Friday, May 15, 2009

Cutting your way to greatness

The Big Three auto companies certainly aren’t selling as many cars as they used to. As such, they need to reduce their fixed costs to more closely match their current revenues.

Towards this end, the two sickest “US” automakers are shedding dealers. Thursday, Chrysler gave notices to 789 of its dealers (about 25%) that their contracts end June 9. On Friday, GM gave 18 month notice to 1100 dealers, and is expected to dump another 500 later this year. (GM is also hoping to sell its Saab, Saturn and Hummer divisions, which have their own dealers).

Both claim to have targeted their least profitable dealers. GM said that 18% of its dealers cut account for 7% of sales, while Chrysler says 25% of its dealers account for 14% of sales. GM hopes to cut 42% of its dealers by the time it’s all over. Meanwhile, Ford is also reducing dealers, but in a less confrontational way.

The ailing automakers are in a tough spot. Having too many dealers means that its sales are spread across too many dealers, making it hard for the others to survive. It’s like throwing the sickly out of an overcrowded lifeboat in hope that the rest will survive.

The dealer associations question the logic of the cuts (as in these commentaries in NJ and LA). Dealers are the distribution network for the car companies — more dealers means more sales, less dealers means less sales.

Cutting dealers makes certain assumptions about the substitutability of demand through alternate distribution channels. In some cases, shifting demand is plausible, as when a dealer is closed in a metropolitan areas where the buyer can drive another 10 miles to another franchise.

However, in some cases, substitutability is highly suspect. For example, Chrysler is cutting its only dealer in El Centro, a farming town in Southeast California (population 40,000). Those residents won’t drive an hour to Yuma (or 90 minutes to San Diego) to buy their next Dodge truck: they’ll buy a Toyota or a Ford (or a Chevy if that dealership stays open).

The other problem is that many (or most) of the dealers that GM and Chrysler want to kill aren’t interested in dying. As autonomous economic actors, they are going to find other ways of making money.

Some may become independent used car lots, repair shops, or other auto-related businesses that build on their loyal customer pays and service their previous customers. But clearly some are going to sell new cars for someone else. Multi-brand dealership will just push their other brands; former single-brand locations will be looking for another brand to carry. For example, the (PBS) Nightly Business Report Thursday interviewed one axed Chrysler dealer who’d already signed up to sell Kias.

It’s impossible for a firm to cut its way to greatness: closing dealerships and plants isn’t going to solve the underlying problems. GM, Chrysler (and to a lesser degree, Ford) still have to figure out a way to make cars people want to buy.

At the same time, longer-lasting, high-quality cars mean that per capita auto sales may never return to the levels demonstrated in the 1990s. US sales (for all makers) peaked in 2000 at 17.4 million; early predictions for 2009 were for 11 million units.

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