Almost anyone who has been following the auto industry, especially in the U.S., will agree that lately it has had a bumpy ride. For one thing, the difficulties of GM and Ford have filled the headlines for several months now, and there has been lots of speculation about how severe these problems are. In addition, the auto parts maker Delphi, which was spun off from GM in 1999, is now in the midst of bankruptcy proceedings and actively negotiating with both the United Auto Workers union and GM. Yet another challenge is growing global competition: Virtually all the Japanese brands are showing an increase in market share in the U.S. And finally, questions continue to persist about advances in technology, especially as they concern the new hybrid models. John Paul MacDuffie, a professor of management at Wharton and co-director of the International Motor Vehicle Program, spoke about these issues with Knowledge at Wharton’s Mukul Pandya and Robbie Shell.

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John Paul MacDuffie podcast transcript: Car Trouble: From Higher Gas Prices to Hybrids and More…

Almost anyone who has been following the auto industry, especially in the US, will agree that lately, it’s been a very bumpy ride. For one thing, the difficulties of GM and Ford have filled the headlines for several months now, and there’s been lots of speculation about how severe these problems are. To add to those difficulties, the auto part maker Delphi, which was spun off from GM in 1999, is also in the midst of bankruptcy proceedings, and is engaged in active negotiations with both the United Auto Workers Union and with GM. Yet another challenge is growing global competition: Virtually all the Japanese brands are showing an increase in market share in the US.
And finally, questions continue to persist about new technology, especially as it concerns the new hybrid models. John Paul MacDuffie, a professor of management at Wharton, spoke with Knowledge at Wharton’s Robbie Shell and Mukul Pandya
about these issues.

Knowledge at Wharton: Let’s start with GM and Ford. How unusual are their troubles? After all, auto company crisis are not that rare. From Chrysler’s near bankruptcy in 1979 to the present day, many companies have had sales slumps and severe financial difficulties. What’s going on?

John Paul MacDuffie:
Well, the auto industry often does see quite dramatic swings in competitive fortunes. It’s not unusual to see headlines of crisis followed a couple of years later by headlines of return to profitability and strong sales.

Often one or two hit products can often make the difference. Chrysler, which a couple of years ago seemed to be risking one of its nine lives on difficulty again, has come back quite strongly, but there are some differences in the current situation.

Right now, GM and Ford are still very heavily dependent on big SUVs and trucks, so products that are out of sync, certainly, with current energy prices and maybe with some of consumer preferences. Competitors have SUVs and trucks also, but they maybe have a more diversified product line. This has happened before, that the American companies have been out of sync with consumer demand, but that’s nothing that you fix that quickly. It takes time to get new products into the marketplace, and in the meantime, you may lose some consumer loyalty.

Another worrisome sign for GM and Ford is that they may lose some loyalty from American consumers who have been loyal up until now. There are many competing automakers building in the US that aren’t seen as so foreign anymore. A lot of consumers are ready to try an import model from a Japanese, a Korean, a German maker, and then they like what they find, so then they may not have reason to come back when the product lineup matches better.

Finally, I’d say that GM and Ford are trying to wean themselves, right now, from these very high rebates that have been a characteristic of the US auto market. They started in order to try to boost sales during the slow economy after 9/11, but rebates reached as high as $4, 000-5, 000 a vehicle, slicing profit margins to a very, very thin level.

So, to try to back away from those is a sensible move, it’s probably long overdue, but coming at a time that gas prices are so high and they don’t always have the products, this means they’re losing quite a lot of market share. To give up market share in favor of profitability, again, you could argue it makes some sense, but at a certain point, getting smaller makes everything more difficult for them, in this industry where economies of scale still matters.

Knowledge at Wharton:
Looking at Delphi’s negotiations with the UAW and GM, what are the implications of this three way dance, for each of the three parties, and for the US auto industry in general?

John Paul MacDuffie:
Well, Delphi’s fate really is very intertwined with both GM and the UAW. The wage issues and the struggle with the union over labor costs have gotten the most attention, but also in bankruptcy court have been some days of testimony about all the contracts Delphi has with GM on which they lose money, thousands and thousands. So this again grows out of their history, from being spun off from GM, feeling a need to continue to supply GM even at these losses.

Part of what Delphi needs from GM is a summary negotiation of those contracts, just as they need renegotiation of wage costs with the UAW, so there are these three way talks going on. GM bears some responsibility on the labor side for Delphi workers, as well, so they can’t simply let that play out independently. I’ve been relatively optimistic, given the stakes, that the parties will find some solutions. But things move quickly, and I’ve seen some headlines recently that GM is refusing to negotiate a number of the contracts, the UAW has now held strike authorization votes at the Delphi factories, and the pace is increasing. The bankruptcy judge is sitting, waiting to hear the case that the labor contracts should be invalidated completely.

Circumstances may escape the parties ability to reach a positive resolution. If Delphi takes a strike from the UAW, it probably shuts down GM factories almost immediately. In GM’s weakened state, perhaps that hastens their slide towards bankruptcy, so it’s a very precarious situation.

