WSJ/Page One Feature: Auto Industry Faces Effects of Price Pressure As Economists Debate Possibility of Deflation
November 21, 2001
By NORIHIKO SHIROUZU and JON E. HILSENRATH
Staff Reporters of THE WALL STREET JOURNAL
DETROIT -- Economists are debating whether the U.S. is headed for deflation -- broadly declining prices that, if they got out of hand, could worsen into a spiral of vanishing profit margins and postponed purchases.
There's nothing academic about this debate for Beth Ardisana. She runs a firm called ASG Renaissance that provides contract labor to Ford Motor Co. Ms. Ardisana and her managers have had to inform about 150 workers that their wages will drop 7% across the board. The cut is a response to a mandate from Ford that all firms providing it with contract labor reduce their billing rates by 7%, to help the money-losing auto maker conserve cash.
It is the first outright wage cut Ms. Ardisana has had to resort to in her 14 years in business. Her Dearborn, Mich., company's profit margins sank to "dismal points" even though the firm also cut executives' pay, she says.
Deflation or no, the auto industry is facing intense price pressure, and this has begun to ripple out to related firms and workers. For now, the ripples seem confined to certain sectors of the economy. But the repercussions of lower prices in the auto industry illustrate the economic dangers that can arise when a hugely important business must operate with an acute lack of pricing power.
1Consumer Prices Fell 0.3% in October, but Industrial-Output Decline Continued (Nov. 19)
2Retail Sales Soared 7.1% in October Led by a 26.4% Jump in Auto Sales (Nov. 15)
3Economists Get Sense of Deflation From Declining Wholesale Prices (Nov. 12)
4The Outlook (Nov. 12)
Figuring in the zero-percent financing that U.S. auto makers offered to move vehicles after the terror attack, the companies faced an effective 4.7% drop in the prices they got for their cars in October. For light trucks, it was a 1.3% slide. That helped push the U.S. producer price index, which measures the prices charged by manufacturers, down 1.6% in October, for its biggest monthly drop on record. The consumer price index, which measures the prices paid by individuals, also declined in October, by 0.3%.
It's trends like this that raise the deflation specter. Industrial-commodity prices have sunk to their lowest levels in more than 15 years. Prices of imported clothing have been falling consistently for nearly a decade, and TV sets for two decades. "I've spent my whole career looking under every rock for the next wave of inflation, and I've run out of rocks," says Stephen Roach, an economist with Morgan Stanley. "We're going to get a lot closer to deflation than people think."
The price weakness, however, has been concentrated in manufactured goods, such as cars and computers, that are fully exposed to the intensifying competitive winds of the global economy. Prices for services -- a much bigger part of the U.S. economy -- are still rising. Partly for that reason, many economists are far from ready to declare that the entire $10 trillion U.S. economy is heading for a deflationary spiral, a pernicious decline in prices that policy-makers would have a hard time bringing to a halt.
To become a real worry, economists say, price declines would have to extend to assets that are the underpinnings of family wealth, such as homes and stocks. Home prices have continued to rise, albeit more slowly, this year. Stocks are down from the spring of 2000 but have rebounded in recent weeks.
Another comfort is that consumers don't appear to be taking on a deflationary mindset. Instead of postponing purchases, on the logic that things will keep getting cheaper, they have splurged on low-cost cars and kept shopping at discount stores.
The kind of deflationary quagmire an economy can tumble into is illustrated by Japan. There, productivity gains don't play a key role in driving prices lower. Instead, prolonged recession does. In this virulent version of deflation, price declines become widespread and entrenched, squeezing profit margins. Companies with large debts find them harder to pay off, because their debts are fixed, but their revenues are falling. Financial institutions become stuck with mounting levels of bad loans. And consumers hold on to their cash, concerned about their outlook for their own incomes and waiting for prices to fall even further.
The U.S. had its own spell of this in the Great Depression. Between 1929 and 1933, consumer prices collapsed by an average of 7% per year.
