Business November 2010

Can GM Get Its Groove Back?

Buyers remain wary, and Washington is unlikely to recover all its bailout cash. But the colossus has slashed costs and spiffed up its cars—and is rejoining the global race.
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But just because GM can build a Corolla—or even something better—doesn’t mean that the company can persuade the rest of us to buy it. Brands are precious but nebulous things, hard to build and easy to destroy. GM’s three-decade pattern of pulling features out of cars to pay for the company’s growing legacy costs has left American car buyers perhaps irrationally wary of its products.

That’s why it was so critical for GM to close the ailing Pontiac marque and revamp the dealer network, which everyone except the auto dealers agreed was hopelessly bloated with a lot of dealers who didn’t sell many cars—and thus didn’t generate enough profits to afford a shiny, updated facility and small army of service staff. The lackluster customer experience further eroded the brand.

The actual process of closing dealerships was mishandled. Cole says that Washington is “incredibly naive” about the car business; the administration initially pushed the firm toward Toyota’s model of fewer, higher-volume dealers, even though this approach would have undercut GM’s traditional competitive advantage in smaller towns. Then things lurched in the other direction, as politically connected dealers lobbied frantically against closings. After Congress passed a law in December of 2009 giving shuttered dealers the right to arbitration, GM mailed letters to 660 of them, offering reinstatement.

Nonetheless, the company says it is now happy with the number of dealerships, which has been trimmed to about 4,500 from the original 6,000. GM believes that these cuts, along with the other changes the firm made in bankruptcy, have left a company that can break even in a recession. So far, so good: the “new GM” posted strong net income in its first two quarters, even though U.S. auto sales look likely to be less than 12 million units this year. Compare that with 2006, when 16.5 million light vehicles were sold in the U.S.—and GM still lost money.

Post-bankruptcy, GM is unquestionably a more viable firm than the stumbling giant we put on life support two years ago. The worst fears of many critics—including me—were overblown. The government did not simply leave the bloated legacy costs intact in order to protect its political friends.

Still, there are reasons to worry—to worry about the future profitability of the new GM, and to question whether the government will recover enough of the money we spent to make this a good deal for the American public.

To start with, GM hasn’t shed all its legacy costs. The pension plan, which is underfunded by $26 billion, was not terminated in the bankruptcy, as such plans often are, with their assets turned over to the government’s pension insurer, and the beneficiaries frequently forced to accept a reduced payout. Instead, GM’s earnings will face a drag from that underfunding for years to come.

More worrying still is the possibility that GM’s labor woes are not over. Though the bankruptcy brought the firm’s hourly-compensation cost down to within spitting distance of what foreign-owned manufacturers pay their U.S. employees, Bob King, the new president of the UAW, already faces intense pressure to roll back some of the concessions.

Dealing with any new wage demands will be particularly sticky because starting in the middle of this decade, the automakers must comply with new CAFE standards, which raise the required fuel efficiency of cars from 27.5 miles per gallon to 39 mpg, with similar increases for trucks. The administration says the new rules will raise the cost of a car by $1,300, but data from the National Research Council suggest that the real cost could be at least twice that. With those higher costs, GM—which still has a major brand handicap—may have trouble making inroads into the small-car market.

These factors will weigh on investors’ minds as they decide what price they are willing to pay for the initial public offering of shares that GM has scheduled for this winter. For the taxpayers to get their money back, the company needs to end up valued at about $70 billion. This is theoretically possible—but doesn’t seem very likely. The company’s peak valuation, in 2000, was $57 billion. That was back when the company had a 28 percent share of the U.S. market. This year, that number looks to be less than 20 percent. And for all GM’s efforts, its car business is still depressingly dependent on “fleet sales” to places like car-rental agencies. Those don’t help the public’s brand perception; and since rental companies don’t hold cars for long, they also flood the market with late-model used cars that compete with GM’s newer offerings.

Moreover, 2000 was also the peak of the stock market. This year, we’re in the middle of a historic recession, with a stock market trading some 25 percent off its 2000 level. Many analysts think that the stock sale is being pushed too fast. The company has only two—possibly three—quarters’ worth of earnings to persuade investors that it has turned around. Assuming the company really is on the rebound, an offering in 2011 or later would be much more likely to attract a high price. But while this November is not a very good time for the company to be going public, it is unfortunately a very good time for beleaguered Democrats to be soothing voters with the prospect of getting their money back.

In the end, the bailout will probably cost voters a lot of money, and worse, more money than it had to. And there are all sorts of questions about whether other companies will be tempted to seek a government bailout, or whether the cost advantage that GM gained in bankruptcy might put pressure on other manufacturers’ margins, ultimately forcing them to follow suit.

On the other hand, had the government not stepped in, the GM liquidation would arguably have deepened the recession—not tumbled us into Great Depression II, as some more-hysterical bailout supporters claimed, but raised the unemployment rate and lowered GDP somewhat. A libertarian economist of my acquaintance recently confided that he thinks the bailout has been surprisingly successful—“not necessarily a good idea, but far from the worst thing the administration has done.”

After spending a few days in Detroit, this assessment strikes me as about right. The bailout wasn’t a good idea, and it will probably cost billions. But the government wastes billions of dollars every year, because for the United States, $1 billion adds up to the equivalent of less than one venti latte per American. At least in this case, we got something in return: a functional car company, resurrected from the ashes of the old GM’s bloated carcass. Americans probably won’t notice the few extra dollars they spent on the bailout. But they may eventually be glad when another shiny new Buick Enclave rolls off the Lansing assembly line, and into their driveway.

Megan McArdle is The Atlantic’s business and economics editor, and the editor of the business channel at theatlantic.com.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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