South-Western College Publishing - Economics  
Cost Cutting in Car Construction
Subject Costs, Prices and Profit
Topic Production and Costs
Key Words Costs, Return on Sales, Joint Ventures, Earnings, Sales, UAW
News Story

Ford Motor Company is attempting to reduce its costs by $1 billion in 1999 in order to maintain its return on sales of over 5 percent. It is keen to enter joint ventures, such as one with a German company to build transmissions in Batavia in Ohio. It has already cut costs by $5 billion since 1997. Its mix of vehicles is also helping to raise earnings. However, if auto sales fall as expected, the return on sales will be flat.

GM reduced its costs by $4 billion in 1998 and expects a similar reduction in 1999. However, its return is only 3 percent on sales even after adjusting for the effect of the 1998 strike. GM is going to establish some new small-car factories where workers will assemble large modular parts that have been built by suppliers. It is hoped that the new plants will be about one-third the size and cost of existing plants. The United Auto Workers fears job losses but is still negotiating.

(Updated March 1, 1999)

1. Ford is hoping that joint ventures can help reduce costs.
  a) Why might they cut costs?
  b) What kinds of fixed costs might be less? Which kinds of variable costs might be lower?
  c) Draw a diagram showing the initial marginal and average total cost curves for Ford. Now illustrate what happens when Ford engages in a successful joint venture given your answer to (b).
2. Ford states that its return on sales (its profit divided by sales) depends on the level of auto sales.
  a) Draw another set of cost curves for Ford. Add a horizontal price line that shows Ford currently making a small return on sales.
  b) Explain how you know that Ford is making a small return on sales. Illustrate your answer by indicating the amount of profit and the amount of sales revenue on your diagram.
nbsp; c) Assuming that costs are reduced and that the price remains the same, explain why a drop in sales units might cause the return on sales to be flat. Illustrate in a second diagram at the side of the diagram in (b).
3. GM is planning to build new factories to assemble outsourced modular components. How might this departure be expected to reduce costs substantially?
Source Fara Warner and Joseph B. White, "Ford Plans to Reduce Costs by Another $1 Billion", The Wall Street Journal, January 8, 1999.

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