Followup

Mike Smitka

One quick point: if the underlying analysis of the previous post of a specific link between the housing bubble, the use of home equity lines and thence car sales is accurate, then we should see that showing up in differential behavior in low-bubble and high-bubble economies: areas with big bubbles should have had a greater car sales boom and a greater crunch (including repossessions). Of course empirically that could be difficult to identify, because the "bubble" areas (as I believe is very much the case, but have not checked) have higher unemployment and hence will have lower car sales and higher repossessions, independent of a finance link. Perhaps that can be done because only certain classes of credit histories showed a propensity to use home equity, whereas unemployment may hit both the conservative and the spendthrift alike. That's not an easy empirical task, closer to what might be needed for a serious PhD-level research project if not a multi-year PhD thesis project.

No More Clanging Clunkers, No More Sales

Mike Smitka

What, now that the clunkers program has clanged to a close? In a couple days we'll see what total August sales were like – I'm risking bytes of criticism writing now – but I'm afraid it will be back to business as normal. Afraid, because normal this year has been an SAAR of 10 million or less. The level of enthusiasm makes it clear that sales have been pulled forward; it'll be payback time. The problems run deeper: cars were affected by the bubble, and not just housing.
A recent NBER working paper by Atif Mian and Amir Sufi of the University of Chicago bolsters the argument that I've made in earliers notes. My analysis was based solely on an analysis of sales and scrappage data relative to the vehicle stock; they started out with data on 266,000 individuals in the Equifax credit rating database. (Don't worry – they couldn't actually look at individual records, but instead had to extract information from data that Equifax had already sanitized and then mildly aggregated.) But combined with data on geography and housing prices and demographics, they could paint a picture of where prices had gone up, areas where housing supply was "inelastic" so that shifts in demand showed up as higher prices rather than more construction. They could then look at who borrowed: not those with in places where prices moved little, but those who were in "hot" markets, and who started out with lower incomes and/or lower credit scores. And did they ever tap the equity; credit records made it clear that these people were also buying a lot of vehicles, vehicles they earlier had not been able to afford. But those same locations are ones where mortgage holders are now under water (see Federal Reserve data on credit conditions, illustrated by maps color-coded at the county level). They're losing their houses and their cars, not buying new ones. In other words, there was a bubble in the auto market as well, people buying on credit backed by unrealized capital gains.
That really is not news, though it makes for sobering and poignant stories (see the New York Times series on the Beth Court neighborhood in Moreno Valley, outside LA). But what Mian and Sufi show is that behavior didn't change much in the many urban areas where there was no run-up in housing prices (I'll append a graph I created from the Case Schiller real estate index that illustrates the contrast). In other words, the big boom in car sales came from the same people who were splurging on home renovations and vacations by pulling equity out of their houses. Well, that equity isn't there to the tune $1 trillion in California alone (data from an August 13th study by First American CoreLogic). In Nevada 45% of homeowners have negative equity of 25% or more of their mortgages; in California, 25%. These people aren't buying cars anytime soon. So while house prices may have bottomed out – and the recession ended – that doesn't mean the good times will roll again.
That's not only because of all the people who lost everything (or soon will, given that 5% of the labor force has now been unemployed for over 27 weeks, and another 2% for 15-26 weeks). On average the rest of us are worried. State and local governments are only now cutting their budgets; commercial real estate hasn't hit bottom yet. There are a lot of pink slips yet to be distributed. So there's no reason to think those of us who were more conservative in our habits are suddenly going to loosen pursestrings that long have been tight. Let's be honest with ourselves; if we're thrifty, it's by necessity: home equity is what we have from paying down the mortgage, not because the spot of mother earth we occupy was suddenly worth megabucks

The graphs below look at housing prices relative to the CPI index, real GDP and nominal GDP. One focuses on four of the metropolitan areas with the greatest run-up in prices, a couple of which have come back to earth, and then some. The other highlights cities where there was comparatively little change. I left the scale the same on both, which results in a lot of blank space on the second one, plus it's hard to read because the graphs lie more or less on top of each other. Which is the point it is meant to illustrate.

Here's a link to a powerpoint from a talk I gave yesterday (Aug 25, 2009) that includes additional material.

Click to enlarge!

Click to enlarge!

