Quotes of the day

Meet Joe and Jane Average. They live someplace warm and sunny, far removed from the cold rustbelt and the dark gray clouds over Detroit. Jane works for an insurance company and Joe does computer support for a large nationwide tech company. As a matter of fact, Joe and Jane met on the job when he was a contract worker at her site. While driving to work in a Toyondissandai, an average Asian branded car, they hear on the radio that General Motors may go bankrupt. GM will run out of money to operate by the end of the year. The crippled giant automaker has three options. Get loans from the government, go through reorganization under Chapter 11 bankruptcy, or be forced to liquidate under Chapter 7. GM says they won’t file for Chapter 11 and there isn’t any credit available without government involvement. So GM may end up being liquidated. Joe and Jane give a moment’s thought to how it might affect them.

“No wonder,” Jane says, “Nobody buys an American car anymore,” telling her self silently what a smart shopper she was as she gazes approvingly at the interior of the Toyondissandai.

Joe says, “Boy, I’m glad I didn’t take that job with that automotive supplier. Can you imagine having to work in a factory?” Joe asks, silently trying to forget having to sit in a cubicle most of the day.

“Can you imagine having to live in Detroit?” Jane jokes, and Joe laughs, as they drive past a graveyard.

Only 12% of the US economy is manufacturing. Most people, like Joe and Jane, work in other sectors, in their case the service economy. The closest the average Joe and Jane gets to any kind of factory or shop is watching How It’s Made on cable tv. Actually so few Americans are involved in manufacturing that How It’s Made is made in Canada. Most people don’t make things so they have no idea how things are made.

Joe and Jane Average may have heard the phrase “supply chain” tossed around in connection to the auto industry’s crisis. I’m guessing that it means about as much to them as other terms like “credit default swaps” and “derivative securities” do. Let me give Joe and Jane a little lesson about how things are really made.

The automakers mostly assemble major components and subassemblies provided by suppliers into finished automobiles and rely on a supply chain. As the name implies, the supply chain involves a multi-tiered network of businesses that provide both raw materials and finished products that go into automotive components and ultimately complete vehicles. Usually vendors are classified as either Tier 1 or Tier 2 suppliers, depending on whether they sell directly to the automakers or sell to other suppliers. It’s not a rigid difference since many companies are themselves both tier 1 and 2, and there are many levels in tier 2. Components can move around a bit before they are completed. Perhaps supply web is a better metaphor because of how interlinked and interrelated the various companies are. That’s for one part or component. A modern car or light truck probably has 20,000 individual “parts” before they are assembled into major components or sub-assemblies.

Many companies that are part of the automotive supply chain don’t just make automotive parts, they supply a number of industries. Johnson Controls, for example, one of the three biggest tier 1 suppliers, gets about 1/3 of its revenue from the automotive industry. A large part of the manufacturing base of the country, 12% of the economy as mentioned before, is one way or another involved in the auto industry. Remove the domestic automakers and their supply chain and you’ve removed most of the US manufacturing base. You can’t make F-22s if you have no manufacturing base.

Using the chain metaphor, you can understand how a break in one link immediately affects the chain in both directions, up the chain and down the chain, and also breaks the entire chain. So when one company fails, the companies below the broken link dependent on selling things up the chain are distressed, and the companies above the break depending on using downchain products are distressed. When Plastech, a large tier 1 and 2 supplier of molded parts failed, Johnson Controls and other tier 1 vendors stepped in with a reorganization plan to ensure supply of parts they needed for their own production. Plastech ultimately supplied about 5000 different parts to all three domestic automakers.

What’s been described as a ripple or tsunami affect takes place, with bankruptcies and economic distress radiating in all directions. I think there might be a better aquatic metaphor. As individual companies circle the drain, other companies get sucked into the whirlpool.

The companies are so interconnected and the connections go in many directions. You can see how if GM goes bankrupt and that bankruptcy causes suppliers in its supply chain to fail that Ford might also be threatened because it can’t get parts. It wouldn’t be just Ford. Joe and Jane think that if GM, Ford and Chrysler disappear Toyota, Honda, Nissan, Hyundai and other foreign companies with North American operations will just sell cars to the people that used to buy Chevys, Fords and Dodges. They hear ads about Camrys made in Kentucky with 86% US content. Joe and Jane Average don’t understand that much of the US content in Toyondissandais assembled in the US comes from the same supply chain dependent on the domestic companies. If GM is liquidated the foreign owned assembly plants now operating in North America would have a difficult time producing cars because of supply chain disruption. Foreign owned suppliers in North American will also be distressed because they sell to the domestics as well as to the transplants.

So lots of businesses will fail or be distressed, laying off workers, buying less. Joe and Jane’s neighbor, John Doe, may lose his job. For now, though, Joe and Jane still feel somewhat secure in their service sector jobs. Soon though, Jane’s department starts to cut back. Her company offers automobile insurance and auto sales were down 30-40% before GM went belly up. She’s in a different part of the company, but you know how things are when belts are tightened. The insurance company cut back on their contract labor but Joe had already moved on to a different contract position so he’s still safe in his job, for now.

Back to the supply chain. The thing about a supply chain is that it’s almost infinite, like a fractal or a house of mirrors. It includes things generally not associated with making cars, like the Cray supercomputers at GM’s Tech Center, or the desktop computers and CAD software used by an engineer at a component vendor. Joe doesn’t work for an automaker or parts supplier, but his company has a contract with a large Tier 2 automotive vendor in Michigan that is struggling to stay in business. They decide to go with a cheaper IT contractor and Joe’s employer starts retrenching.

Auto sales by now have completely cratered. Joe and Jane may have thought that nobody bought American cars, but in November of 2008 the domestic brands had a 55% share of the US market. Normally, when you remove more than half a market’s supply, prices from remaining producers should go up because of the law of supply and demand. However, the fire sale prices as GM went down and took all its dealers with it meant that other brands could not raise their prices. They had a hard enough time just making cars with the collapse of the US auto supplier base. Their dealers had to cut prices to stay in business as the surplus GM fleet hammered retail prices.

Jane’s employer has now closed its auto insurance division. Jane’s hopeful to keep her job since her company just received it’s third tranche of TARP funds, but she worries and she expects a pink slip every day. She talks to Joe on the phone a lot. His company has really cut back. He was offered the choice of a severance package or a transfer back to the company headquarters so he took the job. They’d like to meet on weekends, but can’t afford to fly. Joe’s living expenses are making it hard for them to keep their house.

rokemronnie on December 5, 2008 at 10:11 PM