Why Toyota wants GM to be saved—a game theory case study

Here’s the latest twist in the auto bailout:

Detroit’s Big Three aren’t the only automotive companies that want to see the government step in with some much needed financial help.

Overseas automakers, most notably Toyota Motor, all endorse some form of federal aid to keep General Motors, Chrysler LLC and possibly Ford Motor out of bankruptcy.

[source: CNN "Why Toyota wants GM to be saved"]

The news seems strange. Business is a dog eat dog world. The usual response is to kick a competitor while he is down. As McDonald’s founder Ray Kroc put it, “If any of my competitors were drowning, I’d stick a hose in their mouth and turn on the water.”

So why would Toyota help the Big Three? Game theory tells us to think deeper. The real reason Asian automakers want to help is out of self-interest. The CNN article explains several of the strategic reasons for helping the US automakers.

They involve:

• supply costs
• demand issues
• deterring new entrants

Let’s examine each issue in detail. (all quotes are from the CNN article on the bailout)

Supply costs

While automakers are competitors in car sales, they are indirectly partners in the auto parts supplier market. The more cars that are sold-regardless of who sells them-the greater demand there is for parts, and consequently, the lower the price will be for everyone.

Asian companies have a vested interest in protecting demand for the delicate supply market:

The overseas automakers, who between them produce more than 3 million vehicles a year at U.S. plants, all worry their production would be hurt if one of the U.S. automakers went under. That’s because a Big Three failure would likely lead to widespread bankruptcies in the auto parts supplier industry.

The risk is increased because many parts only have a single supplier. Ultimately costs and time for production would be increased in the transition period. And increased costs would further damage automakers because of demand issues.

Demand issues

All automakers depend on another common item-the health of the U.S. economy. The more severe the recession, the worse car sales will be. Foreign automakers depend on U.S. sales and worry about further declines.

The pain has been tangible for Toyota which has had to cut production:

The latest cutbacks came Monday when Toyota announced it was putting plans to open a new plant in Mississippi on hold indefinitely, even though it is about 90% complete. The plant was set to start building the first domestically produced Prius in 2011.

Sometimes competition can be put aside for bigger issues. Asian companies are guessing that a Big Three bankruptcy would have too large an impact to ignore. That’s why they are worried less about their share of the car market and more about how big the market will be.

Deterring new entrants

High start-up costs often keep entrants out. They worry about joining a market where an incumbent can price gouge, drive them out, and then recover profits later. In the auto industry, there is also an issue of excess capacity-it might be unprofitable to join a market at current production levels.

And this is why Honda and Toyota are scared about the U.S. companies failing. It sets up a chance for entrants to come in much easier:

The final concern for the overseas automakers is a longer-term problem. If a U.S. automaker fails, that could open the door for a Chinese or Indian automaker to buy up the assets of the failed automaker and create a new low-cost competitor in the U.S.

While China and India may eventually come into the U.S. market, incumbents would rather have that happen later.

In conclusion

The bailout illustrates why it might not always be a good idea to kick your competitor when he is down. Propping him up might be the lesser of two evils.