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Japan's Headlines: China not Clunkers

Mike Smitka

The top headline in the Nikkei today (Aug 7th) was neither their recession, nor their pending general election (and the potential change of government). It was July car sales in China, up 64% from from 2008 to roughly 1.1 million units. That's above the clunker-driven 1.0 million level in the US, and (as the percentage increase suggests) out of synch with sales doldrums during the past couple summers.
Part of the reason is that, despite the American perception of China as an economy dominated by exports, it's a country the size of the continental US, and that huge domestic expanse is peopled by 1.3 billion would-be consumers. The Chinese government is determined that they will be consumers. To make that happen, the government is providing plenty of domestic stimulus, unhindered (at least in comparative terms) by domestic banking problems, and with little of the pointless tax cuts and other fluff that bolstered the price tag of the "stimulus" package passed in the US. The ongoing construction of a national highway system provides plenty of room to speed things up (reversing the policy stance of a year ago, when the fear was inflation).
There are also vehicle-specific policies with bigger environmental implications than the US program that gets rid of a few seldom-driven¹ "clunkers." Their tax breaks and and scrappage incentives (that include provisions to help rid rural roads of smoke-belching 3-wheelers), was implemented in a timely manner in January 2009. The focus is small vehicles, those with under 1600cc engines, with no loopholes to subsidize the purchase of trucks (unlike the US "clunkers" program). And if you visit Shanghai or Suzhou, while you'll find the roads filled with scooters and motorized bikes, the noise level is a fraction of what it used to be: they're electric, driven by batteries. The garages of condos include outlets to plug them in at night, enough to power the daily commute. But diesel fuel in China is still sulfur-laden, so the next-best alternative, a clean-diesel powered vehicle, is not yet an option there -- as was the case until two years ago in the US. So China can't (yet) follow the European option of small, clean and very-long-lived diesel powered cars.
Now the China market is profitable for the moment, and important to global firms. GM has actually shifted its international operations HQ to Shanghai, anticipating its sales there to top 1 million units in the near future; VW already sells over 1.0 million units a year. Accordingly everyone is pouring on capacity and dealers.
This may be a "bubble" of sorts. Already the shift towards smaller vehicles makes it less of a gold mine than a year ago on a per-vehicle basis. Meanwhile, the number of players is mind-boggling: not only are all of the major international players in the market (VW and GM have the top two spots) but there are still 80 local players. Yes, 80 -- because local governments support their "favorite son" firms. If you visit China, watch how the make of taxis varies as you move from city to city. The government is pushing for consolidation, and a couple of the bigger players have bought up a couple small ones. Others have quietly exited. But consolidation has been policy for years and years, and still there are 80 firms! Unless push comes to shove, Beijing has all too little clout at the local level, and this is just one example.
Lots of players ultimately means little profit. GM, Toyota and their rivals are jointly placing a big bet that that does not happen until they've been able to recoup their investment. However, that's a game of "chicken" and at the moment no one wants to blink and ease off on the throttle. I smell a bloodbath in the making, red ink puddled all over balance sheets. That may be 3 years away, but it will happen.
Meanwhile lots of incumbents remain due to (local) government largesse. A couple will turn out to have been well run and innovative, though at present they are still woefully lacking in engineering sophistication. In the background Beijing -- not the locals -- is making a big push towards electric vehicles; ditto battery technology. So a few local firms are likely to focus on electric vehicles (not nightmarishly complex hybrids), and in a market where drivers don't expect to go hundreds of kilometers at a stretch, there will be a local market (unlike in the US). The transition in drivetrain technologies may allow a couple global players to emerge out of the current plethora of small, high-cost producers.
Note that this has strong parallels with the Japanese case. There government policy also pushed for consolidation, and it also failed to accomplish that. Now the early post-WWII market did have about 30 players, and without local government support [Japan's is not a decentralized political system] or other deep pockets half of them soon exited; Toyota and Nissan both picked up with an extra factory or two in the process. The bottom line however was a market with a dozen firms, no dominant firm or even a "Big Three" that could mute competition. In Japan, it was improve efficiency or fail, and in the end that gave birth to Honda and Toyota.² Japan's auto industry succeeded because industrial policy failed; the same, I suspect, will prove the case in China.³
Notes
1. Unfortunately the mandatory "CARS" survey that is part of the US "clunkers" program doesn't ask how many vehicles were owned. It does ask how many miles were driven the previous year -- as far as I can tell, no data from that question are yet available. Not surprising: most dealers haven't been able to get their "clunker" deals approved, much less gotten a check.
2. There are of course other Japanese firms, but only Honda, Toyota and Suzuki remain autonomous. Nissan is controlled by Renault, Mazda is de facto controlled by Ford, Fuso is owned by Daimler, Nissan Diesel by Volvo Truck, Toyota has purchased Hino and Daihatsu outright and has a large stake in Subaru/Fuji Heavy and Isuzu, and MMC has survived through the inexplicable largesse of its creditors and of Mitsubishi Heavy Industries.
3. I have only cursory knowledge of India. In contrast, I began studying about China in 1971, and while I ultimately became a Japan expert (more practical at the time), I've followed (and taught a course on) the Chinese economy for over 20 years, and have visited the country repeatedly.

