Commentary: Can Motown Get Out of This Funk?
The Big Three auto makers have maneuvered themselves into a box -- one about the size of a glove compartment. They've grown addicted to the cash flow from sales fueled by 0% financing and hefty rebates, and they've trained customers to expect a steady diet of the givebacks. But now even those profit-sapping deals aren't enough to prop up the U.S. companies. The sad truth is that Detroit is losing ground in its struggle to pull out of its slow, decades-long downward spiral.
General Motors Corp. launched the discounting blitz in late 2001 as a way to revive sales, which sagged in the wake of the September 11 terror attacks. Its logic was simple: Squeezed by huge "legacy" costs, including a now-$19 billion shortfall for retiree pensions, and required by contract to keep paying workers even if it shuttered production, GM needed to keep those factories humming and the cash coming in. It counted on being able to throttle back on the discounts once the economy turned around and new models arrived that could compete with Japanese and Europeans rivals on high quality and snazzy design, not price. And if GM could win some share from Ford Motor (F ) Co. and DaimlerChrysler (DCX ), all the better.
Nearly two years after the discounting blitz began, though, all three U.S. car companies are hurting. Incentives have become Detroit's Godzilla, crushing all profit margins in its path. Domestic carmakers' incentives this year are averaging $3,300 per vehicle, according to CNW Marketing Research Inc., up 39% from a year ago. That alone sucks roughly $3.6 billion a month out of Big Three profits. GM's net margin from North American auto operations slid to 1.8% in the first quarter, down from 2.2% in the fourth quarter and 4.1% in 1999. Ford slipped even further, from 6.2% four years ago to -0.2% in 2002. DaimlerChrysler stunned investors on June 3 by saying that soaring incentives were contributing to a $1.2 billion second-quarter loss at the Chrysler Group. And it's not just profits that have been hurt. Says Wesley R. Brown of Los Angeles auto consultant Nextrend: "They've ruined the image of these brands because it's almost to the point where they're paying you to take the vehicle off the lot."
Factory capacity, meanwhile, is far outpacing demand. And the only ones gaining ground are foreign rivals. Domestic auto makers' sales are down 4% this year, and they've surrendered more than a full point of market share to Asian and European makes. Even GM has slipped lately, from 27.9% a share a year ago to 27% today. Goldman, Sachs & Co. (GS ) analyst Gary Lapidus estimates the industry is holding $80 billion worth of unsold vehicles, a traffic jam that would cross the U.S. four times over.
The accelerating problems -- and Motown's seeming inability to stop them -- have left some on Wall Street questioning whether one of the Big Three could eventually be forced into bankruptcy court. Auto executives scoff at that suggestion. All three have strong cash positions, and GM and Ford, at least, are adding to that. None faces an imminent cash crunch. GM Chief Financial Officer John Devine called Wall Street doomsayers "Chicken Little" during a June 10 investor briefing. "The sky is not falling," he says.
But the clouds are certainly gathering. Although GM still thinks it could meet its overall profit goal of $2.85 billion this year, its profits from North American auto operations may "fall well short" of the targeted $1.7 billion to $1.9 billion. The difference will come from profits at the GMAC financial services unit and improvement in Europe. Ford says it will make about $1.3 billion, up from a net loss of $986 million last year. Most of that will come from Ford's credit arm; it expects to make little or nothing on North American auto sales. Chrysler came into the year with a $2 billion profit target; now it hopes to break even.
Motown execs are right about one thing: there's little immediate threat of a financial collapse. GM's net liquidity has steadily improved for the past two years; it is up $3.3 billion from the end of 2002. GM holds $20.6 billion of cash, vs. $15 billion of long-term debt. Ford has $26.6 billion of cash -- up $1 billion in the first quarter -- -and just $1 billion of its $14 billion in debt comes due in the next five years.
DaimlerChrysler has held a credit advantage over GM and Ford for some time, thanks to its strength in Europe. However, following the second-quarter warning, Standard & Poor's (MHP ) placed the company on CreditWatch with negative implications. Last April, S&P also placed GM on negative CreditWatch, citing weakening demand. Ford has been there since last fall, partly over pricing concerns. However, S&P Managing Director Scott Sprinzen says: "Over the next few years there's no meaningful risk of default, given their cash positions and their ability to finance operations."
There are other, less obvious reasons why bankruptcy is unlikely. Chapter 11 wipes out all shareholder equity, and it's unimaginable that the Ford family, which controls 40% of the voting stock and three of Ford's 14 board seats, would sign off on its own disenfranchisement. For Daimler to eject Chrysler would involve disentangling shared operations and product plans -- not to mention alienating Chrysler suppliers who also make Mercedes-Benz parts.
But Detroit faces a long, slow erosion of market value unless it can kick the incentives habit. Even when the economy turns around, Japanese and European rivals are likely to see the most benefit. They are flooding the U.S. with attractive SUVs and pickup trucks and leading the craze for "crossover vehicles" that blend components of cars and trucks. The problem is, Motown has no edge; it no longer has any unique market segments to mine. Despite the '90s truck boom, the Big Three have surrendered 12 points of share since 1993, sliding to 61.8% of U.S. light-vehicle sales.
Until the economy shows some life, though, GM says it will continue pushing marketing incentives. The company has little choice -- it needs to keep cash flowing to cover its growing retiree costs. The Big Three face a combined U.S. pension shortfall of roughly $32 billion and an estimated $9 billion in annual medical costs. Says Wagoner: "We've learned at GM the hard way that it's difficult to solve your challenges while you are shrinking." If Ford and Chrysler didn't follow suit, predicts Global Insight analyst Rebecca Lindland, "Their sales would collapse."
Longer-term, the only real solution is more extensive reductions in capacity. The Center for Automotive Research in Ann Arbor, Mich., estimates that, excluding imported vehicles, North American factory capacity exceeds demand by 2.2 million vehicles. But Detroit's labor contract bans plant closings and requires carmakers to keep paying idled workers. So as Big Three sales slide steadily downward, the companies have had to wait for the next round of bargaining to seek permission to cut capacity. This fall, Ford will negotiate to close two assembly plants; GM may also press for some factory closings.
The true measure of how badly incentives have damaged the auto makers' pricing power will come in the next few months. Chrysler is offering discounts on its just-arrived Pacifica crossover vehicle. Will the Big Three also have to slap incentives on such new vehicles as Chrysler's snazzy Crossfire two-seater; Ford's new F-150 pickup trucks and Jaguar XJ; and GM's Cadillac SRX sport-ute and Chevrolet Malibu sedan? "The test is, when they launch these new vehicles can they get off this drug?" asks Raj Sundaram, president of Automotive Leasing Guide Inc. If not, Motown could be trapped in the incentive box far longer than it dreamed possible. And its road to recovery will keep getting steeper.
|Corrections and Clarifications "Can Motown get out of this funk?" (News: Analysis & Commentary, June 23) mischaracterized Standard & Poor's outlook on two auto companies. This spring S&P revised its ratings outlook on General Motors Corp. and DaimlerChrysler to negative. However, it did not place either company on negative CreditWatch.|
By Kathleen Kerwin
With David Welch and Christine Tierney in Detroit