Bloomberg story

See a quote of me in Bloomberg, on Honda. But I also suggested that the reporter, Alan Ohnsman, call Toshi Amino -- the quotes of Toshi are much more central to the topic. With US$1.00 = ¥84.24 [and €1.00 = ¥106.66] this morning (10am EDT on 25 Aug), Honda's strategic position of "make where you sell" looks pretty good compared to Toyota's heavy export orientation.

Mike Smitka

Taking It In(house)

Automotive suppliers in North America continue to face many challenges. First, they are capital constrained at a time when the “factory” is trying to build more vehicles – it is not just the odd “hot” car that is in short supply, it is entire brands. Second and surprisingly, the past 18 months’ turmoil facilitated new entry. The French firm Faurecia is an example, since it was (at least in relative terms!) cash-rich and scooped up several suppliers that were in temporary trouble. That immediately expanded Faurecia’s customer base, and since they (like many suppliers) are emphasizing new technologies, such access to the purchasers and engineers at target customers is important.¹ Finally, at least in the United States, there remain both incentives to as well as increased potential for assemblers to pull work in-house.
Ford is explicit in this. Mark Fields, their President for the Americas, notes they will add 635 jobs to undertake work currently done by suppliers (Automotive News, 9 August 2010, p. 8). This represents a reversal of trends over the past 15 years, when among other things GM and Ford spun off the bulk of their parts operations into (respectively) the supposed-to-be-independent firms Delphi and Visteon. Both ended up in Chapter 11, and in both cases their former parent companies bought back or otherwise propped up some of the factories they had spun off. Now GM appears to have found purchasers for some of those (e.g., the former Saginaw Steering), but they remain the lender of last resort to more suppliers than they would like. So not all of the reversal was undertaken willingly, and thus may in due course be reversed. However, Ford in particular continues to have the issue of legacy costs, since it did not go through bankruptcy. If it can avoid offering early retirements and rehire some of those on extended layoff, then those “legacy” costs fall on a per-vehicle basis.
At the same time, the UAW made major concessions, permitting two-tier wage structures. That means that bringing work in-house is more attractive as a commercial proposition, particularly when suppliers are unionized or otherwise have a labor cost approaching that of new “Detroit 3” hires. Ford has already pulled work in-house. Locally, the Strasburg VA facility of International Automotive Components used to make door panels for the F-150, at the rate of one every seven seconds; Ford now does that work itself. Labor costs weren’t the only issue; at the northern end of the Shenandoah Valley, the Strasburg plant is no longer well-placed geographically, as all the east-coast assembly plants, including the former Ford truck plant in Norfolk, VA, are now shuttered.² Now none of the plant’s customers are within an 8-hour drive. Indeed, most of their output gets exported to Ontario, a long haul from here, made worse by the need to skirt first mountains and then Lake Erie.
Now at another level the organizational structure that made albatrosses of the plants handed over to Delphi and Visteon remains. In-house suppliers will remain unionized, and executives will have incentives to “game the system” by skewing head counts and pushing for internal transfer prices that cloud the real costs of such operations. Furthermore, it is very hard to create incentives that encourage innovation, absent arms-length price setting for transactions and wage setting that need not follow larger corporate norms. So how well things will work really is an issue of management discipline. In the early days of GM under Alfred Sloan, senior management had hands-on engineering and operational experience. They could and did intervene, even while implementing a structure of divisionalization that on paper tasked senior executives with strategic tasks and divisions with operational tasks. But once the locus of power shifted to finance–an inevitable trend as that’s the only common language shared by the divisions of large corporations–then things gradually deteriorated. Shifting work to “out-house” suppliers was, uh, something that smelled bad to all concerned: the line executives, the unions, engineering staffs and even corporate staffs, threatening power and perks. Costs (and in the old days, quality problems) could be passed on to the assembly operations and the customer.
Those concerns aren’t central in the short run of one or two model cycles–as long as the wage gap between incumbents and new hires does not create too much friction. To the extent that new hires work in new operations, Ford and others can finesse that, because they can keep the two groups from mixing. Where such control issues are a problem may ironically be Toyota: over the past two decades, it has had a hard time finding places to invest its hoard of cash. One thing it did do was build up stakes in suppliers, which it believed (with some justification!) would offer better returns than Japanese financial markets. Furthermore, growth was at Lexus. Rumors I’ve heard in my wanderings among suppliers make me suspect that the pressure to pinch pennies fell by the wayside–plus engineers and purchasers were just plain busy, and watching costs took time they didn’t have.
The Detroit 3 should not emulate Toyota. Instead, they should let suppliers be suppliers.

