Disruptors to shape auto industry's future

TRAVERSE CITY, Mich.—The automotive industry may not be sure what is coming next, but looming disruptors definitely will have an impact on its future.

That was the universal message from the Center for Automotive Research's Sales Forecast Workshop, part of its Management Briefing Seminars held Aug. 1-4 at the Grand Traverse Resort and Spa in Traverse City, Mich.

The panel included moderator Sean McAlinden, CAR Group's chief economist and vice president for strategic studies; G. Mustafa Mohatarem, General Motor's chief economist; Steven Szakaly, chief economist for the National Automobile Dealers Association; Michael Robinet, IHS Markit managing director; Jeff Schuster, senior vice president of forecasting, LMC Automotive; and Itay Michaeli, director, U.S. autos and auto parts, for Citi Investment Research and Analysis.

Each shared similarities and differences in opinions, but three core themes emerged—low fuel prices and their impact on future fuel-related regulation; the impact of Millennial buyers; and autonomous technology.

“The politicians might not believe it, but the U.S. really is an island of stability in a pretty turbulent world,” Mohatarem said. “We've seen Brexit, we've seen turmoil in the Middle East, we've seen the South China Sea issues, we're seeing deep recessions in Brazil and Russia. Compared to anybody else, the U.S., and particularity North America, is doing very well, and we're really a very stable economy.”

All of the economists agreed with one item—oil prices will remain low for the foreseeable future. Mohatarem said a major development to watch will be the next set of countries to develop shale capabilities, which he believes will continue to be a game changer as it migrates outside of the U.S. and Canada.

“I don't see anything out there that suggests that's about to change,” Mohatarem said of low oil prices. “Once you've developed the shale technology, it can be used in a number of countries. I think Argentina and Mexico will be next because they have very similar geographies as the U.S.”

Low gas prices also puts pressure on auto makers and their suppliers to meet the 2025 CAFE requirements. McAlinden said hybrid sales are declining, with the Prius off by 25 percent despite there being three times as many hybrid models on the market overall. With the price of oil, and thus the price of gas, low, consumers are flocking toward trucks and other larger-sized models.

“People are worried that consumers are tapped out, especially in the U.S. market,” McAlinden said. “I think the fuel price freefall is almost permanent and has a lot of meaning for years to come.”

He said he's worried that the industry has reached a plateau, citing a few key indicators—the lease rate, the fact the industry has to keep extending the length of loans for consumers to afford vehicles and that the industry is moving to higher and higher incentives.

“These are all warning signs to an automotive economist that things have slowed down,” McAlinden said. “We're resorting to price breaks and other financial gimmicks to keep sales at a certain plateau.”

Car payments/loans have increased over the last decade from 9.8 percent to 12 percent as a share of personal income, Szakaly said. He also noted that regulations could push the cost of new vehicles higher.

“We cannot continue to grow the sales and transaction price at a rate that outpaces wage growth,” Szakaly said. “Consumers are simply not going to be able to continue to make those increased payments and increased loan terms.”

Mohatarem has a more positive outlook, at least in the near term. He believes the industry is still on track for another record year. But he added that the economy has been slow to recover from the Great Recession and for it to further pull itself out, the housing market will have to play its traditional role.

“The strong fundamentals of the economy are reflected in vehicle sales,” Mohatarem said. “The auto sector has led this recovery and has behaved very much like it typically does in a recovery. Last year we had an all-time record for vehicle sales in the U.S., and in Canada and Mexico also. I stay on the path that this year will be a new record. I don't see any fundamental change in the economy.”

Long term, Szakaly said the outlook on gas is great for consumers and SUV sales, but not great for auto makers trying to meet CAFE standards. The economist said his firm forecasts 17.7 million U.S. light vehicle sales for 2016, before dropping to 17.1 million next year, 16.7 million in 2018 and 16.5 million in 2019, then bouncing back to 16.7 million in 2020. The used vehicle market is very similar, projecting 40.4 million units for 2018, up from 38.7 million in 2008.

Beyond 2020, he said there's real potential for the U.S. to reach new heights—18.5 to 19 million units—with one caveat.

“I think after 2020 there's huge potential in this market, if we don't regulate this potential demand away through CAFE and other regulations, of seeing 18.5 to 19 million units as these Millennials start to age,” Szakaly said. “As they start to earn more income and form families, they're going to come back to this market, and they will buy cars. But not if we make them cost six or seven thousand dollars more because every vehicle has to be a hybrid.”

