How Do Recalls Impact Automobile Companies?
An Investor's Guide to Recent Developments in the Auto Industry
The impact of recalls
In the previous part, we looked at the ignition-related vehicle recall by General Motors (GM). Vehicle recalls are not something new for the US (IVV) automobile industry. Ford (F) had a major recall related to Firestone tires at the beginning of this century. Recalls are a routine affair for an industry that’s expected to produce more than 17 million units this year. However, certain recalls get a lot of media attention, either due to the gravity of the malfunction or the sheer volume of vehicles involved.
What are the costs?
Every vehicle recall has a cost associated with it. The previous chart is a snapshot of some of the costs associated with a vehicle recall. First and foremost, there are direct financial costs related to the replacement of the faulty part. This includes both material costs and service costs.
Litigation-related costs account for another major chunk of direct financial costs. Toyota (TM), for example, paid $1.2 billion to US authorities last year to settle the case relating to the recall of its faulty ignition switches.
What about indirect costs?
There are indirect costs involved in recalls, such as damaging the company’s image. Frequent recalls by an automaker reduce the brand’s perception in consumers’ minds. Automakers spend billions of dollars each year building brands. Globally, automakers spend anywhere from 3%–5% of their annual revenues on advertising.
There’s also an opportunity cost related to lost sales when consumers start doubting the company’s ability to produce quality products.
Meanwhile, amid all the gloom created by the recent recalls, Fiat Chrysler (FCAU) has called for further consolidation in the automobile industry. But does the automobile industry have a real need for consolidation? We’ll look at this in our next part.
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