WASHINGTON, March 17 (UPI) -- In 1979-80, at the time of the Chrysler bailout, I and many other commentators predicted that saving Chrysler would simply result in bankrupting Ford. Now, 24 years later, this prediction may finally be on the brink of realization.
Ford was saved after 1980 by two things: the strength of its businesses in Europe, which continued making profits even while losses spiraled in the United States, and the long economic boom that began in 1982, to which 1990-91 can now be seen as more of an interruption than a terminus.
The automotive industry in a severe downturn is very like the recently popular "Weakest Link" game show. The automobile is the largest equipment purchase for almost all consumers, so when the economy deteriorates automotive sales drop off by a much greater percentage than gross domestic product in general. For example, in the 1973-75 downturn, U.S. automobile sales declined from 14.6 million to 11.1 million; in the 1978-82 downturn, U.S. automobile sales declined from 15.4 million to 10.5 million -- in both cases, drops far steeper than that of the economy as a whole. The problem for U.S. manufacturers was exacerbated by the increasing market share taken by imports -- in 1978-82, sales of imported automobiles increased, in spite of the 32 percent drop in the automobile market as a whole.
As the economy gets worse, and automobile sales decline, U.S. and foreign automotive manufacturers fight with increasing desperation for market share, with the battle being both domestic to the U.S. market, the world's largest, and, increasingly in recent years, international. This is because automotive plants are extremely expensive, and the workforces unionized, so the marginal cost of producing an extra car that you can't sell is generally quite small compared with that of reducing production and existing with unutilized plant and human resources. As we have seen in the last year, ever more aggressive sales incentives are used to "move the metal" and maintain unit sales volume.
Eventually, if a downturn continues, it becomes impossible to maintain sales volume even with heavy discounting and incentives, and the market collapses to a much lower sales level. At that point, all competitors have generally been making losses or greatly reduced profits, and one or more competitors finds itself in extreme cash flow difficulties, with its plants and workforce heavily underutilized, a huge excess in capacity, and a hemorrhaging of cash. In the words of the game show, it becomes the "Weakest Link" and is eliminated from the game.
As a result, automobile company after automobile company has disappeared. In the downturn of the mid-1960s, it was Studebaker-Packard. In the 1973-75 downturn, it was Britain's British Leyland, which was bailed out by the British government at enormous cost to the British taxpayer. In 1979-80, it appeared likely to be Chrysler, which was bailed out by the U.S. government but -- because loans rather than cash were used, and Chrysler acquired a highly capable CEO in Lee Iacocca -- the bailout worked and Chrysler was restored more or less to health. Later in the 1980s, it was American Motors, sold to the French Renault in 1982, then on-sold to Chrysler in 1987, after which production of AMC vehicles was halted.
In the recession that began in 2000, and was delayed through 2002 in the automotive industry by aggressive "zero percent financing" deals and very low interest rates, the eventual sales downturn is likely to be severe, perhaps as severe as in 1978-82. From the peak of 17.8 million units in 2000, which had declined only to 17.1 million units in 2002, we might expect to see a decline in U.S. auto sales to a level of around 12 million units at the trough of the recession, perhaps in 2005. Such a drop would undoubtedly produce huge financial strains in the industry, already weakened by the orgy of zero percent financing in 2001-2.
An additional problem this time around, as in the early 1980s, will be government mandates on engine design -- in the early 1980s, fuel economy standards that benefited small car imports at the expense of large car domestic manufacturers, but this time around, even more expensively, mandates such as the California requirement for zero emission vehicles. These requirements, which force manufacturers to make extremely expensive engineering changes for which there is no visible customer demand, are highly damaging to the U.S. automotive industry -- essentially, environmental cleanup is being carried out at the expense of General Motors and its competitors, rather than that of the government and taxpayers who demand it. The requirements also do very little good in the long run -- the rise of the ugly, dangerous and catastrophically fuel-guzzling sports utility vehicle, after all, was the result of a fuel efficiency standard mandated by government, from which SUVs, as "trucks" were exempt.
So which manufacturer will be the "weakest link" this time? Had Daimler-Benz not intervened in 1998, it might well have been Chrysler. That company, from which Iacocca retired in 1993, had introduced few new models in the last decade of its independent life, and was subject to a fierce battle for control involving the leveraged buyout artist Lee Kerkorian. By 1997, it was still making good money, but it is fairly clear that Chrysler management knew that the writing was on the wall. In one of the poorest acquisition decisions in recorded history, Daimler Benz, fattened by the profits on its magnificent Mercedes brand, "merged" with the ailing Chrysler in 1998 -- and promptly saw Chrysler's operations descending into a black hole, with the company losing $1 billion per quarter by 2000.
However, Mercedes, while not what it was, remains the most successful up-market automobile brand, and it seems inconceivable that the arrogant DaimlerChrysler top management, backed by the equally arrogant Deutsche Bank and -- such is the European system -- by the German taxpayer, if necessary, will allow their appalling mistake to be revealed in all its horror by closing Chrysler.
