THE AUTOMOTIVE CRISIS: HOW WE GOT HERE, WHERE WE ARE HEADED, AND WHAT WE CAN LEARN With some implica

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THE AUTOMOTIVE CRISIS HOW WE GOT HERE, WHERE WE
ARE HEADED, AND WHAT WE CAN LEARN (With some
implications for Real Estate, Economic
Development, and Business Generally)

• September, 2009

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Some upfront housekeeping

• Thanks are due to
• My hosts, IAMC (especially Hazel Pankey) and
  session sponsors (Lubbock EDA and McCallumSweeney
  Consulting)
• IAMC members who provided input Jeannette
  Goldsmith, David Hocker, Ron Kitchens, Jennifer
  Lantz, Doyle Shea, Bleecker Totten, James Winter.
• My sources, including CasesaShapiro, CSM, Key
  Bank, BEA, Wards Sean McAlinden, Dennis
  DesRosiers, R L Polk, Merrill Lynch, Comerica,
  etc. etc.
• Caveats are
• All errors and interpretations are my own
• A North American (rather than global) focus
• A discussion of the automotive crisis, not the
  broader recession
• For questions, more information, data, etc.
  gamercer2_at_gmail.com

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Contents

• How we got here causes of the disastrous impact
  on the Detroit 3 of the volume collapse
• The scale of the collapse
• Detroits disproportionate suffering
• Causes of the Detroit problem short-, medium-
  and long-term factors
• Where we are headed an attempt at a forecast
• What we can learn lessons from the fall

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The scale of the collapse the industry drives
off a cliff
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Detroits disproportionate suffering the Big 3
hit hardest
US Sales Detroit share falls from 75 in 1985 to
45 in 2009e
Transplants and Imports
GM Ford Chrysler
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Detroits disproportionate suffering 2 out of 3
file bankruptcy

• General Motors, after its bankruptcy, is now
  owned by a consortium of the US and Canadian
  governments, the UAW, and former bondholders
• Congratulations! Everyone in this room owns
  about 150 of GM
• Chrysler, after its bankruptcy, is now owned by a
  consortium of the US and Canadian governments,
  the UAW, and Fiat
• Still burning cash, perhaps 500 mm per month?
• Ford avoided bankruptcy, but primarily by
  mortgaging itself in 2006
• Roughly 25 billion raised even the Blue Oval
  symbol and trade names such as Mustang were
  pledged

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Putting the bankruptcies in perspective
Source is Bankruptcydata.com scale is billions
of of pre-bankruptcy assets
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But shouldnt we have seen this coming? In
market share
Source Wards AutoInfobank
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and in profits?
Source Moodys, Company Reports Casesa Shapiro
Group estimates for 2007 Chrysler results and for
2008 Big Three results
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Causes of the decline and fall

• Short-term factors debt, debt, and more debt
• Medium-term factor drunk on trucks?
• Long-term factor outmoded basic beliefs

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Short-term factor debt. The case of General
Motors

• Business School 101 Companies facing cyclical
  markets should not carry a large burden of debt,
  in order to survive downturns.
• GMs debt exposure (year end 2007, prior to
  current crisis)
• Owed to banks long-term bonds 33 billion
• Owed to workers retiree health care 47
  billion
• Owed to workers pensions 11 billion
• Owed to suppliers (negative) working
  capital 34 billion
• Owed to dealers (US only) excess car inventory
  15 billion
• on revenue of some 180 billion

Source company financial statements all figures
exclude financing captive (GMAC)
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Illustration of GMs debt problem Toyota
comparison

• Toyota (and Honda similarly) can turn to its
  business partners for funding to get through a
  downturn GM drew down all its sources, and so
  had to turn to Washington for funds.
• Debt exposure (year end 2007, prior to current
  crisis)
• GM Toyota
• Owed to banks 33 4
• Owed to workers RHC 47 0
• Owed to workers pensions 11 6
• Owed to suppliers 34 13
• Owed to dealers 15 0
• on GM revenue of some 180 billion, Toyota some
  250 billion
• and GM equity of negative 35 billion, Toyota
  positive 115 billion

Source company financial statements all figures
exclude financing captives Toyota FY ending
3/2008
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Medium-term factor the truck boom leads to a car
bust.

