By Robert R. Ebert, Ph.D.
Buckhorn Professor of Economics
It is the best of times, it is the worst of times. With apologies to Charles Dickens, that paraphrase of the opening words to A Tale of Two Cities sums up the situation in the automobile industry today. General Motors and Ford are faced with one of the worst crises in their histories. For Toyota, though, it may be the best of times as it proceeds on an expansion path that could have it unseating GM as the world’s number one motor vehicle producer.
There are several dimensions to the crisis in the United States auto industry. Those dimensions include issues of supplier and manufacturing integration, production efficiency, product development and pricing strategy. We begin by looking at parts suppliers and conclude with a discussion of the prospects for the major auto manufacturers.
Delphi and Visteon
Delphi Corporation filed for bankruptcy on Oct. 8, 2005. Visteon Corporation returned 23 of its parts making operations to Ford Motor Company as part of a restructuring plan (Sherefkin, “Visteon,” 16). Dozens of other auto parts companies sought Chapter II bankruptcy organization in the past year including five with annual sales in excess of one billion dollars. Many smaller parts firms that are still healthy want to sell out because they cannot meet the demands by GM and Ford that parts be made in Asia at lower cost that in the U.S. (Sherefkin, “Supplier,” 46).
Delphi is a former GM parts division spun off from GM in 1999. It has annual sales of nearly $29 billion, with $15.4 billion of that to GM, which is still highly dependent on Delphi for parts (McCracken and Stoll, October 10, 2005, A1). Visteon was spun off from Ford in 2000 and has annual sales exceeding $12 billion (Sherefkin, “Visteon,” 16).
The spin-offs of Delphi and Visteon from their parent firms represented a departure from the auto industry historical trend toward vertical integration. Past experience suggested that GM and Ford brought parts manufacturing in-house and increased the degree of vertical integration because switching suppliers requires assemblers to incur costs when they have to develop knowhow with new vendors (Monteverde and Teece, 212).
Among the reasons for vertically integrating in the auto industry are improved coordination of the production process and avoiding exploitation by a monopoly supplier. The design, production and testing of a motor vehicle require a high degree of coordination between the supply and assembly functions. And, a company that was only an assembler would face the possibility of high prices from a single supplier of a component (White, 1971, 77-87).
In divesting themselves of the operations that came to be called Delphi and Visteon, GM and Ford were apparently discounting the historically persuasive argument for vertical integration. They were trying to reduce costs of components by making their former in-house operations compete for business with other outside suppliers. It didn’t work, and both Ford and GM are faced with possible legacy costs associated with the failed experiment.
GM has obligations for Delphi retiree pensions and health benefits that could run anywhere from one billion dollars to nine billion dollars over the next several years, depending on how well Delphi (which lost $4.8 billion in 2004) emerges from Chapter 11 (McCracken and Stoll, October 10, 2005, A10). As this article is being written, Delphi is negotiating with its unions to reduce employment by 24,000 jobs in the U.S. from the current 34,000 and lowering hourly wages to $12.50 from the current average of $27 an hour. Also involved is a proposal to sharply reduce pension and health benefits. If negotiations with the unions are not successful, Delphi has said it will ask the courts to terminate labor agreements, which could trigger a strike and interrupt the flow of parts to customers such as GM (Barkholz, 1, 51).
Visteon is also asking its workers to reduce their wage and benefits package to an $8 per hour level. Already, Visteon’s average North American wage and benefit structure has been reduced from $38 to $17 per hour. Ford Motor Company had to bail out its former parts operation by taking back 23 Visteon operations and 17,400 UAW workers which left Visteon with only 800 workers in 19 plants in North America but 120 factories around the world – Asia and Mexico where wage costs are much lower (Sherefkin, “Visteon,” 16).
Estimates are that in the 1970s, GM was 70 percent vertically integrated, Ford was 50 percent and Chrysler was about 30 percent. By the late 1990s, the comparable numbers were 43 percent for GM, 38 percent for Ford and 35 percent for Chrysler. With the spin off of Delphi and Visteon, those percentages probably dropped another three percent or so in the early 21st century (Chappell, “Unlike,” 22).