----

Notes

1. I am a judge for the Automotive News PACE supplier innovation competition, doing vetting visits to 2-3 finalists a year for the past 15 years. During that time innovation went from undertaken reluctantly and irregularly because the product line or company was at risk to a core (or the core) element of corporate strategy.
2. See joint work by James Rubenstein of Miami [of Ohio] University and Thomas Klier at the Chicago Fed, check the link at right for several  working papers and Fed publications.

Mike Smitka

The Simple Economics of Social Security and the Trust Fund

Post moved to HERE at our companion blog US and Economics.

Inside The Chrysler Dealer Arbitrations

The Chrysler dealer arbitrations have been completed. Out of 108 arbitration hearings Chrysler maintains they won 76 of the decisions to 32 in their favor of terminated dealers. 32 out of the 789 franchises initially rejected have now received a “Letter of Intent,” which still makes th dealer subject to the nefarious whims of Chrysler when it comes to re-establishing their business. Word has it that Chrysler has employed unscrupulous tactics with their jilted dealers, leading to their overwhelming won/loss ratio.
On the heels of the final Chrysler arbitration numbers comes the Special Investigator General Troubled Asset Relief Program (SIGTARP) report. This is the government’s own audit of the use of TARP funds to bailout Chrysler and GM. The report castigates the Auto Task Force, led by Ron Bloom, Steve Rattner, and Steve Girsky for forcing the terminations. It seems the Task Force wanted to impose the “Toyota Throughput Model” ON GM and Chrysler. The OEMs might not have had any choice in cutting down their franchise count. After all Rick Wagoner was fired for not submitting an aggressive enough restructuring plan after taking TARP money from the Bush administration in December 2008. There isn’t enough space to analyze SIGTARP here. Others have already done so and the document speaks for itself. There is no doubt it would have been quite helpful to dealers locked in arbitration with their OEMs, had it been available at the time.
How Chrysler, in particular, went about their termination process is telling. Chrysler aggressively pursued arbitration, probably at the behest of CEO Sergio Marchionne, who thinks the dealers work for him. GM, on the other hand, wasn’t as aggressive as new CEO Ed Whitacre quickly figured out who his customers are and worked to restore many dealers quickly.
We talked to Carl Woodward, CPA of Woodward and Associates, Inc. Mr. Woodward has 38 years experience specializing in auto business accounting serving hundreds of auto dealers. He also has actual dealer experience as a partner/owner. Mr. Woodard participated in about twenty dealer arbitration cases on behalf of dealers. We have also spoken with dealers, some who won and some who lost their Chrysler arbitration hearings. A common theme arose from these conversations. Many of the Chrysler terminations made no sense at all. They were made based on incorrect data, incorrect interpretation of data, and quite possibly out of retribution toward dealers who had stood up for themselves in the past.
Chrysler typically fought against motions to transcribe arbitration proceedings. It seems they routinely took advantage of the lack of auto business and financial experience of some of the arbitration judges. Chrysler must not have wanted a record to be available when they took different sides of an issue depending on who the arbitration judge happened to be. For example, Chrysler might take a position that LIFO counts as working capital if that argument works in their favor, supporting a dealer they retained over one who was terminated. In another situation they might argue that LIFO reserve does NOT count as working capital if that argument supported the termination of a dealer. If the arbitration judge didn’t know the difference, and the dealer wasn’t knowledgeable and well prepared, this worked out in favor of Chrysler. As a practical matter, LIFO reserve DOES count as working capital. Chrysler must not have wanted a record to be available. Why have to deal with precedent if it is inconvenient?
In at least one instance, Chrysler retained a dealer with negative working capital over one with many times Chrysler’s own guide formula. Chrysler got caught on it when the dealer was well prepared with a knowledgeable attorney and CPA experienced in these matters.
In my own case, I have been in and around the auto business for 40 years. Until recently I have NEVER heard from any manufacturer any assertion that fewer dealers sell more vehicles. A spot check of Chrysler’s Alpha – Genesis project revealed interesting results. The project involves consolidating all of the Chrysler – Jeep - Dodge – Dodge Truck franchises under one roof. Imagine a market that has a 3 dealerships, one for Chrysler, Dodge/Dodge Truck, and Jeep. Now you put them all in one location. Yes, it’s probably good for the dealer who ends up with the 4 franchises under one roof, unless he/she had to boost overhead substantially to accomplish it. But I have yet to find an instance where overall Chrysler market share increases under this circumstance. My research is admittedly anecdotal. But others I have spoken to, including Carl Woodward and various dealers, are telling me the same thing. Even a couple of “factory people” have made the same observation without agreeing to attribution. When challenged in arbitration hearings to prove that Alpha – Genesis has been proven to achieve the stronger market penetration Chrysler says it desperately needs, they have, to my knowledge, not been able to provide any data to support their assertion. Might their entire premise to terminate dealers be based on a false premise?
Tammy Darvish, co-leader of the Committee to Restore Dealer Rights and vice president of Darcars Automotive Group in Silver Spring, MD weighed in: "It is curious that there is no accountability for the gross error in judgment on behalf of the Auto Task Force in addition to those that we believe committed perjury in Federal Bankruptcy court and in Congressional Hearings. Raising your right hand and swearing to tell the truth, the whole truth and then doing everything else but is unconscionable."
There is no doubt that it has been better for the economy to have a relatively orderly restructuring of GM and Chrysler instead of a disorderly liquidation. But the motives and tactics of Chrysler, in particular, are repugnant at best.
Addenda: We bloggers on Marketplace July 19, 2010

