Collapse of the Big Three

Collapse of the Big Three

America was once the leader and pioneer in the auto industry, a title that the country had for decades and a title that was so dear to America's heart that it was unfathomable to think that title might ever be lost. It's commonly misconstrued that America invented the automobile, when in reality that honor goes to German Karl Benz in 1885 (Rozema, 2010). "Americans did, however, industrialize the love of the automobile. America loves big, fast cars, and for many decades American car companies shared the biggest slice of the auto industry pie" (Rozema, 2010). America made having a car and the business of making cars firmly entrenched in American culture. This was a fact which kept the economy stimulated and which provided a consistent level of financial stability for the nation and the civilians within it. However the decade of the eighties marked the time when that began to serious slip away as Japan and Germany offered extremely competitively priced cars that had a high level of quality (Rozema, 2010). This marked a seriously influential reason for the beginning of the end: the decline of the big three.

The collapse of the big three car companies (Ford, General Motors, and Chrysler) was indeed a complex process of which many causes were responsible. In 2005, an interview with NPR put it perfectly, "Though the trio has dominated the American market for decades, its grip is slipping fast due to the perfect storm of business decisions -- poor ones -- raising health-care costs and strong foreign competition. The Big Three's decline has already been felt by 130,000 workers that have been laid off since 2000. It's only beginning to really impact the larger economy" (Gordon, 2005). While this excerpt offers several reasons for why the big three were losing so much business, one of the more compelling reasons offered was the real manifestation of formidable foreign competition.

Foreign Competition

As the narrator writes in the book Once Upon a Car, "Executives came and went at the Ford headquarters, but none of them was able to help Bill [Ford] stave off the flood of Toyotas, Hondas, and other foreign cars that were relentlessly beating Ford in the market" (Vlasic, 2011). When it came to the fierceness of foreign competition, executives at Ford, GMC, and Chrysler, had to have felt like they were paddling out water in a sinking ship. In 1997 the big three dominated the American auto market; in fact, Ford was number one in California as recently as 2005 (Schoenberger, 2007). However, once the tables turned they turned very rapidly. "An article from The Detroit Free Press (2005) stated that the combined market share of GM, Ford, and Daimler Chrysler was at an all time low of 60% in 2004. Currently, Toyota, Honda, and Nissan are the top three foreign competitors with market shares of 13.1%, 10.8%, and 6.6% respectively (Standard and Poors 2004)" (Gatesman, 2005).

When a consumer market makes such a rapid and immediate shift in preference and behavior it's often for a complex and multi-faceted amount of reasons, reasons which reflect the changing times. When any consumer market changes their preferences and choice of an automobile, it's the reflection of changes in society, lifestyle changes, controllable changes and incontrollable ones.

One of the reasons why foreign cars were able to ease the market away from the big three was because they really were better quality. American cars still had a reputation for questionable levels of quality and that was something they just weren't able to shake; this was unfortunate as cars from overseas were being introduced to the market that had levels of quality that cars made by the big three just couldn't compete with. A Business Week article written in 2001 demonstrates that the problems facing the big three started with the engineers: "Factories make the cars the way they are supposed to be made, but that is the problem. The materials and the design of the car are poor quality. U.S. manufacturers also end up spending more in warranty costs than foreign manufacturers" (Gatesman, 2005). All of these facts point to a lower level of quality of American cars. If a car is going to be known for being a lower quality than its competitors, it should have a significantly lower price tag to match. Otherwise, there's the danger of American car companies appearing as though they're charging the same price for lower quality, comparable to a snake oil salesman.

However, as one scholar points out, it's useful to determine how Lancaster's Theory of Consumption can be applied to the car industry and the collapse of the big three.

The graph is very basic and it demonstrates the mix of traits between reliability and safety of car A versus car B. Simply put, consumers who purchase Car A, place safety as more important than reliability; consumers of car B. place reliability as superior to safety (Gatesman, 2005). The use of the theory is to help the determination of which characteristics are fundamentally important to the general purchaser of cars in America, shedding light fundamentally on how one of the reasons of the collapse of the big three was able to occur at all through the loss of market share (Gatesman, 2005). Examining the work that economist Gatesman conducted for this theory is indeed revelatory as it assumes that "a consumer obtains more utility with the higher quality car he/she buys. Since consumers are utility maximizers, they will buy the best quality car. Quality is represented by specific characteristics such as: safety, warranty, gas mileage, and reliability. Therefore, these variables will reveal what makes a 'quality' car and what consumers value most" (2005). It's important to acknowledge as Gatesman points out, that some consumers will just be purchasing the car based on its price alone and so the comparison needs to reflect the price. "Market share is the dependant variable and defined by the following equation:

Market Share = (# of x cars sold / total # of cars sold in the segment) x 100

(where, x is the type of car, Camry, Impala, Sebring, etc.)" (Gatesman, 2005).

