GM Bankruptcy Part III: Why GM Failed

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Comments: 3

Tag: GM, General Motors, John Smale, Roger Smith, Jack Smith, Wagoner, Henderson, Bankruptcy, Brand Management

June 16, 2009

“You never want a serious crisis to go to waste.”
 
White House Chief of Staff to President Obama, Rahm Emanuel

As I wrote in part two in this series of articles on the GM bankruptcy, the reality of GM’s problems are complex and deeply rooted.  Technically, GM failed late last year because it was insolvent.  For the past five months, until formally filing for bankruptcy this month, the company survived on $20 billion of emergency Federal loans.  This article will address a number of factors that lead to GM's failure. 

Discussion will first cover the technical unraveling of the company’s balance sheet as well as some of the more systemic problems at the company over the years.  What will be presented is the global recession starting in the 4th Quarter 2007 overwhelmed the company as revenue declined sharply draining cash reserves.  A poor balance sheet going into the financial crisis created a scenario that undermined its business plan and shortly lead to insolvency.  However, even though the company’s liquidity position was negative most of the decade, if not for the sudden global economic problems, GM’s financial situation was being managed fairly well.  Historical data will be presented illustrating GM’s financial state leading into the economic crisis.

GM’s mismanagement over the past 30 years is legendary and very well documented.  During that time, nothing has suffered more than the product and the once distinguished brands under the company’s umbrella.  In 2005, GM Vice Chairman Bob Lutz went as far as to publicaly call Buick and Pontiac “damage brands.  I will add to Lutz’s statement that by the time he came on board in 2001, all of the company’s North American brands were either damaged or severely tarnished by years of neglect.  This article will also address how that came to be.

The Balance Sheet

GM management understood they could have cash flow problems when
company made the decision to undertake a significant restructuring in 2005.  The company pulled ahead the launch of its GMT-900 SUV and pickups to give them time after the earlier car launches were not successful and did not improve the profit picture. The company needed to leverage the high margins on these vehicles to maintain cash flow while the company reduced its footprint in North America (GMNA).

As Figure 1 illustrates, starting in the 1st Quarter 2007, revenue at GM began to improve with the launch of the GMT-900 SUVs.  For 2007 GMNA generated $112 billion in revenue, a 3% increase over 2006 as sales fell 6% from 4.1 million vehicles in 2006 to 3.8 million in 2007.  GM’s revenue in 2007 was comparable to 2004 levels and improved 6% over 2005 at the start of the restructuring effort.  Much of the sales increase is a direct result of the GMT-900 launch.  Excluding 2008, revenue was improving at all the operating regions.  However, total automotive revenue fell 16% to $159 billion in 2008 compared to the previous year's result of $189 billion.  In 2008 GMNA revenue fell 23% or $26 billion, which accounted for almost all of consolidated automotive group's drop.  The company had strong revenue growth up until the market fell apart in the US last year. 

 Figure 1:  Automotive Revenue by Region

It is also apparent from Figure 2, the company improved the revenue with its newer products.  The graph reflects gross revenue minus incentives.  Since early 2000 through the 4th Quarter 2007, GMNA increased the revenue per unit by just over 20% including incentives.  GM's revenue per unit began to increase significantly in early 2007 with the launch of the GMT-900s.  By the end of the 2nd Quarter, revenue dropped 17% per vehicle.  Incentives increased by about $500 on average over the previous year but the real impact was on the decline of the high profit GMT-900 line of trucks as fuel prices soared in 2008.

During the first half of 2008, as fuel prices increased, truck sales slowed across the industry.  In the first six months of the year, GM’s truck sales across the board were down 22%, including the high profit margin fullsize pickups and SUVs such as the Cadillac Escalade and Chevrolet Tahoe.  Car sales were also down 8%.  However, corporate sales at Toyota, Honda, Nissan and Hyundai were stable or increased over that same time period.  Toyota saw cars sales at its Toyota, Lexus and Scion brands drop 2.5%.  Honda, Nissan and Hyundai’s company sales rose 14%, 5.3% and 14% respectively as customers transitioned from trucks and SUVs to more fuel-efficient passenger cars.  At the time it appeared GM truck buyers left for Japanese and Korean passenger cars in droves. However GM’s new Malibu, CTS and even the Cobalt did well as sales were up 31%, 33% and 18%.  Except for a few select newer vehicles, buyers stayed away from GM as the competition picked up car sales.