Another possibility would have been Nissan. That company, always a poor second to Toyota in the Japanese and international markets, had lost a great deal of money in the prolonged Japanese downturn of the 1990s and was close to collapse. Then in 1999, a minority share in it was bought by the French Renault (not in itself a positive sign, given Renault's own unhappy history) and outside top management was imposed, in the form of the Brazilian Carlos Ghosn. Ghosn applied to Nissan the one business technique that Renault, in the very competitive European market, had truly mastered: squeezing suppliers.
By breaking apart the cozy Japanese supply relationships, fortified by cross shareholdings that had made Nissan cost uncompetitive in world markets, Ghosn within two years restored Nissan to profitability, and began to revivify the company's product line. With Japan showing signs of economic recovery, and Ghosn still in charge, it seems likely that Nissan will maintain its new-found profitability and return to the traditional role of Japanese companies: taking market share off the Americans around the world.
The Italian Fiat will almost certainly be one victim of the current unpleasantness, particularly as its patriarch Gianni Agnelli died in January. The company lost $4.6 billion in 2002, and its market share in the highly competitive European market has been eroding for some years. Like most Italian companies, it failed to build up enough reserves from profits in the good years to withstand a downturn, and it must now be considered highly vulnerable to a takeover either by a competitor or by the Italian government.
However, with Fiat having few attractive models and a declining market position, a takeover by a competitor, perhaps General Motors, which owns 20 percent of Fiat, would be almost entirely a cost-reduction, consolidation and asset-stripping exercise, with little of the company's operations remaining independent, possibly not even the brand name outside Italy. Putting Fiat out of independent business, however, makes very little difference in the U.S. market, where its market share is tiny.
Of the major U.S. manufacturers, Ford, which lost $980 million in 2002 after losing $5,453 million in 2001, is in the most vulnerable position. It spent heavily in the 1990s, acquiring premium European brands such as Jaguar, Volvo, Land Rover and Aston Martin, in an attempt to strengthen its position in the luxury car market. In the boom years, this largely worked -- Jaguar, for example, was an extremely profitable franchise in the late 1990s. However, since 2000, even after all the acquisitions, Ford's U.S. market share has been declining, from 19.5 percent of U.S. car sales in 2000 to 16.4 percent in 2002, and from 28.3 percent of U.S. truck sales in 2000 to 25.5 percent in 2002.
Ford's overall U.S. market share was 21.1 percent in 2002, down 1.7 percent from a year earlier. More importantly, the U.S. truck market, in which Ford is more dominant, and which had grown steadily to 52.7 percent of the U.S. market in 2002 (of which SUVs themselves were 25.2 percent) is poised to decline, both because of the renewed safety questions surrounding SUVs and because of their extraordinary fuel inefficiency at a time of rising fuel costs and strategic worries about oil supplies. Thus Ford's U.S. position, already poor (the company lost $278 million at an operating level in 2002 on North American automotive operations) is fated to deteriorate further.
Europe, which saved Ford in 1978-82, won't do so this time. The company lost $725 million on automotive operations in Europe in 2002, although its market share (including Jaguar, Volvo and Land Rover) there increased marginally from 10.6 percent to 10.9 percent. Of particular concern is a directive from the European Commission that from 2005, automobile markets within the EU must used standardized pricing, rather than the highly variable pricing between markets that is currently been used, which is highly beneficial to Ford, strong in high-price Britain.
As in the United States, the European market declined by 3 percent in 2002, and can be expected to decline significantly further in the years ahead, although Eastern European sales (where Ford is not particularly strong) may hold up better than in the West.
Outside Europe, Ford is strong in Brazil, Argentina and Mexico -- none of them with markets where much growth can be foreseen in the next few years. It has almost no presence in China, although a Ford joint venture there opened production in January 2003. In Japan, it owns 33 percent of Mazda, a declining Japanese manufacturer with only a 5 percent domestic market share.
Most frightening are Ford's financial statements, in particular its balance sheet. At December 31, 2002, the company had only $5.6 billion of stockholders' equity, compared with $162 billion of debt. Of course, this includes the financing activities of Ford Credit, so the balance sheet is partly that of a bank. Even so, a decline in stockholders equity from $18.6 billion in 2000 to $5.6 billion in 2002 suggests that all is far from well, and that the company's financial flexibility is extremely limited.
The company is rated BBB, reduced from BBB+ in October 2002, by Standard and Poors, but as in many such cases the rating agencies may be following rather than leading the deteriorating reality.
Finally, the company's pension plan, which was $596 million over-funded at December 31, 2001, was $7.3 billion under-funded at the end of 2002, so pension contributions can also be expected to a drag on future Ford operations.
Ford has a long and honorable history, dating back 100 years this year. It was, of course, the pioneer worldwide of automobile mass production. It makes fine cars, both its own and Lincoln, but also the marques it has bought -- Volvo, Jaguar, Land Rover and Aston Martin.
But in this downturn, it may well be time to bid Ford a regretful goodbye.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
