The Last Great Automotive Race
"During the 1990s, Baby Boomers accounted for about half of all consumer spending in the U.S., according to a recent McKinsey Global Institute study." —The Wall Street Journal, Oct. 21, 2008
Many observers say the auto industry is now crossing into its most difficult period since the Great Depression, and that statement is mostly accurate. But it might be better to look at what should be referred to as the Last Great Automotive Race, with an ill-defined finish line that might be 12, 18, or even 36 months away. Instead of automobiles, it is the automakers that are competing. Endurance and economics will determine which auto companies survive and continue to thrive in this century—and which will become automotive footnotes in history texts.
In this race it will be the economic variables that matter.
These are the variables:
1. Baby Boomers
In January of this year the first of the 79 million members of this generation started accepting their Social Security checks, and the last will retire by 2034. Older boomers have been the most ardent and reliable of car buyers since 2000, solely because those over 50 make up the one demographic where incomes went up against inflation in this decade. Whatever impact this group has in this race will be widespread, and it will depend mostly on these car buyers' habits in the runup to their retirement.
Factors such as retirement accounts losing $2 trillion to the current financial crisis are already making an impact on boomers' car-buying decisions. And once boomers are securely retired, it is highly doubtful they'll keep purchasing new vehicles in the same buying cycles they generally have. A possible window into our future car-buying habits might be found in Japan: That new-car market hit its sales peak in 1990, at 7.777 million. Today Japan struggles to sell its aging population 5.9 million new cars. If the U.S. market follows that trend, within a decade or two the American car market might sell just 12.5 million vehicles in its best years, which is what it sold in 2007, a down year. Of course, 2008 is looking to be even worse.
Finally, retiring boomers might choose not to flaunt their wherewithal by purchasing as many luxury cars as they have in the past 20 years. They might even surprise the following generations by choosing the most practical and fuel-efficient models.
2. Shrinking Auto Ownership
Currently there are close to 220 million cars, trucks, and SUVs on American roads. Recent history of the retail auto industry, which until a few years ago had sales topping 16 million units annually, shows that one out of every 13.75 vehicles is replaced each year. However, the financial crisis now has this figure falling to one out of every 16.9 vehicles; the difference between the two numbers represents the growing pent-up demand for replacement vehicles in individuals who have opted to postpone their normal car trading cycles.
In the past it would have been a given that sooner or later all of the 220 million vehicles on the road would be replaced. This time could well be different: Current and future energy and economic realities may result in the first net overall reduction in total vehicle ownership in America. An irreversible shrinkage in the ownership of automobiles is the outcome many car companies now doing business fear most.
3. Oil Pricing
What happened in the oil market over the past five years has been the result of speculation getting ahead of demand issues (BusinessWeek.com, 4/1/08), but it is reasonable to assume that in the near future, as the supply and demand equation permanently shifts into negative territory, the cost of oil will be substantially higher than it has been in the past. So, while many economists and oil analysts agree this energy tragedy is coming—many suggest that the day of reckoning will dawn between 2012 and 2015—the real question is whether the American economy can deal with the future reality of $250 per barrel of oil and $8- to $10-a-gallon gasoline.
In combination with virtually stagnant wages for the middle class over the past eight years, with little relief in sight, the question might not be whether people can afford new fuel-efficient automobiles, but whether they can afford to drive at all. If this summer's $4-a-gallon gasoline caused a 10% reduction in driving, while fueling a debt crisis that has been difficult to repay, will $8-a-gallon gas force tens of millions to stop driving altogether?
More important to the discussion, will these new oil prices radically and permanently alter an economy such as ours, which demands low-cost energy as its greatest driver for growth?
4. Availability of Credit
With the subprime lending industry totally discredited and now effectively out of the auto industry's reach, what becomes of the home buyers who had good credit before they signed a disastrous interest-only mortgage, or one featuring negative amortization, or an adjustable-rate mortgage? At this point, it seems no one can forecast that. Their inability to make higher payments may destroy the credit standings of hundreds of thousands or even millions of people whose credit was good enough to qualify them for these Alt-A mortgages before this crisis.
However, as in the meltdown of the 1980s, many individuals who once had spotless credit ratings could watch their credit scores crash. Meaning they will not be new car buyers again for at least seven years—10, if they are forced to declare bankruptcy. That could cost automakers millions of sales in the coming decade.
5. Challenges to Dealers
Over the past eight years many, if not most, of America's successful franchised dealers again shifted gears. That they've solidly emphasized retailing more used cars is completely understandable: These days a used-car sale can make the dealer as much as four times the profit he nets selling a new vehicle.
Dealers have always responded to new-car sales crises by improving aspects of their business outside the showroom. In the 1970s dealers began regarding professional finance departments as new profit centers. The downturn in the '80s pushed dealers to improve and expand their fixed operations, such as service and parts sales. The slump late in that decade saw many dealers build oversize body shops. And most recently used-car operations have been covering the weaknesses in dealers' financial statements.
It was an easy fix; good used cars from late-model fleets and the public's normal car-trading cycles fed the expansion at packed wholesale auctions. But Detroit has cut back on fleet sales, and wholesale values on used trucks and SUVs have plummeted—turning them from reliable, "fast-turn" and high-profit used vehicles into dusty lot décor. Today, the most fuel-efficient used cars at auctions are going for nearly retail. It's dawning on dealers that the used-car golden goose is not going to lay nearly as many eggs as in the recent past. Therefore, in 2009, many new-car dealers will have to reverse course and, ironically, find ways to sell new cars—no matter what economic environment prevails.
These are the crucial factors that will determine who wins this Last Great Automotive Race.
After we find the bottom of this economic downturn, the car business will recover and every car company will cross that changing finish line securing their existence—if:
• The baby boomers put off retiring and go one more decade as strong car buyers, and if
• The economic crisis winds down enough to restore consumer confidence to where normal car trading cycles resume, and if
• The national credit scores don't decline further, and if
• Oil doesn't go to $250 a barrel in the near term, and if
• The income levels of Generations X and Y improve as they enter middle age, and if
• Car companies bring out new products that are in line with public expectations.
That's a lot of ifs.
The real question is, which car companies might survive if everything goes wrong? And which can survive if only a few of the listed variables turn out right?
Detroit's survival, deserved or not, is at stake partly because of our society's macroeconomic conditions. But it's also in growing peril because of our sudden, unwelcome negative financial awareness. The new uncertainty of everyday life in America is sinking automobile sales single-handedly; remove that uncertainty and even the newly downsized Detroit can go back to minting money by selling cars.
That, of course, is easier said than done. Former Secretary of State General George Marshall once said that history is like a river flowing out to sea, continuous, each action moving the next forward. If that's true, then we have hit a bad stretch of rapids. That won't be comfortable—and these dangerous waters only serve to move the auto industry's survival finish line farther downstream.