The Next Big Thing Is About 1.4 Liters

Future engines are getting downsized for cost and environmental reasons. But due to increasing efficiency, there shouldn’t be much if any reduction in performance. Why do with 5 what you can do with 3? Classic engineering progress.

According to this month’s AEI (Automotive Engineering International), Nissan, Chrysler, VW, GM and a number of other automakers will be releasing engines in the 1.4 liter range. These will supplant current engines in the 2.4 liter range, and will feature a variety of efficiency enhancing features such as Direct Injection and turbocharging.

Coupled with more efficient CVT or dual clutch transmissions, or with just more speeds these powertrains will find their way into vehicles expected to return over 40 mpg, in an effort to raise each manufacturer’s fleet average fuel economy above the nominal 2016 CAFE target of 35.5 mpg.

Chrysler Seeks $448m In Hybrid/EV Funding

Specifically, its seeking to build a test fleet and establish annual production capacity of 20,000 electric vehicles. The proposed test fleet includes 100 hybrid pick ups, 100 hybrid mini vans, and 165 electric cargo mini vans for the US Postal Service.

The money would in be matching funds, meaning Chrysler puts up half the amount and the Government funds the other half. More info here.

Chrysler Goes Belly Up (For A While)

Chrysler has filed for bankruptcy reorganization, in part because bondholders did not accept a Treasury offer of about $2.45 billion for their $6.9 billion in debts. It would be interesting if some of those creditors had insurance policies on those
bonds that would pay them more in case of default than the Treasury offer.

Anyway, this isn't the end. Chrysler will be reorganized and come out and "merge" with Fiat. The UAW membership has overwhelmingly accepted wage and benefit concessions (considering how that's much preferable to not having jobs). In the
mean time, Chrysler will slash its dealership network to match its reduced output and sales. And output for the next 30 to 60 days is going to be zero as it idles all of its assembly plants. I don't think the market is going to miss those cars
that are not produced.

After the reorganization, Bob Nardelli will also exit as CEO and the company can figure out how to start paying back the loans from Uncle Sam. This is sort of a short preview of what GM might eventually go through. Sort of like a test case
without a merger partner. More details will follow in the coming weeks.

It's kind of like an alcoholic going to rehab after getting divorced before getting married again. When he comes out he's going to be bossed around (guided) by his new second wife and living on the payments from Uncle Sam. And there's still no guarantee that he won't fall off the wagon.

But he'll have a lot fewer debts, his ex-wife won't even make him pay alimony so long as he goes away, and maybe he'll have fewer other creditors as well. Except for Uncle Sam wanting his money back. Then eventually the couple will have kids and, with any luck, the kids will turn out to be far better than the ones from his previous marriage.

White House Statements On Viability Plans

The White House basically told GM and Chrysler their plans won't work ("are not viable"). Both companies are uncompetitive, have too high of cost structures to survive and compete, and rely too much on large vehicles and SUVs. And both have overly optimistic outlooks on marketshare retention and pricing power.

Specifically, the summaries say GM's assumptions are break-even at best by 2014, with legacy liabilies reaching approximately $6 billion per year by then. This says it all: "Even under the Company's optimistic assumptions, the Company remains breakeven, at best, on a free cash flow basis throughout the projection period, thus failing the fundamental test of viability." Further, "Under its own plan, GM generates $14.5bn of negative free cash flow over its 6 year forecast period."

As for Chrysler, the statements included "...every single one of Chrysler's brands are in the bottom quartile based on JD Power APEAL scores", "... about 40% of quality issues (IQS/100 vehicles) are design related...", and "...in the first quarter of 2008, approximately 34% of buyers were subprime or near-subprime..."

The summary cited excessive costs due to a lack of scale, falling marketshare, overly optimistic assumptions, low quality image, and low odds of keeping up with CAFE standards.

Read the GM summary here.

Read the Chrysler summary here.

Finally, the White House goes on to back the warranties of vehicles purchased from these two companies during the restructuring period.

I'll leave you with this thought. Might GM and Chrysler products experience a decline in quality? Will it be hard to pinpoint if it's because low employee morale results in lower product quality, or struggling dealerships submit every little fault as a warranty claim? After all, it's backed by Uncle Sam. Just a thought.

