Monday, May 04, 2009

Why Has the U.S.-Owned Auto Industry Failed in North America?

May 4, 2009 

There may not be any one answer, but the 800-pound gorillas in the room are: short-term managerial focus on profits, uncompetitive quality in terms of durability and cost of ownership, and the union's reluctance to adapt to changing circumstances.

I find it hard to believe that the near-complete meltdown of the U.S.-owned auto industry has elicited such little commentary or reflection. Even though I expect blatant propaganda from our government and mass media, I am still surprised by the massive spin and general complacency over what is clearly a watershed collapse and a host of new precedents with unforseen consequences.

It's as if America watches its U.S.-owned auto industry fall and then yawns, changing channels to something more "upbeat."

The news is both Orwellian and Kafkaesque, coarsely propagandistic and twisted at the same time. Chrysler, we are told by our president, will emerge stronger, better, more wonderful than ever, etc.

Really? Based on what? Sadly, the company has almost no new models in the works, and has partnered up with another failed auto company in Europe which is essentially propped up by another government (Italy) keen on saving a relative handful of high-profile unionized industrial jobs.

Fiat has not sold many cars in the U.S. for the simple reason they are not competitive in price or value. That a Chrysler/Fiat marriage will quickly create and build vehicles which will compete on price, value and durability with those made in Ohio, Kentucky, Tennesee and elsewhere in the U.S. by Japanese-based manufacturers is a bit of a stretch.

We are also reminded almost gleefully (or is it desperately?) that Ford is still standing, due to raising billions of dollars back when that was still possible, and it's still selling lots of cars in North America. That it "only" lost $1.4 billion in the last quarter was cause for massive celebration and a tripling of its stock.

Yes, that is good news, but shouldn't we also be looking at what the collapse of GM and Chrysler means for the entire U.S.-owned industry and the nation as a whole? The fact that Ford sold 136,000 vehicles instead of collapsing is good news, but what is the company's long-term viability? And is the survival of one of the Big Three and the reduction of the other two to shadows of their former selves really cause for a sort of weirdly complacent celebration?

It seems to me that such catastrophic events should be cause for reflection and analysis, not yet another PR-propaganda blitz about how happy-happy it all is.

Here are some observations which may or may not be telling. I am not an industry insider; these are only the observations of a one-time resident of Detroit (summer of '68) and a tight-fisted/marginalized consumer who has never bought a new car but who has kept in touch with U.S. nameplate vehicles via rentals and family-owned cars.

1. Much is said about poor management in the Big Three, but less is said about the short-term focus on quarterly profits that characterized their corporate culture. As I recall, the U.S. automakers paid out bonuses of several thousand dollars each to its unionized workforce when profits were in the billions, so perhaps we should note that the focus on short-term profits might not have been limited to the executive suite and major shareholders.

Maybe we should examine whether the short-term focus on quarterly profits that was certainly part of the Big Three's demise is itself bankrupt. Maybe this corporate philosophy is leading American industry to the junkheap because it creates all the wrong incentives and disincentives: an obsession with profits rather than quality, a dearth of long-term planning, a pressure to pay out bonuses and dividends rather than pay down debt and all the rest.

Maybe the collapse of the Big Three is not just an indictment of the Big Three but of Corporate America in general. The endless propaganda spewed by the financial press never tires of glorifying Corporate America with stories about "the top 100 companies," the top 50 innovators, the best companies to work for, etc. etc. etc.

Maybe it's as simple as: those companies with long-term planning and an abhorrence of debt will prosper and all those which focus on short-term profits and acquiring debt will wither.

2. Most of the profits generated by the Big Three in North America came not from manufacturing vehicles but from financing the sale of those vehicles.In other words, the auto industry securitized its way to "prosperity" just like the investment banking and housing industries.

When you no longer can make a profit manufacturing a product, then you focus on the profits and fees generated by selling debt to consumers to buy the product. Is this anyone's conception of a healthy robust sustainable capitalism?

