I. Industry Overview A. History The automotive industry in the United States has long been an industry of national pride.

Not only has the industry been a source of economic grown through the past century, but it has also brought a number of production innovations that have become models for other production industries. Throughout the 18th and 19th centuries a number of self-propelled vehicles were invented throughout Europe which were powered by steam engines. Examples of such vehicles include Nicholas-Joseph Cugnots Fardier a Vapeur (Steam Dray, Wiliam Murdochs steam carriage, Henry Taylors steam buggey, and Josef Bozeks stem car. The car as we know it however, can first be traced to the invention of the 4-stroke internal combustion engine. Such an engine relies on the ignition of an air-fuel mixture into a controlled explosion occurring inside a combustion chamber. The explosion, the power of which is increased by compression of air, forces a piston downward which in turn rotates a drive shaft to rotate and the wheels to turn. This idea was first designed by two men, Nikolaus Otto and Rudolf Diesel, who invented the gasoline and diesel engines respectively. Today, these types of engine not only remain nearly identical in concept, but also account for nearly all car engines in use today. Interestingly, some engine types such as the hydrogen fuel cell engine and the electric motor engine, both of which are considered modern innovations, were also developed (although in basic form) around the same time period as the gasoline and diesel engines. In addition to these engine types, advances in other automotive features, such as accelerator pedals and steering wheels in the late 19th century allowed for the formation of what can be considered the car as we know it. Aside from advancements in automotive technologies, infrastructure also played an enormous role in bringing cars into mainstream use. Most importantly, the issuance of drivers licenses, installation of traffic lights, and construction of roads made driving safe and beneficial to consumers. The real driving force behind the adoption of cars as a transport option was in advances in their production. This began with Henry Fords use of the assembly line, allowing for mass production of vehicles starting in 1913. This allowed for economies of scale to take place making cars affordable to the general population. Consumers also benefited from scale economies that occurred from the convergence of various industry firms such as General Motors and Chevrolet. Consumer preferences also became important as a means of product differentiation, choice in paint colors for example. These price and feature aspects led cars to be widely adopted by the time of the second world war until present day. The post war era of American manufacturing was dominated by three firms; Ford, General Motors, and Chrysler, collectively refered to as the Big 3 or Detroit 3. From the post war period until the early 1970s, these three firms went unchallenged and accounted for the vast majority of auto sales in the United States. However, the auto market changed drastically starting in the early 1970s with the Oil Embargo of 1973 in which members of OPEC/OAPEC greatly restricted the supply of oil to the United States. In 1965 international auto firms comprised only 10% of the US market. The oil embargo led to increased consumer demand for cars that were both fuel efficient and reliable. US manufacturers were unable to keep up with international competitors such as Toyota and Honda (located in Japan) which gradually built a reputation upon affordable and cost effect cars. From this point forward, firms such as Honda and Toyota slowly but surely increased their market shares, today accounting for 52.9% of U.S.

auto sales. Not only did these firms produce higher quality cars, but they also developed innovations in production and value chain management, Just In Time (JIT) manufacturing being the most notable. The result of this history is a market in which today, consumers are more knowledgeable, have more access to information, competition is intense, industry concentration is relatively high, and economies of scale have led to lower consumer prices and near universal adoption rates (in 2009 the U.S. Bureau of Transportation Statics stated that there were 254 million registered passenger vehicles in the United States and 312 million people.) II. Industry Structure The automotive industry consists of passenger vehicles, light trucks, towed vehicles, motorcycles, and mopeds. In 2011 total auto sales in the U.S. were reported at 12,734,200, which amounts to a 10.2% increase over 2010 sales (NADA). The major players in the market along with their respective market shares in order of greatest to least are General Motors (19.66%), Ford Motor Company (16.58%), Toyota (12.92%), Chrysler (10.69%), Honda (9.01%), Nissan (8.19%), Volkswagen AG (3.47%), Other Imports (19.49%). The four firm concentration ratio (rounded) is .59, indicating a medium concentration level. The HHI index on the other hand is 1103. Under the U.S. Justice Department policies concerning market concentration, the U.S. Auto industry would be considered moderately concentrated, and while not meriting intervention could warrant the department to monitor the industry. 2012 sales revenues on new cars were $540,000,000,000 according to the United States Department of Commerce. Short term sales trends have been on the incline, with sales of just over 10 million units at the end of 2008. However, although sales have increased markedly recently, the increases represent a recovery towards long term totals, as car sales began to slide rapidly in the period leading to the 2008 financial crisis and worsened for the first year of the crisis. Based on long term comparisons, total sales are still low. For example, 16 million units were sold in both 1987 and 2007. The market share of U.S. firms to that of international firms is also on the decline, with the Big 3 accounting for only 44.97% of sales to 55.03% attributed to import firms. In particular, Japanese firms now account for 30.1% of sales as of 2011, a significant increase since their fortunes began to rise in the mid-1970s. Aside from the sales and market shares of firms, trends have significantly changed in terms of product offerings. Based on the most recent sales reports from March 2013 comparing sales to March 2012, sales of cars has decreased 1.3% from 2012, Light Duty Trucks sales have increased 9%, cross over sales have increased 12.6%, and SUV sales have increased 8.7%. It is important to note the sales of subcategories within those segments however. In the car sales segment, sales of small cars increased 5.2%, Luxury car sales increased 4.4%, midsized cars decreased by 7.1% and large car sales decreased by a total 65.5%. The percentage of sales for the car segment can easily be explained in that consumers as a whole no longer see the value in large gas guzzling vehicles, and are instead substituting them for smaller fuel efficient cars. Sales in light-duty trucks, which includes SUVs has increased 9% since 2012, the exception being minivans which have decreased 8.4% and luxury SUVs which have decreased 3.2% in sales. As a general statement, demand for fuel efficient cars in on the incline for a number of reasons. Firstly, consumer tastes are changing to reflect a desire for more practical vehicles. This change is tastes can partly be attributed to the reduction in real income per capita following the 2008 economic crisis and partly to consumer awareness and informative campaigns for environmental protection. Secondly,

