The Big Three have turned around their sad-sack product lineups, culled brands, slashed costs and largely restored their relevance to American car buyers, to the U.S. manufacturing economy, and to the culture at large. But in addition to the pesky continuing weakness in consumer confidence and other challenges that confront the whole industry, there remains one huge obstacle particular to General Motors, Ford and Chrysler: overcoming their incentive habit for good. Integral to the vast restructuring of the industry over last three years has been the idea that none of them again would succumb to the temptation to lunge at cheap sales for short-term advantage while undermining their long-term profitability and brand equity. They've been able to restore margins at the same time they're gaining market share, and executives now use the term "production discipline" like an industrial-strength mantra — and are sticking with it.
"We've made a concerted effort across all of GM that we're going to be roughly at the industry average" for incentive spending, Kurt McNeil, vice president and general manager of the Cadillac division, told AutoObserver.com. "We'll be competitive, but not [spending] leaders — and we'll stick with that." Added another highly placed domestic marketing executive: "I'll bet a box of doughnuts that GM, Ford and even Chrysler are going to do whatever we can to stick to a low-incentive strategy. Because the reality is that this is the only way they're going to continue to post consecutive quarters of profitability they way they have been doing."
However, now a perfect storm of factors is brewing that will put the newfound convictions of Big Three executives to their biggest test yet: gales blowing in from every direction thanks to the tepid economy, the return to form of Japanese brands pending the final impact of the floods in Thailand, the incipient high-volume ambitions of Korean and German rivals, and the continued relative vulnerability of GM, Ford and Chrysler product lineups to gasoline prices that remain over $3 a gallon. Already, thanks to some of these factors, the Big Three have had to keep pickup-truck sales from wheezing, by rolling out incentives in September that averaged about 30 percent higher than just six months ago. The big question is whether GM, Ford and Chrysler will be able to resist spreading their ancient impulse toward generous incentivizing to the rest of their product lineups, like some contagion, especially if their rivals themselves utilize incentives more than in the past.
Prognostications on the future direction and intensity of incentive spending, in general, are all over the map. "Manufacturers are going to be adding ever more incentives toward the end of the year because everyone is fearful that, as Honda and Toyota come back, they will stall out the momentum of their competitors," said Doug Scott, senior vice president of GfK Automotive, a market-research firm in Southfield, Mich. Dan Montague, an analyst at the Autofacts forecasting unit of Pricewaterhouse Coopers LLP, said, "Incentives will rise; there's no doubt about that. But there won't be any type of incentive war like what we've seen in the past." As Himanshu Patel, a JPMorgan Chase analyst, saw it in early October, incentives are "clearly not" surging. And John Krafcik, president of Hyundai of America, told AutoObserver.com there's "no question" incentive spending will increase. "You'll see lots of manufacturer-driven growth, and deals for consumers will be better."
Ivan Drury, a U.S. sales analyst for Edmunds.com, said, "We expect to see incentives increase again" as Japanese brands attempt to battle back up toward the 40 percent of the U.S. market they commanded before the natural disaster in March — and their subsequent drop to only about 30 percent. Although the strength of the yen versus the dollar will constrain the Japanese from getting too aggressive in subsidizing purchases of their lower-priced vehicles despite newly adequate supplies, Toyota, Honda, Nissan and others "are going to try to make up for lost ground, so we'll start to see their incentives pile on," Drury said.
And specifically, will the Big Three be able to remain on their best behavior for long? Or will their determination waver? Outlooks vary on that issue as well. "Everyone is waiting for that to happen," said Tim Mahoney, chief marketing officer for Volkswagen of America, which has its own self-appointed challenge in increasing its share of the U.S. market over the next several years. "I don't know if it will." George Cook, executive business professor at the University of Rochester and an erstwhile marketing executive for Ford, said that the auto business remains "an industry of habits. If they see that the packages they have don't tend to keep moving market share forward, now that Toyota has come galloping down the highway again, they'll revert. Right now, they're protecting margins, and I don't blame them." GfK's Scott believes that the Big Three "are on a lot surer footing over the long haul about where they want to be on this issue."
Off The Wagon
In any event, while incentive spending may rise around them, there's no doubt that the Big Three will be watching their incentive behavior like newly rehabbed drug addicts on edge to avoid any recidivism. Month to month, even during the recent trimming of industry expectations for 2011, they have been proud to note they've been keeping such tendencies well in check since the Great Recession and U.S.-government bailouts prompted them to shift their business models to demand-pull manufacturing rather than the supply-push paradigm they wallowed in for decades. "We're seeing that incentives in the month of September were actually down a bit from August, and year-to-year, they're still down a bit," said Erich Merkle, Ford's head of U.S. industry analysis. "We're not seeing this rash of incentive spending that some folks have been talking about."
