The Government, the Auto The Government, the Auto Industry, the Environment, Industry, the Environment,

and the Economyand the EconomyWalter McManus

Automotive Analysis Division

University of Michigan Transportation Research Institute

Physical infrastructurePhysical infrastructure

America’s Road NetworkAmerica’s Road Network

Ben Fry

US Suburban Population and Vehicles Grew Together, 1900 to 2000

0

10

20

30

40

50

60

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Perc

en

t of

Pop

ula

tion

0

100

200

300

400

500

600

700

800

900

Veh

icle

s p

er

1,0

00

Pers

on

sPercent of Population in Suburbs

Census Years

Vehicles per 1,000 Persons

Sources: US Census Bureau and Ward's

Legal infrastructureLegal infrastructure

Patents, trademarks, and IP Business laws (including franchise) Bail outs (1980 and 2009)

Ownership (GM & Chrysler) Loans (Ford)

Regulation (more later) National Innovation System

National Innovation SystemNational Innovation System

Education of workforce Basic research University of Michigan $1 billion in federal

research (out of total UM budget ~$6.5b) National energy labs

Safety and emissions

• NHTSA and EPA

Theories of regulation

• Public interest theory

• Capture theory

Public interest theory

• Helping hand

• Markets often fail due to externalities and monopoly

• Governments are capable of correcting market failure through regulation

Public interest theory

• Clean Air Act established clear, measurable targets based on science

• EPCA and EISA was (intentionally) ambiguous

Capture theory

• Invisible hand

• Markets

• Courts

• Government regulators are incompetent, corrupt and captured

National Program

• History– Calif. 1960– Clean Air Act 1970– Energy Policy and Conservation Act 1975

• 2007– Energy Independence and Security Act

NHTSA

EPA

ARB

Can youCan youname that name that vehicle?vehicle?

Industry-Wide Improvements in Fuel Economy and Detroit 3 Profits:Sensitivity Analysis

Walter McManus

Automotive Analysis Division

University of Michigan Transportation Research Institute

We used a future-market simulation to estimate the impacts of higher industry-wide fuel economy requirements. Both supply and demand are affected.

• Baseline “Middle” Market Scenario • Fuel Economy Improvement Scenarios

• 30% (CAFE 2020 or Pavley 2016)• 40%• 50%

• Consumer Demand for Vehicles with Higher Fuel Economy

• Cost of Supplying Vehicles with Higher Fuel Economy• Sensitivity Analysis

• Uncertain Factors• Tornado Diagrams

• Findings

We began our analysis with a scenario that represents a mid-range outlook for the market in the near future.

Sales by Automaker & Segment, Future-Market Mid-Range Scenario

Thousands of Units

Segment Chrysler Ford GM Honda Nissan Toyota Others All

Luxury Car 44 85 237 65 65 199 239 934

Midsize Car 242 403 711 513 272 703 894 3,739

Small Car 131 340 467 487 327 742 606 3,100

Luxury CUV 0 72 44 55 23 76 0 269

Midsize CUV 83 158 178 90 129 137 259 1,035

Small CUV 92 344 400 200 83 307 137 1,563

Minivan 292 0 0 127 0 106 45 570

Large Pickup 411 612 654 0 0 114 0 1,791

Small Pickup 29 0 65 21 96 137 0 349

Large Luxury SUV 0 31 26 0 0 25 51 133

Large SUV 0 52 244 0 0 20 12 327

Midsize SUV 160 102 184 0 94 69 43 651

Midsize Luxury SUV 0 0 0 0 0 0 349 349

Small SUV 94 0 0 0 0 0 11 105

Large Van 15 140 135 0 0 0 0 289

All Segments 1,592 2,339 3,345 1,559 1,089 2,634 2,646 15,204

Source: The Planning Edge, April 2009

Consumer demand was modeled as a system of demand equations (one equation for each automaker by segment market entry).

Expected Fuel Costs of Operating for Entry n

(seg i & oem j)

First YearFuel Price

Retail Price for Entry n

(seg i & oem j)

Consumer Demand for Entry m

Vehicle Lifetime

Consumer Discount

Rate

First Year Miles Driven

Rate of Change in Miles per Year

Expected Fuel Price Growth

Overall Discount Rate

Effective Consumer Price for Segment i from Automaker j

Effective Consumer Price for Segment i from Automaker j

Effective Consumer Price for Segment i from Automaker j

Effective Consumer Price for Segment i from Automaker j

Effective Consumer Price for Entry n(seg i & oem j)

Fuel Economy (MPG) for Entry n

(seg i & oem j)

An industry-wide increase in vehicle fuel economy has impacts on OEMs’ and dealerships’ product costs, on product prices, and on consumers‘ willingness to pay for vehicles—leading to changes in profits.

