Why the Auto Industry is Struggling in One Sentence
Ford gets 150% of its profits from the sale of trucks, including SUVs. This in itself tells us a great deal about their business. Sales matter a lot, profit, obviously not so much.
In spite of car sales have declining, truck sales in the United States are still booming. A full 70% of the vehicles made by U.S. automakers these days are trucks, either what we would normally consider to be a truck or an SUV, which automakers consider to be trucks as well.
Ford reports that it gets 150% of its profit from their line of trucks and truck-like vehicles. This only can mean one thing, that they are making a lot of money from trucks and losing a lot of money by making cars.
We may rightfully wonder how such a thing could happen, other than the company simply getting blindsided by recent results where people switched from cars to trucks en masse. This hasn’t really been the case though and this really has to more to do with the way cars and trucks are marked up than anything.
The focus of the auto industry has always been on sales, and in particular, market share. Market share is a worthy goal, but any share over and above the point of profitability takes us in the wrong direction, as the goal surely cannot be to lose money on something, or it at least shouldn’t be. We are being greedy when we do this and we get punished for it.
When we do business to seek to earn a profit, as opposed to non-profit organizations, the task is to price what we sell at a level where we can first cover our costs, and then add extra for profit, and we need at least a reasonable profit, otherwise we’d be better off investing the money elsewhere.
We would think that this basic principle of business which is the cornerstone of success in business actually would be at the forefront, but it generally rides in the back seat where car companies are concerned, and sales and market share sit side by side in the front.
Auto makers are involved in manufacturing, and to be fair, you can’t just wave your arm and make changes in your line overnight, but when we see unprofitable models continue to be sold, and in particular, when they are priced at a level where the company takes a loss, or a company insists on having a presence in markets that just aren’t profitable at all, this should raise a big red flag.
Given that the truck/car profit distribution isn’t just a one off and is a real trend actually, without knowing anything else about Ford’s business, we can say with full confidence that they would be better off if they just became a truck company.
Losing Money on Sales Is Something to Eliminate
If 150% of a company’s profits are from trucks, then we know that they are losing quite a bit of money selling cars, and whether or not they should even be doing this anymore becomes an open question. We then need to examine how these losses are distributed, where perhaps they do make money from certain models and not others, but it makes no sense to sell cars at a loss.
An automaker has to sell a certain number of units of a model to be profitable, so this may not just be a matter of their pricing them too low. If they price them in a profitable way, their sales may and likely would be too low to make a go of it, given that competitors may continue to try to undercut them and sell their own vehicles at a loss to win this business.
This is like making a donation to the public though, and while there may be times when an automaker is forced to do this, if they make too many cars that is and have to dump them, but this should be avoided as much as possible and we certainly should not want to make this sort of thing our strategy.
We see this every year though, where automakers have significant inventories that they want to get rid of to make way for next year’s model. It’s nice to roll out new models in a timely way each year, but when we put this ahead of profit, which automakers clearly do, this is clearly a case of profit taking a back seat to sales.
It is hard to imagine how it would not be wiser to look to tailor their production to the market more, and tailor it to the market in a way that they can make money and not lose money on these sales. If you have a lot of this year’s inventory on hand, this means that you have not planned this very well and the solution should not be to dump these cars at an even bigger loss so that you can roll out more that will be essentially sold below real cost as well.
This might seem to be crazy but this is exactly what automakers do, and they especially will not be open to remedial action that involves delaying model year releases. Providing that they could figure out a way to make money from these vehicles under any scenario, which is at least somewhat of an open question, they could put a model year on hold and just sell the vehicles on hand until enough of a need arose to build more.
If someone took over one of these companies and set as the company’s prime goal not ever selling another vehicle at a loss, this would certainly serve to cull the herd. It may very well turn out that a company like Ford should just get out of the car business, and let competitors bear these losses, or they may be able to save a few models that actually make money, but getting rid of losses is the only sensible approach.
This will obviously mean that they will have to shutter some of their production, even a pretty big amount, but given that trucks deliver all of the profit and make up 70% of Ford’s sales, they will at least be at 70% production even if all cars were mothballed.
Oddly enough, automakers will mark up their trucks very highly, especially by offering a bevy of options that can drive the price of a truck into what is considered the realm of luxury vehicles. Truck buyers do seem to be a little different breed and ones that it seems far easier to make money on.
It’s Better to Let Your Competitors Lose the Money
Part of the issue may be that the car market is much more competitive price wise, and in particular, competitors seem to be happy enough pricing them at a loss, and if you don’t do the same, they will win this business.
We should not be willing to do this though, and it’s simply better to let the other guy lose money on sales while you seek to actually make money on them, and losing on a sale should be considered to be a failure. We usually do our best to avoid failures and business losses, but it’s part of the plan with automakers, and this is a real problem.
Since sales numbers are king, this also will see automakers look to take over the world, and if they lose a lot of money in certain markets, they at least made a bunch of sales, so that somehow makes this all right. Maybe you made money in a certain country years ago but have lost a lot since, but if profit isn’t central to your decision making, this can go on indefinitely.
Auto sales rose a lot between 2010-2016, where they levelled off and are still around the all-time high for this even though we’ve dipped a bit below this now. This is not a market that has fallen upon hard times sales wise, but it certainly has profit-wise, and it’s because the business has become even more cutthroat.
If everyone gets cut, all you will end up with is way too much blood on the ground. This is the opposite of the normal collusion that we see when competitors align and look to artificially elevate prices, but this one is competitors acting in a way to artificially lower them.
It is not an easy task for automakers to swallow whatever pride that they have over their sales numbers and cut back on their production enough to increase profit more, as their current operations are geared for a lot of excess and retreating from this is going to cost some real money as well as involve a lot of jobs lost. We shouldn’t want to either make too many cars, or even to employ too many people, as neither are consistent with any sensible conception of how to run a for-profit company.
They can certainly be thankful that they are selling all these trucks and making all that money from doing it, otherwise the industry would be more like Tesla, who can’t get enough back from the sale of theirs and are just sinking further into the mud with each passing year. If you are losing money from selling cars, you have not priced them high enough, and if you cannot sell as many at a higher price, you are making too many of them.
Ford’s net margin these days is only 1.38%. This isn’t just too low, it’s a terrible number and is evidence of how thin a piece that they are willing to shave off for themselves these days. This is including their truck sales with much larger margins, and the margins with their cars is well on the wrong side of zero.
Another thing that automakers need to look at closely is the profitability of their foreign markets. Ford in particular has gotten clobbered by this. Their EBIT margin in North America is a fairly respectable 7.8%, providing $1.9 billion in profit, and Europe is at least delivering positive numbers at 1.3% and $119 million, but things get ugly from here. South America is delivering –11.2%, the Middle East and Africa –8.5%, and the Asia Pacific region coming in at –3.6%. In total, over $300 million has been lost in these three losing regions.
This doesn’t necessarily mean that Ford should pull out of all these regions, but they definitely should look to cut this number down as having a worldwide brand is only a good thing if you’re making money in the markets that you are in.
This can’t be about people not being able to spend as much as we’d like so we just cut them a deal, or seeing our competitor cut people deals to the point where they are losing money on these sales and we decide to join them and lose more on our own.
Ford has been around since the early days of auto making, and old organizations can become married to the past so much to miss even what should be obvious. Sales are king, and will likely remain so for some time, even though we do need to ask ourselves why we would want a sale that we lose money with. Until they can ask that, the deals will just keep coming.
Editor, MarketReview.com
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