Saturday, 19 December 2009

What’s Really Going On

J. D. Power recently released the results of their study on owner retention. According to the study Mercedes Benz showed a significant increase in owner loyalty from 2008 at 67%, the highest score since J. D. Power has been measuring retention, and finished in the top spot. Honda, Toyota, Subaru, and Lexus complete the top 5. As I read the results of this study I thought of conversations I’ve had recently with Dealers who own multiple franchises including both Imports and Domestics. Some of these Dealers have had Chrysler and/or GM franchises terminated or have been told their franchise agreements will not be renewed.

It seems there are quite a few lessees bringing their GM or Chrysler vehicles back at termination of a lease that was put on the books 36 - 48 months ago through GMAC or Chrysler Credit. The way this is supposed to work is the lessee returns to the Dealer to turn in their previous lease vehicle and drives away in a same brand comparable vehicle, classic owner retention. Because of GMAC’s many issues, including having to service both Chrysler and GM dealers and their new commitment to “realistic” residuals, lessees who might prefer to stay in a GM or Chrysler vehicle are faced with a radical increase in monthly lease payment. This “lease payment shock” situation has not been happening at Dealers of the top 5 Manufacturers on the J. D. Power retention list, as their OEM captive finance arms have continued to provide consistent lease support of their products.

So what is a returning lease customer to do when faced with a multi hundred dollar increase in their monthly lease payment? Some consumers might just leave with a bad taste in their mouth and go to another Manufacturer’s dealership. At a multi franchise Dealer, someone returning a Suburban, Yukon, Escalade, etc. might find happiness in a new Mercedes Benz, BMW, or Audi SUV at a dealership of the same owner. Someone returning a Cadillac STS might be thrilled to lease a new Lincoln MKS or a new Benz E Class. In my years of watching the Dealer leasing business I have often encountered these “lease payment shock” situations with domestics OEMs but rarely with the Japanese and European imports. It’s easy to see where GM and Chrysler’s market penetration is going. Firing executives can’t make up for a lack of competitive and consistent lease support.

Dealers who hold multiple franchises do so to keep from being totally dependent on a single OEM. This is also the type of Dealer that was targeted for termination by GM and Chrysler. They must want their Dealers to be so dependent on them that they become totally vulnerable to whatever their single OEM’s products and programs happen to be at any point in time. It seems they would prefer their Dealers not to have options when it comes to retaining a consumer who is looking for a replacement lease vehicle.

According to their logic, they want their Dealers to spend more on their facility, at a time when consumers more and more regard their computer monitor as the showroom. A savvy Dealer, or any business person, for that matter, will want to reserve as many options for themselves as possible. If GM and Chrysler can’t support their own products, why should they mind if a Dealer who puts the customer in a brand from another OEM? Perhaps GM and Chrysler think consumers are so loyal to their brand they will opt for a much higher lease payment than before, for a new like brand similar vehicle. Or maybe they know they are “behind the eight ball” but want their Dealers to suffer along with them?

At the very least, it becomes apparent that Manufacturers who manage their business in such a way that facilitates repeat business are far more likely to achieve it than those who don’t.

It’s Ed and the Board’s GM Now!

Just as President Obama has taken "ownership" of the U. S. economy, Ed Whitacre and the GM Board of Directors have taken "ownership" of GM. Let’s do a quick “body count.” Fritz Henderson, went from “hero” to “resigned” in a matter of weeks. Board Chairman Ed Whitacre recently said of Henderson, "The board gets along with Fritz; he has our unanimous support." After Henderson was "broomed" Whitacre then assumed Henderson’s CEO position in addition to his own Chairman of the Board duties, at least temporarily. At least Alan Mulally, President and CEO of Ford, had time to learn on the job before he found himself in total crisis. And Mulally came from a manufacturing background.

Brent Dewar, recently appointed by Henderson as head of the Chevrolet brand was “dismissed” and replaced by James Caldwell, who recently was head of Chevrolet fleet operations. This might make the people responsible for maintaining GM’s residual values a little nervous. Mike Richards, a recent Bob Lutz recruit after he left Ford, resigned as head of Buick-GMC after eight days. Lutz himself was reassigned and his marketing responsibilities were given to Susan Dochtery. Lutz is still vice chairman and a special advisor to Whitacre. I presume Lutz will be whispering into whichever of Whitacre's ears Steve Girsky isn't. Girsky is a board member and another special advisor to Whitacre, and is regarded by many as the mastermind of the dealer terminations.

Docherty had been tapped by Henderson to replace Mark LaNeve, who recently resigned as North America vice president of marketing and advertising. Ray Young recently announced his resignation as CFO. Mark Reuss, son of ex GM President Loyd Reuss and known as the “father of the Aztek,” is now the new Whitacre appointee as President of North American Operations. After running GM Australia for 18 months, Reuss was recently made vice president of engineering before this most recent appointment. According Whitacre, “Mark and Susan are terrific!” Given Whitacre’s recent endorsement of Henderson, LaNeve, and others, skeptics might be looking for salt shakers. The list of GM execs who have left the company recently is much longer than the names mentioned here. Many were only in their jobs for a very short time. Whitacre and the Board have brought executive “musical chairs” to a new level.

Currently there are many more questions than answers. Whitacre has been unspecific at best in answering questions, as was Lutz at the recent LA Auto Show. Whitacre's public statement about Henderson’s departure was that “we all decided it was time for a change.” This after eight months on the job and the resent endorsement. GM is operating like a privately held company when, in fact, all taxpayers are owners. Churning executives does not breed confidence.

We’d all like some answers to some compelling questions. Some examples? How many of these executive changes were planned? Which of the “retirements” were actually firings? What do the severance packages look like for these people? Are “gag” agreements included and if so, for what price. What specifically caused the sudden rift between Henderson and the Board? Why did the Company reverse Fritz’s decision to sell Opel? Was Fritz blamed for the collapse of the Saab and Saturn deals?

Afew more questions: Henderson AND LaNeve were the public faces of the dealer terminations who misrepresented GM’s “savings” before Congress. Were they scapegoats sacrificed now that GM needs to rebuild its relationships with dealers? What does Steve Girsky know about anything? Who is the genius who thought it was a good idea to axe hundreds of Cadillac dealers compelling many potential buyers have to drive hundreds of miles for sales and service? How does “high throughput” per dealer make GM profitable? What has been the government Task Force role in the recent executive changes? Where will GM get the money to pay back the European governments that “bridge loaned” Opel while a buyer was being sought? How does GM expect to maintain U. S. market share of 19% after shedding 4 divisions, Saturn, Saab, Hummer, and Pontiac, while also cutting hundreds of dealers who represent the brands that GM kept? The Buick LaCrosse is a great vehicle, but what else does GM have on the way of compelling new vehicles to sell? How do you expect to force the market for VOLT beyond the “early adopters” without huge government subsidies and/or tax credits, especially if the price of fuel stays steady? And how does that work when the government is your owner? Does the government help you compete against Ford, Toyota, Honda, etc. who also employ thousands of Americans? What happened to the innovative diesel engine that was being readied for production? Did postponing that program provide money for fired executive packages and to pay off European governments?

Don’t tell me these new appointees are so great after you praised the last group just before you fired them. You need to give me and a lot of others compelling reasons to buy your stock when IPO time comes around. Gratuitously firing executives for not getting the instant results you desire is reminiscent of the behavior of a petulant owner of a pro sports team. If you’re so smart, why don’t you show them how to do it without destroying your resale values. You’re not building up a reservoir of trust and confidence in potential investors, let alone prospective buyers.

David Ruggles
submitted to Wards Dealer Business for January 2010

Friday, 27 November 2009

Published in Auto Finance News

Fanning the Flames

By David Ruggles

Recent quotes from high-profile individuals have really kept the pot boiling in recent days. First, Arizona senator and previous presidential candidate John McCain was quoted as saying, “If anybody believes that Chrysler is going to survive, I'd like to meet them." This touched off a firestorm of comments from a variety of people with differing opinions, including congressmen from the state of Michigan. Meanwhile, Michael Steele, chairman of the Republican National Committee, called General Motors Corp.’s $1.2 billion third-quarter loss “further proof that President Obama's economic experiments are wrong for America." All this during a week in which talk abounded about GM’s potential IPO plans and the Dow hit 10,400.

In the middle of all this, Lee Iacocca weighed in with his opinion. In his mind, “Chrysler has a better chance of survival than does GM, which is just too big.” In my mind, Chrysler’s chance of survival is 50-50 at best, while GM’s chances are much better. But I’m not a politician, so I can speculate publicly. I am, however, rooting for both companies for the good of the country and all the people who depend on the auto industry.

