Auto Meltdown - End of an era (Part II)

In my previous post I covered details on the current state of auto industry and the reasons that led us into this bubble. In this post I will be focusing specifically on US auto industry and how it got into the current mess.

The top 3 American auto companies(GM, Ford, Chrysler) are teetering on the brink and are currently going through the worst crisis of their lifetime. They have been piling up huge losses, losing market share to Japanese, Korean and German auto majors, their shares have been battered and are trading at 50-70yr lows and are almost on the verge of collapse due to a steep drop in sales. Feb '09 was the one of their worst months in several decades and most of them saw a big drop in demand - GM's YoY sales reduced by 53%, Ford reduced by 48% and Chrysler by 44%. For Q4 2008 GM alone lost around $30 billion and Ford lost around $5.9 billion. All the top 3 companies are running low on cash reserves, their corporate rating has suffered making it both expensive and tough to borrow in the market. They are currently looking to the US government to bail them out.

The decline of the big 3 companies started couple of decades back in the 80's when Japanese cars started making headway into US market. Here are my thoughts on some of the reasons that led them to the current state:

• Lower Product quality: Japanese cars are known for their quality and reliability. This was one of the key factors that helped them differentiate effectively against American cars and grab market share. The big 3 had ignored this for too long. By the time they started to improve their product quality, the flood gates had been breached and Japanese cars had established themselves in the US market. Though the gap has reduced over the last decade still Japanese cars are ahead of US manufactures in terms of quality and reliability.

• Lack of Innovation: The big 3 got too comfortable and were slow to innovate. Japanese cars had better technology & fuel efficiency than the equivalent American cars, which lagged Japanese cars in terms of technology by few yrs. Classic example is hybrid vehicles. Toyota had a head start on competition in hybrids. US car manufacturers are also lagging in their research for alternate technology cars. The internal combustion technology has been around for over 100+ yrs around and cars today are still based of the same technology that ran cars beginning of 20th century. Compare that with technology change in computer industry! The fact that oil is finite is well known. Car manufacturers are just waking up to the fact and developing alternate technologies.

• Slow to change to evolving market trends: American cars are traditionally known for their big, powerful and gas guzzling vehicles. Over the last few years due to steep increase in price of gasoline and increased awareness of environmental issues, consumers are starting to migrate to smaller more fuel efficient vehicles. American car manufacturers had failed to forecast this trend. They suffered heavily when oil prices shot up last summer due to their weak line up of small cars. In the small car market they are the underdogs today.
  

• Higher Cost of ownership: Though the purchase cost of American cars tend to be a little lower than equivalent Japanese cars their operational cost is higher due to lower fuel efficiency and lower reliability(especially as they age). The expected lifetime of American cars is also lower than Japanese cars. These factors together result in higher cost of ownership for American cars.
  

• Unsustainable Labor agreements: American car manufacturers had entered into unsustainable labor agreements with union back in the sixties when they were doing well and were flush with lot of cash. They are stuck with these contracts now and the cost of benefits/Pensions runs up to around 10% of car cost. This is unsustainable and is a big drag on American companies, forcing them to spend valuable cash into benefits than in R&D.

• Spread too thin and wasted money in acquisitions: Over the last couple of decades American companies spent lot of their cash on buying up multiple brands. They were looking at acquisitions as a key strategy of growth (inorganic growth). If you look at their portfolio there will be multiple cars from different brands in the same segment with little differentiation. Each of their brands were also fighting against each other and grabbing market share. A lot of these acquisitions were also overpriced and were not managed well. Classic example is Ford acquisition of Jaguar and Land Rover. Ford sold them last year after losing billions of $'s. In comparison, Toyota & Honda were very focused on organic growth and invested in their improving their products. They invested in improving the technology, quality and reliability of their products and used it to effectively differentiate and grab market share.

All the above factors had led to a gradual decline of American car companies over the last couple of decades. The last straw to break the camel's back was the sudden increase in oil price last summer and subsequent credit crisis/depression leading to a steep fall in demand. At this moment of crisis they are stuck with a line up of big, powerful vehicles that are not in demand anymore, precariously low cash reserves, excess capacity etc. Though their very existence is in question now, I think they will survive this crisis. However they are past their peak and I doubt if they can ever get back to the original market position.

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 final post of this series I will be covering my thoughts on the future of auto industry.

Photo credits : dsheubert