How Detroit's Automakers Went from Kings of the Road to
Roadkill
February 2009
The Wall Street Journal
Joseph B. White
Senior Editor
JOSEPH B. WHITE is a senior editor in the Washington, D.C., bureau of The Wall
Street Journal. A graduate of Harvard University, he has worked for the Journal
since 1987, and for most of that time he covered the auto industry, serving as
Detroit bureau chief from 1998-2007. He writes a weekly column on the car
business and the regulatory and social issues that surround it for the Journal's
online and print editions, and contributes new-car reviews to SmartMoney
magazine. Mr. White is co-author (with Paul Ingrassia) of Comeback: The Fall and
Rise of the American Automobile Industry, and won the Pulitzer Prize for
reporting in 1993.
The following is adapted from a speech delivered at Hillsdale College on January
26, 2009, at a seminar on the topic, "Cars and Trucks, Markets and Governments,"
co-sponsored by the Center for Constructive Alternatives and the Ludwig von
Mises Lecture Series.
I'D LIKE to start by congratulating all of you. You are all now in the auto
business, the Sport of Kings-or in our case, presidents and members of Congress.
Without your support—and I assume that most of you are fortunate enough to pay
taxes—General Motors and Chrysler would very likely be getting measured by the
undertakers of the bankruptcy courts. But make no mistake. What has happened to
GM is essentially bankruptcy by other means, and that is an extraordinary event
in the political and economic history of our country.
GM is an institution that survived in its early years the kind of management
turbulence we've come to associate with particularly chaotic Internet startups.
But with Alfred P. Sloan in charge, GM settled down to become the very model of
the modern corporation. It navigated through the Great Depression, and
negotiated the transition from producing tanks and other military materiel
during World War II to peacetime production of cars and trucks. It was global
before global was cool, as its current chairman used to say. By the mid-1950s
the company was the symbol of American industrial power—the largest industrial
corporation in the world. It owned more than half the U.S. market. It set the
trends in styling and technology, and even when it did not it was such a fast
and effective follower that it could fairly easily hold its competitors in their
places. And it held the distinction as the world's largest automaker until just
a year or so ago.
How does a juggernaut like this become the basket case that we see before us
today? I will oversimplify matters and touch on five factors that contributed to
the current crisis—a crisis that has been more than 30 years in the making.
First, Detroit underestimated the competition—in more ways than one.
Second, GM mismanaged its relationship with the United Auto Workers, and the UAW
in its turn did nothing to encourage GM (or Ford or Chrysler) to defuse the
demographic time bomb that has now blown up their collective future.
Third, GM, Ford, and Chrysler handled failure better than success. When they
made money, they tended to squander it on ill-conceived diversification schemes.
It was when they were in trouble that they often did their most innovative
work—the first minivans at Chrysler, the first Ford Taurus, and more recently
the Chevy Volt were ideas born out of crisis.
Fourth, GM (and Ford and Chrysler) relied too heavily on a few, gas-hungry truck
and SUV lines for all their profits-plus the money they needed to cover losses
on many of their car lines. They did this for a good reason: When gas was cheap,
big gas-guzzling trucks were exactly what their customers wanted—until they were
not.
Fifth, GM refused to accept that to survive it could not remain what it was in
the 1950s and 1960s—with multiple brands and a dominant market share. Instead,
it used short-term strategies such as zero percent financing to avoid reckoning
with the consequences of globalization and its own mistakes.
Competition from Overseas
In hindsight, it's apparent that the gas shocks of the 1970s hit Detroit at a
time when they were particularly vulnerable. They were a decadent empire—Rome in
the reign of Nero. The pinnacles of the Detroit art were crudely engineered
muscle cars. The mainstream products were large, V8-powered, rear-wheel-drive
sedans and station wagons. The Detroit marketing and engineering machinery
didn't comprehend the appeal of cars like the Volkswagen Beetle or the Datsun
240Z.