I recall the tone and buzz during the previous Chrysler bailout. After the economy began to turn around and Chrysler became profitable again, Iacocca became so incensed at a comment made by President Ronald Reagan that he paid off the government-guaranteed loans early. This, despite the fact that Chrysler did not receive an interest credit for the early payoff, which represented an unexpected windfall to the taxpayer. Reagan had reportedly whispered in Iacocca’s ear that it was a good thing Jimmy Carter was in the White House, or Chrysler would have been “down the tubes,” or some such comment. In Iacocca’s mind, there was serious satisfaction to be had by paying the government off early — almost as good as spitting in Reagan’s eye. In addition, he got the government out of Chrysler’s business. Taxpayers made out well on the previous auto industry bailout. Not commonly known is the fact that the government imposed an additional $1 million per month administrative fee in addition to collecting interest at the rate of 15.9%. Taxpayers also saved the expense of hundreds of thousands of people on unemployment compensation and the forced assumption of Chrysler’s pension liability on the Federal Pension Guarantee Fund. Unfortunately, the previous Chrysler bailout success was wasted with the DaimlerChrysler “merger of equals” and the ill-fated sale to Cerberus Capital Management LP.

A re-read of Iacocca’s autobiography from 1984 is just as interesting 25 years later as it was at the time, and provides real insight to the events of that era. There are some real similarities with current events in the auto industry. In the book, Iacocca rails at the government Loan Guarantee Board, the Auto Task Force of their day, for making Chrysler sell its corporate jet. He recalls the decision to pay the government guaranteed loans back seven years early, even though it was a risky move at the time and saved no interest. It took the government a month to figure out how to deal with a loan guarantee paid off early, especially one in the amount of $813,487,500. Iacocca won a bet with New York City Mayor Ed Koch — a bushel of apples — over who would pay off its loan guarantees first, New York City or Chrysler. Chrysler had borrowed $1.2 billion for 10 years, but paid it back in full in three. The automaker paid $404 million in interest and $33 million in administrative fees. In addition, the government received $311 million for warrants issued at $13 per share, at a time when Chrysler shares were trading for around $30. This was an additional windfall for the taxpayers in return for a temporary foray into “socialism,” a term heard loudly and often in those days. Iacocca takes some real shots at the Reagan administration and “laissez faire” economics in his book.

Auto industry history is being written again. Auto manufacturers can make money as fast as they can lose it. GM’s and Chrysler’s future is uncertain at best, as is the economy that supports the industry as a whole. Oldsmobile, Plymouth, Eagle, Pontiac, and Saturn are brands that have disappeared or are on their way out. But for those who assert the government can’t do anything right, the previous auto industry bailout had a great outcome for taxpayers. This time around, I hope the “nattering nabobs of negativism,” to quote Spiro Agnew, will be forced to eat crow again.

David Ruggles is a former dealer-owner and consultant with nearly 40 years’ experience in the auto industry. He has conducted an annual seminar on auto dealership issues and processes in Japan since 1993, and helped develop specialty software focused on pre-owned leasing. He can be reached at ruggles@msn.com.

The following was cut for space reasons, and for being overly political for the publication:


It will certainly be interesting if GM can achieve a successful IPO, pay off the government loans, and buy out the government stock holdings at a profit to taxpayers. In the minds of some, there must not be any precedent for the government doing anything successfully. I suspect there are some who might replay Steele’s quote, and those of others who opposed the GM/Chrysler bailouts, back to them repeatedly during a political campaign at some point. But Steele is known for having “foot in mouth” disease, and I’m pretty sure McCain’s future political aspirations do not extend beyond the state of Arizona. As I recall, it was a Republican administration that "bridge loaned" GM and Chrysler with approximately $17 billion dollars in December 2008, after Congress had turned down its own bailout plan.

Wednesday, 28 October 2009

Rattner's "Tell All"

I have been trying to resolve a mystery for months. When it was announced that General Motors and Chrysler were terminating dealers as a part of restructuring through bankruptcy, I smelled a rat. So did many who have been around the auto business for a while. Historically it has been a practice of auto manufacturers to add sales points as a method of driving volume and market share. Were we expected to think they no longer cherish these objectives? In a complete turnaround from their histories, they asserted that closing dealerships saved money for the manufacturer. The mystery? Whose idea was it? Who imposed it? I have speculated that it was forced on GM and Chrysler by the government’s Automotive Task Force in its zeal to impose a “Toyota Throughput” model. Both the manufacturers and the Auto Task Force blame the other for the dealer terminations.

Part of the answer came at the recent Auto Finance Summit held in Las Vegas at Red Rock Hotel and Casino. One of the high points was an address to attendees by Rick Wade, a member of the Automotive Task Force. During his address, he never specifically mentioned the decision to cut dealers, but his tone indicated that he thought everyone figured that dealer terminations were necessary to make GM and Chrysler viable. He came across as an enthusiastic, bright, and well-intentioned person who was placed in a position, with the other members of the Task Force, where important decisions had to be made quickly. He was quite pleased, as am I, that GM and Chrysler have been, at least temporarily, “saved.” Before being called to serve, Wade was certainly an auto industry outsider, for better or for worse.

But the real bombshell has been Steve Rattner’s recent article in Fortune magazine, where he reveals all sorts of interesting inside information. Rattner is the now-resigned head of the Automotive Task Force during the Chrysler and GM bankruptcies, the real “car czar.” Some of the information he reveals probably should have stayed “inside” for a while out of common courtesy and discretion. In particular, he shares his personal views on GM management, and Rick Wagoner in particular, in a particularly caustic manner. He reveals the content of private conversations. In his tell-all piece he also acknowledges the challenge of dealing with the N.Y. attorney general’s investigation of his former firm, Quadrangle, while simultaneously heading up the “Team Auto,” as they called themselves. He freely admits that he and his fellow task force members knew little of the auto business.

It is true Team Auto had no real precedent to rely on and faced a critical time schedule. It made me wonder why he was selected to the post in the first place. He must not be expecting to be considered for any important positions in the future as it is unlikely that anyone would speak candidly to him knowing his penchant for being less than discreet.

The Bush administration had “bridged” GM and Chrysler over to the Obama administration with an injection of $17.4 billion in TARP funds in late December 2008. The decision to use a Section 363 bankruptcy strategy to accomplish a quick “cleansing” of liabilities through Chapter 11 has at least temporarily saved the two companies and hundreds of thousands of jobs. For this, I commend Rattner and Team Auto. If things go as planned, GM will IPO in the next couple years and buy out the government’s stock holdings. Chrysler’s situation is much more fragile and depends on Fiat more than anyone should be comfortable with. But GM and Chrysler were saved at a time when their liquidation could have touched off a catastrophic chain of events in the auto industry and the overall economy.

So what about my mystery? Who made the decision to terminate dealers? I’m not talking about shutting down Pontiac and Saturn or selling Saab and Hummer. A business case can be made to support these decisions. I’m talking about decimating the Cadillac dealer network and terminating thousands of viable GM franchises across the country. I’m talking about terminating 789 Chrysler, Dodge, and Jeep franchises.

There was a recent article in Automotive News on Jim Press, Chrysler’s now discredited and terminated co-president, which itemizes many apparent contradictions in Press’ career. I distinctly recall Press and GM CEO Fritz Henderson during the Senate committee hearings itemizing the “savings” they would realize by terminating dealers. I didn’t hear anything that smacked of the truth. It is now disclosed that Press had his own private reservations about terminating dealers. Mark LaNeve, the recently deposed head of GM sales, has stated publicly that he is worried about GM’s lack of dealer coverage and its negative impact on sales and market penetration. He expressed concern about GM making orphans of 900,000 GM owners. Then there is the quote from Joe Eberhardt, Chrysler Group’s past senior vice president for sales and marketing: “When a company loses a dealer, its overhead costs stay the same and — at least in the short term — it loses a few hundred car sales. There's no immediate payback." Carl Woodward, a longtime CPA serving auto dealers, also disputes any claims of net savings to auto manufacturers by terminating dealers. In his 6,000-word article for Fortune, Rattner took no credit for the dealer terminations. I wonder why.

published in Auto Finance News

Sunday, 13 September 2009

How Do You Measure Quality in the Auto Business?

Am I presumptuous enough to lecture J.D. Power on how to measure quality? Not really. My point is that there is more than one way to calculate vehicle quality. General Motors and Ford are sporting some gaudy J. D. Power rankings these days. Some of their products are ranked as equal to the leading imports. I’m sorry to have to leave Chrysler out of this discussion. It is anyone’s guess where Chrysler’s future quality numbers will end up, given that many important decisions are being made by Fiat. Fiat’s hallmark has not been quality in the past and many dealers, including myself, still have a bitter taste in their mouth from Fiat’s last foray into the U.S. market. But Chrysler/Fiat will be a subject for another day.
So what might be a better measure of quality than J.D. Power and other quality surveys? I submit that resale value is the most important measure of quality as perceived by consumers and the market in general. Quality is more than fit and finish. Quality includes how well an OEM’s vehicles hold their customer’s money together. In this regard Honda and Toyota have set the mark. Other than their traditionally high fit, finish, and NVH (Noise, Vibration, and Harshness) achievements, they have eschewed large volume fleet sales. They have also disdained direct to consumer rebates. As a consequence, their CPO (Certified Pre-Owned) programs serve to strengthen their strong resale values whereas the Domestics are desperately trying to rehabilitate themselves. Consumers do not appreciate the OEM, with whom they just did business, undermining the value of their new vehicle. They might appreciate the rebate they just received that helped motivate them to buy, but they certainly resent waking up one day and discovering they are thousands of dollars “upside down” in their recently purchased vehicles. Many owners of Domestic vehicles don’t find out how bad their financial situation is when they try to trade their vehicle 36 months or sooner into their finance contract. There is no doubt the resale value issue has a strong impact on whether a consumer is a repeat buyer frm an OEM.

