A picture of the problem

Byline: | Category: Economy | Posted at: Friday, 19 December 2008

 auto.jpg

This picture was above the fold at Drudge earlier today.  It accompanied a story about the ever-evolving proposed auto-bailout.  The picture, however, illustrates much of the problem, and contra-everything else you’ve read, it’s a problem that has nothing to do with the unions.

First, a little history.  Years ago a new car buyer would go to the auto dealer and look at the cars on the lot.  They would be a representative sample of that year’s models from which you could make a decision, but you weren’t expected to buy from the lot.  No, once you settled on a model, then you would go to a book and order the exact options you wanted.  Then a few weeks later the car would arrive and you would pick it up at the dealer.  This is how I remember my father buying the 1970 Oldsmobile Vista Cruiser station wagon (tell me that this isn’t a Family Truckster) that we picked up literally on the way to the hospital before bringing home my mother and my baby sister.

vistacruiser.jpg

Contrast that business model with the first picture showing a row of nearly identical unsold cars.  Consider what it costs to pay the man shown cleaning them, or to pay the insurance on them, or the loan that the dealer takes to afford his stock.  Now consider how much the dealer stands to lose on his unsold 2009 inventory when he has to slash prices to make way for the 2010s.  I don’t know the actual numbers, but it wouldn’t surprise me if several thousand dollars of the cost of every car is attributable to overhead management.

Now consider how long it takes to produce a car.  You might be surprised to learn that from start to finish the entire process takes hours, not days or weeks.  Consider also that every dealership in the lower 48 is no more than four days from Detroit and you’re probably already seeing the makings of a solution to significantly reduce the price of a car, lower the dealer’s liability, and increase Detroit’s bottom line.

The solution is simple. Each dealer has a representative sample of cars on their lot–enough so that you can make a decision, but not so many that you should expect to drive off the same day with the car you want.  (Aside:  I can think of no other industry where you actually pay less to get exactly what you want now than you do to order it and wait.  But Detroit’s business model is so utterly backwards that this is exactly what happens.  If you happen to find the car you want on the lot, the dealer is so anxious to reduce his inventory that he gives you a price break to drive it away instead of charging you more for the convenience of immediately giving you what you want.  How stupid is that?)  You then order the car you want and the dealer guarantees a delivery date–usually less than ten days. 

The benefits of such a system are obvious.  The automakers would only plan to produce enough inventory to give each of their dealer’s a representative stock.  That frees up their remaining capacity to produce to actual demand.  The newly available time then allows the automaker to retool to produce more of the hotly-selling models and removes thousands of lemons that won’t sell from clogging prouduction. 

The dealers won’t be sitting on millions of dollars of loans to cover the cost of large lots full of unsold cars that all require costly insurance, constant cleaning, and eventual markdowns to eliminate excess inventory at the end of the model year.

And the customers win by getting essentially the same thing they get now–I just bought a new car a couple months ago and since the dealer didn’t have exactly what I wanted, they had to ship it from another dealer, meaning that I had to wait several days for the car anyway–but at a lower price.

Everyone is so focused on the labor cost of a car, but even with the generous UAW contract, the actual labor cost of manufacturing a car is only about 10% of an average $24,000 car.  Slash that by a third and the price of a car drops only eight hundred bucks.  As much as I think the average UAW employee is overpaid, they aren’t the source of the problem.  The larger problem is that, for the money, the cars that American manufacturers are manufacturing aren’t the cars that American buyers want to buy.  By freeing up the capacity currently used producing to an (overly optimistic) forecasted demand, the car manufacturers could then have plenty of available time to make the cars that market says that people really do want to buy. 

But they’re never going to get there if instead they’re busily building what is shown in this other Drudge picture:  a lot full of cars, many of which will have to eventually be sold at a loss.

auto2.jpg

UPDATE:

Bill Hobbs adds this comment:

Here’s the basic problem with your proposal: If I need a new car today, and Carmaker A tells me I have to wait a week, and Carmaker B has cars on the lots at dealerships near me, Carmaker B is more likely to get my business.

This is the current business model that the carmakers use.  So let’s play with some numbers to learn why it is unsustainable.

