Is General Motors Running Out of Gas?Published: June 15, 2005 in Knowledge@Wharton
General Motors may be down but it's not out. At least not yet.
True, it's been a tough year for the giant auto manufacturer: a $1.1 billion first-quarter loss, junk-bond status for its debt, a largely lackluster lineup of models, and a mountain of health-care and pension liabilities that builds an immediate cost disadvantage into every vehicle that rolls off the line.
But experts at Wharton and elsewhere who follow the car and truck business say that GM is not on the verge of filing for bankruptcy protection, that it has a talented management team and that some new models on the horizon may rev up sales. In addition, a much-publicized bid for GM shares by billionaire financier Kirk Kerkorian is a sign of confidence in the company, according to Wall Street analysts. GM also has an especially profitable gem in its consumer-financing subsidiary, General Motors Acceptance Corporation (GMAC), and GM's assets are worth far more than the company's relatively paltry market capitalization of $18 billion would indicate.
For GM to survive and thrive over the long term, however, the company needs more than a few hot models, although desirable products are certainly pivotal; it requires a major structural and cultural overhaul, these people say. GM must start thinking small -- not an easy task for a company that has never done that -- and accept a diminished, yet still significant, role in the global auto business. If GM had recognized years ago that a steady erosion of its share of the U.S. vehicle market was inevitable, it might have taken strategic steps to ratchet down its size on its own terms, according to Wharton management professor John Paul MacDuffie. As things stand, however, GM is going to continue to shrink, not by its own volition, but largely due to pressure from competitors and macroeconomic conditions over which it has little control.
"GM will end up being smaller," says MacDuffie. "If they had accepted that idea sooner, it would have helped them. The very slow adjustment to the market-share trends is why they have continued some strategies that have turned out to be bad choices." Whenever the company lost market share, he adds, the rallying cry always was, "We're going to get it back. We're going to get back to 37% or 33% or 29%." Today, GM's share of the U.S. market is 25.6%. By comparison, Ford Motor's share is 18.2%.
MacDuffie -- who is also co-director of the International Motor Vehicle Program (IMVP), which has a network of researchers at universities worldwide and is funded by major automakers and suppliers, including GM -- says it is understandable why that rallying cry has been so constant. GM's entire way of thinking has long been built on the benefits of economies of scale: Good things happen when the company's plants are operating at full capacity and sales volume is rising. But that culture has been showing signs of strain for a long time as competitors, mostly from Asia, have eaten away GM's market share.
Slow in Learning
GM was slow to get its plants ready to build "flexibly," that is, to assemble multiple models in each plant, says MacDuffie. But because it is more expensive to outfit a plant with that capability, GM hesitated to go that route. GM's sales projections showed the company selling a large volume of large vehicles, especially sports utility vehicles. If the product sold well, everyone was happy. If it did not sell well, GM found itself stuck in a money-losing situation.
"That belief in volume, and doing whatever it takes to keep volume, has driven a lot of their decisions," MacDuffie points out. "GM's labor costs are fixed, meaning they remain the same regardless of what the volume of sales is. GM wanted to keep factories open as much as possible. There was some value in that strategy, but I think they overdid it. That strategy delayed them in starting to engage the United Auto Workers (UAW) on [health care and pension issues]."
John Moavenzadeh, executive director of IMVP, describes GM as "a formidable company with substantial resources. They have managed turnarounds before in the past." But Moavenzadeh labels the company's current situation "dire," adding: "It seems to me like they can't get out of this trap with the company in its existing form, or by making incremental improvements, or even by getting a few more hit products. It seems like there has to be some sort of a restructuring that takes place."
Another researcher at IMVP, Matthias Holweg, a lecturer at the Judge Institute of Management at the University of Cambridge in England, says "GM is too conservative, not inventive enough." He adds: "In terms of product design and engineering, the Big Three [GM, Ford and Chrysler] have fallen behind their Japanese competitors. Recently, Chrysler has developed a much more attractive product strategy. Neither Ford nor GM has been able to adapt to that."
Gerald Meyers, former chairman of American Motors, a now-defunct company that once competed with GM, Ford and Chrysler in the days of the Big Four, also predicts that GM's market share will continue to shrink. In 10 years or so, he says, "The U.S. auto industry will be much like the European industry is right now -- in a word, fragmented. Everybody will be fighting to get as much as 15% of the market. Nobody will exceed that for very long, if they get it at all."
