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Troubled automaker faces fight for its life

Throughout its nearly 100 years of existence, General Motors has been an icon of business. "What's good for GM is good for the country" -- a loose paraphrase of a statement made 50 years ago by a GM president -- has come to summarize for many the pervasive role of corporations in America. Yet the icon appears to be crumbling. Standard and Poor's downgraded the company's credit rating in May, first quarter losses were huge, and the company recently announced the layoff of 25,000 employees. W. P. Carey experts look under the hood to comment on problems that stretch deep into GM's supply chain.

2005-08-03

It's no mystery where most of General Motors' financial hemorrhaging originates: GM North America. When GM released its 2005 first quarter earnings in April, GM Latin America/Africa/Mid-East had increased net income; GM Asia Pacific's net income had fallen but it still posted a profit; and GM Europe had trimmed losses. GM North America, on the other hand, had lost $1.3 billion after earning $401 million a year earlier.

In June, GM Chairman and CEO Rick Wagoner announced that the company would slash 25,000 jobs in North America by 2008, close an unspecified number of plants and undertake several other actions in order to cut costs by $2.5 billion.

Soon, industry watchers, pundits and shareholders were asking what was wrong with GM. The obvious answer is declining sales. But exacerbating the sales decline, according to experts at the W.P. Carey School of Business, are deeply rooted problems in the company's supply chain management, specifically its health-care costs, production redundancies and supplier relationships.

Health care in the supply chain

While people first think of auto parts manufacturers as being General Motors' largest suppliers, Thomas Choi, a professor of supply chain management at the W. P. Carey School of Business who has studied GM, said health-care providers actually represent the largest supplier in terms of dollars spent. The automaker provides more than a million current and former employees and their families with health care at an estimated cost of between $5 billion and $6 billion a year. While addressing shareholders in June, Wagoner said health care added $1,500 to the cost of each GM vehicle, representing "a significant disadvantage versus our foreign-based competitors."

Long-term contracts with the United Auto Workers union that are rich in benefits are one reason why GM's health-care costs -- indeed, those of Ford Motor Company and DaimlerChrysler as well -- are higher than those of foreign competitors. Wagoner said GM would work to renegotiate those contracts in an effort to bring health-care costs down. The current contract, however, does not end until 2007, and so far union leaders have not sent out any public signals that they are willing to negotiate any major changes. As formidable as are the union contracts, the skyrocketing cost of health care is an even more daunting obstacle because neither the company nor the union can easily control it.

"[Automakers] have been struggling to control their health-care costs with quite a number of strategies, including some that brought them periods of relief in the 1990s," said Bradford Kirkman-Liff, a professor in the School of Health Management and Policy at the W. P. Carey School. "But unfortunately, there was a lot of reaction to the efforts involving the use of managed care and health maintenance organizations, so they moved away from those plans."

Between 2000 and 2003, when automakers were loosening restrictions on health plans, the rate of inflation in health-care costs increased. In 2004 there was a slight decline in the rate of inflation, and there are indications that the pace is moderating this year. Still, health care remains a major cost expenditure for GM and other American automakers.

"It's a major problem, and these firms are going to have to address it -- probably with a reduction in benefits," Kirkman-Liff said.

That means working with the unions, particularly the UAW. When GM first announced that it would seek to renegotiate benefits in union contracts, it appeared that the automaker was going to take its turn locking horns with the UAW. Choi said that historically, one of the Big Three goes to battle with the UAW and whatever deal is hammered out is accepted by the other two carmakers. Whether or not that's the case now, there's no doubt that GM has to cut its health-care costs, either with the help of the unions or by taking drastic steps.

One of those steps might be to declare bankruptcy. Many experts in the field have dismissed the notion of GM filing for Chapter 11, but others like Kirkman-Liff don't find the notion so farfetched. He points to the airline industry, where carriers have gained some key concessions from unions by filing or threatening to file for bankruptcy. GM also may take another page from the airline industry's playbook and say that unless it cuts health-care costs it will not be able to fund its long-term employee pension plans.  

"Another thing that might happen is that they could just simply announce to their union that they are dropping all prescription drug coverage for retirees, because starting in 2006 all retirees will be eligible for prescription drug coverage under Medicare," Kirkman-Liff added. "If you look at the most recent reports, it looks like the Medicare prescription drug coverage may likely be more generous than what General Motors is currently providing to their beneficiaries."

A gridlock of brands

While reducing health-care costs is clearly a top focus for GM, it's not the only trouble spot for the ailing automaker. In terms of its product offerings, GM has attempted to be all things to all people. While pushing the competition out of limited shelf space in the supermarket may work for a soft drink company, it can be disastrous for a carmaker.