What's Wrong With the Auto Industry?

So the big news of the day is Rick Wagoner was forced out of GM. Of course GM and Chrysler are both in a big pickle and it's a very complicated problem.

But the fundamental issue is that they are not really in business. They are cash-devouring problems that the US government now control and support. I view this move as Washington asserting its grip and making an example of current/past management. But that's not going to solve what's wrong with the industry.

First and foremost the problem with the auto industry is poor management. Management that does not understand automobiles.
Cars are not widgets nor are they commodities. Consequently they cannot be treated as such. If they were there would not be nearly as much variety nor emotional attachment to them. They are not just "needs" but they are to a large extent "wants".

Is it coincidence that the two companies in most trouble now are not run by engineers? Did you know that Honda, Daimler, VW, Nissan/Renault, BMW, and Ford (don't need Uncle Sam's money at the moment) are all headed by engineers? Toyota is one of the major exceptions. But incoming CEO Akio Toyoda is a diehard car enthusiast. The management at these companies have a keen understanding of automobiles and what their customers want.

Secondly, it is again poor management in the larger sense. No long term strategy. How many reorganizations and reshufflings have GM and Chrysler announced over the years? How many times have those companies said the next time they'll get it right? How many times have they exchanged one ill-conceived strategy for another mid-stream? More times than a cat has lives. They have never had any viable long term strategy and then properly executed it. It's always one quarter to the next.

Thirdly, they depended too much on the availability of easy credit (so did the economy as a whole) for people who were not creditworthy. In other words, the market for automobiles was smaller than it appeared, which further exacerbates the problem of overcapacity now that the market has shrunk.

Lastly, it is ineffective and counterproductive government regulations that have contributed to the mess. Healthcare costs are a part of it. Labor unions another (and they are getting more sway with card check). CAFE (Corporate Average Fuel Economy) on the surface doesn't seem too bad. But today's 262 page final rule for Model Year 2011 is full of errors and poor assumptions (more on that later).

So the question now is how can these two companies turn out good product when they're worried about going under in a matter of days? The answer is that they can't.

And that's why any pretension that GM and Chrysler are businesses should be put to rest. Business implies profits. And any hope that these organizations will ever turn one again is pretty slim. They should be allowed to go bankrupt and reorganize or dissolved. Throwing good money after bad is not the solution. Nor is a government task force or nationalizing these companies going to solve any more problems in the long run.

What Happened to Detroit?

After decades of mismanagement and mediocrity, we’ve all seen many of the overarching issues laid-bare in the past several weeks. In a nutshell here are the Detroit 3's problems:

1. Poor Management, Perpetual Reorganization, No Solid Long-Term Strategy

Actually their long term strategy essentially amounted to lobbying to keep the status quo in terms of fuel economy and regulatory standards. Cheap gas spurred big profits in SUVs and other vehicles that were not necessary in the numbers in which they were produced, and also put the manufacturers at the mercy of fluctuations in fuel prices.

All the while they went from one failed plan to another with no consistency in long term outlook. Every couple of years each manufacturer would roll out a new initiative but the outcome was usually more of the same: Shrinking market share and decreasing profitability, while spreading their marketing too thin on far too many brands.

2. Producing Vehicles the Market Doesn't Want

The domestic manufacturers produce 8 of the 11 worst cars of 2008 according to Consumer Reports. That becomes even more of a problem when demand is constantly shifting and their plants are geared to only producing a few models, with little flexibility.

Because of continued production of less desirable vehicles they’ve hurt the value of their brands. Sure, by many objective measures the domestic manufacturers have made great strides in productivity, cost, and quality.

But they missed the boat on building exciting, interesting, and desirable vehicles. The reason for this simply is that the executives do not understand cars. They may understand some of the numbers, but until the cars are what people want to buy, they’ll never make the numbers.

3. Excessive overhead (labor cost, healthcare, etc)

Not much of the fault is with the labor unions. They negotiated what they could. Sure it was shortsighted and the results helped dull America’s competitive edge and drove jobs to Mexico and overseas. But the real fault lies with management that would be so inept as to ALLOW the unions to push them into the agreements that they did.

