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Rick Wagoner's Game Plan


It's a chief executive's nightmare. The better you execute, the more improvements you make--the more your stock drops. That was the position G. Richard Wagoner Jr. found himself in last October. A day after General Motors Corp. (GM) announced that it had lifted operating earnings 30% in a stagnant car market, Standard & Poor's downgraded the auto maker's debt with no warning. Surprised investors rushed to sell, and the stock dropped 8%. Credit analysts pointed to GM's $76 billion pension fund, which they estimated at the time to be underfunded by as much as $23 billion. GM will have to plow in billions of dollars for years to keep the fund flush, they said.

The earnings gain was no accounting fluke, either. GM finished the year just as strong, with an operating profit of $3.9 billion, nearly double what it earned in 2001, on 5% higher sales of $186.2 billion. GM clearly leads the rest of the U.S. Big Three car companies, reflecting real operational improvements that Wagoner, 49, helped make in the past decade, starting when he was chief financial officer and later as chief operating officer. After GM lost a staggering $30 billion during a single three-year stretch in the early '90s, Wagoner and Chairman John F. "Jack" Smith Jr. forced GM back to basics. They slashed costs, cut payroll, and overhauled aging plants. Once he took over the corner office in May, 2000, CEO Wagoner pulled the efficiency collar even tighter. Now, GM ranks close to Honda Motor Co. (HMC) and Toyota Motor Corp. (TM) in productivity and has made strides in quality. GM also recaptured leadership of the truck business from rival Ford Motor Co. (F), a coup that made the company billions. Last year, GM even nudged up its share of the U.S. market, to 28.3% from 28.1%.

But as good as those moves are, they pale next to the problems of GM's weak car brands and gargantuan pension payments. In essence, Rick Wagoner is battling 30 years of management mistakes that have left him with immense burdens and very little room to maneuver. Chief executives from Frederic Donner to Roger Smith built up a bloated bureaucracy that cranked out boring, low-quality cars. Turf battles at headquarters sapped resources and diverted attention from a rising threat out of Asia and Europe. Those competitors drove away with the U.S. car market. Now they're aiming to do the same in sport-utility vehicles and trucks--the last bastion of U.S. dominance. GM's most profitable segment is also under attack by environmentalists and safety regulators, and more and more buyers are flocking to smaller crossover SUVs.

Even worse for GM was the buildup of lavish health and retirement benefits for workers that it agreed to in fatter days as a way to buy peace with the United Auto Workers. The company says the gap between its pension funding and future liabilities is now $19.3 billion. That means GM will have to pump as much as $4 billion into the fund over this year and next. Providing health care to former and current workers will drain an additional $5 billion per year. The pension costs alone will cut projected 2003 net income from $4.2 billion to $2.8 billion. Providing for retirees saddles each car rolling off a GM assembly line with a $1,350 penalty vs. a Japanese car built in a new, nonunion U.S. plant, says analyst Scott Hill of Sanford C. Bernstein & Co. That's a daunting handicap in an industry that struggles to make an average operating profit of $800 per vehicle.

Those huge legacy costs explain why Wagoner has kept the heat on his competition with the 0% financing deals he unleashed after September 11, 2001. Closing plants and accepting a smaller chunk of the U.S. market--the route his rival, Ford, has taken--would give GM fewer vehicles over which to spread those big pension and health-care costs. And thanks to an onerous deal it struck in 1990 with the UAW, GM has to pay furloughed workers about 70% of their salary for years after they're laid off. Says Wagoner: "We have a huge fixed-cost base. It's 30 years of downsizing and 30 years of increased health-care costs. It puts a premium on us running this business to generate cash.Our goal is to grow. We don't care who we take it from."

All that would make the outlook for GM pretty bleak, except for one thing: Eventually, those legacy costs start to diminish. Starting around 2008, the ranks of GM's elderly retirees will thin, relieving some of the burden. After that, more of the incremental gains Wagoner has been achieving will fall to the bottom line rather than to retirees. The results could be dramatic.

That makes Wagoner's imperative clear: He has to keep up cash flow to cover those costs until they start to shrink. At the same time, he must continue to rack up improvements in quality, efficiency, design, and brand appeal. If he can come anywhere close, he just might pull off an impressive turnaround. A stock market rebound would help immensely. GM's pension fund holds its own if it earns 9% a year on its investments. Each one-point rise above that is worth $700 million to the fund.

With much of the focus on GM's financial crunch, it's easy to lose sight of Wagoner's greatest achievement--and the best reason to believe that he might beat the legacy monster. Walk around GM's sprawling headquarters complex today and you soon realize that against all odds, Wagoner is making real progress in energizing GM's torpid culture. He broke with GM tradition by recruiting two respected outsiders for key positions--Robert A. Lutz as head of product development and John Devine as vice-chairman and chief financial officer. And he has given them extraordinary leeway to fix the company's problems.