The facts of the matter are, GM’s US operations survived for the better part of 15 years on the success of its full size pickup trucks and SUVs.  In 1995, GM sold approximately one million vehicles in this market segment out of a total of 4.8 million sales.  Ten years later, the company was selling 1.4 million a year out of 4.5 million.

The sharp drop in GMNA revenue and revenue per unit in 2008, illustrates how dependent the company was on the GMT-900s to generate positive cash flow.  

Figure 2:  GMNA Revenue Per Vehicle

GM began to take on debt in the early 2000s to rectify its unfunded US pension liability.   At the end of 2002, the pension plan was unfunded by $19 billion. Starting in 2003 GM took on long-term unsecured debt to rectify the obligation.  GM had substantial cash to offset most of the new debt, however, its liquidity position began to deteriorate.  The company had a negative net liquidity of around $12 billion until the 1st Quarter of 2008.  During that same period, GM was also able to maintain a stable cash position of over $20 billion.  As Figure 3 shows, GM’s situations rapidly declined beginning in early 2008.  GM’s 2009 1st Quarter reflects the $13.4 billion in emergency Federal loans received at the beginning of the year.

The strain to fully fund the company's pension plan is apparent from the following excerpt for its 4th Quarter 2003 press release.  For additional information see GM's 3rd Quarter report.

GM generated more than $32 billion in cash in 2003, about three times the company's original target, including more than $10 billion in cash from automotive operations, as well as proceeds from non-core asset sales and global debt offerings.

GM's strong cash performance enabled the company to contribute a total of $18.5 billion to its U.S. pension plans and $3.3 billion to the Voluntary Employees' Beneficiary Associated (VEBA) Trust for retiree health-care benefits in 2003. As previously disclosed, GM contributed an additional $2.4 billion to the VEBA Trust in January 2004.

"These moves considerably strengthened our balance sheet, and enabled us to end the year with our combined U.S. hourly and salaried pension plans fully funded," Wagoner said. "This was a remarkable accomplishment considering that these plans were nearly $18 billion underfunded at the start of 2003."

According to GM's 2008 10K filing with the SEC, the company had $39.9 billion in loans payable and long-term outstanding debt for the automotive operations in addition to the $30 billion for the UAW healthcare agreement.  At the time the company filed for bankruptcy,
the company said it had $172.8 billion in debt and $82.2 billion in assets.

Figure 3:  Automotive Operations Liquidity

It is pretty clear going into 2008, the chance of GM filing for bankruptcy looked greater and greater.  In hindsight, the historical data also suggests that GM had a business plan based upon some very risky assumption including reasonably cheap fuel prices and a stable economy. 

The company took on excessive debt to fund their legal obligations with the union and retirees, however, through the sale of assets such as Allison Transmission, GMAC, Hughes etc., it was able to maintain a stable cash position up until the very end.  In order for GM to have survived the sudden drop off in sales without bankruptcy, GM would have had to have over $40 billion in cash on hand. 

GM bet the ranch when it launched the GMT-900 as it had no other viable options after the unsuccessful launch of a series of passenger cars earlier in the decade.  From the data presented it appears it was a reasonable business decision.  Figure 3 suggests the decision to move up the launch of these vehicles starting in late 2006 was valid and did help to significantly improve revenue.  However, they were not as successful as intended because of escalating fuel prices.  With fuel cost increasing, revenue from trucks slowed.  Unlike other auto companies GM could not gain traction in the market with its passenger cars to account for the lost revenue on trucks. 

