How bankruptcy and restructuring are changing the Detroit Three—What it means for suppliers
By Bernard Swiecki
With GM and Chrysler both undergoing bankruptcy restructuring procedures, the North American automotive industry of late 2009 and beyond will be forever different from that which preceded it.
The Detroit Three that emerge from this crisis will be significantly more focused. GM has jettisoned Saab, Saturn, Hummer, and Pontiac. Chrysler will be a smaller, more competitive version of its former self. Ford, even though it is not in bankruptcy, has already shed Jaguar and Land Rover and will likely shed Volvo soon. GM has sold a majority of its General Motors Acceptance Corporation (GMAC) finance arm.
These reductions do more than shrink three companies that were giants from decades ago. They also undo the much more recent bloating that took place during the 1990s, when, flush with SUV and pickup profits, Ford and GM went shopping. They did more than just acquire automotive brands such as Jaguar, Land Rover, Volvo, Saab, and Daewoo. They also bought nonautomaker properties that included vehicle repair shop chains.
But competition, desperation, and the fear of liquidation have a way of providing clarity more lucid than any consultant's flip chart. The Detroit Three have done their homework to identify which assets are critical to survival and to jettison the rest. Smaller but infinitely more focused, they will more closely resemble competitors like Honda and Toyota.
Ford, the only member of the former Detroit Three not surviving on government funds, will, for a time, be the only publicly traded American car company. Because of extensive government ownership, GM and Chrysler will essentially function as private companies for, most likely, at least a year after emerging from bankruptcy.
Both Chrysler and GM will have to handle the delicate situation of being, to a large degree, partially owned by the United Auto Workers (UAW) union. The long-established tradition of pattern negotiations between the union and company management will be delicate in a situation where partial ownership effectively makes the union a de facto participant in company management.
Both the UAW and the U.S. government, of course, have described themselves as reluctant shareholders who plan to sell their stakes in GM and Chrysler in the near future. The UAW thus would be able to partially fund the Voluntary Employee Beneficiary Association (VEBA) account they maintain with the Detroit Three to provide benefits to retirees. Upon selling its stake, the U.S. government would thus recoup a small portion of the funds it provided to keep the companies afloat up to and during their bankruptcy restructuring procedures.
But we've heard these words before. When the Nixon administration consolidated several failing railroads to create Amtrak in 1971, Nixon also pledged that the federal government was a reluctant shareholder and would sell its stake as soon as it was prudent. Nearly 40 years later, Amtrak is no closer to private ownership than it was when those words were uttered.
Car companies, of course, differ from railroads in a number of ways, including the fact that they face much more intense competition from various automakers around the world who sell their cars in the U.S. Amtrak never had to face a Toyota or Volkswagen version of a railroad deciding to compete with it to transport Americans around the country. It's likely that the competitive and global nature of the automotive industry will compel both the UAW and the federal government to sell their GM and Chrysler stakes.
The World Trade Organization (WTO), of which the U.S. is a member, also is likely to weigh in on the matter, claiming that government ownership stakes create unfair advantages, conflicts of interest, and so forth. So far politicians from Japan, for example, have stated that they support the U.S. government's efforts to save GM and Chrysler despite the fact that they believe these efforts violate WTO rules. Whether or not this claim is correct, this apparent tolerance of a rules violation is likely to have an expiration date once GM and Chrysler show significant signs of vitality.
The key to everything, including the reasons for bankruptcy and the goals of the restructuring efforts, is proportion of costs to market share and, therefore, revenue.
As overseas competitors took ever-larger portions of the U.S. market, the Detroit Three gradually became companies with the revenues of small companies but the cost structure of large ones. Everything they have done—from new agreements with the UAW, to selling and eliminating divisions, to shedding manufacturing capacity and dealerships—is aimed at bringing this ratio back to sustainable levels.
Before the global financial crisis that began last September, it appeared that the changes the Detroit Three had made up to that point, including the landmark 2007 contract with the UAW, would suffice. But the crisis proved too much to handle when combined with the companies' already fragile financial situation.
GM's financial situation provides a perfect example. Before bankruptcy, GM had about $74 billion in debt. Managing to keep up with the interest payments on such a debt load was a daunting proposition, particularly when coupled with the need to spend heavily on updating GM's product portfolio. GM now estimates that, after emerging from bankruptcy, it will have about $17.3 billion in total debt. Thanks to the VEBA funds to which the UAW had already agreed, it will also have no obligations to provide former manufacturing employees with benefits.
Suddenly it becomes possible for GM to meet its debt obligations and have enough money left over to invest in new products and, perhaps, make a profit and pay dividends, with market share less than 20 percent.
Repercussions for Suppliers
What does it all mean for suppliers? After all, many were already pushed to their limits even before all this began. Maybe the first thought to keep in mind is that financially healthy automakers are more likely to be good partners for their suppliers than struggling ones.
A recent study by Planning Perspectives reveals that automakers that had traditionally scored at the top of the list for having good relationships with suppliers dropped significantly when they encountered financial problems. Ford, however, improved its score the most of all the firms surveyed. If GM and Chrysler follow Ford's lead when they emerge from bankruptcy, North American automotive suppliers—at least those that are still around—might finally breathe a sigh of relief.