Trouble in Motown

Despite its second-best U.S. sales year ever in 2001, many of the auto industry's key players find themselves in financial trouble.

It seems that sales of 17.2 million units doesn't go as far as it used to.

Ford Motor Co., once the darling of the industry, has become the poster child for this paradox. Only a year ago analysts were predicting Ford would surpass General Motors as the world's largest automotive manufacturer. This year finds Ford in financial trouble, facing layoffs, plant shutdowns, and a stock price that is at its lowest point in seven years.

GM, though it's not hurting as badly as Ford, is in a difficult financial position. DaimlerChrysler's Chrysler Division, the third of Detroit's Big Three, also is in trouble.

As a group, the Big Three have continued their market share slide. European and Asian automakers now control about 39.6 percent of the U.S. market, their highest penetration in history. The Big Three's dire straits have, of course, made their way to their suppliers. Delphi and Visteon, the two largest suppliers, have announced thousands of layoffs, and many smaller suppliers have been forced to do the same. Textron has sold its automotive division to Collins and Aikman, while TRW also has indicated a desire to leave the automotive industry. Several notable automotive suppliers, such as Federal Mogul, LTV Steel, and Mexican Industries either are flirting with bankruptcy or are bankrupt.

How Could This Happen?

So why is all this financial hardship hitting now, at a time when it seems automakers should be raking in near-record profits based on near-record sales?

First of all, it's not hitting everyone equally.

The recession currently gripping the country seems to have had a smaller impact on its richest residents, as many luxury automakers had an excellent year in 2001. Mercedes, Porsche, BMW, Jaguar, Audi, Volvo, Lexus, and Acura all reported record sales years in 2001.

However, domestic automotive sales plummeted after the Sept. 11 terrorist attacks. General Motors was the first automaker to respond to the subsequent drop in consumer confidence by implementing zero percent-financing incentives. Ford and Chrysler Division followed suit almost immediately.

Many foreign manufacturers initially sat on the sidelines but eventually joined the fray with their own zero percent-financing offers. Consumers responded favorably, and October sales set an all-time record. The brisk sales pace continued until the end of the year. 2001 annual sales reached 17.2 million units - just shy of the record 17.4 million units sold in 2000.

GM pressured other OEMs by extending its zero percent-financing incentives. While other OEMs bemoaned the profits lost on their generous offers, no one dared pull the rebates for fear of hurting demand. GM ended its zero percent rebate in January 2002, and other OEMs followed suit almost immediately.

At the Automotive News World Congress in January, GM President Richard Wagoner estimated that automakers had "pulled ahead" between 500,000 and 1 million sales in 2001. That is, almost 1 million consumers who would have bought a vehicle in 2002 bought one in 2001 because of the generous incentives.

Automakers are discovering that there is a high price to pay for the torrid sales pace generated by the rebates. Because of those pulled-ahead sales, automotive sales in 2002 are expected to be significantly lower-most analysts estimate U.S. sales of just more than 15 million units. What's more, the sales automakers pulled ahead did not generate the profits possible under normal market conditions because of those generous rebates.

Hyundai: Exception to the Rule

The recession seems to be having a bigger impact on makers of less expensive cars; but even at the very bottom of the price curve, Hyundai is finding success.

Hyundai nearly abandoned the U.S. market in the 1990s. It had ruined its reputation by selling cheap, unreliable cars. Public perception mirrored the results of a J.D. Power Initial Quality Survey (IQS)-Hyundai was the perennial bottom dweller.

To reverse its fortunes here, Hyundai introduced new vehicles with better quality to the North American market. It bolstered customer faith in their products by adding a 100,000-mile bumper-to-bumper warranty. Its IQS performance, along with sales, improved dramatically. 2001 sales totals were a 41.7 percent improvement over 2000's. Hyundai sold 346,235 cars in the U.S. in 2001, compared to 260,730 for Saturn, GM's "import-killer" division.

Hyundai is making no secret of the fact that it now wants to follow the path of other Asian and European manufacturers by adding an assembly facility in the U.S. It likely will follow the path blazed by these firms by building a new facility in the South, where attitudes toward unions are less friendly. In addition, Mississippi's head of economic development recently made a trip to Korea, if that tells you anything.

The Korean government remains a large shareholder in Hyundai, and for now, the company seems to depend heavily on subsidies. A U.S. assembly plant, depending on how much capital suppliers lay out, would cost Hyundai between $500 million and $1 billion. Coupled with Hyundai's existing debt (which is quite substantial) and American wages, that obligation may prove too much to bear if Hyundai's creditors tighten the screws.

Lessons

Hyundai has made its strong market push by providing more value than its rivals. Hyundai's most recent sales figures, added to those of its Kia division, total almost 570,000 units—more than Chrysler, Pontiac, Jeep, Buick, VW, or GMC. In short, beating Hyundai's approach will be difficult for players in an industry in which margins already are laser-thin. The question begs to be asked: If the Big Three have fared this poorly in a 17.2 million-unit market, what will happen when the market shrinks to 15 million units or less?

The Big Three appear to be functioning with a broken business model: They can't sell cars without incentives that kill their bottom lines.

At the same time, even with the most generous incentives on the market, they continue to lose market share to foreign automakers that sell cars despite smaller incentives. The Big Three are in a difficult predicament, and they all acknowledge the need to reduce incentives to improve their bottom lines. They just can't seem to shake the addiction.

Chrysler, which regularly criticized General Motors for forcing it to match GM's zero percent-financing incentives, has been perhaps the most outspoken opponent of incentives. Yet, it just announced increased rebates of up to $2,500 on 2002-model vehicles.

The habit is hard to shake, indeed.