Should Congress approve a Big Three bailout? No, it’ll be painful, but the US automakers must be left to their fate instead of being bailed out by the US government, argues Mark Bursa. Yes, these are exceptional times requiring exceptional measures and the alternative could be very much worse, not just for Detroit but for the whole US economy, says Dave Leggett.
Mark Bursa: “Barack Obama’s election catchphrase was ‘Yes, we can’. The lawmakers’ response to the Big Three bailout demand needs to be the opposite: No, we can’t.”
The Big Three CEOs have rolled back into Washington, in a convoy of hybrid cars rather than a private airforce of Learjets and Gulfstreams. And they’ve apparently brought the plan that will convince the US Government to bail them out to the tune of $25 billion [their requests, submitted last night, could now total up to $34bn – ed].
Arriving in their private jets last month was, in hindsight, a very bad move. The publicity was awful, the senators were riled. And the hoo-ha distracted from the big issue, of course. When the big three jetted in a couple of weeks ago, they didn’t have a plan. They simply tried to scare the crap out of the Senators, by quoting a doomsday scenario under which 14m Americans – 10% of the total workforce – could be out of work if the Big Three went bust. So best hand over the $25bn, eh guys?
Unfortunately for Messrs Wagoner, Mulally and Nardelli, the average Senator is smarter than that. Fourteen million jobs? Not really. That figure came from a 2003 US Center for Automotive Research study, and it refers to “economic contributions of the motor vehicle to the US economy”. In other words, anyone whose job is something to do with cars. That includes fast-fit fitters, car wash operators, used car dealers, even taxi drivers.
And, of course, it includes workers at transplants owned by Toyota, Honda and others non-Big Three automakers, as well as their dealers and suppliers. They’re hardly going to shut up shop in sympathy, are they? A more realistic estimate of jobs directly related to the Big Three, their direct suppliers and dealers, would be around 3m people, not 14m.
So would every single one of those workers immediately become unemployed if the Big Three declare bankruptcy? Of course not. And here’s why the US administration should not simply pump $25bn into the Big Three’s leaky coffers. The idea that, without a massive bailout, the Big Three will immediately shut down is ridiculous. The worst-case scenario is Chapter 11 Bankruptcy protection, the US equivalent of receivership here in the UK, which effectively freezes debts and prevents them from being called in.
Chapter 11 buys companies time to restructure. It’s widely used, for example, in the airline industry, where currently four of America’s six main carriers are operating under Chapter 11. Americans won’t buy a car from a bankrupt automaker, the unions whine. Well, they’re happy to fly on a bankrupt airline. In the circumstances, it might actually stimulate sales in Patriotic America.
While no major automaker has entered Chapter 11, the process has been used successfully in the automotive supplier sector, too. One example is particularly close to home for GM – Delphi, its former parts division, which has been in Chapter 11 since October 2005.
What happened next? The US Delphi operations have been a bloodbath. No less than 20 of the 28 US plants in the network in 2005 have been closed or sold. And 27,000 of the company’s 33,000 US jobs have been lost. That’s 72 percent of the facilities and 82 percent of the workforce.
One business sell-off even involved an acquisition by a Chinese company of one of Delphi’s US operations. In May 2006, Torch Spark Plug Co bought all the production equipment of a Delphi spark plug plant in Flint, Michigan, for $3 million. By December it had shipped the equipment for 15 production lines to Zhuzhou, China.
But get this – apart from a few sales of businesses where the activity was considered non-core, such as batteries, catalysts and interiors, Delphi’s plants outside the US have largely avoided the axe. And in emerging markets such as China, Russia and India, the company has carried on expanding.
The entire focus of the company has changed. It’s no longer over-dependent on GM, and it’s no longer over-dependent on the US. It’s much leaner, and much more global. Had it not been for the credit crunch, Delphi would have come out of Chapter 11 this year. This gives the clearest picture of the sort of action that the Big Three will need to take if they are to survive.
A $25bn bailout would not solve the problems – indeed, it could be argued that such a move by the US Senate would be wrong, both morally and legally. At the current rate of cash-burn ($2bn a month for GM, around $1bn a month for Ford and Chrysler), the $25bn would all be gone in six months, lost in day-to-day funding of the business.
Where’s it going? Into the pockets of the workers. And the ex-workers, with their retiree and healthcare benefits. The powerful United Auto Workers union has for years held the whip hand in Detroit. At the first Big Three meeting, Republican senator Tom Coburn delivered a startling statistic. The total hourly compensation package for employees of the Big Three averages $73.21, compared to an average of $44.20 at US Honda, Toyota and Nissan plants, and $31.59 across all US production jobs.
He said: “The United Auto Workers union and Big Three executives jeopardised the future of their companies by allowing employee costs to cripple their competitiveness.” Sounds familiar? To a Brit, the echoes of Longbridge 1979 are unmistakable. The spirit of ‘Red Robbo’ [union activist Derek Robinson – ed] lives on in the Rouge, in Ypsilanti and in Hamtramck.
