A government plan to rescue the U.S. automobile industry with $14 billion in emergency loans to General Motors and Chrysler was approved by the House of Representatives late on December 10, but the proposal continued to face stiff opposition from Senate Republicans. While the lifeline loans would give the Detroit automakers some breathing room, legislators and auto executives remain under enormous pressure to come up with a plan to resolve the industry’s deep structural and management problems.

The plan’s opponents in the Senate say that bankruptcy would be a more suitable outcome; a bailout would generate little motivation for the automakers to change their business models, and would likely lead to similar requests for government handouts down the line, they argue. 

Wharton management professor John Paul MacDuffie, who specializes in automotive research, favors government assistance to the industry, with strings firmly attached, over a forced bankruptcy. A negotiated financial package, he notes, could have the same impact as a reorganization accomplished through the bankruptcy court without the expense, delays and uncertainty that might cost the government even more in the long run. In addition, the size and complexity of the three automakers’ operations would make it highly unlikely that the industry could pull together all its claimants and get them to swiftly agree to a pre-packaged bankruptcy plan, he says.

He also points out that many of the wage and benefit differentials between U.S. companies and foreign carmakers that could be the subject of bankruptcy reorganization have already been negotiated away by union leaders, substantially narrowing the gap between what the Detroit-based companies pay per vehicle and what foreign firms pay overseas and in U.S. plants. The companies also resolved accelerating pension and retiree medical costs with a 2007 union agreement that shifts costs off the automakers’ books in 2011 and into a trust administered by the unions.

Moreover, any plan to restructure the industry should focus not just on cutting back on workers, plants and brands, MacDuffie says, but also on building relationships with suppliers and learning how to compete in the global marketplace. Over-attention to cost-cutting and short-term financial results has repeatedly prevented Detroit from pulling ahead of its competitors with initiatives that might have prevented the current crisis, he argues.

“What’s striking is there are these pendulum swings inside companies where they start to do something they learned or are emulating from Toyota or Honda and then they pull back,” he says. “Either a financial crunch comes or there are internal political dynamics between reformers and conservatives and we have these swings back and forth.”

According to MacDuffie, Detroit-based automakers have already taken costs out of their operations, perhaps too much so. The U.S. auto industry needs to think more about providing value to its customers to make them willing to pay more for the vehicles Detroit builds. The companies have already begun to make strides in improving quality, but consumer perception lags the new reality. He adds that constant marketing ploys, launched after the terrorist attacks on the U.S. in September 2001, have also worked against creating a sense of long-term value in U.S. cars.

“The Detroit Three basically trained people to think of paying a very low price for their vehicles and waiting for the next big rebate,” MacDuffie says. “It really degraded the sense of value. I think these companies can persuade people to pay enough of a premium to allow sufficient profit margin to generate funds to reinvest in research and development. They will not get out of this bind by cost cutting alone.”

MacDuffie, who is also co-director of the International Motor Vehicle Program (IMVP), a consortium of academic researchers focused on the auto industry, has favored the creation of a committee to oversee any government aid to the auto industry, as was done with the successful Chrysler loan guarantees in 1979. “You don’t want Congressional committees and staff writing out the business plan for these companies,” he warns.

Strings Attached

Susan Helper, an economics professor at Case Western Reserve University in Cleveland and a researcher at IMVP, says that the strings attached to any government program for the auto industry should fall around three general sets of conditions. First are issues related to “the way the pie is divided,” particularly questions about executive compensation that could be addressed using benchmarks for establishing pay standards. The second set of conditions would be related to keeping jobs in the United States. Automakers should not be able to use taxpayer funds to make their operations more efficient by moving them to Mexico, she argues.

Finally, and most important, the industry should be required to lay out ways in which it will commit to improving relationships with suppliers in developing new manufacturing processes, Helper says. Oversight should not focus only on financial goals, but also operational outcomes that will make the companies viable over the long term. She points out that all the attention to labor costs in the automotive bailout debate misses the point that parts account for a much bigger chunk of industry expenses than labor, 50% versus 10%.

U.S. automakers have developed bottom-line relationships with their suppliers, in which they design a part and offer the work to the lowest bidder, Helper says. This gives suppliers the incentive to slash costs and little motivation to innovate and come up with better solutions. Japanese automakers are well-known for developing long-term relationships with their suppliers that encourage innovation and learning throughout the supply chain that eventually generate revenue and profits for all those involved.

The complexity of a car demands tight interrelationships between suppliers and manufacturers, she adds. “There is a limit to what suppliers can do on their own. The usefulness of their part depends a lot on the other parts that are next to it.” Auto production also is highly vulnerable to what the industry calls “system effects” such as noise, vibrations and a harsh ride that could be eliminated with better teamwork. “If parts don’t fit together right, you get squeaks and vibrations,” she says. “People are already doing things cheaper; what they need to do is think differently.”

Helper and MacDuffie both contend that oversight of federal aid can use benchmarks, such as J.D. Power quality reports or global executive compensation standards, to gauge the automakers’ progress on long-term structural change.

Why Not Bankruptcy?

Despite the desire to work out a pact that could save millions of workers their jobs in an already fragile economy, many remain unconvinced that anything short of bankruptcy will make Detroit change its ways.

Wharton management professor Lawrence Hrebiniak says the executives are pleading for relief now with little intention — or ability — to right their troubled industry. “They want to avoid bankruptcy so they can get the loans, and if they get the money the strategies won’t change that much. Six months later, they’ll be coming back to the taxpayers.”