Opel & GM

Mike Smitka
Further to my earlier post, Is there a GM without Opel?, the sticking points of GM's negotiations with the Magna-Gaz/Sberbank are over intellectual property rights: Opels are (currently) the core of GM's international operations and rights thereto can't be freely given away. My opinion stands: GM cannot afford to let Opel go and remain an ongoing enterprise. Too many of its engineering resources are bundled into Opel, and vice-versa. Germany doesn't want restructuring, enough unemployment already, and as partners in the current "trust" that controls Opel... How this works out is crucial. And apparently some at GM concur.
More posts shortly, following up on the June Business History Conference in Milan, on the tension between "administration" (as in MBA) and management (as in long-run health) and on health care. But first I have a book review, a manuscript review and an article to complete, all on the Japanese economy. And it's hard not to spend time reading about political turmoil, with PM Aso about to dissolve the Diet for an election that will almost surely dislodge him (and probably the ruling LDP coalition) from power.

Toyota and General Motors

Mike Smitka
The new General Motors was spun out of bankruptcy on Friday, July 10th. Its prospects are uncertain. The new cost structure and (one hopes) an end to complacency should lead in time to successful enterprise. Eventually: we should find caution in that GM's now much larger rival Toyota continues not only to lose money, but to lose it at a faster rate than GM-old.
What gives?
First, Toyota has gone where the money is: larger vehicles in North America. Toyota now sports V-8 engines, a full-sized pickup truck and a range of SUVs and other light trucks. Does that sound familiar? Well, so are the consequences: red ink. It was making its Tundra pickup in both Indiana and Texas; no more. All production is now in Texas – and that plant was closed for over 3 months in summer-fall 2008, and runs only one instead of two shifts. So it has billions in sunk costs that are generating little to no revenue, and is reluctant to lay off workers, as that policy has been a mainstay in its battle to keep plants union-free. Nor is the prognosis good: even if gasoline prices stay low, Toyota has few rural dealerships. Despite cutbacks, the Detroit Three still do.
Second, Toyota has focused on the American market in general, again because that is where the money is. The company is a modest player in Europe, and a latecomer to China; the population in Japan is aging, and the number of licensed drivers in its home market is in decline. It may book profits in Japan, because that's where the production of most Lexus vehicles is still located. But sales depend on the US.
It gets worse: product planning also followed the money. Anyone of my generation can remember (or often owned) a Toyota at one time (my first new car purchase, in 1981, was a Toyota Tercel). They were small, sparingly powered rust-buckets, but with good mechanicals for their time (by today's standards, they were junk). No longer are Toyotas small or sparingly powered. That pairing generates profits – the public perception of fuel economy is swayed by the Prius, but the Prius makes no money, at least since the price was lowered to fight the Honda Insight at the same time that the yen strengthened. But back to that pairing: such vehicles are peculiar to the North American market, and don't sell well in Japan or Europe. Those markets are left with larger vehicles that don't fit, they're just a bit too large on every dimension. Toyota thus struggles to sell such potential high-margin vehicles everywhere else in the world.
Third, they became a big company with big ambitions, replete with MBAs in various HQ functions. For those who don't know their history, Toyota was bailed out by the Japanese government in 1950, because they kept "pushing the metal" on dealers despite a recession. One measure, along with kicking the Toyota family out of management, was to split off the sales functions to increase their ability to say "no" to the factory. The separation between Toyota Auto Sales and Toyota Motors lasted about 30 years, but they've now been merged for 25 years. Headquarters staff over the past decade came to dominate product planning, investment planning, well, MBAs plan. But not always well, not when they are far removed from the "real" world of sales and manufacturing. Sure, Toyota was earning a better return on assets, 5+% instead of the early 3-4%, while return on equity was pushed to 15% and above. And sales kept increasing, first overtaking VW, and then briefly GM.
They were going to rule the world; they had already taken over Daihatsu and Hino inside Japan, and more recently acquired stakes in Fuji Heavy Industries ("Subaru") and Isuzu, both former GM affiliates. They upped their share of Denso to a controlling stake. And there was Lexus, and the Tundra, all those other nice high-margin vehicles. To support this growing empire took a lot of investment. But while the product plan looked good on paper, it wasn't necessarily what the people on the ground were comfortable making and selling. Furthermore, product proliferated, a car for every niche for every name plate. Inside Japan Toyota maintained 5 distribution channels and 47 cars in its 4 "legacy" channels, 9 for its new Lexus channel, and 13 more at Daihatsu (covering the minicar end of the spectrum). Add another 14 light commercial vehicles – but leaving out all of the heavy truck and bus makes of Hino – and they have 83 model names inside their domestic market. [my count] Toyota's brands are muddied and the cars are bland.
It doesn't take much imagination to see what happens to marketing costs. To make matters worse, Toyota outright owns several large (40-plus sales point) urban dealerships, because they can't operate as profitable ventures. (Not that people seconded from headquarters – with salaries paid by the parent company – improve matters.) And think of the engineers: they're so busy doing product, and all that totally new stuff for the US, that they don't have time to do things right, at least by their standards. Recalls are up sharply. Costs, too, because forcing commonality takes time, and time they do not have. (Remember, in today's auto industry most manufacturing is at parts firms, so using parts in common is the key to cost control.)
Fourth, they have their own unions to contend with, and those unions include engineers and regular office workers, not just factory hands. Plus it's easier to coordinate inside Japan, because even today language skills are weak. So we now find Toyota entering a steep recession with the ability to build 10 million vehicles, all according to plans from HQ, but with sales of only 6.5 million. Worse, they have added to that capacity not only in places such as Texas but also in Japan, where they can now build 4.5 million vehicles. In the process they have allowed their export share to gradually rise from under 40% in the mid-1990s to roughly 65% in 2008. But even as exports have fallen due to the global recession the yen has strengthened, amplifying their losses.
We may not have seen the worst of it. Toyota has quietly added a couple stamping facilities, bought from a failing domestic supplier. But it surely has many other suppliers, pushed to match its expansion, that have weaker cash reserves and weaker management. As things stand, they will have to pick up the tab (which to me is ethically appropriate, but is surely not part of the financial projections of their MBAs). And already their ROA has swung from 5.9% in April-June 2007 to -10.4% in Jan-Mar 2009. That's a swing in profits before taxes of Δ¥1,654 billion (or ΔUS$17.8 billion at this weeks average of ¥93 per dollar). Toyota maintains a sterling (though recently lowered) credit rating and sits on $30 billion in cash and securities and $40 billion in financial receivables. But it also has $64 billion in short-term debt and long-term debt due this fiscal year. Far better than GM, but as a big, heavy firm its cushion is not as comfortable as it once was.
Wish the new president Toyoda Akio good luck! If it wasn't for his ability to borrow to tide things over, he'd be facing a tougher battle than GM's new CEO Fritz Henderson.

