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Tuesday, June 2, 2009

Does General Motors’ Bankruptcy Really Mark the End of an Era?

On June 1st, General Motors (GM) filed for bankruptcy protection. $20 billion dollars in government aid later, the company has now realized what has been inevitable all along. The efficiency of global competitors has brought the auto giant to its knees. As a result, the United States’ government now has a 60 percent stake in the company. The United Auto Workers’ Union (UAW), creditors and the Canadian government own the remaining 40 percent. In lieu of the new ownership, the name “Government Motors” would better suit the company. It is now official: the auto industry in the United States is effectively nationalized as two out the three giant U.S. automakers are now under the supervision of bankruptcy judges, the U.S. and Canadian governments. (Chrysler LLC filed for Chapter 11 bankruptcy on April 30th.) One can only wonder if Ford Motor Company will suffer the same fate in the near future in spite of the short-term success of its restructuring efforts.

Cost-Benefit Analysis for Taxpayers

Taxpayers are not given a choice when the government decides to take ownership in what was once a private business, and unfortunately, the results of this decision will be grim. Failure is a part of business, and the market is resilient in the sense where the death of business cannot be prevented. The only probable outcome of this type of decision is taxpayers are stuck with a sunk cost. While an argument can be made that government involvement buys time, it also creates bigger and more catastrophic problems in the future. As death is part of life, the death of business is just as certain when a business does not adapt and move with the times. When the government gets involved, it is funding a bottomless pit and cannot sustain the life of the business regardless of how much money it invests.

Taxpayers have now unwillingly invested $50 billion in GM - $20 billion in loans prior to the Chapter 11 filing and $30 billion in promised aid during the restructuring. The Bush and Obama Administrations have argued that GM’s failure would produce a calamitous ripple effect on the economy as suppliers, plant workers, dealership employees and many other businesses would be affected. However, General Motors’ problems did not begin in 2008. The giant automaker has been dieing since the 1970’s. The question that confronts taxpayers now is how much money will the government continue to invest in order to keep GM on life support and prolong what the market will eventually correct and has already begun to correct since the early 1980’s?

Near 600,000 vs. less than 60,000

In the 1970’s, GM employed nearly 600,000 Americans, and the company sold one of every two cars in the United States. (1) The 1980’s brought revolution to the auto industry. The emergence of foreign competition put pressure on American car companies to change the way they did business. Toyota Motor Corporation was able to rapidly grab market share through its innovation and by pioneering new ways to produce a wide range of quality automobiles at a low cost. Toyota was among the first of the automobile manufacturers to re-invent the mass production process to lower costs and become more efficient.

In the meantime, GM along with the other two major U.S. automakers (Chrysler and Ford) was very slow in adapting their business models to the dynamic changes in the market. Pressure from the UAW prevented scaling back on some of the company’s unsuccessful brands. As a result, dealerships, workers and factories were kept open in spite of a hemorrhaging market share which came at the expense of future innovation and opportunity. In addition, GM’s expansion of General Motors Acceptance Corporation (GMAC) in recent decades has caused the automaker to become less focused on making quality automobiles and increased its exposure to other negative economic impacts. Due to GMAC’s expansion into home loans, the company felt the impact of the housing crash as foreclosures began to mount. Over-diversification along with the reluctance to change long-held business practices has put the once dominant auto giant in the position it is in today.

Market Forces Trump Political Forces at a Substantial Price

Returning to the argument made by the Bush and Obama Administrations, one must wonder just how much of a ripple effect will the failure of GM have on the economy and how much of this decision is political. It is clear that GM cannot continue on the path it has been on for the past 30 years. Considering that GM’s workforce is currently one-tenth of what it was in the late 1970’s, it is safe to say that the market has already adjusted, and the full force of the negative ripple has already been felt. If American automakers cannot sell cars, then businesses that rely on their success will have to look elsewhere in order to thrive. The businesses that quickly adapted survived and those that did not have already perished. Therefore, what exactly is $50 billion supposed to save? The government is attempting to apply a band-aid to companies that have been bleeding for decades, and now this exorbitant band-aid will be applied to what is nothing more than a slow leak.

