Stricter fuel-economy regulations would add about $3 billion annually to the gross profits enjoyed by Detroit auto makers, according to a study by the University of Michigan Transportation Research Institute.

The study’s authors also conclude more change is needed in top management at the Detroit Three, particularly at General Motors Corp.

The corresponding increase in new-vehicle sales that would come from fuel-economy improvements would be enough to fill two assembly plants for the Detroit auto makers, says the study, which claims the domestic companies routinely have underestimated the positive effect on profits from making their fleets more fuel efficient and have been out of touch with consumer wants for the past two decades.

The study’s conclusions, which amplify findings in a report it released in 2007, contradict long-held industry assertions that harsher mandates threaten profit potential. Surprisingly, tightened regulations will benefit Detroit auto makers more than their Japan-based rivals, who enjoy superior reputations for fuel economy, the report concludes.

The study’s results are achieved by combining a forecast that calls for annual U.S. market sales to reach 15.2 million by 2016, with a product-cost model that accommodates for improving fleet fuel economy by up to 50%.

The authors, Walter M. McManus, director-Automotive Analysis Div. for UMTRI and Rob Kleinbaum, managing director for RAK & Co., say they sensitivity-tested their findings using varying estimates for the cost of fuel-efficiency technology and other factors and got similar results throughout.

“The chance that increased profits could exceed $6 billion is 18% if fuel economy standards were increased to 40.4 mpg (5.8L/100 km), but only 6% if standards remain at the mandated 35 mpg (6.7L/100 km),” the study concludes.

“There is compelling evidence that the Detroit 3 have systematically underestimated the value of fuel economy to customers. (Therefore), raising fuel economy standards will not cost more than consumers would be willing to pay.”

A comparison of fuel-savings to the cost of annual upgrading vehicles to improve fuel economy portends an advantage to the consumer that ranges from $201 to $1,290, depending on the vehicle segment.

The claim that stricter fuel-economy mandates undermine auto makers’ profitability is based on the assumption auto makers have a firm grasp of consumer wants. This is “unproven,” says the study, which also takes a swipe at the news media.

“Story after story frames the issue of a struggling industry that will not survive tough fuel economy standards,” the study says. “However, there is substantial evidence that the domestic auto industry has ignored customers’ demands for fuel economy.”

Co-author McManus, who like Kleinbaum is a former GM employee, takes aim at the bankrupt auto maker, claiming “internal research for decades that found customers value fuel economy far more than the company’s financial calculations assumed.”

The auto maker “systematically discounted these research results when calculating the benefits of improving fuel economy, often by as much as two thirds,” the study says.

This led to “the belief that fuel economy was not ‘worth it’ (and) became so ingrained into the culture of the company, and so institutionalized in decision making that the senior people might not even be aware that they have been ignoring their own research.”

“It was standard practice in the industry to discount consumer research – but only (in the areas) of fuel economy, safety and quality issues,” McManus says. “We believed we knew better what people really believed. We were wrong.”

The fuel economy movement would benefit Detroit more than the Japanese, the authors say, because the Japanese are further along the fuel-economy cost curve.

“Basically, what is the competitive advantage of the Japanese? Quality and fuel economy,” Kleinbaum says. “If you increase the mandate for fuel economy, the competitive advantage diminishes. So the whole competitive advantage the Japanese have over the Detroit Three becomes less.”

Asked why sales of SUVs and pickups continued to rise over the years if fuel economy was important to consumers, the authors point to the Detroit Three’s pricing tactics.

“The industry has very sophisticated tools for pricing and incentives” and simply lowered the cost of the less-fuel efficient vehicles as gasoline prices increased, McManus says. “But (as a result), their profits started falling. So (the consumer demand for fuel-efficiency) has been affecting them.”

Adds Kleinbaum: “People stay away from small cars in droves, some say. But the companies doing well are the ones that made small fuel-efficient cars. And the ones that made high-powered vehicles are in bankruptcy.”

In addition, UMTRI surveyed major companies in other industries that have undergone the type of restructuring GM and Chrysler Group LLC, newly emerged from Chapter 11 protection, are implementing.

Citing experiences at Continental Airlines Inc., Xerox Corp., International Business Machines Corp. and others, the study links successful restructuring to a reconciliation of product portfolios and consumer expectations. In addition, changes must be quick and meaningful, dysfunctional corporate cultures must be transformed and management teams must be overhauled.

“Existing executives tend to think they are a victim of circumstances and that they just need more time to execute their game plans,” Kleinbaum says in a conference call with the media. “The consequence is they do not move fast or far enough.”

He says CEO Fritz Henderson, who replaced Rick Wagoner atop GM ahead of the company’s bankruptcy filing, may be the right “insider” to lead the auto maker, but he needs to change the top 50 to 100 people, particularly in North America.

“If he keeps surrounded by the same people, they’re not going to make it,” Kleinbaum predicts. “The biggest concern is he has not publicly stated he’s willing to (clean house).

Toyota (Motor Corp.) recently changed 40% of its top management recently, and they are hardly in the position of the Big Three.”

Henderson said last week there would be “significant” changes in management, but Kleinbaum is concerned those moves will be focused more on cost-cutting and less on culture change.

He suggests Henderson tap lower-level employees in North America, where he would find “some competent, gutsy people,” and pull from the ranks of GM’s Asia/Pacific and Latin American operations, where executives are more results oriented and fast moving. He also advises filling the remaining upper management positions with industry outsiders that will bring in new perspectives.

The authors say new Chrysler CEO Sergio Marchionne is doing just that in his remake of Chrysler, but that Ford “would benefit from changes deeper down” in the ranks.

The goal of the study is to help drive a change industry culture and get auto makers to embrace fuel-economy improvements as a business opportunity, not simply a government requirement, Kleinbaum says.

“What we would like is to have the chance to get people to realize they made a mistake over the years and it is time to rethink these issues.”

emayne@wardsauto.com

dzoia@wardsauto.com