Ubiquity is the Enemy of Cachet
So how do Toyota Camry and Honda Accord, two of the best selling vehicles in the U.S. auto market, maintain their cachet in the face of their large sales volumes? In my mind, its boils down to the fact that you rarely see those vehicles in fleet and rental service. In addition, you don’t see consumer rebates advertised. Just as I was becoming sold on the J. D. Power rating on the Chevy Malibu and the good things said about the car in the press, I observed a couple hundred Malibus decked out as taxis at McCarran Airport here in Las Vegas. At the taxi cab pick up station there was Malibu after Malibu rolling up to pick up passengers. It left a bad taste in my mouth. While there are many Toyotas and Hondas coming back into the market as pre-owned vehicles, they are mostly three year old lease turn ins and natural trade ins, whereas there is a much higher number of Domestics recycling in a year or less. Many of these are daily rental turn ins. This, coupled with direct to consumer rebates outweighs any J. D. Power quality ratings in the mind of consumers..

Resale Value, Residuals, and Leasing
Leasing is in the news again. GM and Chrysler have both announced recently they will re-enter leasing. I still can’t get used to the idea that Chrysler finances and leases through GMAC. Chrysler has been out of leasing since last July when lenders forced them to give up leasing as a condition of granting essential financing. GM’s lack of capital and huge residual losses forced GM to scale back leasing last fall. GM will be leasing through U.S. Bank in 5 northeastern states. Other OEMs have continued to lease through their captive finance arms and independent banks. GM and Chrysler have lost substantial market share as a consequence of their not being in the leasing business for the last months.
What is the lure of leasing to an OEM? They can offer lower monthly payments for shorter terms and achieve a higher degree of repeat business through leasing. In addition, there are depreciation credits available as the title of a lease vehicle is held in the name of the OEM. These depreciation credits come in handy if the OEM is profitable. In addition, trade equity and cash down payment lowers the monthly payment a lot more on short term lease contracts than on long term finance contracts. Cycling the consumer more often leads to increased market share when your competition can’t compete. Lower resale value (residuals) means it costs Domestics to subvent their residuals and money factors to be competitive with Toyota and Honda.
And now we see Ford is pushing their new world class Taurus, bi turbo, direct injection, AWD, etc. as a police cruiser. They already devalued the name Taurus in past years by making it the most common fleet vehicle in history. It appears Detroit has not learned their lesson.

Ruggles in Wards, reprinted with permission

Ta-Ta Clunkers; Now What?
Let's hope a dead spot won't follow successful program
By David Ruggles, Ward's Dealer Business, Sep 1, 2009 12:00 PM

Cash for Clunkers has been a surprise success to many, including government.

Hopefully, we won't have a serious dead spot now that Clunkers is kaput. We all know how rebates can be like getting on drugs.

Training consumers not to buy until the next program contributes to a “whip saw” market that makes good consumer satisfaction impossible. It also makes marketing dependent on loading up dealers' inventories and then introducing a program to sell them.

Still, Clunkers was worth it. In my 38 years in the business, this has been only the second time I have seen a federal initiative spark so much sales activity in the new-vehicle business. The first time was when the Nixon administration repealed the excise tax on cars in 1971.

There have been other government initiatives that stimulated sales, but mostly through tax policy. Most recently, the Bush administration provided a substantial tax credit for those purchasing a vehicle over a particular GVW rating.

This was meant to spur the purchase of trucks by ranchers, farmers, plumbers, and other small business people. It also spurred the purchase or lease of Navigators, Escalades, Suburbans, etc. to doctors, consultants, and anyone who could take of advantage of the business write off.

But the tax policy measures didn't have the broad appeal of Cash for Clunkers.

As a consequence, about 707,000 old vehicles have been designated for the crusher. Engines have been destroyed to ensure the clunkers do not find their way back into the system. Initially, this is having an impact on the Buy Here, Pay Here dealers. What the Feds call “clunkers,” they call inventory. Any revival of the program will exacerbate their plight.

Clunkers is not the only factor impacting the pre-owned market. The low seasonably adjusted annual sales rate has generated fewer sales. This means fewer pre-owned vehicles will be available down the road.

A lot fewer rental vehicles have been placed in service. There's a dearth of new leases put on the books. As pre-owned values strengthen, fueled by the inevitable shortage, there will be more people in an equity position than before.

I expect this trend will be tempered by people keeping their vehicles longer. We all know that above-average miles have a major impact on true resale value at auction. But the trend is certainly toward higher pre-owned prices down the road.

Despite the recent rise in pre-owned prices we hear complaints from dealers that some guidebooks' loan values are not reflective of what is really going on in the pre-owned marketplace, so owners who should show equity are shorted by lenders who use those guides in their finance advance calculation.

Another interesting by-product of the strengthening pre-owned market might be the impact of current lease returns to the OEM captives and independent bank lessors.

I am told many lenders took write offs for current and anticipated residual losses. Some of those previously stated losses may turn out to be profits in the current marketplace, which is driven by the pre-owned shortage and low fuel prices.

Pre-owned values can only go so high, but perhaps we have not yet hit the ceiling. Just imagine a world where new vehicles can be sold without rebates or dealer “trunk money.”

A true pull market scenario would strengthen pre-owned values even more and provide even more trade equity for would-be buyers. Might we be able to return to the pre-Joe Garagiola days when the baseball player turned Chrysler TV pitchman said, “Buy a car, get a check” in 1975? My guess is probably not.

The domestic auto makers have trained an entire generation not to purchase unless there is a rebate. In addition, there are just too many competitors all vying for sales. Where will it end up? Nobody knows. Here's hoping those guidebook loan values will catch up with the market. Dealers and consumers need all the legitimate help they can get!

Former auto dealer David Ruggles is president of Advanced Concepts & Techniques. He is at Ruggles@msn.com and 312-925-1863.

Sunday, 6 September 2009

No Smoking Gun? -- Financial Innovation

Mike Smitka

The appellation "luddite" rings nasty, at least to this economist. I am after all an erstwhile student of the history of innovation and am steeped in "IO", the economics of "Industrial Organization." But look as I may, I cannot find evidence—far less make a compelling case—that the recent spate of acclaimed financial innovation is beneficial.
Let me accept at face value the claims of innovation. Now securitization goes back decades, if not more. Bank letters of credit and bill discounting are both forms of credit insurance, and they go back centuries. So I'm skeptical that Wall Street has innovated rather than merely created an impenetrable smoke-screen of complexity.
Mind you, my skepticism is tempered by my own experience in finance, working on Eurodollar syndicate loans to Latin America in the late 1970s, in the first heady days of large-scale international finance since the collapse of such markets in 1914. For those too young to remember, every single one of those loans went bad, taking the economies of a continent with it—and giving regulators the option, which they failed to exercise, to shut down Citibank. Instead forbearance was the game of the day. But at the time they were marketed as safe. First, syndication allowed banks to diversify their risk, since the organizers could sell off the bulk of what were for the time very large loans, while those purchasing it were doing so in bite-sized chunks from different borrowers and different countries. Second, banks could hedge their funding and maturity risk, because while these were long-term loans (one I worked on to a "greenfield" Brazilian steel venture carried a 12-year term) the interest rate was reset every 6 months against LIBOR (the London Interbank Offer Rate). If interest rates bumped up a bit, banks wouldn't face the potential disintermediation that was at the time plaguing savings and loan banks. (Remember your history?—the plague is typically fatal. It's an appropriate adjective.) Banks didn't even need to boost their deposit base, but could borrow in the very same London market, arbitraging their good credit ratings (LIBOR) to lend on to Brazil (LIBOR+25bp at the peak of the bubble). Sound familiar?
Anyway, what are the claims made for securitization, credit default insurance and the like? The fall into two main camps, that these innovations lowered the cost of finance, and that they provided finance to borrowers who for one reason or another lacked access.
If we look at the macroeconomy, did firms go on an investment boom? No, to the extent that we'd label the last decade of growth "robust" (which requires ignoring what happened to wages), then the sources were consumption and exports. If all of these new products lowered the cost to borrowers, it's not there in the data, or at least not enough to show up without resorting to fancy econometrics.
How about access? Well, sure, lots of new borrowers got money up front, but we have incontrovertible evidence that those who received sub-prime "mortgages" couldn't handle the payments. (Not that a "3/27" ever made sense as a loan; such "mortgages" were never anything more than a bet that real estate prices would continue to appreciate). Now we're starting to see other sorts of borrowers. The most prominent right now is credit card debt, but commercial real estate loans are starting to go bad. Losses on local and state government debt, another area of innovation, will surely follow. So improved access turned out to be a short-run illusion. And this shouldn't be a surprise: back in antiquity, in the 1990s, it wasn't as though banks enjoyed zero rates of default on their portfolios. They took their chances, but generally were able to pay for their mistakes, rather than needing bailouts.
Innovation in finance ought instead to be looked upon as fool's gold, which can only be sold to the naive. (And remember the age of those "in the game"—naïve was apropos.) The essence of banking, and of finance in general, is the proper measurement of risks. We've had claims of a "new world" in finance since the days of the South Sea Bubble. But underlying cash flow analysis isn't a matter of rocket science, it's a matter of wisdom. Who knows what the risk characteristics are of a new product?—initially, no one. And how do you regulate it? Too little and too late. New products arise in the shadows, because finance is a very mature product, and there just isn't anything new under the sun.
To conclude: there is a smoking gun. It's too soon to tell, however, whether a conviction of involuntary manslaughter will follow. For those wielding the gun committed crimes against multiple economies, killed their employers and robbed the wealth of millions of unsophisticated citizens. But the outcome will likely be a mistrial: the defendant has bought off a lot of potential judges and jurors and remains able to buy expert witnesses sufficient to shout down the prosecution.

