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Auto Industry In Global Depression

March 5th, 2009
A certain indicator of how dire the circumstances are for the global automobile industry is the behavior of Toyota, which is without a doubt the most important and healthiest car manufacturer on the planet. It has now joined with Detroit and European auto producers in soliciting their governments for a bailout. Toyota has formally requested that Tokyo provide a “bridge loan” of $2 billion, this request following recent sales figures indicating that the Japanese behemoth experienced a decline of 40% in sales of motor vehicles in its largest market, the United States.
Toyota is in trouble, and it is actually in far better shape than almost every other auto manufacturer. When it comes to the competition, things are much worse. Especially with General Motors, which witnessed a catastrophic drop in sales of 53% in February, the news is becoming increasingly grim. The full force of the Global Economic Crisis is impacting all the grandiose plans and decisions of the world’s automakers, in the process shredding them to pieces.

Why is it that virtually all of the auto manufacturers are in varying states of deep distress? The answer lies in the nature of the automobile business, and strategic decisions made on the basis of dream-like optimism. This is reflected in the staggering levels of over-capacity in auto manufacturing worldwide. At present, the combined capacity of all the carmakers throughout the world amounts to more than 90 million cars annually. The deadly demand destruction being inflicted by the Global Economic Crisis has reduced purchases to about 50 million units per years, meaning that the world’s auto companies have nearly double the productive capacity that can be absorbed by current consumer demand.

The automobile business is one of the most costly and complex to run. The industry produces a consumer product annually in the tens of millions of units that is costly, complex and customized. The productive infrastructure required is both vast and exceedingly expensive. Before the onset of the Global Economic Crisis, the world’s carmakers bet heavily on a rising global marketplace that could annually absorb up to 100 million cars annually, and leveraged themselves to the maximum extent to finance the creation of the global network of assembly plants, parts manufacturing factories and distribution networks. The business model became far more globalized, adding another layer of complexity. For example, a U.S. customer who purchases a certain VW model will end up owning a car assembled in Germany, but equipped with an engine built in Mexico. In other words, a Mexican VW plant builds an engine, sends it across the Atlantic Ocean to Germany, which in turn sends it back across the Ocean in the form of an assembled car, to be purchased at an American dealership. This global supply chain is expensive, fragile, and only makes economic sense if all the manufacturing components of the business are operating at full capacity. What I just described has all the characteristics of a Rube Goldberg business model, yet virtually every major automobile company in the world conducts their business according to the pattern I have just described.

With the collapse in demand caused by the Global Economic Crisis, practically every major auto manufacturer is faced with the identical problem; over-capacity that was established with high margins of leverage, leading to massive losses with a worldwide demand for only 50 million cars each year. The reaction thus far by the automakers is to besiege their governments with requests for massive bailouts, warning that without the public purse to cover their losses, the result will be layoffs, disastrous collateral damage to the overall economy and the extinction of the industrialized base.

There is no easy solution to the massive economic problems impacting this now globalized industry. What is clear is that the auto industry is in the midst of a deep global depression. And while much of the reason for their distress lies with very bad business decisions and strategies, the leaders of the car industry are probably correct in claiming that their demise would bring about severe consequences. Unfortunately, there may be no alternative, as the issue may ultimately come down to who becomes insolvent first; the auto companies or the sovereigns being asked to bail them out.


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