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Eyeing the automotive dilemma

The good news: the North American automotive market has a bright future. The bad news: nobody knows when that future might start.David Cole, chairman for the Center for Automotive Research, has been the mainstream media’s go-to interview for all things automotive, sitting with outlets as varied as NPR and CNN. Late last November, he shared his views with MPW.MPW: How did the U.S. automotive industry get here?

Tony Deligio

February 11, 2009

9 Min Read
Eyeing the automotive dilemma

The good news: the North American automotive market has a bright future. The bad news: nobody knows when that future might start.

David Cole, chairman for the Center for Automotive Research, has been the mainstream media’s go-to interview for all things automotive, sitting with outlets as varied as NPR and CNN. Late last November, he shared his views with MPW.

MPW: How did the U.S. automotive industry get here?

David Cole is the Chairman of the Center for Automotive Research (CAR; Ann Arbor, MI). He was formerly Director of the Office for the Study of Automotive Transportation (OSAT) at the University of Michigan Transportation Research Institute. He has worked extensively on internal combustion engines, vehicle design, and overall automotive industry trends.

Cole: How we got here sort of depends on where we begin. If you go back into the early part of the last century, the industry went through an ongoing contraction, and we ended up with the Big Three. We’re that past World War II, the ‘50s, and the ’60s. Then basically, when we got into the ’70s and the ’80s, things like the fuel economy issues and price really created the opportunity for imports to start having an impact.

As production was localized here, the new guys had new facilities, hired new workers, and the old guys had lots of retirees and benefits for retirees. That amounted to literally a couple of thousand dollars per car legacy costs, and it was not just the retirees and their healthcare and pensions, it was the declining market share, which meant that as the market share went down, more of the burden was put on fewer workers.

So in many respects, for 20, 25 years, it’s been like trying to run a marathon race and your competitor has got a track suit and track shoes on and you’re wearing galoshes and carrying a bowling ball, which really makes competition more difficult. It’s particularly more difficult, obviously, in vehicles with lower margins like small cars. The cost differential there had a real impact – luxury cars and the vehicle segments that the internationals were not in initially like the trucks and SUVs – you could carry that load, because since the beginning of the early ’80s we had really a sellers’ market for over 20 years in trucks and SUVs.

Therefore a common criticism is that Detroit made people buy trucks and SUVs. When we entered 1980 with a price collapse and the CAFE standards had been set in the 70s, with 27.5 mpg on cars and a little over 20 mpg on trucks, the industry began to design cars to meet fuel economy standards, which were substantially higher for cars then for trucks. Consumers came to the showroom and they looked at the cars that had to meet the higher standard and the trucks, and the trucks rang their bell and they began to buy trucks and SUVs. Truck sales for a number of years, what we call light trucks, have exceeded the sales of cars. That was one of the unintended consequences of CAFE, that when consumers no longer cared about fuel economy, the fuel standards actually forced them into trucks and SUVs to get what they were looking for.

So in an effect, all through this period, the domestics were carrying this added burden of legacy costs, which per hour of work were getting greater and greater because of lost margins, so it was really a compounding type of a problem, but when you look at it from a business model perspective, the idea that you’re making money on only a narrow range of vehicles is just not a very healthy kind of model. Anyway, that’s sort of a little history of where we were, and why the domestics have been carrying this bowling ball and wearing galoshes for a long, long time, and that finally changed.

MPW: A lot of talk lately has been about the efforts in Washington to aid the industry; what is your take?

Cole: It’s very touchy. It’s kind of like someone trying to commit suicide. They run up to the bridge, they crawl up on the edge, they jump, and then a half a second later they change their mind. It’s all over. What we’re concerned about is a cascading impact because of the tightly knit fabric of the industry, where we already have a very fragile supply base, and if one of the major customers goes down, this could telegraph down through the suppliers and take everything out – the internationals as well as the other domestics. You’d get to three million jobs pretty quickly. 
If you look at our economy, the highest value-added sector in the economy, or the highest economic multiplier, is manufacturing, and auto is the highest in manufacturing. For an assembly plant, each worker there – the suppliers or indirectly in the community – supports eight or nine other people. A Wall Street job might support one other person.

