Explaining the Auto Companies

Yesterday Megan McArdle did a pretty fair job of explaining the business model that the Detroit auto companies use. Rather than summarize it here I suggest you just go over there and read it. I thought I might provide a few annotations.

Megan writes:

In the early 1950s, for various reasons Detroit developed a cozy three-way oligopoly. The UAW developed a cozy monopoly on supplying labor service to that oligopoly. In some ways, the UAW helped sustain that oligopoly.

Pattern bargaining was one of the ways that the UAW sustained the division of market share among the Big 3. Every three years the UAW picks a “strike target”, the company with whom they’ll negotiate the new contract. Once the contract has been negotiated, they negotiate essentially the same contract with the other two auto makers. This prevents competition among the auto makers on the basis of price.

Megan writes:

But Toyota’s system was developed in the absence of a strong union; the adversarial model that the UAW had developed along, however historically necessary, made the Toyota example completely unworkable in a Detroit plant.

Not only was the adversarial model historically necessary U. S. labor law makes it a legal necessity as well. Any unionized auto company in the United States will proceed along an adversarial model rather than a Toyota-style group model.

Megan writes:

Detroit should have reacted, I’m sure, by making smaller cars. But smaller cars were harder to make for Detroit. Buyers thought of them as a non-premium product, which meant they wouldn’t pay for the lucrative options packages. And because they used fewer materials, the labor component became a relatively larger part of their cost. Labor was where Detroit was least competitive.

Product niches are a big problem for the Detroit auto makers. By the mid 1970’s their shares of the low end were already eroding. Mercedes and BMW were already beginning to cut into their market shares in the luxury end of the market and when the Infiniti and Lexus were introduced in the late 1980’s and early 1990’s it cut into Detroit’s market at that end, too.

Increased share for Detroit over the period of the last twenty years has largely come from creating new niches, e.g. minivans and SUV’s. It’s possible they can do that again but absent that it’s hard to see where increased market share will come from for them. The lower end is going to receive increased pressure from Chinese and Indian car makers which will make competition for the remaining niches that much fiercer.

Megan writes:

What about management? I hear you cry. Management’s salaries can (and are) being cut, for the same reason that labor’s may be: they’re not set in a perfectly competitive market. But they’re not a big part of Detroit’s overall cash problem. With a burn rate of $4 billion a month above revenues, getting all of Rick Wagoner’s cash back, and making him buy his own coffee to boot, will run the company for about a minute.

Most of the rest of management is boring, middle class folks who are not magnificently remunerated: purchasing managers and payroll supervisors, sales executives and engineers. Their salaries will be cut, and a lot of them will lose their jobs. But a fair number of them make less than the UAW, and there are a lot fewer of them.

I think Megan is being too easy on management and the auto makers’ salaried employees, generally. The companies continue to have multiple levels of middle managers making pretty decent salaries. And I hate to break it to Megan but for reasons that confound me as much as their ranks have shrunk over the last twenty years they haven’t shrunk as fast as the numbers of hourly employees have.

Here’s Megan’s peroration:

The really miserable thing is that even a total bankruptcy may not be enough. Wipe out the shareholders, cut the bondholders to the bone, shuck the gold-plated medical benefits, toss out the UAW contracts, close the dealers–and we still may be left with companies that cannot make a profit without a now-defunct financing business based on ever-growing loans to ever-poorer credit risks. The Big Three, with the help of the UAW and all their other partners, has spent 25 years building a reputation for poor reliability and ugly cars. Brands matter. Once destroyed, they’re very hard to repair in the best of times. These are not, quite, the best of times, are they?

As I’ve written before the compensation plans, hourly and salaried, of the auto makers need to come into line with the earnings expectations for the companies. They’re not the only companies who are in that fix: banks and other financial companies need to adjust their compensation plans to the new realities that face them. So does government. And the professions won’t be far behind.