The Government, the Auto Industry, the Environment, and the Economy Walter McManus Automotive Analysis Division University of Michigan Transportation Research Institute

Physical infrastructure

America’s Road Network Ben Fry

Legal infrastructure n Patents, trademarks, and IP n Business laws (including franchise) n Bail outs (1980 and 2009) o Ownership (GM & Chrysler) o Loans (Ford) n Regulation (more later) n National Innovation System

National Innovation System n Education of workforce n Basic research n University of Michigan $1 billion in federal research (out of total UM budget ~$6.5b) n 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 –Clean Air Act 1970 –Energy Policy and Conservation Act –Energy Independence and Security Act

NHTSA

EPA

ARB

Can you name that 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 SegmentChryslerFordGMHondaNissanToyotaOthersAll Luxury Car Midsize Car ,739 Small Car ,100 Luxury CUV Midsize CUV ,035 Small CUV ,563 Minivan Large Pickup ,791 Small Pickup Large Luxury SUV Large SUV Midsize SUV Midsize Luxury SUV Small SUV Large Van All Segments1,5922,3393,3451,5591,0892,6342,64615,204 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 Year Fuel 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 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 DirectIndirectFuel Cost Revenues Variable Costs Vehicle Fuel 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.

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.)

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.

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 Factors Range Used in Sensitivity Analysis UnfavorableBaseFavorable 1. Fuel economy cost curves multiplier Indirect cost multiplier Profit Margin on new technology0%5%10% 4. Price of gasoline ($/gallon)$1.50$3.00$ Real rate of change in gasoline price-2.0%0.0%5.0% 6. Rate at which miles driven falls8.0%5.2%2.0% 7. Consumer real discount rate18.0%7.0%2.0% 8. 1st year miles driven (miles)10,00015,00018, Relative consumer response to operating v capital costs Horizon for valuing expected operating cost (years) Industry size (millions of units)

Tornado 30%

Tornado 40 %

Tornado 50%