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If General Motors Corp. (GM) were any other company, its problems would have sorted themselves out a long time ago. Logic says that when your cash holdings exceed your entire valuation in the stock market, some Wall Street shark is going to swoop in, snap up the good parts, and toss the rest. Companies with bloated factories and workforces got religion the hard way 20 years ago, in the days of "Neutron Jack" Welch. And with today's more active boards, CEOs who consistently lose ground to the competition usually don't need Donald Trump to tell them they're fired.
But GM, of course, is no ordinary company. With sales of $193 billion, it stands as an icon of fading American industrial might. Size and symbolism dictate that its fate has sweeping implications. After all, GM's payroll pumps $8.7 billion a year into its assembly workers' pockets. Directly or indirectly, it supports nearly 900,000 jobs -- everyone from auto-parts workers to advertising writers, car salespeople, and office-supply vendors. When GM shut down for 54 days during a 1998 labor action, it knocked a full percentage point off the U.S. economic growth rate that quarter. So what's bad for General Motors is still, undeniably, bad for America.
And make no mistake, GM is in a horrible bind. That $1.1 billion loss in the first quarter doesn't begin to tell the whole story. The carmaker is saddled with a $1,600-per-vehicle handicap in so-called legacy costs, mostly retiree health and pension benefits. Any day now, GM is likely to get slapped with a junk-bond rating. GM has lost a breathtaking 74% of its market value -- some $43 billion -- since spring of 2000, giving it a valuation of $15 billion. What really scares investors is that GM keeps losing ground in its core business of selling cars. Underinvestment has left it struggling to catch up in technology and design. Sales fell 5.2% on GM's home turf last quarter as Toyota Motor Corp. (TM), Nissan Motor Co. (NSANY), and other more nimble competitors ate GM's lunch. Last month, CEO G. Richard "Rick" Wagoner Jr. and his team gave up even guessing where they'll stand financially at the end of this year.
Worst of all, GM reached a watershed in its four-decade decline in market share. After losing two percentage points of share over the past year to log in at 25.6%, GM has reached the point at which it actually consumes more cash than it brings in making cars, for the first time since the early '90s. GM, once the world's premier auto maker, is now cash-flow-negative. That's a game changer. Without growth, GM's strategy of simply trying to keep its factories humming and squeaking by until its legacy costs start to diminish is no longer tenable. If market share continues to slip, its losses will rapidly balloon.
Normally a company in such straits contracts until it reaches equilibrium. But for GM, shrinkage is not much of an option. Because of its union agreements, the auto maker can't close plants or lay off workers without paying a stiff penalty, no matter how far its sales or profits fall. It must run plants at 80% capacity, minimum, whether they make money or not. Even if it halts its assembly lines, GM must pay laid-off workers and foot their extraordinarily generous health-care and pension costs. Unless GM scores major givebacks from the union, those costs are fixed, at least until the next round of contract talks in two years. The plan has been to run out the clock until actuarial tables tilt in GM's favor (a nice way of saying that older retirees eventually will die off). But with decreasing sales and a smaller slice of the market, that plan backfires -- leaving GM open to an array of highly unattractive possibilities.
How bad could it get? BusinessWeek's analysis is that within five years GM must become a much smaller company, with fewer brands, fewer models, and reduced legacy costs. It's undeniable that getting to that point will require a drastically different course from the one Wagoner has laid out so far. He is going to have to force a radical restructuring on his workers and the rest of the entrenched GM system, or have it forced on him by outsiders or a bankruptcy court. The only question is whether that reckoning comes in the next year, if models developed by Vice-Chairman Robert A. Lutz fall flat; in 2007, when the union contract comes up for negotiation; or perhaps in five years, when GM may have burned through its substantial cash cushion.
Why is it so hard for those inside GM to see the inevitable? Take a step into the Detroit mindset. No active employee was even alive in 1930, the last time a rival sold more cars in the U.S. than GM. The idea of being No. 1 is etched into the company's DNA -- which makes it all but impossible for execs to embrace a strategy of getting smaller. And union leaders have never seen a problem that couldn't be ironed out at the bargaining table. "I think GM and the American auto industry are facing a lot of competition," says United Auto Workers President Ronald Gettelfinger. "But we've always had difficult times."
