Tuesday, November 18, 2008

And On to the Auto Industry

It turns out the investment banks were just the first companies to feel the brunt of the massive economic dislocation that all started from the credit crisis now some 18 months ago. Bear Stearns' sudden collapse last spring turned out to be just the beginning of the woes for the independent investment bank model, with Lehman Brothers declaring the largest bankruptcy in U.S. history in September, and Merrill Lynch turning itself over in a firesale to larger Bank of America. The rest of the regional and money center banks soon followed suit, with their stocks all suffering huge declines over the past couple of months, the primary driver behind the major U.S. indices' runs to several fresh multi-year lows this fall, including as of Monday's close where the Nasdaq is at a fresh 5 1/2-year low and the S&P 500 sits just 2 points above it own early November nadir. Since then, most sectors of the market have taken massive lumps, with scares especially focusing on homebuilders, insurers, and lately retail as well as the consumer appears to have finally rolled over after years (decades, really) of spending far more than we make, as a country overall.

Now the latest victims are the automakers, with GM and Ford shares both sitting at or just above multi-decade lows, and the business of these once-proud American institutions severely broken. And naturally, we've got the short-sighted pro-spending clowns in Congress -- this time it happens to be the Democrats, but we all should know that over the balance of this year it's been as much the Republicans as anyone -- pushing to "bail out" the automakers by simply throwing money at them. The Democrats' proposal, championed by House Majority Leader Harry Reid of Nevada, involves emergency loans of some $25 billion to the Big Three, in the hopes that this can tide these companies over until the economy recovers enough to repair their ailing businesses.

As bailouts have become all the rage during a truly ridiculous 2008 in America, the simple solution so supported by the current administration has just been to throw money at our problems. And not just thousands, or even millions or hundreds of millions. Billions of dollars. Just throw it at the problem, and it will go away. We can see how well that seems to be helping the banks, mostly all of which are right up against fresh multi-year lows of their own even after Treasury has spent now some $270 billion of taxpayer money under the TARP program to prop up their balance sheets with capital infusions. And you know what? This would be an even stupider approach for the car companies in this country.

These bozos in Congress fail to understand even the most basic precept of economics and finance. Throwing money at a problem to make it go away carries with it an implicit assumption, without which simply donating cash to an enterprise or an industry cannot possibly be expected to do anything but delay the inevitable. For capital infusions alone to work to save a company or a sector of the economy, the underlying business models need to be strong and viable. Throwing money at a problem can work when the only issue is a short-term cash flow problem, where the cash infusion will help a company bridge the time until the economy or other external factors will stabilize and allow their underlying successful businesses to recover on their own. But if you take a business that has been slowly dying for, say, 30 or 40 years like GM and Ford, and simply give them money, that's not a bridge loan. That's like emptying your wallet down the garbage disposal, and turning it on high. To use a better example, it's like pouring more and more water into a bucket with a huge, gaping hole at the bottom. Give GM and Ford and Chrysler $8 billion each without requiring massive changes among those three companies -- not just requiring them to submit a plan for change like the Harry Reid proposal would -- and you might as well circle the date, sometime in late 2009 / early 2010, where we'll be right back here having these exact same discussions, only all of our wallets will be $25 billion lighter.

The U.S. auto industry is so horribly run, it's seriously laughable to hear about it even if you don't have any understanding whatsoever about the industry as a whole. You don't need one to get just how funked up these companies' business models are. GM's market share in the United States sat at a whopping 53% back in 1966. Now it sits at 20%. And it's still dropping. And yet GM has done nothing to right itself, to reorganize, in all those years, longer than many of us reading this today have even been alive. Ford is in a very similar situation. The leadership of these companies, weighed down by one of the strongest unions in the world today, has remained paralyzed since the friggin 1960's, and as a result, these companies have been literally dying a slow death for more than four decades.

Everyone knows that Japanese automakers Honda and Toyota came onto the scene in America in the 1980's and basically took over. The Accord and the Camry became the gold standard of efficient cars driven in the U.S., and have led this country in sales for well more than a decade among car purchases. It is well known that one of the keys to Honda and Toyota's success in this country has been their focus, both marketing-wise and cost-wise, as Toyota has just three car brands in America, and Honda has just two. GM, meanwhile, continues to push on with eight brands -- GMC, Pontiac, Buick, Cadillac, Saab, Saturn, Chevrolet and Hummer -- many of them purchased during the past decade or so as it is. It's not that some of these are bad cars per se, but the inability to focus on fewer brands definitely hurts the company's ability to drive market share, in the U.S. and abroad. Not to mention that each of one these brands carries its own cost structure, from a General Manager and his or her management chain, down to brand managers and marketing folks, its own finance group, its own chain of dealers, distributors, etc. This is incredibly costly, and while their Japanese counterparts have whittled these cost lines down to just a few, GM continues to this day to have to pay eight sets of each of these lines of employees, contributing greatly to the massive problems with the company's cost structure. And here we are today.

