Auto Meltdown - End of an era (Part 1)

This is the first of a 3 part series on Auto Industry meltdown. As part of this post I will be covering the current state of auto industry and my reasoning on what led to this bubble.

Current State

February 2009 has been the worst month for US auto industry in decades. The overall auto industry demand has fallen to 4 decade lows of 9.1M vehicles in 2009. The top 3 US companies sees their demand halved from last year's base. GM was the worst with 53.1% decline, Ford 48% decline and Chrysler 44% decline. The Japanese car companies fared slightly better than US companies however still took a significant hit. Toyota saw 40% decline in sales, Honda saw 38% decline and Nissan 27% decline. There is a virtual blood shed happening in auto market both US and globally.

US has been the top auto market in the world for years peaking at 17M+ vehicle sales in 2007. China was a distant second coming in at around 7M+ vehicles in 2008. For the first time in history Chinese car sales exceeded US car sales in Jan 2009. Is this going to be trend in future?

Auto Bubble - How did this happen?

Over the last couple of decades US has been experiencing an 'Auto Bubble' similar to the housing bubble or the dot com bubble. The demand in US auto industry is unsustainable. Overall there are around 251M vehicles in US and 199M licensed drivers this translates to around 1.3 vehicles/driver. I think this would most likely be the peak vehicle ownership ratio. It will start going down from here and eventually settle down between 1-1.1 vehicles/individual. Here are some of the key factors that led to this bubble:

  • Low interest rates and easy availability of credit in the last couple of decades fueled an increase in consumption(similar to housing) leading up to a bubble. It will be interesting to check out the foreclosure(or equivalent) rate for auto industry.
  • Low cost of Fuel - Low gasoline cost in US meant low operating costs for owning a car. This spurred people to travel more and buy more cars and less fuel efficient vehicles. In fact the average miles/gallon in US is 17.1 which is very low by global standards. People really didn't mind this low fuel efficiency till recently due to low fuel cost in US(one of the lowest in western hemisphere).
  • Reducing ownership cost -Technology improvements, innovation and automation has made cars more affordable and cheaper to operate at the same time offering more features and comforts. Opening up of US economy to Japanese and Korean cars also contributed to this trend.
  • Increase in disposable income - Over a 30 yr window between mid 70s to mid 2000's the average car price of american cars increased by 15% in constant currency terms. The average per capita income increased by more than 270%.
All the above factors led to building up of a bubble over the last couple of decades leading to peaking of demand in 2007. When the economy took a turn for the worse last year due to credit crisis things really started falling apart and auto companies started taking big hits with a drastic reduction in demand culminating in halving of their sales this Feb.

Please let me know your thoughts on the above. If I've left out any more key factors feel free to add to the above.

In my next post I will be covering my analysis of how Detroit got into this mess


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