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TALKING BUSINESS: Car industry skids
Fri, Nov 28 2008

It has been by now accepted that one of the main reasons for the current global financial crisis was the United States living beyond its means for too long, setting a bad example for the rest of the world and dragging it along into what could become the worst economic reverse since the Great Depression. The Detroit Three - General Motors, Ford and Chrysler - are in the worst predicament, but no other carmaker has been spared the pain and the fall of a single big name could have far-reaching ripple effects throughout the world.

Although it was the housing market that went bust first, setting the process in motion, it is the motor vehicle industry where this spendthrift lifestyle was at its worst - driving a car that cost by far more than one's annual income was a commonplace sight. With the benefit of hindsight, many from outside the industry, from analysts to lawmakers and environmental groups to academics, have been pointing accusatory fingers at the big three car manufacturers in Detroit for not realising the error of their ways and investing in more energy-efficient cars instead of catering to public demand, which at the time was heavily on the side of big and fuel-greedy trucks and sport utility vehicles.

Bashers sometime forget that the three carmakers have been in the process of slimming down for years, reaching an agreement with the powerful United Auto Workers (UAW) labour union in 2007 that would help cut their costs down the line. But in a troubled economy with unpredictable fuel prices, it is hard to deny that those measures are too little too late to help here and now.

Had the crisis hit in 2010, or even 2009, the industry would have been in a better position to deal with the crunch on its own - by then the effect of the deal with UAW would have been yielding tangible results, while new and more fuel-efficient car models would be hitting the market in droves. As it is, the Detroit Three has been forced to go begging cap in hand to Washington to ask for help.

Few, if any, were surprised, since it had been expected for months ever since the first bail-outs in the US banking industry. But GM's admission earlier in November that it could run out of cash to continue operating before the end of the year, has cranked up the pressure from the start - everyone knew the situation was bad, but no one thought it was that bad. Even under the most optimistic scenarios, GM and Chrysler are expected to exhaust their reserves by mid-2009 and Ford by the end of the same year.

The US car market is at is lowest ebb in 25 years, selling 11 million vehicles in the 12 months to October, well below what the industry considers the healthy threshold of 16 million, and the outlook does not appear like changing soon. Forecasts that car sales would pick up strongly in 2010 or 2011 are little consolation for the manufacturers that need the cash now.

Even allowing for the emergency fire-sale of assets overseas, built up at no small cost over decades, such as GM divesting its stakes in Suzuki and Subaru or Ford's decision to sell most of its shares in Mazda, the only two viable options appear to be a government bail-out or reorganisation under bankruptcy laws, generally referred to as chapter 11 bankruptcy after the part of the US Bankruptcy Code that governs such proceedings.

Divided opinion
Bankruptcy reorganisation was devised to protect companies whose long-term prospects are sound and the Detroit Three fall into that category, with strong operations outside the US and their painful restructuring in North America finally in sight. But the carmakers themselves are strongly opposed to it, backed by some analysts, arguing that instead of protecting them, it would only hasten their end. They cite consumer surveys, which suggest that anywhere between 80 and 90 per cent of potential customers would not be interested in buying cars from a bankrupt manufacturer over fears that their warranties would not be met, spare parts would be hard to come by and the loss of residual value, making it impossible to sell their used cars.

Instead, they are asking the federal government for easier access to funds from the $25 billion low-cost loan package granted to encourage the development of more fuel-efficient cars and a further $25 billion to ease the pressure on their cash flow.

On the other side of the argument, opponents say that the cash injection would do little to help the companies in the long term. At the current rate that the Detroit Three are burning through their reserves, it would merely delay what critics see as an inevitable end or pave the way for demands for an even bigger bail-out in the future, once the money runs out. For them, bankruptcy is the only solution, even though it would force a number of interested parties to swallow a bitter pill - labour unions would see their hard-won high wages and benefits evaporate, shareholders like Chrysler's majority owner Cerberus Capital Management would be wiped out and the car dealers, whose strength in numbers have given them enough political clout to effortlessly oppose cost-cutting moves, would lose business in droves.

Recalcitrant labour unions and car dealers in particular have been singled out by the critics as two constituencies that have hamstrung the Detroit Three at home, even as their overseas operations do well. Critics point out that foreign auto makers that have opened car plants elsewhere in the US, such as the non-unionised South, have not encountered such difficulties with their employees, not least because they have not amassed such large legacy costs in the shape of contributions to future heath care and pensions, while at the same time running slimmer dealership networks.

