Wednesday, November 12, 2008

The Infuriating U.S. Auto Industry

Living in a state that seems to be in a permanent recession, and where it sometimes appears that the state government's leading solution to decades of economic decline is, "Wait until the auto industry rebounds," it's frustrating to see how short-sighted the domestic auto industry is. The auto industry's decline has been actively abetted by Congress which, rather than pressing for fuel economy standards that make sense in the context of the world's oil supply and demand, has time and time again favored consumption over conservation.

Right now the auto industry is hoping to get its hands on $25 billion in loans, already approved by the Bush Administration, to build more fuel efficient vehicles. How fuel efficient? So that they can meet a 35 mpg CAFE standard by 2020. You know, like the Civic Hybrid's 42 mpg combined average, or the 46 mpg achieved by the Toyota Prius. Oh, let's give the domestic auto industry its due - Ford's compact hybrid SUV's combined average is 34 mpg - they're almost there. Too bad it will take another twelve years and $25 billion to get that extra 1 mpg.

If you approach gas mileage honestly, you already know you don't need hybrid technology to achieve 35 mpg. In 1989, 20 years ago, Honda introduced its CRX HF, which achieved a 45 mpg combined average. The Geo Metro achieved similar fuel efficiency. In fairness, the method for calculating fuel efficiency has changed, and these cars would probably get about 38 mpg combined averages by today's standards, probably a bit less for the Metro, although by the same token we could presently build even more fuel efficient versions of those same cars. What those cars do is demonstrate that if you put a small, fuel efficient motor in a small, light car, you can achieve high fuel efficiency - something that, surprisingly, still needs to be said. This is a context where I'll be the first to admit, the CRX and Metro weren't and aren't the cars for everyone. But let's not pretend it's about technology, as opposed to wanting a large set of features and amenities that increase vehicle weight and decrease fuel efficiency. A huge part of the investment in fuel efficiency is about how to squeeze V8 power out of a V6 engine, or how to reduce vehicle weight without reducing size, performance, or amenities.

Criticisms of the auto industry almost always include a potshot at organized labor, if not an outright call to bust the unions. The history of generous union contracts plays a role in the current plight of the automakers, but not in the way that is typically depicted on the Wall Street Journal's editorial page. The Big Three have actually done a respectable job of paring down their labor costs and raising plant efficiency, to the point where the cost of labor provides only a marginal advantage to foreign auto manufacturers. They are weighed down by their huge obligations to retirees - health and pension benefits. A big part of GM's present cash flow problem comes from its obligation to pay billions of dollars to the UAW, to as part of a deal to transfer pension and retiree health care obligations from its books and onto the union.

But unions do remain a part of the problem, in that their lobbying efforts have largely followed those of the Big Three. When the Big Three were making a lot of money selling inefficient, high margin vehicles, the UAW had their back. Big profits mean profit sharing checks, and a possibility to negotiate higher wages during the next round of contract negotiations. I don't find that insidious, so much as short-sighted. It's their job to try to get more money for their members. But while the auto manufacturers themselves bear responsibility for lobbying (and obtaining) fuel efficiency standards and exceptions that let them "build the cars people want" (when gas is less than $4/gallon), and let them avoid investing in the technologies that might allow them to build comparable cars with much greater efficiency, I think that a union has an obligation to look at the long-term as well. Unions are often very willing to ignore the long-term financial picture for an employer or industry, and to sell out new members in favor of obtaining preferential treatment or benefits for their existing members. A union has an obligation to negotiate for the benefit of its members, but UAW-type negotiations seem to focus on existing membership (often at the literal expense of future members, and sometimes also of retirees) over the short term, without regard for the long-term effects on the employer or even themselves.

Is it needless to say? The UAW has joined GM in its quest for a federal bailout. Getting billions in federal money lets everybody avoid making tough decisions, while avoiding the consequences of decades of selfishness, short-sightedness and incompetence. Many opponents of the bailout suggest that it will simply enable "business as usual", and there's little reason to doubt that's what GM and the UAW most desire.