environmental regulations have forced car companies advance research in engines producing higher efficiency. Lastly, a number of government policies (to be discussed below) have provided incentives for consumers to purchase low emissions/high MPG cars. The industry is also distinguished by extremely high barriers to entry. Scale economies have allowed for firms to produce at average costs that simply cannot be matched by startup. Such a barrier means that any firm that attempts to enter the industry is forced to market to niche consumer segments. Such companies include SMART and Tesla. However , even in such cases entry firms must appeal to higher level consumer tastes and such an appeal is reflected in prices. This has the effect of limiting consumer demand for their products, capping the total revenue they can reasonably achieve, and thereby preventing production investments that could lead to comparable economies of scale. In tandem with scale economies, the specialized nature of production is very specific to the product. In other words, if the product proceeds to fail, it would be difficult if not impossible for a firm attempting to enter the market to redesign production to produce another product. Additionally, the simple amount of capital needed to setup production would be prohibitive in itself. Machinery for example is very specialized and also very expensive. Another barrier is the existence of a large distribution and dealership networks that the major auto firms have. Such a network makes it easy for consumers to test and purchase cars. Given the size of auto expenditures relative to average consumer incomes, consumers are far less likely to purchase a car without testing it first. Lastly, the availability and cost of replacement component parts makes cost of ownership lower for consumers purchasing from the larger firms. Therefore, rather than seeing new firms organize for entry into the U.S. auto markets, the more likely occurrence is the entry of international firms. Such firms have advantages in that they also enjoy economies of scale in their home markets and have depth of experience and working capital needed to finance a market entry in which losses in early years may be necessary to survive in the long term. Prime examples of such firms include Kia and Fiat (Fiat-Chrysler).

III. Growth There are also a number of factors that directly affect the growth of the market. Firstly, and perhaps obviously, price. The demand for cars in the United States is very elastic (Apendex ) with own-price segment elasticities ranging from -1.9 to -3.4. A number of reasons account for this fact. First, all cars are for the most part are close if not identical substitutes. Second, the relatively concentration of the industry combined with scale productions means that there are a relatively low number of product offerings, meaning that research and acquisition costs for a consumer to compare different models is relatively low. Third, because of the purchase price relative to income, consumers are more likely to seek out the lowest prices as well as the best quality. In other words, the long term investment nature of the purchase makes demand more elastic to price. Also closely related is consumer income elasticity. Again, because of the large expenditure to income ratio, changes in consumer income is related to sales. If consumer incomes increase, so too will sales. Such is evident given the data presented in section II relating to demand changes for particular vehicle segments occurring through the progression of the economic crisis.

Another factor that affects growth of the industry is the price of complementary goods and the availability of substitutes. In the case of this industry, complementary goods would include, but not be limited to gasoline, replacement parts, maintained costs, etc. It goes without saying that an increase in gas prices will undoubtedly change the demand for cars, especially so given that consumers have a generally long period of time to seek out substitutes. This brings into the equation the availability of substitutes to cars as a whole. That is, what substitutes are available to consumers. Consumes in cities are more likely to substitute a train or a bus for their car in the event of high complementary good prices. The same however cannot be said for those in rural areas, who may simply substitute a more efficient car for a less efficient one given high complementary prices. In all then, complementary good prices surely affect the demand for automobiles in general, but the shift in demand can be either positive or negative depending on the nature and extend of the price increase, demographics, and availability of alternative modes of transportation. The same logic can also be applied towards used cars, which in many cases can serve as perfect substitutes for new cars. A third factor that can affect growth is the availability of financing of auto loans. The vast majority of car sales are purchased using funds received from a lender of some sort. It can then be expected that If the supply of credit decreases, the demand for cars will also decrease as consumers will be willing, but unable to purchase a vehicle at a high price using cash funds. By extension, this furthers the idea that the auto industry is sensitive to economic conditions, as lenders typically only restrict lending in such economic conditions.

IV. Governmental Regulations In the United States, regulations primarily affect three areas relevant to auto sales; emissions, safety, and taxation. The most well-known standards are emissions standards. Authority to set such standards is regulated in two way. First, the Environmental Protection Agency (EPA) has the authority to set national regulations pertaining to greenhouse gas emissions. The agency tends to focus on three pollutants; Carbon Dioxide (CO2), Nitrous Oxide (NOX), and Sulfur. These regulations pertain solely to the manufacturing of automobiles. After the sale of the vehicle, state and local bodies are free to regulate emission standards as they see fit. The present of these regulations has implications in two areas. The first comes in terms of production costs and product price. Many such regulations call for advanced engine systems which bring with them high research and development as well as production costs which are in many ways passed onto the consumer. The second has to do with product offerings. The most notable regulations that have been passed regulate fuel economy standards. In particular, all cars sold in the United States must average 54 miles per gallon of gasoline by the year 2025. This and similar requirements have implications in terms of costs, prices, and ultimately revenues. It also has implications for investors, as it can be expected that the companies that produce the most innovative designs will thrive as these standards are implemented.

The second set of regulations comes via safety restrictions presented by the United States Department of Transportation.