20 October 2005

Why is General Motors in Trouble?

Delphi and General Motors are pushing hard to make drastic cuts in employee compensation. But, the most fundamental problem it has is that its poor car design and quality have led most consumers to by imports or other competitors, when faced with a choice between comparable vehicles at comparable prices. The businesses cannot be saved unless this problem is solved. And, if that problem can be solved, cuts to employee compensation could be far less draconian.

Of course, it would also be easier to negotiate compensation cuts from the rank and file and to convince them that the need to economize is real, if your actions didn't symbolically undercut your message, which is what you do when you give all of your senior executives raises upon going bankrupt, as Delphi just did.

Does Delphi Need To Cut Compensation From $65 an hour to $20?

The CEO of Delphi, the bankrupt General Motors automotive parts supplier spun off from GM in 1999 (with which GM has a variety of elaborate contract and is obligated to guarantee about $12 billion in potential benefits liabilities to employees and retirees), claims that "The average union worker's wage-and-benefit package at Delphi is about $65 an hour" and that it needs to pay about $20 an hour, a more than two-thirds cut in pay and benefits, to be competitive in the market, despite its "decision to increase cash bonuses and extend severance packages to 18 months for [600] top executives." Delphi employs about 185,000 employees worldwide including "45 manufacturing sites employing 49,000 workers" in North America.

Delphi is also a bellwether of the domestic automotive industry. A Delphi collapse could easily take money losing General Motors down with it. A stunning pay cut of the scale proposed by its CEO, could lead General Motors (which this week reached a major giveback labor pact with its unions in an effort to fend off bankruptcy), to follow suit, and any labor cost cuts by General Motors would have to be matched by competitors with similar price structures, like Ford and Daimler-Chrysler, if they wish to stay profitable.

Digging A Deeper Hole

It is hard to make a profit by selling cars, when you take a loss on every car that you sell. In the first half of 2005:

August 30, 2005

General Motors Corp., the world's largest automaker, lost an average of $1,227 per vehicle sold in North America during the first half of 2005, the most of any U.S. automaker, according to an industry analyst.

Ford Motor Co., the second-biggest U.S. car maker, had a loss of $139 per vehicle, while DaimlerChrysler AG's Chrysler Group produced a profit of $186, Laurie Felax, vice president of Harbour Consulting in Troy, said Monday.

GM and Ford are trying to cut costs as they struggle with excess capacity while raw material prices and benefit costs rise. Ford has trimmed employees and has said more cuts will come, while GM is in talks with the UAW in an effort to lower health-care expenses.

Nissan Motor Co. led the world's biggest automakers with a profit of $1,826 per vehicle, followed by Toyota Motor Co. with $1,488 and Honda Motor Co. with $1,203.

Is GM a Welfare State?

The CEO of General Motors has repeatedly complained about the impact of health care costs on its bottom line and has also bemoaned its past decisions to establish defined benefit pension plans and a health care plan for retirees. In the wake of layoffs spurred largely by declining market share, General Motors, at least according to George Will (I'm not sure that he is reading the figures right), has 2.5 retirees for every employee, all of whom must be supported.

George Will has been going at the General Motors as a welfare state meme since at least May of this year, and rehashed it in his column today, and the coincidence of health care costs per car being greater than the per car loss is notable, although even he admitted that crappy quality cars coming out of the factory were part of the problem in his May article.

Today, he states:

Largely because of generous benefits won by the UAW in palmier decades, GM's North American auto business is hemorrhaging money -- $1.6 billion in the third quarter. This is in part because its employee-discount-for-everyone pricing has worked, sort of: Until that promotion ended at the beginning of this month, GM was selling lots of vehicles -- but losing more than $1,000 per sale. In the first nine days after the discounts ended, GM's sales plunged 57 percent.

He also clarifies just how much of a wage cut Delphi is asking for:

[T]o get to a total compensation cost of $20, including health care, retirement and workers' compensation, "which is high in the states we are in like New York, Ohio and Michigan," you have to have a basic hourly wage of $10. Pay at Delphi's plants in China is roughly $3 an hour."

Two Businesses: Cars and Financing.

Daniel Gross at Slate offers more insight with less blatant meme pushing. He argues that General Motors needs to massively cut rank and file labor costs to the phenomenal extent proposed by Delphi's CEO but is prevented from doing so by the threat of a strike even though he views the UAW as a weak union at the moment. A strike is an effective threat, he says, because:

And yet GM can't bully its way to financial health like Delphi because, given its current strategy and structure, it's too scared of the UAW. GM simply can't afford to run the risk of a strike.

GM has a pathological need to produce and sell cars—even at a loss—because it needs the revenues. . . . A company that has high structural costs, pays a healthy dividend, and has made large investments in infrastructure needs to have all its factories running to the fullest extent at all times. A strike, even for a week or two, would prove devastating. It would halt production and screw up the just-in-time delivery system. Some dealers would have fewer cars to sell, or lose out on expected sales. Rivals would rush to capitalize on GM's woes by offering incentives. And as the last few decades have shown, once GM's customers go elsewhere, they tend not to return. . . .

There's another reason GM can't afford a strike. It's no secret that GM is essentially two companies: an unprofitable car-making company, saddled with poor products and high operating and legacy costs, and a profitable lender, General Motors Acceptance Corp. For the past few years, GMAC has been more profitable than the car-making operations. In the third quarter, GMAC turned a $675 million profit. [Ed. While automotive operations lost $1.6 billion.]

