Why Both Ford and GM's Profits Could Be in Danger


It's been an extremely profitable first half of 2013 for both Ford and General Motors . One huge reason for this is that their most profitable vehicle segment, full-size pickups, are selling at a rapid pace. The F-Series and Silverado sales are up 22% and 27% so far this year and don't look to be slowing down with the automotive market continuing its rebound. But there is one scary development for investors that could potentially reduce the profits made from these full-size trucks by thousands of dollars.

Pricing power
Full-size pickups bring in the majority of the profits for domestic automakers; analysts estimate each truck sold could bring in as much as $10,000 in profits. In addition to that, transaction prices for trucks have increased faster than other vehicle segments.

Graph by author, information from Automotive News DataCenter.

There are a couple reasons for ever-rising truck prices: brand loyalty and a 50-year tariff on light trucks enacted in 1963. While few trucks now are subject to the tariff, mainly because Toyota builds most of its trucks on U.S. soil, it still keeps some competition away which indirectly leads to higher prices. Consider that in midsize car segments there are 15-20 brands competing compared to the more profitable truck segment which has a fraction of the competition.

In reality the competition is even less than it seems between domestic automakers because of brand loyalty. The line in the sand has been drawn for decades, so you're either a Ford or GM driver - there is no grey area. Because of this automakers can get away with high prices because they know their customers will likely purchase from them again, regardless. If the tariff were reduced or abolished it could bring in extra competition, which could potentially reverse transaction prices by thousands of dollars.

Bargaining chip
Detroit automakers are using the tariff as a bargaining chip during the Trans-Pacific Partnership negotiations. Japan is still the world's third-largest auto market and is virtually closed off from U.S. automakers. If Detroit agrees to abolish the tariff then it might be enough to negotiate domestic automakers' entry to Japan - but there's doubt among executives if this would ever truly happen. The worst-case scenario being that the tariff is reduced or abolished but U.S. automakers still get the runaround from Japan and fail to gain market entry.

This development does have some Ford and GM executives worried because a weak yen gives Japanese automakers more incentive to produce vehicles in Japan and export them to the U.S. market - using the exchange rate as a way to increase profitability. It's the main reason for Toyota's huge 94% increase in profits last quarter. If the weak yen is used aggressively, then Toyota could load up features and incentives to try and get its foot in the door of the very profitable U.S. full-size truck segment.

For now the tariff is a road block stopping Toyota and Honda from exploiting their advantage, but if removed could have an effect resulting in more competition and lower prices. That could drastically reduce Ford and GM's profitability.

Bottom line
Ultimately, if the tariff is used as a bargaining chip to gain entry into Japan's market, it could be worth it. Chances are that with such high loyalty rates and decades of industry knowledge, Detroit's trucks would still dominate the market.

Michelle Krebs, senior analyst at Edmunds.com told Detroit News:

The simple fact of the matter is, Detroit reigns supreme when it comes to trucks. When it seemed like Toyota was going to take over with its trucks, they didn't make a dent. And in the current truck boom, Nissan's Titan sales are down.

One thing is for sure, reduced profits from full-size pickups would drastically hurt Ford and GM's share price and this is a development to keep a close eye on as negotiations progress.

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The article Why Both Ford and GM's Profits Could Be in Danger originally appeared on Fool.com.

Fool contributor Daniel Miller owns shares of Ford and General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published