To motivate his team, the self-effacing Wagoner leaves his ego at the door and lets his executives do their jobs. "Rick acts more like a coach than a boss," says David E. Cole, director of the Center for Automotive Research (CAR) in Ann Arbor, Mich. Thus it was Lutz who rolled out Cadillac's lavish Sixteen prototype luxury car at the Detroit auto show earlier this month as Wagoner sat in the background. Afterward, Wagoner chatted with a few reporters while Lutz held court beside the 16-cylinder vehicle, surrounded by a huge crowd, drinking a martini, and wearing someone's lipstick mark on his cheek.

That low-key style has helped Wagoner in tearing down GM's warring fiefdoms. Since giving the swaggering Lutz rule over product development, Wagoner has spiked the design-by-committee system and cut the time it takes to develop a new car to 20 months from nearly four years. GM used to have different studios for each division working on car designs that would get passed on to marketing, then engineering, then manufacturing. Lutz has one committee to cover the entire process. Every Thursday, he hashes out what vehicles should look like and which division will build them, along with a small group that includes Group Vice-President for Advanced Vehicle Development Mark T. Hogan, GM North America President Gary L. Cowger, Design Chief Wayne K. Cherry, and Chief Engineer James E. Queen.

But low-key doesn't mean hands-off. Lutz may make the day-to-day decisions on car design, but Wagoner reserves final say. He meets monthly with top execs, who see car designs much earlier in the process. The ones they think are promising move ahead fast. Says retired executive Richard C. Nerod, who ran GM's Latin America operations: "Rick cut out a lot of the infighting and the bull----."

Wagoner also exerts control by imposing tough performance standards. A legendary number-cruncher who rose up through GM's finance division, he holds top managers to strict measures. GM, like most big companies, always had performance goals. But they never went nearly as deep or into as much detail. Says Cowger: "Everything can be measured."

Everyone, too. Even Lutz, the larger-than-life product czar who flies his own fighter jet and sparked Chrysler's 1990s resurgence with cars such as the Dodge Viper and PT Cruiser, isn't exempt. Lutz was judged on 12 criteria last year, from how well he used existing parts to save money in new vehicles to how many engineering hours he cut from the development process.

Clearly, Wagoner's own ideas on how to fix GM have evolved. He seems to have learned from a brush with grand strategic vision back in the '90s, when, like now-deposed Ford CEO Jacques A. Nasser, he explored ways to grow outside of building cars. Wagoner was behind the decision to pump hundreds of millions into GM's OnStar Corp. telematics business and DirecTV satellite-TV service. Neither produced big revenues for GM. Now, with Devine applying a cold dose of realism to GM's finances, there's little illusion that such diversions can fix the cash crunch. "That was a dream a couple of years ago, but it's not reality," Devine says. "The math will tell you that the principal driver of revenue and profits is the car-and-truck business in North America and Europe."

If Wagoner has brought a new intensity to GM, he probably gets it from his mother, Martha, a onetime school teacher. Family members recall one Christmas several years ago when she doggedly kept baking cookies despite a broken arm. "My mom has a task orientation that you sometimes see in my brother," says Judy Pahren, a financial-services manager who is one of Wagoner's two sisters. Rick had a Norman Rockwell upbringing in Richmond, Va. He picked up a rabid devotion to Duke University basketball from his father, George, an accountant at Eskimo Pie Co. Wagoner got a chance to play for the Blue Devils as a walk-on. He demonstrated a deft shot but learned the limits of his athletic ability. "The knock on Rick was that you couldn't slide a phone book under his jump," says roommate Charles H. McCreary III. The devotion to alma mater remains, though: A few years ago, he ordered a custom "Duke blue" Suburban SUV.

After Duke, Wagoner got his MBA at Harvard Business School, surprising some upon graduation when he chose GM over potentially more lucrative jobs on Wall Street. Wagoner's knack for crunching numbers propelled him through stints at GM units in Canada, Europe, and Brazil. His big break came in 1992, when then-CEO Smith tapped him to be CFO after a boardroom coup. Even as CEO, Wagoner is known for a low-key lifestyle. He prides himself on juggling his work schedule to attend games and other activities of his three sons. And when entertaining, Wagoner is more likely to cook on his backyard grill than hire a caterer.

Wagoner's willingness to let others shine is a classic trait of leaders who have boosted their companies to exceptional performance, says Jim Collins, author of Good to Great. As a longtime GM insider, Wagoner has other advantages: He knows what brutal facts need to be confronted, and he can assess which veterans can handle key jobs. Says Collins: "Wagoner has the opportunity to take it back to great." But the odds are stiff--only 11 of 1,435 companies Collins studied made such a lasting transformation. And those that did required an average of seven years to get breakthrough results.

