Commentary: Slow Down Those Assembly Lines

The auto industry seems to be entering the slow lane. Even fat rebates and 0% financing deals couldn't prop up November sales. Auto makers sold 13% fewer vehicles in the U.S. last month than a year earlier, and the Big Three collectively suffered an 18% drop. As a result, the industry's annualized sales rate skidded to about 16 million vehicles in November--down from 18.6 million as recently as August.

So with sales softening, are carmakers starting to think about trimming capacity? Hardly. In fact, they're doing quite the opposite. Apart from Ford Motor Co. (F ), which has announced fourth-quarter production cuts of 2.6%, auto maker after auto maker is ramping up production in the U.S. to gain share. The inescapable conclusion: The battle for the hearts and wallets of American car buyers is about to get a lot nastier, and even strong players like Honda Motor Co. (HMC ) and Toyota Motor Corp. (TM ) could get pinched. Pricing will continue to fall, and margins will be squeezed for most. Says Sanford C. Bernstein & Co. analyst Scott Hill: "Everyone thinks they're going to steal more market share than they will."

Consider that Detroit's carmakers and their foreign rivals with stateside plants have announced plans to add enough capacity to build another 1.5 million vehicles by mid-decade. That's in addition to the 20 million vehicles that can already be built in the U.S., not to mention about 3 million cars and trucks shipped here each year from European and Asian plants. Add it up, and more than 24 million vehicles will be built annually for the U.S. market--40% more than the 17.4 million cars the industry sold in 2000, its best year. Even if foreign carmakers cut imports when their new U.S. production comes on line, that's still far more cars than U.S. buyers can handle.

How will the coming demolition derby play out? With the Japanese and Koreans ramping up production the most, it's tempting to predict that imports will eat Detroit's lunch. But the situation isn't so clear-cut. Although Ford and Chrysler will likely suffer, General Motors Corp. (GM ) may emerge stronger. And while Honda and Toyota are expected to gain share, Nissan (NSANY ) and Hyundai are taking a big gamble. Says GM Vice-Chairman Robert A. Lutz: "Someone is going to be disappointed."

Ford will be hurt the most. Its sales are down 11% this year, more than any other big auto maker. And relief won't come until at least 2004, when the company plans to replace its aging Taurus sedan with the first of a quartet of crossover sport-utility vehicles. That's why Ford has targeted five plants for possible closure in the next few years.

Nissan Motor Co. is headed in the other direction. Emboldened by an impressive comeback, Japan's No.3 auto maker has built a $1.4 billion plant in Mississippi. After it opens in 2003, the factory eventually will produce 400,000 vehicles a year, more than doubling Nissan's North American capacity. The plant will mostly build full-sized pickups and SUVs, a gamble given that the Japanese have had a tough time cracking those Detroit-dominated markets.

Also facing long odds are the third-tier players who have been competing mostly on price. Consider Hyundai Group. It's building an Alabama plant to crank out 300,000 Sonata sedans and Santa Fe SUVs a year. That means Hyundai, which sells 380,000 vehicles today, would need to boost sales by 40% to sell out its new plant.

Detroit's big players won't necessarily have it any easier. Although Chrysler's (DCX ) sales are down 3% this year, it figures it can sell 1 million more vehicles by 2010, to nearly 3 million, mostly in North America. The company is rolling out a host of new passenger cars, ranging from crossover SUVs to all-wheel and rear-wheel-drive cars that appeal to sporty buyers. Chrysler will try to grab share with aggressive pricing, since it can make those new models on the cheap by using parts and engines from partners Mitsubishi and Mercedes-Benz.

The idea is to snag car-market share from the imports. Will it work? A decided maybe. Detroit has routinely failed to push back foreign brands with its autos. Since 1997, the Big Three's share of the passenger-car market has tumbled to 46.2% from 60.6%. And while all three have lost buyers, Chrysler has the weakest position in the business: Passenger vehicles make up just a quarter of sales.

That's one reason the Big Three could end up stealing buyers from one another, rather than their foreign rivals. GM may have one advantage: With its plants nearing Honda-level efficiency, GM has the financial muscle to develop new cars and use aggressive incentives to move them. Cars due in 2003 such as the Pontiac Grand Prix and Saturn Ion are engineered to be sportier than rival models.

If GM does make gains, don't expect it to dent Toyota and Honda. Japan's No.1 and No.2 are increasing SUV and minivan production, and are the most likely to hit their increased sales targets. Popularity helps: In November, Honda bucked the downward trend, increasing sales 4.6%. Toyota's November sales were off, but by only 5.2%. It's easy to see why: Demand for the companies' models keeps inventory at two-thirds the level of domestic producers.

Inevitably, though, the increased production means everyone will be scrapping for profits as competition heats up. Detroit's margins will be most threatened, because imports are hitting the truck market. That's where the Big Three still get most of their earnings. But the massive new capacity means even Honda and Toyota could see slower profit growth. The only clear winners: U.S. car buyers, who will continue to be able to choose from plenty of good deals and new models.

By David Welch

    Before it's here, it's on the Bloomberg Terminal.