Greg Mankiw looked up the Consumer Reports of ratings of car companies and found:
Dead last was Chrysler. CU recommended zero percent of the Chrysler vehicles they tested. That’s right–zero. Second to last was General Motors. CU recommended 17 percent of GM models. By contrast, most other companies had half or more of their models get the thumbs up. Honda was the top ranked brand; CU recommended 95 percent of its models.
Mankiw writes:
Is it any surprise that Chrysler and GM are now in the process of going out of business? From the perspective of the Consumer Reports advice, it looks like their business model was to count on the ignorance of the buying public about the quality of their products. Their bankruptcy should perhaps be viewed as a success of the market system.
This makes sense to me, but I wonder if it explains too much. Presumably these companies have been making crappy cars for awhile. How did the companies stay alive so long? In all seriousness, perhaps the market system would’ve been more successful had it shut down those companies 10 or 15 years ago.
Beyond this is the principal-agent problem, or moral hazard, or whatever it’s called, by which the people who make the decisions to make crappy cars are probably not actually going broke themselves: the companies might fall apart, but they’ll do OK, I assume. So I can see how the companies could stay alive for awhile, living off their assets and their ability to borrow money. I just don’t completely see it as a “success of the market” that they’ve been hanging on so long when the low quality of their products has been public knowledge.
How did the companies stay alive so long? In all seriousness, perhaps the market system would've been more successful had it shut down those companies 10 or 15 years ago.
Would you like the shutdown of factories and dealerships — at a cost of significant amounts of physical and human capital as well as goodwill* — to be triggered by a single generation of bad products? I'm not sure that is optimal either.
*http://en.wikipedia.org/wiki/Goodwill_(accounting)
Another thing that kept GM and Chrysler going was heavy dependence on fleet sales (to auto rental agencies, government installations, etc.). Quality and long-term reliability are of less importance in this market.
Maybe availability bias has a role. I flew into Detroit last night. Rental car lot full of American cars. Drove a Chevy Impala. Roads full of American cars. Almost surprised when I passed a Toyota Camry.
This is, of course, an entirely expectable sight. But I wonder if this concrete evidence in front of their eyes blinded them to what their own statistics (from, say, California) clearly showed for decades.
Second, cars tend to be sold as much as bought. The legacy dealer networks (and social networks supporting them) bouyed sales. With GM now slated to end up with only about half the dealers they had 5 years ago, this will fray substantiallly.
Third, there's additional inertia [aka brand loyalty] — similar to the long tendency to elect Democrats in the American South even after it was clear the region was more philosophically attuned to the Republican party. I will defer to those who spend their lives on this issue, but didn't that also last decades?
This is a subject I know way too much about, but to be brief:
1. The ratings are a) a general scoring system that includes a bunch of factors and b) cars generally from all companies have improved tremendously over the years in reliability and some other measures. The ratings, for example, penalize GM because many of its offerings are larger and CR rates fuel economy highly. The implication is that somehow the Big 3 cars are stuck in the 1970's and they aren't.
2. To disagree with ZB, it's not sampling bias or availability bias. These people aren't idiots. They know their market share and what sells.
3. Even if we assume CR is perfectly right – not objective but actually correct – people don't optimize every decision on an objective scale. How many people even do that for their lunch choice? How come all those other places that are way suboptimal are still serving food? They clearly provide a product that fits the needs of customers, even if a ranking system says it isn't the absolute best choice. You like this car, this truck fits your needs, who is CR to tell you this other one is better?
4. If you look at the actual quality differences – especially if you put aside Chrysler, which has had more issues over the last year after the Daimler ownership fell apart – they are relatively small. Do many people really value turning radius as much as CR does? When gas was $2, it was clear that many, many people didn't value fuel economy as much as CR always has. (I'm a subscriber to CR.) In the 1970's, the build differences were huge but now they relatively small and much of the ratings gap has to do with how you perceive the readability of gauges, the perceived quality of plastic trim, etc. This is important, really important, because it speaks directly to the worth of a ratings system as a measure. The ratings reflect the reality that GM has been driven by cost issues to produce larger vehicles. The market loved them, bought them in droves and only a few years back GM made record profits.