• Even as the American market collapsed, the
  Detroit 3 lost share within that market. How did
  this come about? This is a development that has
  gone on for years.
• Hypothesis as to the factors behind this
  weakening
• The truck boom (SUVs and pickups) earned the
  Detroit 3 vast profits
• which they used to fund adventures rather
  than reinvest in the core business
• leading to relatively neglected and
  uncompetitive car product lines, once the truck
  boom ended.

The Detroit 3 have lost market share in the
USA-plus-Canada every year since 1993. Dennis
DesRosiers
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The truck boom of 1990-2005

• It is hard to overstate the shift to light trucks
  in the USA over the years (due to regulation,
  consumer preference, and marketing).

Millions of units sold, US market
Source Sean McAlinden from Wards data
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The truck boom of 1990-2005

• It is also hard to overstate the flood of profits
  that flowed from the American love affair with
  light trucks. See the example of Fords Michigan
  Truck factory
• in 1998 the Michigan Truck Plant had
  become the single most profitable factory in any
  industry anywhere in the world. It was cranking
  out 1,040 full-size sport utilities every
  workday. The factorys annual production was
  worth almost 11 billion greater than the
  global sales for Fortune 500 companies like CBS,
  Texas Instruments, Honeywell, and Nike The
  factorys profits from those sales were even more
  spectacular about 3.7 billion in pretax
  profits while Ford had 53 assembly plants
  worldwide, the Michigan Truck Plant accounted for
  a third of the companys entire profits. There
  were fewer than 100 companies in the world that
  earned more than this single factory did in
  1998
• Source Keith Bradsher, High and Mighty

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The truck boom of 1990-2005 PERSONAL OPINIONS

• With profitability assured by the cash flow from
  trucks, Detroits Big Three spent much of the
  1990s engaged in all sorts of adventures not
  necessarily related to the core business of
  making cars.
• Ford bought Aston Martin, Jaguar, Land Rover,
  Volvo, and Hertz, embarked on a series of
  downstream business extensions (e.g. purchasing
  car maintenance companies, collision repair
  shops, and salvage yards), spun off Visteon and
  then unwound all these
• GM started and then stopped EV-1, diverted large
  sums into fuel cell research, spun off Delphi,
  sold Hughes Aerospace, aggressively expanded GMAC
  into home mortgages, bought Daewoo Motors, got
  into a deal with Fiat and then back out, starved
  most of its alliances (Suzuki, Isuzu, Saab) all
  for nought
• Chrysler of course cashed out (to the great
  benefit of its shareholders the 36 billion paid
  would today buy Ford plus GM plus Daimler itself,
  with about 6 billion left over) by selling
  itself to an unsuspecting Daimler
• A move that is considered very sound by many
  observers.

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The truck hangover uncompetitive cars

• Partly as a result of the truck boom, Detroit
  allowed its vehicle platforms to age relative to
  the competition, which as a result gained share.
• Age distribution of NA product platforms
  1996-2008

Green 0-2 years old yellow 3-4 red 5-8
years black 9 or more years Source Dennis
DesRosiers
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Long-term factor outdated beliefs
Context Critics of the Detroit automakers recite
a long litany of explanations for apparently
foolish actions stupidity, evil intent,
disregard for the environment, arrogance, refusal
to learn, inward focus, etc. I find these
assertions unsatisfactory, preferring instead to
identify the incentives that can explain
seemingly suboptimal behavior. Thesis The
Detroit automakers suffer from adherence to two
core beliefs (one related to demand and one to
supply) that drive a wide range of behaviors.
The reason they cling to these core beliefs is
that they held true for many years, and as large
firms can be slow to revise views, they have only
recently realized these two have become
obsolete. Prediction As Detroit goes through
its restructuring, obsolete views such as these
will be swept from the system, allowing a more
successful mindset to emerge assuming the
companies survive the crisis.
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Long-term behavioral factors Core Beliefs

• The demand-side core belief Form trumps
  function.
• Definition cars self-expression, status
  symbol, my face to the world
• Strategy slow upgrades of functionality, more
  rapid shifts in appearance
• Successful when cars are novel, one car per
  household, few other status symbols, car quality
  low, ability to differentiate high
• Genesis of belief the oligopolistic 1950s and
  1960s, when an otherwise unchanged model could
  soar in sales with a styling change
• Exemplar 1965 MY Ford Mustang an
  otherwise-unchanged rebodied Falcon that sold 1
  million units in 18 months (Ford expected
  150,000)
• This belief no longer holds
• Cars are now seen by many Americans as appliances
• In the USA there are now 2.5 vehicles/household
• Families now display status also via phones,
  iPods, vacations, kitchens
• Car quality is high enough to no longer drive
  rapid purchase cycles
• Stylings ability to differentiate lower (due to
  regulation, aerodynamics)

