Fresh Off Its IPO, Can GM Stage a Comeback?Published: November 23, 2010 in Knowledge@Wharton
After years of declining market share and unprofitability -- and a multi-million dollar bailout by the United States government -- General Motors is once again a publicly held company. The automaker, which raised some $20 billion through last week's initial public offering, is on sounder footing than it has been in years and is expected to turn a profit in 2010.
Yet the new GM still must compete in a tough global market. So the question remains: Can the new GM perform better than the old GM? Knowledge@Wharton posed this question and others to Wharton management professor John Paul MacDuffie, whose research focuses on the auto sector.
An edited transcript of the conversation follows.
Knowledge@Wharton: The IPO for the new General Motors raised about $20 billion for the company through the sale of shares in the new GM. How will that help position GM to compete globally against Ford and Chrysler, and against the other major automakers around the world?
John Paul MacDuffie: GM already has been competing globally with considerable success -- in some ways, it has been more successful in recent years outside the U.S. than in the U.S. What the IPO does, above all else, is allow GM to move away from the perception of being a troubled company that needed government bailout money, to the next stage of the story they very much want to tell, which is: They are a reborn company that is on the move with a lot of exciting new products to offer consumers; [they are] doing very well globally; and [they are] on the way to being fully independent again.
I think that's the biggest gain -- a gain in consumer perception.... and it's probably a boost for the morale and spirits of GM's own employees.
Knowledge@Wharton: Does the infusion of the cash itself from this sale do anything in particular to help the company?
MacDuffie: It goes back to the government.... [GM was] 61% owned by the U.S. government before the IPO, and now it's down to about 33%. That's a big shift, and it is the most fundamental consequence of the IPO. Some of the other shareholders also sold small stakes [including] the Canadian government, the United Auto Workers and the Canadian Auto Workers. For the unions, those proceeds will go to support their health and pension funds.
Knowledge@Wharton: Why is it that the U.S. government still owns a pretty good chunk of GM? What is the rationale behind that?
MacDuffie: It all goes back to the industry bailout, which I think is exactly what GM felt created some stigma for them. But at the time, it was absolutely essential, or they would have likely ended up in Chapter 7 bankruptcy and liquidation. The government made a judgment call ... that this was not just a crisis of one company, but it was actually an industry crisis. General Motors and Chrysler were in the worst shape -- if they failed, it would take down most of the supply base, which would make it impossible for Ford to produce cars, and for many of the foreign automakers that are building cars in the U.S. It's an industry with a lot of interdependency in the supply base, so in order to avert an industry disaster -- with potential job losses of one to three million, according to various estimates -- [the government] decided to step in and rescue GM and Chrysler, forcing them to make a whole set of changes, and putting them through a very rapid bankruptcy process so they could emerge as new companies.
Knowledge@Wharton: Just to reiterate your position on the bailout itself: Was it a good thing for all concerned -- for the unions, for the corporations themselves and for shareholders?
MacDuffie: Well, nobody is happy about the bailout having happened, or needing to happen. And there's a big concern, politically, about the government rescuing companies that may be too big to fail. That's part of the negative association with the bailout that certainly is a big concern to GM. My view is that this was perhaps a once-a-century, once-a-three-fourths-of-a-century event. The great recession that we've been through ... was only exceeded by the Great Depression. That was the last time there was any kind of similar scope of government action involvement in the private sector.
And so, I wouldn't want this to be a regular occurrence. But I think it was warranted under these conditions. Ford, of course, did not take any funds from the government. That has benefitted Ford in a number of ways, although it has left them with more debt to manage. As GM, and eventually Chrysler, go back to being private companies, the government will be paid back. Will it get all its money back? That's still an open question. Shares sold last week at $33 a share; in order for the government to have its stake fully repaid, GM stock would have to be selling for about $53 a share. That's still quite a gap. But both GM and the government felt that it was important to do a sale as soon as possible of some of the stock, to signal that the government doesn't wish to stay in the business of owning a private company. And GM by no means wishes to stay a ward of the state.
Knowledge@Wharton: You mentioned Ford and Chrysler a moment ago. Ford Motor Company itself urged the government to help GM and Chrysler, did it not -- because of the possible ripple effect on all the suppliers in the auto industry?
MacDuffie: That's correct. Ford saw that it would be impossible for them to continue producing vehicles if GM and Chrysler failed. And so, they did urge the government to take that action.
Knowledge@Wharton: Ford's market cap as of today, November 22, is about $56 billion. And GM's market cap is about $51 billion. Does that sound about right to you, given the relative strengths of Ford and General Motors?
MacDuffie: Well, that certainly marks a reversal. For most of the last century, except for the very early years of the auto industry, General Motors was the larger company, with the larger market cap over Ford. It reflects the fact that GM is now a much smaller company, and it also reflects the fact that Ford has been receiving a very positive response in the stock market lately. [That response comes] not only because of Ford's not having received bailout funds, but also because in some ways, [Ford's] recovery and some of its current strengths have been evident for a while now. Those include several very strong new products; quality levels that ... seem to be quite consistently high across the product line; some refocusing on cars, as opposed to just trucks and SUVs; and [an emphasis] on keeping the margins for those vehicles high enough to keep [the company] in a financially sustainable position.