This article relies on Toyota financial reports, on a 3-part series in the Daily Automotive News 小室祥子「トヨタ・新時代への展望」『日刊自動車新聞』 連載: 26, 27, 30 June 2009 and an article in Bungei Shunju 井上久男「覇者トヨタに何が起きたのか」『文芸春秋』March 2009, 94−108. While I did not stumble across it before drafting this note, see also the 22 June 2009 Bloomberg article Toyoda Asks How Many Times Toyota Errs Emulating GM Failures by John Lippert, Alan Ohnsman and Kae Inoue. Based on it, I edited my comments on the operation of the San Antonio, TX truck plant. They also note that Toyota dedicated its Woodstock, Ontario car plant in December 2008, and provide other examples of the firm's (overly) ambitious expansion plans.

WMRA Radio Show Mon 13 July

Michael Smitka will be on a live program, Virginia Insight, on WMRA Public Radio in Harrisonburg Virginia Monday, July 13 at 3 pm EDT. You can listen to an archived podcast HERE.For more information see the show's website; the host Tom Graham brings a fascinating array of individuals to WMRA's studios, including periodic updates on Virginia politics. WMRA is my local station, and I'm glad to be a supporter!

Ruggles Report - I Was Wrong!

I Was Wrong! But Don't Tell My Wife I Admitted It!

David Ruggles

I predicted that Chapter 11 bankruptcy for Chrysler and GM would cause chaos and linger for years. Well, I was right about the chaos part. Little did I know what can happen when the government is the driving force behind a Section 363 sale in a Chapter 11, and how much influence the provider of Debtor in Possession financing has - especially when they also happen to be the government.
I do, however, remain dead set against the arbitrary termination of Dealers. Let’s hope there is a favorable result from the House Resolution currently pending in Congress to reinstate Dealer’s rights under state franchise law. It’s probably too late for rejected Chrysler Dealers but GM Dealers may have a chance.
The recently published photo of Greg Mauro in Automotive News standing in front of his newly completed Chrysler – Jeep store should be evidence to all how arbitrary and counter productive the Dealer terminations are. The Mauro family does things one way: First Class. The idea that Chrysler would terminate a proven, profitable and successful dealer is still a shock. Particularly since they had just completed a $6MM plus new facility at the behest of the OEM.
Further, the idea the Task Force would mandate leaving an entire town like Ames, Iowa, a major university town, without representation is another shock. The examples go on and on. With such geniuses running these companies why would anyone want to own their stock? I won’t even start on GM in this column although they have officially been approved for their own Section 363 sale and have their own inane closings to account for.

