Fuel Economy and Fixing Detroit

Study finds that an industry-wide mandated increase in fuel economy 35-40 mpg would increase Detroit automakers' gross profits by $3 billion annually.

Published: 23-Jun-2009

ANN ARBOR -- As the domestic automobile industry struggles to address the worst financial crisis in its history, a new report released today by the University of Michigan Transportation Research Institute (UMTRI) analyzes critical choices faced by automakers and finds that broad, deep, fast change is necessary for success.

According to the report, "Fixing Detroit: How Far, How Fast, How Fuel Efficient?" successful turnarounds hinge on rapid cultural transformation, which requires replacement of management teams. Further, the report finds that the existing culture within the domestic auto companies systematically underestimates the value of fuel economy, which has crippled profitability.

Modeling the impact of increased fuel economy standards, the study finds that an industry-wide mandated increase in fuel economy of 30 percent to 50 percent (35 miles per gallon to 40.4 mpg) would increase Detroit automakers' gross profits by roughly $3 billion per year and increase sales by the equivalent of two large assembly plans. The chance that increased profits could exceed $6 billion is 18 percent if fuel economy standards were increased to 40.4 mpg, but only 6 percent if standards remain at the mandated 35 mpg.

"Our findings support rapid, wide-reaching change in business models," said Walter McManus, director of UMTRI's Automotive Analysis Division and co-author of the report. "The key to a long-term recovery is executing an excellent portfolio of products, and we find that increasing fuel economy standards will lead to a portfolio of products that is more likely to raise the profits of the Detroit 3 automakers than to lower them."

Rob Kleinbaum, former GM employee and consultant and report co-author, said the industry attitude about fuel economy is symptomatic of its current culture.

"For years it has discounted consumer research results when calculating the benefits of improving fuel economy, often by as much as two thirds," he said. "If GM had followed its own market research results over the last three decades, they would not be in Chapter 11 today."


Speed & Scope

The report analyzes extensive literature on the successful turnaround of six international companies of comparable size, diversity and distress to the domestic automobile industry. Research revealed universal approaches critical to success:

Fuel Economy

The report models the impact of three different fuel economy standard increases -- 30 percent (35 mpg), 40 percent (37.7 mpg) and 50 percent (40.4 mpg) -- on the profitability and sales of the industry and separately for the Detroit 3, the Japan 3, and all others. The model captures the cost of fuel economy improvement on suppliers, its impact on pricing and the resulting changes in demand. The inputs to the model are the most recent and accepted estimates of all the key parameters, but since there is debate on many of these values, the report conducts an extensive sensitivity analysis on the results.

Modeling results include:

The value given to fuel economy by automakers has critical impact moving forward. According to the report:

In a sensitivity analysis conducted on inputs to the model, the report finds:

The new report builds on studies published by UMTRI beginning in 2005 predicting that the three biggest domestic automakers stood to lose billions in profits and thousands of jobs in the event of an oil spike -- a prediction borne out as Hurricane Katrina and tensions around the world sent prices skyward. The studies documented the financial risks to Detroit automakers and the risks to American jobs of higher fuel prices, and predicted that gas prices more than $3 per gallon could lead to combined losses of $7 billion to $11 billion of profits for Detroit automakers.

By the time gasoline prices spiked to more than $4 a gallon in July of last year, Ford and GM had already reported combined losses on their automotive operations of more than $57.2 billion. And through the first quarter of this year their cumulative automotive operations losses since 2004 total $83.6 billion. In addition, they have lost 14.2 points of market share since 2004 (GM down 8.8 points and Ford down 5.4 points).

TO ACCESS THE REPORT: http://deepblue.lib.umich.edu/bitstream/2027.42/63024/1/102298.pdf

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