Sector Report - January 2009

U.S. Auto Industry

The U.S. automobile industry, comprised of General Motors, Chrysler, and Ford, is in shambles.  U.S. auto sales for the month of November reached monthly lows not seen since 1983, and with the economy set to get worse in 2009, things are looking more bleak than ever for the big three U.S. car companies. 

Sales in November fell 31.5% for Ford compared to the previous year, and November sales fell even further for GM, as the company sold 41.3% less cars than they did just last year. 

What has caused this precipitous drop in sales for the once mighty U.S. automobile companies, commonly referred to as the “Big Three”? The easiest answer that comes to mind is the state of the economy.  The automobile industry is an extremely cyclical industry, as car companies’ successes are very correlated with the overall health of the economy.  When the economy is doing poorly, less people buy cars, and as a result sales numbers drop.   But there are more factors than the poor economy that have led the Big Three to be on the verge of bankruptcy.

First, they have been too slow to adapt to market trends and consumer demands.  When oil prices were low in the late 90’s and early 2000’s, the Big Three, with their massive SUVs, were making an absolute killing.  Ford F-150s, Chevy Suburbans, and Cadillac Escalades were being purchased at extremely high rates by consumers who had money to spend and didn’t have to worry about the high price of gas.  But, as gas prices began to increase, the big three did not adapt quickly enough with more fuel-efficient cars that cash-crunched consumers were looking for.  Instead, foreign companies such as Toyota and Honda began gaining market share in the U.S. with their more fuel-efficient and reliable cars that seemed like smarter buys compared to the gas-guzzling U.S.-made cars.  For example, Toyota Prius sales soared 69% in 2007, and for the first time, Americans bought more Toyota Prius’ than Ford Explorers, the top-selling SUV for more than a decade. 

Another factor that has caused the Big Three to face increasing pressures to survive is the horrible contracts that they have signed with the United Auto Workers (UAW) over the years.  The UAW, which is a high-priced, unionized workforce, has been a burden for the Big Three for so long, and it is one of their biggest competitive disadvantages.  The first problem that the UAW creates for the Big Three is a huge wage gap between the U.S. auto companies and their foreign rivals that manufacture cars in the U.S.  It costs more than $73 per hour on average to employ a UAW member, while it costs foreign car makers like Toyota and Honda an average of around $44 dollars per hour.  This $29 wage gap between what the Big Three pay their employees and what their foreign competitors pay theirs is huge, especially when considering how many workers the Big Three employ and when considering the fact that the Big Three are already less profitable than their foreign competitors in the first place.  Other problems that the UAW poses for the Big Three include demands for healthcare coverage, retirement benefits, and many other concessions.  Quite possibly the biggest problem for the Big Three is that it is extremely hard for them to make any changes to the contracts, even in tough economic times, because the unions are always able to go on strike, an action that would be absolutely disastrous.

What does the future hold for the Big Three? Can they get out of this recession alive?  Many analysts and experts still have differing opinions, but everyone agrees that it will be extremely tough for them to survive.  The government has already bailed out the Big Three with a clause that will force them to become profitable by March 2009.  Just last week, the government also provided $6 billion to GMAC, General Motors’ financing unit.  This was huge for GM, as they can now provide better financing options to potential customers who might not have enough money to buy cars anytime soon. 

Personally, I think it is ridiculous for the government to expect that the Big Three will become profitable by March.  I believe the government must continue to bail out the car companies, as a bankruptcy for any one of them would be disastrous for the economy.  But, the action to improve the Big Three must take into account that their struggles are more than just cyclical.  There are underlying issues that must be fixed for any of the Big Three to be able to compete with companies such as Toyota and Honda in the future.  They must fix their contracts with the UAW to make operating their business more viable.  They also must focus on making cars that consumers are looking for, such as more fuel-efficient cars.  If the Big Three do not make fundamental changes to their business models, and they do not close the gap between themselves and their foreign competitors, they have no chance of survival in the long-term.

Niki Pezeshki

College Trillionaire