If a car manufacturer has five different models, each available in eight exterior colors and two interior colors, along with two different engine choices, and three different option packages available, they will create 480 different standard configurations for that model year.  For a dealer to stock just one of each kind he needs a three acre lot and has about ten million dollars in inventory, requiring about $50,000 a month just to service his loan. 

So when Bill shows up to buy the Toyota Rav4 in burgundy red with the grey interior in a 4-cylinder model with the Limited package, they have it available . . . IF he was the first one to visit the dealer looking for that car.  If someone else before him already bought the same configuration from the dealer, that dealer will have to wait six to eight weeks for a replacement to be manufactured and shipped.  Now the manufacturer could try to mitigate Bill’s lost sale by forecasting how many of that particular package are going to sell that year, and therefore, stock more than one–but now we’re talking about doubling or tripling the dealer’s inventory.  Sure, there are market analysts out there who will help you to project demand, but the number of 2008s (and even some 2007s) still on dealer lots right now tell you how successful those forecasts are–even when there isn’t a downturn in the economy.

This is the current business model the auto manufacturer’s employ.  It is unsustainable, with or without a bailout package.  It is also not specific to just American manufacturers.  The model I mentioned above is the car I bought two months ago.  I went to a local dealer, and from their lot full of dozens of Rav4s, they did not have what I wanted–and I didn’t even care about the color–I only wanted a 4-cylinder, 4-wheel drive, with a Limited package.  They had to transship the car from another Toyota dealer somewhere else in the country so that I could have it a few days later. 

If you are Volvo or Jaguar or some other overseas manufacturer you have no choice but to employ the business model described above–unless you employ the Harley Davidson model of order-and-wait.  Surface transportation times virtually guarantee  that orders can’t be filled in less than six weeks.  But American manufacturers (and foreign manufacturers with American plants) aren’t confined to being weighed down with significant overhead. 

One of the carmakers is going to figure out what I’ve described.  And whomever it is will profit, even in this economic downturn, while those who don’t, will (or should) go bankrupt.  Giving taxpayer money to any company who doesn’t understand that retail (the auto business is no different than any other retail) is all about increasing inventory-turns, is a waste of our money.  And those who do understand that, don’t need, and won’t take our money.

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25 Responses to “A picture of the problem”

  1. Bill Hobbs Says:

    Here’s the basic problem with your proposal: If I need a new car today, and Carmaker A tells me I have to wait a week, and Carmaker B has cars on the lots at dealerships near me, Carmaker B is more likely to get my business.

    I don’t worry about whether or not the dealer or the carmaker makes a profit or sells at a loss – that’s their business, not mine, and I assume that they have a “floor” to their price below which they will not go. If they go below it, they better have a good reason. Which brings me to my idea:

    I think a better business model would be for carmakers to sell turnkey transportation solutions, not vehicles. Here’s what I mean: Don’t just sell me the car. Sell me the car, and include lifetime service/maintenance on it, so that I don’t have to worry about scheduling or paying for routine maintenance, oil changes, etc., over the first 100,000 miles of the car. Further, assure all customers that major breakdowns will be repaired or the vehicle replaced. Add the cost of that to the cost of the vehicle – most cars won’t break down, so if everyone pays a little more, all car owners could be insured against major breakdowns.

    The point is to give consumers the confidence that if they buy Carmaker A’s car, they will have no additional costs for the next five years other than gasoline and car-washes. Heck, I’d even have my dealerships add car washes and let customers use ‘em for free.

    Oh, and American car makers these days ought to offer customers the incentive of receiving shares in the company (instead of cash rebates). You’d be more likely to buy from a company again in which you have stock.

  2. Instapundit » Blog Archive » THOUGHTS ON THE AUTO BAILOUT from Bob Krumm. Says:

    [...] THOUGHTS ON THE AUTO BAILOUT from Bob Krumm. [...]

  3. NormD Says:

    I question some of your assertions.

    Hours to produce a car??? Including the extended supply chain? No way. While final assembly may take hours, this assumes that someone is maintaining an inventory of parts that are ready to assemble and these must be ordered to forecast. Also I thought auto makers used JIT deliver of parts, so you could only get your desired model of car assembled if the parts are in the supply stream.