Thursday, 27 August 2009

Followup

Mike Smitka

One quick point: if the underlying analysis of the previous post of a specific link between the housing bubble, the use of home equity lines and thence car sales is accurate, then we should see that showing up in differential behavior in low-bubble and high-bubble economies: areas with big bubbles should have had a greater car sales boom and a greater crunch (including repossessions). Of course empirically that could be difficult to identify, because the "bubble" areas (as I believe is very much the case, but have not checked) have higher unemployment and hence will have lower car sales and higher repossessions, independent of a finance link. Perhaps that can be done because only certain classes of credit histories showed a propensity to use home equity, whereas unemployment may hit both the conservative and the spendthrift alike. That's not an easy empirical task, closer to what might be needed for a serious PhD-level research project if not a multi-year PhD thesis project.

Tuesday, 25 August 2009

No More Clanging Clunkers, No More Sales

Mike Smitka

What, now that the clunkers program has clanged to a close? In a couple days we'll see what total August sales were like – I'm risking bytes of criticism writing now – but I'm afraid it will be back to business as normal. Afraid, because normal this year has been an SAAR of 10 million or less. The level of enthusiasm makes it clear that sales have been pulled forward; it'll be payback time. The problems run deeper: cars were affected by the bubble, and not just housing.
A recent NBER working paper by Atif Mian and Amir Sufi of the University of Chicago bolsters the argument that I've made in earliers notes. My analysis was based solely on an analysis of sales and scrappage data relative to the vehicle stock; they started out with data on 266,000 individuals in the Equifax credit rating database. (Don't worry – they couldn't actually look at individual records, but instead had to extract information from data that Equifax had already sanitized and then mildly aggregated.) But combined with data on geography and housing prices and demographics, they could paint a picture of where prices had gone up, areas where housing supply was "inelastic" so that shifts in demand showed up as higher prices rather than more construction. They could then look at who borrowed: not those with in places where prices moved little, but those who were in "hot" markets, and who started out with lower incomes and/or lower credit scores. And did they ever tap the equity; credit records made it clear that these people were also buying a lot of vehicles, vehicles they earlier had not been able to afford. But those same locations are ones where mortgage holders are now under water (see Federal Reserve data on credit conditions, illustrated by maps color-coded at the county level). They're losing their houses and their cars, not buying new ones. In other words, there was a bubble in the auto market as well, people buying on credit backed by unrealized capital gains.
That really is not news, though it makes for sobering and poignant stories (see the New York Times series on the Beth Court neighborhood in Moreno Valley, outside LA). But what Mian and Sufi show is that behavior didn't change much in the many urban areas where there was no run-up in housing prices (I'll append a graph I created from the Case Schiller real estate index that illustrates the contrast). In other words, the big boom in car sales came from the same people who were splurging on home renovations and vacations by pulling equity out of their houses. Well, that equity isn't there to the tune $1 trillion in California alone (data from an August 13th study by First American CoreLogic). In Nevada 45% of homeowners have negative equity of 25% or more of their mortgages; in California, 25%. These people aren't buying cars anytime soon. So while house prices may have bottomed out – and the recession ended – that doesn't mean the good times will roll again.
That's not only because of all the people who lost everything (or soon will, given that 5% of the labor force has now been unemployed for over 27 weeks, and another 2% for 15-26 weeks). On average the rest of us are worried. State and local governments are only now cutting their budgets; commercial real estate hasn't hit bottom yet. There are a lot of pink slips yet to be distributed. So there's no reason to think those of us who were more conservative in our habits are suddenly going to loosen pursestrings that long have been tight. Let's be honest with ourselves; if we're thrifty, it's by necessity: home equity is what we have from paying down the mortgage, not because the spot of mother earth we occupy was suddenly worth megabucks

The graphs below look at housing prices relative to the CPI index, real GDP and nominal GDP. One focuses on four of the metropolitan areas with the greatest run-up in prices, a couple of which have come back to earth, and then some. The other highlights cities where there was comparatively little change. I left the scale the same on both, which results in a lot of blank space on the second one, plus it's hard to read because the graphs lie more or less on top of each other. Which is the point it is meant to illustrate.

Here's a link to a powerpoint from a talk I gave yesterday (Aug 25, 2009) that includes additional material.


Click to enlarge!

Click to enlarge!


Friday, 7 August 2009

Japan's Headlines: China not Clunkers

Mike Smitka

The top headline in the Nikkei today (Aug 7th) was neither their recession, nor their pending general election (and the potential change of government). It was July car sales in China, up 64% from from 2008 to roughly 1.1 million units. That's above the clunker-driven 1.0 million level in the US, and (as the percentage increase suggests) out of synch with sales doldrums during the past couple summers.
Part of the reason is that, despite the American perception of China as an economy dominated by exports, it's a country the size of the continental US, and that huge domestic expanse is peopled by 1.3 billion would-be consumers. The Chinese government is determined that they will be consumers. To make that happen, the government is providing plenty of domestic stimulus, unhindered (at least in comparative terms) by domestic banking problems, and with little of the pointless tax cuts and other fluff that bolstered the price tag of the "stimulus" package passed in the US. The ongoing construction of a national highway system provides plenty of room to speed things up (reversing the policy stance of a year ago, when the fear was inflation).
There are also vehicle-specific policies with bigger environmental implications than the US program that gets rid of a few seldom-driven1 "clunkers." Their tax breaks and and scrappage incentives (that include provisions to help rid rural roads of smoke-belching 3-wheelers), was implemented in a timely manner in January 2009. The focus is small vehicles, those with under 1600cc engines, with no loopholes to subsidize the purchase of trucks (unlike the US "clunkers" program). And if you visit Shanghai or Suzhou, while you'll find the roads filled with scooters and motorized bikes, the noise level is a fraction of what it used to be: they're electric, driven by batteries. The garages of condos include outlets to plug them in at night, enough to power the daily commute. But diesel fuel in China is still sulfur-laden, so the next-best alternative, a clean-diesel powered vehicle, is not yet an option there -- as was the case until two years ago in the US. So China can't (yet) follow the European option of small, clean and very-long-lived diesel powered cars.
Now the China market is profitable for the moment, and important to global firms. GM has actually shifted its international operations HQ to Shanghai, anticipating its sales there to top 1 million units in the near future; VW already sells over 1.0 million units a year. Accordingly everyone is pouring on capacity and dealers.
This may be a "bubble" of sorts. Already the shift towards smaller vehicles makes it less of a gold mine than a year ago on a per-vehicle basis. Meanwhile, the number of players is mind-boggling: not only are all of the major international players in the market (VW and GM have the top two spots) but there are still 80 local players. Yes, 80 -- because local governments support their "favorite son" firms. If you visit China, watch how the make of taxis varies as you move from city to city. The government is pushing for consolidation, and a couple of the bigger players have bought up a couple small ones. Others have quietly exited. But consolidation has been policy for years and years, and still there are 80 firms! Unless push comes to shove, Beijing has all too little clout at the local level, and this is just one example.
Lots of players ultimately means little profit. GM, Toyota and their rivals are jointly placing a big bet that that does not happen until they've been able to recoup their investment. However, that's a game of "chicken" and at the moment no one wants to blink and ease off on the throttle. I smell a bloodbath in the making, red ink puddled all over balance sheets. That may be 3 years away, but it will happen.
Meanwhile lots of incumbents remain due to (local) government largesse. A couple will turn out to have been well run and innovative, though at present they are still woefully lacking in engineering sophistication. In the background Beijing -- not the locals -- is making a big push towards electric vehicles; ditto battery technology. So a few local firms are likely to focus on electric vehicles (not nightmarishly complex hybrids), and in a market where drivers don't expect to go hundreds of kilometers at a stretch, there will be a local market (unlike in the US). The transition in drivetrain technologies may allow a couple global players to emerge out of the current plethora of small, high-cost producers.
Note that this has strong parallels with the Japanese case. There government policy also pushed for consolidation, and it also failed to accomplish that. Now the early post-WWII market did have about 30 players, and without local government support [Japan's is not a decentralized political system] or other deep pockets half of them soon exited; Toyota and Nissan both picked up with an extra factory or two in the process. The bottom line however was a market with a dozen firms, no dominant firm or even a "Big Three" that could mute competition. In Japan, it was improve efficiency or fail, and in the end that gave birth to Honda and Toyota.2 Japan's auto industry succeeded because industrial policy failed; the same, I suspect, will prove the case in China.3
Notes
1. Unfortunately the mandatory "CARS" survey that is part of the US "clunkers" program doesn't ask how many vehicles were owned. It does ask how many miles were driven the previous year -- as far as I can tell, no data from that question are yet available. Not surprising: most dealers haven't been able to get their "clunker" deals approved, much less gotten a check.
2. There are of course other Japanese firms, but only Honda, Toyota and Suzuki remain autonomous. Nissan is controlled by Renault, Mazda is de facto controlled by Ford, Fuso is owned by Daimler, Nissan Diesel by Volvo Truck, Toyota has purchased Hino and Daihatsu outright and has a large stake in Subaru/Fuji Heavy and Isuzu, and MMC has survived through the inexplicable largesse of its creditors and of Mitsubishi Heavy Industries.
3. I have only cursory knowledge of India. In contrast, I began studying about China in 1971, and while I ultimately became a Japan expert (more practical at the time), I've followed (and taught a course on) the Chinese economy for over 20 years, and have visited the country repeatedly.