• Impact
• Policy of upgrading vehicle functionality slowly,
  opting instead for sheet metal and model name
  changes (Ford midsize sedan names since 1980
  500, Fusion, Granada, Taurus, Taurus again
  Toyota Camry)
• Strategy of betting on flashy individual new
  model launches, which have short half-lives (e.g.
  Chrysler 300, Pontiac Fiero) rather on steady
  updating of entire lines (e.g. BMW 3 5 7)

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Styling as a differentiator reduced impact?
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Long-term behavioral factors Core Beliefs

• The supply-side core belief Scale trumps
  efficiency.
• Definition economies of scale are the key to
  profitability
• Strategy pursue capacity via organic growth or
  acquisition and for any given capacity, always
  produce the incremental unit
• Successful when fixed costs of product
  development and manufacturing are very high,
  market is in a growth phase, price discrimination
  is easy
• Genesis of belief from the Model T onward into
  the 1980s production typified by inflexible
  large transfer lines, product development manual
  and complex, market steadily growing, external
  styling and branding conceal identical
  mechanicals under varying model names
• Exemplar 1965 GM B body sells 1.7 mm units in
  one year, under names LeSabre, Bel Air, Biscayne,
  Impala, Caprice, 88, Bonneville, and Catalina
• This belief no longer holds
• TPS recasts the value equation to waste
  minimization and flexibility, from scale
  maximization CNC machines, CAx tools, etc. aid
  the switch
• Developed markets mature, reducing capacity to
  absorb excess units
• New competitors and smarter consumers break the
  pricing paradigm

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Impact of the belief in scale

• The ill effects of the belief in scale economies
  above all else are several
• A focus on maximizing production leads to a
  belief that all units are equal, from a Maybach
  to a Mercury to a Mazda, regardless of varying
  margins, leading management to slight profits in
  favor of unit market share (thus the smallest OEM
  sampled has the best returns to shareholders)
• When the goal is maximizing output, any costs of
  complexity are ignored incrementalism is free.
  Thus GM sells fewer cars than Toyota, but stocks
  roughly three times as many part numbers, at
  great cost.
• In pursuit of more volume, OEMs push into
  developing markets, despite low per-car profits
  thus forecasts show that by 2015 most of global
  unit growth will be in emerging markets but the
  developed world will likely still control some
  75 of global revenues -- the same as today
• With a focus on units moved rather than on
  profits made, management can lose sight of the
  fundamentals, leading to strategy by slogan
  (e.g. first mover advantage) evaluation of
  winners and losers by unit share, not by bottom
  line results and the cult of the visionary
  CEO.
• And finally, pursuit of scale at all costs leads
  to MA activity in order to grow, despite the
  poor track record of OEM mergers.

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The Poor Track Record of Western OEM Mergers
(partial list)

• GM-Saab bankrupt
• GM-Suzuki exit
• GM-Fuji exit
• GM-AmGen/Hummer exiting
• Ford-Jaguar exit
• Ford-Land Rover exit
• Ford-Aston Martin exit
• Ford-Volvo exiting
• Ford-Mazda success1
• Chrysler-Simca exit
• Chrysler-AMC success
• Fiat-Lancia failure
• Fiat-Alfa Romeo failure
• VW-Skoda success2

• VW-Audi success3
• VW-SEAT failure
• BMW-Rover exit
• Renault-AMC exit
• Renault-Nissan success4
• Renault-Dacia success
• Daimler-Chrysler etc exit
• PSA-Simca etc failure
• Peugeot-Citroen success?
• 1 only after many years
• 2 but Skoda was rebuilt from scratch
• 3 Piëch has suggested this is not so
• 4 an alliance, not a merger

NB Success and failure assigned according to
whether the merger achieved stated goals of the
acquirer NB I leave it to my audience to
evaluate the Japanese MA track record, e.g.
Toyota/Daihatsu
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Contents