    I have heard several claims that labor accounts for only 10% of the cost of a car? Can this be correct? So how do the costs break down? Or are labor costs being hidden by saying, for example, 20% of the cost of a car is an engine and not mention that 80% of the cost of the engine is labor?

  4. W.C. Varones Says:

    There is also an ocean of unwanted new cars parked in the vacant parking lots of Legoland in California:

    http://wcvarones.blogspot.com/2008/11/scenes-from-depression.html

    The number of unwanted cars there has increased significantly in the month since that photo.

  5. Drew Says:

    Bill…you need to lease a BMW, everything is included (and I’ll bet they’re not the only one offering that deal either).

  6. Rick Forman Says:

    I purchased my last 2 Ford pickups that way with a small caveat. I went to the Ford website. Generated a build sheet and emailed it to the dealer. I deal with the fleet manager. He cuts the order (without a deposit) and 4-6 weeks later my new truck was ready to go. All that was left was signing the paperwork. It took me less than 15 minutes to close the deal when I took delivery and be on my way.

    The sales process is going to have to change as well. No more, “Pack your lunch kids we’re off to spend the day at XYZ Motors to buy a new car”. While some like the trading game, I don’t have time to dick around all day.

  7. mdv Says:

    You raise a good point about the massive inefficiency of the current distribution system. There seems to be a “we’ll make it up in volume” attitude that permeates the auto industry. Hopefully “just-in-time” delivery will be a feature of the remade auto industry.

    One thing that I question about the recent and oft quoted numbers– for years we were told that the Big 3 were at a huge disadvantage because each car, in effect, included two or three thousand dollar tax for supporting legacy costs. (the number varied, but it seems to me it was always in that ballpark). Now, thanks to testimony at the bailout hearings, we’re told that the labor costs for a typical UAW produced car is 10%. So how do we reconcile the $2,000-3,000 legacy cost with the 10% labor (or $2,400 in your example) cost? Did the original legacy cost number include the labor for building the new car? If so then it was a pretty blatant misrepresentation. (The implication was that the legacy cost was dead weight added to the cost of the car) Or is the true cost of labor 10% PLUS the legacy costs? That would make the case that the Big 3 is at a considerable competitive disadvantage more plausible, but makes the 10% of cost number grossly understated and misleading.

  8. fustian Says:

    Here’s an even better idea.

    Figure out the very few models that the majority of buyers actually buy. Then build those and have them available on the lots.

    In that case 70% of the customers will get instant gratification, another 10-20% will settle for what’s on the lot, and the remaining 10% can order cars from other lots or from the factory.

    And, that’s pretty much what they do, I think.

    If what you say is true, then all of the car dealers should be unprofitable and needing a bailout.

    But, they’re not. Only Detroit.

    An insider once described to me the wrenching design decisions that had to be made to get the cost of a Detroit made car to match that of an import.

    My money is still on a combination of extra labor costs (and don’t forget work rule idiocy) together with bad management decisions as an explanation for Detroit’s troubles.

    I also disagree with the idea of offering lifetime service. Because there would be no money in service, we’d get substantially less of it. And do you really want your dealer to tell you that you need to drive another 10,000 miles on those old bald tires before they will even consider replacing them?

    Not good.

  9. Ronnie Schreiber Says:

    Bob,

    I’m pretty sure that the practice of filling up storage lots (along with rebates and other incentives) and the related decline in custom orders from the factory started in the 1970s after the oil crises in 1973 following the Yom Kippur War and then again in late 1979 after the Iranian Islamists took the US Embassy personnel hostage in Tehran. The car companies are manufacturing concerns and the way manufacturing companies make money is by making (and selling) stuff. Sure, building to order makes a lot of sense, but you still have to keep the line moving to keep costs down due to efficiencies of scale.

    Another factor was Honda’s introduction of the Accord in 1976-77. There wasn’t a stripper model because Honda figured out that if it put an AM-FM radio in each car, the unit cost dropped to about $10, so the cars came from the factory well equipped, with the only options being dealer installed items. The dealers didn’t mind this because it helped move a lot of cars and also the profit on dealer packs is nice.

    You can still order a car, and car enthusiasts often know exactly how to work the system with the right order codes to get all the go-fast stuff without the fluff. The legendary “Yenko” Chevys were the result of a dealer working the order codes to perfection.