Gatesman used this formula to construct his hypothesis which was that mainly, Lancaster's theory had to be absolute for nearly all cars: people need to prize the individual traits of the cars they purchase, and these traits were basically encapsulated by foreign cars (and completely lacking in domestic cars) at the time of the auto industry collapse (2005).

Gatesman used the empirical model revolving on the following dependent and independent variables: These variables selected for his equation are worth closer examination.

Price

The sticker price for the model -- even if consumers don't end up paying this price

Data used -- the most standardized value ever.

Control variable

Country where cars are produced

At the time of Gatesman's work, some foreign car companies had factories on U.S. soil, hiring U.S. workers.

Dummy variable

Safety

Based on National

Highway Traffic Safety Administration (NHTSA) data

Cars are crashed full frontal at 35 mph. The lowest score in each category is used for the cars: cars are only as strong as their weakest link.

Warranty

Assumption: if consumers have to pick between two similar cars they're naturally going to pick the one with the better warranty.

Warranties are important as they lower repair costs.

Warranties are treated as a dummy variable.

Reliability

Rating taken from autos.msn.com

This rating can be seen as the "repair cost"

Dummy variable

Gas Mileage

During the collapse of the big three, gas prices were at an all-time high.

Is still a factor in some car-buyer's decisions

Market Share Lagged

Dictates the popularity of a given car.

(Gatesman, 2005).

Ultimately, all of these factors helped him to come up with the following formula.

"% Market share = ?1 - ?2

price + ?3 safety +

4 reliability lagged + ?5 gas mileage + ?6

warranty + ?7

Market Share lagged + ?8

US"

(Gatesman, 2005).

The goal of this formula is to better illuminate what features consumers preferred the most when it came to automobiles during the early 2000s. In illuminating these preferences, it should shed light on the demise of the big three automakers, as one would assume that the characteristics preferred were ones which American cars simply did not possess. Most consumers don't purchase cars impulsively. The purchase of a car first starts with a decision made in the mind of the consumer that a new car is needed, then the consumer weighs the advantages and disadvantages of various models (Khan, 2007). The behavior and thought processes which go into a consumer choosing one brand over the other is a complex and multi-faceted process and the consumer's ultimate decision depends on their perceived consumer value of a given vehicle.

Consumer value= Costs of the vehicle -- Total Benefits

In this formula the costs of the vehicle would include things like the price of the car, gas, maintenance, possible injury in case of accident, parking, pollution and annoyances such as traffic (Khan, 2007). The total benefits would be the fun of driving, the aesthetic value of the car, ease of transportation, the fun of owning the car, the help it might provide one's work or family and other values (Khan, 2007). The formula for calculating the percentage of the market share that cars made by the big three vs. cars made by foreign automakers highlights where the consumers head was at during this decline of the American auto industry.

This formula created the following values for the following automobiles:

"Mean Values for Each Model:

Car Market Share Price Safety Reliability Gas Mileage

Chevy Impala 4.49 18400.70 4.23 3.60-19.80

Chrysler Sebring 1.00 18340.56 4.17 4.75-20.67

Ford Taurus 8.09 18406.00 4.40 4.70-19.22

Honda Accord 8.81 16922.10 4.00 4.44-24.30

Nissan Altima 3.29 15931.00 3.69 5.00-22.75

Toyota Camry 8.70 17651.80 4.00 4.40-22.45"

(Gatesman, 2005).

Of the table above one can see that both price and market share were taken from Ward's Automotive; the figures for safety, reliability and gas mileage were taken from autos at msn.com (Gatesman, 2005). When examining all of these characteristics in the format of a table, such as the one above, the preferences of consumers becomes crystal clear and it's not at all difficult to understand why foreign cars started to surge ahead in popularity. Essentially foreign cars were offering the consumer more -- better gas mileage and better prices, greater reliability. The value to the consumer was exponentially higher, and no one could ignore it.

