Auto Industry

Nobody could be surprised that consumers have turned away from big, gas-guzzling pickups and SUVs and toward more fuel efficient cars and crossovers. But industry analysts are slack-jawed at the speed at which demand for trucks has gone from merely eroding to downright collapsing.

Not surprisingly, the catalyst appears to be gas prices. The American Automobile Association reported the national average price for regular gas hit $3.96 on May 30, versus $3.19 a year ago.

Meanwhile, U.S. sales of large pickups have quickly gone from bad to worse. Large pickups fell only 3.2 percent to about 2.1 million for all of 2007, versus about 2.2 million in 2006.  But in January 2008, large pickups fell five percent from the year-ago month; in February, down 9.9 percent; and in March, down 14.9 percent, according to AutoData Corp., Woodcliff Lake, N.J.

“While this trend has been going on for a few years, there has been a dramatic acceleration over the past few weeks,” said Lehman Brothers auto analyst Brian Johnson, in a May 29 newsletter to shareholders.

Truck sales have been eroding, and the ingredients for this change have been accumulating, since at least 2004. That’s when gas prices began to take off.

More recent developments include the subprime credit crunch, the bust in housing construction, and the strategic decision among the U.S. domestic brands to try and keep a lid on incentives, sacrificing sales volume in hopes of regaining profitability.

Earlier this week, Johnson cut his full-year 2008 U.S. sales forecast to 14.9 million units, and took 600,000 units out of his North American production forecast, to about 13.7 million.

Ford Motor cut its second-quarter production schedule on May 22, and warned of cuts in the third and fourth quarter, Johnson said. Following the announcement, Ford President and CEO Alan Mulally was widely quoted saying that gas prices seem to have reached a “tipping point” where shoppers are changing their behavior. Even wealthy households have increasingly begun taking gas mileage into account when choosing a vehicle, according to CNW Marketing Research.

Johnson said in his May 29 note he thinks Ford will have to cut back its production even more. In addition, he said truck inventories are also too high at General Motors, even after a strike that cut sharply into truck production.

“While we were pleased with Ford management’s rapid response to the deteriorating demand, we believe that the actions signaled so far may not be enough,” he said. Johnson said Ford production will probably be down 13 percent this year, including a 17 percent cut in truck production.

As previously noted, all this creates an ominous environment for launching the redesigned Ford F-150 pickup this fall. Ford is counting on the truck to keep its U.S. sales crown. But then, nobody thought the market would change so fast.

Photo by Flickr user Bombardier, CC 2.0

For a couple of reasons, used cars are a growing priority for luxury-brand automakers like Porsche. First, many people who buy high-end, expensive cars tend to graduate from a used car to a new one. Second, used cars are an important profit center for dealers, especially when new-car sales are slow. Finally, as leasing has become common, it’s important for car companies to protect used-car values.

In leasing, the customer effectively borrows the difference between the upfront cost of a vehicle and what it’s projected to be worth at the end of the lease. The more a used car is worth at the end of a lease, the less the leasing customer has to borrow, which in turn lowers monthly payments.

Luxury auto brands are also promoting the sale of off-lease cars and trade-ins as “certified pre-owned” cars, or CPO for short. Unlike most used cars, CPO cars are inspected and refurbished by the dealer, and come with a warranty. That can add $1,500 or more to the price of a luxury car, but many customers feel the additional comfort level is worth it.

In all, the luxury brands are trying to get their new-car dealers to sell more used, off-lease vehicles. That keeps them out of the hands of independent used-car dealers who can give the brand a bad name, and away from wholesale auctions where prices are rock-bottom. If the actual market price of a vehicle coming off lease is lower than the automaker and its finance company expected, the automaker can incur a loss.

I spoke in New York on May 28 with Mick Pallardy, vice president for the eastern region for Porsche Cars North America. Pallardy, based in Herndon, Va., is responsible for Northeast markets from Virginia to Maine. The following are edited excerpts:

BNET: Do people really move up from used cars, or is there a used-car mindset that says, “I’ll only buy used, let somebody else take the hit on depreciation”? (According to Automotive Lease Guide, the average new car depreciates 40 percent as soon as it’s purchased, or 55 percent after three years.)

Mick Pallardy: It’s (Porsche is) really an aspirational brand. Certified pre-owned is how a lot of people first gain access to the brand. About 60 percent of CPO customers go on to buy a new Porsche. If you include all used cars, not just certified pre-owned, it’s 70 percent.

