Will Obama Administrations Policies Bankrupt General Motors Afterall?

The reason GM might be heading toward its doom again is that its very savior – the Obama administration – might in fact have set it up for failure.

Here’s how:

The fact is that GM – like other American automakers – has had a hard time competing with its Asian and European rivals in the compact and the mid-size market. That’s because its market incentives have been very different from theirs. Thanks to shorter driving distances, narrower roads and relatively high gas prices, foreign makers’ home consumers are attracted to smaller cars — making this segment their core strength. Not so in the good ole U.S. of A where the core strength of American carmakers has been large, gas-guzzling trucks and SUVs.

Americans are naturally drawn to these cars for a whole host of reasons including relatively lower gas prices that haven’t made them prohibitively expensive to drive in the U.S. But the other big reason why SUVs are so important to American car makers is government policy, specifically CAFÉ (Corporate Average Fuel Economy) standards. These standards were meant to diminish gas consumption and reduce America’s dependence on Arab oil – the eternal boogeyman of American foreign policy. But they have – and this will come as a complete surprise to H&R readers! — done the exact opposite!

That’s because when CAFÉ was originally formulated in 1979, it imposed stricter gas mileage standards on cars than on light trucks. So American carmakers did the rational thing and started using the light truck designation for SUVs to escape the CAFÉ noose. The upshot was that in America, the market share of “light trucks” – aka SUVs — grew steadily from 9.7% in 1979 to 47% in 2001 and remained in the 50% territory till 2011. Given that SUV’s constitute a far bigger share of the American market than the D-segment, it is a bit odd that Woodhill’s analysis focuses mainly on the D-segment, completely ignoring SUVs. This omission is particularly curious given that American carmakers have far greater per vehicle profit margins on SUVs – GM on average makes $5,000 per SUV – than on smaller cars. Indeed, GM for the longest time has relied on sales of its full pickup trucks for a major portion of its US revenues and operating profits.

So the big question is how is the SUV market evolving and how will it affect GM’s survival going forward?

Not well. Just as the original CAFÉ standards created the SUV market, the Obama administration’s new rules might destroy it — and with it GM’s core strength.

The Bush administration started closing the SUV loophole to prove its commitment to reducing America’s dependence on foreign oil after its Iraq misadventure. In 2007, it mandated national fuel economy standards of 35 mpg — a 40% increase – by 2025, something that its own estimates suggested would cost the industry $85 billion. It started scrapping the car/light truck distinction, requiring carmakers to post overall gains regardless of vehicle category. In theory this gave American car makers more flexibility to meet the new mandate, but in reality the mandated fuel efficiency increases were so onerous that American automakers couldn’t squeeze them all out of their small cars and had to tinker with their SUV technology, diverting precious R&D dollars from what Americans consumers really want – greater horsepower.

But the Obama administration is now driving a Tahoe through the opening that the Bush administration created. It has upped the 35 mpg to 54.5 mpg by 2025. This is higher than the 50 mpg that the Prius currently delivers. There is no engine anywhere on the horizon that could deliver that kind of gas mileage. So American carmakers are making heroic efforts to redesign the rest of the vehicle to get to that target.

The Wall Street Journal reported recently that Ford is gambling on an all-aluminum body for its iconic F-150 pickup trucks, something that will make the vehicle lighter –not to mention costlier and deadlier – to meet the Obama mandate. (F-150 is the world’s most profitable line today. But whether it will remain so after it switches to aluminum which will jack up per vehicle cost by at least $1,500 is completely uncertain.) Meanwhile, GM is opting to produce two different trucks – one full-sized and high-powered and then, about two years later, a smaller truck. Notes the WSJ, the latter:

“won’t be able to haul quite as much gravel or tow as much gear as the bigger model, but GM is counting on it to offer 20% better gas mileage, without the extra cost of heavy use of aluminum parts.”

In other words, GM is making one truck line for its customers and another one for the president. If the president could buy all the vehicles produced for him, GM would flourish. But, if he can’t, he might well deliver GM to bankruptcy’s door yet again.

He might have saved GM from its own incompetence just to kill it with his.

Source: Shihka Dalmia