There are several reasons to believe the Big Three will succeed in holding the line on incentives this time around, arguably for the first time in modern automotive history. The fact that they've managed to succeed already is one big argument in their favor. They didn't succumb to the temptation to juice incentives when industry sales faltered in August, nor have they real responded in any significant way to Toyota's assertive incentive programs since last spring. "Summer was filled with lots of potential problems, and the car market navigated through it," noted a high-ranking industry marketing executive.
Moreover, an entire network of accountability on this crucial point has sprung up like a cottage industry around the Big Three's promises. GM executives found that out in January when they juiced incentive spending temporarily, in a short-term play for market share that in part was tied to their desire to hold on to existing customers who may have had a hankering — in the days before the devastating natural disaster in Japan — to defect to Toyota, Honda, or Nissan, or fast-rising Hyundai or Kia. Even though GM's industry-leading incentive explosion boosted January sales by 23 percent over a year earlier, the resulting questions from automotive analysts and press had executives apologizing more than celebrating. "We just wanted to get off to a fast start for the year," Don Johnson, GM's U.S. vice president of sales, explained sheepishly.
More important for the long term, of course, is that GM, Ford and Chrysler no longer have compelling financial and operating reasons to overdo incentives. The Big Three have slashed their overall U.S. production capacity over the last three years, and have restructured their labor economics, which have dramatically dropped their breakeven points, restored profitability, and vanquished the old paradigm in which executives felt keen pressure to "move the metal" at nearly any cost just to have an outlet for their excessive output.
Another major new advantage for GM and Ford, especially, is their new competitiveness in the small-car segment where they were barely representative for decades. GM has replaced the Chevrolet Cobalt with the Cruze compact, the tiny Korean-built Aveo with the soon-to-be-launched Sonic subcompact, has added the Chevrolet Volt for interest, and also will be introducing a new Buick compact, Verano. Meanwhile, Ford has scored big hits across the segment with the new Ford Focus, Fiesta and Fusion. Moreover, the Big Three have been leading the way in heavily "contenting" even their small cars in ways that tend to de-commoditize them — and, among other things, make them less vulnerable to incentivizing. "Instead of spending on incentives, they're putting more into the cars and selling them stronger on their natural attributes, the advanced standard features and options" such as Ford's Sync system, Drury said. "I wouldn't be surprised to see that continue to hold true."
Still another reason to maintain faith in the Big Three's intentions is that they continue gradually to wean themselves away from their long dependence on sales to daily-rental vehicle fleets. In the past, the price-leveling effect of relying on Hertz and Avis for sales continually would exercise an undermining influence on automakers' prices in the retail market as well. "Chrysler, especially, has begun to wean itself away from these rental fleets," Scott observed.
Of course, the "Big Three" don't operate monolithically in regard to incentive spending any more than they did recently, for instance, in agreeing with the United Auto Workers on proprietary wrinkles in the companies' individual new labor pacts. So it's clearly possible that the pressures to open the incentive spigots will fracture the relative solidarity of the Big Three on this issue. Chrysler remains most vulnerable to such forces. The company managed to survive 2009 and much of 2010 largely because of bargain-basement fleet sales and industry-leading lucrative incentives that helped paper over the hasty attempt to transform Chrysler's product line. But even after new owner Fiat has introduced a number of new and overhauled Chrysler models, the company remains short of full coverage of some important segments of the U.S. market. "Chrysler is the least competitive, especially in small vehicles, so they will have to really discount their stuff the most," Drury said. "They've redesigned and freshened some models, but they're still not the best in most of their segments yet."
Overall, however, executives inside and outside the Big Three are sticking with the "discipline" theme like a football coach who has found a new formula for winning and would be foolish to give it up for the old playbook once again. Or, to use another metaphor, "Once you start that again, once you put that needle back in your arm, you're basically back on an incentive high again," one executive said. "And you may never get back off it."
The Big Three have stepped successfully through a window of opportunity in 2011, picking up sales, market share, momentum, and even favorable new labor contracts. But can they take bigger advantage in a way that will reshape their fortunes, and the U.S. auto market, for the long term? Are GM, Ford and Chrysler capable of leveraging their new advantages in product balance, profitability and marketing into a reversal of decades of relative decline? "Rising" a new series by AutoObserver, looks at their chances.