Not surprisingly, GM disputes this analysis. Wagoner declined requests for an interview, but spokesman Tom Kowaleski says the company is confident it can rebuild sales momentum. "We're going to fight our way back and get more share," says Kowaleski. He also says the board is solidly behind Wagoner and that even if his plan falters, GM is prepared. "This company has a significant amount of planning in place and is looking at contingencies. Don't think that we don't have long-term plans."
Increasingly, though, the solutions will slip from GM's control. At some point the laws of physics take over and, like steelmakers and airlines, GM is at the mercy of global forces. It simply cannot compete in a global economy with the enormous burden it now carries in legacy costs. It certainly cannot meet those costs for long off a shrinking sales base and negative cash flow. And distracted by those woes, it can't begin to make the investments necessary to match the Koreans on price, the Japanese on quality, and the Europeans on performance.
Let's be clear: GM is not in danger of going bankrupt while it still has a cash hoard. It has a ton of liquidity -- $19.8 billion in cash, marketable securities, and money it can tap from a pre-funded retiree benefits fund. That doesn't count $8.3 billion available from bank lines and probably $5 billion GM could draw on from its profitable General Motors Acceptance Corp. (GM) finance subsidiary. Several analysts already expect GM might have to cancel its $1.1 billion-a-year shareholder dividend; it could also raise $10 billion to $15 billion by selling GMAC's mortgage and insurance businesses.
But all that cash just ensures that GM can continue its ways for a few extra years. Without a sharp course correction, GM is on a glide path to disaster. Things got downright embarrassing in April when Toyota Chairman Hiroshi Okuda raised the possibility of hiking prices to give GM breathing space, saying, "I'm concerned about the current situation GM is in." (Toyota subsequently backed off.) Wagoner has ratcheted up the urgency level in recent weeks, signaling to unions that he needs relief from GM's $5.6 billion in annual health-care costs and accelerating the delivery of new sport-utility vehicles and pickups by several months. And it now looks like he may bite the bullet and close at least a couple of auto plants to reduce GM's overcapacity. But he probably won't quickly enact a fundamental restructuring of GM's tired business model. And without that, he is relying on new car and truck models to stop the sales slide. That's a high-stakes bet that he probably can't win.
If he fails to turn around sales, Wagoner probably won't be around to make the tough decisions in later years. Even GM's long-suffering board will have run out of patience by then. "It's difficult for us to see, if volumes and share continue to fall, how they're going to get the significant cost cuts necessary to stabilize cash flows," says Mark A. Oline, an analyst at the Fitch Ratings service, which has GM debt at a BBB- rating, one notch above junk, with a "negative" outlook. "Having that kind of cash drain is unsustainable over the long term."
GM's remaining options involve pain for workers or investors. Here is our assessment of how the crisis might play out:
GM'S PLAN A SOFT LANDING
Remember the old ad slogan, "This is not your father's Oldsmobile"? Well, this is no longer your father's auto industry -- but GM is still run as if it were. Fifteen years ago management struck a deal with unions that made it all but impossible to close auto plants or lay off workers without incurring massive costs. GM also agreed to cushy retiree benefits that put it at a severe disadvantage. Much of what ails GM today flows from that accounting reality and its inability to increase the business at home. The need to keep those plants running, to generate cash, and to feed a sprawling web of aging auto brands compromises car design and results in too many models that sit for years without an update. The bedrock principle upon which GM was built -- offering a car to feed every market segment -- has degraded into a series of contrived brands, most with little identity, and bland, overlapping product lines.
That explains how GM's "performance" division, Pontiac, ends up as one of four units selling essentially the same family-hauling minivan. Or how Pontiac's G6 sedan was launched this year with a basic four-speed transmission and cheap plastic interior, making it a middle-of-the-pack contender against cars like the Toyota Camry, Honda Accord, or Nissan Altima. Says Gerald C. Meyers, who ran American Motors Corp. until it was bought by Renault in 1984 and who now teaches crisis management at the University of Michigan: "Instead of deciding what they want to do, they do everything and do none of it well."