And make no mistake about it, after GM emerges from Chapter 11, the current fullsize pickups and SUVs will continue to generate the cash flow to fund the restructuring of the company until a more balanced profitable portfolio of products can be released.  Today, these vehicles make up approximately 31% of GM’s sales (Jan-to-June 2009) and up 1% from last year.  According to Automotive New production data (ending May 30th), GMT-900 production was down 40% compared to GMNA's total production being down 50% in that same period.  Last year this time fullsize truck production accounted for 50% of GM total production in North American and today it is 64%.  If historic trends hold true, fullsize pickup truck sales/production will lead the recovery in the auto sector as the economy rebounds.  As I discussed in an earlier article (See
2009 US Auto Sales May Have Reached Bottom - Slow Recovery Expected), there are indications pickup truck sales as a segment are improving.

It also needs to be remembered, the 2005 Delphi bankruptcy cost GM $12.5 billion dollars since its filing.  Only now, three and a half years later, does that situation appear to be resolved.  It will cost New GM over $2 billion (subsidized by the US Treasury) to finance Delphi’s emergence from bankruptcy in addition to GM taking over some of Delphi’s plants. 

Mis-Brand Management

 The roots of GM problems date back to the 1960s.   The company’s dominance created a culture that was resistant to the realities of changing national mood as the federal government began to seriously meddle in GM’s business for the first time with safety, emission regulations and eventually fuel economy requirements.   Up until that time, the auto industry was for all practical purposes self regulating.  GM including the rest of the US industry had to rethink everything about their business.  That included how they designed and manufactured cars and the type of vehicles they were designing.  The two oil crises only added to the industry’s woes.  These sudden changes put the US auto industry into a tail spin and the economic recession in the early 1980s almost bankrupted both Ford and Chrysler. 

The auto industry quickly but not successfully as a whole shifted to unibody, front wheel drive vehicle with new engines incorporating new technology.  All of these changes at once caused horrific quality problems.  In the case of GM many of their products ended up looking alike by the mid-1980s because money was spent on the significant retooling of the company to meet the new government requirements.  Less effort was dedicated to brand differentiation

Since the US auto industry was dominated by the Detroit 3 for so long, their cost structure was set up according.  Most of auto production in the US was by union labor and the supply chain was a captured unit within the companies.  The efficiencies at the companies were also set up accordingly, for GM, Ford and Chrysler to compete with each other and not imports from Japan.  The company’s passed on their inefficiencies to the consumer because the fixed costs for the entire industry were the same.  However, that would change as these US companies lost market share and consumer taste shifted to small cars.

The US auto companies were blind sided by the sudden changes in the business environment. With the swift rise of the Japanese auto companies in the US market because of their fuel efficient small cars, the Big 3 lost their dominant position.  The US companies could not compete on price and quality.  Rectifying the cost structure has been a challenge ever since.  The end result was huge
philosophical changes to manufacturing and design that resulted in boring cars with poor quality.  For labor that meant a huge reduction in staff at the companies and significant outsourcing of production parts to suppliers.  GM eventually spun off its own internal supplier as Delphi in the late 1990s.  For instance, the city of Flint, sixty miles north of Detroit, GM once employed 79,000 people.  Today the company only employs approximately 8,000.  To keep peace with the union, GM and the other companies agreed to lucrative contracts for their remaining union employees.  Ultimately, this created the unsustainable legacy burden GM has had to grapple with for the better part of this decade.

The changing business environment and government oversight during the 1970s began to take its toll on the company.  Under Chairman and CEO Roger B. Smith, the company undertook it largest ever restructuring which arguably destroying the company in the process.  With Smith at the helm, the company’s market share declined from about 44% in 1981 to 34% by the time he stepped down in 1990 on relatively flat sales volume (Figure 4).  Suffice it to say, restructuring GM in the 1980s to improve efficiencies was an imperative but it was so poorly mis-managed it almost took the company down shortly after Smith retired (See Maryann Keller’s Rude Awakening and Albert Lee’s, Call Me Roger for additional insight into the Smith era).  Post Smith management has been trying to put the company back together ever since with varying degrees of success.

Figure 4: GM Sales and Market Share

I contend the real missed opportunity to fix the company's core auto operations dates back to the crisis in the early 1990s when GM again was close to bankruptcy.  Two years after Roger Smith retired, GM’s board of directors fired then Chairman and CEO Robert Stemple and installed long time board member John Smale as Chairman and John (Jack) Smith as CEO.   Smale served as Chairman of the board until stepping down from that position in 1996.  Jack Smith then took on the duties of Chairman.  In the shake-up Rick Wagoner became CFO.

