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Running Out Of Gas


On Mar. 10, General Motors (GM) Chairman and Chief Executive G. Richard Wagoner Jr. hopped on the company jet with his chief financial officer and some top sales execs to visit dealers in Dallas and on the West Coast. The idea of the trip was to shore up morale -- and, more important, to get some answers to the vexing question of why GM can't pump up market share and wean buyers off profit-eating incentives. One Texas dealer says Wagoner was extremely upbeat, vowing that some of GM's new and upcoming models and a new advertising push would turn things around.

Less than a week later, Wagoner was decidedly less ebullient. On Mar. 16 he and CFO John M. Devine stunned Wall Street with a warning that GM's flagging sales will result in a huge hit to the bottom line in 2005. With market share sliding in the first two months of the year, from 27.2% for 2004 to 24.9% -- the lowest level since a two-month strike shut the company down in 1998 -- GM as a whole expects a net loss of $846 million in the first quarter.

Like more and more companies these days, GM relies increasingly for profits on its financing arm. But while General Motors Acceptance Corp. (GMAC) is expected to earn close to $2.5 billion this year, significant losses in the auto unit could come close to wiping that number out. The company says it could earn as little as $600 million in 2005, down sharply from $3.6 billion last year.

Some analysts think even that figure is optimistic. As investors fled the stock, pushing it down 14% on Mar. 16, to 29, a somber Wagoner told investors and analysts: "We have to address some long-standing fundamental problems with the company."

NO REBOUND IN SIGHT

He does -- and fast. It's becoming painfully obvious that Wagoner's four-year-old strategy of using rebates to grab market share and generate cash has failed. Company insiders say the 52-year-old CEO is getting heat from the board, and some mid-level managers are losing faith the top brass will make the bold moves needed to execute a quick turnaround. Without a dramatic rebound in sales -- an unlikely prospect anytime soon -- GM may be forced to shrink the company to a size that more closely matches its diminished market share. Wagoner may have to go back to the United Auto Workers to get concessions to trim his workforce and lower health-care costs. He will also have to squarely face a dilemma that has haunted GM for years: Can it really continue to support eight competing divisions? "GM is simply too big," says Sean McAlinden, chief economist at the Center for Automotive Research. "They have to shrink."

That's something Wagoner has been loath to do. For three years he has tried to stave off market-share losses by boosting sales incentives and selling more cars to rental fleets. At first the gamble seemed to make sense. Since union contracts force GM to pay workers at least 75% of their take-home pay when they are laid off, Wagoner figured he might as well have them working.

By selling more cars, even at lower margins, GM would preserve its customer base. More important, that was the only way GM could generate enough cash to pay its huge retiree obligations. The idea was to slog along until 2008, when the company's retiree population is projected to start declining. By then, Wagoner & Co. reasoned, the company's new lineup of cars, sport-utility vehicles, and trucks also would be out, allowing GM to pull back on profit-eating incentives.

Things haven't worked out as planned, though. Wagoner's strategy is dependent on GM at least maintaining the market share of roughly 28% it has held in recent years, plus some growth in the auto business. But industry sales are off 5% from their 2000 peak of 17.4 million vehicles. What's more, amid rising gasoline prices, sales of large SUVs are slumping. As one of GM's strongest markets, that segment has been crucial for both sales and profits. Full-size SUV sales are off more than 20% this year, and GM's Chevrolet Tahoe sales are down 30%. Meanwhile, sales of the company's new passenger cars -- the Pontiac G6, Buick LaCrosse, and Chevrolet Cobalt -- are too sluggish to pick up the slack.

Add it all up, and GM's finances start to look very precarious. Dropping two percentage points of market share may not sound like a big deal. But in GM's case even a small shift makes a huge difference, because it can't cut its costs to match the sales drop. In addition to paying huge sums for idle workers, its health-care costs for retirees are growing. As a result, estimates Deutsche Bank (DB) analyst Rod Lache, each percentage point of lost market share means roughly $1 billion in lost profits to GM's North American operations.

That's not all. GM's European operations are expected to lose $500 million this year. There also will be some one-time charges coming from GM's ongoing restructuring in Europe. The upshot, predicts Merrill Lynch & Co. analyst John Casesa, is that the global auto business could lose $2.2 billion this year. That means that GM overall could earn less than $300 million.