Capacity limits?!

If you thought you'd heard it all, well ... is this a harbinger of more widespread problems? The Yomiuri Shimbun today (July 12) notes that Nissan is halting 4 assembly lines because it can't get shipments of its ECU (engine control unit) from Hitachi, whose Hitachi Automotive Systems subsidiary can't get shipments from the "fab" that actually makes the chip "because they are too busy." Automotive News adds that Hitachi ships the same ECU to two other unnamed makers, who will also face shortages and perforce must stop their assembly lines.
Now this may be a short-term, random incident. But the context (viz. the Yomiuri story) is booming demand for semiconductors in many sectors. At the moment the US auto market is anything but booming. However, suppliers face tremendous pressure to control costs and that means they will be very cautious about building up inventory and rehiring workers.
So maybe it's just as well that demand hasn't surged.

Mike Smitka

Fleet Sales and Push Marketing



In April I wrote a column on the auto industry’s continuation of “push marketing,” despite assertions from the industry acknowledging the ills created by the practice. I wrote the column in the context of Toyota’s public relations and sales challenges. In response to a severe sales downturn, in the wake of the safety recalls and associated adverse publicity, Toyota bought back market share with huge incentives. This precipitated a similar effort by Toyota’s competitors in an effort to keep pace. This effort included the recently bankrupt GM and Chrysler, who had specifically disavowed “puh marketing” as a part of restructuring. The incentives included rebates, subvented financing, dealer “trunk money,” and optimistic lease subventions. In the case of Chrysler there have also been additional payments to consumers who use leasing or residual based financing through credit unions and other independent lenders.

Along the same lines, I am reading a new book, written by ex dealer Mark Ragsdale, entitled “Car Wreck, How You Got Rear-Ended, Run Over & Crushed by the U.S. Auto Industry.” In the book Ragsdale rails against “push marketing” practices employed by OEMs to artificially boost sales. He details how “push marketing” has contributed to the issue of “negative equity” in consumer trade ins and how this has led to increasingly longer term financing, rebates, diminished resale value, and the vicious circle that has rendered a huge percentage of consumers “un-financeable,” even those who are employed.

“Push marketing” strategies also include aggressive fleet sales. Noted automotive journalist, Jim Henry, recently provided input on the most recent June sales figures by noting that “fleet sales for the month were up 59% over the same period last year to just over 200,000 units." To be fair, last year at this time Chrysler and GM were in the throes of their bankruptcies. The Asset Backed Securities market, which had provided financing for most fleet and rental units, was barely functioning. This year the huge increase in fleet volume has been largely due to the replenishment of daily rental fleets due to an increased availability of funding and pent up demand. As I rent vehicles these days, I am no longer provided a beat up 40,000 mile “beater.” While this rental replenishment is a good thing, and indicative of renewed health in the ABS market, it should not be construed as evidence of a real retail resurgence.

There is an underlying weakness in retail demand in the automotive market at a time when real good news is desperately needed. The retail SAAR for June came in at only 8.6 million units, according to J. D. Power. This is down from May 2010. While fleet sales are much more profitable than before for the D3 due to the recent restructurings, it is retail demand that the economy and the auto industry desperately needs. GM and Chrysler are positioning for initial public stock offerings, GM as soon as the first week of July. Used car values are at historical highs, which should somewhat alleviate consumers’ negative equity positions in their trade ins. But the average trade in is a much higher mileage vehicle these days due to consumers, fleets, and rental companies having had to hold on to vehicles longer. The OEMs are able to break even or make money on lower retail sales even while paying huge incentives. The Detroit 3 no longer are required to pay UAW members to stay home and watch Oprah in the case of a plant shutdown. But consumer confidence is still weak and unemployment high. The European financial problems have shaken investors, which has been reflected by the recent drop in the Dow Jones average. This has rubbed off on consumers. Yes, the country's economic recovery is proceeding at a slower pace than expected.