3. The durability of Big Three-manufactured cars was simply not competitive. The Big Three chose to tout the J.D. Powers reports on the number of defects found per new vehicle as the proper metric for their improved quality; as a low-income marginalized consumer my metric was more demanding: can this car run for 12+ years with almost no maintenance or repair bills?

Unfortunately, I do not personally know of any Big Three-manufactured vehicle which lasted past five or six years without incurring major maintenance or repair bills--often in the thousands of dollars. The Big Three trucks have a pretty good record of lasting 10+ years with low costs of ownership, but the rest of the fleets have poor records of long-term durability and ownership costs.

This lack of durability of the Big Three vehicles receives almost no visibility.The fact that a car made by American workers with largely American-made parts in Tennesee lasts a decade or more with virtually no repairs or maintenance required while the 10-year old Big Three vehicle is either junked or a problem-riddled "beater" is the 800-pound gorilla in the room few have cared to discuss.

My Dad surrendered his devotion to Ford's Lincoln Continental only after the company broke his decades-long loyalty by refusing to repair a transmission which failed a few months after the warranty expired. How can a transmission in the company's luxury car fail? How could the company not see the wisdom of repairing their topline vehicle for a customer who bought and owned their cars for decades?

In my view, this incident sums up why the Big Three are collapsing: poor quality, poor customer service, and a high cost of ownership. It's simply too expensive to buy and own a Big Three car unless you sell it at a hugely depreciated price within the warranty period-- at which point you've already lost thousands of dollars.

So the last car my Dad bought (new) was a Chrysler 300, that company's topline vehicle. Now six years later it is riddled with electrical problems which have cost thousands of dollars to fix. This is also not unusual.

Meanwhile, the car I bought used that was made by American workers with mostly American parts (a 1998 Honda Civic) is in its 11th year of service with virtually no repairs except a faulty sensor we replaced in a few minutes with a tool borrowed from a Kragen Auto Supply.

My experience of European-made cars is also poor when measured in durability and the cost of ownership over 12 years (10,000 miles a year for 12 years, as any modern vehicle should be able to last 120,000 miles without costly repairs.) My Dad's one foray into the Mercedes line ended like all other Mercedes I know of personally: with a $4,000 repair bill around year 8-10.

If you walk around any large parking lot in California and tally up the brands of the vehicles, you would find the vast majority are Japanese brands made in the U.S. American trucks are in evidence but there are very few Big Three sedans or even minivans. The reason is not disloyalty, it's simple economics: the depreciation of value and long-term ownership costs of Big Three and European brand vehicles are so much higher than the Japanese-brand vehicles that few can afford the Big Three or European brands.

The transmission in my brother's topline Alfa Romeo just failed after four years, requiring $6,000 in repair bills. Atypical? Let's put it this way: how many times have you personally known a transmission in a U.S.-made Toyota or Honda to fail, ever? I drove my 1985 Honda Accord to the wrecking yard after 20 years of service because it no longer passed California's strict smog tests. Someone could have pulled the tranny and probably gotten another 20 years out of it. That trannies in Lincolns and Alfas fail after a few years is incomprehensible. And don't even ask about electrical systems.

4. There are three basic explanations for this decline in durability. One is that the Big Three relentlessly squeezed their parts suppliers to lower costs, and since that's all that mattered then the quality of those parts declined--you get what you pay for.

Meanwhile, the Japanese management philosophy is quite different; they seek to establish a consortium of parts suppliers which they will work with for years if not decades. Yes, price matters but quality matters above all else. The suppliers eventually learn they can make a profit by supplying high-quality parts in quantity to Honda, Toyota, et al.

Poor parts lead to parts failures and durability vanishes.

The second possibility is that the Big three consciously pursued Planned Obsolescence as a guiding strategy, based on the 1950s-60s-era habit of prosperous U.S. housholds buying a new car every three years.

After all, real income and wealth when measured in constant dollars was rising from 1946 through about 1969, so the typical American household could afford a new car payment and thus a new car.

Detroit pumped out exciting new models every year, fueling the desire for the "new hot look." The release of new models was a national event.