Unintended Consequences
I find it curious why is no one is talking about safety issues associated with Dealer terminations. The Ames, Iowa vacuum provides just one example. Chrysler owners in this Midwestern community must now either take their vehicles to independent service centers for routine maintenance or drive MANY miles to an authorized Dealer. To my knowledge, Jiffy Lube and other independents don’t have access to information regarding safety recalls on new vehicles. Or if they do, it doesn’t seem like it fits their agenda since they can’t do the work anyway.
So we now have thousands of orphaned owners turned over to independent shops instead of being serviced by factory trained technicians. The safety recalls are only one reason this is important. Factory trained technicians also know where to look for other problems. Often these are little problems that turn into bigger problems if they are not addressed. For example, it came to my attention in the 1990’s Ford had an issue when they started putting cabin pollen filters into Taurus and F150. I f the filters weren’t changed at proper intervals they would clog and burn out HVAC blower motors.
Steve Finley from Ward’s Auto World recently “outed” Steve Girsky as the man behind the arbitrary Dealer terminations. Girsky is a former GM employee and Wall Street analyst who is now a member of GM’s board of Directors representing the UAW’s Voluntary Employee Beneficiary Association (VEBA) interest. According to Mr. Finley Girsky gave an address at a recent NADA convention where he said he thought the domestic auto makers should reduce their dealer counts by 70%.
The question in my mind is how Girsky came into such a position of influence. To my knowledge true visionaries like Maryann Keller and/or James Womack, and even the retired Lee Iacocca, were available and were not consulted. For those who haven’t read it, The Machine that Changed the World by James P. Womack, Daniel T. Jones and Daniel Roos is a must read. It was fascinating to read in the early 90’s and even more so now that many of their predictions have come true. And anything by Maryann Keller is on target and fascinating.
The Task Force selected a guy like Steve Girsky for advice and failed to bring in more proven voices. It seems the people making the decision to cut Dealers weren’t aware of the cost transfers to the Dealers made by the OEMs over the years. Their calculations of per Dealer marketing costs neglected the fact that the OEM’s own over production caused them to spend wildly on incentives. It had nothing to do with the number of Dealers. If anything, their Dealer coverage was an asset, something well recognized by Ford and anyone knowledgeable in the industry.
Yet, for all the chaos and the counter productive termination of thousands of Dealer franchise agreements, the two OEM’s appear “saved” for now. Time will tell how decimating their distribution network will benefit them.
It is important to note the U. S. Government Task Force has taken a different road than European governments. In exchange for bridge loans and other contributions, the European countries have chosen to exact employment commitments, as if employment guarantees are the answer to a bloated OEM’s problems. Dealer closings weren’t a part of any European plans. At least the U.S. government has mandated draconian job, pay, benefit, and work rule concessions to give Chrysler and GM a fighting chance.
Imagine if the Task Force had taken the European approach. We might have saved our Dealers but the companies would have been stuck with keeping non productive assembly plants and a bloated work force.

What’s Next? More Chaos?
Ford is making progress in terms of market share. They sure look better off on the surface than GM and Chrysler. But Ford is having trouble negotiating GM/Chrysler level labor parity with the UAW, who now owns significant positions in the competition. The UAW is playing hard ball with Ford as it knows Ford will do almost anything to avoid going to the government. The Ford family isn’t willing to take a chance on losing its special category of voting stock. They would most certainly lose that status in a Chapter 11 filing.
In addition, Ford borrowed a LOT of money to be able to dodge the fate that befell Chrysler and GM. And unlike their Detroit competitors, they have to service the totality of their debt! It’s great to be perceived as the superior company, but they just cannot afford to give up a major per vehicle competitive disadvantage. But the UAW believes they have Ford at a negotiating disadvantage and will work it for all its worth.
Long term, how do the Detroit 3 compete with Toyota, Honda, Nissan and other Japanese manufacturers? Honda just raised capital in Japan paying less that 1 percent interest. Toyota and Nissan also have access to cheap capital. Money owed to the U.S. Federal government and U.S. banks commands at least interest rates typical of corporate America while Ford is paying whatever rates were agreed to when they retrenched in 2006-07.

The Road to Recovery
Chrysler is trying to restart production. Most major suppliers are in Chapter 11, with the exception of Magna who just purchased Opel, GM’s European subsidiary. Ford, Toyota, Honda and the other U.S. manufacturers are watching their own suppliers closely. Not commonly known is the OEM’s all use the same suppliers. If a major supplier goes down, it shuts down production for everyone.
Moreover, many surviving Chrysler Dealers are having trouble obtaining essential financing and floor plan arrangements through GMAC It seems Chrysler terminated a significant number of Dealers who were financially sound and would have qualified for GMAC floor plan, or already had their own set up through local banks. Instead, they kept many who don’t have floor plan and can’t qualify through GMAC. What were they thinking?

