Driving off a cliff

U.S. auto sales drove off of a cliff in November.

The numbers from Autodata show that the industry as a whole is down almost 37% from last November, and GM and Chrysler are especially hurting, with sales down 41% and 47%, respectively.  Toyota fared better than the industry average, but still lost a third of its sales from last year.

Industry sales have been down all year, but the November numbers were especially shocking. 

In this post, we'll look deeper into the numbers to see what they say about the industry and what they say about the market.

Cars and Trucks
One of the things that jumps out about the sales figures is just how dependent the Big 3 are on truck NovTruckSales
sales.  Combined, the Detroit automakers derive two-thirds of their sales from light trucks.  Chrysler sells three times as many trucks as it does cars. 

Toyota, Honda, and Nissan get most of their sales from cars.  In fact, I was surprised to see that the "Japan 3" sell more cars in the U.S. than the Detroit 3.  Toyota has the largest share (21%) of cars in the U.S. market.

So when gas prices topped $4 per gallon earlier this year, the sales of gas-guzzling trucks fell off dramatically.  Because of their dependence on trucks, Detroit suffered far more than the Japanese and European automakers.

Essentially, customers shifted their purchase patterns to cars when gasoline prices became a burden, and that helped Japan at the expense of Detroit.

November was different
But what happened in November was fundamentally different from what happened earlier in 2008.  In November, car sales and truck sales both declined at about the same rate.  The truck / car differences we described above disappeared (along with $4 gas).  In November, all of the automakers were hit pretty hard.

So what is going on?

November is different because customers stopped buying vehicles, regardless of whether they were a truck or a car

In most of 2008 vehicle purchasing decisions were affected by fuel economy — and the market shifted to buying cars from buying trucks.  In October and November, purchasing decisions were affected by the overall economy — and vehicle buyers disappeared. 

All of this has amounted to a fatal one-two punch for Detroit.  Wobbled by disappearing truck sales when gas prices were high, the knockout punch for the Big 3 came when the overall market dried up.  While the economic downturn has hit all of the automakers, Detroit has crumpled under the weight of its legacy burdens.

As the Big 3 executives go back to Washington (this time driving hybrids instead of riding in company jets) to ask for emergency funds, I'm still wondering: What will change?

Why we specialize in Toyota (and Lexus and Scion)

When Suzanne and I bought Lowell's back in July, a lot of our friends and family wondered why the business focused exclusively on Toyota brands (Toyota, Lexus, and Scion).  There are historical reasons, but there are also significant benefits to our customers.

At first, specializing in one brand seems like a very limiting choice, since only a fraction of the cars on the road are Toyotas.  Why not serve the whole market?

There are three basic reasons we specialize:

  1. It makes us better.  With cars becoming more and more complex, keeping detailed knowledge of the unique properties of all of the brands becomes impossible.  By getting specialized training for Toyota, we're better able to recognize problems unique to Toyota vehicles.
  2. It makes us faster.  Our specialized knowledge lets us diagnose and repair problems faster than a multi-brand repair shop can.  We also stock a variety of original Toyota parts so that we can perform most maintenance or repair in the same day as the vehicle came in.
  3. It makes us more affordable.  Servicing today's more complicated vehicles requires very specific parts and equipment, which is costly to keep across multiple brands.  By focusing exclusively on Toyota, we can keep our inventories smaller and our equipment more up-to-date.  These lower costs help us keep prices lower.

Finally, this combination of better, faster, and more affordable reinforces itself: When we have deeper expertise, we provide superior service faster, which helps us keep costs (ours and yours) lower.

[where: 111 Mechanic St, Lexington, KY 40507]

The Big 3: Thoughts on a bailout

No matter how far you've gone down the wrong road, turn back.  (Turkish Proverb)

In my last post, I chronicled what I think has caused the collapse of the American auto industry: heavy retiree costs; poor timing; and the current economic slump.

As auto executives went to Capitol Hill with hat in hand (after stepping off of their private jets), the question of the day is: Should we bail out the auto industry?  I'll outline my thoughts on that issue here, and would be interested in what you think.

I feel that I pay taxes to contribute to the general well-being of the community, state, and nation (which, ultimately, will pay me back).  My hope is that those tax dollars are allocated to the beneficial initiatives that one person or business cannot afford alone: things like roads and infrastructure, national defense, police and fire protection, and the like. 

I also hope that some dollars are dedicated to the cooperative "moonshot" projects that make our country, community, and industry great.  These include things as grand as the Marshall Plan to rebuild Europe after World War II or actually going to the moon in the Apollo missions, as well as more pedestrian initiatives like DARPA (the defense research agency which spawned the internet and many other technology advancements) and SEMATECH (the government-sponsored semiconductor industry consortium which helped build huge international advantage for companies like Intel and AMD).

So is bailing out the auto industry (and its suppliers and all of their employees) worthy of such "moonshot" status?  I think that it is… IF…  It is in the national interest to preserve the domestic automakers.  The ripple-effects of the collapse of these companies, the loss of so many jobs, and the subsequent social and economic ramifications could push the overall economy into a state of depression.