Now, most cars look blandly alike: yet another gorilla in the room few mention as a proximate cause for Detroit's decline. The best Big Three vehicle I've driven in the past 10 years was a PT Cruiser; it had good visibility, a clean interior and a decent ride. And it didn't look like a 1993 econobox dressed up with a rounded rear end like most other cars.

Unfortunately for Detroit, real (inflation-adjusted) U.S. household income began slipping in 1970 and has continued sliding ever since. As interest rates climbed in the 70s and the quality of Detroit's vehicles visibly slipped, people turned to the Japanese cars partly because they could no longer afford to buy an American car every three years or maintain one that fell apart in a few years.

A "gentleman's agreement" with the Japanese automakers to limit their imports drove the Japanese companies to build massive capacity in North America.

The third possibility is that the Big Three's supposed obsession with quality was largely short-term when compared to the Japanese. Thus the focus turned to reducing defects in new vehicles, not to making those vehicles so they lasted for a decade or longer with little maintenance.

Please read this excerpt from How Detroit Drove Into a Ditch (Wall Street Journal, Oct. 25, 2008)

In Detroit, amid worker alienation and the "blue-collar blues," Chevies, Fords and Plymouths rattled, rusted and rolled over -- and those were the good ones. The Ford Pinto's gas tank was prone to explode into flames when the car was hit from the rear, making the Pinto the poster product for corporate callousness. In 1978, after three Indiana girls burned to death when their Pinto got rear-ended, Ford became the first company to be indicted for reckless homicide. The company later was acquitted, but public opinion judged the Pinto guilty.

For all the Pinto's infamy, perhaps no car better captured America's decade-long haplessness than the pug-ugly AMC Gremlin, which debuted in 1970 and died -- mercifully -- in 1980. The Gremlin's shape, fittingly, was first sketched out by an American Motors designer on the back of a Northwest Airlines air-sickness bag. On Aug. 20, 1979, 18-year-old Brad Alty, fresh out of high school in Mechanicsburg, Ohio, was driving his Gremlin to work when the car broke down. He was two-and-a-half hours late to his first day on the job at a new motorcycle factory that Honda Motor was opening in central Ohio.

For the next few weeks, Mr. Alty and his 63 co-workers did little but sweep floors and paint them with yellow lines. Then they started building three to five motorcycles a day. And at the end of each day they would disassemble each bike, piece by piece, to evaluate the workmanship. Mr. Alty hated it, and he kept getting grief from his older brother for working for a Japanese company. "I thought I had made a mistake by going to work there," he recalled recently. "It was like, 'What the heck am I doing here?' "

But Mr. Alty stuck with it, and Honda stuck with him. Honda's real goal was to build cars in America, but the motorcycle plant allowed it to test the mettle of American workers for a modest investment. The workers passed the test. Honda started building Accords in Ohio in November 1982. Ironically, some U.S. Honda dealers actually protested that they wanted to sell only Accords made in Japan. But the quality of the Ohio-made cars was soon confirmed.

If any of the Big Three pursued equivalent efforts to make quality more than a buzzword or marketing pitch, I have yet to read about it.

5. The UAW continued to act as if the Big Three still held the same quasi-monopoly they'd enjoyed in the 1950s and 60s. Exhibit One is the Ford-UAW agreement pictured below. Is this the agreement of a union fearing the dissolution of the industry and companies which support it? Is this the agreement of a union obsessed with lowering costs to enable the companies it depends on to survive and prosper against intense global competition? Clearly it is not.

In the context of a quasi-monopoly, perhaps it made sense to demand shorter work weeks and ever-higher pay, benefits and bonuses. But it seems likely that the UAW failed to consider the long-term consequences of Detroit's decline in quality when compared to its global competitors, the consequences of American household's decline in real wages and the consequences of skyrocketing healthcare costs to its three employers.

I'm not trying to bash the union or its members here; all I'm saying is that the union is also an enterprise, and as such it has to adapt to changing realities if it is to survive.

I last addressed the auto industry in December 2008: An Adversarial Culture: Auto Industry Bailouts (December 4, 2008)

NOTE: if you're in the U.S. stock market in any way, you might be interested in the weekend entry Another Look at the VIX

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