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Worse Than You Think - Part 3

The three largest automakers in the United States have clearly been deficient in their diligence and results. While there are structural and procedural differences between them what is common between General Motors, Ford, and Chrysler is an inability to produce a viable core product. The key question that absolutely has to be answered, and in full, is how these companies can credibly promise that all money loaned to them will be paid back, not only in full but with interest. If the car companies want an exceptional package to help them, their credibility and logic for requesting it must be just as excellent.

So, with that in mind, let's examine the latest arguments from the CEOs of GM, Ford, and Chrysler. The information presented here comes from the Detroit Free Press:

First, admitting that they blundered in taking private luxury jets to Washington in their earlier visit, the executives this time promised some symbolic signs of humility, including "salaries of $1 a year and the elimination of corporate jets". I will give them a small nod there, but also note that those steps were late and now appear to be reluctant, rather than the actions of truly concerned leaders.

Second, GM's CEO said if they do not immediately receive what they want, as in almost twenty billion dollars before the end of the month, "the company will default in the near term, very likely precipitating a total collapse of the domestic industry and its extensive supply chain, with a ripple effect that will have severe, long-term consequences to the U.S. economy." That was the wrong thing to say, for many reasons, but topping the list is the sense of extortion implied in it - they are effectively saying 'give us lots of money without getting any guarantees we'll behave, or we'll make sure lots and lots of innocent people get hurt.' It does not matter if they meant it that way, it's a threat and a stupid one. It's also the wrong thing to say, because it highlights how badly these nimrods have bungled their companies; if they cannot keep their businesses running for more than a month if they are not babied, there is no sane reason to give them billions of tax dollars, period. And third, like their previous behavior, this statement demonstrates no sense of personal responsibility, no humility, no remorse for the damage that their poor management has done up to now. By all rights, the first condition of any assistance to these companies would be the complete and permanent replacement of their boards of directors and all chief officers (CEO, CFO, CIO, CAO, etc), on the grounds of clear dereliction of duty.
But moving on for a moment, let's look at what the companies promise to do to become succcessful again:

"GM's total request now tops $18 billion, with $12 billion in loans and an additional $6 billion as an emergency line of credit should the economy continue to worsen. In return, GM pledged to shed four of its U.S. brands, nine factories, up to 31,500 workers and roughly $30 billion in debt through 2012, all to make a profit excluding taxes by 2011."

Addressing GM's proposal for a moment, the reader might want to note that GM's suggestions do not address any core issues - the management practices, structure of labor agreements, or the image problems for American carmakers. These proposals come down to just firing people and shutting down factories. Historically, companies that do this most often produce one of two results - they become smaller players in the industry, or they go out of business. Therefore, while reducing payroll and the number of brands may well be necessary, GM needs to do a lot more if they want to truly become competitive, and that begins with finding and addressing the real causes of their present condition.

- continued -

So how did they get into this mess? There are a number of myths floating about, which need to be cleared away first:

1. The US market does not make hybrids.
Well, they were slow getting into the game, but Ford and GM make a lot of hybrid models now, more in fact that many foreign carmakers including Honda. American hybrids are not only small sedans, but also include some luxury sedans, trucks, and even a couple sports car models.

2. Detroit only builds inefficient cars.
Not true. While there are some gas hogs out there - what is the moral argument for having a Hummer, anyway - a lot of American cars get 30 mpg or better, and in many cases better than their Asian counterparts. GM had some fun pointing out that their Tahoe hybrid gets better mileage than a Toyota Camry, for example. Recent tests indicate that American cars are of equal quality to most popular foreign makes, are often safer and cost less to own and maintain.

3. American cars are unpopular.
GM alone sold nine and a half million cars last year, and is the world's largest seller of automobiles. In the United States (the largest single-country market), Ford sold almost nine hundred thousand more cars last year than Honda, and Chrysler's US sales beat those of Nissan and Hyundai put together.

4. It was stupid for the companies to invest so heavily in trucks and SUVs.
Not at all. Historically, trucks and off-road vehicles have been the most profitable segment for the industry, which is one reason why Toyota, Honda and Nissan have been trying so long to make popular SUVs and light trucks.

