How ironic.
Congress is entertaining a $25 billion bailout of the autos. The President and Secretary of the Treasury are OK with this as long as it doesn’t come out of the $700 billion TARP money.
To the average person, the problem with GM is well known. Indeed, most realize that there have been fundamental, structural problems for the past 20 years.
We have been beaten at a game that we invented.
There is no doubt that a failure of GM would be disruptive to markets. This must be balanced by the fact that doling out to GM will cause a rush of suitors looking for government dough.
Most importantly – will it solve the problem?
Image courtesy of Wikimedia Commons
First, let’s get the history right. The title quote is not quite accurate. In 1953, Charles Erwin Wilson (who was president of GM) was nominated to be the Secretary of Defense. In answering a question before the Senate Armed Services Committee, he said he saw no conflict of interest between GM and his new job “because for years I thought what was good for the country was good for General Motors and vice versa.”
I don’t think this quote applies any more.
Right now the debate is focused on whether we should bail out GM or let it go into Chapter 11.
What we know
- GM’s problems are not new but have been exacerbated by the recent economic downdraft.
- GM costs of production are way out of line. While some estimation is necessary, the hourly cost for a GM laborer is about $70 per hour. Toyota is less than $50 per hour. Roughly speaking, GM pays 40% more than Toyota. GM cannot be competitive with this differential.
- The UAW has made it clear (November 13, 2008) that they are unwilling to make further concessions: “We’ve made concessions and done everything we could to make the company profitable over time,” a UAW official told Bloomberg.
- Paying a premium wage is OK – if there is higher productivity. But that is not the case – it is the opposite. The quality of GM production (yes, I know there are some exceptions) is inferior to its competition.
- This is not just a blue collar problem. While data are not as easily available, it is reasonable to think that the white collar cost greatly exceeds those of competitors in Japan in Germany.
- This is not just an issue with costs. Management has made strategic choices that bear considerable responsibility for today’s mess. That is, simply rolling back the costs will not put GM on the right course to be competitive in the future.
- The most serious strategic mistake was the consistent underinvestment in research and development by GM (and Ford) compared to its competitors over many years. This is a classic example of trading off the long-term for some extra cash in the short term. [For more on the short-term/long-term trade off, see my post “My Warning in 2005”.]
What we don’t know:
- What is the story with GM’s pension plan? They are saddled with a massive defined benefit program. With the recent collapse of the stock market, they must be underfunded – the question is by how much. The U.S. Pension Benefit Guaranty Corp (PBGC) said today that GM has not been responsive to the agency’s requests for updated information on the pension plans. My guess is that the pension obligation alone, if known, would drive the stock to near zero value.
A few observations
- Simply doling out money will not solve the structural problems. It will just buy some time. I know that sounds like Richard Shelby – but I think most people agree with this statement. However, it does not mean we do nothing.
- In the ideal world, we could have a Chrysler-like “investment,” like an unofficial Chapter 11 with debtors taking haircuts and labor contracts being renegotiated. Politically, I think it would be impossible to broker this.
- A Chapter 11 would be disruptive – few would buy a GM car because the warranty would have a big question mark on it.
- No one wants to see hard-working Americans laid off.
- GM is strategically important for the U.S. economy. For example, many firms that supply the defense department do important business with the autos.
What I would recommend:
- Government should consult with the UAW and offer a deal: either all contracts are reopened and radically renegotiated to make GM competitive, or the firm will go into Chapter 11. The UAW should also be told that competitive compensation will be applied at all levels (white and blue collar). My guess is that Chapter 11 is the outcome. To me, it is the only politically feasible way to renegotiate the contracts.
- Assuming a Chapter 11 is the outcome, the government immediately steps in and guarantees all warranties. This keeps GM operational.
- Stock holders will get zero. Bond holders will take a haircut. GM gets a chance to radically reorganize. The reorg will produce a smaller firm with far fewer models.
- New management is injected.
- Government provides investment in the New GM (and gets warrants). A precondition of the investment is that R&D spending must not fall below the average of the most prominent foreign competitors.
- Government does its best to minimize the negative impact due to the inevitable loss of jobs. This might include relocation stipends for people moving out of the production areas, education stipends for retraining and could even include extra infrastructure investment in hard hit areas (that would generate employment).
Tough medicine
I know this is tough medicine and will not be easy to pull off. While Ford is in a stronger position than GM, it is obvious that it faces some of the same issues with respect to competitiveness. While I have focused on GM, any solution must involve all the autos. The goal, of course, is to rejuvenate this important component of our industrial structure. While our economy has shifted towards being a service economy, I believe it is important to retain strength and have a diversified economy. GM should play a robust role in economy. Right now it is just a weak link.
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“We have been beaten at a game that we invented.”
–Strong, but fair, criticism. We’ve come a long way since the assembly line innovation and I think your right, the international competitors in this game have taken a more shareholder valuable view of long-term viability rather than focusing on the immediate opportunities with no strategic options on the table. The autos failed to calculate the value of the “strategic option” here with investment in R&D. Case in point is the hybrid tech/electric tech. Even if it cost a billion dollars a year to move the technology forward while the margins on larger vehicles were fat, the option would probably be keeping them out of Ch 11 now.