But it took the spike in gas prices—and the economic disruptions it caused—to
really open the door for the Japanese automakers.
Remember, Toyota and Honda were relative pipsqueaks in those days. They did not
have much more going for them in the American market prior to the first Arab oil
embargo than Chinese automakers have today, or Korean automakers did 15 years
ago. The oil shocks, however, convinced a huge and influential cohort of
American consumers to give fuel-efficient Japanese cars a try. Equally
important, the oil shocks persuaded some of the most aggressive of America's car
dealers to try them.
The Detroit automakers believed the Japanese could be stopped by import quotas.
They initially dismissed reports about the high quality of Japanese cars. They
later assumed the Japanese could never replicate their low-cost manufacturing
systems in America. Plus they believed initially that the low production cost of
Japanese cars was the result of automation and unfair trading practices.
(Undoubtedly, the cheap yen was a big help.) In any case, they figured that the
Japanese would be stuck in a niche of small, economy cars and that the damage
could be contained as customers grew out of their small car phase of life.
They were wrong on all counts.
There were Cassandras—plenty of them. At GM, an executive named Alex Mair gave
detailed presentations on why Japanese cars were superior to GM's—lighter, more
fuel efficient, and less costly to build. He set up a war room at GM's technical
center with displays showing how Honda devised low-cost, high-quality engine
parts, and how Japanese automakers designed factories that were roughly half the
size of a GM plant but produced the same number of vehicles.
Mair would hold up a connecting rod—the piece of metal in an engine that
connects the piston to the crankshaft. The one made by GM was bulky and crudely
shaped with big tabs on the ends. Workers assembling the engines would grind
down those tabs so that the weight of the piston and rod assembly would be
balanced. By contrast, the connecting rod made by Honda was smaller, thinner,
and almost like a piece of sculpture. It didn't have ugly tabs on the end,
because it was designed to be properly balanced right out of the forge. Mair's
point was simple: If you pay careful attention to designing an elegant,
lightweight connecting rod, then the engine will be lighter and quieter, the car
around the engine can be more efficient, the brakes will have less mass to stop,
and the engine will feel more responsive because it has less weight to move.
Another person who warned GM early on about the nature of the Japanese challenge
was Jim Harbour. In the early 1980s, he took it into his head to try to tell
GM's executives just how much more efficient Japanese factories really were,
measured by hours of labor per car produced. The productivity gap was
startling—the Japanese plants were about twice as efficient. GM's president at
the time responded by barring Jim Harbour from company property.
By the late 1980s, GM's chairman, Roger Smith, had figured out that his company
had something to learn from the Japanese. He just didn't know what it was. He
poured billions into new, heavily automated U.S. factories—including an effort
to build an experimental "lights out" factory that had almost no hourly workers.
He entered a joint venture with Toyota to reopen an old GM factory in
California, called New United Motor Manufacturing, Inc., or NUMMI. The idea was
that GM managers could go to NUMMI to see up close what the "secret" of Toyota's
assembly system was. Smith also launched what he promoted as an entirely new car
company, Saturn, which was meant to pioneer both a more cooperative relationship
with UAW workers and a new way of selling cars.
None of these was a bad idea. But GM took too long to learn the lessons from
these experiments—good or bad. The automation strategy fell on its face because
the robots didn't work properly, and the cars they built struck many consumers
as blandly styled and of poor quality. NUMMI did give GM managers valuable
information about Toyota's manufacturing and management system, which a team of
MIT researchers would later call "lean production." But too many of the GM
managers who gained knowledge from NUMMI were unable to make an impact on GM's
core North American business.
Why? I believe it was because the UAW and GM middle managers quite
understandably focused on the fact that Toyota's production system required only
about half the workers GM had at a typical factory at the time. That was an
equation the union wouldn't accept. The UAW demanded that GM keep paying workers
displaced by new technology or other shifts in production strategy, which led to
the creation of what became known as the Jobs Bank. That program discouraged GM
from closing factories and encouraged efforts to sustain high levels of
production even when demand fell.