Part of the problem, then, is getting down to the facts of the matter. From the earlier financial reviews of the companies, we see that the cost of making these vehicles, on average, exceeds the revenue they bring in. So, trite as it sounds, the first major plan would have to address either justifying raising prices to cover the costs and a reasonable margin, reducing costs to the point where the company makes a reasonable profit margin, or both to achieve that necessary goal. A lot of people get worked up by that word, but profit is a company's pulse, a vital need. And for all the sophistication of modern management, it's amazing just how many people forget the first need - if the company does not make money, it can do no good for anyone.

We'll come back to that. For here, let's go back and see what the executives plan to do to make their companies competitive.

"Ford's recovery blueprint said it would invest $14 billion over the next seven years to boost its vehicles' fuel efficiency, and it said it would improve the overall efficiency of its fleet by an average of 14 percent next year. And Ford is calling for a partnership among automakers, suppliers and government to develop new battery technologies."

Well, it's a plan, sort of. The problem is, Ford's cars and trucks have been increasingly efficient for more than a decade now, but it's lost ground anyway. This plan does not do anything really new, so it's not likely to solve Ford's long-term problems.

"GM would focus on four brands -- Chevrolet, GMC, Buick and Cadillac. It would sell Saab, shrink Pontiac to a niche brand and consider selling or closing Saturn, GM President Fritz Henderson said Tuesday. GM plans to trim U.S. dealerships from 6,450 to 4,700."

As I said earlier, this is nothing more than dumping payroll and facilities. By itself it can assure GM of nothing more than reduced revenues and the prospect of corporate death. It may be necessary to take these steps in order to drastically cut costs now, but they do nothing to address the root causes of GM's condition.

"Chrysler said it would cut costs by slashing employee benefits and terminating its lease car program. Of the three companies, only Chrysler left open the possibility of a merger."

Note that Chrysler has the lamest proposals of all three, doing nothing to address the costs of making their vehicles.

"All three automakers plan to meet with the United Auto Workers union today in Detroit to debate what cost savings could be wrung from the union contracts. Up for discussion was the possibility of scrapping a much-maligned jobs bank in which laid-off workers keep receiving most of their pay."

It took a while to get there, but here we finally see a step that could make a substantive difference to the survival prospects of these companies. The question here, is whether the UAW truly understands the decision before it; if they refuse to agree to major concessions, the union could do serious and permanent harm to all of its members, and obliterate the union itself as a significant labor force.

Looking at the numbers, it appears that 640 thousand employees work at the three companies. That by itself is an interesting number, but it's important here because if the average pay and benefits total per employee were reduced by, say, twenty thousand dollars a year, that would create savings of 12.8 billion dollars. What that means, is that even if the UAW agreed to massive pay cuts across the board, this would not bring in all the savings that the three companies say are immediately necessary to survive.

Stepping back to the basics, again, any business needs to do a number of things in order to survive. Making a profit, of course, is the first goal, but to do that you have to make a product, market it in a way that creates demand, and transact the sale to bring in the money. That works for everything from lemonade stands to car makers. Having addressed the myths before, we have to ask just why efficient, attractive, well-made cars for reasonable prices are not selling as well as their competitors. Well, some of that is a lag in image - I'm old enough to remember when Toyotas and Hondas were not very good, and they only sold because they were cheap. In 1978 there was no high-end Honda or Toyota sold in the US; it was all cheap cars all the time. And even when their cars began to improve in quality and comfort, it took a while to win over American car buyers. The domestic companies would seem to be facing the same situation now, an image problem that won't go away in the short term, not least because these companies continue to reinforce the negative impressions. GM's mistakes include holding on to GMAC (what, pray tell, is the rationale for a car company holding mortgages?), threatening to raise prices in 2009 after a similar claim in 2007 failed, and as I mentioned in part 1 they wrote off a slew of tax credits (39 billion dollars in all) in the tacit admission that they may never have taxable income in the forseeable future to apply them against. The combination of those three blunders would scare off just about any investor doing his homework, let alone a CPA deciding whether this is a viable business which can be expected to repay a loan in eleven figures. As for Ford, well just yesterday I mentioned that the company revisited its horrific Pinto design and coverup escapade with the incredible F150 flambe'. Nothing like torching your top model, to create similar results in your net income reports. And as for Chrysler, can anyone think of a single model from this company in the last quarter-century, where it was the clear leader? Whether cars, trucks, or SUVs, there is not one Dodge or Chrysler product which is clearly superior to the field in quality, value, or features. Yes, they made the 300, the Dodge Ram, and some of the Jeeps are pretty good, but that's as good as they manage - even the Dodge Charger is just a 'good' car, not great by anyone's definition.

