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Another (mostly) Positive Verdict On The Plan For Detroit

John Paul MacDuffie is an associate professor of Management at the Wharton School, University of Pennsylvania, and co-director of the International Motor Vehicle Program (IMVP). We asked him for his thoughts on President Obama's plan for the auto industry.

The new auto industry plan represents more aggressive action than we've seen before; government isn't just writing checks based on proposals from the automakers. But the new plan still stops well short of true nationalization; government won't be managing these companies. Obama, in other words, has found a middle path. And this is a good thing.
We’ll see how the specifics play out, but I’m glad to see the government challenge unreasonable assumptions in General Motors and Chrysler’s past plans. I’m also happy the government is suggesting that the companies need to change what they are doing, rather than simply restructure their costs to survive the demand downturn. The message to GM to cut brands and nameplates further is a good idea, while the mandate to reduce debt is clearly a message to the bondholders.
There is still nothing about working in a different way with suppliers, which (predictably) bugs me. Nor is there anything about how to deal with the problem of too many dealers.
The overt threat of bankruptcy makes sense, too. It needs to be a credible threat and the best way to make the threat credible is to prepare seriously for it. If the threat works--if the bondholders, the UAW, the dealers, and suppliers make the necessary concessions--the government can always step back from it at the last moment. Meanwhile, the backstopping of warranties mean consumers can feel confident buying Chrysler and GM cars, no matter what happens to the companies.
I was pleased to see a bunch of language recognizing the price problem of the US automakers. It should be a small step to recognizing that suppliers are part of solving this (although I’m not holding my breath). The persistence of quality problems, particularly at Chrysler, also gets appropriate emphasis.
So what are my main worries? Supporting the Chrysler-Fiat merger is still questionable, in my view, and my biggest concern is how much everything is premised on economies of scale arguments. It’s not simply clear that smaller companies do a lot worse than big companies in terms of their cost structure.  
First, even the smaller auto companies are at a high enough level of scale to surpass the minimum efficient threshold--the level of volume at which industry-standard efficiencies can be attained--certainly in manufacturing and supply and possibly even in product development. (Smaller companies may need to rely more on supplier-developed designs).  
Second, there are diseconomies of scale, not to mention problems with coordinating efforts across companies with very different routines, cultures, etc. Chrysler’s past experience with Daimler, GM’s with Fiat, and all the other past combinations justified by economies of scale should raise real alarm bells here. Not to mention that with suppliers so beaten down by past price cuts, there isn’t much of anything left to squeeze out of them, even assuming the leverage of greater scale in purchasing. Call this a non-economy of scale at the present time.
Third, even the use of common parts across similar products, as another way to get scale benefits from an alliance, can take years. (Right now, Chrysler’s product portfolio doesn’t overlap with Fiat’s, but let’s imagine that they would argue this is a future benefit of their tie-up.) The Renault-Nissan alliance, one of the few that can be judged successful, took five to six years to get the point of having the same parts used in different products built in different factories. If the parts are different and alliance partners simply shift to using the same supplier, the savings are relatively low; working out the engineering and tooling for actual parts sharing is much more difficult and much slower. So any benefits from scale economies of this sort wouldn’t help Chrysler any time soon.
It might be premature in terms of enacting policy, but I’d like some recognition of a point we made in the memo from the International Motor Vehicle Program--that a greater supply of fuel-efficient cars won’t necessarily be enough to prompt demand for those vehicles. Over the long run, we need to give both automakers and consumers a credible reason to prepare for higher gasoline prices in the future--and, as a result, to shift their purchases towards fuel efficiency. Truck/SUV sales once again passed car sales in January, because of low gas prices (although it’s partly because the Detroit Three keep increasing their incentives on these vehicles to clear their inventories).
There are also a bunch of potential risks with “scrapping clunkers” and no agreement on whether they achieve the long-term goals of reducing emissions. That said, the programs in Germany and France have certainly pumped up small cars sales in the short term.
Finally, I’m mindful that this is really the first time that we are seeing any Obama Administration policy on the auto industry; the Bush Administration set all the previous requirements. I was impressed with Obama’s (and the task force’s) attention to the symbolic aspects of Monday’s announcement: the emphasis that these companies failed to prove financial viability; that they failed to meet the TARP loan conditions; that the failures were those of leadership; the Wagoner resignation; the protection of consumers; the steps to address the disproportionate impact on certain states and communities; and the strong words of being completely committed to having a viable US industry at the end of this process.

--John Paul MacDuffie