Profits

DirectIndirect Fuel Cost

RevenuesVariable Costs

VehicleFuel Economy

Price

Vehicles

We used information from J.D. Power and Associates’ Power Information Network (PIN) to define Retail Price, Gross Profit, and Direct and Indirect Costs at the level of the combined enterprise of

an automaker and its dealerships.

• Vehicle Price Less Customer Cash Rebate

• + Customer Cash Rebate

• + Dealer-Installed Options Price

• = Dealer’s Price

• Factory-Configured Vehicle F.O.B.

• + Freight, Advertising, & Holdback

• = Dealer Invoice

• + Cost of Dealer-Installed Options

• = Dealer’s Variable Cost

• Dealer’s Price

• - Dealer’s Variable Cost

• = Dealer’s Gross Profit

• Factory-Configured Vehicle F.O.B.• - OEM’s Variable Vehicle Cost• - Customer Cash Rebate• = OEM’s Gross Profit

Evidence that automakers underestimate the value of fuel economy to consumers leads us to reject the assumption that fuel

economy is optimized in the baseline scenario.

Fuel Economy Improvement:Supply Price and Consumer Willingness to Pay

0% 20% 40% 60% 80% 100% 120%

% Improvement in MPG

$ p

er

Vehic

le

Supply Price

True WTP

Assumed WTP

A

B

D

C

RP0

WTP0

The improvement in fuel economy raises both the vehicle marginal cost and the vehicle marginal revenue curves, and vehicle unit sales could rise or fall,

depending on which marginal curve shifts more. (If we had assumed that in the baseline fuel economy were optimized, then unit sales could only fall.)

Vehicle Marginal Cost & Marginal Revenue

Vehicle Unit Sales

$ /

Ve

hic

le

MR1

MC1

Q1Q0

MR0

MC0

We estimated the detailed impacts on the industry of three levels of inprovement in industry-wide fuel economy: 30%, 40%, and 50%. Industry total gross profit increases relative to the base case in all three scenarios; Detroit 3 gross profits increase roughly $3 billion (8%) relative to the base case in all three scenarios.

Market MPG 26.9 35.0 37.7 40.4

Detroit 3 $39.5 $2.9 $3.2 $3.1

Japan 3 $27.1 $0.9 $0.7 $0.3

Others $18.8 $0.9 $1.0 $1.2

Market Total $85.3 $4.6 $4.9 $4.6

Detroit 3 7,276 527 521 446

Japan 3 5,282 72 (27) (171)

Others 2,646 145 147 133

Market Total 15,204 408 641 408

Sales and Gross Profit ImpactsBase 30% 40% 50%

Gross Profits (billions)Scenario O/(U) Base

base 30% 40% 50%

Vehicle Sales (000)Scenario O/(U) Base

Base 30% 40% 50%

In the auto industry model of fuel economy, costs, demand, and gross profits we identified 11 future-market factors that cannot be predicted with certainty. Analysts such have widely different prior beliefs that most empirical evidence is unpersuasive. Our approach is to do a sensitivity analysis for these factors in each of the three scenarios.

Sensitivity Analysis: Influence Factors Subject to Uncertainty

FactorsRange Used in Sensitivity

AnalysisUnfavorable Base Favorable

1.     Fuel economy cost curves multiplier 2.00 1.00 0.502.     Indirect cost multiplier 2.20 1.50 1.003.     Profit Margin on new technology 0% 5% 10%4.     Price of gasoline ($/gallon) $1.50 $3.00 $7.005.     Real rate of change in gasoline price -2.0% 0.0% 5.0%6.     Rate at which miles driven falls 8.0% 5.2% 2.0%7.     Consumer real discount rate 18.0% 7.0% 2.0%8.     1st year miles driven (miles) 10,000 15,000 18,0009.  Relative consumer response to operating v capital costs

0.33 1.00 3.00

10.  Horizon for valuing expected operating cost (years)

10 15 20

11.  Industry size (millions of units) 14.2 15.2 16.3

Profits

DirectIndirect Fuel Cost

RevenuesVariable Costs

VehicleFuel Economy

Price

Vehicles

Tornado 30%

Tornado 40 %

Tornado 50%