And then there are the management structures. Take a look at GM's org chart - there are fifty-two "chief" officers and "general" officers of the company, and we are not even out of the C-suite yet. Can you say 'Peter Principle?' Sure you can, and here is a prime example. What stands out here, is that there are ten direct reports to the CEO, all of whom have more power than a CEO at 95% of all other corporations. This alone can help explain why GM puts out so many redundant models and brands, and cannot find a way to reach a cogent, clear business plan.

The Ford org chart is no better; fifty-seven top corporate officers, many of which seem to have some less-than-vital roles. And let's not forget that while this is ostensibly a public company, the Ford family have arranged things so that in the end, they make the calls. Nothing like having a position with lots of responsibility, but in the end no real authority, huh?

There is no org chart available for Chrysler, although from what I read in trade magazines, the ghost of Lee Iococca is as big on sprawling confusion of well-dressed mandarins, as anyone at GM or Ford. Let's not forget that Chrysler is technically a private company, answerable much more to Cerberus and Daimler (who still hold 19% of the company) than to the public.

As harsh as it sounds, the fact is that none of the three companies in trouble has the right management team in place to deal with the problems. None of the three companies, for example, has explained where the money - if granted - would be applied, apparently hoping to just use it in general operating expenses. In fact, GM's CEO as much as said that he wants a no-strings gift of billions of dollars to be applied directly to current payroll and accounts payable. The desire may be understandable, but this clearly does nothing to address the root causes of the crisis. And so, the only rational response is to refuse that trap. In the final analysis, so many problems exist that only a complete reorganization can possibly address them effectively.

Yet, GM's CEO says that in the case of bankruptcy, debtor-in-possession may not be possible for GM. There are a number of reasons for that. First are the reasons put out by CEO Rick Wagoner himself:

1. The size of GM's debt and needs would make financing very difficult, even without the current credit crisis going on;

2. Bankruptcy would be used, he says, to address legacy costs and capacity utilization, two areas where GM is already making improvements and planning ahead; and

3. There is a likelihood that the weak consumer interest in a trouble American carmaker, would collapse completely in the event of a bankruptcy.

There are additional reasons to think that GM does not want to go through bankruptcy, however, and one of the biggest I can think of went into effect in the middle of 2002. Chief officers of every public corporation in the United States sign quarterly reports confirming their personal and specific responsibility for the material accuracy of their financial statements. Where in the past an executive could claim he had no knowledge of unethical practices turned up in an audit or SEC investigation, the provisions of Sarbanes-Oxley closed off that loophole and set guards at the door. A bankruptcy for GM would mean a set of forensic audits at the minimum, and any substantive violation would lead to fines and criminal charges for everyone in the C-suite. I'd lay odds right now that there are things in GM's numbers that no executive wants to have to explain.
So let's be clear: It may well be that General Motors, Ford, and Chrysler are not looking at a Chapter 11 Bankruptcy and reorganization, but at liquidation and a lot of very bad legal troubles. Given the conditions discussed above, a Congress determined not to reward businesses that fail, and a public mistrust of these companies, it appears unavoidable now. And yet, there is still no solid indication that the executives at any of these three corporations is prepared to address that reality.


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Comments (18)

DJ, I am astounded when I h... (Below threshold)

DJ, I am astounded when I hear arguments for the bailout that suggest that "innocent" workers will be forced to pay the price for incompetent management. Having worked in the corporate world for many years, I can say that innocent workers always pay the price. It's just reality.

