It’s Time to Get Worried About the Auto Industry—and the Economic Havoc It Could Wreak
It’s Time to Get Worried About the Auto Industry
Bill Pugliano/Getty Pictures
The poor March jobs numbers and the very feeble first-quarter GDP figure are fueling concern about a slowing economy–but they shouldn`t, at least not yet. Both figures seem to be susceptible to some measurement error, are likely to revised higher by the government`s economic analysts, and will most likely improve in the coming months. The trends in both employment and GDP are basically fine.
There is one area, however, where we should be worried about both the short-term numbers and the overall trend: cars.
The automobile industry is less influential than it once was, but it remains the largest manufacturing industry and retail sector in the United States. With deep supply chains and perhaps the highest average per-unit cost of any widely sold retail object ($32,000 in December 2016), it is a very big deal. And as a lending institution, it`s also the generator–and beneficiary–of a big amount of credit.
Each month, we get a reading on the health of the auto industry. Since the economic turmoil of two thousand eight and 2009–which caused General Motors and Chrysler to seek bankruptcy, and in which only Ten.Four million fresh vehicles were sold–auto sales have rebounded smartly. For each of the last two years, about 17.Five million fresh cars have been sold in the U.S. But car sales seem to have hit a wall. In April, sales of cars and light trucks were off Four.7 percent from the year before, a decline of 70,000 vehicles. That marks the fourth straight month, every month this calendar year, in which sales have declined on a year-over-year basis. So far in 2017, sales are off Two.Four percent, or by 133,000 vehicles.
Now, that means that instead of contributing to retail sales, and hence growth, car sales detract from it. But that`s a relatively petite hit. Losing 113,000 in car sales at an average price of $32,000 means losing $Four.Two billion in sales. Every month, U.S. retail sales are about $470 billion.
So why should we worry? Well, the decline of car sales in an era of near-full employment and continued economic expansion is an anomaly. It could mean that car sales may have hit something of a near-term plateau. Or it might be that with the rise of carsharing, the uptick in urban living, and millennials doing their millennial thing and eschewing ownership, we`re beginning to see the effects of budding structural decline in the request for fresh cars.
It`s also possible that automakers are victims of their own success. For all the headlines about continual recalls and quality constraints, cars made and sold in America are long-lasting vehicles. It used to be fairly infrequent for cars to be able to rack up 100,000 miles. Now it`s routine. The average age of a vehicle on the road in the U.S. has expanded dramatically in latest years, in part because people are reluctant to buy fresh vehicles every few years and in part because they don`t need to be substituted as quickly. For the same reason, cars that come off two- and three-year leases make compelling buys because they`re cheaper than fresh cars but still have slew of life left in them.
As much as the engineering of American-made cars have improved, the engineering of the business doesn’t seem to be keeping tempo.
But the real concern is that, as much as American-made cars have improved from a value and engineering perspective, the engineering of the business doesn`t seem to be keeping rhythm. In producing cars, manufacturers practice rely on the philosophy of just-in-time inventory: You buy and keep on forearm only the parts you`re going to use today. Doing so means you avoid tying up capital, reduce storage costs, and are able to adjust more quickly to short-term swings in request. All sorts of businesses have adopted the same mentality. And consumers, enabled by technology that produces everything they want to them when they want it and in the quantities they need, have followed.
And yet when it comes to actually selling the cars manufactured through ultra-efficient, market-sensitive methods, automakers seem to be remarkably old-fashioned. The big auto companies don`t take reservations or deposits and then go make the number of cars that have been ordered (as Tesla does). Rather, they make forecasts about request based on how they think the economy will do, schedule production well in advance, and attempt as much as they can to run their factories around the clock. (The less downtime in your equipment and labor force, the more productive the company is.) So they churn out massive quantities of shiny fresh cars, shove them to the lots, and then rely on the dealers to budge the product.
When sales don`t materialize as expected, however, inventory can pile up. Which is exactly what is happening. At the end of April, General Motors reported that it had 935,758 vehicles in inventory–which is one hundred days` worth of selling activity at the current rate. A year ago, GM had 618,000 vehicles in inventory, indicating only seventy one days of selling activity. Inventory, in other words, is fifty percent higher than it was a year ago. Ford, for its part, had about seventy two days` worth of selling activity in inventory in April (about the same as it did in April 2016).
That represents a yam-sized amount of capital–all the parts and labor required to build the vehicles–that is effectively depreciating. A fresh car can`t be a fresh car for more than a year. When inventory builds up at the same time that sales are declining overall, dealers and automakers have to get more aggressive on sales: cutting prices, providing more incentives, pushing credit on lighter terms. All of which can be hurting to short-term profit margins. And while other businesses react very quickly to short-term switches in request, car manufacturers are often slow to ratchet back production. That`s partly because slashing production publicly signals competitive weakness and partly because running a factory at a slower rates reduces the profitability of that factory.
“millennials doing their millennial thing and eschewing ownership” It’s always amazing to me how people keep attempting to put a different spin on “lower paying jobs and more college debt” as some kind of intentional switch. More.
So what usually happens is that after several months of fighting to budge product, car companies abruptly cut production. That`s bad for the companies and for their workers, who might not get as many hours or overtime as they hoped. (Which is also bad news for the retailers and restaurants in the communities where they work.) It`s bad for the vast network of suppliers who are all of a sudden faced with a cutback in orders. The suppliers, in turn, quickly reduce their own production, thus cutting wages and reducing the supplies they purchase. And so on.
In this massive industry, rather than tap on the brakes gently and modulate their speed, thus providing everyone behind them the capability to adjust at a leisurely rhythm, the vehicles at the front of the line insert on their brakes–which can lead to a cascade of fender benders, near-misses, and crashes in the broader economy. If fresh car sales numbers don`t improve soon, that`s precisely what we`ll see in the coming months.
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