Smale was instrumental in recruiting Ron Zarella in 1994 who was then president of Bausch & Lomb to instill in the auto company, mass consumer product marketing and business school principles.  GM at this time lacked a true market data and analysis division in the company, and it was thought this resulted in GM’s lackluster product.  The company’s approach to identifying needs in the market and designing vehicles accordingly lacked sophistication.

Zarella eventually would become president of GM ‘s North American operations.  Under Zarella the Brand Management marketing philosophy at the company was institutionalized.  Under his direction, each vehicle model would have a brand manager who was likely to have been hired from the disposable good industry with no automotive experience.  In practice GM de-emphasized its once strong divisional brands and focused instead on individual model nameplates.   The direct consequence was product that was designed for everyone eventually appealed to no one.   Paralysis by over analysis overrode instinctive design decisions eroding divisional brand character.

Brand Management failed to deliver and GM’s market share continued to decline.  Under the influence of both Smale and Zarella, market share dropped from 33% in 1994 when Ron Zarella was hired to 28% in 2002. Product launch, after product launch continued GM’s death spiral.  Zarella left GM in late 2001 to return Bausch & Lomb as CEO and Smale retired from the board in 2002.

Chairman and CEO John Smith and as of 1998 COO Rick Wagoner were more focused on structural issues at the company such as creating one North American operation and removing the fragmented divisional legacy structure.  Creating a structure based on commonality was Smith’s priority.  Smith was also focused on growing the business globally and entered into emerging markets such as China and Russia and solidified their position in Korea with the purchase of Daewoo’s assets.

Smale's oversight on the board, relegated GM insiders to restructuring the internal workings of the company and the product was outsourced to outsiders not familiar with the automotive business or the company's product problems.  

Rick Wagoner formally became CEO of GM in 2000.  In late 2001 Bob Lutz was personally recruited by Rick Wagoner and soon replaced Zarella as head of GM’s North American operations.  Shortly thereafter Wagoner and Lutz dismantled the Brand Management structure and brought product design over marketing back to the forefront.  However, the damage had already been done as many car products designed under the direction of Zarella’s Brand Management approach were too far along for Lutz to cancel or redesign.  It could be argued, Wagoner and Lutz's biggest mistake were not doing just that. But in reality and without hindsight, it was not practical.

The last products designed under Zarella were to be high volume mass appeal cars such as the midsized Pontiac Grand Prix, Buick Lacrosse, Saturn Ion, Chevrolet Malibu and  Pontiac G6.  When released to the market, all failed miserable and contributing greatly to GM’s eventual collapse.   Starting in 2000, GM released the Buick LaSabre, Pontiac Bonneville and Oldsmobile Aurora, just at the time when the market was shifting out of large cars into smaller crossovers and larger SUVs.  Only the LaSabre would live a full product cycle as the Pontiac and Olds were discontinued early. 

Specifically, Brand Management institutionalized poor planning and uninspiring product at the company.  I used to refer to GM’s product cycle as the death spiral.  By way of example, historically GM would plan to sell 500,000 for a new midsized Chevrolet sedan.  When the vehicle would go into production, it would not be accepted in the market for lack of appeal.  GM would only sell a fraction of the planned volume to retail customers which was instrumental in developing its business case for approval.    Because of restrictive labor agreements GM needed to keep the assembly plants running.  As a result, the company would end up selling the remaining planned volume at little to no profit to fleet customers such as rental car agencies.  The company would then cut advertising and increase incentives to control cost and try to retain retail penetration (no it does not make sense). The net effect would was reduced resale value for the retail customers at the time of trading in the vehicle for a new one.  At a certain point GM would hemorrhage money, layoff workers and eventually close plants and go through a painful restructuring.  Each cycle there would be hope the next round of product would stop the cycle but yet it would continue – product cycle after product cycle.  The pattern was most evident with their car lines.