But not all deflation is so troublesome. The U.S. has also had spells of deflation that never held back economic growth. Prices fell through much of the 1920s, for example, even as the economy boomed. It has had other periods, in 1949 and again in 1955, when prices fell briefly but then recovered as the economy gathered momentum. And in some industries, such as microchips, technology drove such consistent cost improvements during the 1990s that companies like Intel Corp. were able to push prices lower and still make record profits.
As the chip case shows, price declines can be beneficial for many, especially consumers. In oil, every dollar decline in the price of crude has the effect of a $9 billion tax cut, says Edward Yardeni, a Deutsche Bank economist.
Price weakness so far has been "a net benefit to the economy," contends Mark Zandi, an economist with Economy.com. "It has allowed consumers to remain in the game."
But the auto industry shows how, if price declines go too far, they can begin to ripple through the economy in ways that hurt some consumers as well as producers.
Falling prices aren't new to auto executives. They've grappled for nearly five years with declining prices for most vehicles, when these prices are adjusted for the content and quality of the vehicles.
Until recently, the industry could cope. It saved money with measures such as trimming travel budgets, streamlining assembly lines and squeezing suppliers for discounts. Productivity improvements, rising volumes, technology and innovations such as sport-utility vehicles also helped Detroit to stay ahead of the curve. As sticker prices stagnated, consumers got better products for the same money. Sales volumes rose in part because cars were more affordable, and manufacturers could make profits, sometimes even record profits.
Now this virtuous circle is showing signs of breaking down. The combination of a softening general economy, rising unemployment and problems like overcapacity and price wars is outstripping auto makers' traditional responses.
Costlier Services
Meanwhile, the prices for many services auto makers buy keep moving up. Ford's health-care expenses in North America for current employees and retirees have risen an average 9% a year in the past decade, to about $704 a vehicle, estimates Goldman Sachs analyst Gary Lapidus. He expects them to rise another 6% annually over the next 10 years. Todd Nissen, a Ford spokesman, calls Mr. Lapidus's projection "conservative." Ford projects a "double-digit" increase in health-care expenses annually over the next few years, he says.
Adding to the burden are recalls for quality problems such as the Firestone-Ford Explorer tire debacle, discounts, research into clean technology such as fuel cells, payouts to dismissed executives and contractual raises for hourly workers negotiated during the boom years.
The result: Even though overall sales in 2001 could match the second- or third-best year ever, Ford and DaimlerChrysler AG are losing money, and General Motors Corp.'s North American profit margins are razor-thin. A few years ago, U.S. auto makers and suppliers considered sales of 15 million vehicles a good year. Now, "we can't sustain the industry as we know it on 15 million," says Peter J. Pestillo, chairman of Visteon Corp., a Ford supplier.
Mr. Pestillo, a former Ford vice chairman, says Visteon has told contractors who supply it with workers that their payments will be cut by 7%. It's also looking at possible compensation cuts for its own staff, he says.
Ford -- which had the most efficient car and truck plants in North America in 1999, according to the consultants Harbour & Associates -- now is running in the red. Its North American productivity, measured in labor hours per vehicle, declined in 2000, according to Harbour, although it was still slightly better than GM's. Profits from Ford's once-lucrative SUV franchise have taken a hit as GM, Toyota and Honda, among others, have matched or bettered Ford's models.
At some Ford offices, lights now are being shut off automatically to conserve electricity. Ford said earlier this year it would eliminate 4,000 to 5,000, or about 10%, of its white-collar workers in North America by year's end. It has eliminated bonuses for top executives, halved its dividend and taken 230,000 vehicles out of its production capacity by eliminating shifts and slowing assembly lines. That's the equivalent of a full-sized assembly plant.
These are most likely just a prelude to much bigger restructuring moves Ford is expected to announce in January. The plan is said to include plans to shutter some assembly plants permanently and lay off tens of thousands of white-collar and blue-collar workers.
