Plight of the Detroit Three

Scenario: An auto-industry symposium is to end with a lively panel discussion labeled, “Plight of the Detroit Three.” The panelists are a free-enterprise economist, a car-industry insider, and an industrial-management researcher. The economist goes first.

Economist—defender of our free-enterprise systemIt seems unfair. The foreign-owned assemblers enjoy large financial advantages. The states where they operate, mostly in the South, lured the outsiders with tax abatements and subsidized training. Then there’s the scarcity of labor unions in these right-to-work states. That and the relative youth of the work forces have kept wages and health expenses comparatively low, and retirement payments nearly zero. Their advantage: about $2,000 per car. The Detroit Three could have moved south and gained similarly, but they would still be stuck with huge pension payments. Anyway, abandoning their long-standing home base was socially and politically not possible.

So, the domestics keep shrinking, and their Great Lakes-area manufacturing center suffers continual losses of jobs, tax revenue, and economic health. On the other hand we, the consuming public, have benefited from the fierce competition between old-line and transplant producers. We pay much less for cars than people in countries less open to free-market competition (e.g., most of Europe). Also, no small thing, the economic activity generated in the southern states creates wealth and a better life for hundreds of thousands of citizens there.

For whatever is unfair about all this, for the country it is economically beneficial. The system works!

Automotive-industry authorityFor all their financial misery, the domestics produce fine cars. Five, 10, 20 years ago they didn’t. The reputable assessment sources—car magazines, J.D. Power reports, and so on—found offerings of the Detroit Three low in most measures of quality and function. Today the ratings show scarcely any gap. Moreover, the productivity disadvantage, large just six years ago, has been erased. Labor-productivity is about 30 labor hours per vehicle for the domestics and the Japanese big three (Wall Street Journal, June 6, 2008). All this is astonishing. Given their years of lower profits, the domestics have had much less capital to invest in better cars and production.

The Detroit trio has husbanded its limited capital though low-risk strategies: Let the transplants try out new designs and technologies, then jump in whenever one proves itself in the market. Meanwhile, maintain good engineering and operating capabilities, the dependable route for closing gaps in quality, function, and production.

A prime example: For years, all producers, foreign and domestic, have made considerable investments in low-carbon engine technologies. Thus, as any foreign-based producer is able to make a viable market for cars with those technologies, the domestics are able to respond, though with costly delays. The followers lose customers, market share, and profits when the leader creates a hit. On the other hand, being a follower saves a lot, because it is expensive to be the leader and to make a market.

That the foreign brands retain higher resale values may be explained mostly by lag effects: It takes years to rebuild a tarnished reputation. If the public had realized that the transplants’ car offerings were no longer better, the Detroit Three would have been selling many more cars in recent years. Their financial situation would have been far brighter, perhaps enough to have avoided government

intervention.

Industrial management researcherA telling indicator as to how the gaps have been closed is amount of inventory the producer must carry. If the maker misreads the market, it ends up with lots of costly inventory (and its dealers much more). If it has poor quality, it is plagued with inventory in the form of rework and scrap. High buffer inventories are the penalty when equipment is not dependable, labor poorly trained, product designs difficult to produce, production lines inflexible, suppliers mistreated, and logistics and information channels overly long and problematic. Manufacturers globally have been well educated on all this—lessons originating decades ago in Japan and often referred to as the Toyota production system.

Twenty years ago the Detroit Three had miserable inventory numbers, as compared with Japanese counterparts. Today, that gap is not only gone; it is mostly reversed. For some years, Ford and GM have operated with lower inventories than the Japanese Big Three. (Having been merged with Daimler, then privatized, Chrysler’s data are muddled.)

Long-term trends amplify the point: In the past 15 years Toyota’s total inventory has doubled, to 31 production-days’ worth. GM’s and Ford’s trends have been opposite, from highs of more than 70 days’ in 1974 down to about 25 in 2002—before rising again. (Since 2002, inventories have grown for nearly all of the major global automakers.) How could GM and Ford have continued to operate reasonably in the face of 25-plus years of plunging inventories? The only explanation that makes sense is continual, wide-ranging process improvements. Financially, the shrinking inventories would have generated year-by-year free cash flow, investable in anything from better quality to R&D. Most important, unclogging the channels compresses total reaction time. In contrast, the enlarged inventories of the main foreign assemblers (Honda an exception) equate with slowed responsiveness.

As for the composition of the inventories, the largest component is finished cars and for-sale parts While that is the case for all global carmakers, the trends differ. In the past decade finished inventories at Ford, GM, and Nissan are up and down, no clear trend. Honda, on the other hand, stands out for halving its finished products since the early 1990s. Opposite to that are Toyota, BMW and Volvo, each greatly increasing its finished items—and without offsetting reductions in purchased and in-process materials. Those increases are indicators of underlying problems, including deteriorating linkages along the value chain to the key player, the ultimate car owner.

This is no attempt to put an artificial shine on the beaten-down domestics. The inventory data come from audited financial reports of each company. Anyone can verify the numbers using annual reports on company web sites.

And so . . .This debate, hypothetical but realistic, steers clear of what to do about the still deep financial and demand-based difficulties of the Detroit Three. It does, however, say that the domestic assemblers are not, as has been professed, inept.

Richard J. Schonberger177 107th Ave. N.E., #2101Bellevue, WA 98004425-267-1143Sainc17@qwestoffice.net