While I think that preserving the American auto industry is a potentially noble pursuit (worthy of my tax dollars) and I think that it could contribute to the well-being of my country and community, I haven't heard a plan to preserve the industry

I don't think a bailout is warranted until 3 basic questions are answered:

  1. What is going to change?  Before we can devote tax dollars to companies which are burning cash at record speed, we need to know what is going to change…  None of the executives or labor leaders have offered any ideas on why a big pile of money will change their pattern of losing it.  A government bailout won't help until the companies do business differently.  And the Big 3 haven't talked about doing business differently.
  2. Where are the cars?  Where are the market-changing cars that the market wants?  Until Detroit has innovative and desirable vehicles which people will buy, they won't be economically viable.  The Big 3 executives have offered lots of promises, but not much evidence that such vehicles are ready to go.  And there is no talk of an inspiring "moonshot" project to make Detroit vehicles worth buying again.
  3. What happens to the retirees?  Detroit is struggling in part because of its massive pension and insurance obligations — much of it for retirees.  How are they going to restructure those obligations without a) unloading them on taxpayers, or b) depriving the retirees of promised benefits?  So far, I've heard nothing productive in this regard.

A bailout will fail if all it does is prop up an already-failing industry.  Until the companies and the congress talk about permanently and productively changing the way the industry operates, a bailout just staves off the inevitable. 

Detroit has been on the wrong road for 35 years or more, and they're running out of fuel.  We shouldn't give them more gas until they change where they're headed…

[where: Detroit, MI]

The Big 3: Why they are failing

I grew up outside of Detroit, and most of my family still lives up in Michigan.  My grandfather enrolled in General Motors Institute (now Kettering University) on the GI Bill after fighting in World War II, and eventually became an executive with GM.  Many of my aunts and uncles still work in or around the auto industry.  Growing up, my family only owned GM vehicles: My first car was a 1971 Oldsmobile Cutlass which I drove to 200,000 miles.  My second vehicle was a 1971 Firebird, which I still have.

I love GM (even though I'm committed to Toyota now).  And I love Detroit (and all of their pro sports teams – Even the 0-10 Lions.)

So it deeply saddens me to have watched the slow, inexorable slide of the American auto industry as it now approaches complete collapse and its executives beg for bailouts from Washington.  It is a tragedy not only for the formerly-huge companies, but for all of the employees and suppliers and employees of suppliers in Michigan and across the country.

There are probably hundreds of factors in the Big 3's decline.  Here are three which I think are most important:

  • Pension, Insurance, and Retirement: Throughout their history, the automakers increased pension and retirement benefits for their employees to avoid boosting wages.  This allowed the companies to skip the short-term pain of paying more for labor, but the long-term effect was disastrous: Many employees had 20- or 25-year careers with generous 40-year retirements paid by the company.  Multiply this by tens of thousands of retirees, and the financial obligation weighs heavily on each car sold.  GM reports that health care obligations alone cost them over $1600 per vehicle.  Toyota's costs are closer to $200 per vehicle.
  • Wrong Vehicles, Wrong Time: Something happened to the cars Detroit produced around 1973.  The vehicles got bigger, less powerful, and less well-built — all just as the energy crisis started to hit.  For the past 35 years, American automakers have had a horrible sense of how customer needs changed.  Their responses have typically been "too little, too late".  In the 70's they missed the need for fuel-efficient cars.  In the 80's and 90's, they skimped on quality as Honda and Toyota offered the world's most popular models.  In this decade, they poured all of their new-product efforts into the highly-profitable SUV and big truck segments.  Then gas hit $3 and $4 a gallon.  Detroit then scrambled to show it planned high-MPG "green" vehicles (like the Chevy Volt) by 2010 to 2012, while Toyota and Honda had well-proven and popular technology in the marketplace.
  • The Soft Economy: As the overall economy has weakened, people are buying fewer cars.  The freeze-up in financing has compounded the automakers' ability to entice customers to buy their vehicles.  As sales across the industry have fallen off, the Big 3 are in the weakest competitive position.

These factors, when combined, account for the implosion of the automakers.  As 1) Detroit has failed to deliver what the market needs, and 2) the overall market shrinks — resulting in a 45% sales drop in just one year for GM — the industry can't afford to pay for the massive obligations represented by its retirees.

So that's my Cliff Notes version of what's wrong with the Big 3.  In my next post, I'll explore whether a bailout of the industry makes sense.

(P.S. If you are interested in an extended discussion on GM's pension obligations, check out Roger Lowenstein's While America Aged, which devotes about a third of the book to how GM got into this situation.)

[where: Detroit, MI]

Dealership Economics, Part III: Toyota

Toyota-logoIn the first two installments of Dealership Economics, we talked about why the car sales process is so vague and about the importance of the service department to the dealership's business.  In this post, we'll look at what the dealership company's financial statements say about Toyota's position in the auto industry.  

With the financial crisis at GM, Ford, and Chrysler (more on this in an upcoming post) making front-page news every day, you might wonder about the implications for Toyota in this economic downturn.  Toyota has definitely been hurt by the recent slump (see here and here), although it is not in the disastrous financial shape that Detroit's automakers are in.

So how will Toyota fare relative to the industry?  We can learn a lot when we go back to the dealership company we looked at in our other posts.

When we look at the numbers, two things jump out right away.  The first is that the Big 3 automakers' share — in both number of cars and dollar amounts — has eroded dramatically in just one year.  In just one year, the Big 3 has shrunk from over 35% of this company's car sales to under 30%.  Even if the economy were stable (which it obviously is not), such loss in share indicates that Detroit isn't making cars that people want.

The second number which jumps out is Toyota's share.  Even as the economy is deteriorating and car sales are slumping, Toyota grew its share of sales to 21%.  So, while the industry is getting weaker in a weak economy, Toyota's position within the industry is getting stronger…

So, what does this mean for the long term?  When the economy recovers, Toyota is in the best position to lead the automotive industry.  In addition, the long-term bets that Toyota made years ago (hybrids, flexible manufacturing, etc.) have helped sustain it through these difficult times.  In the end, Toyota will emerge as the dominant player in the auto industry.

Dealership Economics, Part II: Service

In Part I of Dealership Economics, we looked at the financial reasons the car sales process is so perplexing.  In this (shorter) post, we'll look at where the service department fits in to the business.

ServiceWhen someone buys a new car, there is a widely-held myth that they are required to return to the dealer for service to keep their warranty valid.  In fact, you can service your car elsewhere, and the warranty still holds — and there is a section of your owner's manual which should state this fact.  But the superstition persists, and is often reinforced (or, at least, not refuted) during the sales process…. Why is this?

I think it goes back to the economics of the dealership.  As I looked over the financial statements of the dealership company, I saw one set of statistics which really jumped out at me:

  • 85% of a dealer's sales is generated from car sales (58% from new cars, 24% used cars, and the rest from finance, insurance, and "other").
  • The remaining 15% of sales comes from the service department.

That might not be so surprising… But here's where it gets interesting:

  • The service department generates almost half (45%) of the dealer's profit

The cars are expensive, but contribute relatively little profit to the business.  The service department is relatively small, but generates huge profits for the dealer…

It is to the dealer's benefit to maintain the warranty myth, and keep as much of that service business to themselves as possible. 

If you have a relatively new Toyota, Lexus, or Scion, and would like to service it at Lowell's, you shouldn't let concerns about the warranty hold you back. 

Dealership Economics, Part I: Car sales

I hate going to the dealership to buy a car.  I don't like the haggling over the price, and I don't like the games they play (like "I'll have to run that by my manager…").  While there are a few dealers who are "up-front" on prices (for example, I shopped at CarMax for my last vehicle), most are less-than-forthright when it comes to pricing.  Why can't they just tell you what the price is? 

For fun, I like to look over financial statements for different kinds of companies (I know… I need to get a new hobby).  This weekend, I was looking over a the earnings for a company that owns several dealerships, and I learned some really surprising things about the economics of dealerships which helps me understand why the purchase process is so convoluted.

This particular company sold new cars for an average of about $30,000.  Out of that $30,000, it paid the car manufacturer (Toyota, GM, Ford, etc.) an average of $28,000.  Out of the $2,000 that was left, about $1,500 per vehicle goes to things like rent, salaries and commissions, and advertising. 

That means that when this company sells a new car, it will make only $500 in profit for its owners.  I say "only" because they have to buy a car for $28,000 and keep it on the lot and hope that it does eventually sell…  That's a pretty big risk to get less than 2% in return.

This helps me better understand three distinct behaviors I've noticed at dealerships:

  1. Vague Pricing: The dealer can take advantage of a customer's lack of knowledge about pricing to generate much higher profits.  If, for instance, they could convince an uninformed customer to pay $1,000 over what other customers would pay — $31,000 — then most of that extra $1,000 is profit and the dealer stands to make about $1,500.  So, by getting the customer to pay just 3% more, the dealer can triple its profit.  Being vague pays off.
  2. Needless Add-ons: I remember shopping for a new Accord in Lexington many years ago (this was before I met Lowell), and not being able to find one without pin-striping.  There were usually a host of other add-ons — special floor mats, trunk liners, wheel locks, etc. — as well.  I knew I didn't want to pay $150 for $5 worth of colored tape, but a "plain" Accord didn't seem to be an option.  But if the dealer gets customers to pay a few hundred dollars for some cheap "special" options, then they significantly boost their profit.
  3. Pushing Insurance: When the deal was closing, I always wondered why the dealers would push insurance so hard — openly questioning the quality of their product by telling us all of the things that could go wrong with the car.  Well, it turns out that the company I looked at made nearly as much by selling financing and insurance for the car as they did from selling the car itself.  Much like the add-ons, this is where the dealers can really grow their profits. 

So, the next time you are looking to purchase a car, don't be surprised if you see these strange, infuriating tactics. 

In Part II of Dealership Economics, we'll look at how the service department fits into the business.