He took a closer look at the Millennial buyer and while a number of factors go into why they're delaying major purchases—getting married later and burdened with student loans—the real reason for the delay is that on average they're making less compared to other generations. He said the typical car buyer makes about $80,000 per year, while Millennials are still only making $32,000 per year on average.

Only about 29 percent of Millennials make $100,000 per year, while 45.5 percent make more than $60,000 per year, according to Szakaly, and the average income for a Millennial car buyer is $49,900, significantly below the average.

“They're young; this is to be expected,” he said. “They haven't had a lot of experience in the job market, and they also entered, in many cases, into one of the weakest job markets we've ever seen. Wage growth has been pretty much stagnate, so it's going to take some time for these people to earn the seniority in order to start buying these cars.”

However, there are signs this is starting to change. Szakaly said the No. 1 reason for Millennials buying a new car is having kids as indicated by 52 percent of respondents to a survey he cited. No. 2 was improved content, which 22.3 percent of participants indicated.

“We're looking at probably at least another five or maybe seven years before this generation really has an outsizing impact on this market,” he said.

McAlinden identified a number of major disruptions the automotive industry faces in the near future, three of them focused on autonomous vehicles—auto makers partnering with new mobility markets, investment in the deployment of connected or automated vehicles and the Tesla autopilot situation.

Automated vehicles have the potential to reshape many industries, but Szakaly said the issue of liability needs to be sorted out.

He cited Rio Tinto, a mining company that has been running automated mining trucks since 2008. Szakaly said automation has increased productivity and safety, with a one-tenth accident rate compared to the non-automated ones. Furthermore, he added that the accidents that do occur are usually people running into them, not the automated truck running into something else.

But the mining company has some advantages—a controlled space, central monitor and mandated service intervals. None of those ideal conditions are prevalent on the road, especially service intervals.

“Consumers consistently misuse any product that is made,” Szakaly said. “They'll think of something ridiculous, that no engineer will have ever thought of. And no lawyer either. And they're going to misuse it; they're going to break it. That's a problem in this industry when we're talking about automated technology because there's a big question about who's going to be at fault in these situations. Who is actually going to be responsible?”

Szakaly said consumers don't service their vehicles consistently and in an automated world where the technology is responsible for the vehicle performing, that's a major problem. He said by 50,000 miles, the willingness to perform regular service falls to less than 40 percent. And overall, only 31 percent of vehicles in the fleet are regularly serviced and maintained.

“The failure of automated systems is going to be very different from say someone's transmission because they didn't change the fluid, or someone's engine because they didn't go in for an oil change,” Szakaly said. “That's a personal problem that affects one vehicle. Failures in automated systems will affect multiple vehicles and could possibly lead to fatalities. There is a 100 percent certainty that consumers will misuse it. There is a 100 percent certainty that if we don't have mandated service intervals, someone's system will not be maintained.”

Robinet said currency is the main driver as to why vehicle manufacturers locate in other markets, in an effort to reduce risk by mitigating the impact of currency fluctuation.

“There is some plateauing going on depending on where you are in the industry,” Robinet said. “It's really incumbent upon suppliers to really look out and say to themselves what's critical for me, how do I find my groove, maintain profitability and reduce risk in this kind of environment.”

Mohatarem said a strong dollar is good for the economy. Creating high quality money has value globally, and people are willing to pay for that as long as we maintain the institutions that back it up, he said. All else equal, he estimates the U.S. would be running a trade deficit at 2 to 2.5 percent without that.

“Not a huge concern,” Mohatarem said. “We're always talking about trade and the dollar in a negative way. The fact is a strong dollar is good for the U.S. It importantly reflects the faith the world has in our institutions, our judicial system, our treasury, our central bank. Just think about it: Without doing anything, people are willing to give us money at roughly 2 percent of our GDP because they want to hold our dollars and use our dollars. Our dollars facilitate global trade.”

None of the economists seemed overly concerned with Brexit. Mohatarem branded it as more of a U.K. story than a European story. However, he said the bigger impact is what the decision will have on the pound, how it's weakened against the euro and the dollar in the short term.

Overall, his outlook on the U.S. economy is very strong, especially when looking out to uncertain situations around the world.

“There's not a whole lot of risk taking going on in the U.S. economy,” Mohatarem said. “The household balance sheet is very, very strong right now. There's some concern about lenders, but lending to autos has been so comfortable that there's probably more available supply than demand for credit. The Consumer Financial Protection Bureau is putting pressure on lenders to restrict credit in the auto sector. But I think it's so profitable—probably the most profitable activity for lenders right now—that I don't see that having a huge impact.”