In many ways GM did not get religion on reasonable product planning until the middle of this decade.  For example, in response to Chrysler’s successful entry into rear wheel drive sport/luxury cars with the Chrysler 300 and Dodge Charger, GM planned to introduce their own line of vehicle to capitalize on their apparent success.  On paper the 240,000 plus rear wheel drive fullsize passenger cars appeared to have been a huge success for Chrysler.  Early on in the planning, GM anticipated this new lineup of vehicles would account for over 400,000 sales a year.  This extensive program would build upon work being conducted by their Australian unit and replace many of GM’s mid and fullsize vehicles.

On the surface, the GM initiative made a lot of business sense.  The major engineering work was already underway at
GM’s Australian business unit, Holden and Chrysler had shown there was a substantial market in the US for these vehicles.   However, digging into the quality of the sales numbers reveals, 39% of the 125,000 Chrysler 300s and 49% of the 115,000 Dodge Charges were sold to fleets in 2007.

GM in time would rethink their plans for rear drive and cancel all but two at this point.  As of now only the new for 2010 Camaro would be released and built in GMNA.  The replacement for the Pontiac Grand Prix, the G8 was not built in the US but imported from Holden starting in 2008.  The volume of the new Pontiac G8 was consistent with the retail volume of the Grand Prix, at about 20,000 to 30,000 per year prior to the market collapse.  For the 2007 model year, approximately 80% of the 100,000 Pontiac Grand Prix went to fleet sales.  If not for the rethinking of the retail sales volume, GM could have tooled up for 100,000 Pontiac G8s in NA, and been fleeting 70% just like the Grand Prix, continuing the death spiral. GM wised up to the realities of the market and prevented a serious mistake.  Since the cancellation of this program, the company has been a lot more conservative in its planning estimates for new programs.

Poor product and planning during the 1980s through the early 2000s cost GM a generation of car buyers.  As all of this was going on, GM captured the fullsize SUV market based off their successful pickups.  To cover the huge legacy cost accumulated over many years GM capitalized on the success of their trucks and SUVs to generate cash flow. 

For many years GM’s biggest problem has always been their poor market acceptance of their cars.  It was not until than CEO Rick Wagoner brought in the legendary Bob Lutz to instill focus on the product in 2001.  It was at that time the transformation of GM began to really take place.  Wagoner with the help of his team specifically Lutz set out to undo years of mismanagement of the product.  Shortly after Lutz arrived, Wagoner was unshackled from the legacy of the 1992 boardroom coup.

GM’s relationship with its unions of course was instrumental it is downfall central.   During much of this time company was forced to restructure and become more efficient.  To get necessary concession from the union to downsize and cut labor the company GM continued to negotiate huge labor contracts resulting in a larger and larger legacy burden.  The end result is the company supports approximately one million retirees.  A burden derived from lost market share, improved efficiency and a shift to outsourcing much of its non-core manufacturing.  There is a reason why Delphi, the once captured auto parts supplier was spun off in the late 1990s.  Delphi entered bankruptcy in 2005 for many of the same reasons GM recently did as well.

Conclusion
I focused on a few key aspects of GM’s problems not generally discussed or well understood.  Moreover, the GM tragedy was a continuous function that happened over many years of poor management, poor planning and poor execution of the product.  For many years, GM failed the American consumer and by the time management tried to rectify the situation, it was too late.  The company’s balance sheet just was not manageable as the global economy quickly deteriorated. 

Brand Management failed to revive the company’s product which was needed right after the crisis in the early 1990s.  Brand Management missed the SUV craze early on and GM was late to market with crossovers.   Acknowledging that very early into his role as CEO Wagoner brought in Bob Lutz who undid many of the policies of Ron Zarella.  Until Zarella and Smale left the company, the political conditions were not right to fully rethink the product design and development process. 

If not for the current recession, the data suggests GM under Rick Wagoner had a good chance of finally turning the company around. However, Wagoner may have become the public face of all that was wrong with company.  The data presented certainly indicates the company was able to improve its revenue and restructure without resorting to more debt – that is until the economy eroded proving the plan flawed.  The company’s future also rests with the many structural changes he implemented prior the bankruptcy such as, consolidating the company’s global footprint, eliminating the multitude of divisions in NA and its strong push in emerging markets.  However, as it plans to soon emerge from bankruptcy GM's strongest assets are its soon to be released future product pipeline.  Current CEO Fritz Henderson also appears to be building upon initiatives begun under his predecessors except under a more aggressive schedule with deeper cuts.  Based upon early results, he seems to have the right balance as an agent of change and yet consistency to steer the company forward.

