Monday, June 1, 2009

GM & Chrysler in Chapter 11--What's Going to Happen Now?

I’ve been trying to put some things about the automotive industry into some sort of mental perspective lately and quite frankly it’s a challenge.

Now, both GM and Chrysler are in Chapter 11. Bear in mind that this level of bankruptcy is not necessarily a bad thing. Think major airlines. Seemingly, most of the major carriers have filed Chapter 11 at least once and yet airplanes continue to fly toting passengers to their destinations. The only domestic automaker which seems impervious (barely) to the Chapter 11 flu is Ford. Ford appears to have been able to make many of the changes needed in order to weather this “perfect storm”.

That said, there are some who are questioning why or whether or not there is a need for domestic automakers. I tend to think that there is but remain mystified at our seeming inability to sustain the industry domestically.

I marvel at the notion that we have 3 American automakers all of which to one degree or another are floundering. And yet, by my count there are 7 Japanese automakers doing business in the U.S. (I’ll list them for you: Toyota, Honda, Nissan, Subaru, Mazda, Mitsubishi and Suzuki) along with 4 German manufacturers (Mercedes, BMW, Audi and VW). Interesting.

So what’s the difference? The answer to that would take people with far more expertise than I have untold volumes to dissect, discuss and debate. So what’s the short version?

Much has been made of labor costs and labor unions and legacy costs. This has been a burden which has bedeviled the Detroit 3 for decades. Unfortunately it has never been resolved due to intransigence which has led to the whittling away of union benefits but which has also led to an erosion of the Detroit 3’s integrity. The final concessions being made now include a 17.5% ownership position in GM by a UAW retiree health care trust fund. Who would have thought that the UAW would essentially own a big chunk of an automaker? And even with that the Ch 11 filing could not be avoided. And of course, the majority ownership of GM will be the U.S. government at 60% with the Canadian government in third place at 12%.

These costs have seriously inhibited the capability of the Detroit 3 to innovate, engineer and make quality vehicles at a price point which consumers find attractive without the additional major expense of incentives of up to 20% of the retail price of the vehicle.

More importantly, the Detroit 3 has never embraced management processes which are streamlined, responsive to change and forward thinking. Processes are ponderous and inhibit the ability to introduce models which meet changing consumer needs and tastes on any kind of timely basis. Toyota, Honda and Nissan all introduced new sub-compact models 3 years ago in the Yaris, Fit and Versa.

To date none of the Detroit 3 has managed to come up with a comparable model. If the 3 largest Japanese manufacturers can introduce vehicles like this (all in the same year) positioned to fit changing driving habits due to fuel prices, why couldn’t the Detroit 3? Like the “J3” the “D3” employ highly skilled and creative engineers and designers. What was the difference? In a word, the difference was institutional. Is forward thinking inhibited by management structure, legacy costs or both? I tend to think it’s a function of both.

Detroit’s ponderous monoliths are doubly handicapped by a large “dealer body” which is present in virtually every marketplace in America which can justify a Chamber of Commerce. Not so with import manufacturers.

With its restructuring, GM will be closing up to 40% of its franchise dealers (that includes Hummer, Pontiac, Saturn and Saab). Chrysler has notified 900 of its intention to terminate their franchises and untold hundreds of Ford/Lincoln/Mercury dealers have closed or consolidated.

This will help the D3 to have a sustainable dealer-body. Let’s put it this way, Toyota has managed to become the largest selling manufacturer with about 1700 dealerships while GM has had in excess of 4000.

Domestic manufacturers dramatically expanded their dealership base following World War II when GIs were coming home. Auto manufacturers had excess capacity based on their expansion as war industries. GIs wanted cars, manufacturers wanted to make them—a perfect marriage. Dealerships expanded rapidly, serving small communities throughout the nation. In the 1970’s when Asian makes were introduced to the U.S., the development pattern of communities and economic bases was largely set and it was easier for Asian manufacturers/distributors to target the dominant markets for the greatest efficiency of penetration. And they were incredibly successful at doing that.

So domestic manufacturers have had the additional disadvantage of a far larger body of dealerships—many of them small, serving small markets and marginally profitable. Although in these markets, the importance of the dealership to the fabric of the community is often times substantial.

The dealer-body is vital to the success of the manufacturer. They are independently owned franchises. However, one of the biggest differences between a McDonald’s franchise and an automobile franchise is that at McDonalds you not only have the facility but you make and sell the food the McDonald’s way too. With an auto dealership, you buy the wholesale product and then merchandise and sell it according to loose guidelines. This has led to a great deal of consternation over the decades for dealers, manufacturers and consumers (and perhaps that’s putting it mildly).

So, there are multiple dimensions to this issue on both a micro and macro level. Will direct government involvement help substantially to revive and restructure it? In all likelihood, it’s the only chance the domestic auto industry has.

And finally, is a domestic auto industry (D3) important to America? Let’s go back to earlier in this post; there are 3 domestic auto manufacturers doing business in the U.S. There are 7 Japanese and 4 German manufacturers as well as others. The erosion of the market segment dramatically escalated over the last 5 years for a variety of reasons—but let’s focus on the most obvious—because the D3 relied on fuel inefficient, though popular “body on frame” SUVs and pick-ups too long for profitability. They put all their eggs in that basket and then failed to respond to changing needs and trends. Add to that, dramatic increases in fuel prices topping out at $4.50 a gallon in 2008 and the “perfect storm” of conditions for catastrophe were present and the domestic industry fell victim.

Can this industry recover? It has to. It’s that important to American jobs, society and the American economy. It won’t be easy. But it’s possible. And hopefully, like the airlines, the industry will be back, serving the public in a seamless fashion as it works through Chapter 11 and beyond to do a better job of serving the American public.

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