The reason they're in crisis now is because they have been losing so much money, and then the credit crunch sharply reduced sales (many buyer's can't qualify for loans) AND reduced the credit available to the companies, especially since their existing debts (bonds) have continued to be downgraded. It's a vicious cycle resulting from the 3 points above.

By the time they realized this it was all too late. We’re now at a stage where it looks unlikely that GM and Chrysler will be able to stave off bankruptcy without government support (and even then it’s not looking too bright). The reason is because their businesses are not strong enough to survive in good conditions, much less to weather the storm.

Too Big To Fail?

Not to be too much of a cynic but see what I meant last week? There's no business case for a GM/Chrysler merger but.... maybe taxpayers will foot the bill.

GM/Chrysler Takeover/Buyout/Merger

A day later and it still doesn't seem like a good idea for GM. This article goes into a little more detail about the cash GM would get from Chrysler's coffers, which would be advantageous in the tight credit environment that currently exists. Let's be real. That $11 billion isn't going to save a company that is burning $1 billion per month, especially after it absorbs another company that's also bleeding. What's that going to buy? Another 6 to 12 months?

It seems like the real end game would be to create a company that has so much impact on the American economy, whether real or perceived, that it would not be allowed to fail. By merging the two they would have further bargaining leverage with governments, suppliers, and dealers, as well as the ability to drastically reduce industry capacity. That would (perhaps) help hasten a recovery by bringing supply more in line with demand.

However, I still think it's a bad idea and that adding two companies in crisis isn't going to result in anything but a big stinking pile of you-know-what.

Chrylser Up For Sale (Again)?

Chrysler, the oft troubled automaker, is rumored to be in merger talks with GM. Why should GM even consider doing such a thing?

As if it didn't already have enough problems of its own, the very idea of taking on a boatload more headaches makes as much sense as trying to teach a pig to fly.

There's no way to sugarcoat it. Chrysler is a basketcase and won't likely survive as an independent. The company makes vehicles the market doesn't want, has too much legacy cost, few products in the pipeline, and most importantly too few paying customers. On top of that the industry already has too much capacity. So there's even less room for mediocrity. It's amazing Chrysler has survived this long. And now it's clamoring for a lifeline.

But why should anyone throw it one? Throwing good money after bad isn't going to turn things around. This is a company that should've died long ago. Now it's a dead man walking.

Auto Leasing Losses

A number of auto manufacturers are cutting back on leasing. The reason is because they are losing money, in some cases a lot of money on previous lease deals that were, at the very least, optimistic in the projected resale or residual values of the leased vehicles. Chrysler has left the leasing business entirely. GM, Ford, and Toyota are scaling back somewhat. All took big hits.

The Wall Street Journal reported that Ford lost $2.1 billion in the second quarter of 2008 on leasing, GM lost $2 billion, while Toyota has set aside reserves for a “large” write down for leasing.

At the heart of the issue is excess capacity. The manufacturers used leasing as a way to keep the factories running. It is often less costly to keep making the vehicles and selling them at break even or at a small loss than to idle a factory and still pay the overhead. Thus they had to find customers for all these extra cars.

What do you do to find customers (notice I didn't say "buyers") for extra cars without lowering retail prices? You lease them at very attractive rates, in some cases at ridiculously low rates. That preserves the retail price of the new car for the time being.

The problem with that, aside from attracting customers who often could not afford to buy the product and thus not enhancing the value of the brand by creating future buyers, is the manufacturers took on a lot more risk.

When a company sells a product it eliminates price risk. The item sold for X dollars and it's a done deal. When a company leases it is projecting what the car will be worth used when the lease runs out. It is also projecting the customer will not default.

Any time projections are made there is risk. The bottom line is the manufacturers bet wrong. The auto market has tanked and now those cars coming off lease, especially the less fuel efficient ones, are worth a lot less than projected. On top of that they have suffered higher default rates due, in part, to the collapse of the credit/mortgage markets.

Leasing, on the scale that it was done, was a bad idea. Not only did it artificially inflate the market size, the additional units "moved" were the riskiest transactions for the manufacturers. In summary, the manufacturers sold off tomorrow for reprieve today. Except that was a couple of years ago. Tomorrow has arrived and it's time to pay. Hence the losses.