APRIL 2004

U.S. Auto Sector Outlook

In the March 2004 issue of the Chicago Fed Letter, Federal Reserve Bank of Chicago senior economist Thomas Klier outlines the proceedings of a conference sponsored by the Bank last November. The conference brought together over 80 auto industry experts in order to assess the outlook for the U.S. auto industry and the impact of changes in the industry on the Midwest economy. Issues of interest included: 1) identifying the key market participants; 2) describing the different operating practices of these manufacturers; and 3) tracking the changing location of industry activity.

More than 1.3 million workers nationwide are employed by the auto industry and industry output represents over 3 percent of the U.S. economy. The traditional industry represented by the Detroit-based Big Three automakers (General Motors, Ford, and Chrysler) has lost market share to foreign companies (several of which operate "transplant" factories in the southern U.S.). Import sales represented 12 percent of U.S. light vehicle sales in 1996 and 20 percent in 2003—a "trend...partly driven by exchange rate movements." In addition, several foreign producers now offer a full range of vehicles that includes SUVs and full-sized trucks. The combined market share of traditional domestic models has declined from 73 percent of sales in 1996 to 60 percent in 2003. The introduction of new products by foreign automakers "...added significant production capacity inside the U.S." increasing the existing level of excess capacity in the industry.

The Big Three U.S. automakers saw an increase in light vehicle sales during the most recent recession, but those sales came at price—large sales incentives eroded profit margins. Domestic automakers face high fixed costs for labor, plant, and equipment. In particular, labor costs have been rising due to rapidly increasing health care costs that are paid to current workers as well as in benefits to retirees. Given these fixed costs, it proved cheaper to produce and then sell vehicles with incentives than not to produce and shutter plants. By comparison, Japanese carmakers do not face such a cost structure due to their younger and non-unionized labor force.

In terms of the location of U.S. auto production, the trend has been southward. While "Detroit remains the hub of this industry...one-third of supplier plants and one-fifth of assembly capacity [is] currently located in southern states." In 1995, facilities in Michigan, Indiana, and Ohio accounted for 51 percent of auto supplier plants. By 2003, those states’ share had declined to 44 percent. Thirty-three percent of auto parts plants now are located in southern states such as Kentucky and Tennessee. "...[N]ear-term plant closures, affecting approximately 12,000 jobs that are primarily located in the Midwest" were part of the new contracts between the United Auto Workers and the Big Three.

Looking ahead, conference participants discussed a longer-term trend that will challenge the U.S. auto industry. "...[A]n important driver of the increasing global nature of the industry will be growth in emerging markets." Due to income and population growth, "[a]s a group, these markets are likely to account for 90 percent of vehicle sales growth over the next decade." While mature markets have historically been home to a large share of production capacity, a forecast of the distribution of added global automotive production capacity shows Asia (excluding Japan) "...adding 82 percent of the net addition of 8.4 million units..." in order to serve local demand.

Conference participants made recommendations as to how domestic automakers can meet the challenges facing the industry. Noting the fixed labor costs of domestic automakers and the most recent recession’s break in the expected correlation between industry profits and capacity utilization, a new flexible business model was suggested. "Instead of devoting one assembly line to the mass production of one model, companies need to be able to produce several widely different models, based on different platforms, on the same assembly line." This translates into the need for quicker new product development and smaller assembly facilities powered by fewer employees. In order to stem the loss of jobs in the Midwest that are associated with plant closings, it was suggested that states could "...improve the industry mix by attracting foreign supplier companies...."

The director of the Economics and Business Group at the Center for Automotive Research predicted that "...the U.S. market will continue to grow and will regularly achieve sales of 20 million units by 2012." Competition for sales in such a market will be stiff given an industry outlook predicted to include: "...changes in product technology...; further consolidation through mergers and alliances, both at the assembly and the supplier company level"; and "...the current product offensive by the domestic automakers which are launching around 100 new models in the U.S. over the next few years..."