As long as financing for fleet and rental sales is available we might expect to see an even higher sales rate of these subsidized sales. Under “normal” circumstances we might be complaining about how these fleet and rental sales contribute to the rapid depreciation of like model pre-owned vehicles recently purchased by consumers, contributing to their negative equity situation. But in today’s environment, aggressive short term lease subventions and aggressive daily rental recycling just may be the ticket to bolster the industry until other fundamentals have time to fall into place. In addition, the current and future pre-owned market needs the availability of additional pre-owned inventory. As always, it’s a question of balance. Will the industry know when to hit the brake pedal on fleet and rental sales?

Wards July 2010

How do you like your cone? – double-dip?

Part I

Where will growth come from, as the stimulus money runs out? – though the construction portion will keep being shoveled out for months to come. The dollar is weak against the Canadian dollar, the yen and the yuan, but not against the euro and has strengthened against the Mexican peso. So exports? – not likely. And exports simply aren't a big enough slice of our economy (about 10%) and are more sensitive to foreign incomes. Good for exports to China, but not otherwise. It keeps US imports low, too, but that's a reflection of bad news, not a source of good news.

What of the consumer? Unemployment remains high, and long-term unemployment is at record levels. Job losses remain high, so there's uncertainty. For the rich, who tend to save, capital gains and dividends and corporate bonuses remain low.

Investment still faces a housing and now a commercial real estate slump. We have, at least for a couple more years, too many houses and too many strip malls and office buildings for our population and income. Manufacturing is ticking upwards, but from a very low base; car sales may be 20% above their bottom in 2008-9, but remain 30% below peak levels.

Then there's government. The city across the valley from me is likely to go into receivership, lose its charter and revert to town status. Northern Michigan, which I just left, remains depressed. The local marina, which for years provided a big boost to city income, has almost no seasonal slips rented; there used to be a waiting list. Transient rentals and fuel sales were nil on some days the past two weeks. And over everything hangs the fiscal situation of California and Illinois. State and local government continue to lay off employees, even as the Federal government has stopped hiring.
So how do you like your cone? We're an obese society; we had an obese economy. Double-dip goes without asking. But there is a triple-dip crowd. You have to beg for a single dip, and we're not doing that.

Part II

Congress seems to be (wrongly) spooked by deficit hawks, and may go into reverse mode. Ironically, by prolonging the recession(s), that will leave us in a worse fiscal position, because most of our current deficit is the result of slow growth – falling revenues – and not a burst of expenditures.

Unfortunately post-banking-bubble recoveries tend to be slow, because it is structural distortions (too many houses) that have to be unwound, and short of buying up and bulldozing new developments, there's no quick way to do that. (We also have a growing population, so we will eventually have demand, and when retiring baby boomers can sell their houses, that will spill over even into such examples of excess as Las Vegas.)

A new working paper by M. Miyazaki from the International Monetary Fund makes the (with hindsight!) obvious point that the news is worse than that: revenues tend to grow with the economy, not faster than the economy, and so are very slow to recover to earlier levels. (See In Search of Lost Revenue, which is at the non-technical end of the spectrum of IMF working papers: you don't need an economics PhD to read it.)

Now it's conceivable that we could cut expenditures to speed the process. But we seem to have a proclivity for war, and for getting older. While I'd like to see us change the former, I have a vested interest in the latter, as does everyone reading this. And demand for most of the rest of what the government does, federal, state, and local, is a function of population. The US has a small government, in international comparison, so it's hard to find ways to significantly cut expenditures. Plus the last time I looked, we could cut all non-defense, non-aging related expenditures at the Federal level and still have a deficit.

Let's not kid ourselves: if revenue doesn't recover on its own and since expenditures can't be cut, then at some point we need to enhance revenues. A lot. My preferred alternative would be a national value added tax.

But demagoguery aside, there's no urgency; interest rates remain at record lows, and not just on short-term debt. However, we can't wait a decade before doing so. Hence even if Obama does not do so – it's hard to see that happening – the next president must. It will be a disaster if the radical right trumps conservative sensibility and precludes that presidential campaign from being over how to raise taxes, not whether to raise them.

Mike Smitka