BNET: How much is an average car worth after a certain amount of time? Is there a rule of thumb?

MP: It’s hard to say specifically, because we have so many different models and so many different trim and equipment levels. For the 911 (model), especially, we have people scouring the country for a specific model, or a specific feature, or a specific color. They look all over the country, they have all these online tools, they look all over, and when they find what they’re looking for, they’ll either come get it, or pay somebody to ship it to them.

BNET: I read that Porsche had record sales for CPO (691 cars in April 2008, versus 548 in the year-ago month; 6,581 in 2007, versus 6,114 in 2006).

MP: Just about every month is a record.

BNET: Are you pushing that program?

MP: We have programs in place (to encourage the dealers to buy CPO vehicles and sell them at retail). For the next fiscal year we will also be enhancing the CPO warranty, to something that’s in keeping with the brand. You don’t want it to go to the independent (used-car) dealers, because of the customer handling. You want the customer handling to be in keeping with the brand.

Image via Flickr user KB38, CC 2.0

Mercedes-Benz is playing legal hardball with a major U.S. dealership group, Sonic Automotive, a publicly traded auto dealership chain with $8.3 billion in 2007 revenues based in Charlotte, N.C. Sonic owns nine Mercedes-Benz dealerships plus 160 other franchises around the country, making it one of the nation’s three biggest dealer chains, and a major Mercedes-Benz retailer.

At issue is the car company’s ability to persuade — or compel — independent dealers to upgrade their dealerships to meet the automaker’s new standards. Mercedes-Benz is trying to get most of its 300-plus U.S. dealers to join its Autohaus Initiative, which among other things calls on dealers to “glass in” their service garages so that customers can observe repair work.

In other worldwide markets, Mercedes-Benz and other manufacturers own most of their retail dealerships. In the U.S., however, ironclad state franchise laws strictly regulate what the factories can and can’t do, especially when it comes to terminating a franchise or appointing a new one.

That’s exactly what Mercedes and Sonic are now arm-wrestling about. In a March 17 complaint, Sonic accused Mercedes-Benz USA, the German automaker’s U.S. sales and marketing subsidiary, of “unfair and deceptive trade practices.” Sonic charges that MBUSA effectively vetoed Sonic’s proposed acquisition of an additional Mercedes-Benz dealership, Beck Imports in Charlotte, earlier this year.

According to Sonic’s complaint, filed in Charlotte’s Mecklenburg County Superior Court, it wasn’t the first time MBUSA made it difficult for Sonic to add more Mercedes-Benz dealerships. Last year, the suit said the automaker held up a Sonic acquisition in California, claiming that Sonic had failed to live up to an even earlier agreement to upgrade four other dealerships.

Sonic claims it has made “substantial progress” toward meeting the Mercedes-Benz standards, but charges that the automaker is applying unfair and improper “leverage” to force Sonic to spend millions of dollars on its other dealership, or lose its ability to grow its Mercedes-Benz business by acquisition. Sonic asks for unspecified damages.

In its May 19 reply, Mercedes-Benz denies any wrongdoing, and insists that “Sonic’s claims are barred by its own breach of contract,” for failing to make the required improvements.

The franchise laws are in part a reaction to the early days of the auto industry, when the factories would reward their friends or punish a dealer who was out of favor, by withholding cars, or by appointing another dealer nearby. North Carolina, where Sonic is based, has a reputation for particularly dealer-friendly state laws.

Mercedes-Benz owns only one retail dealership in the U.S. market, a showcase on New York’s Park Ave., which features a showroom originally designed by Frank Lloyd Wright.

Ford revealed the gory details of its recently reported production cuts, but more importantly showed a much more pessimistic outlook beyond simply cutting back on building too many trucks.

Besides its own troubles, Ford’s announcement includes a heavy element of, ”Hey, it’s not just us, the whole industry’s in trouble.” Ford cut its full-year forecast for the entire industry to a range of only 15 million to 15.4 million vehicles, including medium and heavy trucks.

The middle of that range translates to fewer than 15 million “light vehicles,” excluding medium and heavy trucks. That would be the worst result in more than a decade, and a sharp comedown from U.S. sales of about 16.1 million light vehicles in 2007. Some analysts thought J.D. Power and Associates was too pessimistic when it predicted in March that industry sales would fall below 15 million, but as other forecasters follow suit, J.D. Power’s forecast will be in the middle of the pack pretty soon.

