Can U.S. carmakers ride out a recession?
Weaker-than-expected sales could incite suicidal price cutting and badly damage GM, Chrysler and Ford.
(Fortune) -- As most economic indicators continue to flash yellow - and occasionally red - a vigorous debate is unfolding about how far auto sales will fall this year.
With all three of Detroit's automakers under significant financial pressure, the debate is more than academic. None of the three is expected to make a profit in the U.S. in 2008. Should sales turn out to be considerably weaker than expected, it would not only create larger losses but could also incite another round of suicidal price cutting that would seriously damage all of the companies.
The forecast from ever-optimistic General Motors (GM, Fortune 500) increasingly looks isolated at the high end of the range. Newly appointed president Fritz Henderson reasserted his company's expectation that sales will come in at 15.7 million to 15.8 million light vehicles, according to Automotive News. Henderson said that credit is ample and consumers have not yet suffered from widespread declines in employment and income. Henderson's forecast would appear to hinge on a strong pickup in activity during the second half of the year, since sales in January and February ran at a rate of 15.2 to 15.3 million. Exactly what will produce that pickup, he doesn't say.
That's not the viewpoint of Chrysler CEO Bob Nardelli, who doesn't see any economic improvement coming in '08. He describes the current downturn as "bathtub-shaped" as opposed to v-shaped, implying it will be of longer duration. Chrysler's business plan calls for sales of 15.5 million cars and trucks this year, but Nardelli says he is ready to adjust that as required. He continues to cut costs proactively. Recently he announced the closing of Chrysler's West Coast design studio and said he would turn the two-week summer production shutdown into a company-wide vacation.
Meanwhile, Ford (F, Fortune 500) CEO Alan Mulally told a meeting of Fortune editors on Wednesday that he doesn't know how sales will come in this year, though his business plan still calls for sales of 15.7 million. As CFO Don LeClair points out, however, the important thing is not the actual number of sales but the amount of discounting required to achieve it. If consumers have to be enticed back into showrooms with especially generous incentives, then the number of units sold becomes almost irrelevant to the impact on profitability.
The industry's biggest bear is J.D. Power and Associates, which on Wednesday lowered its forecast to 14.95 million vehicles, down from 15.7 million in December, on signs of declining consumer confidence and spending, as well as turbulence in financial and economic markets. "Unfortunately the current environment is fraught with uncertainty and risk, worsening oil prices and weak housing and stock markets," said economist Bob Schnorbus.
If there is any good news from a sharper than expected decline, it is: added urgency to the restructuring that all three companies are undergoing. Another silver lining: A steeper downturn now could mean a steeper upturn later. Since most people can't put off buying a car forever, a deferred purchase in '08 should lead to one in '09 or '10. Car sales tend to follow a consistent trend with fat years following lean ones.
With an extra push from favorable demographic trends - a population bulge creating more licensed drivers - automakers are expecting better times in a couple of years. Chrysler president Jim Press likes to say that he enjoys visiting maternity wards because each new baby represents 13 car-buying cycles over its lifetime. Automakers will get an extra benefit in 2010 from the full effect of wage and benefit concessions negotiated last year with the United Auto Workers. GM expects the benefits of the contract to total some $4 billion annually.