Ford has done a lot of the right things lately, and they've seemed to benefit from that in their stock price, and more importantly in [terms of] consumer perception.
Knowledge@Wharton: All of the U.S. auto companies for many years have had a reputational issue concerning the quality of their cars. From what I understand, the cars are much better quality now. But do you think GM still has a reputational problem going forward? Will it have to do anything special to convince consumers that not only are we back, but we have good, exciting, quality, reliable automobiles to sell to you?
MacDuffie: Well, this issue is very much in the eyes of the consumer and there are lag effects in terms of reputation. I'm sure it's very frustrating for GM, for Ford, to see some perhaps lingering perceptions of quality problems from the past....
The key for Ford has been improving quality quite consistently across the product line. GM, for a number of years, has had certain models that have been very successful with quality, and they have gotten awards and the like. But they have also had other vehicles with a lot of quality problems. All it takes to keep that reputation alive is hearing from a friend or a neighbor or a colleague about a bad experience with a GM product, and then it reinforces whatever negative perceptions you have.
And consistency is tough to maintain across all products. Obviously, a lot of these products have parts that come from suppliers all over the world, so it's not all completely under your control. These are very complex supply chains to manage. But that's the test that every automaker has to pass these days. And the fact that Hyundai, the Korean company, has improved its quality so much has had a tremendous impact on its sales. Its market share has grown percentage-wise more than anybody's in the U.S., during the crisis and continuing to the present day. It continues to be a race where everybody's running faster just to keep up.
Knowledge@Wharton: Do you think GM has exciting new vehicles in its pipeline that will get consumers excited in the years to come? Secondly, does the company currently have any vehicles -- perhaps the Volt or the Cruze -- that might get people excited about the company, and looking at GM cars again?
MacDuffie: There are a number of GM models that are very promising in that regard, and they almost all occupy different categories, or different spaces. For Buick to start having some products that people are excited about, like the Lacrosse, is a bit of a change because while they had some loyal consumers, they were mostly seen as being more conservative. There wasn't much that was seen as really new in the Buick line, and that's starting to change. Buick, of course, in one of the interesting international ironies about brands, has been GM's top-selling brand in China for a long time. They have a cross-over vehicle, which was a space that the U.S. companies were a bit slow to move into -- car-platform-based SUVs. The Equinox, which has gotten rave reviews, is selling very well. And then you mentioned the Volt and the Cruze. The Cruze [a compact sedan] competes in a very tough segment against Toyota and Honda products, and is getting very good reviews. And the Volt, of course, is this new electric vehicle which has a bit of a unique design, and everybody's waiting to see it. The buzz on it is certainly great. The price is going to be high. The demand is uncertain. But it helps GM, as it would help any company, to be perceived as having some products that are at the technological edge.
And I think they'll need to continue to do that. [It's] a little bit like quality: One tranche of new, exciting products [moves a company in a new direction]. But you've got to keep filling that with new products to keep the momentum going.
Knowledge@Wharton: Getting back to the ownership issue of GM -- its main joint venture partner in Shanghai, SAIC Motors, has purchased about a 1% stake in GM. What are the implications of that? What does that tell us about their relationship?
MacDuffie: Well, it tells us that it's a close relationship. It's a relationship that over a considerable number of years has probably shifted from being one in which GM was primarily transferring knowledge and technological expertise to its Chinese partner in return for access to the market. The Chinese firm is starting to produce some of its own vehicles and is clearly catching up in a number of those areas. I don't see it in larger symbolic terms, as "China Inc. is buying a U.S. landmark company." It's really much more of what we see very commonly -- international joint venture partners sometimes taking an equity stake. I suppose you could say it's a vote of confidence, as well as an indication of the collaboration that they have had for some time, and will continue.
Knowledge@Wharton: The IPO created, of course, a lot of buzz about the company. But what exactly has changed? How is the new GM different from the old GM, aside from the government ownership part of it? But I mean internally -- management, and perhaps its management structure, management style. Has anything changed from the old company to the new that's significant?
MacDuffie: Many things changed as a consequence of the bankruptcy. GM shed a number of brands, including Pontiac, Hummer and Saturn. They closed a lot of plants. There's an old GM, which exists now as a separate company, which consists entirely of assets which are being slowly sold off in one way or another. So, in one fell swoop, they had some of the least productive or [least] useful assets shifted off of their balance sheet. They've had a lot of management changes, of course. They have their second new CEO since the bankruptcy ended. Well, first there was an interim CEO, Fritz Henderson, who was a long timer, and then [soon to retire chairman] Ed Whitacre, and now Dan Akerson. [There are also] a number of new board members, and that was one of the primary ways that the new owners, the government and the unions, exerted some governance control -- through appointing new members of the board.