Revenue Shortfall
At GM, worsening price competition in the U.S. has been on track to chop about $600 million off the beginning-of-the-year revenue forecast. Since the terrorist attacks, estimates of the revenue shortfall have widened by a further $300 million. So GM is aiming to cut its $60 billion annual bill for parts in North America. After several years of trimming those costs by 2% to 3%, GM says it now is aiming for 4% to 5% annual savings, primarily by working more closely with suppliers to find cheaper ways of making parts. It also is thinning its white-collar ranks.
For most of the late 1990s, Detroit offset stagnant pricing mainly by leaning on suppliers of seats, steel, rubber, electronics and brakes to drop prices for their goods every year. According to a recent study by IRN Inc., the annual price cut requested by major auto makers and the largest suppliers averaged 3.8% in 1997 and 5.4% in 2001.
But as price pressures have intensified, the ability of many suppliers to comply diminished, and, according to many industry executives, now is virtually gone. Visteon's Mr. Pestillo predicts that some of his competitors will be forced to find merger partners or dismember themselves. Many smaller suppliers, unable to cope with price-cutting pressures, are just folding.
Meanwhile, car buyers keep applying their own pressure. Armed with detailed dealer-invoice data -- and well aware there are multiple vehicles and brands in nearly every segment and price range -- shoppers have more power than ever to force down prices on all but the most desirable vehicles.
The price pressure is starting to cause a chill even for workers at auto factories that had been generating enormous profits. At Ford's massive Michigan Truck plant, not long ago billed as the world's most profitable car plant, some workers are still putting in overtime building Ford Expedition and Lincoln Navigator SUVs. Not because of soaring demand, though. The reason is that Ford has eliminated one of three production shifts and cut 850 jobs through attrition, as sales of the current vehicles have slid. Now, a reduced work force is building the current models and readying a new generation for launch.
Some workers here are concerned enough to have begun tightening their belts. "Knowing that possibly six months from now we may hit a little bump on the road, I don't shop like I used to," says Darryl Nolen, a 35-year-old worker at the plant. He no longer goes out and spends $700 on a pair of "gators," sleek alligator-skin shoes, as he used to a few years ago. He and his wife used to eat out at favorite places like Benihana and Outback Steak House three times a week or more. Now they stay home much more often.
A Need to Adjust
And workers are racking up as much overtime as they can in order to salt money away. Lionel Reeves, a 43-year-old single parent with two boys, says he sometimes grabs the chance to work two shifts a day, filling in for people taking time off for deer hunting. "I tell my boys that a lot of things we need, we are gonna get, but a lot of things that you want, we are gonna hold off," he says. "The way the economy is right now, some of those wants and needs gonna have to adjust."
That goes double for small subcontractors like ASG, the company run by Ms. Ardisana. Even before the latest 7% cut, ASG, which also does business with Chrysler, had two billing rate cuts that amounted to an about 3.5% hit on ASG revenue over two years. To absorb them, she laid off a handful of administrative staffers, froze merit raises this summer and asked employees to make a co-payment on health insurance. The moves still weren't enough. "We had no buffer to absorb more cuts" when Ford hit her with another demand, she says.
So now the blow falls more heavily on ASG employee Ellen Silverberg, who works as a contract employee for the Ford recycling division. Ms. Silverberg, 43, has already taken two big hits to her income this year. Indeed, she almost lost her job in August. Her Ford bosses saved it, but she suffered a 33% wage cut as her hours were reduced to two days a week from three. She won't starve even after the additional 7% pay cut because her husband has a decent-paying job.
Yet, worried about the future, she now brings lunch to work and eats at a cafeteria only once a month, if at all. She also has cut down her "impulsive spending" and will go easy on buying gifts for this holiday season. "I'm trying to come up with more creative gifts," she says, "that are lower in cost."
Write to Norihiko Shirouzu at norihiko.shirouzu@wsj.com5 and Jon E. Hilsenrath at jon.hilsenrath@wsj.com6
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