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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Factories are shuttering across the Rust Belt, but at the General Motors plant in Lansing, Michigan, the assembly lines are still rolling. This plant is supposed to showcase the “new GM”: no sullen human cogs tightening bolts on an endless stream of indifferent cars, but small autonomous teams working together to produce top-quality automobiles. A massive, multi-building affair with a gleaming white exterior, the facility has been recently refurbished. It looks like what a car dealership might want to be when it grows up.

Then you go inside, and you are peering into the innards of the American auto industry. For as many times as I am reminded about the facility’s new bells and whistles and environmental certifications, this still looks a lot like the old GM. A stamping machine the size of a summer cabin turns sheets of metal into body parts. Incomplete autos with their gray-metal bones half exposed roll down the line, one every 72 seconds. At regular intervals, robot arms seem to jump out of nowhere, unerringly delivering dozens of precision spot welds in a few seconds. Workers step out onto the line with the rapid-but-casual grace that comes from long repetition, tighten here and fill there, then step back to let the next car roll forward.

It’s all a bit magical. Watching raw materials turn into familiar objects always is—but especially so in an auto plant, where the sheer scale both captures and defies the imagination. Perhaps it was that magical mood that made me look at the Buick Enclaves rolling off that assembly line and think: Hey, I wouldn’t mind owning one of those. Since I’m an unrepentant latte-sipping coastal urbanite, that’s a rather novel thought.

But the Enclave, GM’s luxury crossover sport-utility vehicle, is a pretty good car. It is, I am unashamed to say, very attractive. It also gets good marks for performance, noise reduction, and safety. And Buick seems to have a lot of happy customers. This year, Buick and Lincoln-Mercury topped the American Customer Satisfaction Index—the first time that American carmakers have occupied the two top spots. Cadillac was just two points behind.

If it weren’t for the $50 billion we’ve given GM over the past two years, this plant might well be dark, the machines silent, the workers scattered. I opposed the bailouts, at the time; I couldn’t see how the chance of a slightly worse recession merited the government’s giving $50 billion to a company that had been steadily, even willfully, marching toward disaster for decades. But since we went and bailed out the auto companies anyway, I went to Detroit to find out what our $50 billion bought us—and whether we had any hope of getting that money back.

According to former “Car Czar” Steven Rattner, writing in his recently released Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry, when President Obama sat down to talk about the automakers, he asked, “Why can’t they make a Corolla?” For many people, that question seems to cut to the heart of the decline of American auto manufacturing. Why can’t GM make a decent, affordable, small car?

The truth is, GM can make good small cars. It does make good small cars. The company’s Opel division has regularly been on the list of the top-selling European (read: small) cars. The problem is, success in Europe hasn’t translated to the United States, which is GM’s core market.

Stephen Girsky, who became an adviser to the autoworkers when the financial crisis hit the auto industry, and now is a vice chairman at GM and sits on its board, argues that the reason American auto manufacturers haven’t produced the elusive American Corolla is that there’s no market for it—or at least, not at a price point that the old GM was able to meet. He mentions the Fiat 500, the smash-hit economy car that is supposed to save Chrysler. “In Europe, that car sells for 15,000 euros. I’m not sure it could get 15,000 dollars here. It won’t sell for that much money.” Nonetheless, even Girsky agrees that if GM can’t make a profit on cars, rather than only on the trucks that have provided its sporadic margins for the last two decades, the company can’t make it.

Of course, Toyota makes money on small cars in America. But Detroit’s legacy costs have all but guaranteed that it can’t follow suit. For decades, U.S. auto companies have been struggling with the lavish deals on wages and benefits that they made with the United Auto Workers back in the days before foreign competition broke down the Big Three’s cozy oligopoly. David Cole of the Center for Automotive Research estimates that this left GM with a “cost penalty” of more than $1,000 per car between its production costs and the competition’s.

With the union clinging fiercely to its benefits, management could take the money out of only one place: the cars. As Cole says, “You’ve got this sunk cost, and your competitors are setting the price” in the small-car market. “What do you do? You start pulling features out or using cheaper materials.”

That meant that at any given price point, they had to offer lower quality than their competitors—especially in the smallest, cheapest cars, for which the cost penalty was so large in proportion to the total cost. No wonder the Big Three were so focused on trucks and SUVs, where they could more easily fold legacy costs into higher selling prices.

With GM’s government-backed bankruptcy in June 2009, all of this has changed. Though critics worried that government ownership would hamstring the company’s efforts to close plants and cut jobs, the administration was surprisingly businesslike. In Rattner’s telling, when auto-task-force member Ron Bloom brought up the loss of tens of thousands of autoworker jobs, Chief of Staff Rahm Emanuel responded succinctly: “Fuck the UAW.”

GM has closed 13 plants and shed 25,000 union jobs, bringing its total number of hourly employees to just 53,000 in the United States. It has also turned retiree health costs over to the union, closed dealerships, reduced debt. All in all, Cole estimates that the reorganization let GM reduce its costs by $4,000 to $6,000 per car, with $1,000 of that coming just from debt reduction. “Now, instead of a cost disadvantage, you have a cost advantage.”

Cole says that GM is already using that advantage to deliver higher quality, even in the small-car market. He points to the latest Chevy Cruze, the company’s answer to the Corolla and the Civic. With a sophisticated new rear suspension, spacious interior, and small-but-important amenities like better noise reduction, it’s arguably a better car than its Japanese competitors. As Jack Baruth, a reviewer on thetruthabout cars.com, recently wrote, “It’s well-positioned against the Civic and Corolla. I believe that it beats both of those cars in significant, measurable ways.”

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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