The Scoop — and the Squeeze — on Automaker Profitability

As we prepare for the automakers to announce third quarter earnings, it is worth stepping back a moment to ponder what these reports are likely to say about the state of the auto industry in general.

Overall earnings are likely to be a surprise — at least for those who have been tracking the headlines as the monthly sales are reported. The tone has been generally very upbeat — so much so that some reporters I have talked with are shocked to learn that, as recoveries go, so far this one has been very modest.

A good comparison would be the period from 1982-1986. Those with long memories will recall that sales in '86 established a new all-time high. This time around, we are still a long way from getting back to pre-recession levels.

But profits have been good. As sales continue to recover, albeit slowly, one could be forgiven for assuming that profits should be climbing as well. We will find out for certain over the next few days, but I expect profits to be flat — even down for many automakers.

One obvious reason is the mess in Europe. The US market went through a partial restructuring during the downturn. Europe is still locked into a mode with far too many factories, producing too many vehicles for too few buyers.

Growth overseas is slowing markedly. Even China — a bright spot recently — is shining a bit less brightly.

That brings us to the United States. Since the recession, the US market has been less competitive than one would normally expect. For example, last year's earthquake in Japan triggered a shortage of product. This allowed all automakers to hold firm on pricing, which directly links to strong profits.

This year, automakers have been pushing sales a bit harder. Fleet delivers are up. More importantly, incentives are climbing. Often this is hard to track directly as the car companies are getting very creative in how to manage their incentive investments. One place incentive costs will be sure to go up is as a drag on profitability.

Competition is really the issue. Globally, the US is looking like a very attractive market — at least when compared with other markets. Toyota and Honda are pushing hard to regain lost momentum. VW is on the march toward its widely proclaimed goal.

In short, profits are likely to be getting squeezed. And the squeeze is likely to be getting tighter.