Compare that with how the most successful car companies -- Toyota, Nissan, and Honda (HMC) -- do things. They concentrate research dollars on fewer vehicles, pack them with the latest features and technologies, manufacture them in low-cost, nonunion U.S. factories, and update them relentlessly. Look at the numbers: GM execs doled out $7 billion for capital spending and research and development last year, vs. $15.3 billion for Toyota. The portion of that spent in North America gets spread over GM's 89 auto models and eight divisions, compared with Toyota's 26 nameplates in three divisions. Toyota models average sales of 80,000 units a year in the U.S., whereas GM squeezes out just 52,000 sales per model on average. And Toyota models stay on the market for an average of three years before their next redesign, compared with nearly four for GM's cars.
Car customers like a bargain, but they aren't stupid -- they want the best car or truck, period. Too often, GM compromises on engineering so that its models can go into selected plants to keep up production volume. Example: GM's Hummer H3 SUV, which comes out later this year. Designers wanted this new, more compact Hummer to have the wide, aggressive stance that distinguished its bigger siblings, the H1 and H2. But to make the five-passenger truck cost-effective, GM trimmed its width by about six inches. That way it could use the narrow truck platform that hosts the Chevrolet Colorado and GMC Canyon small pickups. The decision saved engineering dollars and will help max out volume at the Shreveport (La.) plant, which is struggling because the two trucks have missed volume targets. But the pickup platform can't accommodate GM's vaunted I-6 truck engine, and auto enthusiasts are already grousing that the H3 may turn out to be underpowered.
GM's Kowaleski responds that the H3 will have adequate power and increased fuel mileage. He adds that GM increased its capital spending to $8 billion this year and that the company's plan includes taking vehicle platforms, engines, and parts from around the world and using them to quickly and cheaply hit growth segments. He says: "Would you like to have as much as Toyota spends? Yeah. Do we? No. So we have to be smarter."
But clearly, GM also needs to decide what it does well, focus its resources on that, and scrap the rest. Wagoner's plan seems to be to engineer a soft landing, paring some of the company's onerous legacy costs and, most likely, closing down some plants. But he isn't oblivious to the problems. At a meeting with mid-level managers last December, Wagoner described the strategy of engineering cars to use up production capacity as a "legacy cost," says one manager who heard the presentation. He says that when Wagoner introduced GM's corporate controller to walk through the company's challenges, he added: "After this, some of you may wonder why you still work here." And Wagoner has been moving methodically on a plan to merge Pontiac, Buick and GMC showrooms. Once the 1,500 or so dealers have all three of those brands, it should be easier for him to trim redundant models and focus the brands more sharply.
But Wagoner will be hard-pressed to get enough relief on medical costs, at least before the scheduled contract negotiations in 2007. The Center for Automotive Research (CAR) in Ann Arbor, Mich., estimates that GM could save at least $1.2 billion a year just by closing the gap in co-payments and deductibles between different kinds of employees. A single, salaried worker pays at least $100 a month toward health costs, while hourly union workers pay no premiums and only a $5 co-pay on drugs. But so far, the United Auto Workers leadership has shown no sign that it's willing to reopen a contract that still has two more years to run. When GM's Group Vice-President for labor relations Gary L. Cowger suggested synching up the union and nonunion plans, UAW Vice-President Richard Shoemaker quipped: "If GM wants to give the salaried workers the same health-care plan we have, we're happy to share."
In theory, Wagoner doesn't need the union's help to chop his bloated car brands. He just has to pay a lot of money. Plenty of outsiders have called for GM to kill at least one division, with struggling Buick and Pontiac the leading candidates. But look at how much money GM had to pay for its 2000 decision to eliminate the smaller Oldsmobile unit. It was obligated under dealer franchise agreements to buy back parts, cars, and some service department tooling. And to keep dealers happy, the company paid them $3,000 per vehicle sold in the last full year. The final bill for closing Olds came to about $1 billion. It left plants that made the cars underutilized, and cost GM market share.
