Shuttting Detroit Down

Once upon a time, not so long ago, in a city at the heart of the American continent, General Motors produced cars, like Pontiac’s “Little GTO,” celebrated in Beach Boys songs that captured the thrill of driving Detroit’s latest creations. Today, as GM struggles to appease the government’s auditors just to stay alive, Kris Kristofferson, with a little help from Mickey Rourke, curses the financial wizards from Wall Street that are “Shutting Detroit Down” while “livin’ it up in that New York town.”


Never has the inherent tension between the investor class and the country’s manufacturing sector been more pronounced or the stakes in this particular poker game higher for the future of America. Chrysler may have been forced into bankruptcy first, but it’s GM's downfall that represents the true mid-American earthquake.

Back in the late 1950s, General Motors so dominated the American automobile market that its corporate goals were focused on achieving a 60% market share. The hubris of its executives led them to decide to pick up more and more costs for medical insurance, pensions and retiree benefits, beginning GM’s slide down a slippery slope of poor financial performance

This posed a huge but not initially recognized risk to GM. By taking on these obligations that didn't show up as a cost or balance-sheet liability until the government changed its accounting rules in 1992 and required companies to show the cost of “other post-employment benefits” (OPEB) on their books, General Motors lit a ticking time bomb that has now exploded in its face. In 1972, as GM came the closest it would ever come to achieving its sixty-percent market share goal, GM was paying the entire health insurance bill for its employees, survivors and retirees, and had agreed to "30 and out" early retirement that granted workers full pensions after 30 years on the job, regardless of age. Its world then began to come apart.

In 1973, OPEC’s embargo tripled the price of oil. GM failed to respond quickly enough to the consumer’s sudden demand for fuel-efficient cars. At the same time, the Japanese with their then superior, lean manufacturing techniques stepped into the vacuum, gaining a foothold in the North American car market that they have continued to expand. Ironically, thirty years later the very same inability to shift product offerings during a spike in oil prices precipitated GM’s current difficulties.

GM’s reluctance to go green is often cited by its new government owners as the reason it’s in so much trouble now, but the crux of GM’s problems really go back to those heady days of market domination and financial profligacy.

In the 1960s GM’s annual operating margin (profits divided by revenues) averaged 8.7%. The turmoil of the seventies and the pressure from Japanese competition drove those average margins down to 5.5%. Margins fell by about half to an average of 3% in the 1980s, and about half again to 1.3% in the 1990s (not counting the $20 billion hit GM took when the new accounting rules for OPEB took effect.) Finally, in this decade the slide has actually taken the company into an average of negative margins. Now only the government’s suggested radical restructuring seems to offer a way to stop the bleeding.

It is estimated that the cost of OPEB, essentially GM’s retiree pension and health care programs, have cost the company about $7 billion each year since 1993 and are probably around $10 billion per year now. The bargain auto company management made back in the 60s with labor to provide generous off the balance sheet benefits has now become an albatross that threatens the manufacturing jobs for the Big Three’s own current workers and suppliers across the Midwest. It’s the kind of problem only government can solve.

But the Obama Administration’s early efforts to do so have been far from promising. First it selected Steve Rattner as its “car czar”, a politically well-connected private equity investor and turnaround artist from “that New York town,” someone with no significant automobile industry experience. In addition, the government's demands that GM dismantle more brands and shut down more dealerships suggests the process may get a lot uglier by the May 31 decision deadline.

Luckily the United Auto Workers remain on watch to try to ensure that whatever concessions are demanded of GM’s current and retired employees reflect an equitable shared sacrifice with the company’s bondholders and investors. The kind of GM that emerges from these negotiations will have a huge impact on these workers and on the many industrial towns that depend on the car business for their basic existence.

Ultimately, the decision on how best to “rescue” GM may turn out to be the most difficult call President Obama will make in his first year in office. He will be pulled by pressures from the green gentry left to force GM’s future products to conform to a pre-determined environmental agenda. He also will face predictable Republican calls to let the market work its will, even if it means the end of the company.

President Obama will need the wisdom of Solomon to recognize that today’s workers no more deserve to be punished for the mistakes of prior management than CIA agents do for carrying out the orders of their equally arrogant Republican counselors during George W. Bush's administration. To paraphrase the President’s words, it’s “time to move on” and offer GM the support it needs to “Catch a Wave” and start producing more “Good Vibrations” for America’s hard pressed, but still very critical manufacturing sector.