And let's talk about those dealers for a minute. The Wall Street Journal reported the other day that GM has around 7000 car dealers in the U.S. Seven thousand dealerships. In contrast, Toyota has just over 1400, and Honda close to 1000. Is it any wonder which company's sales model works the best? And yet, GM has done nothing to change this bloated dealership structure. A system with fewer, more centralized dealers is well known and understood to be more efficient, again from a marketing, inventory and maintenance perspective, a premise with which GM management does not argue. But it would be a very expensive and politically unpopular process for GM to eliminate nearly 80-85% of their dealerships, so they just haven't done it. For nearly 30 years now. Toyota and Honda have been eating GM and Ford's lunch, and these companies simply refuse to take the admittedly painful steps needed in order to align these companies with their competitors, and with efficient business practice. And here we are today.

And now let's look at employee costs, which is perhaps the biggest bugaboo of all for companies like GM. Honda and Toyota pay their American workers more or less the same as GM and Ford do. But in its ultimate wisdom in the 1980's, GM pushed for the creation of the Jobs Bank program with the United Auto Workers Union, which guarantees nearly full wages and benefits for workers who lose their jobs due to automation or plant closure. GM originally pushed for the Jobs Bank to help prop up workers' productivity as it looked to automate certain manufacturing functions in its plants, but today the Jobs Bank saddles the company with massive employment and benefits costs for people who aren't even working, yet another significant competitive disadvantage compared to its foreign company peers operating in the U.S. And here we are today.

Moreover, it's a well-known fact that the U.S. automakers, and GM in particular, spend massive amounts on healthcare and other employee benefits as compared to almost all other industries in the country. A lot of this is again due to the significant presence and power of unions in the automaking space, but the companies themselves can be blamed to a large extent for allowing themselves to be negotiated into positions where they are simply losing money hand over fist as a result of employee costs. GM currently pays benefits for more retirees than it does current workers. Is that even believable? After many plant closures over the past few years, GM still owns or leases many properties currently not in use, and yet it is contractually obligated to pay interest on bonds that were issued by municipalities to build these facilities, even though no revenues are currently being derived from the properties. And here we are today.

And let's not forget the companies' manufacturing focus over the past few years as trends have been shifting in the consumer marketplace. While Ford and GM have remained focused on the production of heavy trucks and SUVs that were so popular during the 1990s and earlier part of this decade, consumers have clearly begun shifting to smaller, more cost-effective and fuel-efficient vehicles over the past few years. So while cars like the Toyota Prius and other hybrids produced in growing numbers in this country by Honda have grown in popularity and sales, GM and Ford's factories remain tooled for production of larger vehicles, contributing greatly to the slowdown in sales in the Big Three U.S. automakers. And here we are today.

So there you go. GM and its competitors are not in any way, shape or form experiencing just a short-term cash flow problem. This is a long-term, systemic weakness in the very infrastructure of these companies, leading GM and Ford to be habitual moneylosers. If we just blindly throw $25 billion -- or a hundred billion dollars, for that matter -- at these firms, we are simply putting off the inevitable. And I'm not interested in having my money go towards that, like I assume you out there reading this aren't either. And don't get me wrong -- I actually am not in favor of telling the U.S. auto industry to go screw. Although of course indsutry lobbyists are overblowing this as they attempt to secure a bailout package for the American car companies, there is no doubt in my mind that the economic fallout from allowing Ford, GM and Chrysler to go bankrupt -- which is exactly what will happen within a year at most if nothing is done -- would be huge, and unnecessarily so. Much like I've said time and time again here about Barack Obama's planned tax hikes for those making over $250,000 a year, this is simply not the time or the place to be allowing one of the largest industries in the country to completely go to pot.

Instead of viewing the automakers crisis as yet another huge problem for the current or incoming administration to have to deal with, I view this as a tremendous opportunity for someone to take charge, fix a long-term problem, and help to lead this country into the next generation in terms of dependence on foreign oil. I don't have any problem providing emergency funds to a key industry in this country. But I wouldn't even consider giving it to them under their current cost structures and with their current business models, like Harry Reid's recent push in Congress would do. What we need to do is have someone take charge of this situation, and tell GM, Ford and Chrysler that they can have their $25 billion apiece, but only once they make the massive, sweeping changes in their models that will enable them to survive as ongoing concerns after this money is paid. So they can have $25 billion apiece, money they desperately need to fund their operations right now, but only if they start by completely overhauling their cost structures, aligning the benefits they pay more closely with those of the rest of the country, regardless of how they have done things in the past or what the over-powerful union leaders claim to be willing to agree to. If he or she has to, the person to take charge of fixing this industry will likely need to tell the unions to kiss his or her ass, something which the incoming administration has not shown a willingness to do previously given its generally pro-union stance. We also need to condition the money on these companies' totally reducing their distribution / dealership structures, again to more closely align them with what a company would do if they actually wanted to be profitable in this space.