Knowledge at Wharton:
Let’s turn now to the Japanese brands, whose market share in the US is increasing. Are we seeing a replay of the late 1970’s and early 1980’s with high energy prices driving consumers away from the big gas guzzling American made products towards fuel efficient Japanese models? What’s different?

John Paul MacDuffie:
There are some resemblances, and it is quite striking that the US industry became so dependent on products that consume large amounts of gasoline and really aren’t sold anywhere else in the world except the US.

If you frame it that way, it sounds a lot like the 70’s. But, one of the things that’s different is at that time, the foreign competitors offered the small, fuel efficient vehicles, but that’s really all they offered. So there was a large part of the market that the US companies still had to themselves, and as soon as they were able to offer some small, fuel efficient vehicles, which they did partly with partnerships with Japanese firms, they were able to recover quite well.

Now, the US companies face strong competitors in virtually every product category, and in fact, part of what’s striking is that sometimes the winner in the horsepower races these days, you know, who has the biggest engine and most powerful vehicle in a category, is a company like Nissan, which has set out to distinguish themselves on that basis.

Everyone, in a way, has rushed to more power and worse fuel mileage; that’s what consumers seem to be responding to. I do have some sympathy when the automakers say, look, all we can do is make products available and see what sells, and that’s what we’re stuck with. The Japanese have maintained more strength in passenger cars, and more strength in the smaller, more fuel efficient products and that’s helping them at this time.

Knowledge at Wharton:
In almost every industry, the big question everyone faces is China. The South China Morning Post reported this week that China has set an annual growth rate of 40% for vehicles, parts and components. How do you see the role of China and it’s effect on the global auto market?

John Paul MacDuffie:
China is huge and it’s probably the preoccupation most on the mind of auto executives all over the world, I find. There are both the issues of the growth of the domestic China market, which is what you referred to, and then their possible threat as an exporter of vehicles. Not to mention, the thing that’s been true for a while, which is they are the world’s manufacturer of lower cost parts. So, the bankruptcies of US suppliers are in many cases directly attributable to the fact that the growth has been so strong out of China.

If you look just at their domestic market, that rate of growth is really staggering, and of course everyone wants to be part of growth like that, because the developed countries are relatively low growth, fairly stagnant. Volkswagen has been in China for a long time, and for a long time, they seemed to have a real persistent first mover advantage, but that has changed rather rapidly in the last couple of years.

Also, General Motors had a few years of quite strong success with a big Buick, which is not exactly what you’d imagine would sell well in China, but to a particular class of consumers it sold very well. The price of car loans has gone up because of bank raising interest rates, the cost of fuel has gone up, and most importantly probably, competitors, particularly actually Hyundai, from Korea, have moved in with very popular models. The Japanese are not far behind.

We’re seeing an explosion of demand in the small car end of the market, where you would kind of expect it. It may just mean that the purchasing power of that very large mass of consumers is reaching the point that a private vehicle is something they can contemplate.

So, the domestic drama will keep the industry busy for a while, and the Chinese national manufacturers will also be trying to capture their share of that. Some of them are quite good, quite sophisticated.

It will probably slow up their attempts to sell products outside of China, because it’s important for them to grab a piece of the exploding domestic demand, but it won’t be long before we see Chinese products for sale in the US.

Knowledge at Wharton:
Turning now to hybrids, after the initial flash of enthusiasm about hybrids, first from Toyota and then from Honda, Ford and others, we’re now hearing about a bit of backlash, or at least skepticism.

The strongest refrain seems to be that consumers who spend the extra money for a hybrid won’t ever get it back in savings at the gas pump, even with higher gas prices. Is this critique warranted?

John Paul MacDuffie:
Well, certainly if you just look at a payback period, even with higher gas prices, I would say, it’s not that you’ll never get it back, but it will take a number of years.

Many consumers, faced with $2, 000-3, 000 higher purchase price, won’t want to wait to get that savings back. So the real question is, how much is that the basis for people making this purchase decision.

Of course, probably the best way to lower your gas consumption is buy a smaller, fuel efficient vehicle; it doesn’t have to be a hybrid. Switch from an SUV to a sedan. A lot of people don’t want to do that, so they want to stay with the kind of vehicle they want to get, and then they hope for some better mileage. If they’re not so price sensitive, those consumers might not mind buying a hybrid, which after all is also kind of cool and trendy and is helping the environmental impact over the long run.

I saw a nice quote recently which is an interesting kind of analogy: Do people buy global positioning navigation systems for their cars, hoping to save in the cost of paper maps? If so, it’ll take them a long time to make up for those. Well, of course not, that’s not why they’re buying it, and so it’s part of an education process for people about this new technology, which is appropriate.

