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Published: Jun 29, 2005 in [email protected]

When a bankruptcy court gave United Airlines the go-ahead last month to terminate its pension plans as a step towards returning to profitability, some observers wondered if General Motors—which posted a $1.1 billion loss on $45.8 billion of sales for the first quarter ending March 31, 2005; and whose commercial paper was downgraded to “junk” status in May—might also turn to Chapter 11 as a way out of its woes. But Jagdish Sheth, a chaired professor of marketing at Emory University’s Goizueta Business School, says that despite some surface similarities, GM’s problems aren’t quite the same as the ones facing the airline industry. Instead, he observes, the issues plaguing GM could perhaps be better compared to Social Security, where built-in cost escalators are overwhelming a shrinking base of revenue.

Pension, Healthcare Costs Are Only Part of the Problem
“GM is certainly suffering from burdensome pension and healthcare costs,” observes Sheth, who is writing a book called Why Good Companies Fail. “But it’s also paying the price for some bad strategies that were first implemented in the 1920s—when a number of failing car companies were put together to form GM—and then were never corrected.”

For a long time, GM was viewed as an American success story. By 1962 the company’s business model—which embraced vertical manufacturing capability and a product line designed to fill the budget to luxury markets—had taken it to a market share of 51.4% of all U.S. auto sales. But by the first quarter of 2005, GM’s market share plunged to 25.2%, there was some doubt about its ability to recover, and the company appeared to be in the crosshairs of billionaire Kirk Kerkorian’s Tracinda Corp., which announced its intention to more than double its stake in GM to nearly 9%.

“While this [investment] looks to elevate the profile of GM’s problems, and maybe force a faster restructuring, we think Tracinda will let management handle the task,” said Banc of America equities analyst Ronald A. Tadross in a May 4, 2005 report. “Capacity reductions, brand terminations, quality investments, asset sales—including large parts of GMAC—and union benefit discussions could be accelerated. But, given the margin and debt disadvantage GM has, cash for these efforts needs to come out of the coffers and that is a gut-wrenching decision because the brands could be dead, as evidenced by the company’s anemic residual values.”

So far the company seems to see the threats as rooted in a lack of effective sales and marketing efforts. In an April 19, 2005 earnings release, Chairman and Chief Executive Officer Rick Wagoner noted that the company’s responses will include “aggressive” product introductions, new marketing initiatives, and further reductions in healthcare and other costs.

An Auto Maker or a Finance Company?
But if GM is serious about a comeback, says Sheth, it will need to pay more attention to the root causes of its predicament. “GM’s current structure can be compared to that of Social Security,” he says. “It has made financial promises to a wide range of existing and retired employees that can only be supported by an increasing level of contributions from new ones. There’s some question about its ability to successfully do this.”

Sheth isn’t exactly surprised by GM’s predicament. After all, at “the basic DNA level,” General Motors has been driven by finances, not operations, he notes.

“GM’s engine has long been its financing activities, such as the 1919 launch of General Motors Acceptance Corporation (GMAC), which provided consumers with the ability to buy GM cars and trucks on an installment plan,” he says. “And management’s preoccupation with finance-driven activity led it to a decision, early in the company’s history, to give each of its many brands a high degree of autonomy. This reduced the company’s ability to capitalize on economies of scales.”

A review of GM’s quarterly filings with the Securities and Exchange Commission lends weight to Sheth’s observations. GMAC’s financing results for example, routinely outpace those of the global automobile manufacturing division. In fact the last time that automotive earnings trumped financing results was back in the fourth quarter of 2002.

Sheth adds that other illustrations of GM’s finance-driven strategy include the June 1984 acquisition of Electronic Data Systems Corporation (EDS), a leading data processing and telecommunications company that was spun off in May 1996; and the acquisition, in June 1985 of Hughes Electronics, and its subsequent disposal in December 2003. In both cases, GM created a “tracking stock”—or a special class of voting common stock that is tied to the earnings performance of a distinct business unit—around the acquisitions.

