Auto industry consolidation: Putting profits ahead of robust competition

The necessity of industry consolidation has long been a popular idea among auto executives and pundits. The basic argument has been that the automotive industry — both in the U.S. as well as globally — is so capital intensive that only huge trans-national automakers will survive.

For example, a recent Automotive News (2020) editorial concluded that the late Sergio Marchionne was right. In his much-discussed presentation, “Confessions of a Capital Junkie” (2015), the then-head of Fiat Chrysler Automobiles argued that escalating capital needs required industry consolidation.

The Automotive News (2020) editorial acknowledged that shrinking the number of automakers would “mean a less diverse marketplace, or at least one in which the variance between brands and individual vehicles is likely to shrink over time.” However, that was “not necessarily a bad thing” if it led to improvements in the quality of car design. Therein lies the rub.

Elkann echoes Marchionne’s call for consolidation

John Elkann (2015) has echoed Marchionne’s argument. The Chairman of Chrysler Automobiles said he “is convinced that the automotive industry needs to go through additional consolidation because of the rising costs of developing new cars for global markets.”

Elkann gave a specific example of the benefits of consolidation in a letter to FCA stockholders:

“The 500X and Jeep Renegade are very different cars, but they are manufactured in the same plant and share R&D, which reduces the total investment required by 1 billion euros. That is why I’m convinced that the industry needs and will see more consolidation in the future.” (Snavely, 2015)

Sharing platforms, drive trains and even factories can indeed save a lot of money. However, what Elkann didn’t mention was that a smaller automaker could achieve significant economies of scale through partnerships that allow it to retain independence.

Perhaps more importantly, Elkann did not address the potential negative impacts of industry consolidation. As a case in point, the 500X and Renegade are different in only superficial ways, such as styling. Consumer Reports (2019) has given both vehicles fairly low scores because of issues such as excessive engine vibration, mediocre fuel economy and weak reliability.

We have been down this road before

Right now consumers have a variety of much better choices among subcompact sport-utility vehicles. That might not be the case if the U.S. auto industry consolidated to only a few giant firms. For evidence of this, look at the 1950s.

In that decade the U.S. auto industry became an oligopoly, which is a market where only a few firms dominate. In 1949 the Big Three controlled almost 88 percent of the domestic market. By 1959 that had increased to 97 percent. Along the way the number of independent automakers declined from six — Hudson, Kaiser-Frazer, Nash, Packard, Studebaker and Willys — to three (go here for further discussion).

Investopedia summed up why oligopolies can be so problematic:

“The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, which harms consumers. Firms in an oligopoly set prices, whether collectively – in a cartel – or under the leadership of one firm, rather than taking prices from the market. Profit margins are thus higher than they would be in a more competitive market.” (Kenton, 2019)

The negative impacts of Big Three’s dominance were immediate. By 1955, GM — then the largest corporation in the world — had gained enough clout to engage in what critics charged was price fixing. The GM was generating a 25 percent return on its investment — well above the automaker’s own target and the highest return in the U.S. industry (Cray, 1980). Meanwhile, over the next two decades the last of the independents merged or folded. Even Chrysler had serious financial difficulties in the early 1960s and almost went bankrupt in the late-70s.

‘Detroit Mind’ grew out of an oligopoly

As competition declined among the domestic automakers, complacency grew. Journalist Brock Yates quite rightly critiqued what he called “Detroit Mind” — which he saw as a fixation on cars that were “too large, too heavy, too clumsy and too inefficient to meet the needs of the modern driver” (1983, preface).

John Z. DeLorean tried to buck the system, such as by proposing that GM downsize its new-generation of mid-sized cars in 1973. Head designer William Mitchell opposed doing so — and won the battle (Wright, 1979). GM wouldn’t downsize its line up until the late-70s, after an oil embargo and the passage of CAFE fuel-economy standards.

The federal government has attempted to respond to oligopolies and monopolies (dominance by one firm) through antitrust regulation. The failure to rein in the Big Three in the early post-war period is arguably the key reason why domestic automakers were subsequently pummeled by imports.

Will auto industry repeat past mistakes?

One could reasonably argue that this is old news. Foreign competition has destroyed the American oligopoly. Indeed, the auto industry has long since shifted toward an integrated global market in which chastened U.S. automakers may never dominate again (Kannan, Rebibo and Ellis, 1982).

Back in the early-80s automotive experts argued that the costs of competing internationally were becoming so great that within another decade the number of volume automakers around the world would shrink from 20 to six giant transnational conglomerates (Yates, 1983).

That hasn’t happened. Instead, the number of industry participants has expanded due to the entrance of new firms in emerging markets as well as those pioneering alternative means of propulsion. This raises the question of whether it is actually true that automakers need to “get big or get out.” For further discussion, see economies of scale.

NOTES:

This is an updated version of a story first posted May 1, 2019. Market share for brands were calculated from figures listed in Wikipedia (2013) and Encyclopedia of American Cars (auto editors of Consumer Guide, 1993, 2006) 

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RE:SOURCES

• Auto editors of Consumer Guide; 1993, 2006. Encyclopedia of American Cars. Publications International, Lincolnwood, Ill.
• Automotive News; 2020. “Collaborations suggest that Sergio was right.” Subscription required. Posted September 14; accessed October 2.
• Consumer Reports; 2019. “Ratings & Reliability: Subcompact sport-utility vehicles.” Subscription required.
• Cray, Ed; 1980. Chrome Colossus: General Motors and its Times. McGraw-Hill Book Co., New York, NY.
• Kannan, N. P., Kathy Rebibo and Donna Ellis; 1982. Downsizing Detroit: The Future of the U.S. Automobile industry. New York, NY.
• Kenton, Will; 2018. “Oligopoly.” Investopedia. Updated February 9.
• Marchionne, Sergio; 2015. “Confessions of a Capital Junkie.” Fiat Chrysler Automobiles. Published April 29, 2015.
• Snavely, Brent; 2015. “FCA Chairman John Elkann: ‘I’m convinced that the (auto) industry needs and will see more consolidation in the future.'” Detroit Free Press. Posted April 14.
• Wikipedia; 2018. “U.S. Automobile Production Figures.” 
• Wright, J. Patrick; 1979. On A Clear Day You Can See General Motors. Wright Enterprises, Grosse Pointe, MI.
• Yates, Brock; 1983. The Decline and Fall of the American Automobile Industry. Empire Books, New York, NY.