GM and the UAW
This brings me to the relationship between Detroit management and the UAW.
It is likely that if no Japanese or European manufacturers had built plants in
the U.S.—in other words, if imports were still really imports—the Detroit
carmakers would not be in their current straits, although we as consumers would
probably be paying more for cars and have fewer choices than we do. The fact is
that the Detroit Three's post-World War II business strategies were doomed from
the day in 1982 when the first Honda Accord rolled off a non-union assembly line
in Ohio. After that it soon became clear that the Japanese automakers—and
others—could build cars in the U.S. with relatively young, non-union labor
forces that quickly learned how to thrive in the efficient production systems
those companies operated.
Being new has enormous advantages in a capital-intensive, technology-intensive
business like automaking. Honda, Toyota, Nissan, and later BMW, Mercedes, and
Hyundai, had new factories, often subsidized by the host state, that were
designed to use the latest manufacturing processes and technology. And they had
new work forces. This was an advantage not because they paid them less per
hour—generally non-union autoworkers receive about what UAW men and women earn
in GM assembly plants—but because the new, non-union companies didn't have to
bear additional costs for health care and pensions for hundreds of thousands of
retirees.
Moreover, the new American manufacturers didn't have to compensate workers for
the change from the old mass production methods to the new lean production
approach. GM did—which is why GM created the Jobs Bank. The idea was that if UAW
workers believed they wouldn't be fired if GM got more efficient, then they
might embrace the new methods. Of course, we know how that turned out. The Jobs
Bank became little more than a welfare system for people who had nothing more to
contribute because GM's dropping market share had made their jobs superfluous.
Health care is a similar story. GM's leaders—and the UAW's—knew by the early
1990s that the combination of rising health care costs and the longevity of GM's
retired workers threatened the company. But GM management backed away from a
confrontation with the UAW over health care in 1993, and in every national
contract cycle afterwards until 2005—when the company's nearness to collapse
finally became clear to everyone.
In testimony before Congress this December, GM's CEO Rick Wagoner said that GM
has spent $103 billion during the past 15 years funding its pension and retiree
health-care obligations. That is nearly $7 billion a year—more than GM's capital
spending budget for new models this year. Why wasn't Rick Wagoner making this
point in 1998, or 1999, or even 2003? Even now, GM doesn't seem willing to treat
the situation like the emergency it is. Under the current contract, the UAW will
pay for retiree health-care costs using a fund negotiated in last year's
contract—but that won't start until 2010. GM is on the hook to contribute $20
billion to that fund over the next several years—unless it can renegotiate that
deal under federal supervision.
Quality is Job One
Rick Wagoner told Congress: "Obviously, if we had the $103 billion and could use
it for other things, it would enable us to be even farther ahead on technology
or newer equipment in our plants, or whatever." Whatever, indeed.
This is a good place to talk about the Detroit mistake that matters most to most
people: quality. By quality, I mean both the absence of defects and the appeal
of the materials, design, and workmanship built into a car. I believe most
people who buy a car also think of how durable and reliable a car is over time
when they think of quality.
The failure of the Detroit automakers to keep pace with the new standards of
reliability and defect-free assembly set by Toyota and Honda during the 1980s is
well known, and still haunts them today. The really bad Detroit cars of the late
1970s and early to mid-1980s launched a cycle that has proven disastrous for all
three companies. Poor design and bad reliability records led to customer
dissatisfaction, which led to weaker demand for new Detroit cars as well as used
ones. Customers were willing to buy Detroit cars—but only if they received a
discount in advance for the mechanical problems they assumed they would have.