Cutting the industry forecast seems like an obvious call in light of the high price of fuel, the troubled economy, and the fact that the domestic brands are out of step with changing consumer demand for small cars and fuel-efficient vehicles. No doubt, Ford means what it says when it says the entire industry is in trouble.

But cutting the entire industry forecast is also a face-saving device that allows Ford to project it will maintain its market share, even if its sales decline. If Ford just cut its own production and sales estimates and left the rest of the industry alone, that would imply that Ford expects to lose market share, which no automaker likes to admit.

Ford also cut its profit outlook, so that leaves maintaining market share and achieving its cost-cutting targets as just about the only silver linings left in  2008, provided Ford can achieve those goals.

Ford Motor is widely reported to be cutting back on production of big SUVs, on top of cuts announced earlier.

As painful as it must be, it’s more evidence that the Detroit 3 are sticking to their common-sense strategy of cutting production to match demand. The traditional alternative is to keep production going, and as the saying goes, “lose money on every unit, but make it up on volume.”

Ford needed to take action. According to the Automotive News Data Center, Ford had not cut production this year as much as rivals General Motors or Chrysler. Year-to-date through May 10, Ford’s North American production was down only 5.5 percent, to 971,669. Chrysler production was down 19.4 percent, to 793,247. GM was down the most, 24.7 percent to 1,106,875, but almost one-third of the drop could be attributed to a supplier strike.

The upshot was a 109-day inventory of light trucks for Ford. That is, at the present sales rate, it would take that long to sell them. A 60-day supply is the industry benchmark.

Production cuts also take some pressure off the game of “chicken” among the Detroit Three. So far, none of them has resorted to a true fire-sale round of discounts in the form of big consumer incentives — like zero-percent financing, or “Employee Prices for Everyone” from a few years ago. Chrysler’s present “$2.99 gas” promotion hardly seems to count, since consumers have to give up bigger cash deals to get the discount gas. Chrysler also withheld the deal from its biggest gas-guzzlers, and the deal expires June 2.

The next thing to watch is if Chrysler renews the deal. You’ll know panic has set in if it does — or, worse, sweetens the deal by, for instance, giving consumers cheap gas on top of the big cash deals, or applying it to all models.

Hyundai seems determined to break out of second-tier status in the U.S. market — or die trying.

The Korean automaker is about halfway through introducing a remarkable 16 all-new or facelifted models in just over six years, from late 2004 to early 2011. Were the auto industry cliché that “It’s all about product” actually true, Hyundai would be be in a terrific position to gain ground on first-tier companies such as General Motors, Ford and Chrysler, plus Japanese giants Toyota, Honda and Nissan.

Michael Deitz, product planning manager for Hyundai’s U.S. unit, outlined the company’s plans in a May 9 presentation in New Jersey, just as Hyundai was about to introduce an updated model of its Sonata sedan. Next up is an all-new flagship sedan, the Genesis, which has an optional V-8 engine and is due in July. Hyundai is pitching the Genesis as a competitor to luxury imports like Mercedes and BMW that will cost tens of thousands of dollars less.

It remains to be seen whether shoppers will see things Hyundai’s way, though, because it’s also “all about” brand perception. Hyundai is still saddled with a reputation for cheap, entry-level cars with poor quality, even though the reliability of its vehicles has improved greatly. Some models, for instance, have recently won decent marks for quality from J.D. Power and Associates and positive ratings from Consumer Reports. Hyundai’s model range also now includes somewhat more expensive cars, topping off at around $20,000 suggested retail — and rising. In 2004, Hyundai’s most expensive cars were priced under $17,000.

From 1998 to 2001, Hyundai’s U.S. sales more than tripled to more than 300,000 a year. In fact, Hyundai is now the No. 4 import brand in the U.S., a development that might surprise many consumers. More recently, though, its rate of growth has slowed. Hyundai’s 2007 U.S. sales were 467,009 vehicles, according to AutoData, just 2.5 percent ahead of 2006. Overall, its U.S. sales are still less than half of Nissan North America’s 2007 total of just over 1 million cars.

Hyundai and its sister brand, Kia Motors America, have kept a revolving door spinning for U.S. sales and marketing executives the last few years, according to Automotive News. Some were shown the door remarkably abruptly. Both brands belong to South Korea’s Hyundai-Kia Automotive Group. In its push for growth, Hyundai apparently won’t take no for an answer, not from its executives, or even from the customer.