Monday, 20 July 2009

Opel & GM

Mike Smitka
Further to my earlier post, Is there a GM without Opel?, the sticking points of GM's negotiations with the Magna-Gaz/Sberbank are over intellectual property rights: Opels are (currently) the core of GM's international operations and rights thereto can't be freely given away. My opinion stands: GM cannot afford to let Opel go and remain an ongoing enterprise. Too many of its engineering resources are bundled into Opel, and vice-versa. Germany doesn't want restructuring, enough unemployment already, and as partners in the current "trust" that controls Opel... How this works out is crucial. And apparently some at GM concur.
More posts shortly, following up on the June Business History Conference in Milan, on the tension between "administration" (as in MBA) and management (as in long-run health) and on health care. But first I have a book review, a manuscript review and an article to complete, all on the Japanese economy. And it's hard not to spend time reading about political turmoil, with PM Aso about to dissolve the Diet for an election that will almost surely dislodge him (and probably the ruling LDP coalition) from power.

Tuesday, 14 July 2009

Toyota and General Motors

Mike Smitka
The new General Motors was spun out of bankruptcy on Friday, July 10th. Its prospects are uncertain. The new cost structure and (one hopes) an end to complacency should lead in time to successful enterprise. Eventually: we should find caution in that GM's now much larger rival Toyota continues not only to lose money, but to lose it at a faster rate than GM-old.
What gives?
First, Toyota has gone where the money is: larger vehicles in North America. Toyota now sports V-8 engines, a full-sized pickup truck and a range of SUVs and other light trucks. Does that sound familiar? Well, so are the consequences: red ink. It was making its Tundra pickup in both Indiana and Texas; no more. All production is now in Texas – and that plant was closed for over 3 months in summer-fall 2008, and runs only one instead of two shifts. So it has billions in sunk costs that are generating little to no revenue, and is reluctant to lay off workers, as that policy has been a mainstay in its battle to keep plants union-free. Nor is the prognosis good: even if gasoline prices stay low, Toyota has few rural dealerships. Despite cutbacks, the Detroit Three still do.
Second, Toyota has focused on the American market in general, again because that is where the money is. The company is a modest player in Europe, and a latecomer to China; the population in Japan is aging, and the number of licensed drivers in its home market is in decline. It may book profits in Japan, because that's where the production of most Lexus vehicles is still located. But sales depend on the US.
It gets worse: product planning also followed the money. Anyone of my generation can remember (or often owned) a Toyota at one time (my first new car purchase, in 1981, was a Toyota Tercel). They were small, sparingly powered rust-buckets, but with good mechanicals for their time (by today's standards, they were junk). No longer are Toyotas small or sparingly powered. That pairing generates profits – the public perception of fuel economy is swayed by the Prius, but the Prius makes no money, at least since the price was lowered to fight the Honda Insight at the same time that the yen strengthened. But back to that pairing: such vehicles are peculiar to the North American market, and don't sell well in Japan or Europe. Those markets are left with larger vehicles that don't fit, they're just a bit too large on every dimension. Toyota thus struggles to sell such potential high-margin vehicles everywhere else in the world.
Third, they became a big company with big ambitions, replete with MBAs in various HQ functions. For those who don't know their history, Toyota was bailed out by the Japanese government in 1950, because they kept "pushing the metal" on dealers despite a recession. One measure, along with kicking the Toyota family out of management, was to split off the sales functions to increase their ability to say "no" to the factory. The separation between Toyota Auto Sales and Toyota Motors lasted about 30 years, but they've now been merged for 25 years. Headquarters staff over the past decade came to dominate product planning, investment planning, well, MBAs plan. But not always well, not when they are far removed from the "real" world of sales and manufacturing. Sure, Toyota was earning a better return on equity, 5+% instead of the early 3-4%, while return on equity was pushed to 15% and above. And sales kept increasing, first overtaking VW, and then briefly GM.
They were going to rule the world; they had already taken over Daihatsu and Hino inside Japan, and more recently acquired stakes in Fuji Heavy Industries ("Subaru") and Isuzu, both former GM affiliates. They upped their share of Denso to a controlling stake. And there was Lexus, and the Tundra, all those other nice high-margin vehicles. To support this growing empire took a lot of investment. But while the product plan looked good on paper, it wasn't necessarily what the people on the ground were comfortable making and selling. Furthermore, product proliferated, a car for every niche for every name plate. Inside Japan Toyota maintained 5 distribution channels and 47 cars in its 4 "legacy" channels, 9 for its new Lexus channel, and 13 more at Daihatsu (covering the minicar end of the spectrum). Add another 14 light commercial vehicles – but leaving out all of the heavy truck and bus makes of Hino – and they have 83 model names inside their domestic market. [my count] Toyota's brands are muddied and the cars are bland.
It doesn't take much imagination to see what happens to marketing costs. To make matters worse, Toyota outright owns several large (40-plus sales point) urban dealerships, because they can't operate as profitable ventures. (Not that people seconded from headquarters – with salaries paid by the parent company – improve matters.) And think of the engineers: they're so busy doing product, and all that totally new stuff for the US, that they don't have time to do things right, at least by their standards. Recalls are up sharply. Costs, too, because forcing commonality takes time, and time they do not have. (Remember, in today's auto industry most manufacturing is at parts firms, so using parts in common is the key to cost control.)
Fourth, they have their own unions to contend with, and those unions include engineers and regular office workers, not just factory hands. Plus it's easier to coordinate inside Japan, because even today language skills are weak. So we now find Toyota entering a steep recession with the ability to build 10 million vehicles, all according to plans from HQ, but with sales of only 6.5 million. Worse, they have added to that capacity not only in places such as Texas but also in Japan, where they can now build 4.5 million vehicles. In the process they have allowed their export share to gradually rise from under 40% in the mid-1990s to roughly 65% in 2008. But egven as exports have fallen due to the global recession the yen has strengthened, amplifying their losses.
We may not have seen the worst of it. Toyota has quietly added a couple stamping facilities, bought from a failing domestic supplier. But it surely has many other suppliers, pushed to match its expansion, that have weaker cash reserves and weaker management. As things stand, they will have to pick up the tab (which to me is ethically appropriate, but is surely not part of the financial projections of their MBAs). And already their ROA has swung from 5.9% in April-June 2007 to -10.4% in Jan-Mar 2009. That's a swing in profits before taxes of Δ¥1,654 billion (or ΔUS$17.8 billion at this weeks average of ¥93 per dollar). Toyota maintains a sterling (though recently lowered) credit rating and sits on $30 billion in cash and securities and $40 billion in financial receivables. But it also has $64 billion in short-term debt and long-term debt due this fiscal year. Far better than GM, but as a big, heavy firm its cushion is not as comfortable as it once was.
Wish the new president Toyoda Akio good luck! If it wasn't for his ability to borrow to tide things over, he'd be facing a tougher battle than GM's new CEO Fritz Henderson.

This article relies on Toyota financial reports, on a 3-part series in the Daily Automotive News 小室祥子「トヨタ・新時代への展望」『日刊自動車新聞』 連載: 26, 27, 30 June 2009 and an article in Bungei Shunju 井上久男「覇者トヨタに何が起きたのか」『文芸春秋』March 2009, 94−108. While I did not stumble across it before drafting this note, see also the 22 June 2009 Bloomberg article Toyoda Asks How Many Times Toyota Errs Emulating GM Failures by John Lippert, Alan Ohnsman and Kae Inoue. Based on it, I edited my comments on the operation of the San Antonio, TX truck plant. They also note that Toyota dedicated its Woodstock, Ontario car plant in December 2008, and provide other examples of the firm's (overly) ambitious expansion plans.