During the 1990s and the 2000s, a number of the surveys that industry executives
accept as reliable guides to new vehicle quality began to show that the best of
GM's and Ford's new models were almost as good—and in some cases better—in terms
of being free of defects than comparable Toyotas, Hondas, or Nissans. But the
Detroit brands still had a problem: They started $2,000 or more behind the best
Japanese brands in terms of per-car costs, mainly because of labor and legacy
costs, with a big helping of inefficient management thrown in. To overcome that
deficit, GM and Ford (and Chrysler) resorted to aggressive cost-cutting and
low-bid purchasing strategies with their materials suppliers.
Unfortunately, customers could see the low-bid approach in the design and
materials used for Detroit cars. So even though objective measures of defects
and things gone wrong showed new Detroit cars getting better and better,
customers still demanded deep discounts for both new and used Detroit models.
This drove down the resale value of used Detroit cars, which in turn made it
harder for the Detroit brands to charge enough for the new vehicles to overcome
their cost gap.
GM, Ford, and Chrysler compounded this problem by trying to generate the cash to
cover their health care and pension bills by building more cars than the market
demanded, and then "selling" them to rental car fleets. When those fleet cars
bounced back to used car lots, where they competed with new vehicles that were
essentially indistinguishable except for the higher price tag, they helped drive
down resale values even more.
So the billions spent on legacy costs are matched by billions more in revenue
that the Detroit automakers never saw because of the way they mismanaged supply
and demand. This is why the Detroit brands appear to be lagging behind not just
in hybrids—and it remains to be seen how durable that market is—but also in
terms of the refinement and technology offered in their conventional cars.
What to Build?
The recent spectacle of the Diminished Three CEOs and the UAW president
groveling before Congress has us focused now on how Detroit has mishandled
adversity. A more important question is why they did so badly when times were
good.
Consider GM. In 2000 Rick Wagoner, his senior executive team, and a flock of
auto journalists jetted off to a villa in Italy for a seminar on how the GM of
the 21st century was going to look. Wagoner and his team talked a lot about how
GM was going to gain sales and profit from a "network" of alliances with
automakers such as Subaru, Suzuki, Isuzu, and Fiat—automakers into which GM had
invested capital. They talked about how they were going to use the Internet to
turbocharge the company's performance. And so on. But five years later, all of
this was in tatters. Much of the capital GM invested in its alliance partners
was lost when the company was forced to sell out at distressed prices. Fiat was
the worst of all. GM had to pay Fiat $2 billion to get out of the deal—never
mind getting back the $2 billion it had invested up front to buy 20 percent of
Fiat Auto. GM said it saved $1 billion a year thanks to the Fiat partnership.
Obviously, whatever those gains were, they didn't help GM become profitable.
At least GM didn't use the cash it rolled up during the 1990s boom to buy
junkyards, as Ford did. But GM did see an opportunity in the money to be made
from selling mortgages, and plunged its GMAC financing operation aggressively
into that market. Of course, GM didn't see the crash in subprime mortgages
coming, either, and now GMAC is effectively bankrupt.
GM's many critics argue that what they should have done with the money they
spent on UAW legacy costs and bad diversification schemes was to develop
electric cars and hybrids, instead of continuing to base their U.S. business on
the same large, V8 powered, rear-wheel-drive formula they used in the 60s—except
that now these vehicles were sold as SUVs instead of muscle cars. And indeed,
Detroit did depend too heavily on pickup trucks and SUVs for profits. But they
did so for understandable reasons. These were the vehicles that consumers wanted
to buy from them. Also, these were the vehicles that government policy
encouraged them to build.
When gas was cheap, big gas-guzzling trucks were exactly what GM customers
wanted. Consumers didn't want Detroit's imitation Toyota Camrys. Toyota was
building more than enough real Camrys down in Kentucky. GM made profits of as
much as $8,000 per truck—and lost money on many of its cars. Federal fuel
economy rules introduced in 1975 forced GM to shrink its cars so that they could
average 27.5 miles per gallon. GM did this poorly. (Remember the Chevy Citation
or the Cadillac Cimarron?) But federal laws allowed "light trucks" to meet a
lower mileage standard. This kink in federal law allowed GM, Ford, and Chrysler
to design innovative products that Americans clamored to buy when gas was cheap:
SUVs. When Ford launched the Explorer, and GM later launched the Tahoe and the
upgraded Suburban, it was the Japanese companies that were envious. In fact, one
reason why Toyota is on its way to a loss for 2008—its first annual loss in 70
years—is that it built too many factories in the U.S. in order to build more
SUVs and pickups.