MPW: What do you think government should be doing in the short term?

Cole: In the short term, it needs to provide a bridge until we have stability in the credit markets. Everybody is quick to blame the auto industry and rotten decisions they made – well, everybody has. That’s characteristic of every human being, government, industry. But the unique part of this problem is there are two things that people rely on credit to buy. One is obviously homes, and the other is cars; 90% of the people that buy cars, borrow money to buy, and when the credit market has collapsed as it has, that has shut down car sales dramatically.

MPW: Going forward, what is a more normal level of auto production? It had gotten as high as 17 million vehicles.

Cole: Well, over time, we’re going to get back there for two reasons. One is pent-up demand – you look out at I-94, people are still driving, putting miles on, so we’re wearing the fleet out, and we’re at a very, very low level of sales, so you have pent-up demand that will come back. The second factor is, there’s household creation here. Our birthrate and the immigration levels mean we’re creating households, in contrast to places like Japan and Western Europe, with lower birthrates and declining household creation. So the long term is really very good in terms of demand for vehicles once we get past the credit crunch.

MPW: Given that, what are realistic market shares for the Big Three going forward?

Cole: They’ll have, with the implementation of the new labor contract, rough parity on costs, so they get to take the galoshes off and put the bowling ball aside. It depends on how able they are to meet what the customers want. So where that will stabilize, I’m not sure. I do think it’s likely that Chrysler is probably going to be absorbed somewhere. I think it will be difficult for them, as essentially now a North American company. So, I’m not sure exactly where I’d put Chrysler in this, but as far as Ford and GM, yeah, they’ll be competitive. They’ll have their ups and downs, but once they get this cost parity in place and once they’re globally integrated – GM is pretty much there now, Ford will be there in a couple of years – that scale offers real value. That’s one of the challenges Chrysler has, it doesn’t have global scale, it doesn’t have global volumes.


Our interview with David Cole continues….

MPW: Can you talk about the evolution of the relationship between the suppliers and the OEMs; where do you see that headed?

Cole: Well it’s a tough period, and it was a tough period, for a couple of reasons. One is, historically, with the volumes and market share that the domestics had, that supply base was created to support that. Because the domestics have lost market share, of course a lot of that business has gone away, so suppliers are operating at lower capacity. Also, the domestics tended to have a fairly large number of suppliers in any given commodity area, and what they’re looking for now is very similar to what you see with the Japanese, which would be fewer suppliers and a more intimate relationship. So we’re really in a transition to restructuring of the suppliers to the industry. That’s been happening over the last couple of years, and it’s a very painful kind of thing. The idea here is that as you lose volume if you have two suppliers supplying the same thing, each operating at 50% capacity, it’s better to have one supplier at 100% capacity. Now his cost structure is going to be much lower, so that’s sort of the idea behind this, and there’s going to be some winners and losers. People are falling off the table pretty regularly.

MPW: Can we innovate our way out of this crisis?

Cole: You have a couple of things that happen in a crisis. One is you take a lot of cost out, so the fixed cost is being lowered. Not as fast as the revenue is falling, but what that sets up is, when things turn around, there will be significant profitability, huge profits. When we get back to some reasonable volumes, based on pent-up demand, all the cost reductions that are occurring and the capacity that’s being taken down mean we’ll get a better balance between capacity in the market, and pricing power comes back to the industry.

MPW: What would be your advice in the short term to auto suppliers to weather this?

Cole: The companies that have gone down have been pretty typically the companies that have too much debt. So a company that doesn’t have a lot of debt is in a lot better shape than a company that has excessive debt. You had a lot of companies that were combining, one company buying three or four other companies, and when you do that, you incur debt. It’s a funny thing right now, money is cheap if you don’t need it, you just can’t get it if you do. That’s the problem, it’s not of any price. But in any event, once we get to a more stable environment with the credit markets, that’s going to have a huge impact on the overall economic behavior.—[email protected]

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