A decade from now, "Ford will be in the mid-teens and GM will be in the high teens," adds Meyers, an adjunct professor at the Ross School of Business at the University of Michigan. "They might be making money at that point, if they can cut [costs]."
No Bankruptcy Filing
Meyers and MacDuffie agree that there is no need for GM to file for bankruptcy under Chapter 11 of the U.S. bankruptcy code, which protects companies from creditors while they reorganize. "Not a chance," says Meyers, noting that GM is sitting on a cash hoard of $20 billion and has access to about another $20 billion. "There's no scenario that I can think of, or any condition, that GM will do a Chapter 11 any time soon."
Meyers says the overriding factor that explains GM's woes is "a failure to design and manufacture vehicles that are attractive to enough people that they're willing to pay the price at which GM can make a profit. That sounds pretty fundamental, but that's the heart of their problem." GM had high hopes for the new Pontiac G6 and the Chevrolet Cobalt, but sales have been lukewarm. Arriving in showrooms later this year will be the much-anticipated Pontiac Solstice, a sporty roadster. GM has other new products due out for the 2006 and 2007 model years, including a new line-up of large SUVs, which the public may not welcome with open arms, given the price of gasoline.
"The critical point is right about now," Meyers says. "GM is about to give birth to several series of vehicles that are meant to show the way out of difficulty." The lackluster response to the G6 and Cobalt, however, "is an ominous sign. If that's what GM is going to do, that's not enough."
MacDuffie echoes that view. "If the products aren't selling, everything else that GM may try to do is too little, too late. The fact that large SUV and truck sales are going down is not a big surprise. But why aren't their new models selling? They have heralded them. They have talked them up. The reception has not been that positive. The point is, you can't go a long time ignoring your car line, then come back and expect to outsell the [Toyota] Camry, [Honda] Accord and [Volkswagen] Passat."
Meyers notes that GM also is buffeted by macroeconomic winds that are damaging the company's bottom line and over which it has no control. Prices for steel, oil and plastics all have risen in recent years. GM also is burdened with legacy costs over which it has little control if it keeps its current promises to employees. "Health care is the one you hear most about -- and it's big," Meyers says. "But pension costs are enormous too."
Meyers also cites GM's culture as a key barrier to turning the company around. "GM's got enormous momentum of the wrong kind. It has, in decades past, been hugely successful. The culture has said, 'Whatever we've done in the past will repeat itself', but that's not working in the current environment." Meyers admires GM's top executives -- G. Richard Wagoner Jr., chairman and CEO; John M. Devine, vice chairman and chief financial officer; and Robert A. Lutz, vice chairman of global product development and well-known "car guy." "I know these people personally," says Meyers, noting that "they are doing their utmost to turn that organization around. So far, they have not succeeded."
Meyers does not expect GM to receive any significant relief in the form of a willingness by the United Auto Workers to reopen their current labor agreement, which expires in 2007, and grant concessions to GM to save the company money. "The UAW shows no inclination to back off and I don't think they can as a practical matter," Meyers says. "The UAW's position is, 'We didn't create your problem and were not going to solve it.'"
MacDuffie says there probably are informal talks taking place behind the scenes between management and the union to lay the groundwork for a serious discussion of employee legacy costs in preparation for a new labor contract in 2007. But he, too, doubts how much GM will get from the union. "When a company comes and says, 'We want to reopen the contract,' one response is, 'Why?' Some people are incredulous that the union isn't offering concessions, but there has been a lot of distrust."
A View from Wall Street
David R. Giroux, an investment analyst at T. Rowe Price, a mutual fund company in Baltimore, is well aware of the obstacles GM faces. But he says all the news is not bad for shareholders. For one thing, the various components of GM are worth much, much more than the market value of GM would suggest. "The stock is somewhat attractive because of the underlying value in some of their non-North American [car] business," Giroux says. "Their GMAC business is probably worth $40 per share if it can be separated from GM. So you have a $30 stock and $40 of value in GMAC, plus a lot of cash on the balance sheet. It's an attractive stock just from breakup value." Giroux calls GMAC the "crown jewel" of GM. In 2004, GMAC had net income of $2.9 billion, about 80% of GM's total net income.
Giroux sees other pluses. GM's Asian operation, while not as healthy as it was last year, is still a bright spot for the company. He praises Wagoner and other senior executives as a "very strong management team." And he calls Kerkorian's May 4 tender offer for 28 million GM shares, at $31 per share, a "positive" development for GM shareholders. "He's been a very successful auto investor over time. He made a timely bet on Chrysler in the 1990s. He entered Chrysler at a good price, pushed management to use cash flow to pay dividends, and pushed Chrysler into the arms of DaimlerBenz."
