Lessons Learned from GM

I find myself confused each day I hear the arguments being made in Washington concerning the automakers plight for a handout from the US taxpayer. If this was any other industry or company, the markets would have corrected this mistake years ago and we would not be dealing with the stories headlining our media outlets today.

When a company focuses its efforts on what it makes and itself, and loses the focus on its consumer, I refer to this as a production orientation versus a market orientation approach. Simply stated, when your prime focus is not on the consumer and is on yourself, the chances for success are greatly minimized.

I reference the buildup of technology and all its hype in the 1990’s. Many technology companies were engaging some very creative and intelligent engineers and mathematicians in the development of cutting edge applications and technologies. These very smart people got the financial world caught up in their development. The venture capitalists and investment bankers began the “spin” which created a highly frothy and expectation ridden investment market. It was not uncommon to hear an entrepreneur tell me that “if I can only capture 1/10 of one percent of this market, my company will be worth millions”. Many fell for this line and made the investment.

These technological entrepreneurs were correct in their analyses that their technologies were truly unique and capable of creating dramatic change in the marketplaces in which they competed. I am sure that the bits and bytes that they were developing were nothing less than creative genius. However, for so many of these technology upstarts, they had a production orientation and assumed that consumers would buy their technology. These technologies might have changed the way things performed; however, consumers did not see the value of this change versus the cost that would be incurred. Had these companies had a marketing orientation and done the requisite analyses, they would have found that consumers would not pay for this new technology because its benefit was not worth the cost. Some of the same technologies that were developed at the beginning of the “tech boom” are just being accepted in the markets today. It was not the technology, it was the consumer’s lack of acceptance that led to the downfall of so many technology companies of our not so distant past. So many of these companies were just ahead of their time.

A case in point from the summer of 2008 involves a company we advised which used the satellite communication service Iridium. Sky Connect leads the industry in Iridium-based voice and tracking systems for aircraft, with certified systems flying on every type of aircraft throughout the world. Sky Connect was sold to EMS Technologies, Inc. (NASDAQ: ELMG) in August 2008. This transaction displays that the services Sky Connect was offering its customers were truly unique and were seen as a value added offering. I cite this example with the following background. Iridium was originally launched in 1998 and subsequently went bankrupt in 1999. In 2001, it was re-capitalized and launched with a new emphasis and approach. The initial commercial failure of Iridium had a dampening effect on other proposed commercial satellite constellation projects, including Teledesic. Other networks (Orbcomm, ICO Global Communications, and Globalstar) followed Iridium into bankruptcy protection, while a number of other proposed schemes were never constructed. The concept would eventually have consumer application, but in the late 1990’s and early 2000’s, these communication networks were not being accepted by the buying public.

So what does all of this have to do with the automobile industry in the United States today?

A lot.

It was a former General Motors CEO and Chairman of the Board -- the legendary Alfred P. Sloan Jr. -- who foresaw the problems that are now causing such consternation at his former company today. "Any rigidity by an automobile manufacturer, no matter how large or how well established, is severely penalized in the market," Sloan wrote in his 1965 memoir, My Years With General Motors. At the time of this writing, Sloan was talking about his chief competitor, Henry Ford, and the refusal of Ford Motor Company in the 1920s to change its business model to build different cars to suit the changing tastes of American consumers. Interestingly, Sloan's indictment of Ford in the 1920’s is exactly what has been the precipice to the failure occurring at General Motors today.

General Motors has seen a 42 year continual decline in its US market share (from 53% to 20%) even amidst many announcements of “change” within the company. GM has built a company of 8 US brands with about 7,000 dealers. Its chief market competitors Toyota (19% market share) and Honda (11% market share) have approximately 1,500 and 1,000 dealers respectively. To build upon this tremendous difference is the cost of employees and retirees. General Motors has an all in cost per employee (present and retired) of approximately $70/hour, in stark contrast to its foreign rivals who maintain a $40/hour cost. The foreign car manufacturers who build their cars with American workers pay current wages similar to what GM is paying its active workers. But the expenses associated with retiree benefits and the UAW’s “Jobs Bank” program, which guarantees nearly full wages and benefits for workers who lose their jobs due to automation or plant closures, push the actual costs much higher.

The UAW has created this dramatic cost differential as a result of its strength within the Detroit based automakers. The unionized employees have the opportunity to retire in their mid 50’s and to enjoy a lifelong retirement and benefit structure that most American’s would envy.

But labor costs are not the only expense category that is weighing the automaker down. Dealers received an average of just over $3,400 per car sold in incentive money from GM in October, 2008. Combined, these two costs alone push GM into a cost prohibitive position.

Normally a company in such straits reduces its costs until it reaches a sustainable level of cash flow. But for GM, shrinkage is not much of an option. Because of its union agreements, the auto maker can't close plants or lay off workers without paying a stiff penalty, no matter how far its sales or profits fall. It must run plants at 80% capacity, minimum, whether they make money or not. Even if it halts its assembly lines, GM must pay laid-off workers and foot their extraordinarily generous health-care and pension costs. Unless GM scores major givebacks from the union, those costs are fixed, at least until the next round of contract talks. The plan has been to run out the clock until actuarial tables tilt in GM's favor (a nice way of saying that older retirees eventually will die off). But with decreasing sales and a smaller slice of the market, that plan backfires -- leaving GM open to an array of highly unattractive possibilities.

So what does this situation tell us?

According to the noted Harvard Business School Professor Michael Porter in his 1980 bestselling book Competitive Strategy -- in order for enterprises competing in a truly competitive market to thrive they must have the combination of the following attributes: be a low cost provider or provide a differentiated product or service.
GM has done neither of these and there is still no real plan which provides them the opportunity to build on this premise.

So if we are going to provide them the money to stay afloat and keep so many laborers employed, when will the gravy train stop? I continue to look to the leaders of the automotive industry to provide a truly believable plan, one in which I cannot fathom.

What do we tell Toyota, Honda and Kia when we as US taxpayers bail out a failed industry which is only looking for a way to compete? Each of these foreign manufacturers are paying US taxes, employing US workers and being solid business citizens. Many towns have prospered in the wake of investment from these profitable companies. In West Point, Georgia, Kia Motors has invested over $1.2 billion to build a production facility that will cause employment to rise by over 5,000 jobs when considering all the suppliers that will come to the area. If we bail out GM, we tell them to stop spending their money in the US, take their jobs elsewhere because they are just too good and have beaten our companies to a pulp. What incentive do they have to stay here if every time they become more competitive, we support the US companies who could not defend themselves.
My take is that we need to take a good hard look at the unions and the value they are bringing to the economy. What makes a GM vehicle have more value to the consumer because of the total union inspired costs that are poured into the vehicle being produced? I understand why the worker wants this situation but am hard pressed to see the consumers’ benefit. Why can the foreign manufacturers keep the unions out and still pay a reasonable wage and provide outstanding working conditions? I do not think Upton Sinclair had this model in mind when he wrote so prolifically about the abhorrent conditions in the manufacturing world at the turn of the 20th century. The US automakers may be unfixable and we need to be really careful when making these looming decisions on if and how we bail them out.

My advice to GM and the other automakers asking for a handout ---- make a car that is valuable enough to pay the extra money to cover your costs, or eliminate those costs that add no value to consumers.