Demand and the Dollar

1
Demand and the Dollar

• Dynamics in a Six Firm Global Automotive Industry
• October 10, 2002

2
Overview Motor Vehicle Real Output 1990 - 2002
3
Auto Demand in the US is Saturated
4
But, Saturation Can be Linked to Favorable
Economic Conditions
5
The Surging Stock Market Pulled in Capital to the
US, Which Created Strong Demand for the US Dollar
6
The US Dollar Represents a Major Economic Force
Compelling Adjustment in the Auto Industry
7
US Production and Trade in AutosOriginates from
Four Principal Sources Canada, Japan, Mexico,
and Germany

• In 1990, the Canadian dollar traded at less than
  1.20 to the US Dollar. In 2002, it trades
  around 1.60.
• In the case of Japan, there was appreciation to
  84 yen/ in 1995, depreciation to 133 yen/ in
  1998, appreciation to 102 yen/ in 2000, and
  depreciation to around 132 yen/ in 2002.
• The Mexican peso suffered a sudden depreciation
  in the 1995 Mexican financial crisis. In 1994,
  the peso traded at 3.4 pesos/. In 1995, the
  crisis forced the peso to trade at 6.4 pesos/.
  The peso continued to depreciate until 1998, when
  it reached 10.2 pesos/. The peso now trades
  around 9 pesos/.
• The German mark fluctuated in a narrow band
  around 1.6 marks/ until 1997. Then, the mark
  depreciated consistently against the US dollar.
  In early 2002, the mark traded at 2.25 marks/.

8
As the US Dollar Strengthened, Auto Pricing
Collapsed
9
Volkswagen Operating Margins Show the Linkage to
the Exchange Rate
10
Weak Pricing Has Forced Automakers to
Restructure Costs and Increase Quality
11
History Lesson A Strong Yen Precipitated
Flexible Manufacturing Systems

• Yen appreciation against the US Dollar was the
  case in the late 1980s and early 1990s, when the
  Japanese stock market and economy was surging,
  drawing in capital
• Yen appreciation brought Toyotas operating
  margins to a low of 0.94 in 1994
• Toyota and its Japanese peers were forced to
  restructure to lower costs and improve quality
• Honda and Toyota also re-located production from
  Japan to the US, Canada, and Mexico

12
Restructuring to Flexible Manufacturing Will
Increase New Product Introductions

• 2002 Model year - Fifteen new SUVs
• 2003 - Nineteen new SUVs
• 2004 and 2005 -Twenty-seven new SUVs

13
Flexible Manufacturing Will Speed the Replacement
of Models

• By 2005, Japanese makers expect to replace 91 of
  volume over the four model years from 20002 to
  2005
• Over the same period, a Daimler-Chrysler expects
  to replace 83
• GM expects to replace 68
• Ford expect to replace 67

14
Nissan Specialized on Assembly to Lower Costs
15
Toyota Focused on Metal Stamping
16
Honda, Not Surprisingly, Focused on Motors
17
Existing Labor Productivity Differences Suggest
There is Room to Run in Restructuring Domestic
Production
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Summary Much like Japan in the Late 1980s and
Early 1990s, a Surging Stock Market and Strong
Economy Brought Capital Flows into the Country.
This Sent the US Dollar Appreciating Against the
Four Currencies That Matter to the Auto Industry
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The Auto Industry A Modest Optimism is Warranted

• With a surge in new products, especially in the
  compact and small SUV arena, and a strengthening
  North American economy, expect output growth to
  continue to be strong.
• Tough pricing pressure will be the norm for
  nearly all products in this industry
• Profit margins will be adequate for those who
  have undertaken cost restructuring.
• Restructuring has permanently reduced demand for
  labor for both motor vehicles and parts
  producers, and has led to a surge in new capital
  expenditure since 1997

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A Modest Optimism is Warranted (2)

• Restructuring now involves all the major domestic
  producers.
• Domestic producers have been forced by the strong
  US dollar to follow the lead of successful
  flexible manufacturing restructuring programs
  undertaken by Japanese companies in the middle
  1990s.
• In this game of exchange rate driven leapfrog, it
  could soon be the European-based competitions
  turn to reinvent the manufacturing processor
  suffer a decline in profits.

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A Modest Optimism is Warranted (3)

• Auto trade deficits with our major trade partners
  are related to an overvalued dollar.
• Depreciation of the dollar creates relative price
  advantages for domestic production of motor
  vehicles and parts, and will compel a continued
  shift of productive assets into the domestic
  market
• Dont expect the trade deficit in vehicles and
  parts to disappear, but the trade deficit will
  shrink

22
A Modest Optimism is Warranted (4)

• Demonstrated strong growth in trade with Canada
  and Mexico in the 1990s was mostly a result of
  strong US motor vehicle demand in a time of
  prosperity
• Strong growth in Canada and Mexico trade was also
  related to an overvalued dollar
• The primary benefit of NAFTA was to increase
  exports into Mexico from the US

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A Modest Optimism is Warranted (4)

• Overcapacity and rationalization was the
  condition of the industry in the 1980s. Capacity
  additions returned in the 1990s, particularly
  since 1997.
• Expect measured increases in capacity by all
  producers, particularly if the economy shows
  strength
• Domestic motor vehicle production is now one of
  the most concentrated sectors of the economy.
  Dont expect any big domestic motor vehicle
  mergers.
• Parts components with high profits and
  demonstrated growth are also relatively
  concentrated, but still have modest room to run.

24
A Modest Optimism is Warranted (5)

• Mergers over the last four years suggest the
  expansion priorities of market participants.
• Ford, GM, And Daimler-Chrysler intend to expand
  in Asia. They will apply resources until sales
  grow toward their US and Europe market levels.
• The Japanese, particularly Honda, will continue
  to work at turning in a big sales success in
  Europe.