August 23rd, 2006

#142: Automakers

Toyota passed GM as the number one automaker in the world. And it's not surprising at all.

I bought a 1995 Escort in early 1996 and if it hadn't been totaled, I'd still be driving it. Ford did something right with that car; and now I've got another 1995 Escort which has even more miles on the odometer than my last one did, and it runs and drives fine. (Smokes some--burns oil. I think the engine wasn't maintained as well as the one in my last '95 was. That's okay; I've still got the wrecked one and can swap the engines.... ;))

American automakers CAN make good cars, and they can even do it with loss-leaders like my Escorts. I've had three of them (a 1991, and the two 95s) and all three were just excellent cars--so one must conclude that the quality issue is a matter of CHOICE.

The big issues facing American automakers are:

1) legacy costs (ie union pension funds, retired union employee benefits, etc)
2) lack of innovation
3) poor market perception
4) cost/benefit ratio
5) poor quality, both perceived and real

None of these is insurmountable, but it's not going to be easy, and it will HURT--it will hurt investors, employees, unions, and retirees.

I'm going to discuss these issues in the context of General Motors, but they apply equally well to all of the "Big Three".

Legacy costs

Right now, if you buy a GM car, about $1,400 of the price of that car is going right into funds to support union retirees. They have wonderful retirement benefits, thanks to the UAW.

If you buy a Toyota, the number is only $400. Assuming cars of similar price, Toyota makes $1,000 more per car than GM does.

Considering that the unions would rather let the automakers go bankrupt, rather than give in, some union busting is going to have to take place. There is no other way for GM to survive; they must reduce costs and supporting the UAW is one of their biggest ones.

But while the UAW is being busted, non-union employees are going to be laid off, too, because the process of union-busting is never pretty. Short-term shareholders will take a bath. Those who have the nerve to hang onto their stock may fare better. And retirees will see their retirement benefits wither.

Lack of innovation

A lot of this is public perception rather than real. Foreign cars have long had a reputation for being more technologically advanced than domestic cars; but this gap has largely disappeared in recent years.

The primary benefit of much of the "advanced" technology is really more a marketing tool than a real benefit. Americans like cars with torque, for good acceleration, but sophisticated multi-cam engines generally sacrifice low-end torque for high-end horsepower. A 24-valve V6 engine generally makes most of its torque above 3,000 RPM.

For example, my brother's fancy new 2006 Acura TL has a 3.2 liter V6 engine, four valves per cylinder, with variable valve timing; it makes 258 horsepower and 233 lb-ft of torque. But what is most interesting is where in the powerband it makes those numbers. The horsepower figure is at REDLINE (6200 RPM) and the torque peak is at 5,000 RPM.

Compare this with the 3.5 liter V6 that Chevy builds for its Impala line. The engine produces only 214 lb-ft of torque...but it produces it 1,000 RPM lower at 4,000 RPM. And Chevy does all this with a pushrod 2-valve V6 with variable valve timing.

The extra 19 lb-ft of torque will never be missed by most drivers; most American drivers do not rev their engines to their redlines.

The question of "innovation" in cars is really subjective, as you can tell. Dual overhead cams are very flashy and sexy, but in most applications they're actually utterly unnecessary and do more to hurt long-term reliability than they do to enhance performance.

When I bought my 1995 Escort (the first one) I test-drove the Chevy Cavalier and the Dodge Neon, the main American cars in the same class as the Escort. The Chevy Cavalier has always felt "heavy" to me, and the 1995 iteration didn't appeal to me, so it was out of the running fairly early on.

That left the Dodge Neon and the Escort. The Dodge Neon had two basic problems. First, its interior was just cheap. The door panels were hard plastic from top to bottom, with no padding or cloth or carpeting or anything. They looked like shit. But the Neon had a fancy twin-cam engine, producing 132 horsepower and 120 lb-ft of torque (45 and 12 more, respectively, than the Escort's single overhead cam engine). But when I drove the car, I found its acceleration less "snappy" than the Escort's. I eventually bought the Escort.

The Dodge salesman was incredulous at my observation. He knew the numbers and reminded me that the Escort only made 88 horsepower, versus the Neon's 132. But I knew what the "ass-o-meter" was telling me, and it defied the numbers.

Later I had occasion to compare them, and realized why this was so; and I learned that the "ass-o-meter" had been right.

The Neon's base engine makes 120 lb-ft of torque at 4,800 RPM. The Escort's engine makes 108 lb-ft of torque at 3,800 RPM--a thousand RPM lower, and much closer to the regime that I drive in.

Not having the actual torque curves available to me it's hard for me to say how much difference the torque peaks make. But I can say with authority that I rarely drive my engines above about 3,500 RPM; and with the torque peak at 3,800, the Escort's engine matched my driving style much more closely than the Neon's did, which is why it felt faster to me.

GM engineers are not stupid; they understand this. This is why many of their cars still use pushrod engines, rather than multiple overhead cam engines--the benefits are usually not great enough to justify the expense and reliability hit.

Poor market perception

Unfortunately, most people don't understand that. Most people want the biggest/best/fastest/coolest and won't accept that second- or third-best is not only just as good for all practical purposes, but more cost-effective in the long run.

Your local gas station relies on this. They make more money selling higher-octane fuel than they do selling base-grade 87 octane. 90% of the cars on the road don't need anything higher than 87 octane fuel; and those that do typically require 91 octane. So why offer 89 octane fuel?

Perception! 89 octane fuel must have advantages over 87 octane fuel, right? In fact, there is almost never any advantage whatsoever which justifies the 10-cent greater price. A person driving a normally-aspirated car without any performance options is wasting his money on the more expensive grade of fuel.

