Auto Manufacturing - An Industry Whose Time Is Up

It looks like GM (GMGMQ.PK) has tentatively agreed to sell its Saturn brand, only days after agreeing to sell its Hummer brand to a Chinese company. Finally, it seems GM is taking steps in the right direction, shedding non-core assets and brands and closing dealerships. I’m sure that the current economic crisis and the heavy hand of government played no small part in helping encourage these transactions. The question of the day is, “Why didn’t they do this sooner?”. I’m by no means an expert on the subject but it seems obvious that the auto industry has been in trouble for years.

Anecdotal stories of unsold cars piling up in parking lots, 0% financing, cash back incentives, free OnStar/satellite radio, years of free warranty coverage, etc, have been used for some time now to move cars from the factory floor into the hands of consumers. These do not seem to be signs of a healthy industry, poised to relive the glory days at any moment.

Of course, it’s easy to judge managers with the benefit of hindsight, but it does beg the question of what was the fallback plan? Did management really think that sunny days for the industry were just ahead? Why didn’t management pay down debt during the “good times” to put this company in a better position? We don’t know what GM is getting for the sale of the Hummer and Saturn brands, but odds are it is near fire-sale prices. Why GM didn’t take action sooner to reduce debt (by selling assets at far higher prices), restructure the business and re-steer this Titanic in a new direction is worthy of question. Maybe the unions are to blame? Or maybe a version of the Greenspan/Bernanke put was just too tempting to resist for highly paid managers that didn’t want to “rock the boat”? Sadly, I think Tom Velk of McGill University said it best:

The auto industry today is like the textile industry in the UK in the 19^th century. It’s bound to go to the emerging nations: India, China. India has a $4,000 car. […] It’s an industry whose time is up.

The government has made it clear that it wants to see auto manufacturing stay in North America, and in the end, a solution likely will be found. However, bailouts and rescue packages are merely prolonging the inevitable in my opinion (as much as it saddens me to say it).

Disclosure: no positions.

Comments

[mike smitka:]

Underlying what you observe is the ease of entry in auto assembly, both at the firm level (there are now 14 OEMs in NAFTA -- the Big Three, GM, Ford and Toyota; the middle 4, Honda, Chrysler, Nissan and Hyundai; and then comes BMW, VW, Mercedes, Suzuki, Subaru, Mazda, Mitsubishi. Kia has a plant under construction. The same is true at the product level: find a niche, others will follow. Quickly.
The second issue is fixed costs. Starting in interwar period (1920s), firms began offering benefits to workers in the era of "welfare capitalism." That fell by the wayside in the early years of the Great Depression, but pensions and sickness benefits began popping up again in the 1930s, and expanded during WWII. From 1948 (an Inland Steel case that went to the supreme court) benefits became part of collective bargaining. By the early 1960s over 60% of Americans were covered by their employers with some sort of healthcare policy (esp. Blue Cross hospitalization). Moral hazard and adverse selection make optional private insurance unsustainable in the long run, but in the US, unless you're over age 65 and qualify for Medicare, that's your only option. Firm after firm has faced bankruptcy rather than renege on this. The auto industry is only the most recent, with steel and airlines moving first. Productivity improvements and increasing longevity meant the retiree to active worker ratio rose inexorably; exploding healthcare costs added to the pain. And it's not just unions, this became the norm, because insurers and doctors all fought change tooth, claw and nail, whereas the presence of benefits at the best-paying firms muted the voices of those who might have wanted reform. The US is unique in the OECD (developed countries) in this system of piecemeal private insurance.

Jun 07 08:01 AM

[Deweyp:]

To answer the question of why this wasn't done sooner? State franchise laws prevent outright "breaking" a franchise. Look at the problems involved trying to rationalize dealerships by Chrysler and GM even after filing Ch 11. GM has, for the past decade, been reducing the number of dealerships through whatever means possible in a lawful manner to keep dealership volume at a profitable level. A low volume dealership cannot sell a car or truck as cheaply as a high volume dealership making the product uncompetitive with the Asian brands. With the UAW having a strangle hold on the big 3 (picking one target company and holding them hostage in strike, while allowing the other 2 to build and sell cars) it was inevitable that labor and benefits costs would escalate to untenable levels, as the target company had to eventually yield to the union demands or go out of business. As long as sales volume in the US remained high (16 million +) the big 3 were able to survive even though turning in losses each quarter. Reducing sales to less than 10 million was the eventual undoing of GM and Chrysler. Even Honda and Toyota were unable to make a profit at that level. Mike Smitka (comments above) is correct in his analysis of the rise in healthcare costs. The US government is as much to blame in all of this, as imports and transplant autos are allowed to compete here with none of the overhead costs the big 3 face, such as health care for an older workforce and retirement benefits for over a million. As long as this is allowed, this country will continue to lose our manufacturing jobs and history will judge us harshly because of it.

Jun 07 09:21 AM

[33Nick:]

Unfortunately, most modern big businesses have no contingency plans, a reality we all too often see. It shouldn't be too shocking to see that happening with the likes of GM and Chrysler. It is not surprising to see their business plans not having backup plans. What is surprising is why then did we have financial and business man run these car companies then?

Yes, the 2000s are for more nimbler companies that have exit strategies and contingency plans.

The Electricnick.com team.

Jun 07 01:28 PM