Friday, May 13, 2005

GENERAL MOTOR’S RIDE DOWNHILL

G
eneral Motors Corp., the world’s largest automaker, is in red. It reported a consolidated loss of $1.1 billion for Q1 2005. Although GM has 28 models among segment top three in initial quality and dependability studies by the J.D Power and Associates, its market share in North America declined to 25.2% in Q1 2005, down from 26.3% last year. The stock price continues a downward trend, declining from $68 in end 2004, to the current price of $31. The credit rating has been downgraded to a junk status. CEO Rick Wagoner faces some of the toughest challenges in Corporate America: rapidly shrinking market share, restrictive labor rules, growing foreign competition, and a $1,600 per car cost disadvantage compared to Asian competitors.
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Moreover, all his strategic options seem messy. Should he anger dealers by culling weak car brands they don't want to lose? Or does he antagonize his unions by aggressively cutting the fat benefits they so treasure? No easy choices here. Perhaps that's why Wagoner has been desperately trying to maintain the status quo rather than face the inevitable need for seismic change. But half measures won't do at the $193 billion giant. Instead, GM must commit itself to a risky and costly transformation if this turnaround tale has any hope of a happy ending.

TUNNEL VISION
O
wing to management hubris that tolerated sluggish responses to its threatened industry dominance, GM has found itself stuck in second gear for a quarter century. Dealers, eager to protect their own showrooms, have been loath to let the company shrink the number of brands it offers. Asian competitors gain an advantage by spreading development and marketing dollars across fewer nameplates. And United Auto Workers leaders, fixated on maximizing the take of their members, have saddled GM with work rules and benefit costs that make it unable to compete globally. The result of all this self-interest and tunnel vision: GM has effectively become a finance company that actually loses money making cars.

INDUSTRY OVERVIEW AND ANALYSIS
A
s elicited in the recent S&P Industry report, with pressure from higher raw material and healthcare costs, expenses for retirees, increased competition, greater incentives, and lower production volume, profits directly from manufacturing and selling vehicles have shriveled for the US big three auto-manufacturers. However, profits from financial operations grew. As a result, they are vulnerable to decreased financial profits, a risk that should increase in the expected rising interest rate environment. It also means that they need to improve profitability from their core manufacturing operations. Automobile inventories, especially for the two largest domestic brands (GM and Ford), are above average.

Profit margins of manufacturers have been hurt due to rising prices of inputs as a result of consolidation of steel suppliers with increased pricing power, and manufacturers have been unable to pass increased costs to consumers due to fierce competition in the US market. However, consolidation of suppliers also contributed to more efficiency and lower cost to produce vehicles.

While the domestic market is saturated, growth in international markets provides domestic manufacturers opportunity for sales and profit growth. Many, including GM, have taken joint venture projects in China. Capturing large market share is vital in the industry due to economies of scale. However, the “Big Three” US automakers have been losing shares to foreign companies in the last few years.

With more information available on the Internet and overall improved quality among manufacturers, buyers have gained substantial bargaining power based on price. With market share at stake, many manufacturers offer generous incentives in the forms of rebates and discounted financing which further cut into their low profit margins.
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MUST DO…
A
nalysts at the Business Week feel that first, management has to give up the naive notion that it can survive by simply holding on until the retiree base begins dying off later this decade. Also, GM's unions must accept that the days of some of their most lucrative benefits have passed. Such changes will hurt, but because of GM's huge number of current and retired workers, small changes reap big savings. Management must address such strategic challenges while GM still has time and cash to mount a comeback.

Second, GM dealers have to recognize that the auto maker's collection of me-too nameplates has to be trimmed. GM has 89 car nameplates across eight brands in North America; Toyota Motor (TM ) Corp. has only 26 nameplates across three brands. Triage is warranted on one or two GM brands so the remaining ones can get the distinctive vehicles and marketing support they'll need to beat back competition from the likes of Toyota and Honda, and eventually new entrants from China. This is unavoidable if they hope to match the leaner selling structures of Asian competitors.

Also, GM should continue to focus on external and growing markets like China, where it already has an establishment, as this would provide a natural hedge to a certain extent to its performance with relation to the US economy.

Finally, shareholders have a part to play. They must allow management to use some of its huge cash horde to shutter up to four assembly plants, fund early retirement buyouts for thousands of workers, and speed up replacement of GM's aging car models -- all while probably cutting its dividend. That's asking a lot from folks who already have seen $38 billion in GM market value evaporate over the last five years. But if they don't aggressively push for transforming the behemoth quickly into a smaller and eventually more profitable company, they risk watching the value of their shares erode even further.

RAY OF HOPE?
A
dvent of the Kerkorian: In a recent development, Kerk Kerkorian, the famed corporate investor, doubled his stake in GM to 8.8%. Analysts from JP Morgan feel that this is likely to be beneficial to the overall cause of the firm and its shareholders, and may particularly bring about some radical strategy changes and more empowered negotiations with the Union. The shareholders may get the cash dividends that were earlier threatened due to GM’s losses.

Toyota’s helping hand? – Toyota's Chairman has recently urged Japanese car companies to raise prices to help ailing U.S. rivals. At the same time, Toyota has been investing in its US manufacturing facility even as GM and Ford find it difficult to invest capital in view of downgraded junk bonds (Boston Herald). A friend or a foe?

Unless all sides share the pain, this American icon could easily find itself on a collision course with Chapter 11 in as little as five years -- even sooner if the economy turns sour. That's a race nobody wins.

Submitted by Pooja Vivek, Shigeru Kusunoki, Atima Bhatnagar

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