    Ronnie Schreiber
    http://www.motorobilia.com

  10. Mori Says:

    Two points:

    1. Last year I bought a new car … a Chrysler … just like your Dad bought that Oldsmobile station wagon in 1970. Delivery took 30 days, not two weeks, otherwise it was the same as it ever was. The bigger difference was that I could and did sit at my computer and check the available stock at other dealerships in a 200 mile radius, as far as I was willing to drive. I only ordered from the factory because I was being picky.

    2. The same business model you describe is followed by the thriving American car makers (Honda, Toyota, etc.) as well as a the dying ones. So why are the transplants able to make it work? Maybe because UNION PENSION COMMITMENTS are causing the big 2.5 to LOSE money on every car sold? When you’re losing money on every unit sold, it’s kinda hard to make it up on the volume.

  11. Ledru Savage Says:

    I would love to buy a Detroit 3 product like I buy, for example, a Dell computer: to spec, built to order (no waste tied up in inventory).

    But you lost me totally with “…it’s a problem that has nothing to do with the unions.”

    I would say that the existence of the UAW has a lot to do with why you can’t buy a Ford Powerstroke F250 like a Dell Inspiron 380.

    So. The Detroit 3 have a lot of waste tied up in inventory. But the UAW work hours that built them have already been paid.

  12. Paul Gaddis Says:

    Buying a car from a dealership just simply sucks! Over a year ago my wife and I decided that it was time for us to replace our 93 Jeep Cherokee. Great car. It lasted for over 200,000 miles and never left us on the side of the road. So we started looking around. We settled on a Solara. Then we started looking at the vehicles on hand. Most were the convertables. We wanted a hardtop. Most Coupes where sports models without the nav/bluetooth and only “carbon fiber” detail trim. The dealership was in a brand new building but no salespersons seemed to have ever been on line, much less flipped through a copy of Consumer Reports! (Can’t say enough about CR. Their information was better than what the dealership had!) Long story short: We had to force the dealership to order the car we wanted. We went back three times and finally got a salesperson (a woman) who would work with us. Then we started on the price and again, CR knew more about Toyota pricepoints than the dealership! We where polite but firm. It took several back and forths to convince them that, no we would not be buying off the lot, but we would buy the one we where describing to them! It took over two months for the car to arrive. It was just want my wife wanted and it has been a great car so far.
    Both of us where very surprised at how little the dealership was using the web. No terminals that customers could use. Only one big screen tv in the place and it was left on soap operas. The terminals at the sales desks where usually on some web page or another but never on the Toyota website. I will never forget the face of the Sales Manager as he was looking over the CR price info. He seemed genuinely surprised that a couple off the street had all this info that he did not seem to have or know. We just sat there and listened to him explain why they could not sell the car for what we offered and when we did not start crying and offering him more money he gave us the car for the price we wanted. It was simply exhausting.

  13. scott Says:

    This also does not address how dealers actually manage their inventory across the organization. For many, many years now, if John Doe wanted a specific sort of car, and it wasn’t on the dealer’s lot, the dealer consulted a computer. This computer had access to, if not ALL cars currently for sale from that manufacturer, most of them.

    If a match is found, and with that many cars across a whole country it is quite likely something very close would be found, a destination charge is negotiated and, assuming it is vaguely in the same region, the new car will arrive in 1-3 days.

    To me, this suggests a modification of your business model. Instead of one dealer having an inventory of EVERY configuration of a vehicle, a set of dealers within a day’s transport of each other co-ordinate to ensure any given configuration is only a day away.

    I am by no means an expert on the industry, but it wouldn’t surprise me one bit if this is exactly how inventory is actually managed.

  14. Leo Says:

    I’m speaking from ignorance here, but isn’t a substantial part of the problem the CAFE standards? I thought that the manufacturers had to have an average MPG rating that forces them to make cars that no one wants to buy to make the average MPG hit the standards. So dumping neons into the bay, so to speak, allows them to sell pickup trucks.

