Amit Paranjape’s Blog

Demise Of The Big 3: How Detroit Icons Lost Their Way Over The Past 3 Decades

Posted in Current Affairs, Financial Markets/Economics by Amit Paranjape on December 15, 2008

 A lot has been written about the Big 3 bailout. Majority of the articles published thus far talk about all the current problems that are faced by Detroit. Relatively few have discussed how they got here in the first place. I thought I will add my 2 cents to this angle.

 

“You bailed out the Financial Institutions to the tune of Hundreds of Billions of Dollars! All we are asking for is a fraction!” This seems to be general line of lobbying (pleading is probably a more appropriate word…) that the Big-3 automakers are taking to the Congress. This, coupled with the specter of 3 Million direct and indirect job losses, is creating an apparently ‘strong’ case for them. Yet, I am glad to see that there is still some opposition left in the Congress. The opposition might still be a moot point though, since the White House looks all set to bail the Big 3 out in any case.

 

It is worth looking at the ‘If for them…then why not us!’ argument. The big financial institutions had catastrophic failures/near failures, primarily due to the housing bubble collapse and risky investments over the past few years. In some sense, this once in a hundred year event had its origin in fairly recent past. The housing bubble began at the turn of this decade. [For a more comprehensive discussion regarding the 2008 Financial Crisis, please take a look at my earlier articles on the same topic: US Financial Crisis: Who Is To Be Blamed? and US Financial Crisis: The Role Of The Consumer ]

 

Comparatively, the Big 3 automakers have been in their slow death spiral for decades. In fact one can trace the beginning of the end for them, at the 1974 oil shock. Until then, they had a dream scenario of virtually no competition and extremely cheap oil. Hence it didn’t matter what you built; there was demand for it. Engine efficiency was the farthest on anyone’s mind. Those massive 6 Liter V8 vehicles of the 60s and early 70s, often resembling a small aircraft (with those fins!), would make today’s Hummer look like a compact vehicle!

 

The oil shock was a big wake up call, and the Big 3 scrambled to make smaller and efficient cars. But somehow design and quality took a backseat. It took the large scale arrival of the Japanese imports in the1980s that shook up the market again. Initially, the Big 3 probably didn’t even notice those ‘tiny’ Toyotas and Hondas. But soon as their loyal customers started to defect, due in no small part because of the persisting ‘defects’ in the American cars (no pun intended!), Detroit began to take serious notice.

 

Lean Production Systems, Total Quality Management seminars started filling up in the Midwest. Consultants started making money of these Japanese ‘best practices’. It was ironic that the person that the Japanese first learnt Total Quality Management Principles from in post WW II era, Edward Deming, was an American. Apparently in that time period, no American industry cared to listen to him.

 

As the Big-3 started improving their designs and efficiencies in the 1990s, they were perpetually in a catch-up mode. Japanese automakers had taken over a significant lead and they kept widening the gap. At this stage, it is worth mentioning that the legacy labor contracts of the Big 3 started becoming a drag on these companies, while they were trying to be agile and nimble. On a personal note, I can relate to this design gap through first hand experience. In 1994, as a new graduate student arriving in America, I had a chance to rent two different cars in the first couple of months. One was the General Motors Buick Skylark and the other one, the Toyota Corolla. The differences between the two completely startled me. 

 

Just when it seemed that Big 3 was narrowing the gap towards the end of the last decade; they made another short-sighted cardinal error! The 1997-98 Asian financial crisis drove oil to a low of near 10 Dollars. Suddenly, it seemed Detroit again got into fond memories of the 1960s and threw fuel efficiency out of the window. Instead of trying harder to close the gap on the automobile portfolio; they thought they had discovered a new winning strategy, to once and for all defeat the Japanese! The Big 3 always had a bigger portfolio in the light truck segment. These gas guzzlers were the mainstay of utility workers, farmers and other small business owners. With oil hitting new lows, the marketing geniuses of Detroit spun campaigns that made these trucks, an essential for a common white collar worker as well! Soccer moms were also in their target sight. By simply slapping on a mini-bus like body on top of the truck chassis, Detroit created something called a ‘SUV’. Soccer moms who till the mid 90s were confined to station wagons and ugly looking small minivans, now had a great option. Not sure, if the sheer size of these things made the white collar workers and the soccer moms more comfortable or safer?!

