Further to my early post on Cash for Clunkers, see the blog on the Morgan Stanley Global Economic Forum of April 28, 2009. It adds the point that if the market value of a used car is already (say) $2000 and the "clunker" subsidy is $4000 then the net effect is smaller, similar to putting an extra $2000 rebate on a car. Plus it would be further muted by the various strings attached to the two main pieces of draft legislation winding their way through Congress. The bottom line is that it will cost a lot but won't boost sales much. Their blog includes methodology and estimates.
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Thứ Năm, 30 tháng 4, 2009
Thứ Ba, 28 tháng 4, 2009
Follow the Money
The news today is of efforts to cut the cost side of the OEMs, Chrysler of course but also General Motors. Is this good news? To frame that question we need to do two things. First, what of the revenue side? Second, what of the overall value stream? – after all, the OEM slice is a quarter or less of total, not including the aftermarket, consumer finance and so on. The way I read it, we do not yet have any good news, because focusing on costs while revenues slide is chasing a will-o'-the-wisp. And the upstream and downstream segments are on the brink of a deep precipice – but I'm not sure which side of the brink.
To my mind, the key variable at the moment is the residual (resale) value of a vehicle. As long as it remains low, it cuts into the arteries, and staunching the bleeding is hard. A low residual value means that purchasers are more likely to be "under water" on their current vehicle, with a trade-in value less than their loan balance. A low residual value means that leasing is dead, and a straight loan has to be priced higher, to cover the poor value of a vehicle as collateral (never mind the current recession-driven risk that the borrower's income may disappear). And a low residual value means that even if the buyer will pay cash (or has equity in their current car), they will shy away from a great vehicle in favor of one that because of its nameplate will hold its resale value. [I will post this before digging up sample numbers, say of a Toyota Titan and a comparable GM pickup – comments, please!] If the 4-year-out resale value of one vehicle is 50% of purchase price, and of another is 30% – well, no OEM can afford to discount their vehicles up front enough to offset the different.
So how to pull up residuals? Unfortunately the cutback in fleet sales at GM is too recent to have cut the flood of used cars that has depressed their residuals over the past several years. [Or so I assume -- ADESA or various used car guides could provide data.] In a year or two the impact would have been tremendous, had the recession not intervened. After all, GM has the car of the year and good ranking in the JDPowers quality surveys. (Ditto the combination of VEBA and retirees hitting age 65 to handle legacy costs on the cost side come 2011.) But luck was not with them. Maybe the biggest help the government could give is using its purchasing dollars not on new vehicles but on 2-, 3- and 4-year old vehicles to pull up their resale value.
Low residuals hurt other portions of the industry. If a dealer closes its doors, the normal franchise agreement obligates the OEM to repurchase inventory at cost. For the bank that finances this inventory ("floorplan") that is crucial. No bank is prepared to accept 200 cars on a lot when a loan forecloses. But if GM faces Chapter 11, it would no longer be obligated to make dealers (or their lenders) whole. Now if the residual value of GM vehicles was high, lenders could at least figure out what such collateral would be worth. As it is, no lender in their right mind would extend additional financing to a GM dealer (much less a Chrysler dealer). And no dealer would order a new car. That means that these companies will have zero revenue, because even if consumers flock to dealership lots, GM sells cars to dealers, not consumers.
That's of course the downstream viability story: GM may not have any dealers left, due to the collapse of financing, and they certainly won't have dealers buying cars. Costs cuts can never offset such revenue cuts. Of course if GM goes, and there is a massive firesale, Honda and others will face crisis, too, because consumers will have the choice of a new GM vehicle at 50% off – who knows? – and why in such a situation would you buy a used Honda? or a new one?
Now the upstream parts sector is in as bad of shape, maybe worse. While GM is closed they will be ordering no parts (remember that the factories of parts firms employ about 3x the number of manufacturing jobs at GM and its peers). With no orders, no revenue. Now the strategic imperative for suppliers the past decade was to diversify their customer base. But how can they keep their factories open if Honda and Toyota are 25% of their revenue, and GM and Chrysler 75%? And how can they fund the engineering effort on new vehicle models and basic R&D needed to garner orders for vehicles launched in 2012 and 2013, when sales will hopefully have rebounded? I don't think they can. My own feeling is that the downward spiral is not letting up. The tide is still building, and the whirlpool is getting harder to escape.
