Government Motors

Posted on June 23, 2009 by Ben Connard 

General Motors filed for bankruptcy and Chrysler has emerged from bankruptcy.Both hope to become stronger and leaner companies.They may emerge as stronger and leaner, but given today’s automotive market, can they make money?

Both GM and Chrysler can make quality cars.After decades of trailing Japanese standards of quality and efficiency, domestic automakers have largely caught up.GM’s market share even went up in 2007.The Chevy Malibu, Cadillac CTS and Buick Enclave are all extremely popular cars.GM’s hybrid Chevy Bolt (scheduled for a 2010 launch) is supposed to be superior to Toyota’s Prius.Overseas, GM does extremely well, accounting for 65% of its sales.Its Latin American presence is strong and has a leading market share in China at 12%.

The real question is whether GM and Chrysler can make those quality cars at a profit.Many blame GM’s downfall on their contracts with the United Auto Workers.The reality is GM used to have an added cost of $1,400 for each car due to its health-care promises to employees.This was reduced after a 2007 agreement which shifted the liabilities into a union run trust.New hirers also earn wages in line with Toyota and Honda’s US factories.Despite this reduction, GM still fell into bankruptcy.

GM will continue to have liabilities to the union at a rate of $600 million per year in preferred stock dividends.This should be about $300 per car if GM hits its market share goal of 2 million cars domestically.The cost per care is less if it gains more share.And retirees are also being replaced by less expensive labor with compensation to match GM’s competitors.

GM can no longer use its labor structure as an excuse.There still is a brand problem for the companies.Growing up in the 1980s, I learned that Toyotas will last forever while a Chevy will fall apart after a couple years.While the quality gap has been closed, the perception is still there—Toyota cars sell for $3,000 to $10,000 more per similar size car to GM.In addition, consumers are aware that many Toyotas, Hondas and Mercedes are actually manufactured in the South, so the foreign/domestic line is blurred.If a consumer wants to buy American, Ford may be the target anyway as they avoided a bailout.

And while GM and Chrysler go through their restructuring, competitors are taking advantage.Volkswagen is building a new factory to churn out 250,000 cars year and aims to triple its market share from 2% to 6% by 2018.It should be noted that while this is bad for GM and Chrysler, it’s actually good for autoworkers as their expertise will be needed in any new plants opening in the US.

The added competition means GM and Chrysler are going to be in a dogfight for market share.Can they make money in today’s car market?GM’s plan calls for them to breakeven when the domestic market is selling 10 million cars per year (it’s currently at 9.5 million) and their market share is about 18.5% (vs. their current share of 19.5%).This is how the $300 pension liability is calculated as their 18.5% market share translates to about 2 million cars.Some of the estimates might be a little optimistic.The 10 million is high in today’s economic climate.Their market share may fall further as people avoid buying from a company in bankruptcy.And any fall in sales increases their pension liability per car, making it even harder to break even.

GM and Chrysler have other issues.GM’s pension is underfunded by $13 billion.If the companies return to the private sector, as intended, their cost of borrowing will be affected by the bankruptcy.Secured creditors were jumped in line by unsecured creditors (the UAW) during the bankruptcy proceedings, upsetting bankruptcy laws.An Indiana pensions fund representing teachers and police officers challenged this result.The US Supreme Court declined to hear the challenge, but the proceedings will make future lenders warier.

At the end of the day, the real problem is the dichotomy between the world’s annual manufacturing capacity (90 million cars) and the world’s annual car demand (60 million in good times).Long term, the demand for cars will exist as emerging markets grow and citizens’ increase their purchasing power.The IMF forecasts the number of cars worldwide in 2050 will be 3 billion, more than four times the current rate of 700 million.However, in the short term we are clearly making too many cars.

GM and Chrysler recognize this and included cutbacks in factories, workers and dealerships in their bankruptcy plans.This is a necessary step and should be done in the most efficient manner—i.e. closing the most out-dated manufacturing facilities and the least profitable dealerships.The government is already interfering with these needed steps.Senators questioned the closures in their states on June 3rd; Senator Mel Martinez asked “what rhyme or reason is there to this?”The debates will only slow GM and Chrysler’s recovery.

Of course, even if GM and Chrysler cut capacity, the competition doesn’t have to follow suit.Other governments are supporting their car companies.Germany has already stated its manufacturers will not shutter factories in face of a decline.

At the end of the day, there are too many car manufacturers fighting over too small a pie. This is a fundamental problem for all car manufacturers.GM and Chrysler may be the weakest and therefore the first to face bankruptcy, but at the end of the day capacity must be trimmed.  Until then, making money is going to be hard, especially for GM and Chrysler.