 

In the short run, these gas guzzling vehicles got handsome profits to the Big 3 and it appeared that they were finally back on track. Yet the foundation was extremely shaky. Japanese automakers also moved into this space in the late 1990s and once again showed Detroit how those same gas guzzlers could be made more reliable and comfortable. The final death sentence came when the oil prices began a steady rise this decade. SUVs and gas guzzlers were again out of favor and smaller, fuel efficient cars were back in vogue. And the Japanese were not sitting idle either with their R&D; even better fuel efficiency was now available from the newer revolutionary breakthroughs such as the Hybrid Technology. Detroit simply didn’t have any answer for this!

 

The 2008 financial crisis and resulting recession & downturn was the last straw. But, I think attributing this demise to this crisis is extremely short sighted. As described in this article, the demise was around the corner in any case. The present recession was just the ‘straw that broke the camel’s back’!

 

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  1. Dhananjay Nene said, on December 15, 2008 at 8:38 pm

    Nice post. It has been obvious for decades that US cars cannot compete with their Japanese (and now even the Korean counterparts). What you’ve mentioned rings true, though I believe some more factors need to be also considered. One of these is relatively more specific to the auto industry – ie. the unions and their clout. Another one is probably relevant to the US economy as a whole is the ratio of pensioners to workers and the pension and/or health care components that go towards making GM lesser competitive – ceteris paribus. The same political clout due to the large number of people being directly and independent on the auto industry that is pushing the bailout plan today has also contributed to the Big 3 not being able to push down costs to globally competitive levels, and now we are seeing a subsidy kick in to compensate for the inefficiency – the start of a negative spiral.

  2. Sam said, on December 16, 2008 at 10:19 am

    Ya. good points. But I guess the housing bubble burst was not the real cause for financial institutions. Crazy lending patterns and atrocious salaies, commissions and bonuses were equal contributors. If still they need to be saved then auto industry is not asking for too much. Also auto industry has histrory of paying it back to govt.

    Also besides job losses, the setback to american morale [of GM closing down] will be too much to take. I have no doubt that govt will have to bail them out.

  3. Nilesh Sane said, on December 16, 2008 at 10:50 am

    Nicely summarized post.
    My two cents on the topic; the cars which Ford or GM sells for the rest of the world (other than US) are never sold in the US even though these cars are a hugh success else where, case in point is the Ford Mondeo, Ford Focus and the Chevy Optra. I believe there are some regulations which prohibit these cars form being sold in the US and thats one of the reasons why the big three have to spend twice as much in the R&D department because they have to design every car in the US from ground up. A Corolla or a Camary is the same throughout the world, and Honda even goes to the extremes of producing two different Civics by choice.
    I recollect reading that if the bail out is agreed, the US govt will then ask the top 3 to share their platforms with each other and also work towards a greener car together. Its a good thing.
    The Japs are leading the way for the green brigade (what with the Honda FCX), but the second largest auto manufacturer in Japan, Nissan, is apparently way behind in the new fuel or dual fuel vehicles. Could this be due to its extreme exposure to the US market?

  4. atul tulshibagwale said, on December 17, 2008 at 1:18 pm

    Good post. There’s probably volumes to be written on this topic.

    I’d also attribute their demise in a small part to their completely unfriendly posture to environment friendliness. Their sham about the “hydrogen economy” was not bought by the public. I feel they should die for stalling emission standards regulations, for not doing anything to save the environment and on top of that for getting a tax break for their big SUVs.

  5. Amit Paranjape said, on December 17, 2008 at 8:31 pm

    Dhananjay, Sameer, Nilesh, Atul: Thanks for your feedback.

    Atul – In addition to what you have mentioned, I will also add the whole deal with ‘Ethanol’. (There is a lot of material to write about Ethanol subsidies, etc…but will keep that for a separate post).

    With the product mix of Big 3 leaning towards trucks and SUVs, they were having a tough time with the fuel economy standards. Apparently, they found a loophole(?) in the law that allowed them to get some extra credit if these large vehicles were ‘flex fuel’ (vehicles that could run on regular gasoline, as well as 85% ethanol).

    Initially when I saw lot of these ‘flex fuel’ vehicles ads in 2005/2006, I was wondering how suddenly the big 3 decided to go green! Later on I realized the reason.

    Also to add to this, ‘going green’ with MidWest corn based ethanol is a real stretch. Producing ethanol from corn is an energy negative process (Takes more energy to produce a gallon of ethanol, than the energy in 1 gallon ethanol), unlike making ethanol from Sugarcane – as it is made in Brazil.

    Amit


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