One other possibility here. Maybe the best option is providing enough funding (with stringent requirements and not cheap like the bank injection) to get them through the next 2-3 years without defaulting on obligations. My worry is right now the possible adverse systematic effect on the overall economy resulting from a default in the near term. Give them enough time to make a go, with significant hurdle, whilst we climb our way out of the recessionary/depressionary trenches (hopefully 2-3 years is enough!) and at that point we exercise warrants, realize any residual value, and walk away. If there’s a credit event at that point, we pursue the Ch. 7/11 route.
Rebutting my own point. The market does usually see through solutions with little long term conviction to stay the course (TARP quickly comes to mind), and that could drag out the problem and subsequent economic woes.
I’m afraid the what we know section does not paint a very accurate picture and since it is the premise for the rest of the post, it seems the conclusions at the end now also need to be re-though:
1. True — in fact, completely true.
2. yes there is a big differential at present. Actually GM uses $65 hourly number vs. Toyota who usually uses a $47 hourly number. However, when the new UAW deal kicks in in 2010, GM’s cost will go to $45 hourly (as estimated by the Center for Automotive Research) actually bettering Toyota’s which will only go higher because of their wage structure. In addition, the retiree health care cost will go into a veba trust administered (initially funded by gm) by the UAW and off GM’s books — another big savings. This is one of the main reasons GM is seeking a loan to get them to 2010. Their labor cost structure changes dramatically at that time and assuming a reasonable recovery in the economy they could be extremely profitable.
3. Don’t doubt the quote from the Bloomberg story but in today’s hearing on Capitol Hill Gettlefinger outlined a number of steps the UAW has taken to work with the automakers and pledged to do more to work with them. The UAW is invested in the auto companies surviving and few doubt the UAW will make more concessions when the time comes.
4. I’m sorry but it is more than a few exceptions. While the traditional viewpoint of UAW factories is they are of less quality that is simply not true today by any objective measure. The Harbour Report on Plant Quality gives 9 out of the top 10 spots to UAW factories in North America and Canada….yeah that includes the toyota, bmw and volkswagen factories in the south. Truth is the UAW-GM relationship has changed greatly andfor the better under Gettlefinger/Wagoner and you only have to visit one of the more modern plants such as the ones in Lansing to see this first hand. There is little of the animosity and confrontation that marked the past. There are flexible work rules and joint GM/UAW initiatives.
5. I know of no reason why it is reasonable to assume GM’s white collar workers make more. Plus if you have read any headlines of late you will know that GM is no longer making contributions to employees 401k’s, has eliminated all bonuses and has dropped raises to almost non-existent. If your theory were correct wouldn’t employees from the other automakers be busting down the doors to get a job at the better paying GM? Not exactly the picture is it….
6. GM and Wagoner have said repeatedly that despite taking over 9 billion dollars of infrastructure costs out in the last 2 years that they can’t cut their way to profitability. Wagoner has emphasized the need for better products that will earn a change in reputation (good on the first part not much progress on the 2nd admittedly). Gm is the current holder of North America Car of the Year — Malibu, and the Motor Trend Car of the Year — Cadillac CTS. And just this week the Opel Insignia (GM’s Euro brand) was named European car of the year. It does make you wonder if GM has quietly re-established itself as the hottest design house in the business reminiscent of the days of Harley Earl. And the Chevy Volt shows the commitment to technology and re-inventing the automobile. This is way beyond a simple “cost roll back.”
7. I don’t have the number but I”m pretty sure few if any of the automakers match GM’s investment in research and development. GM has 100 hyrdogen fuell cell cars in people’s homes being tested right now as but one example.
Cam,
Hope you are doing well. I have been with GM for the past few years, and want to call into doubt where (and from when) you are getting your facts. I’d like to point out to you that certain of the progress made in recent years by GM.
Speaking for myself, not for the company:
On #2 – there were major adjustments to structure of those agreements in the fall of 2007, and by 2010, we will have largely closed the US wage/benefit cost with Toyota… to MUCH less than 40%. Worth pointing out that the transplants (ie Toyota) are facing mounting campaigns to organize their facilities. If card check happens, anyones guess.
On #3 – again, major adjustments made to the structure and flexibility of those agreements. GM and UAW have a history, and in particular a very good RECENT history, of working through issues — I would point to the flexibility in deferring substantial sums that were to be deposited into the VEBA through 2008 and 2009, which is a significant move made since the quote you cite above. Also worth noting that the UAW is a political body whose leaders do not have, shall we say, the luxury of being “practical” in their public comments.
On #4 – Simply a false assertion. I would refer you to recent Harbour reports, and you will see that on productivity in North America, there is no gap, and in many areas GM has advantages.
On #5 – GM is a very global company, moreso than any of our competitors. So while I would rebut the premise that German employment costs are lower than those in the U.S. (particularly when coupled with the much greater white collar labor inflexibility in Germany), GM has moved to a truly global development process and using the U.S. salaried model as a proxy for GM would be incorrect.