The New GM Small Car
In the meantime, GM has now committed to build a small car in Michigan. Small cars have traditionally provided little to no profit for GM in the past. I wonder why Michigan, a stronghold of the UAW, was selected as the site to build this “important” and symbolic small vehicle?
GM will lean on everyone possible for tax abatement, free land, and whatever else they can think to ask for. How else can they hope to make money on this small car even after the cost reductions they’ve made in bankruptcy?
As the world languishes in recession, the recent uptick in oil prices is probably not the short term trend. I expect to see downward pressure on fuel prices toward the end of the summer driving season. Who knows what oil prices will look like when the new GM small car hits the market? Most assuredly, GM will not sell in enough small cars to make any real difference in the face of cheap fuel prices. And in Michigan, they will also incur significant labor and production costs compared to say Mexico, Brazil, China or even Canada. The same goes for their Hybrid and Plug-In-Electric offerings. Are we to believe that GM’s future depends on high oil prices?

Ruggles on Government Intervention
Lastly, a few words on the controversial tactics employed in Washington. I find it difficult to say government is inherently bad or government is good. It’s usually a mixed bag. Ronald Reagan was fond of saying, “Government is not the solution, it is the problem,” but I find that too simplistic a take.
The government just saved GM and Chrysler from liquidation. Whether that is good or bad is open for debate but they certainly did it imperfectly. In my mind, the Chrysler bailout of the early 80’s was a lot cleaner deal but times and circumstances are much different today.
I view CAFÉ is having been truly bad program from its inception. It is a result of the government not possessing the political will to do what the rest of the industrialized world has done regarding a fuel tax. The European/Japanese model has worked for them. On the other hand, our own dependence on foreign oil has more than doubled since the first oil crisis in 1973, even with the adoption of CAFE.
And now we have “Cash for Clunkers,” or “Cash for Guzzlers” - now officially designated the Car Allowance Rebate System (CARS). CARS has noble intentions, but as my father is fond of saying, “A camel is a horse designed by committee.”
With CARS, the Government has indeed created a “camel.” It currently has the entire new vehicle market temporarily “on hold” while everyone waits for the final details of the program. Consumers will end up frustrated over these details and will probably direct their ire at Dealers, rather than the Government. While the European C for C programs have worked well, I have my doubts for ours. Too many objectives were targeted and the plan lacks focus.
Speaking of Japan, I just returned after a 3 week visit. The Japanese government came up with their own program to try to boost sales of new vehicles. Their program is based on emissions, so hybrids get a huge tax break. The result? Everyone is rushing to buy a hybrid to get the tax breaks. Honda Insights and Toyota Priuses are oversold for months.
Absolutely everything else the industry needs to sell and can deliver NOW isn’t selling. Imagine trying to pay your overhead out of the dribbles and drabs of production you get for one model. The Japanese situation is another example of when government has all the right intentions but doesn’t account for unintended consequences.

The One Thing I Do Know!
There are a LOT of quality Dealers looking for a new franchise to replace the ones that were yanked. More importantly, these Dealers are motivated to take a big chunk out of the backside of the OEMs who jilted them. Import OEM’s are already taking a look at them.
Many rejected Dealers were axed for doing TOO GOOD of a job with CPO and pre-owned vehicles. In other words, their profit or loss was NOT dependent on new vehicle sales and that unfortunately spelled their doom.
Clearly, these Dealers are smarter and more successful than many of the Dealers being retained. The history books will tell the story of how GM and Chrysler are ultimately impacted by cutting their Dealer body. I’m anxious to hear about the success stories of the guys who were jilted, survived, and came back with new franchises to kick GM and Chrysler’s ass!

This July version of the Ruggles Report can be found on his web site at http://www.cybercalc.com/products/Ruggles_Report.html. Mr Ruggles also writes a regular column for Auto Finance News

Business Week Article ... then back to autos

An interview today with Business Week...

Lies, Damn Lies, and Statistics!

