Smith Faculty Opinion Article

December 9, 2005

Why GM's Turnaround Strategy Inspires Little Confidence
By Dr. Peter Morici, Professor of International Business

Over the last two weeks, GM has announced yet another downsizing and reorganization of its ailing North American vehicle business and named a new Chief Financial Officer. None of this will fix GMs systemic problems and arrest its long-term decline. In fact, by spreading legacy costs over a smaller number of vehicles, downsizing North American operations brings GM closer to Chapter 11.

GM knows how to build good cars. Consider, for example, its success in China, where it is not burdened by legacy costs, unrealistic union contracts and overpaid executives, and it does not face an effective incumbent competitor with home field political advantages. Toyota, Volkswagen, GM, and others all face the same opportunities and challenges in China, and GM does well there.

Examining the various ways GM offerings in North America come up short--comfort and esthetics, drivability, and reliability indicates GM is able to hit the mark on one or two these metrics, but usually not all three, at the same time. The basic problem is that GM's costs are higher than Japanese and Korean competitors, and GM tries to make up the difference by putting less into its vehicles than those competitors. GM tries to mask differences in vehicle content and quality with slick ads, such as those comparing the price and size of Chevy SUVs to Lexus, rather than Toyota, offerings, and statements touting that Cadillac reliability beats Toyota when Lexus is the relevant yardstick for GM luxury brands.

The reasons for GMs disadvantages are clear. Legacy costs, bureaucratic management, inefficient product design, and excessive pay for paid blue-collar workers and senior executives raise GMs unit costs above those of Japanese and Korean competitors, even when the latter make cars in North America. Consequently, GM puts less content and lower quality parts into vehicles, spends too little to develop up-to-date engines and transmissions, and updates its vehicles less frequently than its Asian competitors.

GM has been unable or is unwilling to address systemic cost and management problems within its corporate structure, and has increasingly leaned on parts suppliers to cut prices, not just be competitive with overseas suppliers but also to compensate for GM's internal cost disadvantages. Initially, this resulted in inferior parts--parts that don't perform as well and require replacement sooner than those of transplant and imported vehicles and poor consumer acceptance of GM products. Longer term, GM's rough treatment of suppliers is helping force Delphi and others through bankruptcy.

In addition, GM has attempted to compensate for outsized engineering and management costs by building cars for multiple markets on the same platform for example, GM sells rebadged Chevys and Subaru's as Saabs. Earlier this year, GM announced plans to further extend this approach; however this is a difficult strategy to execute, and GM has not proved it workable. After all, why should car buyers pay a premium price for a Saab built on a Malibu platform or a rebadged Subaru?

Consumers have voted out this strategy. They judge that GM vehicles don't deliver the value that Toyota and other Asian brands offer. This is evidenced by the fact that consumers are not willing to pay as much for GM vehicles as they will pay for comparable Asian vehicles and consumers are unwilling to pay GM what it costs to make its vehicles.

The terrible losses GM has suffered in a rapidly growing U.S. economy and the recently announced plant closings are direct evidence that GMs costs are too high, and its strategies to compensate for its high costs have failed.

The GM value gap the difference between the prices GM vehicles fetch and those that comparable Asian vehicles command far exceed GMs legacy and health care cost disadvantages. A smaller GM will have to spread legacy costs over fewer vehicles.

Plant closings don't address outsized compensation for blue collar workers and senior executives, bloated engineer costs and bureaucratic management; rather, plant closings are the direct result of these systemic ills. Plant closings and layoffs may permit GM to temporarily regain profitability but continued under-investment in new products and technology will eventually force GM to again sell vehicles for less than cost, shut more plants, layoff more workers, and further cede market share.

What GM needs to accomplish is easy to articulate but difficult to execute.

At the minimum, GM needs to: renegotiate union contracts to bring its factory labor costs in line with those of Toyota, Nissan and Hyundai North American operation; bring executive compensation into line with what the market for its cars and trucks will bear, and streamline management decision making and design processes to accelerate new vehicle rollouts. Legacy costs need to be reduced, capitalized and removed from the liabilities assessed on making cars, now, and this would require significant concessions from the UAW and selling assets.

Recently negotiated changes in health care benefits, plant closures and layoffs are hardly enough to accomplish these tasks. One can only speculate why GM management and Board of Directors believe GM stockholders should conclude differently. It would appear that GM's management and Board have little more respect for investors than they have displayed for the car buying public.

GMs constant insistence that legacy costs are the source of its problems, when its problems are far larger and deeply systemic, provide graphic evidence that GM's management does not recognize the challenges it faces and labors under a culture of denial.