The Global Auto Industry

The Global Auto Industry

Backgrounder: Detroit’s woes coincide with a blossoming of Asian automakers.

March 2, 2007 12:22 pm (EST)

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In February 2007, DaimlerChrysler executives announced a plan to restructure Chrysler’s operations. As part of the restructuring, the company will cut thirteen thousand jobs, reduce its total production capacity, and consider divesting the Chrysler brand altogether. The announcement, analysts said, could mark the beginning of the end for an unhappy nine-year marriage between the companies, a merger celebrated in its time. There are murmurings that General Motors (GM) may consider purchasing Chrysler, or parts of its operations, though some experts say the idea of such a deal is speculative. Regardless of what happens to Chrysler, DaimlerChrysler’s woes highlight the shifting realities of the global auto industry. As Detroit’s automakers have struggled, Japan’s Toyota is commanding increased influence. A handful of Chinese manufacturers are also elbowing for global significance, especially in the auto-parts market.

What went wrong with the DaimlerChrysler merger?

When the German automaker Daimler-Benz joined forces with Detroit’s Chrysler Group in 1998, the event was dubbed a “merger” but widely interpreted as a takeover, with Daimler-Benz clearly the dominant partner. The German company’s hopes for purchasing Chrysler were twofold: It wanted to increase its access to American markets and to reap the benefits of greater economies of scale in production.

"Two drowning men don’t make a swimmer," says Rhys. "If GM is going to take on Chrysler’s problems, that could be enough to tip GM over the edge."

Things didn’t work out so neatly. Chrysler failed to deliver a steady stream of profits for its new parent company, plagued by the same problem that has riddled the American auto industry more generally—atmospheric costs. Due to locked-in employee contracts mandated by the United Auto Workers (UAW) union, U.S. automakers pay workers actively employed in factories an average of sixty-five dollars per hour, according to Sean McAlinden, chief economist at the Center for Automotive Research, a leading source for industry research. Toyota, whose factory workers are not unionized, pays an average of $45 per hour to workers in U.S. plants. Nor do these numbers include “legacy costs”—including health care, pensions, etc.—that push the differential in personnel expenses even wider. Globally, U.S. companies pay about 20 percent more than their competitors in average labor costs. McAlinden cites data from Chrysler estimating that this difference adds approximately one thousand dollars to the cost of each vehicle it makes. UAW representatives, for their part, credit other factors for U.S. auto prices, including the U.S. health care system and poor corporate management.

Now, as part of its restructuring, Chrysler is shedding thirteen thousand workers. Company executives say they hope to reduce material costs by as much as $1.5 billion in three years. The question is whether this is too little too late—the company hemorrhaged $1.5 billion in 2006 alone. “When you have a merger, the key is really the post-merger period,” says Garel Rhys, an economics professor and auto industry analyst at Cardiff University in Wales. Rhys says reaping economies of scale after a merger is often a painful process, and requires strong decisions by management. In Chrysler’s case, DaimlerChrysler executives are only now approaching those decisions with real urgency. The current consolidations might have had a greater impact in 1998, soon after the companies merged.

What will happen to Chrysler?

It’s unclear. The same cost problems that make Daimler keen to get rid of Chrysler also make it unappetizing to many suitors. One major concern is the $26 billion Chrysler has amassed in healthcare and pension liabilities.

For the meantime, Daimler is pushing to restructure Chrysler, either to make it profitable and perhaps retainable as a subsidiary, or simply to make it more appealing to potential buyers. Chrysler Group’s announced job cuts amount to about 16 percent of its work force. The company also plans to produce about four hundred thousand fewer automobiles per year.

Is General Motors likely to buy Chrysler?

There has been widespread speculation that General Motors might swoop in and buy Chrysler. The Financial Times reported that DaimlerChysler is considering an “all-share” option in which Daimler would sell Chrysler to GM in exchange for an unspecified quantity of GM stock. (In a roundabout way, of course, this would leave Daimler still owning Chrysler—or a portion of it, anyway, diluted by simultaneous ownership of a portion of GM.)

It’s unclear whether an arrangement like this would make sense for GM, which is itself struggling. “Two drowning men don’t make a swimmer,” says Rhys. “If GM is going to take on Chrysler’s problems, that could be enough to tip GM over the edge.” Rhys adds the potential upside of this deal is limited at best. Given GM’s size, it is already reaping most of the benefits available from economies of scale.

Marina Whitman, a professor at the University of Michigan’s business and public policy schools and former GM executive, says she takes these speculations with a grain of salt (though she adds that she has no inside information from her former colleagues). “This is an investment banker’s dream, this kind of purchase,” Whitman says, acknowledging how much money bankers stand to gain from a massive merger. “Sometimes they spin these tales, thinking they can wish them into being.”