Once the tender is completed, Kerkorian, through Tracinda Corp., his investment company, will control nearly 9% of GM's stock. (He had already owned 22 million shares, or 3.9% of GM's outstanding equity, prior to the tender offer.) Owning that many shares will put Kerkorian in a position to push GM management for change, although he has said that he has no plans to attempt to take over GM. "He's all about shareholder value," Giroux notes. "When he completes his tender, it puts him in a position to be more active, maybe even getting a board seat, maybe eventually arguing for strategic alternatives for GMAC, maybe divestiture by selling GMAC or spinning it off to shareholders."
Meyers, the former American Motors executive, has a less sanguine opinion of the bid for GM stock by the 87-year-old Kerkorian. "He's doing what he's doing for money, not for the welfare of General Motors and certainly not for the auto industry and not for the country," says Meyers. "If you follow the money trail to the end, Kerkorian is there with his hand out. He wants to make money. If he wants, he can cause a lot of headaches for GM, just like he did with Chrysler and the entertainment industry." Kerkorian bought and sold film studio Metro-Goldwyn-Mayer several times over a period of decades, garnering a fortune. Meyers adds that Kerkorian can hurt GM "if GM does not respond to his needs. Or he will raise enough hell in the executive suite that they'll wish they did, such as demanding a seat on the board. That would be unthinkable for General Motors."
Wharton finance professor Andrew Metrick says it is unlikely that Kerkorian wants to stage a hostile takeover. Nor is it likely that he is orchestrating a greenmail play, where he places demands on the company and hopes GM pays him a substantial sum to go away, as GM did with H. Ross Perot in the 1980s. "So far, Kerkorian has been good for GM's stock price," according to Metrick, but "if he wants to rattle GM's cage and then get out, that will be bad for shareholders."
What does Kerkorian's purchase of additional GM shares mean for workers and retirees? "I'd be very nervous," Metrick responds. "To the extent there's any cage-rattling here, it's going to involve shutting down [manufacturing plants], not opening [plants]. Kerkorian coming in makes it slightly more likely that changes that will have to happen in the long run at GM will happen in the short run. That's not great for employees or retirees.'"
Metrick says that GM management no doubt cringed when it learned of Kerkorian's tender offer but that his involvement with GM may give management a convenient fall guy to use in making tough decisions. "Maybe Wagoner would like to shut down Buick, and maybe he won't mind if Kerkorian says, 'Shut down Buick.' Maybe Wagoner would like to get the credit without the blame. Sometimes a shareholder advocating for change can help you."
A New Strategy
In May, GM announced that it was launching a new marketing strategy in an attempt to increase U.S. sales. Among other things, the company said it would use price cuts to jump start sales rather than relying on 0% financing and rebates, which have hurt its bottom line in the last few years; eliminate overlapping models and consolidate the Pontiac and Buick nameplates; and strengthen its effort to sell more GM vehicles on the East and West coasts, where foreign car sales are especially strong.
MacDuffie says the new strategy makes sense. "I understand the reasoning. They feel they have terrific products and the world hasn't caught up to that yet, and there are others coming up that will blow consumers' socks off. They can't only focus on saying, 'Wait a few years when we'll have a whole new line of products.'"
The new approach may also mark the beginning of what MacDuffie has said GM must do -- get smaller. "The new marketing campaign is a message of thinning, prioritizing, consolidating -- all of which are sensible approaches to being smaller and managing that in a smarter way," he says. "Thinning product lines across divisions is consistent with putting flexibility in your factory so you can load the factory with a number of products." But in announcing the strategy, MacDuffie hopes that GM does not mean to suggest "that more and better marketing is all it will take to fix things, as opposed to changing elements inherent in the products."
On June 1, GM made a marketing move showing that it has not entirely eschewed short-term attempts to jack up sales and reduce inventory. The company announced that, for the first time ever, it is offering its employee discount to all consumers who take delivery of a new 2005 GM car or truck from June 1 through July 5. The "GM Discount for Everyone" program excludes the Chevrolet Corvette and GMC medium-duty trucks but is compatible with most other incentives currently offered by the company. "Maybe this is the last hurrah in using the discount-and-rebate approach before GM starts getting off that path," MacDuffie says.
If it is clear that all is not doom and gloom for GM, it is also clear that the company is at a crossroads.