it's a Volkswagen. Makes sense.
• Favorite place he's lived: London
• Favorite Ford car: The one he owns, the Lincoln MLK hybrid. Amazingly, it took him 17 gallons to get from Florida to Lexington, a 10 hour drive!

Bill Vlasic's Once Upon a Car

This term I have my students reading 4 auto books:

• Rudi Volti's short historical overview, (2004). Cars and Culture: The Life Story of a Technology, Greenwood Press, 2004.
• Tom Wolfe '51, Kandy-Kolored Tangerine-Flake Streamline Baby, William Morrow, 1965. We were also fortunate to have him as a guest speaker, taking advantage of his visit to campus for the 11th annual Tom Wolfe Weekend Seminar funded by the Class of 1951.
• Stealing Cars: Technology and Society from the Model T to the Gran Torino by John Heitmann and Rebecca H. Morales, just published by Johns Hopkins University Press. Prof Heitman will also be a guest speaker.
and finally
• Bill Vlasic's Once Upon a Car: The Fall and Resurrection of America’s Big Three Automakers–GM, Ford, and Chrysler, William Morrow, 2011. If the GM story quietens, he might be able to join us for dinner in Detroit.

I call attention to the latter book, because we are reading it in conjunction with the visit of Bill Cosgrove '67, a retired Ford executive who worked directly with many of the people from Ford who appear in Mr. Vlasic's book. Mr. Cosgrove has read it a couple times (he also quotes from Maryann Keller's Collision Course), and will expect us to be familiar with the content.

To help with class discussion – at least one student should be familiar with any particular incident Mr. Cosgrove might bring up – and also because Vlasic's book is much richer than we have time to cover in class, students are preparing notes, selecting quotes and following up with questions. Those are divided into 3 pieces:

• Chapters 1-12
• Chapters 13-24,
and
• Chapters 25-32 plus the Epilogue.

I've a good group of students, their notes are thoughtful and they pose good questions. If you've read the book, then they ought to be interesting, and if you're preparing to read it (an "ought to" for anyone reading this blog!), well, come up with your own questions!! This and more are found at Economics 244 at http://econ244.academic.wlu.edu