Sunday, 12 July 2009

WMRA Radio Show Mon 13 July

Michael Smitka will be on a live program, Virginia Insight, on WMRA Public Radio in Harrisonburg Virginia Monday, July 13 at 3 pm EDT. You can listen to an archived podcast HERE.For more information see the show's website; the host Tom Graham brings a fascinating array of individuals to WMRA's studios, including periodic updates on Virginia politics. WMRA is my local station, and I'm glad to be a supporter!

Thursday, 9 July 2009

Ruggles Report - I Was Wrong!

I Was Wrong! But Don't Tell My Wife I Admitted It!David Ruggles
I predicted that Chapter 11 bankruptcy for Chrysler and GM would cause chaos and linger for years. Well, I was right about the chaos part. Little did I know what can happen when the government is the driving force behind a Section 363 sale in a Chapter 11, and how much influence the provider of Debtor in Possession financing has - especially when they also happen to be the government.
I do, however, remain dead set against the arbitrary termination of Dealers. Let’s hope there is a favorable result from the House Resolution currently pending in Congress to reinstate Dealer’s rights under state franchise law. It’s probably too late for rejected Chrysler Dealers but GM Dealers may have a chance.
The recently published photo of Greg Mauro in Automotive News standing in front of his newly completed Chrysler – Jeep store should be evidence to all how arbitrary and counter productive the Dealer terminations are. The Mauro family does things one way: First Class. The idea that Chrysler would terminate a proven, profitable and successful dealer is still a shock. Particularly since they had just completed a $6MM plus new facility at the behest of the OEM.
Further, the idea the Task Force would mandate leaving an entire town like Ames, Iowa, a major university town, without representation is another shock. The examples go on and on. With such geniuses running these companies why would anyone want to own their stock? I won’t even start on GM in this column although they have officially been approved for their own Section 363 sale and have their own inane closings to account for.

Unintended Consequences
I find it curious why is no one is talking about safety issues associated with Dealer terminations. The Ames, Iowa vacuum provides just one example. Chrysler owners in this Midwestern community must now either take their vehicles to independent service centers for routine maintenance or drive MANY miles to an authorized Dealer. To my knowledge, Jiffy Lube and other independents don’t have access to information regarding safety recalls on new vehicles. Or if they do, it doesn’t seem like it fits their agenda since they can’t do the work anyway.
So we now have thousands of orphaned owners turned over to independent shops instead of being serviced by factory trained technicians. The safety recalls are only one reason this is important. Factory trained technicians also know where to look for other problems. Often these are little problems that turn into bigger problems if they are not addressed. For example, it came to my attention in the 1990’s Ford had an issue when they started putting cabin pollen filters into Taurus and F150. I f the filters weren’t changed at proper intervals they would clog and burn out HVAC blower motors.
Steve Finley from Ward’s Auto World recently “outed” Steve Girsky as the man behind the arbitrary Dealer terminations. Girsky is a former GM employee and Wall Street analyst who is now a member of GM’s board of Directors representing the UAW’s Voluntary Employee Beneficiary Association (VEBA) interest. According to Mr. Finley Girsky gave an address at a recent NADA convention where he said he thought the domestic auto makers should reduce their dealer counts by 70%.
The question in my mind is how Girsky came into such a position of influence. To my knowledge true visionaries like Maryann Keller and/or James Womack, and even the retired Lee Iacocca, were available and were not consulted. For those who haven’t read it, The Machine that Changed the World by James P. Womack, Daniel T. Jones and Daniel Roos is a must read. It was fascinating to read in the early 90’s and even more so now that many of their predictions have come true. And anything by Maryann Keller is on target and fascinating.
The Task Force selected a guy like Steve Girsky for advice and failed to bring in more proven voices. It seems the people making the decision to cut Dealers weren’t aware of the cost transfers to the Dealers made by the OEMs over the years. Their calculations of per Dealer marketing costs neglected the fact that the OEM’s own over production caused them to spend wildly on incentives. It had nothing to do with the number of Dealers. If anything, their Dealer coverage was an asset, something well recognized by Ford and anyone knowledgeable in the industry.
Yet, for all the chaos and the counter productive termination of thousands of Dealer franchise agreements, the two OEM’s appear “saved” for now. Time will tell how decimating their distribution network will benefit them.
It is important to note the U. S. Government Task Force has taken a different road than European governments. In exchange for bridge loans and other contributions, the European countries have chosen to exact employment commitments, as if employment guarantees are the answer to a bloated OEM’s problems. Dealer closings weren’t a part of any European plans. At least the U.S. government has mandated draconian job, pay, benefit, and work rule concessions to give Chrysler and GM a fighting chance.
Imagine if the Task Force had taken the European approach. We might have saved our Dealers but the companies would have been stuck with keeping non productive assembly plants and a bloated work force.

What’s Next? More Chaos?
Ford is making progress in terms of market share. They sure look better off on the surface than GM and Chrysler. But Ford is having trouble negotiating GM/Chrysler level labor parity with the UAW, who now owns significant positions in the competition. The UAW is playing hard ball with Ford as it knows Ford will do almost anything to avoid going to the government. The Ford family isn’t willing to take a chance on losing its special category of voting stock. They would most certainly lose that status in a Chapter 11 filing.
In addition, Ford borrowed a LOT of money to be able to dodge the fate that befell Chrysler and GM. And unlike their Detroit competitors, they have to service the totality of their debt! It’s great to be perceived as the superior company, but they just cannot afford to give up a major per vehicle competitive disadvantage. But the UAW believes they have Ford at a negotiating disadvantage and will work it for all its worth.
Long term, how do the Detroit 3 compete with Toyota, Honda, Nissan and other Japanese manufacturers? Honda just raised capital in Japan paying less that 1 percent interest. Toyota and Nissan also have access to cheap capital. Money owed to the U.S. Federal government and U.S. banks commands at least interest rates typical of corporate America while Ford is paying whatever rates were agreed to when they retrenched in 2006-07.

The Road to Recovery
Chrysler is trying to restart production. Most major suppliers are in Chapter 11, with the exception of Magna who just purchased Opel, GM’s European subsidiary. Ford, Toyota, Honda and the other U.S. manufacturers are watching their own suppliers closely. Not commonly known is the OEM’s all use the same suppliers. If a major supplier goes down, it shuts down production for everyone.
Moreover, many surviving Chrysler Dealers are having trouble obtaining essential financing and floor plan arrangements through GMAC It seems Chrysler terminated a significant number of Dealers who were financially sound and would have qualified for GMAC floor plan, or already had their own set up through local banks. Instead, they kept many who don’t have floor plan and can’t qualify through GMAC. What were they thinking?

The New GM Small Car
In the meantime, GM has now committed to build a small car in Michigan. Small cars have traditionally provided little to no profit for GM in the past. I wonder why Michigan, a stronghold of the UAW, was selected as the site to build this “important” and symbolic small vehicle?
GM will lean on everyone possible for tax abatement, free land, and whatever else they can think to ask for. How else can they hope to make money on this small car even after the cost reductions they’ve made in bankruptcy?
As the world languishes in recession, the recent uptick in oil prices is probably not the short term trend. I expect to see downward pressure on fuel prices toward the end of the summer driving season. Who knows what oil prices will look like when the new GM small car hits the market? Most assuredly, GM will not sell in enough small cars to make any real difference in the face of cheap fuel prices. And in Michigan, they will also incur significant labor and production costs compared to say Mexico, Brazil, China or even Canada. The same goes for their Hybrid and Plug-In-Electric offerings. Are we to believe that GM’s future depends on high oil prices?

Ruggles on Government Intervention
Lastly, a few words on the controversial tactics employed in Washington. I find it difficult to say government is inherently bad or government is good. It’s usually a mixed bag. Ronald Reagan was fond of saying, “Government is not the solution, it is the problem,” but I find that too simplistic a take.
The government just saved GM and Chrysler from liquidation. Whether that is good or bad is open for debate but they certainly did it imperfectly. In my mind, the Chrysler bailout of the early 80’s was a lot cleaner deal but times and circumstances are much different today.
I view CAFÉ is having been truly bad program from its inception. It is a result of the government not possessing the political will to do what the rest of the industrialized world has done regarding a fuel tax. The European/Japanese model has worked for them. On the other hand, our own dependence on foreign oil has more than doubled since the first oil crisis in 1973, even with the adoption of CAFE.
And now we have “Cash for Clunkers,” or “Cash for Guzzlers” - now officially designated the Car Allowance Rebate System (CARS). CARS has noble intentions, but as my father is fond of saying, “A camel is a horse designed by committee.”
With CARS, the Government has indeed created a “camel.” It currently has the entire new vehicle market temporarily “on hold” while everyone waits for the final details of the program. Consumers will end up frustrated over these details and will probably direct their ire at Dealers, rather than the Government. While the European C for C programs have worked well, I have my doubts for ours. Too many objectives were targeted and the plan lacks focus.
Speaking of Japan, I just returned after a 3 week visit. The Japanese government came up with their own program to try to boost sales of new vehicles. Their program is based on emissions, so hybrids get a huge tax break. The result? Everyone is rushing to buy a hybrid to get the tax breaks. Honda Insights and Toyota Priuses are oversold for months.
Absolutely everything else the industry needs to sell and can deliver NOW isn’t selling. Imagine trying to pay your overhead out of the dribbles and drabs of production you get for one model. The Japanese situation is another example of when government has all the right intentions but doesn’t account for unintended consequences.