GM has made mutterings about shutting brands – little brands, including Saab, Pontiac, Saturn and Hummer. Ford hasn’t got many brands left to shut, though Mercury must be on the brink. But these would just be token gestures. Rearranging the deck chairs on the Titanic. Remember our Delphi example? How many plants would have to go if GM and Ford were to experience that level of surgery?
Maybe shutting every large pick-up and SUV plant in the US would be what it takes to get US motorists to downsize into more fuel-efficient cars? If you don’t build V8-engined gas-guzzlers, nobody can buy them.
Such actions would not be possible under a Congress bailout, of course. Lawmakers would attach conditions to any bailout that would be aimed at protecting American jobs. The Big Three would be under pressure to close plants in Mexico instead – but without those they’re in even bigger trouble.
Look at that wage differential to the Japanese. Nearly $30 per worker, per hour. Factor in greater profitability, perhaps double the average Michigan plant, at Japanese plants and you can see the extra cost burden of building at a unionised Detroit plant amounts to hundreds if not thousands of dollars per car. It’s only through leveraging NAFTA and building cheaper models in Mexico that they can compete.
Not to mention GM’s increasing use of Korea, via GM-Daewoo, to source mainstream Chevrolet models such as Aveo and the new Cruze compact. It’s these modern, low-cost plants in emerging markets that are the future – if GM is to have a future – not some inefficient Michigan monolith. GM sold a million cars in China last year – and rising. How long before China becomes a GM source point too?
At the risk of being lynched outside Cobo Hall next January at the Detroit Show, perhaps America’s ‘motor city’ has to go the way of the British equivalent – the cities of Birmingham, Coventry and Luton. Birmingham now only makes Jaguars and Land Rovers. Luton only makes vans. Coventry makes – no finished cars at all. One, two or all of the Big Three may need to use Chapter 11 in a bid to survive.
At least Chapter 11 would give the US car industry a last chance to make the much-needed radical cutbacks that just might ensure the survival of its auto companies. For a start, it would allow those crippling union agreements to be torn up. A lot of jobs would go, for sure, especially in Detroit. So perhaps the government’s $25bn would be better used in grants to help Detroit develop new, non-automotive businesses?
But, like Delphi, Ford, Chevrolet and Chrysler could survive as global brands. They’d be leaner and less US-centric. Chevrolet’s biggest markets could end up as China and Brazil, under this scenario. And in time, they could be highly profitable – if the overall size of the Big Three – or perhaps a Big Two – would be smaller than today.
If the US Congress agrees to a bailout, even with strings attached, it would do little more than delay the inevitable. Where will the Big Three be in 12 months’ time? Back asking for more money? Let the market decide, and let Chapter 11 run its course. Barack Obama’s election catchphrase was ‘Yes, we can’. The lawmakers’ response to the Big Three bailout demand needs to be the opposite: No, we can’t.
Dave Leggett: “Would you buy a car off a car company that had gone bust? As core brand values go, it kind of sucks. Chapter 11 risks making things very much worse.”
Have the Detroit Three made costly strategic errors in the past? Yes. Only a fool would deny that was the case, though those errors often only became evident a long way down the track and with the benefit of hindsight.
But there is a need for a little bit of perspective.
Detroit has been getting its collective act together, doing the right things. It has been downsizing or ‘rightsizing’ its North American production footprint. It has been improving its product, building better and higher quality cars and grappling with – let’s be frank – tortuous employee cost issues that have required a delicate negotiating hand. There’s much more to do, but GM and Ford have already gone much further than many thought was possible.
All that genuine progress towards recovery and turnaround has been blown off course by an unprecedented economic crisis that has brought Detroit’s underlying ills to the surface. But raking over the well known underlying ills is partly missing the point. Those structural problems are still there, whatever happens, Chapter 11 or not. Dealing with them has to happen and there’s no argument about that. That is ongoing and the pace now has to be stepped up, obviously.
However, this bridging loan request is a direct response to extraordinary events outside the control of the car companies. It’s not the car companies’ fault that the US light vehicle market has virtually collapsed in a matter of weeks. Even the mighty Toyota is taking a volume and profitability hit in the US.
This is shaping up to be a recession like no other we have seen in the post-war years because of its financial system origins and what’s going on with credit availability. And it has already brought a massive government response and intervention in the banking sector, in the US and in the world.
What’s so wrong with some support for manufacturing in these extraordinary times? Governments elsewhere – especially in Europe – are also proceeding down that path. If you don’t do likewise, aren’t you putting your own companies at a relative disadvantage?
Remember, too, that the US auto industry malaise of recent years has its roots at home. Both Ford and GM have been good performers outside the US and they have done well in that most competitive of markets, Europe. They have also been investing in emerging markets, going where the future growth is. Looked at in global terms, they are far from failing companies.
Despite the tired jokes on NBC’s Saturday Night Live recently, there is also no doubt that product quality is much improved according to independent surveys, such as those by JD Power. And the respected Harbour Report shows that the Detroit Three are now close to matching their Japanese competitors in the US in terms of manufacturing productivity.