The last thing I’ll say is that, let me just use Toyota for an example, their first hybrid, the Prius, obviously was marketed very heavily as a very fuel efficient green vehicle, and already there are people out there passionately trying to push their mileage up to 60, 70, with all sorts of clever driving tricks. But the next product that was a hybrid was an SUV, a medium sized SUV, both the Lexus and the Highlander.

Their design of that engine doesn’t improve gas mileage that much, but what it does allow them to say is that you’ll actually get better engine performance from your hybrid than you would from the V6 gasoline engine that you would have bought otherwise — better torque, a bunch of better characteristics, it’s almost like getting a bigger engine.

They’re obviously not trying to reach the green, environmentally conscious buyer with that: They’re trying to make sure that nobody can say, those hybrids are O.K. But you can’t tow your boat anymore because the engine isn’t powerful enough.

I see it as kind of a strategic bid to widen the market for these drive trains, and the widening is really not going to be based exclusively on arguments about saving on gas prices.

Knowledge at Wharton:
Also, people don’t want to have to go to the gas station that much and keep filling up. That’s one of the appeals of hybrids for many people. [They can avoid] those trips every Monday morning to fill up before going to work.

John Paul MacDuffie:
Depressing experience these days.

Knowledge at Wharton:
Carlos Ghosn, the CEO of Nissan, said recently that Ford’s increased incentives on hybrid vehicles proved that demand for hybrids is slipping. At the same time, Nissan still plans to release a hybrid version of the Ultima this year. What’s going on here?

John Paul MacDuffie:
Carlos Ghosn has been very clear in his view of hybrids. He said, it’s one of a number of technologies to try to achieve some energy savings.

In Europe, there’s probably more excitement about what can be done with diesel engines in terms of fuel economy. He said Toyota gets a big advantage from being the first mover in this, but for us to invest tons of money in coming up with our own hybrid, as the second, third, fourth mover in the market, we’re not going to get very much benefit from it.

On the other hand, we can’t completely say to our customers, hey, we don’t have any hybrids at all, so we’re going to be practical, and we’re going to license the technology from Toyota, we’re going to offer it. But strategically, he feels its by no means obvious that that will be the dominant intermediate technology, lets say, in the period up till fuel cells, which is still 30-40 years off.

Knowledge at Wharton:
One final question: imagine, if you will, instead of Robbie and me sitting with you at this table, that you actually have the CEOs of GM, Ford and Daimler Chrysler sitting here, and they are asking you your advice about what their competitive strategy should be over the next 3-5 years. What would you tell them?

John Paul MacDuffie:
I would probably start by saying I don’t envy them their jobs. Being the head of a global automaker these days, is one of the most complicated jobs out there. So many expectations on so many fronts from such a wide range of constituents.

There’s a couple of things that would not strike them as novel but is probably always worth saying: All of those companies have had moments of seeming to forget some of the basics. All of them have had periods of quality going downhill, at least for certain models. I’ve come to thing that quality is an issue where if you’re not focusing on it and moving forward on it, you’re likely, actually, to be slipping and going backwards. Consumers today simply won’t tolerate that: There’s too much information out there, people’s expectations are too high.

So there’s a lot of blocking and tackling basics in this industry that you really have to maintain excellence in it or you start to be at a disadvantage. They would know that, but it’s much easier to say than it is to do.

Some of these recent developments show the wisdom of product diversification strategy; not putting all your eggs in one basket. All of the American companies fell victim to the lure, the siren call, of these very profitable big SUVs and trucks. I’m sure there was somebody saying, you know, some day gas prices are going to go up, or tastes are going to change, maybe we ought to make sure we’ve got a good strong passenger car lineup.

Those calls were largely ignored, because the profits were too tempting. And really the US had a bit of a protected niche for a while — It’s logical to take advantage of that as long as you can, but you ought to be planning for the day when that advantage disappears.

Being a global automaker is a very complicated issue. There are some challenges in having strong global supply chains, for example, in figuring out how much do you do in China, how much do you do in eastern Europe, other low labor cost places, how much do you try to keep your business with technologically innovative suppliers who are located close to you, so you can have a lot of interaction.

Working on the relationship, the automakers, with the first year suppliers, who are increasingly large and technologically sophisticated, working with them to really involve them in the innovation and product development process. It’s a big change for the industry; neither party is maybe quite ready for it, but that’s worth a lot of attention.

There are habits from the past which tend to focus that relationship on price negotiations and a lot of adversarialism, a lot of fist banging on the table in cost negotiations, and it’s time for the industry to find a way to move past that.

The last thing I’ll say has to do with talent and human resources. To be a truly global company means finding and developing and utilizing talent, executive talent, engineering talent, wherever you can find it in the world and wherever you need it.

This is a challenge for every company. I worry for Ford and GM that their recent troubles have caused them to lose talent. People have wanted to move to other companies. Hyundai has been very aggressive at hiring talented engineers away from American companies, but Toyota, Nissan, Honda have also done it. Toyota is working very hard to globalize their management structure. They’ve been accustomed to having a strong enough cadre…