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General Motors Company (GM), Ford Motor Company (F): Can American Cars Earn the Quality Premium?

It has been four years since the U.S. government bailed out General Motors Company (NYSE:GM) and Chrysler. For years, these two companies, along with Ford Motor Company (NYSE:F), had done everything wrong. They were building cars that consumers didn’t want, that were totally unreliable, and that were inferior in quality. Thus, they suffered from diminishing market share and low returns on invested capital until reality finally hit them in 2008. Ford Motor Company (NYSE:F) was only able to save itself from bankruptcy by borrowing $12.1 billion in long term debt at the height of the credit bubble.

General Motors Company (NYSE:GM)

One reason that American companies languished behind their foreign competitors was due to the perception that foreign brands — especially Japanese ones — were of higher quality and more reliable. This caused buyers to be willing to pay a higher price for say a Toyota over a Chevrolet. However, since re-emerging from bankruptcy in the summer of 2009, American car companies have been making somewhat of a comeback. General Motors Company (NYSE:GM) in particular has been ranking higher in quality and reliability surveys and has seen its luxury brand, Cadillac, return to its former glory. So can Detroit finally change a perception decades in the making?

The quality premium

The 10th chapter of Value: The Four Cornerstones, published in 2009 by management Consultancy Firm Mckinsey & Co. discusses the drivers of return on invested capital, or ROIC, and why different companies generate different ROIC from their businesses. One reason for different ROIC listed by the authors was quality —  real or perceived. The authors discussed General Motors Company (NYSE:GM) and other American companies vs Toyota Motor Corporation (ADR) (NYSE:TM) and Honda Motor Co Ltd (ADR) (NYSE:HMC) as an example.

They argued that years of superior reliability and performance have entitled Japanese brands to a quality price premium. They observed that even if sticker prices on comparable vehicles from both groups were the same, American companies were forced on average to sell at $2000 -$3000 less than than their competitors, thus allowing Toyota Motor Corporation (ADR) (NYSE:TM) and Honda Motor Co Ltd (ADR) (NYSE:HMC) to earn higher returns on capital. This quality premium continued to linger around even as differences in quality diminished over time, proving that the perception of quality may far outlive the reality.

In the month of June, if we take a look at the average transaction prices of General Motors Company (NYSE:GM) and Ford Motor Company (NYSE:F) Vehicles versus Toyota Motor Corporation (ADR) (NYSE:TM) and Honda Motor Co Ltd (ADR) (NYSE:HMC), we find that even though the average transaction price of American brands are slightly higher, the incentives (cash rebates, lease promotions, cheap loans, and dealer incentives) they offer are almost double that of their Japanese competitors.

Company Average Transaction Price Incentives Incentive/ATP
GM $33,218 $ 3,513 10.8%
Ford $33,272 $  2,964 8.9%
Toyota $29,177 $  1,660 5.7%
Honda $27,165 $  1,690 6.2%
Industry Average $31,125 $  2,537 8.2%

Racing up the rankings

Last June, General Motors Company (NYSE:GM) overtook Toyota Motor Corporation (ADR) (NYSE:TM) in the JD Power Circuit for the first time since the survey began 27 years ago. GMC was the second highest scoring brand behind Porsche. Chevrolet came in 5th place ahead of Toyota Motor Corporation (ADR) (NYSE:TM) which placed 7th. All four of General Motors Company (NYSE:GM)’s brands ranked above average in the survey.

“If you were to ask me the question, what corporation has the best quality in the entire industry, the answer would be General Motors,” David Sargent, J.D. Power vice president of global vehicle research, said in a telephone interview with Bloomberg.

Ford Motor Company (NYSE:F), on the other hand, performed poorly in the survey, coming in at 27th out of 28. This can be mostly blamed on its MyFord Touch System, which has seen a high failure rate and sometimes required customers to return their cars to dealers for repairs. Ford Motor Company (NYSE:F) is expected to start rising in the rankings once it gets this technology sorted out. It’s Lincoln Luxury Brand came in at 17th scoring in the average range of vehicles.

The J.D. Power survey is an indicator of initial-built quality since it’s based on the number of problems reported per 100 vehicles in the first 90 days. The survey, however, tells nothing about how cars handle over time. This is where Japanese brands still reign supreme. Last year, in the Consumer Reports new-vehicle Reliability Index, Scion came in first place followed by Toyota Motor Corporation (ADR) (NYSE:TM) and Lexus, all brands of Toyota Motor Corporation (ADR) (NYSE:TM)’s. 7 out of the top 10 were Japanese. The top scoring American brand was GM’s Cadillac which came in 11th place moving up in ranking 14 places from last year.

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