I don't know if we specifically need to require a company like GM to reduce its number of brands, but the fact of the matter is that reducing their cost structures like these firms all need to probably would require some siginificant reduction from a brand perspective. Such a reduction would also clearly help increase demand for its vehicles over the long-run, using the model of the foreign car companies in the U.S., and the dealership and branding changes would also greatly increase these companies' ability to provide excellent service on the vehicles they do sell in this country, also long thought to be a problem for U.S. cars relative to their foreign company counterparts. And while we're on the topic of branding, one of the key moves we should make as far as conditions for GM, Ford and Chrysler to access the money they need to survive this downturn is an absolute requirement for production of large numbers of significantly more fuel-efficient / hybrid vehicles. If I were in charge, I would literally tell these companies that in order to get their money, they need to not only overhaul their cost and distribution infrastructures, but also that, within a short period of time -- say a couple of years max -- 50% of the vehicles they produce need to get at least 50 miles per gallon. Period. It's a tall order, I am well aware, but it's doable. Many of the most popular hybrid-type vehicles out there today in this country already run their first 40 miles on pure battery power, using no gasoline at all for what amounts to 90% of the trips made in these cars. The long-term effect on the environment and on our country's abundance of natural resources, as well as our dependence on foreign oil and our ability to have our fortunes controlled by countries whose interests are often directly opposed to our own, is probably the single greatest benefit of this entire plan.

With any luck, this ill-informed push by the House Democrats will fall flat on its face as far as simply throwing money at the U.S. automakers without flat-out requiring them first to make all the hard decisions and necessary changes to align their companies with other similar entities in the U.S. that are actually designed to make a profit and give a good return on the taxpayers' investment of any bailout funds. This would amount to an irresponsible and really downright wasteful attempt to spend our own hard-earned money in a time when such money is increasingly scarce, and supporters of this bill in Congress ought to be ashamed of themselves. As I said above, I don't view this as a massive crisis so much as a tremendous opportunity for a leader to step up, to insist on fixing the massive problems plaguing one of the key industries in American manufacturing for the past several decades, and most of all, to help the environment and to help keep oil prices down for the rest of time. Normally one simply does not have the practical ability to force these kinds of changes down the throats of any companies, especially in our "capitalist" system, but the current crisis in the automaking industry presents a literal once-in-a-lifetime opportunity to make a massive difference and a massive change for the better for every American. Throwing that opportunity away by simply handing over cash with no strings attached to these firms, thereby all but ensuring they will run out of money again in the near future, would be in my opinion a far worse error than the car companies' refusal to fix their own business models over the past several decades.

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Blogger Mondogarage said...

Good post, as usual, but I feel the need to comment on one particular section where I can provide some illumination.

"And let's talk about those dealers for a minute. The Wall Street Journal reported the other day that GM has around 7000 car dealers in the U.S. Seven thousand dealerships. In contrast, Toyota has just over 1400, and Honda close to 1000. Is it any wonder which company's sales model works the best? And yet, GM has done nothing to change this bloated dealership structure. A system with fewer, more centralized dealers is well known and understood to be more efficient, again from a marketing, inventory and maintenance perspective, a premise with which GM management does not argue. But it would be a very expensive and politically unpopular process for GM to eliminate nearly 80-85% of their dealerships, so they just haven't done it."

I actually work in the field of automotive franchise litigation, and can comment on the above. In virtually every U.S. state, the automobile dealer/franchise relationship is governed by state laws that in nearly every case, limit a manufacturer's ability to terminate a dealership to those cases where the manufacturer can prove the dealership has acted in bad faith, or committed various frauds, or other bad acts. In most cases, not selling enough vehicles is not grounds for franchise termination. These same laws provide the legal basis for any dealer to litigate a proposed termination.

Generally speaking, the manufacturer is not entitled to cull their dealer network simply because they're in financial or economic difficulty. The manufacturers are prohibited from owning dealerships. So, GM/Ford/Chrysler is not in a position to cut their dealer networks in half.