I think those are all the new things. That's an overlay on the fact that there were a lot of areas where GM had made improvements over time, in their manufacturing, in their product design and in their management of suppliers. And [in the case of] many of those things, the goal has been to continue a positive trajectory. So, it's a mix of some of the good things that were happening already that were somewhat thrown for a loop by the financial and industry crisis and the bankruptcy, which caused a lot of restructuring of the sort that we see often in a private equity-based workout. And then, finally, a lot of management changes to set a new tone and take the company in a new direction.
Knowledge@Wharton: Is there any way to know whether management is thinking differently now about how to approach the marketplace? It used to be -- and correct me if I'm wrong -- that General Motors and the other big two automakers used to basically produce product to meet the needs of their production lines, and hope that there would be enough customers for them. And clearly that didn't work out very well. Is there any way to know whether upper management have seriously began to rethink how they look at the whole business, and how it's changed globally vis-a-vis its competitors and what its customers want and that sort of thing? Do we know that yet?
MacDuffie: We can only look for some telltale signs, and keep an eye on a broad array of indicators. But one of those might in fact be the production levels, the use of heavy discounting and incentives to sell products in order to keep the volume levels high. GM used to do that a lot. Arguably, they had a primarily fixed-costs situation in many of their factories, because of both inflexible manufacturing facilities, but also because of the labor costs and the legacy costs associated with that. That was argued to be a reason why they had to keep the factories full, and then use incentives to sell. But, you know, when you're getting almost no margin on your products, sometimes even selling at a loss, that's no recipe for survival.
So far, we see more focus on a smaller number of vehicles that are more intensively marketed, and sort of holding the line on incentives [and] aiming for higher selling prices. All of the brand-building, all of the reputation-building around quality and around new technologies are to help sustain that. The reduction in the number of dealerships, while quite controversial and still somewhat politically fraught, also means they don't have as many dealers competing with each other in a close proximity to be the one who gets the customer. So, that helps in terms of the price-cutting, as well.
Knowledge@Wharton: How would you characterize the relationship between the UAW and the company? What should that relationship look like in the years to come?
MacDuffie: It's a long and complicated history, of course. Another thing that I think is sometimes lost in the retelling of the recent history is that the union and General Motors, and also the union with Ford and Chrysler, have reached some landmark agreements in 2007 that would completely restructure how health care and pension costs were handled in the future. That is now largely implemented. It was unable to be funded in its original form because of the crisis. But the resolution to the bankruptcy has allowed that. So, they had made progress towards finally solving what had been one of their most persistent and difficult problems.
Coming out of the bankruptcy and having to work through so many things has left the companies and the union working quite well together. I think the big question on everybody's mind, if GM returns and is highly profitable, is will the union want to revisit some of the concessions that they've made, and what will the company's stance be to that? I think the company's position would be [that] this was a necessary re-setting of some of their labor costs and shouldn't be viewed as a temporary concession to be negotiated away. I think the union feels that they made an awful lot of sacrifices to help GM survive in this period, including becoming one of the owners, as part of the agreement for how to fund these health care and pension funds.
I don't expect a big confrontation. I do expect the union to want to open those issues. And I imagine, though, having come through this crisis, that they'll understand that the worst thing for them would be to get back to fighting in a very zero-sum way.
Knowledge@Wharton: What will Wall Street's view of GM be now? Will GM feel that pressure quarter-to-quarter to show profit after profit after profit? Will institutional investors give the company a break, because it's coming out of bankruptcy, and therefore give it some time to get on its feet and get its sea legs and work through some issues, or not? How do you see that relationship going forward?
MacDuffie: I suspect that the good will and the openness to giving GM a chance will be relatively short-lived. The feeling will be they have to continue to prove themselves. There's several things which I think make it likely that GM will be able to keep investors satisfied for a while. Some of it has to do with the return, gradually, of the U.S. auto market to closer to historic levels of sales. In the crisis, that level had been around 15 million a year..... In the crisis, sales plunged to 9 million. [That's] a 40% plunge in sales within a couple of months. This year, it looks like there'll be about 12 million. The historical trend on replacement volume -- in other words, how many people replace their vehicles each year -- is about 13 million. Of course, a car, you can hold onto for a while if you need to, and that's what a lot of people have been doing.
As sales return, 13 million seems likely to happen very soon. And then we may be back to 14, 15 million. There's a lot of upside for GM, for Ford, for Chrysler, for all of the companies in the U.S. market, to be getting a part of those sales. GM also is selling very well in emerging economies, where more of the growth is. So, in the U.S., it's a recovery but to what will be a relatively low level of growth. In these emerging economies, like China and Brazil and Russia and India, there's a lot of growth. And GM is quite well-positioned in those markets. Between the recovery of U.S. sales and the global sales, and the current strong products, I think things look good for them for a while.
But, of course, they will have to -- particularly with the stream of successful new products -- have to keep that going. And I think they'll also have to show good management of their global scope, finding ways to turn it to their advantage.