Tuesday, April 26, 2005

We Can’t Handle The Truth:

Robert Lutz’s comments about eliminating the Buick or Pontiac brands from the General Motors portfolio just created further public relations ‘issues’ for GM a few weeks ago. This came shortly after GM announced that their profit estimates for 2005 were high, and that a loss would be posted in the first quarter. Mr. Lutz, hired in 2001 and recently reassigned as the head of Global Product Development, is famous for his candor. He even started a blog earlier this year (GM Fastlane Blog), and he has chosen that forum to respond to the uproar (here).
There have been a wide range of views and opinions throughout the industry published on Mr. Lutz’s comments. Generally, there is outrage that General Motors would even contemplate the elimination of another brand or two, especially considering that GM built the last Oldsmobile in 2004. However, we believe the whole thing boils down to the fact that we, as the public, cannot handle the truth.
General Motors simply has too much automobile capacity, too many employees, and too much overhead for the number of vehicles that they are currently selling. Based on the first quarter sales, General Motors will likely sell approximately 4-million vehicles in North America in 2005. In 2002, GM sold approximately 4.9-million vehicles in North America. Everyone, including GM Management, admits that previous year sales can be attributed to GM’s incentive program, which reached approximately $5,000 in cash per vehicle at the end of 2004. Rick Wagoner (then and current CEO of General Motors) even commented to the executives at Ford and DaimlerChrysler: Quit complaining about General Motors’ use of ever-increasing incentives.
Two things have contributed to the immediate urgency at General Motors. First is that a majority of the sales decline will come in 2005 (GM sold 4.7-million vehicles in North America in 2004). Second is that overhead costs, particularly raw material and health benefits, have been increasing dramatically for the last 18-months.
It is likely that General Motors has (or at least had) a minimum effective scale of approximately 5-million automobiles annually that it needs to build to be efficient. It probably takes a lot of vehicles every year to support 1.1-million retirees, employees and dependents. On top of that, every day that an assembly or component plant is not operational, employees are still paid 95% of their normal hourly wage.
The question then may not be what the executives of GM didn’t see, or may not have been reacting to over the years. A better question may be: How was management able to put off the inevitable for so long? GM has never had the low-cost advantage, and quite frankly didn’t have many ‘have-to-have’ products, other than the light-truck and SUV stalwarts on which the profits relied. GM really has not been a technology leader in a number of years, either. However, it could be argued that General Motors, as well as the overall economy, is now in a better position than a few short years ago. Management’s response to September 11th was pure genius. The escalating incentives over the last couple of years were basically implemented to keep their factories operational, and it worked great for a while.
The downside to this strategy is obvious. Customers purchase a General Motors product just to take advantage of the incentive. However, the upside for GM has resulted in a couple of extra years for it to improve its products (e.g., the resurgence of Cadillac). General Motors management has also taken the opportunity to lobby the US Government and its employees for changes that, it hopes, will make the corporation more competitive. Interested parties should keep an eye on the UAW’s reaction to these proposals over the coming weeks.
The truth of the matter is that General Motors is in trouble, and Bob Lutz voiced the obvious about Pontiac and Buick. General Motors simply has not had sufficient free cash to fund the resurgence of the two brands given the cash infusion required to also revive Cadillac. Even GM’s recent decision to cancel a new vehicle platform (code-named Zeta) will especially impact both Pontiac and Buick. Both brands were slated to receive multiple new product offerings from the vehicle architecture. If General Motors continues to sell 4-million vehicles a year, drastic action is required to address their cost structure. And, the situation will only get worse as material and overhead costs continue to rise.
But what can General Motors do? We say start the process of eliminating Pontiac and seriously consider eliminating Buick as well. Next, GM must trim their work force, scale back on future financial promises to employees, and quit making multi-billion dollar mistakes (e.g. Fiat). General Motors needs to continue to focus on products that customers want to buy, which will allow General Motors to significantly reduce incentives. As an example, consider both Chrysler and Cadillac, which have each demonstrated that automobiles that have either the styling or features that customer’s desire can and will sell. Eliminating Pontiac & Buick will allow General Motors to better utilize their scarce resources.
Whether Lutz’s comments will materialize is still up in the air. However, General Motors faces an uphill battle within the automobile industry. Competing on a lower price strategy alone can only be sustained when your company is the low cost competitor. And although GM’s quality is improving, they do not possess the ‘high-quality’ reputation like some of their competition. General Motor’s incentive structure also hints at the lack of value within their product line, which induces customers to move their buying-dollars toward better vehicles offered by other companies. Soon, General Motor’s lack of a strong competitive advantage will put the company in an even worse position.

Jon Hassert, Ryan Malone, & Kristin Wisotzkey


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