Driven by more consistent, leaner processes and buyouts of tens of thousands workers, the Detroit Three automakers in 2007 nearly erased the productivity deficit – in terms of manufacturing hours per vehicle – against their Japanese-based competitors, despite declining production and shrinking market share, according to Harbour.
Ford supplanted Toyota as the leading manufacturer in initial quality rankings, taking the top spot in five of 19 segments in the 2007 IQS survey by JD Power.
How many people are aware of these things? The ‘perception gap’ continues to play in the minds of the public, but it will be eroded in time. Cars like Ford’s Fusion and future cars like GM’s Volt demonstrate that Detroit isn’t just churning out gas-guzzling SUVs that no-one wants, as the media often cheaply suggests. But you don’t just flick a switch to become ‘GM lean’ overnight. It takes time.
Profitability per vehicle in the US remains a problem because of the Detroit 3’s higher commitments on healthcare and pensions. There aren’t easy answers in that area, of course. It’s perhaps a wider problem for Corporate America and for policymakers to chew on. But these companies are bearing huge social responsibility costs that weigh down on their profitability and competitive position. If that’s not a valid argument for government cutting a little slack for these companies, I don’t know what is.
A bankruptcy won’t solve GM’s immediate problems, which are falling sales and inadequate liquidity. It will most likely make the sales picture much worse as prospective customers shy away from buying a car from a bankrupt carmaker (remember, that ‘perception gap’ means that many already believe Detroit Three cars are inferior quality; bankruptcy surely reinforces that notion). That will hit liquidity further. The business of being solvent and making vehicles for sale, paying suppliers, will get more difficult to achieve. Supplier relations will inevitably be damaged (some are already demanding cash-on-delivery, further exacerbating liquidity problems) and the fallout will be felt across the entire automotive industry in North America.
And the sheer size of the automotive industry means that the whole US economy will be dragged down further. Let’s not argue about how many jobs we are talking about, but it’s going to be a big number, potentially. It’s not just auto company and auto supplier workers; there’s a multiplier effect. There will be a substantial knock-on negative effect on spending and confidence throughout the US economy.
Removing a large section of consumer spending at a stroke will make the recession that is coming next year considerably worse. Investors will take fright and confidence in the US economy will ebb further. That’s bad for everyone, whether you care about America’s indigenous car industry or not.
And the downward spiral for bankrupt car companies would then intensify, a Chapter Seven liquidation of assets beckoning.
To those who believe that sending one of the Detroit Three down will improve things for the other two in the very long run, spreading sustainable business among fewer heads, you may be right. There’s a hard-to-quantify chance that could happen. But getting there is not guaranteed and is likely to be an unhappy journey dogged with high unemployment and great uncertainties. The downside risks that come with Chapter 11 for GM or Ford look potentially huge.
The danger lies partly in the uncertainties that come with a car company being in Ch 11 – and the risks are overwhelmingly on the downside.
Would you buy a car off a car company that had gone bust? How’s the warranty? As core brand values go, it kind of sucks. American consumers are a savvy lot, brand loyalty less a factor than elsewhere. The perception gap isn’t a good starting point. Detroit’s offerings could quickly lose all credibility in this scenario, a lame duck projection forcing a rapid and accelerating slide into the abyss.
The sums being talked about for Detroit’s bridging finance look pretty low when seen in the context of what has already been approved for the US federal financial sector bailout and the risks that come with the alternative.
Should taxpayers’ support be opposed as a matter of principle so that the free market can sort things out untrammelled? Don’t be daft. Look at what has gone on with the banks (to the tune of a US$700bn federal bailout package that attracted far less debate). Governments already intervene in the workings of the economy. They react to recessions with a mixture of fiscal and monetary policy to mitigate their negative impact on jobs and economic activity. That’s in everyone’s interests and that’s when governments need to act: when a course of action is in the country’s interests. This is one such case.
And here’s a lesson from history for those who say government should steer clear. In Europe, Fiat and Renault have enjoyed plenty of state support to keep them in business during hard times in the past. The patient was very sick in the 1970s and 1980s. Without support, it might well have died. End of story. With the support, the patient stayed in business and went on to recover and eventually become fit and healthy. Fiat and Renault are success stories today.
I am not arguing for massive state support, but selective measures like these loans could end up looking very, very significant to future industrial historians. GM and Ford have enough about them to get over this storm and be successful in the long run, if they are permitted to get through the temporary storm that will be 2009 (and an unknown slice of 2010).
The Detroit Three viability plans have to show credibility. They need to amount to a roadmap for getting to where Detroit needs to be, but without the Chapter 11 process. Then it comes down to whether the people running the Detroit show (yes, including UAW chief Ron Gettelfinger) can be trusted to follow through. It is surely worth the relatively small sums we are talking about to give that a shot. These are exceptional times and no one can be in any doubt that next year will be brutal, whatever happens.
The provision of bridging finance allied to thought through company business plans offers the best chance of getting through next year and into 2010 in some sort of reasonable shape. Chapter 11 risks making things very much worse.