The One Thing I Do Know!
There are a LOT of quality Dealers looking for a new franchise to replace the ones that were yanked. More importantly, these Dealers are motivated to take a big chunk out of the backside of the OEMs who jilted them. Import OEM’s are already taking a look at them.
Many rejected Dealers were axed for doing TOO GOOD of a job with CPO and pre-owned vehicles. In other words, their profit or loss was NOT dependent on new vehicle sales and that unfortunately spelled their doom.
Clearly, these Dealers are smarter and more successful than many of the Dealers being retained. The history books will tell the story of how GM and Chrysler are ultimately impacted by cutting their Dealer body. I’m anxious to hear about the success stories of the guys who were jilted, survived, and came back with new franchises to kick GM and Chrysler’s ass!

This July version of the Ruggles Report can be found on his web site at http://www.cybercalc.com/products/Ruggles_Report.html. Mr Ruggles also writes a regular column for Auto Finance News

Thursday, 4 June 2009

Lies, Damn Lies, and Statistics!

David Ruggles
See also Cliff Banks article in Wards
As I watched the Senate hearings today on CSPAN my blood boiled. When asked about the money they would save by cutting their dealer count these guys, Henderson (GM) and Press (Chrysler), engaged in some serious obfuscation. They asserted that by swapping an "under performing" dealer for a "performing dealer" they would pick up the gross profit of the additional sales of the new "performing" dealer. These calculations of the difference between what they got and what they felt they were entitled to makes up the bulk of what they claim the rejected dealers "cost" their companies.
I have a little experience in this area. I have operated dealerships in a number of markets. As a consultant I have visited hundreds of dealerships and worked closely with them. The best dealers are those who have structured their business in such a way as to be less vulnerable to the inevitable downturn in either the new vehicle market or the times when the offerings of their manufacturer weren't well accepted in the market. These successful dealers learned to develop their pre-owned business and other profit centers, and they probably brought in other manufacturer makes to help cover their fixed costs in the event of a market downturn.
These dealers are typically still profitable, despite our difficult sales environment. These are precisely the type of dealers targeted by Chrysler and GM.
Markets are not created equal. To understand the concept, think in terms of MSR, which stands for Minimum Sales Responsibility in the Chrysler business. GM has its own terminology, but the same meaning. MSR is where a manufacturer's national market share percentage is applied to the total new vehicle volume in a specific dealer's market. Any deficiency – shortfall from the target – is what a manufacturer views as lost sales. They can calculate the gross profit they would have made had the dealer hit its MSR. But now they appear to count it as a cost in justifying the arbitrary termination of dealers and their employees. There are additional assumptions. The gross profit they calculate is the margin they make when they sell the a new vehicle to the dealer. The dealer has to sell it at retail to make money themselves, which isn't always possible. MSR also varies by locality; it is certainly possible that a dealer who exceeds MSR in one market would underperform in another.
The fact is, Chrysler and GM resent dealers who have managed their business in such a way as to not be overly dependent on selling their products. Many rejected dealers have been targeted as a result of their business acumen. In addition, Chrysler and GM are moving to force more expense onto their retained dealers. GM has sent out "participation agreements" that any dealer wanting to go forward must sign. It effectively replaces the franchise agreement, forcing dealers to agree to do anything and everything, or else. Don't sign, and the dealer is terminated. GM and Chrysler want more elaborate and expensive facilities. The also want exclusivity in those expanded facilities, meaning the manufacturers won't allow competitive makes in these facilities, even though they are purchased or leased by the dealer, NOT the manufacturer.
Normally, dealers would be protected from these types of unreasonable demands by state and federal franchise laws. But GM and Chrysler are taking advantage of their bankruptcies to avoid these restraints. They are showing why these laws existed in the first place - there is a long history of franchisors abusing franchisees, once the franchisee has money in the business that they can't extract. The auto industry isn't unique, but each store represents a far larger investment than in fast food or most other franchising. Congress and the states had made such blackmail illegal; now Chapter 11 is being manipulated to allow it.
I have a friend who had a Chrysler-Jeep operation yanked from one store, and a Dodge operation from another. Now Chrysler can give them to a competitor. These yanked franchises didn't fall out of the sky, good money was paid for them. Chrysler wants to exact a 3 million dollar building from the other dealer in return for being granting it the franchises. The dealer who was NOT terminated was not selling near their MSR, so there must be other motivations. It will be poetic justice if the yanked Chrysler, Jeep and Dodge franchises languish for lack of a party willing to invest that much for a new facility. Time will tell.
According to Chrysler's Press the distribution costs per vehicle amount to about $1000. Of course, each vehicle bears its proportion of these costs regardless of which dealer they were shipped to. In Press' argument this cost would be less if they could replace under performing dealers with (fewer) performing dealers. But these costs aren't related to the number of dealers – they represent the money spent to develop and maintain the software in the first place.
Furthermore, neither executive mentioned the costs their companies have transferred to the dealer. While claiming there were substantial costs associated with the software and hardware related to their dealer communication IT package, Press neglected to mention that each dealer is charged about $2600 a month for this. He failed to mention that there really are very few, if any, field people these days, as dealer contacts are made by email and telephone instead of actual in-store visits. There was a concerted effort to overstate costs and avoid altogether any mention of how much of these costs are actually reimbursed by dealers. In fact, studies show that each dealer represents POSITIVE cash flow BEFORE they buy a vehicle or a part!
I've been frustrated by previously not being able to determine who made the decision to cut dealers, rather than to allow natural attrition to thin out dealer ranks. (That attrition rate is high at present!) It is hard to believe that Henderson and Press have that little understanding of the auto business. I have to conclude that the initiative to lower the dealer count is driven by the Task Force, who think Toyota's business model is what everyone should emulate. The Task Force may be made up of restructuring geniuses, but they have little understanding of the auto business. Their profession means they are mostly North Easterners who may not even own a vehicle, and are not oriented to the issues of smaller businesses. But when a dealer closes, it likely results in a bankruptcy in which a family's life savings are wiped out. It's not just a job loss. The Task Force doesn't seem to understand this. Closing dealerships will cost sales for Chrysler and GM, something they can ill afford. And the ill-will it generates will cost them a lot more than any potential savings.
Imagine Gillette volunteering to give up shelf space space at the super market to Schick! It's the same principle. Foreign competitors looking to expand their dealer base will scan the ranks of rejected GM and Chrysler dealers. If not for the recession, that would save many of the terminated dealers.
In the meantime the "task force" is driving the bus while all parties deny any micro managing by the government.
But remember: as bad is it is, it's better than liquidation! Those who think Chapter 11 for GM and Chrysler should have been declared last summer have forgotten the financial crisis. To operate in Chapter 11 still requires financing, and for almost a year now that has only been available from the US Treasury. The Task Force is necessary, but the specialized nature of their skill set is apparent. The faster these two firms exit Chapter 11 and the Task Force stops calling the shots, the better.

Wednesday, 3 June 2009

Dealerships are a Cost? - I Don't Think So!