Millinnials Hold the Key to the Auto Industry's Future

As the announcement of Rick Wagoner’s resignation as CEO of General Motors makes clear, the enormous investments the federal government has been making in private enterprises, including the auto industry, will severely test the ability of private sector executives to meet the expectations of their new government bosses. The long-term credibility of Detroit now rests on their ability to win over the rising generation of Millennials, born between 1982 and 2003, who are the future consumers for the auto industry—and the core of President Obama’s political support. Their environmental focus and civic minded attitudes will challenge executives to align their private sector goals with public policy in ways the country has not witnessed since the New Deal. Sadly, so far, it’s a test many business leaders seem likely to fail.
In the case of the American auto industry this failure has deep roots. Attempts to nudge Detroit into producing more fuel-efficient vehicles have been going on since the 1973-4 Arab Oil embargo, which led Congress to establish Corporate Average Fuel Efficiency (CAFÉ) standards for cars and light trucks. When Bill Clinton became President he agreed to delay the adoption of higher CAFÉ standards until it could be proven that such goals were attainable.
This formulation opened the door for what came to be known as the Partnership for a New Generation of Vehicles or PNGV. Reluctantly supported by the Big Three, PNGV provided approximately a quarter of a billion dollars in government research funds to demonstrate the feasibility of producing a midsize sedan that could get 80 mpg. Often called “the moon shot of the 90s,” each car company was to make a prototype of such a vehicle by the politically convenient year of 2000 and begin mass production by 2004, another presidential election year.
Vice President Gore, who had been in charge of the PNGV program since its inception, met personally with the Big Three CEOs from 1998-2000 to make sure they did not forget their past commitments to build an environmentally friendly family sedan. But the answer from many in Detroit was emphatic: profits were coming from SUVs and heavy-duty trucks, not cars. When Gore suggested they deploy a 60 mpg hybrid passenger sedan in 2002 rather than waiting for an 80 mpg version in 2004. Ford’s Peter Pestillo and his UAW ally, Steve Yokich, quickly replied, “no way.” Pestillo maintained, “We need much more time than that to make them cost competitive.
Not all executives were blind to the challenge. General Motors’ Vice-Chairman, Harry Pearce had been the driving force behind GM’s ill-fated EV1 electric car experiment. Despite a bout with leukemia that took him out of consideration for CEO of the company, he and his allies within GM had a powerful influence on the company's CEO, Jack Smith, and a powerful ally at Ford in the Chairman of its Board of Directors, William Clay “Bill” Ford, Jr., great grandson of the company’s founder.
Unfortunately for America, General Motors decided to go in the opposite direction. Rich Wagoner, who became the company’s ' CEO in June 2000, embarked upon an SUV-centered strategy that won GM big profits for a brief period. Since then, however, GM’s stock has plunged 95%, from more than $60 per share to less than $4 in 2009. General Motors, which lost $70 billion since 2005, has seen its market share cut in half. Seven years after the Bush administration basically abandoned the PNGV program, when asked what decision he most regretted, Wagoner told Motor Trend magazine, “ending the EV1 electric car program and not putting the right resources into PNGV. It didn’t affect profitability but it did affect image.” [emphasis added]
Having failed to embrace a public partnership with a sympathetic government, Wagoner was forced to beg for a federal bailout with onerous conditions to avoid bankruptcy. Ironically, he learned this past weekend that the price for such government support would be his resignation as CEO.
Had the auto industry taken Gore’s lead a decade ago and built a positive image among the very environmentally conscious Millennial Generation, it might have built a constituency to support the government’s assistance. Instead, the companies’ brands, particularly GM’s, have taken such a beating that the President-elect recently reminded the car companies that “the American people’s patience is wearing thin.” In contrast to young Baby Boomers buying songs by the Beach Boys celebrating the Motor City’s products, the country seems ready to drive their “Chevy to the levee” and tell the company “the levee is dry.”
But that is not the right answer. Millennials bring not only an acute environmental consciousness to the country’s political debate, but a desire for pragmatic solutions to the nation’s problems that promote economic equality and opportunity. To secure their support, however, the domestic automobile industry has to be seen as a contributor in ending America’s dependence on foreign oil and improving our environment. Not only would such an approach assure the industry’s future profitability, it would also remake its image in a way that will appeal to the next generation of customers, Millennials, and the politicians they support.