The basic economics are changing for the American automobile industry at an alarming rate. Only a few years ago, decisions on product lines, engine platforms, style platforms, safety improvements, marketing development, and fashion were made for consumer demand out five to seven years. This year, we are shocked to find original equipment manufacturers (OEMs) implementing dramatic production and model changes to be made in only one to two years for simple survival.
The U.S. automotive industry has almost unanimously announced production movements away from trucks and SUV production and towards smaller cars. You cannot pickup a newspaper in Detroit without reading headlines noting changes in personnel, production and product. Profits on larger vehicles lured all the automakers to build trucks - even market-savvy Toyota was bitten by the truck "bug" with their new Tundra truck built at their recently built plant in San Antonio, Texas. No one in the industry predicted the changes in demand to be so extensive or so dramatic.
In addition to the changes in production type, the U.S. automotive market is being affected from an influx of "new domestic" competitors seeking lower assembly costs due to the effect of the falling dollar to Euro currency exchange. New assembly plants in Chattanooga, Tennessee, for Volkswagen and similar plants in Montgomery, Alabama, for Hyundai and West Point, Georgia, for Kia have resulted in additional challenges for the traditional domestic companies' market shares. Assembly here on U.S. shores just makes more economic sense, more total cost sense.
As a result of better logistics and supply chain management, we are living on a smaller planet. This increase in productivity, accompanied by our endless search for products at the lowest cost, is resulting in a gradual change in our long-term facilities, equipment, and manpower needs in the United States. Where once growth within logistics companies came with expansion in various warehouses and equipment needs to support assembly of OEM and tier materials, we are now searching for facilities to store materials from foreign lands for sales and final assembly, and space to meter materials to reduce risk of overseas shipping delays. Speed and flexibility are the keys to succeeding in this new import model.
Recently, key domestic automotive purchasing leaders have announced their commitment to source materials from low-cost countries. Automotive - unlike the retail sector - seems to be late to making this overseas shift. Factors have slowed this automotive transformation. Inexpensive labor and lower production costs are but a few of the components in the decision to source a seat or fascia 10+ days away from the final assembly point. U.S. safety regulations, prior commitments with Tier 1 suppliers previously owned by the OEM parent (Delphi, Visteon, and Detroit Axle, for example), inventory concerns, currency issues, the desire to increase model mix flexibility, content regulations, and supply chain costs and risks all have contributed to this slow, cautious advance of automotive offshore purchasing.
Logistics is a critical component to the total cost for any product sourcing. As sea transportation costs become competitive, risks of quality and safety decrease, and reliability for material inventories increase and inventory levels decrease, more commodities will achieve the lowest total cost to be built overseas. A new best solution is constantly being challenged - China may be the "new" Mexico; India, the "new" China; Vietnam, the "new" India. Consumers and providers will always search for lowest cost, and logistics will work to create effective and productive solutions to meet these challenges.
As a result of desire to adapt to changes in customer demand and create flexible manufacturing plants, we find logistics, Tier 1, and OEM companies searching for flexible capital commitments. Domestically, landlords and facility equipment providers are being asked to accept or consider shorter lease terms, as OEM product changes are occurring swiftly when decisions are made to cure demand problems. OEM and Tier 1 manufacturers desire flexibility to reduce the risks created should they build a poorly received product. There just isn't the invested capital, time, or cash flow to wait for consumer tastes to change. Success for every product built is essential for survival. One OEM has planned to move an entire production line within one year from the announcement of the change. This is a huge undertaking - shifting the entire supply chain, building up the assembly line within the new plant, and exiting all assorted support facilities while setting up a different set of support facilities in the new area - all within a single year.
The automotive industry is taking dramatic steps to align itself with customer demand. Recent OEM financial filings show that the value of their larger vehicles (vans, SUVs, and trucks) have forced huge writeoffs. At the end of a two-year lease, the vehicle is not worth the remaining value stated on their balance sheets - in fact, Chrysler has already announced they will stop leasing vehicles. No one expects $2.00-per-gallon gasoline again. Consumers have changed their definition of value when choosing a vehicle, asking more about miles per gallon and cost efficiency.
With the recent increase in gasoline prices, automotive OEMs are looking at various strategies to build the right vehicles in the right places for the right reasons. If it was just a problem with demand, it would be a big enough problem. But the OEMs are facing a demand problem and a supply problem at the same time: not enough cars, too many trucks.
New future fuel economy rules are challenging carmakers on what they will design, sales problems are challenging the mix of vehicles they will build, and the expanding cost of fuel and plastics are making even day-to-day cost budgeting a problem. Even Toyota suffered a year-over-year sales decrease in both June and July of this year. With stock shares in GM and Ford at or near historic lows, the domestic car industry is working hard to convince consumers to bet on them. Each OEM is selling to the financial community that they have a plan for the consumer change in demand - no small or unimportant feat, as this perception affects their bond rating, their cost to borrow money, and essentially their long-term financial viability.
The increase in the cost of petroleum has not just affected the consumer at the pump. Petroleum-based materials have severely increased, causing cost pressures deep within the support/tier industries of automotive manufacturers. Fixed-piece cost contracts or any service contract without indexing due to fuel increases have become severe challenges. According to Automotive News, polypropylene, a resin commonly used in plastic parts, is 45 percent more expensive than 18 months ago. Tire prices have risen nearly 20 percent since March. Natural gas is up 63 percent since January. These cost pressures cannot be absorbed for long periods of time without an effect.
Prospects are rough. OEMs are adapting to stop producing low-selling products. OEMs and Tier 1 suppliers have been absorbing higher costs due to petroleum increases, working to reduce over-capacity work forces, and having little time to make necessary changes to make a profit and prove to investors their value. Nothing is easy for any of them.