So, even if a bailout is arranged that temporarily keeps GM out of bankruptcy, if the downstream and upstream both collapse, well. I want to avoid thinking about what that might look like, and how the industry could start up again. But my quick attempt to follow the money suggests it's flowing down the drain, and the flow is slowing to boot.
To my mind, the key variable at the moment is the residual (resale) value of a vehicle. As long as it remains low, it cuts into the arteries, and staunching the bleeding is hard. A low residual value means that purchasers are more likely to be "under water" on their current vehicle, with a trade-in value less than their loan balance. A low residual value means that leasing is dead, and a straight loan has to be priced higher, to cover the poor value of a vehicle as collateral (never mind the current recession-driven risk that the borrower's income may disappear). And a low residual value means that even if the buyer will pay cash (or has equity in their current car), they will shy away from a great vehicle in favor of one that because of its nameplate will hold its resale value. [I will post this before digging up sample numbers, say of a Toyota Titan and a comparable GM pickup – comments, please!] If the 4-year-out resale value of one vehicle is 50% of purchase price, and of another is 30% – well, no OEM can afford to discount their vehicles up front enough to offset the different.
So how to pull up residuals? Unfortunately the cutback in fleet sales at GM is too recent to have cut the flood of used cars that has depressed their residuals over the past several years. [Or so I assume -- ADESA or various used car guides could provide data.] In a year or two the impact would have been tremendous, had the recession not intervened. After all, GM has the car of the year and good ranking in the JDPowers quality surveys. (Ditto the combination of VEBA and retirees hitting age 65 to handle legacy costs on the cost side come 2011.) But luck was not with them. Maybe the biggest help the government could give is using its purchasing dollars not on new vehicles but on 2-, 3- and 4-year old vehicles to pull up their resale value.
Low residuals hurt other portions of the industry. If a dealer closes its doors, the normal franchise agreement obligates the OEM to repurchase inventory at cost. For the bank that finances this inventory ("floorplan") that is crucial. No bank is prepared to accept 200 cars on a lot when a loan forecloses. But if GM faces Chapter 11, it would no longer be obligated to make dealers (or their lenders) whole. Now if the residual value of GM vehicles was high, lenders could at least figure out what such collateral would be worth. As it is, no lender in their right mind would extend additional financing to a GM dealer (much less a Chrysler dealer). And no dealer would order a new car. That means that these companies will have zero revenue, because even if consumers flock to dealership lots, GM sells cars to dealers, not consumers.
That's of course the downstream viability story: GM may not have any dealers left, due to the collapse of financing, and they certainly won't have dealers buying cars. Costs cuts can never offset such revenue cuts. Of course if GM goes, and there is a massive firesale, Honda and others will face crisis, too, because consumers will have the choice of a new GM vehicle at 50% off – who knows? – and why in such a situation would you buy a used Honda? or a new one?
Now the upstream parts sector is in as bad of shape, maybe worse. While GM is closed they will be ordering no parts (remember that the factories of parts firms employ about 3x the number of manufacturing jobs at GM and its peers). With no orders, no revenue. Now the strategic imperative for suppliers the past decade was to diversify their customer base. But how can they keep their factories open if Honda and Toyota are 25% of their revenue, and GM and Chrysler 75%? And how can they fund the engineering effort on new vehicle models and basic R&D needed to garner orders for vehicles launched in 2012 and 2013, when sales will hopefully have rebounded? I don't think they can. My own feeling is that the downward spiral is not letting up. The tide is still building, and the whirlpool is getting harder to escape.
So, even if a bailout is arranged that temporarily keeps GM out of bankruptcy, if the downstream and upstream both collapse, well. I want to avoid thinking about what that might look like, and how the industry could start up again. But my quick attempt to follow the money suggests it's flowing down the drain, and the flow is slowing to boot.
thanks to DR and JJH and TK for stimulation
I will try to add numbers later
Chủ Nhật, 19 tháng 4, 2009
Downsizing
While interrupted from time to time by the business cycle – exceptionally so at the moment – automotive demand has expanded steadily since the end of WWII in the US, Japan and the EU. As a consequence the normal challenge for auto companies has been expansion. That process was not always orderly, as the different divisions of the larger firms fought for product for their dealers. Such product overlap is particularly severe at Toyota and GM, with the most sales channels. For dealers there is modest downside; additional models mean additional inventory. But each dealer hopes to pick up some incremental sales. Unfortunately that includes sales cannibalized from other sales channels – Pontiac sales robbing from those of Chevrolet – and so the benefits to the manufacturer are smaller. Overall however the bias (as in most franchising systems) is to have too many sales points and too many products from the standpoint of the system as a whole. As disorderly as the expansion path may appear, with firms responding to "hits" by their rivals with product that may mesh poorly with the overall vehicle lineup, reversing that process is much more difficult. Doing it in an orderly manner is well-nigh impossible.
Financial implications aside, trimming capacity presents formidable strategic challenges. First, the menu of vehicle programs must be developed with a 6-8 year time horizon. The allocation of engineering resources is a complicated dance, and has to also mesh with assembly capacity. A firm can work on only 1-2 vehicles in a size class at a time, and delaying a program until later then means some future program must be moved forward or otherwise shifted. So the dance has to position the players with a vision of where the firm wants to be 8 years down the road. That is hard enough when most vehicles programs are merely (?!) developing a replacement to existing product. Downsizing will almost inevitably mean that a firm is set to develop the wrong vehicles in the wrong order.
Second, if products are located rationally in consumer space, canceling one model creates a hole in the overall product lineup. That means that there are greater benefits from moving adjacent vehicles to the head of the development queue. So one less model increases the pressure to re-engineer two or more adjacent vehicles. Doing that of course costs money rather than saves money, so a hole must remain. Such a hole affects dealerships; if a particular sales channel is starved for product, then it will be more difficult for the dealers to maintain the presence in the market in overall staffing and advertising needed to support vehicles that ought to sell well. Downsizing, in other words, can amplify an initial decline in sales. And that's without taking into consideration any negative publicity from media coverage of the process.
Third, developing vehicles entails teamwork; downsizing means breaking up teams. Trying to "cherry pick" the good engineers is hard, and hurts morale – and of course a team without spirit is not much of a team, as is a team that has never played together before, even if (especially if?) it is composed of all-stars. Voluntary buyouts may force a company to "buy back" workers if too many in a give area quit. And in either case a firm will find it difficult to continue recruiting young engineers and other functions where learning the trade takes time.
Fourth, uncertainty looms large. CAFE (fuel efficiency) mandates skew incentives for where to allocate resources, with an impact that varies from firm to firm depending on their mix of domestic and imported vehicles. "Green" incentives that accrue to vehicles that may in fact not be very efficient, the lack of an energy policy that creates uncertainty in the path of energy prices (and which in the US makes diesel more expensive rather than cheaper than gasoline), and the presence of state and local economic development incentives that make a new plant for a company with an expanding market share cheaper than an old plant for a firm with a declining share all make life more complicated.
Then there are legacy costs. Incumbents in the US already had large number of retirees, due to the cumulate impact of increases in longevity and increases in productivity, that left them with an unfavorable ratio of retirees to workers. Downsizing makes things worse. New entrants have no such problems. They have virtually no retirees, their healthcare costs are further lowered by the relatively young age of their workforce, and they have "modern" benefit plans rife with deductibles and co-pays, things that were of little or no concern when such benefits were negotiated by the incumbents in the 1950s.
Finally, what scale is needed for survival? Electric vehicles, hybrid diesels, hybrid gasoline vehicles, natural gas vehicles, fuel cell vehicles – it is unclear which of the next generation of propulsion plants will prove fruitful. All require significant expenditures now that will not generate revenue in the near term. A large firm can have multiple platform teams, very small cars in Korea, small cars in Germany, midsized-cars and light trucks in the US, real-wheel drive projects in Australia, and so on. There are potentially large benefits from that, though to date the track record of "world" cars is poor, in part because regulatory barriers and variations in manufacturing infrastructure make it expensive and time-consuming to adapt a European car for the US market.
Of course there is excess capacity in the market alongside too many models. The ease of entry means that will not change in the medium term – remember, there are 14 producers in NAFTA, not to mention importers. Dealers face their own problems, particularly for those in urban areas, as the internet undermines the value of a large, expensive physical footprint. Downsizing individual firms affects suppliers in an uneven manner, but few suppliers depend on a single customer. Viewed from the other end, a Toyota or a Honda is reliant on the health of suppliers for whom one or another Detroit firm is a major customer.
In short, downsizing can unravel along multiple dimensions. And probably will.
Financial implications aside, trimming capacity presents formidable strategic challenges. First, the menu of vehicle programs must be developed with a 6-8 year time horizon. The allocation of engineering resources is a complicated dance, and has to also mesh with assembly capacity. A firm can work on only 1-2 vehicles in a size class at a time, and delaying a program until later then means some future program must be moved forward or otherwise shifted. So the dance has to position the players with a vision of where the firm wants to be 8 years down the road. That is hard enough when most vehicles programs are merely (?!) developing a replacement to existing product. Downsizing will almost inevitably mean that a firm is set to develop the wrong vehicles in the wrong order.
Second, if products are located rationally in consumer space, canceling one model creates a hole in the overall product lineup. That means that there are greater benefits from moving adjacent vehicles to the head of the development queue. So one less model increases the pressure to re-engineer two or more adjacent vehicles. Doing that of course costs money rather than saves money, so a hole must remain. Such a hole affects dealerships; if a particular sales channel is starved for product, then it will be more difficult for the dealers to maintain the presence in the market in overall staffing and advertising needed to support vehicles that ought to sell well. Downsizing, in other words, can amplify an initial decline in sales. And that's without taking into consideration any negative publicity from media coverage of the process.
Third, developing vehicles entails teamwork; downsizing means breaking up teams. Trying to "cherry pick" the good engineers is hard, and hurts morale – and of course a team without spirit is not much of a team, as is a team that has never played together before, even if (especially if?) it is composed of all-stars. Voluntary buyouts may force a company to "buy back" workers if too many in a give area quit. And in either case a firm will find it difficult to continue recruiting young engineers and other functions where learning the trade takes time.
Fourth, uncertainty looms large. CAFE (fuel efficiency) mandates skew incentives for where to allocate resources, with an impact that varies from firm to firm depending on their mix of domestic and imported vehicles. "Green" incentives that accrue to vehicles that may in fact not be very efficient, the lack of an energy policy that creates uncertainty in the path of energy prices (and which in the US makes diesel more expensive rather than cheaper than gasoline), and the presence of state and local economic development incentives that make a new plant for a company with an expanding market share cheaper than an old plant for a firm with a declining share all make life more complicated.
Then there are legacy costs. Incumbents in the US already had large number of retirees, due to the cumulate impact of increases in longevity and increases in productivity, that left them with an unfavorable ratio of retirees to workers. Downsizing makes things worse. New entrants have no such problems. They have virtually no retirees, their healthcare costs are further lowered by the relatively young age of their workforce, and they have "modern" benefit plans rife with deductibles and co-pays, things that were of little or no concern when such benefits were negotiated by the incumbents in the 1950s.
Finally, what scale is needed for survival? Electric vehicles, hybrid diesels, hybrid gasoline vehicles, natural gas vehicles, fuel cell vehicles – it is unclear which of the next generation of propulsion plants will prove fruitful. All require significant expenditures now that will not generate revenue in the near term. A large firm can have multiple platform teams, very small cars in Korea, small cars in Germany, midsized-cars and light trucks in the US, real-wheel drive projects in Australia, and so on. There are potentially large benefits from that, though to date the track record of "world" cars is poor, in part because regulatory barriers and variations in manufacturing infrastructure make it expensive and time-consuming to adapt a European car for the US market.
Of course there is excess capacity in the market alongside too many models. The ease of entry means that will not change in the medium term – remember, there are 14 producers in NAFTA, not to mention importers. Dealers face their own problems, particularly for those in urban areas, as the internet undermines the value of a large, expensive physical footprint. Downsizing individual firms affects suppliers in an uneven manner, but few suppliers depend on a single customer. Viewed from the other end, a Toyota or a Honda is reliant on the health of suppliers for whom one or another Detroit firm is a major customer.
In short, downsizing can unravel along multiple dimensions. And probably will.