Break already Point For The US Domestic Auto Industry

In April 2009 Ford declared that it would not need government aid and claimed that it had a plan to break already in two years. Ford has been ahead of its main competitor General Motors in scaling down its business by selling Aston Martin, Land Rover and Jaguar over the past two years. GM, meanwhile, went by a enormous reorganization after filing for Chapter 11 bankruptcy proceedings. GM is temporarily majority owned by US government after it invested $57.6 billion in the company.

Per the plan GM executives presented in congressional hearings the company would reach the break-already point by 2011. They further declared that they would cut costs by eliminating 47,000 jobs, closing five more unprofitable factories and cut at the minimum $18 billion in debt from its balance sheet. It was expected that these cost cuts would allow the company to break already when the U.S. auto market returned to between 11.5 million to 12 million vehicles sold per year.

J.D strength and Associates, a global marketing information sets firm, announced its projections about the new automotive industry break-already point. According to Gary Dilts, senior vice president of U.S. automotive at J.D. strength and Associates, due to cost-cutting measures such as renegotiation of union and supplier contracts, the break-already point for the domestic automotive industry will decline by more than 2 million units when comparing current industry conditions to those forecast in 2010. Dilts explains the reason for this decline due to the meaningful declines in the auto industry which resulted in lost sales quantity of more than 7 million units between 2000 and 2009. This sales quantity makes $175 billion in net revenue.

In automobile industry fixed costs make up a greater portion of total costs. The manufacturing plants, assembly lines and technology invested to build vehicles are some of the items forming the fixed costs. Compared to fixed costs, variable costs form a comparatively smaller portion of the total costs. This puts the auto industry into a risky situation due to high operating leverage.

The definition of the operating leverage is the ratio of fixed costs to total costs. The higher a firm’s fixed costs, the higher its operating leverage. In firms having high operating leverage, small percentage changes in sales volumes consequence in large percentage changes in profits. This tendency to change or sensitivity of profits to changes in sales quantity put the firm into a risky position. Per the “Greater Risk, Greater Return” rule this also method more profit if need and consequently sales quantity is high.

In automobile industry since fixed costs are comparatively high, during the recession times, as the need and sales quantity go down the likelihood of earnings to cover the fixed costs will decline, i.e. it will be more difficult for the automobile companies to break already. consequently the automobile companies start cutting the costs, especially fixed costs, like closing the unprofitable facilities, eliminating jobs. For example, GM sold its unprofitable Hummer to a Chinese company.

The car companies should increase the quantity of profitable vehicles and effective advertising activities to be able to sell them to the customers. Increase in the sales quantity will help in covering the high fixed costs and reach the break-already point. In August 06, 2009 Edward Whitacre Jr., the new chairman of General Motors, stated that GM needs to enhance the number of vehicles sold. To do that, he said, the board may decide to move up the set afloat of several new vehicles.

Comparing Ford and General Motor’s Consolidated Results of Operations from Form 10-K these two companies submitted to Securities and Exchange Commission (SEC) back in 2008:

Ford (millions)

Revenue: 146,277

Cost and Expenses: 160,949

Net Income/Loss: (14,672)

quantity of Sales: 5.532

General Motors (millions)

Revenue: 148,979

Cost and Expenses: 179,839

Net Income/Loss: (30,860)

quantity of Sales: 8.144

Break-already points for these companies can be calculated using the Revenue, Cost and quantity figures above.

Ford

Average Price: 146,277 / 5.532 = $26,441

GM

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 quantity GM and Ford had to make to reach the break-already point back in 2008.

Ford: 6.08 – 5.532 = 0.554 million

GM: 9.83 – 8.144 = 1.686 million

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