The Fundamental Issue in the Auto Industry Is Overcapacity

There has been a wealth of wisdom imparted from every corner of the blogosphere as to why the domestic auto industry has failed and why it does or does not deserve a bailout from taxpayers.

One thing I have learned from my crash course in the auto industry these last two years at Tesla: because (nearly) everybody owns a car, they feel they are qualified experts on all matters automotive.

The truth is, the auto industry is very complex, and some of the criticisms that have become the conventional wisdom are misplaced and sometimes naïve, especially what has been written about the auto industry by some tech and social media bloggers.

Waving your hands around and talking about making the iCar and/or appointing Steve Jobs as auto Czar is just plain silly, OK? Yes, it is true that the products of the Big Three are poorly conceived and/or poorly executed, but that alone will not save the industry.

Also, talking about how you owned an American car in the 1970s and it sucked is totally irrelevant to the issue today. (As the old ad campaign suggested, have you driven a Ford lately?)

The fundamental problem is OVERCAPACITY.

Supply has exceeded “true” demand for many years. This shouldn’t happen in efficient markets but this imbalance was perpetuated by the availability of essentially free credit that allowed consumers to overbuy and overspend.

The industry was tooled up and structured to deliver against total market sales of 17MM units a year. When credit dried up this last summer—and markets started the wrenching process of reaching a new equilibrium—it was shocking to watch as the annualized sales figures dropped 20 percent, 30 percent and then over 40 percent by November.

For those who question why the management wasn’t prepared, imagine seeing your total market size shrink 40 percent in four months after being generally level or climbing for years. At the New York Auto Show in March, a lot of the discussion was about forecasting the coming reduction in total market size, which is an important thing because it takes time in the industry to adjust production volume (i.e., reduce shifts and close plants) to meet demand. People were debating whether it was going to go from 17MM units to 16 or 15MM. The most conservative projections were, if I recall, for 14M. In November, the number was 10M.

Because the underlying reasons for the previous market size were driven by the temporary—and now evaporated—availability of cheap credit to anybody with a pulse, this shocking dislocation is likely to be closer to the true market size going forward.

To the credit of the manufacturers, their plans submitted to congress assume future sales in the 11MM unit range, so they have gotten past denial and are into acceptance. This leaves the very ugly process of restructuring the industry to be healthy in a market that has shrunk 36 percent in four months.

So what does this mean in terms of all of the helpful advice being proffered? In my opinion, there is no way around the following conclusions:

1.) The industry must shrink capacity dramatically and quickly to be healthy.

2.) Therefore, a massive restructuring is inevitable. This could be bankruptcy or something that looks just like it but uses nicer words.

3.) In this restructuring, many jobs will be lost. To try to protect jobs (or uncompetitive wages) in this process is simply to be providing welfare and not confronting market reality. Propping up the industry with the logic that it will preserve jobs when the fundamental problem is overcapacity is equivalent to the UAW “jobs bank” that most people immediately recognize as absurd.

The problem is that it is a very scary prospect, and otherwise intelligent people start sounding the alarm with overblown predictions of doom. They say we will have no industrial base, as if somehow the end result of this will be the total destruction of the entire manufacturing capacity of the industry, as opposed to a resizing. They say there will be millions of jobs lost, as if taking steps to artificially sustain these jobs will somehow fix the problem (it will exacerbate it).

I wonder if these folks realize that the rationale they are using (pain avoidance) is the same thing that they criticize Detroit management of—not adjusting to market realities sooner.

Daryl Siry is the former chief marketing officer for Tesla Motors. He now consults on marketing and the automotive industry. You can read more here: http://darrylsiry.blogspot.com.