Wagoner's plan to reverse the sales slide with cool new car models makes complete sense from one perspective: The lineup needs a boost. Even with the generous rebates GM has offered from late 2001 through this winter, its U.S. market share slid 2.5 percentage points. Now that Wagoner is pulling back on incentives, the situation is deteriorating even faster. Merrill Lynch & Co. (MER) estimates that GM's overall sales slid 8% in April as compared to a year earlier. And things will only get tougher if competitors like DaimlerChrysler (DCX) follow through on talk of importing cheap, small cars from China. GM execs exude confidence about the new models they have queued up starting this year: the Pontiac Solstice sports car, the retro-styled HHR compact-utility vehicle, and, later, the all-new Chevrolet Tahoe and GMC Yukon large SUVs. Says GM Vice-Chairman and CFO John M. Devine: "We think we're coming on strong."
But this is a company that sees the cavalry coming to its rescue with each new model year. True, GM managed to pull itself back from the brink of bankruptcy in the early '90s with a strong lineup of pickups and SUVs (and a huge lift from the economy). Recently, its revival of the Cadillac franchise, through cutting-edge design and masterful marketing, has been astounding. Even critics acknowledge that GM's new models are light years ahead of those they replace. But more often, GM's bold forecasts never pan out. Executives wrongly predicted a comeback in family sedans in the '80s, '90s, and as recently as last year. Meanwhile, they took a pass on hybrid gas-electric cars and blew a chance to get a jump on the hot crossover SUV segment with the failed Pontiac Aztek.
On the Threshold
Now, Wagoner is pegging his turnaround largely to a rebound in large pickups and SUVs. That's highly problematic. GM should get some pop just from replacing its aging truck lineup, which is six years old and staggering as buyers turn to smaller SUVs and newer vehicles such as Toyota's Sequoia full-sized SUV and Ford Motor Co.'s (F) rejuvenated F-150 pickup line. GM's Kowaleski says: "Even if those markets don't grow, there is a lot of opportunity for volume and profit." But first-quarter sales of full-size SUVs nosedived 21.5% from a year earlier, according to Autodata Inc., thanks to rising gas prices and competition from crossovers, such as the Honda Pilot, which carry almost as many people while using less gas. GM, with 48% of the big SUV market, is highly exposed to a downturn, according to Merrill Lynch. On the other hand, it has a paltry 19% share of the crossover SUV segment, which now accounts for nearly half of all SUVs sold.
If Wagoner can't find some way to spark a sales rebound, look out below. GM's financial situation is linked so closely to how many cars it pumps out that its cash drain worsens dramatically with each lost point of market share. In a March report, Merrill Lynch estimated that with a 24% share and the current annual U.S. auto sales rate of 16.9 million vehicles, GM would bleed $2.4 billion in cash per year. If share plummeted to 20%, the cash burn would be $4.5 billion a year. Merrill analyst John A. Casesa estimates GM can last five years before it hits a liquidity crisis. "We believe that 25% market share is the threshold," Casesa says. "If GM falls below that, things get ugly fast."
But that assumes overall U.S. car sales remain at their current high level. If rising interest rates, high gas prices, or other factors hammer the economy, the picture darkens further. At 15.4 million vehicles and a market share of 24%, GM would burn through $3.6 billion of cash annually, says Merrill; a 20% share would leak a catastrophic $5.7 billion. "The next blow comes if there is a recession," says longtime industry analyst Maryann N. Keller. "We just got through an [economic] expansion, and the balance sheet is in worse shape than it was before."
LABOR DAY OF RECKONING
It was no coincidence that when GM executives pulled their financial guidance for the rest of this year, they pointed to the uncertainty of getting relief from the company's unions. Wagoner has to decide whether he's willing to settle for halfway measures that will only delay an inevitable confrontation when the UAW contract expires in two years, or if he's willing to risk a labor war to get big savings sooner.
GM doesn't need to open the UAW contract to send workers off into retirement and close some plants. Its factory workers have an average age of 51, so many are close to the 30-year service point that qualifies for retirement. And union leaders might go along with a buyout program. The master UAW agreement says GM has to replace some of the retirees with new workers. But the union has long looked the other way as GM slashed jobs through retirement while hiring almost no new assemblers.