Toyota, meanwhile, continues to enjoy the benefits of in-house parts making. Toyota’s factories in North America are large-scale operations that not only assemble vehicles but make large quantities of the parts for those vehicles. Toyota is as vertically integrated today as GM was 30 years ago (Chappell, “Toyota,” 22).
Toyota vs. GM
Will Toyota surpass GM as the world’s largest motor vehicle producer in the next couple of years? Figure 1 shows Toyota has surpassed Ford and is closing in on GM. As shown in Figure 2, GM’s share of world production has slipped from 20.3 percent in 1985 to 12.6 percent today while Toyota’s share increased from 8.3 percent to 10.7 percent. Furthermore, during that period the share of North America’s vehicle production by Asian and European firms has increased from 2.2 percent to 29.6 percent (See Figure 3).
Toyota is expanding and Ford and GM are retrenching, especially in North America. Faced with shrinking market share, losses of over $3 billion so far in 2005, large legacy pension and health costs, and products that have failed to stimulate customer enthusiasm, GM is scaling back. On Nov. 21, 2005, GM announced it was closing nine assembly, stamping and powertrain plants, and three service and parts facilities which will eliminate 30,000 manufacturing jobs in hopes of achieving $7 billion in annual cost reduction (Wall Street Journal, Nov. 21, 2005).
In another cost-cutting move, GM reached an agreement with the UAW to reduce its health-care costs. GM retirees will now pay $750 a year for health-care costs plus more for prescriptions. This is the first time the company’s retirees have had to pay for health care. The plan is expected to reduce GM’s annual costs by $1 billion a year and reduce its health-care liabilities to retirees by $15 billion.
Ford Motor Company is having its own set of restructuring struggles in the face of its North American operations losing $1.4 billion in the first nine months of 2005. On Dec. 7, 2005, CEO Bill Ford received a proposal to restructure and scale back its operations. It is expected that Ford, which uses only 75 percent of its capacity, will close several assembly plants with the loss of several thousand jobs (Wilson, 1,50).
The one bright spot in the U.S. auto picture at present is DaimlerChrysler A.G.—really a German owned firm, but historically part of the U.S. “Big Three.” The U.S. operations of DC have turned around in the 2000 to 2005 period through a combination of layoffs, cost-cuts and well-executed new model introductions (Power and Taylor C1, C3).
Toyota, along with other Japanese and Asian car builders, continues to develop in the U.S. and global markets. In 2004, Toyota built over 1.1 million vehicles in North America. That number was exceeded in the first 11 months of 2005 and will probably end up between 1.2 million and 1.3 million Toyota vehicles built in North America for 2005. To meet rising demand in the region, Toyota is searching for a new plant site to build more engines and transmissions in the U.S. (Shirouzu, Nov. 12-13, 2005, A3). On November 23, 2005, Toyota announced a plan to build up to 100,000 Toyota vehicles at a Subaru factory in Lafayette, Indiana. (In October, Toyota bought an 8.7 percent share of Fugi Heavy Industries, maker of Subarus, from General Motors.) In addition to the deal with Subaru, Toyota is expanding U.S. capacity with a new truck plant in San Antonio, Texas, which will begin production in 2006 and add 200,000 vehicles to Toyota’s North American capacity (Associated Press).
Toyota built about 8.1 million vehicles world-wide in 2005 compared to about 9 million for GM. GM still has a reasonable lead and if new product introductions would catch on, it could hold onto its lead. Another plus for GM is an ambitious global growth plan including aggressive manufacturing and joint venture agreements in China (White and Hawkins, A6).
Conclusions
The U.S. auto industry is confronted with a period of uncertainty. The long-run survival of both GM and Ford in their current configuration must be considered an open question as they struggle with product and financial challenges. They have lost momentum in the market, and were lulled into a profit complacency with high-margin products such as SUVs that have suffered in the current high fuel cost environment. They also have failed to attract customers with many of their new models and lag in development of new vehicles, such as hybrids.
The competitive situation in the industry is such that consumers have come to expect quality vehicles at discounted prices. Following the ending of the employee price discount program in September 2005, it became clear rational consumers would not accept even GM’s reduced sticker price “value pricing.” Consumers will continue to force the industry – and Ford, GM and Chrysler in particular – to offer high value products at prices reflecting the surplus conditions in the industry. The incentive programs that GM and Ford introduced at the end of 2005 to move products is evidence of that. Of course, the implication for the U.S. automakers is that they are caught in the grips of a vice with price competition on one side and cost pressure on the other.
Globally, GM has a chance to maintain its lead if the marketing cards fall its way. But, Toyota has an aggressive business plan including spending nearly $12 billion a year on new plants and equipment compared to GM’s $8 billion and Ford’s $6 billion. (Treece, 51). Momentum is on Toyota’s side.
Legacy costs, failed experiments to undo decades of vertical integration, consumer skepticism, struggles of Delphi, Visteon, and other suppliers, and increasing profits of foreign-based auto manufacturers in the U.S. create a scenario of ongoing struggle for Ford and GM, especially in North America. The results of this struggle will be benefits for consumers who will have increased product variety from which to choose, improved product quality and reliability, and ongoing price competition. Among the winners will be communities hosting new job-creating transplants owned by foreign based producers. Losers will include workers laid off from the historic “Big Three.” Many workers who keep their jobs will be faced with lower wages and shrinking benefits. In the end, in the early 21st century, we will be witnessing a struggle for the heart and soul of the industry that virtually defined industrial development in the now seemingly distant 20th century.
Works Cited
Associated Press. “Toyota Quickens Quest to Unseat GM.” Accessed at http://www.forbes.com
entreprenuers/entrefinance/feeds/ap/2005/11/23/ap2351134.html on November 23, 2005.
Buckholz, David. “Delphi CEO Miller: Hero or wage wrecker?” Automotive News. November 21, 2005, 1 and 51.
Buckholz, David. “Life is going to be different.” Automotive News. October 17th, 2005.
Chappell, Lindsay. “Toyota: In-house works fine.” Automotive News. October 17, 2005, 22.
Chappell, Lindsay. “Unlike rivals, Toyota lobsters vendors.” Automotive News, October 17,
2005, 22.
“GM to Cut 30,000 Jobs by 2008, Expects $7 Billion in Savings.” Wall Street Journal online
November 21, 2005. Accessed at http://online.wsj.com/article_print/SB113257809378302961.
html.
Hawkins, Lee, J. “GM Weighs Shuttering Some Plants.” Wall Street Journal. November 21, 2005, A3.
McCracken, Jeffrey, and John D. Stoll. “Delphi CEO Sees Major Downsizing in Bankruptcy.” Wall Street Journal. October 1 2005, A1.
McCracken, Jeffrey, and John D. Stoll. “Ford Reports $284 Million Loss’ Restructuring Plan Set for January.” October 21, 2005, A3.
Monteverde, Kirk and David J. Teece. “Supplier switching costs and vertical integration in the automobile industry.” Bell Journal of Economics. 13, Spring 1982, 206-13. November, 14, 2005, 51.
Power, Stephen and Edward Taylor. “DaimlerChrysler Gain Traction from CEO Shift.” Wall Street
Sherefkin, Robert. “Visteon seeks lower wages by moving job out of U.S.” Automotive News. November, 21, 2005.
Shirowzu, Norhiko. “Toyota Plans More Expansion in North America. Wall Street Journal. November, 12-13, 2005, A3.
Shirowzu, Norhiko. “Toyota to Build More of Its Autos in North America. Wall Street Journal online, May 10, 2005, accessed at http://online.wsj.com/article_print/ 0,,SB!!!566853717528430,00.html
Treece, James B. “Toyota's exports will set N.A. reward.” Automotive News.
White, Joseph B. and Lee Hawkins J. “At General Motor Troubles Mount for the Man Behind the Wheel.” Wall Street Journal, November, 11, 2005, A1.
White, Lawrence J. The Automobile Industry Since 1945. Cambridge Massachusetts:Harvard University Press, 1971.
Wilson, Amy. “Bill Ford tackles N.A. crisis.” Automotive News. November 21, 2005, 1.
Wisnefski, Stephen. “GM Plan for Trimming Health-Care Spending IS Ratified by Union. Wall Street Journal, November 12-13, 2005, A3.
275 Eastland Rd.