The problem with this kind os claim is: If we do not observe big firms going out of business, then the market is a success. But, if we observe big firms going out of business, then market is a success!!
For me this is doublethink!
"In all seriousness, perhaps the market system would've been more successful had it shut down those companies 10 or 15 years ago."
Ah, but recall that Lee Iacocca famously arranged for government loan guarantees (commonly called a "bailout" of Chrysler) back in 1979. Maybe that bailout a) prevented Chrysler from going out business 30 years ago, as you would presumably have preferred b) taught other American car companies not to worry about the future, because they could (correctly) expect a bailout if their time of need came; this possibly established a fatal moral hazard. Add to this other interventions (the tax breaks to small business owners for "light trucks") that encouraged the American car companies to stay specialized in SUVs over the last 10 years or so (see:
http://www.usatoday.com/money/autos/2002-12-18-su…
), and you get the incentives for them to drive their business recklessly, right into a ditch.
It seems that consumer opinion lags objective quality measures by several years (see current ratings of Chevy Malibu vs sales). A reputation and brand loyalty can take a long time to build up and just as long to go away, especially for long-lived goods where quality is not immediately and obviously observable, because quality is also a function of time and how much the driver takes care of their car. A lot of what makes up quality, as most consumers observe, is a flow not a stock.
Could it be that the car-buying market isn't perfectly efficient? Or that externalities such as the notion of "buying American" have an influence on purchasing patterns?
I think it's that simple.
If we had lower legal barriers to hostile takeovers, they more likely would have gone out of business.
Two points not already made.
1. GM produces some things quite well (GM produces 3 of CR's top 5 full size trucks) and these subsidize the crap cars they build.
2. The fact that reliability is up (even if objectively true) isn't enough to get me in one of their cars because they appear to employ blind people as designers, use the cheapest possible interior materials, and provide handling that has all of the feel of an ocean liner.
Does anyone have an explanation for why the rental car agencies almost uniformly rely on American car makers for their fleet? I haven't rented a car recently, so selections may have changed in the last few years, but as I remember, any time you got a car at an airport, it was big 3.
@c, re rental cars:
1. Automobile manufacturers have often had equity stakes in the car rental companies (notably Ford and Hertz, but not limited to them).
2. To keep volumes up, American manufacturers have relied on fleet sales — large groups of cars, sold at a lower margin, to large buyers such as rental car companies. In olden times when the Ford Taurus was the #1 selling car in the US, they only kept this crown because they had extensive fleet sales. In individual sales, they were behind the Honda Accord (perhaps it was the Toyota Camry). At that time, the Japanese manufacturers didn't have excess capacity and so were less interested in the fleet sales.
As recent work by Bronnenberg, Dhar and Dube illustrates, there's a lot of inertia in these types of entry effects, and they persist even after the original reasons no longer exist.
GM makes inferior products, bottem line.
For the past year I've been reading drive-by analysis of the auto industry. Everyone wants to boil it down to one thing (e.g., reliance on fleet sales, quality (cause, or effect), etc. My favorite is, "if they would just make cars that people wanted…". Check the sales figures, even in bankruptcy they sell more cars in the U.S. than most mfgrs.
Folks, the auto industry is the most complicated, labor intensive sector of the economy. Unless you understand the ins and outs of all the federal regulation imposed upon them, state franchise laws, product liability for a product that flies down the highway at 70, long lead product cycles, extremely long consumer purchase cycles, labor relations.
Cars are not Fruit Loops.
I've heard a lot of investors are going to start investing in Gm stocks right around the Chapter 11 filing. I am thinking about it after reading this article.
1. GM has not been practicing quality assurance like Toyota and Honda. Six Sigma anybody? The 3 major conglomerates were approached with this concept and rejected it. Big mistake. Now their competition is making products that the general public is buying.
2. If they would of considered bankruptcy before we were in the recession they might of been better off. Now, that things are bad, it is more costly and they are n far greater danger.