But I have to say that one of the reasons that I haven't bought an American car in a while is because of quality and concerns about quality. And that DOES go back to the UAW and the workers. A bad reputation takes a while to turn around.

As someone who is still paying taxes, I very much resent the extortion of GM by saying we'll go into a depression without a bailout. The truth of the matter is that they will be depressed if they don't get the bailout.

Using fewer words, their pr... (Below threshold)

Using fewer words, their problems are (1) they spend too much on the direct costs of producing a car, (2) their overhead is way too high and (3) trying to maintain market share, they produce a lot of cars that aren't very good compared to their competition and drag down their reputation.

Notwithstanding your criticism of their plan to "just firing people and shutting down factories", that is not only exactly what they SHOULD do, it is the only thing they CAN do, at least in the immediate future, in the sense that it lies within their control and doesn't rely on wishful thinking. And while I may be misreading you on this point, GM, Ford and Chrysler do make some really nice cars, their problem is that they produce too many models that s**k.

Accordingly, they need to (1) reduce their labor costs (both the amount they spend per hour and the number of hours required to build a car), (2) reduce the other costs that go into producing a car (supplier costs, marketing incentives to push unpopular cars), (3) reduce the number of nameplates and models they produce to rid themselves of the models they can't sell, and (4) reduce overhead (shutting down factories, laying off white collar workers, eliminate the infamous job bank, and cut back on health care and pension payments to retirees).

What they shouldn't do is predicate their recovery on making lots of profits from fancy new cars they haven't yet developed, haven't yet proven they can build efficiently and which the public hasn't shown a willingness to pay a decent price. Sure, trying to develop, produce and sell these cars should be a part of their future, but it's wishful thinking to feature them as a centerpiece of a turnaround.

And as far as a bailout, what we shouldn't do is give them money so they can go off and see if they can develop a plan. They should already have revised labor and supplier contracts in hand, as well as lists of models, nameplates, factories and dealerships that will be eliminated.

'innocent workers'??? The ... (Below threshold)

'innocent workers'??? The workers who went on strike to get wages, benefits and work rules that put their companies at a serious cost disadvantage? Who engaged in slow downs that drove up the costs? The workers who gave rise to the belief that it was stupid to buy a car built on either Monday or Friday? The ones who helped push through the CAFE rules that precluded the companies from importing gas efficient cars?

Management didn't acquit themselves well, but neither did the workers. They took the cash for as long as they could and now they're moaning.

The Big 2.5 are in a death ... (Below threshold)

The Big 2.5 are in a death spiral, going the way of the British auto industry. Does anyone remember the British auto industry, now an extinct species?

All the actions that they are talking about - reducing brands, reducing dealerships, new labor contracts with repudiated pensions and healthcare benefits for retirees - are actions that they can and will need to perform, regardless of any bailouts. These steps, in conjunction with reorganization under bankruptcy, are the only means to survival for these companies.

The only reason they are talking about these steps are to fool Congress (not hard to do, Congress just wants a fig-leaf in place to cover its own a**) into providing massive amounts of ongoing subsidies. Two weeks ago, they were asking for $25 bn. In two weeks, the asking amount has gone up to $34 bn.

The fate of the US auto industry is a harbinger of what is coming for all of us. The same forces - over-promised and under-funded pensions and retiree healthcare - are going to drive the next group of entities, the state and local governments, into bankruptcies. Followed by Social security and Medicare.

Here's a thought: say GM (w... (Below threshold)

Here's a thought: say GM (which seems to be in the worst shape) goes under. Wouldn't that help the other two?

DJ,Any plans (or l... (Below threshold)


Any plans (or links) to examine how the unprofitable model lines of these manufacturers are driven (no pun intended) by the congressional MPG fiat? In other words, can the big three cut their lower-selling product lines and still comply with fuel efficiency requirements? Or are these requirements part of what shackles the industry?