This is the kind of problem that GM has. Its products are generally "good enough" but people don't want "good enough". They want "best".

Actually, people do want "good enough". They won't use all the capabilities of "best"; they hardly use all the capabilities of "good enough". "Good enough" will satisfy about 95% of the consumers if the packaging and marketing is done correctly.

Honda's Accord was the best-selling mid-sized car for years even though it lacked a V6. Why? Americans still wanted powerful cars; the Accord's 4-cylinder engine was no slouch but it lacked the muscle of a V6--so why did it sell so well?

Because Honda had made it "good enough". It was not optimal, but the Accord could hold its own against the other top dog, the Ford Taurus, and the consistently third-place Toyota Camry. (The Accord and Taurus were alternating in the top slot for several years, in fact.) The Honda's reputation for quality overcame the qualms of those who would prefer a V6 in a family car; the promise of not having to fix the thing every 5,000 miles was enough of a compensation for the lack of a V6. And many people discovered that the four-cylinder engine was just fine, anyway.

Everywhere you look, American cars are seen as using older technology, being less "hip" or "cool". In fact none of the technological differences are really all that significant; there are many good ways to solve the technical problems of making engines more efficient. None of them are actually "new" solutions...but they are perceived as high-tech and "advanced" even though most of the technologies were developed in the 1930s.

Cost-benefit ratio and quality

All this ties into the perception of value for money.

Ford was making the largest SUV on the road, and charging a premium for it. After all was said and done, Ford Motor Company put $15,000 per truck into the bank in pure profit...and they sold every truck they could make at that price, too. This truck was a ladder-frame truck with a wagon body on it; it had a pushrod V8 engine, and a "live" rear axle. No independent suspension, no unibody construction; very little of the mechanicals used technology newer than 1930. (Obviously the powertrain control systems were modern, as were all the safety systems. But the engine, transmission, rear end, body, frame, etc, would have been easily understood by an automotive engineer from 1931.)

Around the same time, Ford cancelled production of the Ford Escort and brought out the Ford Focus. It used newer technology and was supposed to be a new direction for Ford's economy car line. The base price of the Focus was not significantly higher than that of the Escort, but (at least at first) you could not get cars built at that base.

But for the first two years, the cars produced were not very good. There were many recalls and the car rapidly gained a reputation for being utter junk.

Other carmakers have done much the same thing; Chevrolet's Cavalier is being replaced with the Cobalt. The Dodge Neon is being replaced with the Calibur.

The idea is to replace the old car with a new one, with a new pricing structure. This way no one can say, "Ford's new Escort comes with a significant increase in base price...."

Ford did not cut the price of the Focus--no automaker has EVER cut the MSRP of any car--but it changed how the cars were priced, because otherwise they just wouldn't sell. The quality problems with the Focus have long since been fixed, but the perception remains that it's not much of a car for the money.

American cars have always suffered from a perception of lesser quality, even when there was little or no actual discrepancy. Cars cost more every year, and now you can't get into a mid-sized car for less than about $20,000. People are keeping their cars longer. So they want high quality cars, and Japanese cars are perceived as being more durable than American cars.

(This is not actually true. Many Japanese cars suffer higher repair rates after 5-7 years, and the repairs cost more.)

So if you're going to pay $20,000 for a car, why not buy one which everyone says will last longer? Most people will act to maximize a return on their investment, and a car represents a significant investment.

* * *

So what's going to happen?

I don't think the price of cars will ever go down. They haven't yet, and there have been times in the recent past where, if they were going to drop, they would have. Besides, it costs a certain amount of money to develop and build the things, and no one is going to do it for free, so people must be paid and corporations expect to make profits to boot. So, absent a major change in our economy, the price of cars will probably never go down.

The Big Three cannot go on as they have been, that much is certain. The demands of their union personnel cannot long be supported as things are now; GM and Ford are staring down the barrels of bankruptcy court if their labor costs are not brought under control.

The UAW won't, as I said, help them. The history of unions in the United States has shown that many unions would rather drive a company out of business than give up hard-won benefits. This position is, of course, extraordinarily short-sighted.

Toyota is not hampered by the UAW; none of their plants is unionized. The same goes for most of the other Japanese automakers. (Some Mitsubishi plants may be unionized, the ones which were constructed in partnership with Chrysler corporation: the "Diamond Star Motors" plants.) This alone gives Toyota an enormous competitive advantage. Toyota can hire and fire people as it pleases and need not fear changing compensation packages to reflect the state of the economy.

Contrast that with GM, which must have every change in compensation (no matter how minor) approved by the union. Hiring and firing workers happens under the scrutiny of the union. If high demand prompts a need for union workers to put in mandatory overtime, the union can call a strike to force GM to hire more workers...who then will also be union workers, who are owed the same kind of benefits that all the other union workers get, right down to the extra-cushy retirement benefits. (This has happened many times!) If demamd drops and GM wishes to get rid of workers, the union can call a strike to protest; and so workers get laid off--they are guaranteed a job when demand picks up; and in the meantime they receive benefits (and pay, at a lesser rate) even though they aren't working.

The union is such a powerful force that GM has "rubber rooms", facilities which warehouse workers who are utterly worthless, but cannot be fired. These workers are essentially paid to sleep, watch television, read newspapers, drink coffee, and do other things utterly unrelated to the manufacture of automobiles. GM cannot fire them; the union won't allow it...and so these people get $26+ per hour (plus fantastic benefits!) to do nothing constructive whatsoever.

The UAW is not the only problem that GM has; but it is certainly the largest problem that GM has. Solving the other problems won't make a lick of difference as long as the UAW has more control over GM's labor costs than GM itself has.

The unions will go away; or the American automobile industry will perish.