“GM’s deals don’t always make sense from a car maker’s point of view,” explains Sheth. “A recent example involves the American company’s nearly $2 billion payment to Fiat to get out of an earlier partnership agreement. Separately, GM continues to maintain a decentralized management approach nationally and internationally, which impairs efficiency.”

Unlike Toyota, Hyundai and other manufacturers that have tightly integrated operations with a limited number of brand names, GM has a wide spread of domestic and overseas interests, including Buick, Cadillac, Chevrolet, GMC, Holden, Hummer, Opel, Pontiac, Saab, Saturn and Vauxhall.
“They’re all separate subsidiaries, and each brand is responsible for its own destiny,” he says. “This limits the ability of the company to utilize platforms across brands and spread costs in a more efficient manner.

What’s Different About Ford?
Interestingly, although Ford Motor Company’s debt also was downgraded recently to “junk,” Sheth sees significant differences between Ford and GM.

“To begin with, Ford has always been foremost a car maker, not a financing company,” observes Sheth. “And operationally, although Ford and GM both looked to high-margin SUVs to bolster their bottom line, Ford kept up with changing consumer demand by offering other popular lines, from the Escort to the Mustang, that could take up the slack if demand for SUVs dropped (as it has in the current high-gas price climate). In contrast, GM was caught flat-footed with outdated models that haven’t been able to compensate for the drop-off in SUV volume.”

Sheth views GM’s development and current market position through the prism of a concept he calls The Rule of Three. He previously coauthored a book on the topic.
“In competitive, mature markets, there is only room for three full-line generalists, along with several–in some markets, numerous—product or market specialist,” writes Sheth. “Together, the three ‘inner circle’ competitors typically control, in varying proportions, between 70% and 90% of the market.”

In the auto industry’s late 19th century infancy, some 500 manufacturers were building cars in the U.S. alone, none on a truly national scale, explains Sheth. “It took the 1909 launch of the Model T and Henry Ford’s innovations in mass production to establish a standard and initiate the process of industry consolidation,” he notes. “By 1917, the number of manufacturers dwindled to just 23; by the 1940s, the market had consolidated further into three full-line players (GM, Ford and Chrysler) and several niche players such as American Motors, which failed in its attempts at becoming a generalist and was acquired by Renault and then by Chrysler, Checker and Studebaker.”
Eventually, the Rule of Three prevailed, with GM, Ford and Chrysler dominating the U.S. market.

To keep its dominant position, says Sheth, GM should consider stripping away the subsidiaries’ authority and instead consolidating them into a few easily recognizable brands, such as a luxury division—perhaps Cadillac, and one or two others.
But long-run success will likely require more comprehensive measures, adds Sheth.

Can GM Survive?
“There are three strategies that GM could pursue,” he says. “The first involves breaking up the company, similar to the way that AT&T was split apart.”
This approach would likely involve separating GMAC from the automobile manufacturing operations. Under the scenario, the car maker would carry all of the pension liabilities, and its different brands might be stripped and sold off. Sheth says GM’s breakup value could be as much as three times greater than its current market value.

A second strategy, and the one he thinks GM is most likely to implement, would involve pruning back the company’s position—examining which markets play to its strength, and exiting from the ones that aren’t viable. “The earlier termination of the Oldsmobile line and the recent settlement with Fiat is evidence that GM is considering this option,” notes Sheth. “The drawback is that the car maker is likely to divest itself of unprofitable European operations while retaining domestic ones, which carry the pension and healthcare liabilities.”

Finally, it may use a Chapter 11 filing, or the threat of it, to either dump its multibillion-dollar pension and healthcare obligations on the taxpayer-funded Pension Benefit Guaranty Corp., or to gain givebacks from the unions.

Referring to the latter two options as “low-hanging fruit,” Sheth suggests that GM is likely to initially divest underperforming overseas operations, and then shut down some domestic ones, perhaps Pontiac and Saturn. “The capital from the sale of operations, or from their underlying real estate, would provide funding and buy some time for GM,” he says. “But the longer-term problems would still be there.”

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