David Ruggles
See also Cliff Banks article in Wards

As I watched the Senate hearings today on CSPAN my blood boiled. When asked about the money they would save by cutting their dealer count these guys, Henderson (GM) and Press (Chrysler), engaged in some serious obfuscation. They asserted that by swapping an "under performing" dealer for a "performing dealer" they would pick up the gross profit of the additional sales of the new "performing" dealer. These calculations of the difference between what they got and what they felt they were entitled to makes up the bulk of what they claim the rejected dealers "cost" their companies.
I have a little experience in this area. I have operated dealerships in a number of markets. As a consultant I have visited hundreds of dealerships and worked closely with them. The best dealers are those who have structured their business in such a way as to be less vulnerable to the inevitable downturn in either the new vehicle market or the times when the offerings of their manufacturer weren't well accepted in the market. These successful dealers learned to develop their pre-owned business and other profit centers, and they probably brought in other manufacturer makes to help cover their fixed costs in the event of a market downturn.
These dealers are typically still profitable, despite our difficult sales environment. These are precisely the type of dealers targeted by Chrysler and GM.
Markets are not created equal. To understand the concept, think in terms of MSR, which stands for Minimum Sales Responsibility in the Chrysler business. GM has its own terminology, but the same meaning. MSR is where a manufacturer's national market share percentage is applied to the total new vehicle volume in a specific dealer's market. Any deficiency – shortfall from the target – is what a manufacturer views as lost sales. They can calculate the gross profit they would have made had the dealer hit its MSR. But now they appear to count it as a cost in justifying the arbitrary termination of dealers and their employees. There are additional assumptions. The gross profit they calculate is the margin they make when they sell the a new vehicle to the dealer. The dealer has to sell it at retail to make money themselves, which isn't always possible. MSR also varies by locality; it is certainly possible that a dealer who exceeds MSR in one market would underperform in another.
The fact is, Chrysler and GM resent dealers who have managed their business in such a way as to not be overly dependent on selling their products. Many rejected dealers have been targeted as a result of their business acumen. In addition, Chrysler and GM are moving to force more expense onto their retained dealers. GM has sent out "participation agreements" that any dealer wanting to go forward must sign. It effectively replaces the franchise agreement, forcing dealers to agree to do anything and everything, or else. Don't sign, and the dealer is terminated. GM and Chrysler want more elaborate and expensive facilities. The also want exclusivity in those expanded facilities, meaning the manufacturers won't allow competitive makes in these facilities, even though they are purchased or leased by the dealer, NOT the manufacturer.
Normally, dealers would be protected from these types of unreasonable demands by state and federal franchise laws. But GM and Chrysler are taking advantage of their bankruptcies to avoid these restraints. They are showing why these laws existed in the first place - there is a long history of franchisors abusing franchisees, once the franchisee has money in the business that they can't extract. The auto industry isn't unique, but each store represents a far larger investment than in fast food or most other franchising. Congress and the states had made such blackmail illegal; now Chapter 11 is being manipulated to allow it.
I have a friend who had a Chrysler-Jeep operation yanked from one store, and a Dodge operation from another. Now Chrysler can give them to a competitor. These yanked franchises didn't fall out of the sky, good money was paid for them. Chrysler wants to exact a 3 million dollar building from the other dealer in return for being granting it the franchises. The dealer who was NOT terminated was not selling near their MSR, so there must be other motivations. It will be poetic justice if the yanked Chrysler, Jeep and Dodge franchises languish for lack of a party willing to invest that much for a new facility. Time will tell.
According to Chrysler's Press the distribution costs per vehicle amount to about $1000. Of course, each vehicle bears its proportion of these costs regardless of which dealer they were shipped to. In Press' argument this cost would be less if they could replace under performing dealers with (fewer) performing dealers. But these costs aren't related to the number of dealers – they represent the money spent to develop and maintain the software in the first place.
Furthermore, neither executive mentioned the costs their companies have transferred to the dealer. While claiming there were substantial costs associated with the software and hardware related to their dealer communication IT package, Press neglected to mention that each dealer is charged about $2600 a month for this. He failed to mention that there really are very few, if any, field people these days, as dealer contacts are made by email and telephone instead of actual in-store visits. There was a concerted effort to overstate costs and avoid altogether any mention of how much of these costs are actually reimbursed by dealers. In fact, studies show that each dealer represents POSITIVE cash flow BEFORE they buy a vehicle or a part!
I've been frustrated by previously not being able to determine who made the decision to cut dealers, rather than to allow natural attrition to thin out dealer ranks. (That attrition rate is high at present!) It is hard to believe that Henderson and Press have that little understanding of the auto business. I have to conclude that the initiative to lower the dealer count is driven by the Task Force, who think Toyota's business model is what everyone should emulate. The Task Force may be made up of restructuring geniuses, but they have little understanding of the auto business. Their profession means they are mostly North Easterners who may not even own a vehicle, and are not oriented to the issues of smaller businesses. But when a dealer closes, it likely results in a bankruptcy in which a family's life savings are wiped out. It's not just a job loss. The Task Force doesn't seem to understand this. Closing dealerships will cost sales for Chrysler and GM, something they can ill afford. And the ill-will it generates will cost them a lot more than any potential savings.
Imagine Gillette volunteering to give up shelf space space at the super market to Schick! It's the same principle. Foreign competitors looking to expand their dealer base will scan the ranks of rejected GM and Chrysler dealers. If not for the recession, that would save many of the terminated dealers.
In the meantime the "task force" is driving the bus while all parties deny any micro managing by the government.
But remember: as bad is it is, it's better than liquidation! Those who think Chapter 11 for GM and Chrysler should have been declared last summer have forgotten the financial crisis. To operate in Chapter 11 still requires financing, and for almost a year now that has only been available from the US Treasury. The Task Force is necessary, but the specialized nature of their skill set is apparent. The faster these two firms exit Chapter 11 and the Task Force stops calling the shots, the better.

Dealerships are a Cost? - I Don't Think So!

Mike Smitka

The statements of the CEOs of GM and Chrysler at today's Senate hearing on dealership closures make very little sense overall. (For details, see the National Automobile Dealers Association website. Full details should be on the website of the Senate Committee on Commerce, Science and Transportation.) It is true that some dealers run shoddy operations that hurt the brand in the communities where they operate; that is a problem in any franchise system. Current state franchising laws make it very difficult for "the factory" to yank the franchise of such dealers. Well and good if those are the dealerships being targeted – but there is no evidence that is the case. Are there that many bad apples in the GM dealership barrel? I don't think so.
The only GM statement that had any numbers in it refered to incentives paid to dealers and sales people, along with training, advertising and other support, at an average of $1,000 per vehicle.* For GM to save money, they have to cut that number a lot. Is there a lot of fat to be cut?
I don't think so. Here's why.
So let's say GM trims the number of dealers. IT and the like are fixed costs, independent of the number of dealers – though generally dealers get charged for software, brochures, everything. There are thus big savings only if the incentives are trimmed. So the bottom line is that for consolidation to save GM money, the productivity of sales staff and the dealership as a whole has to increase. With 20% of dealerships being cut, each sales person has to sell 25% more (= 1/.8), because for this to make sense the dealership can't add personnel or other costs. All while the dealership is earning significantly less for each car they sell. Is that realistic? I don't think so.
With fewer sales points, GM will somehow have to attract more customers, a lot more customers, to each physical location. They've failed at that in the past two decades. Are GM products so hot now and henceforth that they can get by with fewer locations? I don't think so.
OK, so GM wants newer dealerships, sometimes in new locations, so that volume per dealership can increase. But if I'm making less per vehicle because GM has just cut the wholesale discount, why would I want to do that? Not unless I'm making so much money that I can be coerced by GM into handing more over to them. If I were the banker for such a dealership, how would I react? They want me to lend them a lot of money to build a new dealership in a down market under a marketing plan that intends to cut the margins that dealers earn? Would I as a banker lend them the money to do it? I don't think so.
And hasn't GM ever heard of the internet, customers shopping online, test driving here and there, but coming to a dealership only to sign the paperwork? Does a fancy store add value in the new retailing world? Carpet reeking of mildew is one thing, I've been in dealerships like that, and walked out. But will fancy brick and mortar make me more likely to say "yes" to a harried salesperson? I don't think so.
Finally, what of Certified Preowned Vehicles? GM needs to sell those – especially once leasing starts to increase and rental car companies renew their now-aging fleets. "Underperforming" dealers are still in business because they were doing something right. Looking only at new vehicles is narrow-sighted. Are the fewer number of urban megastores going to let GM move that metal? I don't think so.
One possibility is that this is coming from the Administration's automotive team. They've proven to be brilliant workout specialists, getting the potentially viable portion of Chrysler through Chapter 11 in a manner the bankruptcy lawyers I've talked to thought impossible. Is that skill set likely to suit them to understanding the complexities of franchising, particularly franchising in the multiproduct context of a car dealer? (Dealers have at least 5 business lines, new, used, service, parts sales, finance & insurance brokering, and often a body shop.) Probably not. This lack of understanding may be further muddied by a comparison of dealer averages between Toyota and GM. That assumes that Toyota does well because of its dealerships, rather than the other way around: Toyota's dealers do well because Toyota's market share has steadily risen, ahead of their dealer count. But Toyota's attempt to sell full-sized pickups has flopped, because they don't have all those small, rural dealers who at GM sell their most profitable product. See David Ruggle's post below on The Task Force. He's actually seen restructuring first hand, and knows more of the specialized skills that entails.
Let me hazard a guess, [after consulting with a friend, almost surely wrong] that the incentive system for GM's factory reps focuses on the number of new cars they sell. For them, an "underperforming" dealer makes them look bad, there's no way they can match the bonus of a rival who drew "better" dealers. The smarter dealers watch the mix of used and new vehicles, and if they can snap up preowned on the cheap at auction and make more money, they'll shift their emphasis in that direction. But the reps who handle the certified preowned side of the business, well, they're kept in the back room, out of sight. Management doesn't see their success. [Again, GM was the one to launch the CPO business, and it's built into their rep system, so that doing well on CPOs was a positive, not a negative to reps.] But that means GM will be cutting their smarter dealers, the ones with the best business skills and feel for the market. Does that make good business sense? I don't think so.
* CEO Fritz Henderson: "GM pays about $1,000 a vehicle for dealer and salesperson incentives, advertising, field sales, service and training, and information technology support, he said." Automotive News. There was no breakdown or support for this $1,000 figure. GM does not have anything to say about salespeople and their compensation; that's up to the dealer, whether they work salary, straight commission, or something in between.