Domino effect
The Detroit Three say that they cannot be allowed to fail for another reason - should even one of them flounder, the ripple effects would take their heavy toll on auto parts suppliers, most of whom are not tied to a single major manufacturer, but make parts for at least several. Their argument is that with one down, suppliers will begin to fold, taking down the rest of the industry.

In one advert, posted by GM on YouTube, the carmaker paints an apocalyptic picture of collapse, which would affect more than 239 000 employees at the Detroit Three, a further 740 000 car parts suppliers and 1.7 million in spin-offs jobs. "One out of every 10 jobs in the United States relies on the US auto industry ... That's 13 million people," the ad says, quoting data from an industry-funded study by consultants Center for Automotive Research. According to the same study, the American budget would lose $156 billion in tax revenue if the Big Three went down.

Against that backdrop, $25 billion looks like a small price to pay to keep the industry afloat. For all the criticism and public opposition to a bail-out, the lobbying seems to have struck a chord with the Democrat majority in the US congress and president-elect Barack Obama, who are reportedly sympathetic to a rescue package, but only if it comes with some very tight strings attached, including more restructuring of the way the carmakers operate.

On November 21, the chief executives of the Detroit Three were forced to leave Washington empty-handed after two days of congress hearings, but were given a deadline of December 2 to present convincing plans that they can turn around their fortunes. "Until they show us the plan, we cannot show them the money," house of representatives speaker Nancy Pelosi was quoted as saying. Given that both the legislative and executive branches of government are in a "lame duck" period, one mooted plan is to give the carmakers just enough of a lifeline, no more than $10 billion, to keep them afloat until president Obama can take a more active role in shaping policy for the industry after his inauguration on January 20, the Wall Street Journal reported.

Global ripples
Having already slashed 150 000 hourly and contract jobs over the past five years, US carmakers could be forced to do more of the same, despite opposition from the UAW. Regardless of the cutbacks and increased efforts to save costs at every corner, problems remain: GM is still abnormally large with 12 global brands and scores of models; Chrysler's private equity majority owner makes the company an even less agreeable recipient of federal funding, despite its aggressive effort to cut payroll by a quarter, offering employees to buy out their contracts; even Ford, which appears to be in a better position than its two Detroit peers, is burning through cash at an alarming rate.

They are by no means alone, as carmakers throughout the world have announced lay-offs to deal with lower demand. In Japan, Mazda and Isuzu would cut a total 2700 jobs, while Toyota, which already shed 2000 temporary jobs this year, will slash a further 3800 by end-March 2009. In France, Peugeot-Citroen said it would make redundant 2700 people, while the country would also bear the brunt of Renault's 6000 job cuts.

Renault's Romanian subsidiary, Dacia, has already halted production for two weeks until December 7. The success of the Logan model made in Romania has taken even Renault executives by surprise, but reports in Bucharest have claimed that the carmaker could lay off as many as 3000 Dacia employees, about a fifth of its workforce, if sales continue their fall. Two other notable carmakers in the Balkans - Ford's Automobile Craiova in Romania and Fiat's recently-acquired Zastava in Serbia - are not affected by the crisis because they are simply not making any cars yet.

The Chinese industry, where growth has been spectacular in recent years, now is expected to grow in the low single-digits this year and then stay flat in 2009, according to auto consultants JD Power, quoted by the Financial Times. But the specifics of the Chinese economy, where government influence remains stronger than in Europe or the US, could provide a competitive advantage - should Beijing decide to support alternative fuel cars, it could enforce new standards quicker and more forcefully than other governments.

In Europe, of course, consensus is a lot harder to reach. Germany and France, the two bigger carmaking nations, have been warned already by European competition commissioner Neelie Kroes to avoid giving into the temptation of subsidising the auto industry. "We have all heard calls, particularly in France, Germany and the United States, for support to be given to the car industry. All governments have to resist that," she said on November 21, a day after the Detroit Three saw their initial advances for a federal bailout rebuffed. Rather than lend 40 billion euro to car makers in Europe, double what their US peers are demanding, the European Union should focus on other sectors, such as small and medium-sized businesses, to stave off economic recession, she said.

Opponents of subsidies have one potent example in their arsenal of arguments against indiscriminate cash injections - British Leyland, the company that incorporated most of UK's auto industry with 40 per cent market share when it was nationalised in 1975. Despite billions in government aid and several profitable brands, the group, later known as MG Rover, steadily lost market share to finally go bankrupt in 2005. Time will tell whether any of the Detroit Three will share its fate.

LINK:TALKING BUSINESS: Car industry skids - Business - The Sofia Echo
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