On #6 – This sounds like a talk point that isn’t really anything we “know”. In fact, if you look objectively at the decisions from management over the past decade, you will see that these are.
On #7 – While it is true that GM has borne the burden of considerable funding obligations to pension and retiree health care, GM has not underinvested in R&D. GM is the world leader in biofuel vehicles, is inarguably the leader in fuel cell technology, has a hybrid system in a Chevy Tahoe that results in better city fuel economy than a 4-cylinder Camry, and will be bringing the worlds first mass production electric vehicle to market in 2010 on technology that Japanese competitors are only now conceding may actually work. 11 of our last 13 US launches were fuel efficient cars and crossovers, 14 of our next 15 will be, and in 2009 we will have 20 models in the US with better than 30 mpg (EPA highway), far more than any other competitor.
Chapter 11 would lead to liquidation in short order. The problem the industry is facing is due to the precipitous decline in revenues – something that would only be multiplied by a C11 filing. If cash is flowing out today, imagine if >80% remaining sales vanished? A government guarantee on a private company warranty, that is completely dependent on suppliers continuing to produce parts (who may file for bankruptcy protection themselves when not paid on GM’s filing), is likely to be unconvincing to a consumer. Why take that risk? What about resale value of that new car purchase if the firm doesn’t come out?). That is risky business. I spent a lot of time on Delphi’s bankruptcy, and I promise they didn’t expect to still be in Chapter 11 more than 3 years later — even failing to emerge in the easiest credit environment in memory and with a near-captive customer. An auto company’s customers are far from captive and the global economy is deteriorating. Stakes are high, suppliers are thinly capitalized, and consumers are jittery and a lot poorer than they were 18 months ago.
I am amazed at the country’s, and many members of the Congress’s, insistence that our industrial giants should shirk their responsibilities and file bankruptcy, and be lambasted for daring to manage their restructuring out of court. I suspect that some of those advocating this have a strong vested interest in this occurring (i.e., they are long CDS on GM securities… a market that itself has potential for an interesting chain of destabilizing ‘unintended consequences’ in the event of a GM or more broad automotive series of defaults), or that they have listened too long to those that for reasons unknown, or politically popular, simply despise the idea of “Detroit” and U.S. manufacturing.
What GM and the industry requires is near-term liquidity support to weather this ‘perfect-storm’ downturn. There are many reasons to believe that the future is brighter, that the U.S. industry is on the right track, and that this money will be paid back with interest. If there are warrants or an equity position, it is reasonable to believe this would earn a return. Instructive that even GM’s critics believed, no less than 12 months ago, that GM had a clear path out from its historic burdens, that its product was now the best in its 100 year history, and that it would soon begin reaping the benefits of its new truly global structure. What has really changed since then?
Lend the U.S. autos the money. Chapter 11 will not work, this is too important right now, and on the factors laid out, I like the odds of a decent return on the taxpayers’ money. Lend the money.
I think your “other possibility” that you raise is close to my “ideal scenario” (Option 1). In this world, there is recontracting without the Chapter 11 filing. If there was a real committment on this, it is clearly the least disruptive.
A few comments.
3. Agree this could be positioning but having a negative effect on the Hill.
4. OK. I think we agree that practices still need to be reformed.
5. Well, as I said, we would need the data. I base this on the simple fact that U.S. executives get paid more than European and Japanese comparables. This is based on all industries.
6. I totally agree you can’t cut your way out of this. I say something similar “this is not just an issue of costs”.
7. Check out https://www.spectrum.ieee.org/dec07/5742 the R&D intensity (R&D/Sales) GM=3.2%, Toyota=3.7%, BMW=5.2%, Nissan 4.4%, Volkswagen 4.4%. Notice Ford is 4.5%. I think that Toyota is underinvesting and is headed down the GM path. They should have the 2008 table ready soon.
Thanks for the comments. I appreciate this detailed information from inside the firm. I am certainly aware of the considerable progress GM has made. I know management is trying very hard and there is a long way to go.
You say “if you look objectively at the decisions of management…” well, that’s exactly what I am doing. I have no axe to grind. In addition, I say “GM is strategically important to the U.S. economy.” I think it is reasonable – given the current situatoin — to conclude that there have been mistakes in the development and execution of the corporate strategy.
You say “GM has not underinvested in R&D”. Perhaps you have some data you can share with us. See my response to previous:
Check out https://www.spectrum.ieee.org/dec07/5742 the R&D intensity (R&D/Sales) GM=3.2%, Toyota=3.7%, BMW=5.2%, Nissan 4.4%, Volkswagen 4.4%. Notice Ford is 4.5%. I think that Toyota is underinvesting and is headed down the GM path.
Cam,
Interesting.
I’m trying to imagine “relocation stipends for people moving out of the production areas.”
Can you imagine the new democratic administration encouraging people to leave Michigan? Or leave Detroit, an urban area, considering that urban affairs are reportedly going to be a focus of the Obama administration?