One irony of the current situation is that the only vehicles likely to generate
the cash GM and the others need right now to rebuild are the same gas-guzzlers
that Washington no longer wants them to build. Even New York Times columnist
Thomas Friedman has now come to realize that you can't ask Detroit to sell tiny,
expensive hybrids when gasoline is under $2 a gallon. We have two contradictory
energy policies: The first demands cheap gas at all costs. The second demands
that Detroit should substantially increase the average mileage of its cars to 35
or even 40 miles per gallon across the board. How the Obama administration will
square this circle, I don't know.
Thinking Anew
So now, where are we? GM has become Government Motors. With the U.S. Treasury
standing in for the DuPonts of old, GM is going to try to reinvent itself. One
challenge among many for GM in this process will be coming to terms with the
reality that the U.S. market is too fractured, and has too many volume
manufacturers, for any one of them to expect to control the kind of market share
and pricing power GM had in its heyday. Today, according to Wardsauto.com, there
are ten foreign-owned automakers with U.S. factories that assembled 3.9 million
cars, pickups, and SUVs in 2007, before auto demand began to collapse. That's
more than Ford's and Chrysler's U.S. production combined.
GM's efforts to cling to its 1950s self—with the old Sloanian ladder brands of
Chevy, Pontiac, Buick, and Cadillac, plus Saturn, Saab, Hummer, and GMC—have led
its management into one dark wood of error after another. Since 2001, GM's
marketing strategy has come down to a single idea: zero percent financing. This
was the automotive version of the addictive, easy credit that ultimately
destroyed the housing market. Cut-rate loans, offered to decreasingly
credit-worthy buyers, propped up sales and delayed the day of reckoning. But it
didn't delay it long enough. The house of cards began tumbling in 2005, and I
would say it has now collapsed fully.
Between 1995 and 2007, GM managed to earn a cumulative total of $13.5 billion.
That's three-tenths of one percent of the total revenues during that period of
more than $4 trillion—and those are nominal dollars, not adjusted for inflation.
Between 1990 and 2007, GM lost a combined total of about $33 billion. The six
unprofitable years wiped out the gains from 12 profitable years, and then some.
But old habits die hard. Within hours of clinching a $6 billion government
bailout last month, GMAC and GM were back to promoting zero-interest loans.
During the 1980s and 1990s, GM's leaders refused—and I believe some still
refuse—to accept the reality of the presence of so many new automakers in the
U.S. market, more than at any time since the 1920s. This hard truth means the
company's U.S. market share going forward isn't going to return to the 40
percent levels of the mid-1980s, or the 30 percent levels of the 1990s, or even
the mid-20 percent levels we have seen more recently. One thing to watch as GM
tries to restructure now will be what assumptions the company makes about its
share of the U.S. market going forward. If they call for anything higher than 15
percent, I would be suspicious.
Since all of you are now part owners of this enterprise, I would urge all of you
to pay close attention, since what's about to unfold has no clear precedent in
our nation's economic history. The closest parallels I can see are Renault in
France, Volkswagen in Germany, and the various state-controlled Chinese
automakers. But none of these companies is as large as GM, and none of these
companies is exactly a model for what GM should want to become.
As I have tried to suggest, it's hard enough for professional managers and
technicians—who have a clear profit motive—to run an enterprise as complex as a
global car company. What will be the fate of a quasi-nationalized enterprise
whose "board of directors" will now include 535 members of Congress, plus
various agencies of the Executive Branch? As a property owner in suburban
Detroit, I can only hope for the best.