Auto Sector: Shakeup Coming?

America’s love affair with the automobile rolls on. It’s plain in the numbers: while other sectors of the economy have spent seven years trying to get back on their feet, auto sales have long since zoomed back to historical peak levels. And they’ll be there for awhile, given the average age of the US fleet. Amid all this success, the sector finds itself close to the center of today’s hottest debate: the future of US – and global – trade. Is the North American auto industry about to see a major shake-up?

This sector is no stranger to shake-ups. First, it is very cyclical. High, long-term capital costs expose the sector to the wild swings in sales that come with recessions. Even the most well-heeled of OEMs experience serious cash crunches during economic downturns. Second, the industry is highly competitive. Titans of the industry have been humbled by intra-industry competition on price, quality, efficiency, technology and increasingly on environmental considerations. Third, more and more the industry is geographically diversified – long gone are the days of one-country, fully-integrated firms. Now, OEMs and their supply chains are seeing a wide variety of countries rolling out the red carpet in an effort to get a slice of the action.

Given these vulnerabilities and the overall importance of the industry, it’s hardly surprising that it is highly politically charged. This was probably no more obvious than the near-death experience of the Detroit Three in the immediate aftermath of the Great Recession, when substantial bailouts were offered to each of them, and accepted by two. It’s not the first time crisis has brought heavy government intervention, but it was probably the closest to the brink that the North American industry ever came.

Thankfully, the crisis is over – sort of. Times are good again, with US light vehicle sales consistently averaging close to 18 million units on an annualized basis. That rivals peak sales in the last economic cycle, so it’s pretty hard to imagine times getting much better. Even so, the trade debate has plunged the booming business into an ideological crisis. The problem? Rust belt jobs, lost during the recession, never to return, juxtaposed with a yawning sectoral trade deficit with Mexico. Americans see billions in announced Mexican investment plans of auto majors and their supply chains, and feel a strong sense of unfairness.

This new wave of ‘America-first’ thinking is not just troubling Mexico; Canadian producers are worried that the ill feelings might also shift our way, forcing, or subtly coercing increased production stateside. Canadians also worry about their existing operations in Mexico, from tier 1 suppliers on down, placed there to co-locate with customers. It has the industry on the defensive, and wondering seriously about it next investment moves.

Is a massive shift in production likely? It’s possible, but hardly a cakewalk. First, supply chains are highly integrated. Firms have spent years honing product quality to rigid specifications, and developing finely-tuned logistics to ensure a minimum of inventory management. This can be disrupted tomorrow, but it takes years to replace. Second, auto producers, their share-holders and customers would all need to agree to absorb the higher relative costs of US-based production. Consumers are unlikely to go along, and shareholders won’t be enthusiastic. Competitors will be ecstatic. And workers in the rust belt will have to duke it out with those in the southern states for the jobs. Third, the US is already faced with extraordinary capacity constraints. Today, the industry is operating at 118% of the capacity used in the 2006-07 period – it’s literally bursting at the seams. Fourth, proximity to technology centers is increasingly important, as electronic features and increasingly smart vehicles are the drivers of modern demand. Finally, today’s auto plants are far more capital intensive than in the past – they simply are not the job machines they used to be. Repatriated investments might not meet the expectations that US voters have.

The bottom line?

Competition has been good for the global auto industry. ‘America first’ policies pose a serious threat to that competitive dynamic in a way that could be very detrimental to the Detroit Three in the medium- to long run. Corporations, their shareholders and ultimately consumers all get this. Logic suggests that current talk about production shifts are really not about an overturn, but a tilt of the table. Let’s face it, Americans’ love affair depends on it.

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