The fate of the US au... (Below threshold)

The fate of the US auto industry is a harbinger of what is coming for all of us. The same forces - over-promised and under-funded pensions and retiree healthcare -

sam makes an excellent point. Set aside SS and Medicare/Medicade for a moment and just consider the unfunded retirement plans in the public sector. It's an enormous amount that dwarfs the auto maker's problem and these local/state entities are already making noise.

A timely reminder is in order...myriad US industries had restructurings and cutbacks (including pensions and healthcare) literally crammmed down their throats as a result of bad economic conditions and ineffective business models.

If Washington bails out the domestic auto industry then no one should be surprised when the public employee unions and incompetent municipal and state entities show up with their hand out demanding money.

And the financial sector la... (Below threshold)

And the financial sector laughs their ass off as they count their trillions.

And the financial sec... (Below threshold)

And the financial sector laughs their ass off as they count their trillions.

Name some names jpm100.

I'm trying to think of a major financial company that is laugh(ing) their ass off as they count their trillions.

Trillions of what? Profits? Equity?

Citibank? No
Merrill? No
Goldman? No
Morgan? No
Bank of America? No
Wells Fargo? No

Here's your problem jpm100, you're pissed that the federal government will bail out one industry (financial) and while it considers letting another (auto) fail.

The calculus here is simple and voters (Democrat and Republican) easily understand it: what's more important, your car or your cash?

HughS,I'm pissed a... (Below threshold)


I'm pissed at the disproportionate drubbing.

And please explain what the financial bailout was suppose to accomplish. Especially when
1) We never saw anywhere near the scrutiny of the financial institutions, their plans, or the flight schedules that was put upon the Big 3
2) The institutions were suppose to start lending with the money, they didn't. The banked it.
3) Paulson admitted he had no clue what to do with the money when he asked Congress for the $700 billion.
4) Citibank bailout was in no way shape or form to protect the economy or its customers. It was a flat out corporate rescue.

#3 & #4 got almost zero attention, because...

The Big 3 were made a successful distraction for Politicians, Media, and Pundits who did not do their due diligence on the financial bailouts either from neglect or deliberately.

Oh, yeah I almost forgot
5) the financial bailouts over the past year were 50x than what the auto industry is looking for. Just a little bigger.

And since I have to state t... (Below threshold)

And since I have to state the obvious for you HughS, the fundamental of an economy is the barter of goods. Anything else is an extension of that. Take away the economy of real things, and the rest is just waiting to crumble. Sort of like it just almost did.

Take stupid government inte... (Below threshold)

Take stupid government interference out of the equation and the American auto industry never finds itself in this mess.

Tell you what, jpm, tomorro... (Below threshold)
DJ Drummond:

Tell you what, jpm, tomorrow I will review just why Congress - democrats and republicans BOTH - thought it was necessary to pump $700 billion plus into the financial markets, but not to give $50 billion plus to the auto companies.

Good question, jpm100. The ... (Below threshold)

Good question, jpm100. The answer is that it is a confidence game.
Is the government response to the financial industry disproportionate to that being considered for the domestic auto industry? Yes, it is. There is a reason for this.
If a population loses confidence in its banking system then the whole system will collapse. Our financial system is the linchpin of our economy.
To address your questions:
1) Yes, financial institutions do not face the scrutiny that the auto manufacturers are subjected to. Why? Because financial institutions are the heart of our economy. Think of it this way....big banks are major arteries, auto manufacturers are minor arteries. Disrupt a major artery and you have sudden death, disrupt a minor artery and you have a very bad, but fixable, problem.
2) Yes, the Treasury Secretary has chosen to do what he will with the TARP funding. The auto manufacturers apparently believed they could get the same Carte Blanche deal. Wrong, as they found out.
3) Paulson never admitted he had no clue what to do with the money. He asked for, and got, a blank check to deal with known and unknown problems. Geithner will demand the same.
4) If the auto companies go into bankruptcy there will certainly be massive unemployment. However, the banking system will survive. This is nothing more than economic triage.
As for the Citi deal, you are wrong. If Citi failed, or for that matter AIG, there would have been a financial collapse because of counter party risk and default. Citi still has a positive market cap only because certain foreign investors have helped shore up the value of the bank. Without them the bank's shareholders would be wiped out and the Fed would have to pony up another $30,000,000,000. In other words, the Fed let some foreign investors in for 30 billion so that they, the Fed, would not have to inject more capital.

