Pricing sanity returns to the automotive industry

Last year's improved automotive sales numbers were tempered by the fact that they didn't improve as much as many analysts had forecast—and hoped—before the year began. The 11 percent increase, though mild, was accompanied by one important caveat: Automotive industry profits recovered much more quickly than automotive sales did. Financial health, it seems, has returned to the automotive industry, even if the glory days of roaring vehicle sales have not.

The reasons for this significant improvement start at the top of the automotive value chain. Automakers have held the ground on the sales incentives that had eaten away at the industry's profitability for a decade. What's more, they have not gotten involved in the one-upmanship of competitive reductions in vehicles' base price. Incentives are down, vehicle prices are up, and the transaction value of the average automotive purchase has risen accordingly. Consumers are still getting a great deal—they're just paying a fair price for the product they're buying.

This newly found pricing sobriety is one of the key factors driving today's automotive market to be smaller than it was in years gone by. The other, more obvious factors are still there, including a national labor market that isn't improving as fast as hoped for, tighter access to lending, and jitters about the staying power of the economic recovery.

Automakers have clearly benefited. Ford had the second-most profitable year in its history, despite the historically shockingly small market, and its stock shares are trading at more than 10 times their 2009 price. GM's financial performance has justified an IPO successful beyond even the most optimistic expectations. Chrysler is reporting operating profits. And international automakers have, for the most part, also experienced financial success.

What It Means for Suppliers

The benefits have, at least partially, made their way to suppliers. Many are reporting positive financial performances, revenue growth, and a return to functioning outside the panic mode of the last two years. Supplier stocks are becoming popular on Wall Street, as many analysts have been recommending them as poised to take advantage both of the gradual recovery of automotive sales and of the automotive industry's newfound fiscal sensibility.

Not all of the credit for these recent successes goes to pricing, of course. A key reason that the industry is able to be profitable in so small a market is that both automakers and suppliers have cut waste and capacity so deeply. This smaller automotive market is being serviced by a smaller industry.

Concerns are surfacing, however, that all might not be well for suppliers. Many are still running extremely lean and would find themselves highly vulnerable to a number of potential disruptions: an economic downturn, an automotive sales dip, automaker financial pressure, or insufficient access to capital.

This last factor is perhaps most responsible for keeping automotive supplier executives awake at night, despite the positive news otherwise surrounding the industry. Automakers' purchasing staffs are likewise concerned about the capability of their supply base to make the necessary investments to ramp up parts production as the recovery continues and orders from automakers increase in volume but not necessarily in profit margin.

It is therefore a possible blessing in disguise that the automotive sales recovery has been slower than hoped for. The gradual return to volume production has allowed the supply base to ramp up production more gradually, giving it more time to find elusive financing from a still-stingy financial sector.

Cooperative Makes a Difference

All told, things can be described as proceeding as well as could be hoped for. The question for suppliers is, Will it last? Automaker shareholders and their purchasing executives have been noticing the positive financial reports and stock forecasts hinting that certain firms in the supplier sector may be a bit more profitable than they need to be.

Many suppliers would not have survived the crisis if not for extremely understanding and cooperative actions of the automakers. Now that the worst of the crisis is over, this pricing and contractual flexibility is at risk of reverting to the less cooperative levels experienced in years past.

The U.S. automotive industry continues to undergo structural change. The biggest driver of change looming on the horizon is fuel economy standards that will become increasingly stringent over the next few years. Automakers already are redesigning their products to be more fuel-efficient, lighter, and environmentally friendly. These changes add tremendous costs to vehicles that already have been getting more expensive because of material costs and the inclusion of more safety and information technology.

Supplier executives must therefore judge the months ahead with a wary eye. The ever-evolving business environment of the automotive industry will give them little time to savor the monumental achievement of having survived a crisis that destroyed so many others.

Whether the automotive industry as a whole has taken to heart the lessons of cooperative relationships that made surviving the crisis possible is an open question that soon will be answered.