Fred Wilson, a venture capitalist focusing on technology companies, suggests that we should break up the Big Three instead of bailing them out. Unfortunately, it's not that easy. There's no clean way to divide any of the auto makers by product line, let alone to maintain supply contracts and product distribution by product line. I think that forcing the auto manufacturers to become smaller, more nimble, and able to quickly develop and manufacture new products is a good goal; I just don't see that it can be done by breaking them into smaller manufacturers. (If it were feasible to divide a major auto manufacturer and there were buyers willing to purchase individual car brands, I suspect Cerberus would already be taking bids for the various Chrysler brands.)

Thomas Friedman endorses a WSJ-style solution - and I mean that quite literally. He endorses a proposal by Paul Ingrassia, former Detroit bureau chief for the WSJ, as published in the WSJ (and as linked above).
In return for any direct government aid, the board and the management should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver - someone hard-nosed and nonpolitical - should have broad power to revamp GM with a viable business plan and return it to a private operation as soon as possible.

That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. After all that, the company can float new shares, with taxpayers getting some of the benefits. The same basic rules should apply to Ford and Chrysler.
To me, that proposal seems silly. I am not aware of the magic wand you can wave over a major corporation to replace its upper management with "better people" and instantly transform the company into something lean and competitive. If Ingrassia were honest about it, he would be admitting that's what the Cerberus acquisition of Chrysler was supposed to be about - brilliant financial wizards take the company private, install new management, streamline operations, and transform it into a dazzling success. Yet Cerberus has failed in that effort, and Chrysler stands alongside GM and Ford in seeking a multi-billion dollar handout. It also seems absurd to me that a supposedly conservative, pro-business paper would be suggesting yet another socialization of major American companies, with government-appointed management being the cure-all for the failures of the market. The contempt for contracts is also a curious phenomenon - why are WSJ-brand conservatives so quick to call for the shredding of contracts, when the entire business world revolves around reliance on contractual relationships?

Ingrassia should also be aware that the problem with the Big Three's contracts with suppliers is not that they're overpaying. It's that they've always focused on price, and the squeezing of price concessions out of their suppliers, as a first line approach to cost savings. While a company like Toyota works closely with its parts suppliers to increase efficiency and quality - to save money while maintaining or improving quality - the Big Three have had little regard for anything but the bottom line. Even assuming that the suppliers are able to stay in business after a WSJ-style shredding of their contracts, where's the evidence that turning contracts into confetti will translate into even a penny in cost savings? Similarly, given that the largest burden imposed by union contracts has already been incurred and the cost of labor is no longer much higher for the Big Three than for their non-unionized (or largely non-unionized) competitors, how much will the shredding union contracts actually help? And, as with shredding contracts with suppliers, what of the risk that it will disrupt their ability to make cars? Finally, if the shredding of their contracts is of such import, why not refer them to a bankruptcy court where they can do that through a Chapter 11 filing?

Friedman also has some demands of his own:
Any car company that gets taxpayer money must demonstrate a plan for transforming every vehicle in its fleet to a hybrid-electric engine with flex-fuel capability, so its entire fleet can also run on next generation cellulosic ethanol.
I'm not sure what that means. Is Friedman proposing that all new vehicles incorporate those technologies? That they have the capacity to be "upgraded" to hybrid/flex-fuel vehicles? If he wants those technologies built into every new car, does he believe that the path to prosperity involves increasing the cost of every vehicle by a couple of thousand dollars, while we operate on the assumption that ethanol production will become more green (and be less subsidized) in the future? Seriously, I applaud efforts to increase fuel efficiency, achieve energy independence, make cars cleaner and greener, etc., but I don't see much point in creating a context where the government has to grant a multi-thousand dollar subsidy for pretty much every domestically manufactured vehicle in order for it to be price competitive with imports.
Lastly, somebody ought to call Steve Jobs, who doesn’t need to be bribed to do innovation, and ask him if he’d like to do national service and run a car company for a year. I’d bet it wouldn’t take him much longer than that to come up with the G.M. iCar.
This is cute, but it's a bit like a simplified version of Ingrassia's receiver who will magically replace the upper management of the Big Three with people who know how to run car companies. (People from other industries?) Friedman believes that a culture of innovation (let alone a culture of quality) can be instilled in a company simply by switching it's CEO, but how often does that actually happen? History suggests that the opposite is more likely - an ill-suited CEO will damage or crush a culture of innovation (see, e.g., Hewlett-Packard, Yahoo!, Apple during the non-Jobs years, etc.) Also, sometimes those creative, brilliant leaders bring quirks to their companies that can be as problematic as having boring, conservative, rule-by-committee CEO's. (Remember the period when Apple wouldn't build a desktop PC that required an internal fan?).