What explains Toyota’s relative success in the auto industry?

Toyota’s rise to the top of the global auto industry has been nothing less than meteoric. The company is set to surpass GM, later this year, as the world’s largest car company. Its stock market value already exceeds those of Detroit’s Big Three combined. The New York Times Magazine aptly summed up Toyota’s ascent in a recent cover story (Subscription required) about the company: “Toyota’s performance last year, in a tepid market for car sales, was so striking, so outsized, that there seem to be few analogs, at least in the manufacturing world. A baseball team that wins 150 of 162 games? Maybe.”

Toyota’s rise to the top of the global auto industry has been nothing less than meteoric.

A variety of factors account for this success. Toyota’s corporate culture is routinely credited—often in terms that verge on ethnic or national stereotyping. But to chalk Toyota’s success up to Japanese culture does the company’s individual innovators a significant disservice (and brazenly overlooks examples of less successful Japanese automakers). Experts say Toyota deserves credit for maintaining solid business fundamentals. “Toyota really thought through all the processes of car manufacturing,” says Whitman. “They figured out how to create an interaction between the workers and the manufacturing processes that guaranteed quality and held down costs.”

By synergizing production processes, Toyota has managed to mix highly efficient factory standards with fundamental product quality. One of the company’s internal mottos is to "build quality into processes." A cascade of customer approval and Motor Trend "Car of the Year" awards testifies to the company’s success at meeting this standard. This trend has only increased of late, as the large American market has become increasingly interested in fuel efficiency, a staple of Toyota’s precision-focused vehicles. Fully half the company’s sales now come from the United States, and to a large extent, the once-small Japanese car-maker has been able to brand itself regionally as “all-American,” introducing brands like the Toyota Tundra, which competes with Ford and Chevy’s popular truck lines.

Some experts argue that Toyota’s style of growth has played an equally important role in the company’s meteoric rise. While many companies, including American ones like GM, grew their business through mergers, Toyota focused on organic growth. As the Economist put it in a 2005 special report: “The strategy of consolidating behind the brands has not been entirely successful: Indeed there is an inverse correlation between the number of brands a firm possesses and profitability.” GM, the paper pointed out, owned fifteen brands, more than any company in the world. Toyota, by contrast, owned only four, yet its profits outstripped GM’s handily, and did so relying heavily on homegrown brands like Lexus. This argument is not uncontroversial, however.

Are mergers detrimental to a car company’s profitability?

There is substantial disagreement on this point. The 2005 Economist report argued that the cobbled-together auto behemoths were dinosaurs and credited Toyota’s organic style of growth for its relative profitability. But a number of experts disagree with this analysis. “I reject that thesis, utterly,” says McAlinden. “They keep pointing to BMW and Honda as solo acts that do well, but those are not the rule.” Rhys, for his part, says the Economist’s ultimate argument is “a bit simplistic.” He points out that being able to tap economies of scale is enormously important to the success of an automobile company—and adds that mergers, if properly executed, can help achieve that end.

GM, Rhys says, is a prime example, despite its recent problems. The merger-growth model implemented by the company’s longtime President Alfred P. Sloan cannot be called unsuccessful, even if some of the company’s recent purchases have fallen flat. “GM has been number one in the world since 1931,” he says. “That’s not a bad track record.”

How does China fit into the future of the global auto industry?

Very significantly, both in the production of automobiles, and in the related auto-parts industry. China’s carmakers are pushing for influence both within China’s expanding domestic market and through exports, particularly through partnerships with foreign companies. Currently about 70 percent of cars made in China are manufactured by non-Chinese corporations, though because of government restrictions these companies often need to team up with local manufacturers to be allowed to do business. In total, China will produce roughly eight million vehicles in 2007, up from seven million the year before. In terms of total number of vehicles produced, those numbers already place it ahead of some traditional industry leaders, including Germany.

China’s rapidly growing domestic market is the primary focus of the country’s manufacturers, but China has also recently tested the export waters:  A state-owned Chinese company named DongFeng has made a joint venture with Honda and is now exporting cars to Europe and America. DaimlerChrysler recently cut a deal with the Chinese automaker Chery, and together the companies aim to explore the U.S. market.

But one of the biggest China-related shifts thus far is not in the production of automobiles themselves, but in the manufacture of their parts. “What you’re really starting to see is exports of parts and components,” says Loren Brandt, a professor of economics at the University of Toronto who focuses on China. “Right now exports are on the order of $15 billion—that’s not a big, big number, but it’s growing very rapidly.” Brandt points out this boom in Chinese parts exports, coupled with the many multinational automakers now setting up shop in China, has convinced virtually every first-tier parts supplier to open extensive operations in China. These include the behemoths Delphi, Lear, and Bosch.

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