Sunday, November 16, 2008

Bankruptcy, Bailouts, and the Detroit 3

This originated as a comment at CalculatedRisk. I felt most people had a rather incomplete view of the issues surrounding the American auto industry, so I tried to pull everything together. What follows is an updated version of the original comment. (I may update it further.)

1. While GM, F, and C differ in some details, they basically have the same set of problems and have shared them for a while. The decline has been going on for about 30-35 years for the big 3 as a whole.

2. The decline of the Detroit 3 has been primarily a management failure.

  • The Detroit 3 management teams were slow to adapt their products to higher oil prices in the 1970s, higher build quality imports in the 1980s, better driving imports in the 1990s, and higher oil prices (again) in the 2000s.
  • Failure to close the build quality gap (though overall reliability has improved) has been particularly damaging to the perception of Detroit 3 vehicles in the eyes of American consumers. However, the Detroit 3 have either claimed bias in the statistics or that the issue doesn't matter much to consumers.
  • The Detroit 3 have spent a lot of time declaring Americans won't buy certain types of vehicles despite the fact foreign brands were increasing their market share by building those very vehicles.
  • The Detroit 3 have not regularly improved their vehicles with each product cycle, but instead have alternated between clean sheet "home-runs" and leaving models to rot.
  • All of the Detroit 3 have been profitable at various times during the overall decline, so cash has been available to increase product and process development.
  • The Detroit 3 have not been able to fully integrate lean/JIT/whatever methodologies into their supply chains and company-owned factories and thus have somewhat higher front-line manufacturing costs on average – but the difference is not overwhelming.
  • As the profits from vehicles fell, the Detroit 3 turned more and more to financing to make money, instead of doubling down on product and process engineering.
  • Oddly enough, the wholly-owned subsidiaries of GM and F in Europe have been much more responsive and innovative, so it has been a failure of the North American management teams specifically (C is almost exclusively a NA operation)
  • The Detroit 3 have refused to lead the charge on a national healthcare system in the US even though they support the same thing Canada and would benefit tremendously by being able to unload current and legacy healthcare costs in the US.

3. The Detroit 3 have been stuck with too many dealers due to state franchising agreements. These restrictions make reducing brands - and the associated badge engineering and marketing costs - very difficult and expensive. This issue affects GM the most.

4. Unions share some blame, but are far from the primary culprits.

  • Older workers have good pay and current healthcare benefits, but the two-tier system means new workers are paid roughly the same as the transplants - which aren't paid that much less than current workers.
  • The unions have in fact made many concessions over the years and those might have “saved” the companies at various stages if management had improved and stabilized market share with better products.
  • The UAW's biggest contribution to the Detroit 3 downfall was being very inflexible on work rules.
  • The jobs bank has not made sense since the mid-1980s and the union should have let it die.
  • There is and will continue to be large number of retirees compared to current workers related to each company due to the declining market share of the Detroit 3. Past union contracts currently add large overhead costs to each car, but most of that overhead will go away in 2011.
  • Some of the pension plans have been “fully funded” at times, but the Detroit 3 choose to raid the extra money instead of offloading the plans onto the unions or leaving the money in the funds.
  • Workers in other major auto-producing nations (JP, KR, DE, FR, IT) are heavily unionized (though the union-management interaction is very different) and have good pay (except KR, where labor is still signficantly cheaper).
  • Neither management or the unions have ever been able to get beyond the tradition of labor-management distrust that exists in America (and less so in other big auto-producing countries).

5. A bankruptcy is fraught with problems.

  • A bankruptcy poisons the brands and potentially drives away sales for years, especially if it drags on. This is a hotly debated and very critical point. The Detroit 3 cite (potentially biased) consumer research; opponents point to the recovery of bankrupt airlines to support their argument.
  • A bankruptcy by one of the Detroit 3 throws the supply chain for all into dis-array (including that of the transplants) and potentially takes down the other two.
  • Due to the credit crisis, the Detroit 3 are unlikely to get private DIP (debtor in possession) financing to use during a reorganization period.
  • Because of the 2005 bankruptcy bill, that the Detroit 3 could survive intact is questionable even if the CH11 was widely supported by creditors.
  • Potentially there are $1T+ in related credit default swaps (CDS) (the exact amount is unknown because CDS are not publicly trade) means a bankruptcy could trigger a major “event” for in the financial system.

6. The auto industry remains important.

  • Despite their decline, the Detroit 3 currently directly employ 200,000-300,000 people in the US.
  • Many of the white-collar jobs are high-value added, and keeping those jobs in the US is good for all Americans.
  • The supply chain and other related industries currently employ several million people in the US.
  • The auto industry has driven innovation in a range of other industries - metallurgy, paint, glass, rubber, electronics, plastics, and robotics.
  • When the Detroit 3 have been profitable, the profits have gone mostly to Americans.

7. The barriers to entry for the industry in the very competitive G7 markets are tremendously high (probably exceeded only by the large aircraft and microprocessor industries), and if the companies and their headquarters were to go away, most of the best jobs would be unlikely to return.

The issues listed above lead me to the following conclusions:

  1. There should be a bailout.
  2. Any bailout will have to be done without a formal bankruptcy, but the US government should end up the sole owner (temporarily) due to the amount of money a bailout would involve.
  3. Any bailout should require that several layers of the current management teams at GM and C ultimately be fired or put through fire/rehire wringer. (Mulallay seems to have righted the F corporate structure).
  4. Any "bailout" that doesn't fully address any lingering healthcare issue will just delaying the inevitable. Pensions obligations are less onerous, but should be addressed as well. The UAW will have to compromise here on both.
  5. Any bailout should include a way to shed as many dealers as necessary.
  6. Any bailout should require that the headquarters of one of the survivors be moved at least 4 hours from Detroit so the Detroit 3 groupthink is destroyed forever (4 hours is roughly the driving time to Chicago, Indianapolis, Cincinnati, Pittsburgh, or Buffalo via the Canadian auto plant corridor).

An alternative would be a "pre-packaged" bankruptcy with government-provided DIP financing. However, there would be thousands of creditors to deal with so this could be difficult to arrange. I think government strong-arming would be required to get it done.

If all this sounds like industrial policy to you, it is. But all of the other major auto producing countries have active industrial policies, and the results can be seen rolling up and down the streets in every American city.

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