Industry observers believe Wagoner is laying the groundwork to close a couple of factories and send thousands of workers off to early retirement. That might help, but it still only gets Wagoner about halfway to where GM needs to be. If he targets four of his 20 assembly plants, the company would be running fairly lean. David E. Cole, executive director of CAR, says GM could easily trim production by 1 million cars, or 20% of its capacity, and still have enough to serve the market. GM could save $2 billion per year in the long run by buying out 20,000 workers, estimates Sanford C. Bernstein & Co. analyst Brian A. Johnson. But it would pay $1.5 billion in severance costs to do so.
That would allow GM to build fewer vehicles more efficiently, cut incentives, and pull back on low-priced sales to rental fleets. Plus, the company's remaining factories would be more productive and probably more profitable. "That would hit really bad this year," Cole says. "But it would yield returns." There are several candidates for plant closings: GM has two factories making its Chevrolet TrailBlazer, GMC Envoy, and Buick Rainier midsize SUVs; it could probably get away with one. Its next-generation minivans will likely be built at a plant in Lansing, Mich., which puts the current van plant in Doraville, Ga., on the hot seat. GM is already rumored to be considering the closure of one of its full-size pickup or SUV plants, such as one in Janesville, Wis., or Pontiac, Mich.
Wagoner appears even less likely to start a fight to completely rewrite the union's health-care plan. The union's opposition could soften if GM's fortunes slip dramatically in the next year. But the UAW has almost never agreed to a huge giveback in the middle of a contract. (It did so in 1980, when the federal government demanded concessions as part of its Chrysler bailout, and again for Ford and GM in 1981, when spiking gas prices and a recession slammed sales.) Says Sean P. McAlinden, economist at CAR: "Why would union workers on the verge of retirement agree to cut retirement benefits?" GM's Kowaleski responds that there may be ways to get what GM wants while giving the union something in return: "Do not underestimate the breadth of scheming that can go on to come up with a win-win for everybody."
There might be loopholes Wagoner could exploit. Read one way, the labor contract does not guarantee benefits to retirees -- who account for two-thirds of GM's health-care costs -- and only covers active workers, says Sanford C. Bernstein's Johnson. But one GM insider says that interpreting the contract that way would spark a "nuclear war." The UAW could find any number of ways to strike key supply factories and gum up the company. Wagoner knows that firsthand. While president of GM North America in 1998, he played hardball with the UAW over a dispute involving two union locals in Flint, Mich. Those workers, who made parts needed by every GM assembly plant, struck for 54 days over what they said were local issues. That shut down the entire company, costing it $2 billion and nine percentage points of market share, though GM recovered all but a point of that by yearend.
Labor experts believe Wagoner is raising a hue and cry now to position the company for bigger concessions when contract talks open. "If you want to get the union to cut medical benefits in September, 2007, you don't start in August. You start now," says Harley Shaiken, a labor professor at the University of California at Berkeley. But if the sales picture deteriorates over the next year, GM probably will have little choice but to force a confrontation sooner and radically reshape its cost structure.
THE ENDGAME: A SMALLER GM
Will Wagoner be around to make that choice? By approving his plan and his takeover of the troubled North American business, the GM board has signaled that it is being patient -- too patient, some analysts think. All indications are that Wagoner will be given a couple of years to get traction for his strategy. But if the cash burn rate accelerates and GM's stock deteriorates further, outside forces will pressure the board to take action, or will seize the wheel themselves. "If the board feels they're on the right path, they won't make a change that disrupts that," says CAR's Cole, who has close ties to GM's brass. "But in two to three years, if there is not an improvement on the revenue side, it's over for these guys."
Private-equity investors seem to believe that the company's global cost handicap will eventually force it into bankruptcy court to shed union and dealer obligations. Wall Street bankers already are salivating over the opportunity to pick off GM's profitable mortgage operations. But the auto business is a whole other animal. For now, the legacy costs are too onerous and the politics of chopping so many jobs just too dicey for it to be worth the trouble of a takeover. Says one senior banker: "The joke used to be that all of the airlines would have to go through a car wash...now the car companies are going to have to go through the car wash. That's the challenge for anyone looking at these businesses and saying, