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Insight: The Economic Crisis—and Beyond

2008 is going to be a tough year for vehicle manufacturers. But you can’t lose sight of the demands of tomorrow.

The housing correction that is underway is beginning to spill over into other areas of the economy, as evidenced by the weaker industrial production numbers reported in late 2007 by the Census Bureau. High inventories of durable goods, such as appliances, electronic equipment, and home furnishings, have caused a pullback in industrial production, since the housing market is not expected to be able to rally and absorb those inventories. In the aftermath of the sub-prime mortgage losses, banks have become more risk-averse and are tightening their lending standards. This will slow the economy further—even if someone wants to finance a large purchase, they may not be able to qualify for credit under these conditions. Banks and financial institutions are also beginning to cut jobs because of massive losses from bad loans, so it will not be just the manufacturing sector that is shedding jobs, but the service sector, as well.

A spot-check on consumers shows that debt service levels are at record highs, their homes have lower equity value, and they are paying more for gas. All this weighs heavily on the mind of the consumer, and as consumer confidence goes, so goes consumer spending, particularly as it relates to the automobile. To a large degree, the automakers have been able to mitigate this effect through the heavy use of incentives since 2001 (see Exhibit 1), but the effectiveness of special deals as a prop to sales has been declining. Exhibit 2 shows new home starts charted against U.S. auto sales. The drop-off in housing is evident, and the historical pattern suggests that auto sales should follow. Put all this together and you have sufficient evidence to support a recession. We expect light vehicle sales to drop further in 2008 before the industry begins to see signs of stabilization. For 2008, IRN Inc. is forecasting U.S. light vehicle sales of 15.5 million units, down from 16 million in 2007. In terms of North American light vehicle production, IRN’s forecast is for 14.45 million units, down from 14.99 million expected in 2007.

 

Investing for tomorrow. While 2008 will be a difficult year, automakers need to keep moving forward with product development. Demographic data suggest that they must determine how to serve two distinctly different population segments: members of the Baby Boom generation, and the growing Echo Boom. By virtue of sheer numbers, Baby Boomers have been key drivers of evolution in the U.S. light vehicle market over the past 30 years (Exhibit 3). As the peak Boomer population progressed through their 20s and 30s, their predominant vehicle choices transitioned from small, affordable cars to minivans. By the time they reached the peak income and spending period of their late 40s and 50s, Boomers’ vehicle tastes were driving growth in SUVs and particularly the luxury end of the market. The automakers are preparing now for what Baby Boomers will want in the next decade—vehicles with easy ingress/egress, that sit higher, with a compliant, smooth ride. Crossover SUVs will be very popular with this market segment. In addition, large sedans will also meet their needs, as long as these are designed in a way that will not make Boomers feel old—i.e., not their parents’ large cars (the Town Car, Crown Vic, Cadillac DTS). The Chrysler 300C is a good example of how to attract the Baby Boomers with a contemporary design.

 

The Echo Boom that is entering the driving and car-buying years is the second-biggest demographic segment. Small cars that provide affordable, economical transportation will be the key, as the cycle of vehicle consumer demographics repeats itself. The challenge for the automakers is to develop attractive vehicles for the aging Baby Boomers that will generate profits to fund product development for the Echo Boomer (Exhibit 4). Even during the downturn in the cycle, you still need to keep product development on track. Automakers will be using 2008 to position themselves better for ’09 and ’10. We are encouraged by signs that the Big Three are getting back to the understanding that a vehicle is an emotional purchase. The resulting designs of some products like the GM Lambda program, Cadillac CTS, and the Ford Edge indicate that once we come out of the slowdown, things will definitely be looking up. 

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