"Trillions of what? Prof... (Below threshold)
John S:

"Trillions of what? Profits? Equity?"

Uh, no... trillions in taxpayer funded government bailouts. Total committed dollars as of this morning are $8.5 trillion. If you think an orderly bankruptcy of the three automakers is unthinkable, imagine President Obama's 2010 budget: a $4 trillion deficit and a $25 trillion national debt leading to a default by the government. No welfare checks. No unemployment checks. No Social Security, Medicare, Medicaid, Obama-care checks, no pensions, no nothing.

This would be bit bigger problem than laying some of the 350,000 workers who make unwanted cars. We can't bail out everyone, no matter how much they may contribute to Congressional Democrats.

In 2008 an automobile assem... (Below threshold)

In 2008 an automobile assembler can legitimately live an upper middle class lifestyle if they happen to live in a country in the stage of industrial maturity such as Mexico, Korea, Vietnam, China or India. It is no longer realistic to expect to be compensated at that relative level if assembling vehicles in the US, Canada or Japan. That can only happen with protectionism/tariffs, but ultimately it results in a catastrophic crash.
Each generation must move up in terms of job complexity in order to live at the same relative level as the previous, since there are many 3rd world countries that will be the next India or China in terms of providing relatively cheap sources of labor for relatively unskilled industries such a auto assembly. If you live in the US you can still be involved in the auto industry, you could assemble if you are willing to work for a reasonable wage for your skill-set, or you could be involved in auto industry related design, engineering or management and live a very nice upper middle class lifestyle.
The big 3 have been terribly mismanaged, but they are also saddled with rediculous current labor costs and pensions and medical for retirees. These were all put in place with the mind-set that we would be the global auto manufacturing capital forever. Nothing is forever....you must move on. We need to bite the bullet and these companies should reorganize under chapter 11. The gov't can provide funding to guarantee loans so that consumers can purchase or lease automobiles, and some equity backed loan guarantees to enable the companies to reorganize. The suppliers will get paid for work done during the reorganization and will also receive a % of pre-bankruptcy receivables based on how well things recover. They will need the abiltiy to borrow, and that is where Gov't can provide guarantees. For those assembling vehicles, 401K's will replace pensions (like the rest of us), and they will pay a greater amount toward health insurance. Otherwise, we will be back in this situation again soon.
Has anyone figured out where the money will come from to pay the pensions for our government employees?

Noted today on the Planet G... (Below threshold)

Noted today on the Planet Gore blog...

> Is anyone shocked to realize the (bailout) number has increased from $25 billion to $34 billion in two weeks?

First, DJ, thank you for th... (Below threshold)

First, DJ, thank you for the series. It was good & interesting reading.

As someone above noted, nothing is stopping GM to start implementing their plan now. Of course there are labor contracts & dealership contracts, so not everything can be done at once but working toward this goal does not require the bailout. Second, I would think selling Saab, which is one of GM's points on their plan, is again something that could be started now. GM knew they were getting into a cash crunch even before the financial crisis, raising money by selling off Saab probably should have been done already.

On Ford, I think they might have the best chance to survive. Mostly, just my gut feeling, I am not an expert on the auto industry. I think the success they have in Europe with their car line can be translated to the US over the next few years. Ford has also seemed to be ahead of the others on E-85, a bigger deal here in the midwest than other parts of the country.

On Chrysler, you asked within the last 25 years what product they produced was the top of the line product. I would say the Grand Caravan and Town & Country mini-vans. Toyota & Honda have probably caught up to them recently but for years Chrysler was the minivan company. I think Chrysler is not the leader of these 3 but will just react to whatever happens to the other 2. I also think they could be bought out by someone else. Of course, why sell now, wait to see if Congress throws money your way first.






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