Financial Analysis

Case study: the Ford Pinto Finally, try the following case of the Ford Pinto. What do you learn about the extent to which NPV calculations are appropriate in management situations, and its implications for the way management should use NPV? The case study is based upon contemporary newspaper reports. It is not intended to imply criticism or blame of any of the parties concerned. Introduction In 1978 a Californian court awarded more than $128 million to Richard Grimshaw - a sum then worth $66 million - in compensation and punitive damages against the Ford Motor Company. Grimshaw had been a passenger in a Ford Pinto, a car never sold in the UK. It was a 'sub-compact car and the jury found that Ford had sold two million such cars knowing that they were of a dangerous design. A key aspect of the case was an internal memorandum of 1972, part of which is reproduced in Fig. W5.3. BENEFITS: Savings - 180 burn deaths, 180 serious burn injuries, 2,100 burned vehicles. Unit cost - $200,000 per death, $67,000 per injury, $700 per vehicle. Total benefit - 180 x ($200,000) + 180 x ($67,000) + 2,100 x ($700) = $49.5 million. COSTS: Sales - 11 million cars, 1.5 million light trucks. Unit cost - $11 per car, $11 per truck. Total cost - 11,000,000 x ($11) + 1,500,000 x ($11) = $137 million. Figure W5.3 The arithmetic that cost $66 million. On the basis that Ford considered the savings of $49.5 million to be less than the cost of altering the cars and light trucks to conform with safety standards then being proposed by Congress ($137 million), it was concluded that no design change should be made. It was felt by Grimshaw's lawyers that the massive damages were punitive and were a result of the jury's dissatisfaction with Ford's attitude, as evidenced by the testimony given and the memorandum reproduced in Fig. W5.3. The events On 28 May 1972 Richard Grimshaw, then 18, was offered a lift in a new Ford Pinto by a friend of his family, Mrs Lily Gray. They were heading for the southern California desert resort of Barstow on Interstate route 15 when Mrs Gray's Pinto stalled because of a faulty carburetor and was hit from behind by another car. The Pinto's petrol tank, located only seven inches behind the rear bumper, was ruptured by the impact. Fumes from the petrol that escaped mixed with air in the passenger compartment, a spark ignited the mixture and the Pinto was enveloped in flames. Lily Gray was so badly burned that she died in hospital two days later. Richard suffered 90 per cent burns: he lost his nose, left ear and four fingers. Miraculously he survived. After 52 operations he now has a new nose and ear, but his face will always be a mass of twisted scar tissue and there are more operations to come. He has also been awarded $66 million in damages, the highest ever personal injury award. "I don't want to sound like I'm ungrateful', he said last week after his award was announced, 'but if I had a choice of whether to take this money and go through all these bums and stuff or just lead a normal life, then I'd lead a normal life'. (Mrs Gray's family was awarded about (340,000.)It was more than five years after the crash that Richard's suit against Ford came up in the Santa Anna Superior Court, and by then his lawyers could fall back on several case histories. A court in Florida had awarded $3.3 million damages (about El.6m) against Ford in 1975 following an accident in which a Pinto's petrol tank had exploded. A year later, an Alabama jury had awarded $1.2 million to the plaintiff in a very similar Pinto crash. And as Richard's case began, a Virginia court ordered Ford to pay $625,000 following another incident of a Pinto's petrol tank going up in flames. In none of those cases, however, were punitive damages sought against Ford. Richard's lawyers were determined to press for a punitive judgment, which would involve convincing the jury that Ford had 'consciously and wilfully' disregarded the safety of people who bought Pintos. They knew that Ford's central defence in Richard's case would be that Mrs Gray's Pinto had, at the time of the accident, conformed to all existing government safety regulations and that the leaking petrol was not necessarily the major factor in the tragedy. . Richard's legal team had access to valuable background material before the case began. The hazards presented by the design and positioning of the Pinto's petrol tank had been investigated by several independent organiza- tions since the model went into production in August 1970. A study in 1973 by the University of Miami's accident analysis unit, examining four years of car crashes, had singled out the Pinto for comment. Under the heading 'Gay Tank Integrity/Protection (Ford Pinto)', the Miami unit observed: In each case the gas tank was buckled and gas spewed out. In each case the Interior of the vehicle was totally gutted by the ensuing fire. It is our opinion that three such conflagrations (all experienced by one rental agency in a six month period) demonstrates a clear and present safety hazard to all Pinto owners'. Shortly before Richard's case began, Dr Leslie Ball - former safety chief for the NASA manned space programme and founder of the International Society of Reliability Engineers - had publicly asserted that the release to production of the Pinto was the most reprehensible decision in the history of American engineering'. Ball was particularly scathing about the design and location of the Pinto's petrol tank. There were, he said, a large number of European and Japanese cars in the same price and weight range as the Pinto which were more safely designed. Most used a 'saddle style' petrol tank placed above the car's back axle, out of the line of direct Impact. The basic patent on the saddle-tank, Ball noted, was owned by Ford. A lot more was required to win punitive damages - and Richard's lawyers got it. The production of Ford's own confidential documents and the cross- Examination of senior Ford executives about their contents made an enormous impact upon the jury. And the greatest damage to Ford's case