Detroit's Faustian bargain is likely to continue exacting its toll in 2004. By relying on rebates and cut-rate financing to juice demand during the recession, the Big Three sacrificed profitability to keep factories humming. Now that the U.S. economy is revving up, however, domestic carmakers are finding it hard to escape from incentives. That means financial gimmicks will probably continue to sap profits in 2004. It will take more than a year to undo the consumer psychology that has developed: If the deal isn't good enough, wait a bit -- carmakers will sweeten the pot.
To top it off, because incentive-driven sales persuaded so many drivers to replace their cars during the downturn, there's little pent-up demand to spike sales now, unlike in past economic recoveries. "We have borrowed from the future," says Bank One Corp. (ONE) Chief Economist Diane Swonk. Tempting new buyers will still require monetary inducements, so Swonk predicts that "sales volume will come at the expense of margins."
Call it a hard-luck recovery. The irony isn't lost on Dieter Zetsche, CEO of DaimlerChrysler's (DCX)Chrysler Group. You'd think there would be "some benefit from an economic recovery," he says. But it's hard to find, with big volume gains or major price hikes a faint hope. "At least I don't think a strong economy will hurt us," Zetsche says with a sigh.
Not that there isn't relief in Detroit about the economy. Interest rates remain low, consumer confidence is rising, and the number of vehicles per household is creeping up. In fact, most executives and analysts are projecting sales of about 17 million cars and light trucks this year, up 3% from 2003. That's shy of 2000's record of 17.35 million vehicles. Even so, says Peter Schwarzenbauer, CEO of Porsche (PSEPF), "We'll probably see one of the best sales years in history."
But the most carmakers can hope for is a tapering off of inducements. Ford Motor Co.'s (F) head of North American sales and marketing, James G. O'Connor, ventures some optimism: "As the economy and consumer confidence pick up," he says, "we should see some moderating of incentives in '04."
Why can't Detroit just kick the habit? Blame capacity and too many slow-selling models. Domestic carmakers are saddled with more factories than they need, and union contracts limit their ability to shutter excess capacity, so assembly lines continue to crank out slow sellers.
American-based carmakers are scrambling to design more appealing vehicles that might tempt consumers to pay full price. But that will take years to make a difference. Meanwhile, "pricing will still be aggressive" in 2004, warns General Motors Corp. (GM) market strategist Paul D. Ballew.
It takes a strong stomach to buck the trend. Volkswagen CEO Bernd Pischetsrieder fits that bill. He'd rather let U.S. sales fall substantially, he says, than pump up incentives. For VW, it's better to preserve brand image and resale value and bank on a sales rebound in 2005 when new Jettas and Passats arrive.
The trickiness of balancing capacity, demand, and pricing is reflected in Wall Street's forecasts of Big Three profits. GM is expected to earn $2.9 billion next year, from an estimated $3 billion in 2003. Ford's forecast is $2.2 billion, from '03's estimated $2.0 billion. DaimlerChrysler's earnings are projected to jump to $3.5 billion, from $2.3 billion in '03.
Talk still circulates that GM, which led the rebate push, may back off. Car execs have heard it before. Chrysler's Zetsche says he'll believe it when he sees it.
Corrections and Clarifications
In the graphic "Growth Prospects" accompanying this story, the correct figure for employment in the automotive sector should have been 4,239,000.
By Kathleen Kerwin, with David Welch, in Detroit