It took a couple of years of high gas prices, but since gas topped $3 per gallon and mostly stayed there, even the wealthiest households have increasingly begun to take gas prices into account when choosing a vehicle, according to a survey by CNW Marketing Research, Bandon, Ore.

That’s significant because a hallmark of the last several years of U.S. auto sales has been that luxury import brands like BMW, Lexus and Mercedes-Benz have outperformed the rest of the market. That’s continued even though, by definition, luxury cars with the most powerful engines tend to have terrible gas mileage.

U.S. auto sales hit a peak of 17.4 million light vehicles in 2000, but have since slumped to about 16.1 million in 2007. Forecasts for 2008 are around 15.5 million, the worst in at least a decade. But Mercedes-Benz, for instance, has enjoyed 15 consecutive years of growth in U.S. sales through 2007, including ten consecutive record years.

A chill in luxury sales could indicate a more serious downturn. However, growing concern about gas prices doesn’t mean the rich aren’t buying anything, they’re just being more careful.

“Let’s not go overboard on this,” said Art Spinella, CNW president. “The upper income households are, for example, buying high-end hybrids rather than gasoline-only versions of GM SUVs, Lexus and other big-ticket models,” he wrote in a May 16 newsletter.

Still, the survey results are a sign of the times. Ernst Lieb, president and CEO of Mercedes-Benz USA LLC, based in Montvale, N.J., said separately on May 15 that gas prices are a “huge concern” for his customers, and that Mercedes-Benz is working on bringing more fuel-efficient models to the U.S. market, including hybrids and diesels.

As you might expect, concern about gas prices lines up fairly neatly with income. According to the survey, respondents in the lowest household income bracket, $25,000-$35,000 were most likely to be the most concerned about gas prices when choosing a vehicle, at 61.2 percent as of the first quarter of 2008. In contrast, only 26.7 percent of the respondents from the highest $150,000-$200,000 category in the survey picked the “top box,” indicating they were most concerned.

However, that last number has grown sharply since the middle of 2006. Gas prices started to spike in 2004, but through the second quarter of 2006, “top box” concern among those wealthy households stayed under 5 percent.

The timing makes it look as if the second time premium gas hit $3 per gallon could have been a tipping point.

In the second quarter of 2006, premium gasoline (these are wealthy households, after all) hit a national average of about $3.09 per gallon, according to the Energy Information Administration. It had spiked above $3 before, but went back down. It dipped below $3 again in late 2006 until early 2007, but since then it has stayed above $3. At the end of the first quarter of 2008, it was $3.48.

Mercedes-Benz is unlikely to bring its smallest and cheapest cars to the United States, other than the Smart car, which since January has been distributed separately in the U.S. market by the Penske Automotive Group However, Mercedes-Benz will offer more fuel-efficient diesel versions of several of its existing models in the United States starting in September. Beginning in early 2009, Mercedes-Benz will also offer hybrid versions of its S-Class flagship and its M-Class SUV.

Meanwhile, the company’s U.S. subsidiary is also working on a $300 million upgrade of its U.S. dealerships with new standards for appearance and customer handling, which the company calls the Autohaus Initiative. Ernst Lieb, president and CEO of Mercedes-Benz USA LLC, based in Montvale, N.J. presented the company’s plans at a May 15 meeting of the International Motor Press Association in New York. The following are edited excerpts from a question-and-answer session:

Tell us more about Autohaus. Is it strictly appearance, or is there more to it than that?

It is an open environment, there are glass walls into the (service) shop, the customer can look into the shop and see what they’re doing to your car. It builds trust for the technician. What we don’t want is where the car disappears, and two hours later, “Here’s your bill, and here’s what we did to your car.” In some states it’s not possible, but in some states, you can even have it set up so that customers are walking through the service area. … Not everybody wants it, but for sure, people with the high-performance models, like AMG (the Mercedes-Benz high-performance division), those customers really want it.

What about the dollar and the euro? The dollar’s at $1.55 to the euro, something like that, what if goes to, say, $1.70? What will that do to Mercedes?

For anybody who imports from the euro zone, it’s a huge concern. We do have a plant here in the U.S. so we are naturally hedged to an extent. They are building in excess of 200,000 units a year (many of which are exported). But $1.70, $1.75 (per euro) would be painful. It’s true we have had periods like this in the past, or in other markets, and I can only say that we are not here to optimize for the next six months, we’re here for much longer than that, we will not do anything that will jeopardize the business in the long run.