  15. Mike K Says:

    My Toyota buying experience two years ago began like Paul Gaddis’. I went to two local dealers (Orange County, CA) and was completely turned off. It reminded me of the Volkswagen salesmen in the 1960s when demand was so high you were lucky to attract a salesman’s attention. First, I have six cars, for kids, etc. I left one Toyota dealer and bought a Honda after being ignored because we wanted a basic model. In the second case about six months later, I finally went to the internet, found the car and price at a dealer an hour’s drive away, found great cooperation and even had them put leather upholstery in a basic model where it wasn’t an option. I wanted leather because of dogs. I don’t know why Orange County dealers are so much less cooperative but the internet made the difference. I suspect a lot of people go to the buying services after experiences like I have had. I also tend to find a good independent mechanic and avoid dealer service except for warranty items. It cuts the cost in half.

  16. Rick Caird Says:

    I agree with Bills analysis. We are a “right now” society. So, when I walk onto the lot, the dealer attempts to get me to drive away in a new car, so he does not lose the sale. A “right now” kind of guy is willing to compromise on the features of the car rather than wait. In fact, by only having cars on the lot with the most popular features, the dealer can “upsell” the potential buyer.

    We still have the ability to order a car if we want to be specific about features.

    There is a reason that dealers went to the large number of cars on display and available for immediate sale. They found it was more profitable than ordering. If individual ordering were more profitable, you can be sure the dealer would be pushing that.

    Rick

  17. George Says:

    I would love to order a car exactly the way I want it without the dealer making that decision for me. However, I can see a couple of potential problems. Many consumers like me would order the maximum engine size minimum accessories configuration. Larger engines are less expensive than aftermarket superchargers while aftermarket audio and navigation systems are relatively inexpensive. Can manufacturers to meet their CAFE requirements if customers pick the largest engine available? Can manufacturers and dealers make a profit without building lots of accessories into a car?

  18. Don M Says:

    “…they will create 480 different standard configurations for that model year.”–

    overchoice–Toffler(Future shock)

  19. Paul from Florida Says:

    Labor is 100% of the cost.

    Every material thing in the world is free. Just sitting there, up to the moment you start paying people to mine, forge, bend, design, deliver it.

  20. David Davenport Says:

    Labor is only ten percent of the total cost of a Dee-troit ride? That figure is almost certainly wrong and too low.

    This ten percent labor cost propaganda probably comes from the UAW.

  21. MGCC Says:

    It took 14 comments before Leo addressed the CAFE requirements. From the article: “The larger problem is that, for the money, the cars that American manufacturers are manufacturing aren’t the cars that American buyers want to buy.” Why would anybody make a product its customers don’t want?

  22. 49erDweet Says:

    Bill Hobbs [#1] has a valid point, though, with his “better business model” suggestion – except imo he doesn’t take it quite far enough.

    If one could buy the car of one’s choice knowing she/he would only pay for fuel and car washes for the life of the contract, and if one ever did breakdown or need service a suitable loaner car would be delivered and the car hauled away, only to be brought back when fixed, I would think a certain segment of the public would like this approach. The issue of tire wear and replacement could be handled ahead of time at contract signing, in my view. Dealer pays for registration, insurance and all repairs and routine services. Period.

    This business model already substantially exists in Sweden, I’m told, and is quite popular with those who don’t care to DIY things. Obviously not for everyone. But it sure could introduce a significant revenue stream into dealerships, and I would think that could be a win-win.

  23. mad anthny Says:

    My understanding was that at least part of the reason that manufacturers build so many cars is because it’s cheaper to keep running the lines than to shut them down, since if they shut them down they still need to pay workers due to, well, union contracts.

    Car companies actually benefit from the current system, because their financial arms charge interest to dealers to store the cars. In fact, Chrysler has said they are charging dealers more to store cars that have been on the lots over a year.

    And dealers like the current system, because if they have a car in stock that you fall in love with, there is a good chance you will leave with it today, and maybe be talked into overpaying for it too.

  24. Matt S. Says:

    For what it’s worth, that second picture is a lot full of Toyotas (with Toyota-built Scions). It’s not just the American automakers and their dealers doing this.

  25. barbq_ranch Says:

    Also, the dealership is not a maximum of 4 days away from the factory unless you are willing to pay a large premium for shipping. It doesn’t make any economic sense to send less than a full truckload of cars to an area (maybe split over several dealers).