It's illustrative to point out that most of Toyota/Honda/Nissan/etc.'s dealer networks were established in the last 30 years, in an era where auto megaplexes were already somewhat commonplace, and dealerships located with far less density. Most of the U.S. manufacturer's dealer network was in place as far back as the 50s, 60s, and 70s, where people did not drive out of their towns to buy cars, and virtually every town of 15,000 people had some form of a GM, Ford, and Dodge dealer.

For what it's worth, GM has been able to pretty much combine all their Buick/Pontiac/GMC dealers into single sales points, and Chrysler si rapidly moving to consolidate into Alpha dealerships, where one dealer carries Dodge/Chrysler/Jeep. Ford has done something similar.

However, none of this can be artificially imposed upon dealer networks, and is instead taking place gradually through dealership buy/sell transactions, mergers, and the like.

What I'm getting at is, if GM were to suddenly say "let's eliminate 3500 dealerships", they would likely face at least 2,500 lawsuits in doing so, because they're not working in the same legal landscape as, say, Circuit City, and they don't simply get to shut down locations. The law is not on their side in that regard, and they don't even own the dealerships.

12:11 AM  
Blogger Julius_Goat said...

Fine. But who will bail out the Detroit Lions?

12:48 AM  
Blogger 1Queens Up1 said...

Alright I have never been involved with a union,I have no opinion if they are good or bad (dont care to debate that) but my girlfriend works for the State of CT and is involved in theirs.

Right now the Gov is asking the union to work with her to manage a minimal amount of layoffs and benefits reductions so that the majority of state employees are not affected by this current downturn.
What was the state workers union reply? "Go F yourself!"

So instead of minimal impact, employees may now get laid off in droves. Makes perfect sense in this crazy messed up world.

1:40 AM  
Blogger Hammer Player a.k.a Hoyazo said...

Mondo, thanks for the additional information. FWIW the Journal article did mention something about state laws. Nonetheless, my point still holds true that I wouldn't consider throwing a bunch of money at these guys with that kind of a scheme in place. I feel bad for the dealers who would become redundant, but no way I'm giving billions to a business that is stuck with that situation. The U.S. ought to consider pre-empting those state laws until the dealership situation at the big car companies can be equalized.

1:50 AM  
Blogger sootedshit said...

Hey Hoy. Incredibly eye-opening post.

I am only worried about what you said about the Gov't making GMC and Ford go through "structural adjustments" in order to get their oodles of money. I actually completely agree with you on how they must handle these adjustments, but looking at history with something like the World Bank. The World Bank haa ruined some third world countries by poorly orchestrating these adjustments. I think what it comes down to is that I'm worried about how these structural adjustments will be carried out.

4:16 AM  
Blogger DuggleBogey said...

How can you say that they have taken no steps when you aren't even aware of the situation?

The Union assumes all responsibility for members health care, so that burden is off of GM, saving them 4 billion a year. How is that NOT at step?

Nevermind the fact that the automakers need loans for THE EXACT SAME REASONS the financial institutions need bailouts, that credit is FROZEN and without credit they have to liquidate to make it through the economic rough patch that ALL AUTOMAKERS are suffering through.

That's right, all automakers. Note that Nissan, Honda and Toyota have ALREADY received bailouts from the Japanese government.

If you simply let the US auto industry liquidate, there will be 4.5 million working people affected, and over 1 million retirees. If you think a few banks failing will adversely affect the economy, try 30 percent unemployment.

The government did this exact same style bailout with Chrysler and the loans were paid back to the government and the "bailout" was a huge success. Why do you think that it can't work again, apart from your obvious ignorance of the industry?

6:10 AM  
Blogger Hammer Player a.k.a Hoyazo said...


Tell the truth...did you even read my post?

8:08 AM  
Blogger Bouza In Britian said...

Just to further Mondo's point (which you already commented on), I personally worked in the dealer retail network department for one of the big 3 from 2004-2007. They are actively trying to lower the dealer count as much as possible. Sometimes it takes 10 years to effectively terminate a poor dealer after jumping through all of the hoops. These are not GM/Chrysler/Ford's property, they are explicitly owned by the general public.

Also, please don't forget that Toyota/Honda/etc got to use the Big 3 dealer network as a model before implementing their own.

Actally going through with the bailout is one thing, but just know that their dealer network issues aren't for lack of trying.

2:19 AM  
Blogger Hammer Player a.k.a Hoyazo said...

Again, I hear you guys on the dealer issue. The fact remains that this is just one of many, many issues that need to be worked out for these companies before I would ever support just throwing money at them. Otherwise, all we're doing is buying another year or two, tops, until we're right back in this same spot again. These companies are simply not set up in a way to maximize profit, or even to be the least bit profitable over the long-term. That is not a situation I would support diverting a single taxpayer dollar towards.

Thanks for the comments as always.

2:26 AM  

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