Although something of an aside, whatever criticism may be fairly directed at GM's leadership, or to idiotic statements on global warming, this assertion by Friedman seems like a cheap shot:
Nothing typified this more than statements like those of Bob Lutz, G.M.’s vice chairman. He has been quoted as saying that hybrids like the Toyota Prius “make no economic sense.”
Lutz is more fully quoted as saying that Prius-style hybrids make no economic sense because their price will never come down. As I interpret his comments, he was simultaneously talking up GM's plug-in hybrid technology (i.e., the Chevy Volt), talking down a competing product (the Prius) and noting what is pretty obvious: current hybrid technology comes at a premium price and, if you can't eliminate that premium, you're unlikely to get the type of market penetration that people like Friedman supposedly want. Further, he made the comments several years ago, and related them specifically to the price of gas at that time.
It just doesn't make environmental or economic sense to try to put an expensive dual-powertrain system into less expensive cars which already get good mileage, Lutz said at the North American International Auto Show.

* * *

"Hybrids are an interesting curiosity and we will do some," he said. "But do they make sense at $1.50 a gallon? No, they do not."
It seems unlikely that Lutz was arguing that there's no place for current hybrid technology in the GM line-up, as it's offered in a number of models and he was suggesting at the time that it would be added to GM trucks. It may turn out that Lutz is incorrect, and the current hybrid technologies come down in price, but it's also possible that he's correct and the best and cheapest way to bring hybrid technology to the mass market is through plug-in hybrids. But it is clear that in the four years (actually, almost five years) since he made the statement, current hybrid technologies have not come down in price and you continue to pay a significant premium for hybrid cars. That's why, even with record gas prices driving record sales, hybrids make up only about 3% of the U.S. car market.

What do I want to see for the domestic auto industry? I want to see private capital deliver on its promises, rather than "yet another display" of the supposedly brilliant financiers behind companies like Cerberus getting a public handout when they screw up an investment or prove that they're even less capable than the former managers of the companies they're supposedly rescuing. I would like to see GM find a way to get private money to finance its way through this crisis, even if that means making some unpleasant concessions. I would like the auto manufacturers and their workers to internalize the lesson that you can't make up for deficits in quality by creating a context where new car buyers reliably trade in their cars every two years, passing along the defects to the next guy, while your competitors make cars that are remarkably reliable for people who prefer long-term ownership. Yeah, right.

Finally, the one thing I don't want to hear is anybody who supported the financial industry bailout oppose an auto industry bailout on the basis that the domestic auto industry has collapsed due to incompetent management, greed, poor planning, badly designed products, or overpaid employees - that's a distinction without a difference.


  1. As much as I hate to see Michigan driven even deeper into recession/depression than it is now, absent something a "lot" more focused and pragmatic than the recent "bail out plan" for banks and other financial institutions with lots of lobbying dollars, I can't see writing a check to the big 3.

    I concur that it is unfair to support the one and not the other based on the rationale most are using, but I think one is a disaster and the other one will be . . . and I've pretty much always been opposed to the idea that we have to do something stupid and wasteful again just because it wouldn't be "fair" not to do so . . .


  2. Not to quibble, but I didn't actually suggest that it would be unfair not to bail out the auto industry given the financial industry bailout. The most fair result would probably be to let all of these institutions and companies fail. The real question, I think, is does it cost us less to keep that from happening or to pick up the pieces after it happens.


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