• How we got here causes of the disastrous impact
  on the Detroit 3 of the volume collapse
• The scale of the collapse
• Detroits disproportionate suffering
• Causes of the Detroit problem short-, medium-
  and long-term factors
• Where we are headed an attempt at a forecast
• What we can learn lessons from the fall

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One qualified forecast for total NA sales (CSM)
CSM projects a slow but steady recovery to
historic levels I agree
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To assert no recovery implies belief in trend
reversal (1)
SCRAPPAGE At present new sales are running
below annual scrappage for the first time since
World War II
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Trend reversal? (2)
VMT Do we think that the current dip in vehicle
miles traveled is an inflection point?
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Trend reversal? (3)
OWNERSHIP What might happen to end the growth in
cars per household?
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Trend reversal? (4)
AFFORDABILITY With any reasonable elasticity of
demand assumed, sales seem likely to rise
Most affordable score since the index was first
computed in 1979!
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What about the outlook for individual OEMs? (1)
All else being equal, nothing tracks/forecasts
OEM market share as well as average age of an
OEMs model lineup.
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What about the outlook for individual OEMs? (2)
If this relationship holds, Detroits market
share should continue to slip, all else being
equal (dealer counts, government aid, styling
changes, powertrains)
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Results by OEM, for 2013

• Forecast summary
• Demand does return to normal, though it will
  take time
• We will move from a Big 3 to a Big 6
  (Europeanization) more balance, more market
  share to/fro versus steady trends
• Finally, a focus on profits rather than on
  volumes
• Hopefully, much clearer brand propositions (pull
  vs. push)
• As for Detroit, one view is that GM is okay
  unless it backslides Ford is likely to gain
  thanks to product offensive (kudos to Mazda?)
  Chryslers fate hangs on Fiat et al.

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Contents

• How we got here causes of the disastrous impact
  on the Detroit 3 of the volume collapse
• The scale of the collapse
• Detroits disproportionate suffering
• Causes of the Detroit problem short-, medium-
  and long-term factors
• Where we are headed an attempt at a forecast
• What we can learn lessons from the fall

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Lessons from the fall general business insights

• How we got here eerily similar to the housing
  and financial crisis
• Lessons from all this might include
• Watch your debt load and stress test it for
  extreme scenarios!
• Do not be distracted by the latest big trend
  (trends end)!
• Challenge beliefs that everyone knows are true
  they may not be!
• Looking ahead all cycles look like inflection
  points when youre in the trough
• Additionally economic uncertainty might make all
  real estate transactions more complex (e.g.
  should government takeover now be an explicit
  contractual clause instead of just force
  majeure?)

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Lessons from the fall real estate commentary

• Repurposing closed auto plants has been and will
  be very difficult
• There are success stories
• GM Linden (NJ) becomes Legacy Square retail
  (Lowes , Super Wal-Mart)
• GM Oklahoma City becomes Tinker AFB maintenance
  and repair facility
• Guide plant (ex-GM/Delphi) (LA) to become
  V-Vehicle H/EV plant?
• GM stamping plant (MI) transformed into Midlink
  Business Park
• But these may be few and far between
• GM and Chrysler alone to close 25 mm ft2 in
  Michigan Ford on a similar path
• Facilities closed in the bankruptcy may escape
  environmental cleanup liability, making these
  plants hard for communities to deal with even at
  a zero price
• Greentech initiatives (e.g. Michigans 700 mm in
  credits for battery manufacture, Great Lakes Wind
  Network) are still nascent and relatively small
• New entrants (China, Asia, startups) may offer
  some new opportunities
• There are opportunities in dealing with 3,000
  shuttered dealerships
• The industrys center of balance will continue to
  shift southward
• Has the Southern model of incentives been
  vindicated? (simplistically Northern pattern is
  85 tax abatements, 15 infrastructure South is
  40 tax, 45 infrastructure, 15 training, etc.)
• The local industrial base can never be too
  diversified

• The Southern Shift
• In 1979 South (AL GA KY NC SC TN) had 7.5 of USA
  automotive employment in 2004 15
• In 1979 South had 5 assembly plants in 2008 13
• Of all new parts plants opened between 1980 and
  2006, 67 were in the South
• With Detroit 3 closures continuing, shift will
  accelerate
• Source Thomas Klier, Chicago Federal Reserve

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Final slide

• Please contact me for more data, backup material
  for slides, additional questions, etc
  gamercer2_at_gmail.com
• Thank you!