A Wrong Turn at Chrysler

Chrysler Group's near break-even second quarter and a projected $600 million loss in the third quarter shows that the paint isn't dry on this rebound job

For the past three years, when parent DaimlerChrysler (DCX) has reported earnings, it has been the Mercedes-Benz unit that has dragged down the company's results. Chrysler Group has been the bright spot, cranking out profits on successful models like the Chrysler 300 and Town & Country minivan. But the second-quarter numbers, reported on July 27, painted a markedly different picture: Mercedes posted earnings of $1 billion, while Chrysler rang up just $65 million in profits, vs. $695 million a year earlier. Overall, DaimlerChrysler earned $2.37 billion for the quarter ended June 30, compared with $942 million in the year-ago period.

So, what's wrong at Chrysler? For starters, it has been building more vehicles than its dealers can effectively sell. As a result, it's carrying way too much unsold inventory and laying on heavy profit-eating incentives. Chrysler has both the highest sales incentives in the industry and the highest inventory of unsold vehicles—not a good combination. Car companies book sales when they ship vehicles to dealers from the factory. By keeping the factories churning out vehicles, Chrysler arguably was able to prop up its fourth-quarter and first-quarter earnings. With dealers now choking on unsold vehicles and barking about their carrying costs as interest rates climb, Chrysler is facing an unpleasant new reality.

Chrysler Group CEO Tom Lasorda says the company has begun dialing down its production as it clears out unsold vehicles. He expects a $600 million loss in the next quarter as a result of lower revenues and sales. "No question we need to get our supply in line with demand and lower out inventories," Lasorda said, even before today's earnings report and production announcement.


  Lasorda, who succeeded Dieter Zetsche, now CEO of DaimlerChrysler, had his contract extended by five years on July 27. Zetsche, who left day-to-day management of Chrysler Group last August, has been up front about his role in planning too many new sport-utility vehicles and not accurately forecasting high gas prices. "As fuel prices have been increasing in the U.S., there has been a shift in demand to more fuel-efficient vehicles. As a result, the minivan, SUV, and large-truck vehicle segments suffered while sales in the car segment grew," Zetsche has said (see BusinessWeek.com, 6/28/06, "Daimler's Pedal-to-the-Metal").

Chrysler is as dependent on SUVs right now as crosstown rival Ford (F), and those vehicles have been falling out of fashion, with gas prices climbing above $3.00 per gallon. Vehicles like Dodge Durango, Jeep Grand Cherokee, Commander, and Liberty are all dragging down profits. Chrysler has to maintain heavy sales incentives on the Dodge Ram pickup as Ford and General Motors (GM) have been keeping incentives high to maintain production at their plants and GM gets ready to launch redesigned trucks.

On the bright side, Chrysler is about to increase its small and midsize car offerings with new designs, many of which have gas-sipping four-cylinder engines that are now in greater demand. Jeep is in the midst of launching the small Compass crossover SUV. The Compass is built alongside the new Dodge Caliber, which is selling well at high profit margin. Chrysler also rolls out a new midsize Sebring sedan in the fall, as does a Dodge Nitro crossover SUV. These products are hitting the market just as demand for new small cars and light crossover SUVs is climbing. That should mean a healthier fourth quarter and first quarter for Chrysler, but only if those new vehicle launches are well-executed in what is already a hotly competitive market (see BusinessWeek.com, 6/27/06, "DaimlerChrysler's Smart Move").


  Lasorda is betting that the batch of new cars and crossovers will enable Chrysler to dramatically reduce sales incentives. More than one-third of Chrysler's sales in the second quarter were to rental and corporate fleets, a percentage that's too high because those sales are close to break-even for the auto maker. A lot of those are aging products like Dodge Stratus, the old Sebring, PT Cruiser, as well as some of its slow-selling SUVs.

The company is looking wistfully at its experience with the Chrysler 300. Now in its third year, it carries practically no sales incentives because its design has resonated so well with buyers. But it will be a very tough chore to pull off that kind of success with a new Sebring sedan or even some of the new crossovers. "The 300 established a whole new design space, like the iPod did in its category, and the other vehicles from Chrysler don't seem to pack the same punch," says marketing and design consultant Dennis Keene (see BusinessWeek.com, 1/5/06, "Chrysler's Escape Route?").

True, the 300 is a tough act to follow. But Chrysler has a history of designing its way out of financial straits. And this battle will probably be no different.

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