Mike Smitka
The statements of the CEOs of GM and Chrysler at today's Senate hearing on dealership closures make very little sense overall. (For details, see the National Automobile Dealers Association website. Full details should be on the website of the Senate Committee on Commerce, Science and Transportation.) It is true that some dealers run shoddy operations that hurt the brand in the communities where they operate; that is a problem in any franchise system. Current state franchising laws make it very difficult for "the factory" to yank the franchise of such dealers. Well and good if those are the dealerships being targeted – but there is no evidence that is the case. Are there that many bad apples in the GM dealership barrel? I don't think so.
The only GM statement that had any numbers in it refered to incentives paid to dealers and sales people, along with training, advertising and other support, at an average of $1,000 per vehicle.* For GM to save money, they have to cut that number a lot. Is there a lot of fat to be cut?
I don't think so. Here's why.
So let's say GM trims the number of dealers. IT and the like are fixed costs, independent of the number of dealers – though generally dealers get charged for software, brochures, everything. There are thus big savings only if the incentives are trimmed. So the bottom line is that for consolidation to save GM money, the productivity of sales staff and the dealership as a whole has to increase. With 20% of dealerships being cut, each sales person has to sell 25% more (= 1/.8), because for this to make sense the dealership can't add personnel or other costs. All while the dealership is earning significantly less for each car they sell. Is that realistic? I don't think so.
With fewer sales points, GM will somehow have to attract more customers, a lot more customers, to each physical location. They've failed at that in the past two decades. Are GM products so hot now and henceforth that they can get by with fewer locations? I don't think so.
OK, so GM wants newer dealerships, sometimes in new locations, so that volume per dealership can increase. But if I'm making less per vehicle because GM has just cut the wholesale discount, why would I want to do that? Not unless I'm making so much money that I can be coerced by GM into handing more over to them. If I were the banker for such a dealership, how would I react? They want me to lend them a lot of money to build a new dealership in a down market under a marketing plan that intends to cut the margins that dealers earn? Would I as a banker lend them the money to do it? I don't think so.
And hasn't GM ever heard of the internet, customers shopping online, test driving here and there, but coming to a dealership only to sign the paperwork? Does a fancy store add value in the new retailing world? Carpet reeking of mildew is one thing, I've been in dealerships like that, and walked out. But will fancy brick and mortar make me more likely to say "yes" to a harried salesperson? I don't think so.
Finally, what of Certified Preowned Vehicles? GM needs to sell those – especially once leasing starts to increase and rental car companies renew their now-aging fleets. "Underperforming" dealers are still in business because they were doing something right. Looking only at new vehicles is narrow-sighted. Are the fewer number of urban megastores going to let GM move that metal? I don't think so.
One possibility is that this is coming from the Administration's automotive team. They've proven to be brilliant workout specialists, getting the potentially viable portion of Chrysler through Chapter 11 in a manner the bankruptcy lawyers I've talked to thought impossible. Is that skill set likely to suit them to understanding the complexities of franchising, particularly franchising in the multiproduct context of a car dealer? (Dealers have at least 5 business lines, new, used, service, parts sales, finance & insurance brokering, and often a body shop.) Probably not. This lack of understanding may be further muddied by a comparison of dealer averages between Toyota and GM. That assumes that Toyota does well because of its dealerships, rather than the other way around: Toyota's dealers do well because Toyota's market share has steadily risen, ahead of their dealer count. But Toyota's attempt to sell full-sized pickups has flopped, because they don't have all those small, rural dealers who at GM sell their most profitable product. See David Ruggle's post below on The Task Force. He's actually seen restructuring first hand, and knows more of the specialized skills that entails.
Let me hazard a guess, [after consulting with a friend, almost surely wrong] that the incentive system for GM's factory reps focuses on the number of new cars they sell. For them, an "underperforming" dealer makes them look bad, there's no way they can match the bonus of a rival who drew "better" dealers. The smarter dealers watch the mix of used and new vehicles, and if they can snap up preowned on the cheap at auction and make more money, they'll shift their emphasis in that direction. But the reps who handle the certified preowned side of the business, well, they're kept in the back room, out of sight. Management doesn't see their success. [Again, GM was the one to launch the CPO business, and it's built into their rep system, so that doing well on CPOs was a positive, not a negative to reps.] But that means GM will be cutting their smarter dealers, the ones with the best business skills and feel for the market. Does that make good business sense? I don't think so.
* CEO Fritz Henderson: "GM pays about $1,000 a vehicle for dealer and salesperson incentives, advertising, field sales, service and training, and information technology support, he said." Automotive News. There was no breakdown or support for this $1,000 figure. GM does not have anything to say about salespeople and their compensation; that's up to the dealer, whether they work salary, straight commission, or something in between.

Tuesday, 2 June 2009

The "Throughput" Myth!

David Ruggles
Much has been written and spoken by the administration and in the media about the bankrupt Chrysler and GM Dealers lack of “throughput” as if it is a big drag on Manufacturer viability. This is used to justify the rejection of “deficient” and “extraneous” Dealers. It was pointed out in the Wall Street Journal recently that Toyota Dealers average 1613 new units per year while Chevrolet averages 643 and Dodge 408. The piece used the word “disastrous” to describe Buick Dealers’ 102 unit per year average, as if “throughput” is a settled issue as a negative. It is common knowledge that the administration’s automotive “task force” views “throughput” as a critical element to Chrysler and GM’s future profitability and is using Toyota as their benchmark.
In truth, new vehicle “throughput” has little to do with either Dealer or OEM profitability. For Dealers profitability has everything to do with the ratio of overhead to overall sales, which includes pre-owned, service, parts, etc. Dealers who have been committed to higher overhead levels are desperate to increase new vehicle “throughput” just to break even. Dealers who have been able to keep their overhead under control are less vulnerable to the vagaries of the overall automotive market and to the fact that Manufacturer offerings run hot and cold. Dealers who have learned to maximize the results of their other profit centers are also less vulnerable. In my own experience I ran the 2nd most profitable Chrysler dealership in the Chicago zone in the early eighties. We never sold as many as 100 units in a month. We were making $50 K a month in 1982 dollars during the peak of the Chrysler bailout crisis of that era. Chrysler had not succeeded in getting us to move into a higher overhead facility and otherwise boost our overhead. The profit leader was a large fleet dealer that had to sell thousands of units a year to beat our profit numbers. During that same era, Long Chevrolet, a Dealership that still holds the record for yearly new vehicle “throughput,” was shuttered and bankrupt. And for Manufacturers, each Dealer is a profit center, not an expense.
Toyota, with their high “throughput,” has one of the lowest J.D. Power “SSI” figures of any Manufacturer’s Dealers. “SSI” is Sales Satisfaction Index. Toyota’s high “throughput” must contribute to the fact that their customers are highly dissatisfied with their purchase experience even though they love their Toyota vehicles. Toyota’s sales numbers have tumbled along with the rest of the industry in recent months. Using Toyota as a model may not be the most intelligent benchmark for the “task force” to use as they have posted record losses recently.
It is widely understood within Toyota, and within the industry, that one big reason for the lack of success of Toyota’s superb new truck, the Tundra, is their lack of Dealer coverage. Adding Toyota Dealers will tend to lower each one’s “throughput.” It has been proven that truck owners, who tend to be loyal to their brand anyway, prefer to drive say 30 miles to their nearest Ford, Chevrolet, or Dodge Dealer than drive over a hundred miles to a Toyota store. Further, court documents in Chrysler’s bankruptcy included comments by Jim Press, ex Toyota exec, which indicate he is aware that shedding Dealers is counterproductive to Chrysler’s profitability. If he’s right, lowering the Dealer count to increase “throughput” is counter productive.
According to Joe Eberhardt, Chrysler’s senior vice president for sales and marketing, when a Manufacturer’s loses a Dealer, OEM costs stay the same and–at least in the short term–it loses that Dealer’s new vehicle and parts sales. “There’s no immediate payback,” he stated.
Arbitrarily stating that high “throughput” is an essential element to the viability of Chrysler and GM may sound good to those who think the “Factory” owns all of its’ Dealerships, but those in the know ain’t buying it. If the “task force” actually believes this, and they are in charge of fixing the two ailing automakers, we’re all in trouble! In the meantime, Ford and other competitors are gloating and making absolutely no moves to raise their Dealer’s “throughput” by reducing their Dealer count. I suspect there will be immediate moves by GM and Chrysler’s competitors to pick up some additional market representation by forming relationships with “rejected” Dealers and by securing abandoned GM and Chrysler facilities.

The Task Force

David Ruggles
I'm a vocal critic of a lot of what is being done in the auto business, but it is clear to me that "corporate restructuring specialists" are a specialized breed and it's quite likely that this skill set is not one held by many car people, if any. An executive from Alix Partners has been appointed to head the GM restructuring. They are the foremost restructuring specialists in the world. The sooner the restructuring is completed and the specialists are out of the way, the better. Putting car business people in charge a complex corporate bankruptcy might not be a good idea. Many corporations that handle it themselves do so under the auspices of specialized consultants, who are highly paid. Having said this, I'm not thrilled with the decision to cut dealers. It's not clear who made that decision. I'd sure like to find out [ad hominem attack deleted]!
But without gov't intervention it would have been Chapter 7 for Chrysler and GM and a shut down of auto production in North America for a period of long months.

Monday, 1 June 2009

More on Dealers: My Opinion in NYT

Mike Smitka
Here are a series of brief items in the New York Times "Room For Debate" online forum on their Opinion page: Link here. My contribution starts:
G.M.’s bankruptcy could still unravel unpleasantly. It’s a big customer for the supplier base, and they’re on the edge. Chrysler’s dealers got 26 days’ notice. G.M.’s franchises don’t expire until October 2010. But that’s remote from our everyday experience...

Thursday, 28 May 2009

Everyday People: Why Is Bigger Still Better?

Mike Smitka

Everyday People: Why Is Bigger Still Better? But in order to serve small towns and the many users with different "needs" a car company itself can't be small. Economies of scale in design, engineering and production are large, at this level partially offset by the ability to spin products off of a common "platform". Unlike Europe, the US is spread out – though most people live in suburbs & cities, in the aggregate rural areas remain a big market. Small dealerships are indeed integral to that! Mea culpa: I live in a rural small town.