Wednesday, December 03, 2008

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 successful 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.

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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