Ultimately, GM future success rests with its product and there is a good chance most if not all of the soon to be released cars and crossovers will be successful and profitable for the company.  The real test will come not with this generation of vehicles but with the next.  The questions GM needs to answer for all stakeholders are, can the company follow up year after year with solid product?  Were the philosophical changes implemented by Bob Lutz institutional or just fleeting and the company will revert to its old ways?  I contend it will take time for GM to alter the consumer’s perceptions of the company’s product if Lutz made the systemic cultural changes I believe he did.  GM lost a generation of buyers and it will take a couple generations of product to instill confidence again.  That will only be accomplished by consistently producing world-class products and nurture its remaining brands through continued investment. With its latest product, GM has shown it is capable of doing it but it needs to maintain that momentum.

Now it is up Henderson and his team to assure that this crisis was not wasted, and the company will follow through and build highly focused brands with intelligent world-class product.  GM squandered a great opportunity in the 1990s to remake itself.  The company became distracted by the latest "business school buzz"  with their foray into the disposable goods based Brand Management marketing philosophy.  In the end it
failed because it lost sight of what is important - the product.
 

 

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Comments
Wed Jun 17, 2009 12:37 am
Name: RETIRED | Comment: IF GM HAD TAKEN CARE OF ALL THEIR QUALITY PROBLEMS RESULTING FROM BUYING FROM THE LOWEST OF THE LOWEST BIDDER - THEY WOULD BE IN BETTER SHAPE TODAY.
iNTAKE MANIFOLD GASKETS MADE OUT OF TOILET PAPER HAVE COST GM BILLIONS AND BILLIONS AND BILLIONS OF LOST SALES AND CUSTOMERS....ETC...ETC...ETC............

Wed Jun 17, 2009 4:33 am
Name: Also Retired | Comment: It amazes me even now GM fails to capitalize on technologies it already retains. The new Chevrolet Equinox, GMC Terrain, and Cadillac SRX ought to have had either (or even both) "two-mode" and BAS-plus hybrid systems available as options from the start of their initial introduction later this year. Either, or both, hybrid systems should also be available on the 2010 Buick Enclave and GMC Acadia as well. BAS-plus should have been available on selected GM vehicles for 2010 and nearly all models for the 2011 model year. The well-received Chevrolet Malibu should get the 2.4L direct-injection motor immediately for all 4cyl 2010 vehicles. Also add BAS-plus to it (on either the 4cyl or 6cyl engines) and you will have a true competitor to other hybrid vehicles. The Corvette should have had an option for an "Active Fuel Management" engine with E-85 capability for years now -- even if it means giving up 50-75 horsepower. (You would still be left with "only" a mere 350-375+ hp). This alone should yield an additional 2-3 mpg on the highway. Add BAS-plus, which would add an additional 3-4 mpg on the city mileage figure, and you could likely advertise and sell it as a world-class sportscar that is the most responsible and fuel efficient relative to all the power and performance it exhibits. (The next-generation (C7) Corvette should be designed from the start to include one, or more, hybrid systems as options as well). The brand new Camaro SS which provides a "combined" mpg figure of 19-20 mpg could probably be raised to nearly 23-24 mpg with the addition of BAS-plus yet still have over 400 hp! (I'm old enough to remember when Volkswagen used to advertise their Beetle would provide "an honest 25 mpg" back in the days of the first gas crisis in 1973). The Camaro SS could nearly match that today with over 400 hp? Incredible!! Yes, I know financial times are tough, but please GM use what you've already developed. It does no good letting these systems sit on the shelf. Show potential customers what you're capable of....... Best wishes.

Tue Oct 26, 2010 4:16 amOverdrive
Who really rescued General Motors?
by Malcolm Gladwell

Read more http://www.newyorker.com/arts/critics/books/2010/11/01/101101crbo_books_gladwell?currentPage=all#ixzz13T44kBfS

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