The importance of a perceived high value in an automobile is something which cannot be underestimated, particularly during the early 2000s when the big three started to decline. As one of the factors which contributed to this decline had to do with the rising cost of fuel. "The last place where the American car makers make pretty easy money is full-size pickup trucks. They don't have a lot of competition in that area and also the very large SUVs that are built on those platforms. With fuel prices this high, sales of those vehicles are getting soft and that's the place where they make their money. So that hurts them quite a bit" (Gordon, 2005). The high cost of fuel definitely made the consumer think twice and really feel the drain of driving an SUV. SUVs no longer seemed like roomy vehicles that could handle any road condition and that gave the driver an elevated seat. They started to feel like large, lavish, expensive, wasteful vehicles that were a drain to the consumer's pockets. And just as they were popular in the 1990s, the pendulum shifted to the other side, and they lost favor: they seemed impractical for the changing times.

However, it wasn't just the sheer impracticality of the SUV in the early 2000s that heard the big three automakers, as some consumers were still buying these types of cars regardless. It's that the SUV section of the market was no longer easy money for American carmakers: they started to receive a tremendous amount of competition in this arena. "In the '90s, the Big Three all made a huge amount of money on SUVs as the market moved in that direction and they were there first. But capitalism works. Everyone got into that SUV business. Today, even Porsche's building SUVs and the easy money there is gone" (Gordon, 2005). The very revelatory remark in this statement is in fact that capitalism works. In the spirit of competition and offering the consumer a wide range of choices, other car manufacturers started to make SUVs, ripping this type of vehicle from something that was exclusively American, to creating Japanese and German varieties of it. American car manufacturers simply weren't ready or able to compete in what had become an incredibly high-competition playing field. Some have accused the big three has having "no strategy" to compete in the changing marketplace and meet the needs of the new consumer. The big three had built their fortunes on making massive heavy cars, and they weren't used to adapting their product and they weren't used to creating anything but these types of cars. As one economist noted, when oil prices went up, none of these automakers had an alternative product ready (Hyland, 2008).

As early as the 1970s, the government had developed the Energy Policy and Conservation Act of 1975 which dictated that all automobile companies reach a corporate average of fuel efficiency of 18 miles per gallon by 1978 and 27.5 by 1985 (Dunbar & May, 1995). This dictation was as the result of a desire for energy conservation and a greener automobile policy, but in retrospect, one can't help but wonder if the nation was anticipating a potential spike in gas prices in the years to come. However, the Detroit Three did little to heed this warning, still focusing on bigger cars, which at the time, their customers demanded (Dunbar & May, 1995). This was destructive to their entire business as the data indicated that subcompacts were in fact the fastest growing section of the market (Dunbar & May, 1995).

If one were to examine the table and formula proposed by Gatesman in terms of variables, much is in fact expected with little surprises as regression is the foremost issue in how foreign car makers were able to claim such a large portion of the market share (2005). Below are the results in terms of coefficients; through this table Gatesman highlights two of the variables that do not have an expected sign: price and safety (2005).

"R- Squared

.772

Variable

Coefficient

Significant

T-Statistics

Constant

-16.844

.003

-3.118

Warranty

1.009

.201

1.299

Price

.001

.032

2.226

Gas

.358

.026

2.306

Market Share Lagged .610

.000

6.273

Reliability Lagged 4

1.134

.243

1.185

Reliability Lagged 5

1.35

.159

1.434

Safety 3

-.882 .138 -1.512

Safety 4

.806

.065

1.896

Safety 5

.007

.991

.011

Produced in U.S.

1.392

.250

1.167" (Gatesman, 2005).

As Gatesman demonstrates, one of the unexpected aspects of these results was that price should not have had a negative sign (2005). While price does have a slight coefficient, it's still a positive sign; a potential reason for this surprised result is that the price has gone up through the years because of inflation, but the market share still grows as a result of popularity (Gatesman, 2005). However, it's important to bear in mind that as the price goes up, so does the market share, but these are not two elements which are dependent on one another (Gatesman, 2005).

Ignoring Social Trends, Supply and Demand

One could argue that the fall of the Detroit Three which the world witnessed from 2003 to 2008 was actually predetermined by the events of the late 1970s to the early 1980s. The carmakers of Detroit neither learned from these lessons, nor did they heed the clear signs of the imminent changes to come. The following table demonstrates the trends in a clear and unmistakable manner:

American Car Sales

Year

9,300,000

1978

8,162,000

1979

5,049,184

1982

If one compares this to the production of Japanese cars at the same time, one sees how American automakers failed to ignore a steady threat and infiltration of their market by a competitor that was better reacting and meeting consumer needs.