DISAPPEARING DIVIDEND

The steep losses in the auto unit also mean that GM will have negative cash flow. GM puts the shortfall at $2 billion. And while that will be offset by a $2 billion dividend that the GMAC finance arm will pay to GM, the company must pay $1.5 billion to Fiat to get out of its relationship with the ailing Italian carmaker. Add to that the fact that GM will take a charge for restructuring its European operations, and the company is starting to eat into its $23 billion cash hoard.

What must GM do to turn itself around? Many analysts argue that Wagoner & Co. need to come to terms with the reality that maintaining market share of even 25% is unlikely over the long term. Consider that fewer than two-thirds of GM's sales are retail. The rest go to rental-car agencies or to company employees and their families -- sales that provide lower gross margins. Take those sales out -- or reduce them to the lower levels that the Japanese sell -- and analysts figure GM's sustainable market share is closer to 20%. Says Center for Automotive Research's McAlinden: "GM would be a wonderfully profitable company at 18% market share."

Even if GM is willing to accept what many believe to be inevitable, getting there will be extremely difficult. GM's worsening woes could give it the leverage to wrest concessions from the United Auto Workers, and talks between management and union leaders have begun. The union will never waive the sacrosanct clause that makes GM pay laid-off workers, but it may be willing to compromise if the company offers something in return. GM, for instance, could negotiate a buyout package similar to the one it got from its German union last fall, when its Opel subsidiary cut 12,000 jobs. That could allow GM to shed jobs without adding to its fixed costs. The move is proving pricey in Europe and would be in the U.S., too, but the one-time charge would give way to lower labor costs later.

Another option: Persuade UAW workers and retirees to pay more of their health-care costs. Two years ago construction-equipment maker Caterpillar Inc. (CAT) got the UAW to sign off on a deal that has their retirees and workers paying more than $80 a month for insurance now and more than $100 a month in coming years. GM workers currently pay nothing. If GM's 340,000 union retirees paid $100 a month toward their health-care premiums, GM would save $410 million a year. Since the UAW is in the middle of a four-year labor deal that expires in 2007, GM would need to go back and negotiate any concessions. Wagoner says that with most of GM's high-impact cost-cutting options, "we aren't contractually allowed to do it unilaterally." But, he added, "we will work with them."

Then there's the issue of size. GM's eight brands -- among them Buick, Chevrolet, and Pontiac -- collectively sell five front-wheel-drive midsize family sedans. And Saturn has a sixth coming out next year. Four of its divisions sell a minivan. The result: GM is simply making too many similar vehicles in a market awash with more and more models.

Moreover, since GM has so many models, the company can't redesign them all as often as rivals do. It took nine years before the auto maker replaced the Chevrolet Cavalier with the Cobalt, which arrived this year.

By contrast, Honda Motor completely redesigns the competing Civic every five years. Last year the average model on a showroom floor had been on the market for three years. But GM's average model had been selling for 3.7 years, says Merrill Lynch. From 1999 to 2004, GM replaced 76% of its sales volume with new models, but the Japanese auto maker replaced 113% of its volume. In other words, GM isn't making enough hot new models to get buyers into the showroom.

Wagoner has begun to unload some of the company's excess baggage. He announced the shuttering of Oldsmobile in 2000. He has closed four assembly plants and, since 1998, dropped the hourly payroll to 111,000 from 151,000, mostly through retirement. And top executives have at least discussed the notion of paring down GM's portfolio of brands, though that is a costly and difficult option that few see happening anytime soon. While Buick is on the list, it is one of GM's premium brands in China, so it is unlikely to be closed. If GM decides to cut a brand, Saab and Pontiac would top the list.

In the end, Wagoner and his team may have little choice but to put pride aside and start chopping. Few analysts expect GM to reverse its performance and regain share in the short term. "GM doesn't have many products that are hot right now," says Global Insight Inc. analyst John Wolkonowicz. "And there isn't much coming that will turn it around." Only by scaling its size and ambition to match its shrinking market share can GM hope to regain some of its luster.

By David Welch in Detroit


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