Auto
firms in North America need to act quickly if they are to avoid turning a predictable
downturn into a self-inflicted crisis says Graeme Maxton of autopolis.
Detroit was an interesting place to be last October. I was there. It was just
as the leaves started to drop from the trees and the winds grew colder. The
summer was over and the fall had begun. The season was changing, as it always
does.
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It was interesting for another reason too. The cold winds, the change in outlook
and the fall were there in another way as well. They were the elements that
changed the economic season. The chill from the collapse in technology stocks
which, in turn, brought about the fall in consumer confidence, other share prices
and the until-then swaggering American economy. The long summer of booming sales
was over.
In the last six months, of course, there has been more of the same. The Federal
Reserve has now cut interest rates four times in an effort to boost confidence
and yet share values seem likely to decline further while profit-warnings will
grow. The Dow is in Bear territory while the NASDAQ is more than 65% below its
heady peak. Some economists think it is still 50% over-valued.
For once, it looks unlikely that Mr Greenspan’s magic will work. Most firms
are now expecting lower earnings in the next few quarters, banks are tightening
their lending and consumers are beginning to worry about their debts. (About
time!) This is all typical for the early stages of a slowdown where sentiment
tends to ebb and flow. But, with what has happened so far and what’s already
in the pipeline, we can be increasingly certain that an economic correction
is underway – a little like a chemical reaction. The car that was the US economy
has driven over a cliff and hitting the gas or the brakes won’t make any difference
now. It is not a process that can be put into reverse, even if the impact –
the landing – can be engineered, at least partly.
We’re
still going down
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By GlobalDataSo no matter what the US government or the Federal Reserve now does, consumption
levels will fall, economic growth will remain subdued until at least the second
half of 2001 and unemployment will rise. That is the pattern followed by almost
all corrections – be the landings soft or hard. The dollar will lose value,
companies will shut-shop and political discontent will increase. All of this
is much clearer now, predictable even. What is less easy to forecast however,
is the extent of the troubles to come. How sharp will the slowdown be? And what
are the implications for the auto industry?
Predicting the impact on the auto industry is not so hard
Actually, predicting what all this means for America’s car and truck makers
is not that hard. Although the relentless surge in sales during the 1990s makes
it easy to forget, the US light vehicle market has followed a predictable path
for decades. As the cycle is so regular it is possible to forecast what is to
come with some confidence.
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The
Federal Reserve has cut interest rates four times – but it is almost certain car sales will fall further |
Looking at the trends over the last three decades, the US vehicle market has
a number of very clear and repetitive characteristics. Between 1970 and 1992
there were three distinct cycles, all with the same pattern. First, they all
followed a bell-shaped path. After a five or six years of growth there were
two or three years of decline. Not a few months. Second, the peak of the market
was 30-50% above the low point – so sales always fluctuate widely, not by the
5-10% swings that many are now hopefully anticipating. Third, the cycles lasted
for roughly the same number of years each time.
The current cycle has been unusual
The current cycle, which started in 1992-93, has been unusual, however. First,
it has been far longer than normal. Typically, it should have peaked in 1997
or 1998 – in fact most pundits expected the downturn in 1998 or 1999. But the
economic boom was lengthened, partly by the dot-com mania but also because of
the cut in US interest rates at the time of the Asian crisis. By reducing rates
then, the American economy continued to surge and the world avoided falling
into recession. But, as a result, there were more than eight years of almost
unbroken growth – around three years more than usual. Because of this, the cycle
has another unusual characteristic – the peak was far higher than normal.
The outlook is not good – but it is reasonably predictable
These anomalies are a concern. They may mean that the outlook for car and light
vehicle sales in the US could be especially bleak. But, even if they mean nothing,
the prospects are increasingly predictable. From looking at the past cycles
and the economic trends, we can be almost certain that sales will fall further.
We can be fairly confident that the bottom will be at least 15-25% lower than
the peak. We can also be pretty sure that the drop in sales will last for another
year, at least.
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GM’s
Q1 earnings fell 88% – a sure sign that the industry is in serious trouble |
Light vehicle sales in the US are likely to reach a low point of around 14m
to 14.5m vehicles a year in 2002. This may seem a particularly pessimistic forecast
– it is an 18-20% decline – and yet it is supported by the evidence of the last
three cycles and would still result in a low point 13-15% above the last one
(12.4m). It is consistent with the peak of each cycle too. If anything, it may
prove a little rosy. Think of it like climbing a mountain. The higher the climb,
the longer the road back down. So – depending on how the US government responds
to the slowdown – there is a risk that auto sales could fall further than this,
continue to decline into 2003 or simply stagnate for a while.
Swift action is needed
So what should carmakers do? That’s easy to answer too. First, don’t be fooled
by claims that this is not serious, by companies like Eaton claiming the last
six months have just been an “inventory adjustment”. When GM’s profits
fall 88% (and it thinks this is good), when vehicle production drops 17% and
when a host of parts makers announce plans to sell their automotive divisions
– and all that happens in just a few months, something more worrying is afoot.
The change is much more fundamental than Eaton and a few others with congenital
myopia are suggesting. In an industry already suffering from poor profitability
and excess capacity the prospect of lower sales is a third major exposure for
carmakers – as in “A Perfect Storm”, a recent film. With demand falling
in Europe too and the market comatose in Japan, there is a need for swift action.
Costs will need to be cut – factories will have to be closed, workers laid off
and new models scrapped. Maintaining good cash-flow will become more critical
and much tighter financial management will be needed during the next few years.
Keeping a close eye on early warning signs will be vital too – to plot the downswing
carefully.
Yet with little put aside for a rainy day, many companies are hugely unprepared.
Some will need to act urgently if they are to avoid turning what was – always
– a very predictable downturn into what could easily become a self-inflicted
crisis. In the coming market conditions no one is too big to fail. This is not
a passing cloud – it is the beginning of winter.
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