M. Johnny Rungtusanatham, associate professor of supply chain management at the W. P. Carey School, has looked at GM's product offerings. Each of the GM brands sold in the U.S. offers a variety of body types, bringing the total number of product offerings (i.e., brand X body types) under the GM umbrella to at least 85. Of those 85, 30 types of SUVs can be found among the various brands. GM's product offering could be described as excessive, but it isn't the only carmaker offering numerous models. Rungtusanatham points out that the Ford brand encompasses Ford, Lincoln-Mercury and Mazda -- of which it owns a part. Ford also makes Volvo, Jaguar, Land Rover and Aston Martin.

"The history of General Motors has been shaped by the absorption and incorporation of other automobile companies, and in the process, rather than kill off competing product lines, it tried to maintain them across brands," Rungtusanatham said. Without effective coordination, such proliferation may well lead to unnecessary duplication of fixed and variable resources. "Had GM been more attentive to how it was proliferating its product offerings, perhaps, it would not be in as drastic a cost-cutting mode today," he said.

GM is very much aware of the situation. In addressing its shareholders, Wagoner announced that the company would be "clarifying and focusing the role of each of our eight brands, giving them distinctive, clear, compelling roles in the GM portfolio."  He went on to say that Chevrolet and Cadillac would maintain their full line of product offerings, while GMC, Pontiac, Buick, Saturn, Saab and Hummer will target their offerings to niche markets.

Auto industry analyst Bob Parker, vice president of research for Manufacturing Insights in Boston, said brand proliferation and the redundancy it brings are more endemic to the North American automakers than to their foreign competitors.

"[Foreign carmakers] have been able to do a better job of being a little more flexible in their manufacturing plants," he said. "Even though they have multiple models, they have been able to shift capacity and supply to what is selling. GM has had more difficulty with that because it is very hard for them to shut down a plant because of the somewhat onerous union contracts that they locked themselves into. They don't have a lot of flexibility in shifting that kind of stuff."

Efforts by carmakers to bring commonality among brands in order to streamline production costs have mostly failed. Parker points to an example from Ford that he says typifies Big Three operations. Ford decided to build a new Mustang on the Mazda Six platform so it could get reusability of tooling and common parts. But the engineers in Detroit said the Mustang needed a slightly different platform, which immediately cut 30 percent of the common benefits of using the Mazda platform.

Multiple brands also locks in GM on the dealership end of the business, Parker said. The company has dealership agreements that contain stiff penalties for brand elimination.

Suppliers feel the squeeze

"They end up in brand jail both on the demand side and the supply side," he said. "And in typical automotive industry fashion, they decide they will take it out on their suppliers. They do a lousy job of forecasting, they overbuild products with no commonality -- which puts them in contention with suppliers. Then they have to get rid of inventory and sell at cost or below to turn that inventory into cash, and they lose a billion dollars."

GM's efforts to clear inventory have been good for consumers. After 9/11, GM instituted interest-free financing or cash back. Then the company offered interest-free financing and cash back. In June, Wagoner announced that GM would offer customers the sweet discounts normally reserved for employees.

"When General Motors instituted this [interest-free] marketing ploy, people who had not planned to buy for two more years went out and bought the car right then," Choi said. "In essence, GM is creating fictitious demand by borrowing from their future demand."

The company sold a lot of cars but didn't make much money, Choi said. Nevertheless, the company ramped up to make even more cars. "Suppliers are thinking, 'Good times are here. We're selling cars,'" he added.

But the suppliers end up losing money because the automakers make up losses on the supply side. The pain is even more acute because of the tangled relationships that have developed over the decade between suppliers and automakers. During that time, both General Motors and Ford pared down their operations by outsourcing, while at the same time cutting back the number of suppliers. As a result, the mutual dependency between the automakers and their suppliers deepened.

 

Because of that mutual dependency, Parker said automakers need to do a better job with product life-cycle planning as they introduce new products into the supply chain. He also said they need to improve their ability to reuse components so they can give the supplier volumes they can make money on.

"They need to emulate the [foreign carmakers] in terms of working with the suppliers to take cost out of the product and let the suppliers save some of those costs," he said. There already are examples of how U.S. carmakers can benefit from emulating the closer relationships foreign automakers have built with their suppliers, such as the keiretsu system Toyota worked out with American managers and workers at the New United Motor Manufacturing Inc. (NUMMI) facility in Freemont, Calif.

In the coming months and years as GM attempts to transform itself into a leaner, profitable company, experts warn that it will have to make tough -– and wise -– decisions in order to survive. One shrewd and successful marketing strategy was the recent announcement that it would offer its employee discount program to the general public. The program was launched last month and has been extended to Aug. 1.

The marketing campaign, which could put a squeeze on profit margins across the industry, drove GM's U.S. sales up 41 percent in June, making it the company's best sales month in 19 years.

Regardless, experts say General Motors must accept the fact that gone are the days when it thrived by being a corporate behemoth with thousands of plants, millions of workers and dozens of products. That time in GM's storied history is over.

"There used to be a saying: 'What's good for General Motors is good for the country,'" Kirkman-Liff said. "GM was seen a bellwether company, but that's no longer the case."

Management