In April 2009, Ford declared that it would not need help from the government and stated that it had a plan to break even in two years. Ford has been ahead of its main rival General Motors in downsizing its business selling Aston Martin, Land Rover and Jaguar for the past two years. Meanwhile, GM went through a massive reorganization after filing for Chapter 11 bankruptcy. GM is temporarily majority owned by the US government after it invested $ 57.6 billion in the company.
Under the plan GM executives presented at congressional hearings, the company would break even in 2011. Additionally, they declared they would cut costs by cutting 47,000 jobs, closing five more unprofitable factories, and cutting at least $ 18 billion. dollars in debt from your business. balance sheet. These cost cuts were expected to allow the company to break even when the US auto market returned to between 11.5 and 12 million vehicles sold per year.
JD Power and Associates, a global marketing information services company, announced its projections for the new break-even point for the auto industry. According to Gary Dilts, senior vice president of US automotive at JD Power and Associates, due to cost reduction measures, such as renegotiation of union and supplier contracts, the breakeven point for the domestic auto industry will decrease by more than 2 million units. comparing current industry conditions with those forecast in 2010. Dilts explains the reason for this decline due to significant declines in the automotive industry that resulted in a loss of sales volume of more than 7 million units between 2000 and 2009 This sales volume makes $ 175 billion in net income.
In the automotive industry, fixed costs make up a larger part of total costs. Manufacturing plants, assembly lines, and the technology invested to build vehicles are some of the elements that make up fixed costs. Compared to fixed costs, variable costs form a relatively smaller part of total costs. This puts the auto industry at risk due to high operating leverage.
The definition of operating leverage is the ratio of fixed costs to total costs. The higher the fixed costs of a company, the greater its operating leverage. In companies that have high operating leverage, small percentage changes in sales volumes result in large percentage changes in earnings. This variability or sensitivity of profits to changes in sales volume places the company in a position of risk. According to the “Higher risk, higher return” rule, this also means more profit if demand and therefore sales volume is high.
In the automotive industry, since fixed costs are relatively high, during times of recession, as demand and sales volume decrease, the probability of earnings to cover fixed costs will decrease, that is, it will be more difficult for auto companies to break even. Therefore, auto companies begin to cut costs, especially fixed costs, such as closing unprofitable facilities, eliminating jobs. For example, GM sold its unprofitable Hummer to a Chinese company.
Auto companies should increase the volume of profitable vehicles and effective advertising activities to be able to sell them to customers. Increased sales volume will help cover high fixed costs and break even. On August 6, 2009, Edward Whitacre Jr., the new president of General Motors, stated that GM needs to improve the number of vehicles sold. To do that, he said, the board may decide to advance the launch of several new vehicles.
Comparing the Consolidated Results of Operations of Ford and General Motor from Form 10-K, these two companies filed with the Securities and Exchange Commission (SEC) in 2008:
Cost and Expenses: 160,949
Net Profit / Loss: (14,672)
Sales volume: 5,532
General Motors (millions)
Cost and Expenses: 179,839
Net profit / loss: (30,860)
Sales volume: 8,144
Break-even points for these companies can be calculated using the Revenue, Costs and Volume figures above.
Average price: 146,277 / 5,532 = $ 26,441
Average price: 148,979 / 8,144 = $ 18,293
To cover its Costs and Expenses, Ford had to sell: 160,949 / 26,441 = 6.08 million cars and trucks. To cover its Costs and Expenses General Motors had to sell: 179,839 / 18,293 = 9.83 million cars and trucks. The additional sales volume that GM and Ford had to make to break even in 2008.
Ford: 6.08 – 5.532 = 0.554 million
GM: 9.83 – 8,144 = 1,686 million