GMAC, which was started to help customers buy GM cars, has evolved into a diversified lender. It's a huge force in the home-mortgage and construction-loan business, for example. Indeed, in the third quarter, the mortgage operations accounted for about 60 percent of the unit's profits. But GMAC's bread and butter is still financing the sales of GM cars. To a degree, the company produces the cars at a loss so GMAC can finance them at a profit. A strike that halts production and throws a wrench into sales would thus be a double-whammy for GM. It would lose the revenues from car sales, and it would lose the profits from financing those sales.

What About Product Quality?

One way to test the car quality v. cost concept is to look at comparable cars. I have a four cylinder Honda Accord. The current version of my car has a base retail price of $19,575, which Kelley Blue Book gives a value of $19,281. I compared it to a Chevrolet Malibu with comparable style and engine features. The base retail price is $19,990, and $19,186 is the price that Kelley thinks I would actually have to pay for it, a $95 difference.

Both are midsized four door sedans. Both are assembled in the United States, although Japan is the "country of origin" for the Honda (and unlike China, no one accused Japan of being a low wage sweat shop). Both have automatic transmissions, and the Malibu has modestly less horsepower and almost exactly the same fuel efficiency (both are 24 mpg in the city, the Honda is 34 mpg highway, while the Malibu is 35 mpg highway). The Malibu does slightly better in rear crash tests, the Honda has a slightly better warranty. The total interior space is almost identical, although the passenger cabin in the Honda is 1% larger at the expense of a slightly smaller trunk. The vehicles are similar in exterior size. The standard features aren't identical, but they are similar. In short, Malibu is clearly the comparable car in the GM lineup to my car and to the comparable Toyota Camry.

How do the sales compare?

Last month, 36,842 Toyota Camry's were sold, 33,884 Honda Accords were sold, and 18,216 Chevrolet Malibu's were sold. The Ford Taurus, also in the same class, sold 13,897 units in September. Market share in 2004 for September, for 2004 as a whole, and for 2005 year to date, was similar. The Malibu is gain ground fast after a total redesign of the vehicle in 2004, but the bottom line is that when Honda, Toyota, General Motors and Ford sell comparable cars for comparable prices, Honda and Toyota are winning a far greater market share in the sedan market.

The Chevrolet Uplander Minivan is similarly uncompetitive, ranking 5th in sales in its class behind models from Toyota, Honda and Daimler Chrysler. Chevy came in 4th in market share behind Toyota, Ford, and Daimler Chrysler in the light pickup market. Even massive price concessions in June failed to lift General Motors out of its funk in year to date market share compared to "foreign" competition.

You cannot make a profit unless consumers are at least as willing to buy your cars, on average, as they are to buy a competitor's comparable cars at a comparable price. This simply is not happening for General Motors. General Motors is stuck between trying to sell comparable cars for less than its competitors do, as it did this summer with a great deal of sales success, at the costs of selling every car for a more than a $1,000 loss, or selling cars for at least a break even price and living with a small market share ill suited to an overhead put in place when the company had a far larger market share.

Good Cars Make Up For A Multitude Of Sins.

Many of the costs General Motors is complaining about now, like high retiree pension and health care costs, and costs associated with shuttered plants, wouldn't be breaking its back (by adding such a large labor cost per hour worked by an active worker), if it hadn't been forced to shrink its active workforce to respond to a declining market share. Spread over a larger work force producing more cars, these expenses would have been far more reasonable on a per hour, per active employee or per car basis. In short, much of General Motors woes come down to the diseconomies of downsizing, which are particularly acute in companies like it which provided generous defined benefit pensions and retiree health care benefits to its retired employees, in part, in order to encourage them to voluntarily retire early rather than imposing layoffs, so that it could avoid strikes by unions facing layoffs.

But, none of these dilemmas would have been as severe in the first place, if General Motors had not lost so much market share. The fundamental problem it faces is that when General Motors tries to sell a comparable vehicle at a comparable price, people are overwhelmingly deciding that they'd prefer a car from Toyota or Honda or Daimler Chrysler or even Ford.

Put another way, if employee benefits are such a huge problem, why aren't Ford and Daimler Chrysler, which have similar benefit structures, suffering to the same degree as General Motors? They can still sell cars at a profit, or at least, very close to a profit, and they have defined benefit plans and retiree health care plans too. The answer is that neither has lost market share to the same extent as General Motors, so neither firm is carrying the same kind of legacy costs per active employee.

If consumers genuinely felt that a Honda Accord, Toyota Camry and Chevy Malibu were toss up choices, Malibu sales for 2005 would have been twice as high as they actually were. If a similar improvement were realized across the General Motors lineup, requiring a doubling of the GM workforce, the ratio of retirees to active employees would be 1.25 to 1, instead of 2.5 to 1, and the associated costs per car would be about $600 lower, which would bring General Motors far closer to profitability, even in the absence of the kind of draconian wage cuts being proposed for Delphi. And, of course, if GM were selling more cars, Delphi would also be in better shape (and probably not bankrupt) releasing GM from a major contingent liability for retiree benefits that it will have to bear if Delphi cannot.

Why don't consumers buy Malibus instead of Accords and Camrys? It comes down to a poor reputation for quality and a long track record in recent history of uninspiring designs. George Will is right that GM needs to return its focus to doing an excellent job in its core business of manufacturing automobiles. But, the problem is not so much that GM is a welfare state as it is that it has diverted too much attention to sales and financing, and too little to producing a good product. Ultimately, no amount of hype and no financing deal can substitute for a good product.

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