The Problems Behind the Profits

Automotive Industries, August, 1999 by Ron Harbour

U.S. demand for light trucks is not likely to outstrip supply much longer. And when that happens, watch out.

Did anyone notice recently that on the same day Ford announced its thirteenth consecutive quarter of improved earnings, the company's stock fell 56 cents a share?

Wall St., it seemed, was troubled by some of the other numbers posted by Ford. For example, the company lost $120 million in South America, and profits fell in Europe from the year before. Even in North America, which carried Ford to its record second quarter, industry analysts were leery because all the profits came from the pickup truck, sport-utility vehicle and minivan markets.

Ford is not alone, either. DaimlerChrysler and General Motors are drawing all their profits from the very same segments. And the analysts know high-priced tracks, SUVs and minivans are only going to remain popular as long as the economy remains strong -- or until the next trend comes along.

The so-called experts know this strong economy won't last forever. But it's been on a roll for so long that everyone expects stocks will continue to rise, and the economy will remain strong. So will demand for the automakers' high-priced, and highly profitable, vehicles.

But I have two questions regarding this situtation. First, what is going to happen as supply continues to increase but demand tails off? And second, how long is the American consumer going to pay premium prices for these vehicles?

The supply issue appears to be coming to a head sooner, rather than later. DaimlerChrysler, Ford, GM, Honda and Toyota are increasing capacity and production for minivans, SUVs and tracks, while customers continue to buy as many of them as the factories crank out. But this can't continue forever. The experts on Wall St. know this. That's why they're reluctant to reward Ford and the other U.S. automakers for record quarterly earnings, based solely on one segment of the worldwide market.

Another big factor is the role Honda and Toyota will play in the pickup, minivan and SUV markets. The Japanese have been very slow to bring competitive vehicles to this segment, partly because they didn't expect the trend to last this long, and because they didn't offer competitive, popular products.

That's changing. Honda's Odyssey minivan is the first shot to hit its target squarely in the bullseye. And I'll bet the next one will be the Tundra, the new full-size pickup Toyota is producing at an equally new plant in Princeton, Ind.

With the former U.S. Big Three building more and more trucks, SUVs and minivans, and the Japanese entering the fray with competitive products, demand is not likely to outstrip supply much longer. And when that happens, watch out.

The second issue is more sensitive -- the automakers' poorly kept secret that their record profits are coming from the high margins they command on sales of their most popular vehicles.

Consumers accept the notion that they should be paying a lot more for bigger vehicles that are offered with lots of options. Truth is, these vehicles do cost more -- but not as much as some might think.

Cars being sold for around $15,000 aren't providing automakers with much, if any, profit these days. Vehicles that sell in the $20,000 to $25,000 range might bring $2,000 to $3,000 profit per unit. But the cars and trucks that retail for $35,000 and more may net the manufacturer as much as $10,000 profit -- or even more.

Automakers are posting record earnings because they're raking in big profits on their biggest sellers -- the high-end tracks, SUVs and minivans. Will customers continue to pay premium prices for these vehicles, especially if there's a downturn in the economy, or there are more of these vehicles than the demand requires?

I don't want to be a doomsayer, but this is a delicate situation that's only getting more precarious with each passing record quarter. So watch out -- it could get very interesting a lot sooner than some might think.

Ron Harbour is president of Harbour and Assoc., manufacturing consultants in Troy, Mich.