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!