Can you increase production (at the Mercedes-Benz plant) in Alabama?

We can, but it’s very limited. We can do only a little bit, and that’s it. And the C-Class, for instance, is our biggest (-selling) model, and the C-Class cannot be built there.

What about the A-Class and the B-Class? (smaller cars that are offered in other global markets, but not the United States)

Those are not cars we really consider suitable for the U.S. For the U.S., a Mercedes-Benz has to have a certain concept, a certain appearance. We do customer (research) clinics all the time, and those (cars) really do not add value for us. There are parts of Canada that are very European, and there those cars do quite well. (Earlier in his career, Lieb ran Mercedes-Benz Canada.)

Are your customers concerned about fuel economy?

It is a huge concern on the customer side, it comes up in every customer forum … If you get 80 to 100 customers in a room, for sure this is going to come up.

In a bit of good news for consumers — and clearly bad news for the domestic carmakers — vehicles were more affordable in the first quarter of 2008 than at any other time since immediately after the Sept. 11 terror attacks of 2001. “It’s a buyers market and the producers are being forced to offer bigger discounts in one form or another,” said Dana Johnson, chief economist at Comerica Bank in Detroit, in a May 9 announcement.

The Comerica Affordability Index measures the number of weeks of median family income it takes to buy the average-priced light vehicle, including finance charges. For the first quarter, the index was at 23.9 weeks. That was 0.6 weeks below the fourth quarter of 2007, and down 1.1 weeks from the year-ago quarter.

To jump-start auto sales following Sept. 11, General Motors introduced zero-percent financing. Ford Motor Co. and then-DaimlerChrysler followed suit. The Affordability Index hit a low of 23.8 weeks back then, in the fourth quarter of 2001, the lowest point since 1980.

Pricing had staged a modest rally from the automaker point of view through the fourth quarter of 2005, which marked a recent high of 26.6 weeks. With some zigs and zags, pricing since then has gotten more and more unfavorable for the automakers, and better for consumers, since consumers facing high gas prices have needed persuading. Comerica said that with finance charges, the average light vehicle cost $28,389 in the first quarter of 2008.

Separately, Edmunds.com said on May 1 that incentives hit an estimated $4,247 per vehicle in April for Chrysler LLC, up from $3,835 a year earlier. That was the highest of the Detroit 3 manufacturers. Ford Motor Co. was next, at $3,044, up from $2,972; General Motors incentives were $2,803, down from $3,248, Edmunds said.

Incentives were much lower for the biggest Japanese brands, which have benefited from a turn to more fuel-efficient vehicles. Edmunds estimated April incentives for Nissan North America Inc. at $1,953, up from $1,890 a year earlier; American Honda Motor Co. Inc. at $1,076, down from $1,439; Toyota Motor Sales U.S.A. Inc. was at $714, down from $880.

It looks as if J.D. Power and Associates merely beat the rush when it issued a dismal auto sales forecast that looked far-fetched just seven weeks ago. Just in time for the New York auto show (March 19-20), Power on March 18 cut its 2008 auto sales forecast from 15.7 million, which was already on the low side, to 14.95 million. That would be the worst sales result since 1994.

At the time, the rest of the industry was still getting its head around forecasts that hovered around 16 million light vehicles, the worst since 1998, let alone below 15 million. U.S. sales in 2007 were 16,148,811, down 2.8 percent from 2006, according to AutoData Corp.

So the J.D. Power forecast caused a shudder, even some wisecracks amid the New York auto show buzz, to effect of, “What were those guys thinking?”At the time, Bob Schnorbus, chief economist at J.D. Power, cited the same litany of bad economic news everyone was seeing: the financial crisis, worsening oil prices, weak housing and stock markets, plus lower automaker discounts to retail customers, and the fact that automakers are purposely cutting unprofitable sales to daily rental fleets. But the timing of the Power forecast was ahead of the curve.

Since then, the rest of the industry has been inching closer to the Power estimate. Toyota Motor Sales U.S.A. Inc., for instance, cut its full-year 2008 forecast by about 300,000 in the last month, to around 15.2 million light vehicles. And even then, sales results for the first four months were so poor, hitting 15.2 million for the year assumes some improvement in the second half, said Bob Carter, Toyota Division group vice president and general manager, in a May 1 conference call.