Still, competitors are impressed with the progress Wagoner has made. "I'm a big admirer of his management style," says crosstown rival William C. Ford Jr., chairman and CEO of Ford. He should be--GM's operating profit may not match the $4.6 billion No. 3 Toyota made in just the six months through September. And GM's stock, trading around 37, is down 26% from a year ago. But that performance sure beats Ford's $872 million operating profit and 36% lower stock price.

It's a testament to Wagoner's ability to cut costs that GM managed nearly to double margins in North America last year, to 2.6% of sales. Thanks to efficiency gains, GM is now one of the leanest car builders, with variable costs--labor, parts, outsourced production, etc.--amounting to 62% of revenues, according to UBS Warburg. That puts it ahead of Ford and Chrysler (DCX) at 68%, and it isn't far behind leaders Toyota and Honda at 60%.

With lower costs than its domestic competition, GM is better able to withstand the price war it started with 0% financing. But Wagoner is betting that the cars he plans to launch in the next three years will be good enough to sell on merit, not price. A few "niche" vehicles, such as the hulking Hummer H2, are already out. But the assault begins in earnest later this year with the Chevy Malibu family sedan and Equinox car/SUV crossover, Cadillac SRX small SUV, and Pontiac Grand Prix sedan. "This is one major last-ditch effort to save themselves in the car market," says Joseph Phillippi, a former Wall Street analyst who consults for the industry.

Wagoner, who's not a classic Detroit "car guy," seems content to rely on Lutz and his team to fix the lineup. During one trip through the design studio last year, he spotted a sexy two-door version of the Cadillac CTS sports sedan. "I hope you guys figure out a way to build that," Wagoner said, but offered no solutions, recalls one senior designer. "Rick trusts my judgment implicitly," Lutz says, "but if I came up with some wacky product proposals, he'd pull me back."

The most dramatic gains won't come on a sketch pad anyway but in the way GM selects new car designs and then shepherds them through production. In the past, even if a bold design made it off a drawing board, it had little chance of surviving to the showroom. A concept would go from a designer to the marketing staff, which would try to tailor it to consumers. Then it would go to engineers, who would try to figure out how to build it, and so on. Separate teams worked with suppliers, factories, and parts suppliers on their individual slice of the process, with little interaction.

It was a recipe for mediocrity--and often disaster. The Aztek, which emerged in 2000 as a boxy, garish cross between an SUV and a minivan five years after designers first drew it up as a racy bid for younger drivers, is a prime example. Wagoner was determined to tear up that system by the roots. A few months after taking over, he ordered GM's product developers to ready the SSR concept vehicle for production. A combination of hot rod and pickup truck, it had been a big hit at the Detroit auto show. Wagoner thought its distinctive look, with chrome bars splitting the front grille and taillights, would be a great image builder. But the SSR still had to navigate the old GM system. Because it was announced before engineers had a precise blueprint to build it, the program quickly ran over budget. Today, its cost has ballooned way past the original $300 million projection, to almost $500 million. The $42,000 SSR will hit showrooms this summer, a quick turnaround for GM. But with only 5,000 sales projected per year, it makes for a very expensive showcase.

Since then, Wagoner and Lutz have smoothed things out a bit. Lutz, Cowger, Hogan, and the others decide what goes from the design studios into the funnel of cars that will be considered for funding by GM's Automotive Strategy Board, chaired monthly by Wagoner. Lutz says he and Wagoner have disagreed on some product decisions, but he hasn't been turned down yet. Now, 75% of the engineering work is finished when a program manager sits down to build a car.

That's how GM quickly green-lighted plans to resurrect the Pontiac GTO, its famous 1960s muscle car. For years, Pontiac and Chevrolet wanted a brawny car with rear-wheel drive, which is favored by driving enthusiasts. GM's Australian Holden Ltd. subsidiary had a promising candidate in its Monaro sports coupe, but the idea to bring it to the U.S. never made it out of committee. GM execs simply didn't want to spend what little money it would take to alter the Monaro to meet U.S. safety standards and American styling. Says Lutz: "I just asked, `Why not?"' GM got the program together in less than 18 months. Later this year, Pontiac will roll out the GTO as a 340-horsepower Americanized Monaro.

