Is there a future for General Motors?

Vanessa Drucker, American editor, Fund Strategy

The Obama administration is ploughing huge amounts of taxpayers’ money into the “iconic” car company, GM. But with a long list of entrenched failings, can the “new GM” really change?

An icon on life support

If the General Motors bankruptcy goes according to plan, President Obama promises the reorganisation will let “this iconic company rise again and move toward profitability?” Can the lumbering automaker indeed become profitable in a new guise?

The government contends that by shedding 40% of its dealerships and closing 30% of its American plants, GM can operate more leanly and competitively. Its eight brands will be streamlined into four. Most importantly, it can slash its debt load from about $73 billion (£45 billion) to $17 billion, and knock a couple of billion a year off labour and legacy costs. Note, however, that such progress comes at a steep price (to taxpayers) and through a huge debt-to-equity finesse. The government will have provided $50 billion in return for owing 60% in the new company’s equity, a stake unlikely to be repaid for years, if ever.

Why is the government footing the mammoth bill? Despite immediate downsizing of 20,000 workers, it may be a valid goal to preserve the supply chain base. The vast infrastructure of components manufacturers is intertwined with overlaps among all the American automakers. As another tack, Robert Reich, a former US labour secretary, has suggested the administration is mainly buying time, to reduce the social costs and mitigate a psychic affront of dismantling what the president labels “an icon”. Although he predicts “GM will disappear, eventually”, the bankruptcy eases the transition to the realities of industrial adjustment.

“Part of the government debt will have to be written off at some point,” says Edward Hill, dean of the Levin College of Urban Affairs at Cleveland State University. Looking for a silver lining? President Obama’s next declared mission will be the reform of the health insurance system. Hill says: “you could take some of the money now flowing into the autoworkers healthcare fund, and think of it as a down payment for national healthcare….”

Innovate or die

Sure, size matters, but willingness matters even more. If GM’s culture is so entrenched that the company cannot adapt, or learn to provide the cars consumers want, it will not matter how much public money props it up. “If you look at the life cycle of many family-owned businesses, by the third generation, the grandchildren often tend to run the operation into the ground. GM created a corporate culture like a family business,” says Dave Cooke, founder of Strategic Resource Group, in Northville, Michigan.

Cooke points out how the company insisted on maintaining a distribution channel strategy that was a relic of the 1960s, by adding new dealer contracts, when that network was no longer cost effective. Consider also that GM’s operational expenses, as a percentage of sales, are three times as high as Toyota’s. That discrepancy in fixed costs represents an efficiency shortcoming, rather than a labour issue.

The new GM will keep only four of its brands, namely the Chevrolet, Cadillac, Buick (popular in China) and the GMC (similar to the Chevrolet). Saturn and Oldsmobile are gone, Saab is up for auction, and last week GM sold the Hummer SUV (sports utility vehicle) to Sichuan Tengzhong Heavy Industrial Machinery. “Rather than figuring out its competitive advantages, GM chose a bizarre strategy of gathering brand names, believing that scope and scale would offset labour issues,” says Hill.

In recent decades, the firm’s business culture has expressed itself by disrespecting customers and the supply chain. For instance, it has treated its suppliers as fungible, as if any particular one can be substituted for another. It has “dissed” the customer by neglecting the quality of its vehicles, like by letting major components go though, if they happen to fall outside the warranty time. The company seems to think it can fool purchasers by taking a Chevy Equinox, putting the ignition on the floor, and calling it a Saab. Many Americans are beginning to wonder, if the “new GM” remains sclerotic and mired in an outdated culture, will it suffice to force feed it billions of dollars?

A radical solution

GM and its peers share a common challenge: to keep up with consumer tastes when the public keeps changing its mind, as oil prices fluctuate. “Last year, people switched from loving SUVs to wanting fuel efficient cars. Now gas prices are rising again,” says Sharon Lindstrom, a managing director and consultant at Protiviti (pictured, left). Car companies would rationally build more competitive, smaller cars if demand stayed level. Last year, with average retail gas prices at $3.77 in May, compact cars commanded a 26.7% market share. With pump prices at $1.69 in December, that share had dropped to 18.1%.

One cause behind GM’s downfall has been the Corporate Average Fuel Economy (CAFE) standards, mandated since 1975 on car and truck manufacturers. The standards are averaged across entire fleets; automakers can earn credits with their more fuel efficient vehicles to offset the gas guzzlers. The rules distort the market by creating an incentive to sell small cars at a loss, rather than invest in making them more desirable.

Higher fuel taxes, although controversial, could motivate consumers toward higher fuel-economy choices, says Jeremy Anwyl, Santa Monica-based chief executive of Edmunds.com, a website publisher for automotive information. The proposal has not won many fans, although American fuel taxes are far below those in Europe.

An ideal process would allow a year or two of lead time in advance, to let people adjust and minimise disruptions. Anwyl, who is adamant that the program should be revenue neutral, suggests lawmakers might compensate lower income drivers by substituting a flat, across-the-board income tax credit which would progressively favour those less able to afford the hikes. One drawback is that people may grow accustomed to higher taxes and simply budget accordingly. “The goal is to change fundamental behaviour,” says Anwyl. “With Obama’s rhetorical skills, he could probably sway opinion by drawing on non-renewable resource and environmental issues.” So far, neither political party has shown much enthusiasm for increased taxes on petrol, emissions or engine sizes. It is no recipe for attracting votes.