In addition, The Bush Administration’s initial argument was that Chapter 11 bankruptcy was not an option due to the negative impact a bankruptcy would have on the economy. The Obama Administration made that same argument when it agreed to give GM a second loan. Less than a year later, GM is forced to file Chapter 11. Therefore, the negative impact will now be worsened by billions of dollars in sunk costs.

GM has plans to divest its Saturn, Hummer, Pontiac and Saab brands and shed more than 2,000 of its 6,000 dealerships by next year. As a result, it is estimated that 100,000 job losses will occur from the closure of these dealerships. At least a dozen plants that employ most of more than 20,000 U.S. workers have been identified for closure by the end of next year. Assembly lines in Pontiac, Michigan as well as a Wilmington, Delaware-based facility will be closed later this year. (2)

In summary, the current situation begs the following question: What is the taxpayers' return on investment? The answer is ZERO, and it will remain ZERO in the future. The government has spent billions in an attempt to avoid what market forces will always dictate. When the government tries to prevent the inevitable, not only do market forces trump political forces, but the government’s investment comes at the expense of FUTURE opportunities. It is quite fitting to quote Henry Ford, the founder of Ford Motor Company: “Failure is only the opportunity to begin again, only this time more wisely.” A wiser approach would be for the government to cease involvement with the private sector and allow market forces to bring about new life and opportunity in the automobile industry and elsewhere.

(1) http://jutiagroup.com/2009/05/18/general-motors-abandons-us-workers-focuses-on-operations-in-china/

(2) http://money.cnn.com/2009/06/01/news/companies/gm_bankruptcy/

3 comments:

Eric said...
This comment has been removed by the author.
Eric said...

I remember the oil embargo in the 70's and these companies were so out of touch they kept on making the biggest, ugliest gas guzzlers you ever saw. They fought CAFE standards and meanwhile Honda, Nissan and Toyota stepped in and gave us smaller, more efficient and eventually better cars. GM has been out of touch for along time. They gave us the Hummer.

You can blame it on the union all you want but I think heathcare is the big difference. In other competing countries the healthcare is national and not on the shoulders of the businesses.

GM has been up to no good for along time and maybe they are getting what they deserve. They destroyed public transportation in this country. They fought CAFE standards, seat belts, every safety feature you could think of. Just ask Ralph Nader.

Let's not forget that through GMAC they also got heavily involved in subprime mortgages. I guess they figured it was more intresting to make a killing with crap financial products than focus on their supposedly core competencies.

Here is a contrast. This morning on a European news show they featured Matra a european auto manufacturing company responsible for the Espace which was a very successful minivan for Renault.

Matra had the foresight to retool and they are now making electric bicycles and electric cars.

What has GM done to ever prepare for world changes.

I don't quite understand the logic of selling our most important military vehicle the Hummer to the Chinese. Talk about potential strategic blunders. Then again good riddance. Maybe the Chinese will get better mpgs out of it.

Michelle S said...

Eric, thanks for your feedback. The point is the government should not be imposing such standards in the first place. The cost of gasoline is what dictates the kind of cars the consumer will buy, and companies that quickly adapt to meet customer needs are the companies that survive. While it is true that Toyota led the way in fuel efficiency in the 80's, the "big 3" could not match their labor costs and quality due to union demands.

There was a demand for the Hummer when it was introduced. However, when fuel prices soared, demand declined. I believe that worldwind demand for oil will only increase in the future, so going forward, the divestment of the Hummer brand is a wise move.

As far as healthcare is concerned, let us remember that individuals and businesses are heavily taxed to pay for such healthcare. Nationalization does not mean that it's off the hands of businesses.

Not sure of how GM destroyed public transportation and seat belts.... Unions in the public transportation business prevent improvments and make it inconvenient to use. The government has no business imposing seat belt laws, but I'm no fan of Ralph Nader.

I mentioned in the article about GMAC's venture into the mortgage business. Overdiversification has indeed taken its toll.

We agree that GM has been out of touch and poorly run. The unions are only part of the problem, but a significant one, as they are major reason why GM stayed out of touch. They refused to allow the company to move with the times. A lot of GM's brands should have been divested a long time ago...