Wagoner has also streamlined GM's factories. GM is now the most productive domestic auto maker, having cut the time it takes to assemble a vehicle from an average of 32 hours in 1998 to 26 hours in 2001, according to Harbour & Associates. That compares with 27 for Ford, almost 31 at DaimlerChrysler, 22.5 at Toyota, and 17.9 at Nissan. A big factor was expanding parts shared across vehicles. The new Chevy Malibu, for instance, uses the same platform and many of the same parts as the Saab 9-3 sedan (table, page 54). GM's plants are also more flexible--each of seven full-size pickup and SUV plants can make any of the vehicles designed on that platform.

The cars rolling off GM's assembly lines today are undeniably better built than they used to be. Once ranked below the industry average, GM trails only Honda and Toyota in J.D. Power & Associates Inc.'s initial quality survey, which measures problems in the first 90 days of ownership. Some cars, such as the Chevrolet Impala, even beat the likes of the Toyota Camry. Last year, Consumer Reports recommended 13 GM vehicles--representing 41% of its sales volume--up from 5 last year. But one of GM's most stubborn woes is that many buyers still perceive the Chevy, Pontiac, and Buick brands as musty and second-rate. GM needs incentives averaging $3,800 a vehicle--more than twice what Toyota spends.

The biggest risk to GM's lineup is at the top. Its popular SUVs and pickups accounted for about 90% of profits last year but are under increasing assault from foreign competitors and safety regulators. Like his competitors, Wagoner is banking on crossover vehicles, which combine SUV-like space and looks with a carlike ride and better fuel economy, as a hedge against a big-truck backlash. Cadillac's luxury SRX hits the market this year as a viable rival to the Lexus RX 330 and Mercedes M-class, and Chevy will launch its Equinox as an all-wheel drive crossover. Next year, GM will start offering pickups and SUVs with hybrid gas/electric engines. New designs are also in the works. Lutz has tentatively approved a highly stylized 2007 replacement for the Chevy Silverado and GMC Sierra pickups, which hold a commanding 40% of the pickup market. It will be based on the slick Cheyenne concept truck that GM unveiled in January, which has improved driver and passenger room and doors on each side of the pickup bed to provide easier cargo access. But in small SUVs and gas mileage, GM is playing catch-up to the Japanese.

Wagoner and his team have little choice but to wait out their biggest mess--those massive health and pension costs. Wagoner is brutally realistic: "We'd be accused of a pipe dream if we said in 10 years these issues will go away." GM pays its UAW workers only slightly more per hour than Toyota, Honda, and Nissan (NSANY) pay their American factory workers. But the cost of pension and health-care benefits for current workers is huge--about $24 per hour at GM, vs. $12 at the foreign factories. Pension obligations swelled after the 1990 contract, when then-Chairman Robert Stempel practically guaranteed almost no layoffs. Underestimating the speed of its decline, GM agreed to pay workers for years after a furlough. As losses mounted, GM resorted to early-retirement offers--avoiding billions in unemployment benefits but adding thousands of retirees. Since GM was shrinking faster than Ford, its pension rolls grew more quickly, to 2.5 retirees per worker today, vs. Ford's 1-to-1 ratio. Last year, GM plowed almost $5 billion into the pension fund to shore it up as stock prices fell. But Carol Levenson, an analyst for bond research firm Gimme Credit, points out that GM had to take on $4.6 billion in debt to do it. Until the stock and bond markets spring back, it's three steps forward and two steps back.

That pressure should ease somewhat over the next decade. GM's average worker is 48 years old--five years older than those at Ford or Chrysler. GM's total number of retirees will drop below existing levels by 2010, says CAR's labor and manufacturing analyst, Sean McAlinden. Wagoner believes that even without another bull market to boost the pension fund, GM can handle the drain and maintain its $7 billion capital-spending budget. Meanwhile, to pay down the pension shortfall, Devine is working to sell Hughes Electronics' DirecTV business, possibly to News Corp. (NWS)

Closing the gap on health-care costs will be tougher. This summer, GM and the UAW will start working on a new four-year labor agreement. GM is almost certain to ask for higher co-payments from its 138,000 UAW employees. The union is almost certain to balk. "We don't have an interest in cost-shifting," says Richard Shoemaker, head of the UAW's GM department. GM also is one of many companies pushing to have Medicare pick up a greater share of retiree drug costs. But even Wagoner admits: "I don't see that happening soon."

Can Wagoner return GM to dominance? He has made heroic gains. But he's taking nothing for granted. At a speech in Detroit last year, he told the story of William C. Durant, who pulled together such companies as Buick, Cadillac, and Olds to form GM in 1908. But Durant was more interested in cutting deals than managing, so he wound up running a bowling alley in Flint. "That fate has haunted GM chairmen for decades," Wagoner told his audience. He was joking, of course. But Wagoner will be the first to tell you that his own future is up in the air. It all depends on whether he can save GM from its past. By David Welch, with Kathleen Kerwin, in Detroit


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