was done by its own analysis of the price of building greater safety into Ford cars against the expected benefit derived from saving Ford owners from death or injury by burning. The evidence to the court The figures were buried in a seven-page report from the company's Environ- mental and Safety Engineering' division, which was circulated under the title Fatalities associated with crash-induced fuel leakages and fires'. Ford's experts doubted the government statistics of between 2,000 and 3,500 such deaths every year; their research suggested that most of the deaths in 'fire- accompanied crashes' were due to Injuries caused by the impact not the flames. They concluded that between 600 and 700 fire deaths a year 'is probably more appropriate'. The report pointed out that the chance of petrol spilling from a ruptured tank was significantly greater when a car was hit from behind than from the front, side or after being rolled over. None the leas, Ford's engineers based their calculations of the sums at stake if proposed new regulations were adopted, on the less common hazard of 'static rollovers'. Some common measure was required to make the comparison. The memo noted: "the measure typically chosen is dollars'. Ford's calculations of the value of a human life were based on a 1972 study by the National Highway Traffic Safety Administration (NHTSA), which sought to establish the cash cost of death in a car crash by breaking down and valuing ten separate components. 'Future productivity losses' were so much, medical costs so much, insurance administration and legal expenses so much: there was even a figure - $10,000 - for 'victim's pain and suffering', though the NHTSA steadfastly refused to say how it had been arrived at. The overall 'societal cost' came to $200,000. Ford also allowed a figure of $67,000 for non-fatal burn injuries.From official statistics Ford extracted the figure of 180 deaths per year from burns in rollover accidents. Where some experts disagree with Ford is in their further estimate that numbers emerging alive from such accidents, but suffering severe burns, would also be 180 a year. Some authoritative studies have put this figure ten times higher at 1,800 a year. Based on the benefits of saving 180 lives and preventing another 160 people from being burned, with an allowance for the cost of damaged cars, Ford put the total benefit of a design change at slightly less than $50 million. That was set against the costs -$11 worth of modifications per Ford vehicle sold - of $137 million. That, Ford's engineers observed, was almost three times greater than the benefits, 'even using a number of highly favourable benefit assump- tions'. They could not envisage any developments which would make compliance with the rollover requirement cost effective". On the heels of that memo, the Santa Anna jury heard something of the background to Ford's decision to place the Pinto's petrol tank in such an exposed position. First, Richard Grimshaw's lawyers produced their star 'defector', Harley F. Copp, a senior design engineer with Ford for 20 years, now retired. Against a stream of objections from.Ford's team of lawyers, Copp demonstrated with blackboard, wall chart and models to the evident discomfort of his former employers. (He was helped by occasional indulgence from the bench: I will allow hearsay" the judge declared at one time, 'provided it is reliable hearsay'.) Copp had worked on Ford's successful Capri range in which the petrol tank rode, saddle style, above the back axle; he was certain that this was the safest design (Ford had, in fact, considered using the Capri design on the Pinto). What could a designer like him do, Richard's lawyers asked, if 'corporate management' specified the location of the petrol tank? Follow corporate policy, Copp replied. Had Ford's top management, in fact, issued a design directive for the Pinto's tank? Behind the rear axle, beneath the floor.' Could he estimate how much extra it would have cost to place the Pinto's tank above the axle? 'About $9 more per car," Copp's testimony was reinforced by more memos from Ford's confidential files, demonstrating, Richard's lawyers argued, how Ford had disregarded danger signals in its rush to get the Ford on to the lucrative US small car market (the company's share of this market had been declining at an alarming rate in the face of competition from European and Japanese models). Shortly after Pinto's production began, several Capris with saddle-style tanks came through crash tests with flying colours; next day, Capris with modified tanks placed, like the Pinto's, behind the rear axle were crash-tested and leaked petrol in every cage. Like every company in the ferociously competitive small car market, Ford was exceedingly price conscious. A Ford engineer told the US magazine Mother Jones that the Pinto was rigidly governed by 'the limits of 2,000' -it was not to weigh more than 2,000 pounds and not to cost more than $2,000 (the magazine was the first to publish some of the Ford documents used In Richard Grimshaw's case). A $25 increase in production costs could price a compact out of its market; so could a marginal reduction in sales features such as the size of the boot. 'Do you realize that if we put a Capri-type tank in the Finto you could only get one set of golf clubs in there?' another Ford engineer told the magazine. The result It took the jury in Richard Grimshaw's case one minute to reject Ford's argument that the speed at which Mrs Gray's Pinto had been hit - from 50 to 65 m.p.h. - was the chief cause of the tragedy rather than any defidency in the design of its petrol tank (the jury concluded that impact speed was 35 m.p.h. at the most). Ford's position is that every Pinto it manufactured had met or surpassed the government safety standards applicable at the time, and Pintos produced since September 1976 meet the revised rear-impact standards introduced since Richard was involved in his accident. Mr Grimshaw was awarded punitive damages of more than $128 million against Ford. Ford announced that it would appeal