According to Hrebiniak, bankruptcy would allow creditors, including the government, to sack current management, which he says will continue to be an obstacle to change if it is allowed to remain in place. He is not concerned about the time it might take to resolve a financial restructuring through the courts, because sales and market share would diminish anyway. “That’s already been going on for a long time now,” he says. “If someone can expedite a bankruptcy proceeding, they could force management to start taking some of this seriously. I’ve known these companies a long time. I know there are people in strategic planning who used to pull their hair out because they knew what needed to be done. It just never happened.”

Hrebiniak adds that he understands the economic peril of putting the jobs of hundreds of thousands of workers on the line, but he says auto executives are mostly concerned about their own jobs. “In my estimation, they want to avoid bankruptcy — especially at General Motors and Chrysler — because a total reorganization will shake up the management structure. People who have not been able to pull off change are flying in on their jets, saying, ‘We’re too big for you to let us go under.'”

A bankruptcy filing that would ultimately be adjudicated by a seasoned judge and court officials experienced with restructuring would be a better option than hammering out a deal with Congress and the White House, Hrebiniak contends.

“I just don’t think government is smart enough and wise enough … to enforce and ensure things would change. I’d rather have outsiders,” he says.

But according to MacDuffie, any hope of recapturing sales from already wary consumers would be sharply diminished by a bankruptcy filing that would raise questions about whether the companies could provide parts and service in the future. While negotiators could draft a rock-solid, government-backed guaranty of long-term service in a bankruptcy agreement, consumers would have difficulty believing the promise.

“My worry is that this is something that hits more at a basic psychological level for consumers,” says MacDuffie. “People have good alternative choices of vehicles from foreign automakers. If there is a cloud of bankruptcy and negativity — which is already in the air — why buy from such a company when there are so many other good choices?”

Bigger Questions

A major stumbling block in any restructuring is what to do with the nation’s oversupply of 20,000 auto dealers, who are protected by state franchise laws that prohibit the automakers from pulling their business.

Helper says the number of dealerships must be reduced to reflect the declining market share of the Detroit Three. As some dealerships close, others will gain through consolidation and may be able to take on some of the employees who have lost jobs. Also, she argues, mechanics or sales people could find other jobs in the economy with support through unemployment insurance and retraining programs. Dealer franchise owners could reuse their land and buildings for another purpose.

That is not an option for those directly involved in the industry — including laborers and the owners of plants. If the core industry is allowed to die, she says, the nation will lose a critical economic asset. “That is a capability that would be very difficult to rebuild.”

Political considerations may play a part in how the dealership part of the puzzle is resolved. While members of Congress from states outside Michigan, Ohio and other heavy auto production states may see no upside in a bailout, each state has thousands of auto dealership employees. In addition, affluent owners of dealerships are often major campaign contributors.

Beyond the mechanics of executing a bailout and the nuts and bolts of production cuts and brand consolidation already mapped out in the Detroit Three’s restructuring plans submitted to Congress, industry analysts are calling attention to larger, long-term issues.

“The real question is, what does it take for these domestic players to be competitive again and can they be competitive again,” says Scott Corwin, a partner at the management consulting firm Booz & Company.

Corwin says the key to long-term survival is building an operating model with advantages over competitors that will allow U.S. automakers to react faster. Other auto companies have the ability to produce three generations of autos in the time it takes U.S. firms to come up with two, he notes. “As a result, you are always playing catch-up. There is a clear set of dynamics that need to be met and they’re all working toward that. The question is, will they be able to execute it, and will they have enough funding? The balance sheets are very weak and any hiccup could make it all the more precarious.”

Like MacDuffie, Corwin says the Detroit companies need to focus on building consumer equity in their vehicles. He notes that strong luxury brands essentially invite customers to invest in their products because they retain value over time. U.S. auto manufacturers, he says, are too often focused on building vehicles that they can sell for slightly more than they cost to make. “They should be thinking about ‘How do I ultimately create value for my customer and work backwards in terms of the supply chain and the value chain?'”

William Jackson, another Booz & Co. partner, says Detroit’s future lies in development of new energy efficient models, although that will probably not happen without a regulatory push. “My hope is that not only do we help maintain [the] auto industry [but that] we make a switch to more carbon-free transportation,” says Jackson. “This global warming issue is serious, and the sooner the world moves toward a more carbon-free environment the better. There’s no reason not to start with the auto industry, which — by the way — has done a better job than other industries.”

Corwin argues that if the nation lets its automakers fail, the country will lose extensive research and development capability not only in transportation, but also in alternative energy. “We are going through a change from a century-old technology built on the internal combustion engine to a whole new set of technologies,” he says. “I think electric is the way we are headed and there are all sorts of infrastructure and economic power that exist that could be a huge benefit in making this transition.”

MacDuffie notes that in addition to all the financial and technological problems that hang over Detroit, the auto companies must also address leadership and governance questions. One problem with the U.S. auto companies is that top management typically rises up from the finance ranks. In Japan, where manufacturing processes are better aligned with business goals, there tends to be more engineers in the executive suite.

“When these companies are run by finance people, it means they stay remote from the guts of the business and are not in a position to make calls about the business. That’s where the big strategic mistakes have been made,” says MacDuffie.

Finally, MacDuffie and Wharton management professor Michael Useem addressed the role of automotive manufacturing boards in a “memo” to GM chief executive Rick Wagoner that appeared on the Wall Street Journal website. “The traditional conception of executives leading and directors monitoring worked well in GM’s halcyon era but less so in taxing times over the past 30 years,” the professors write. “Corporate governance has too long allowed a complete separation of these functions, and GM directors would be wise to take more charge while there is still a company to direct. Their predecessors had intervened in the early 1990s to right a listing ship then, and their action this month could help save a sinking ship now.”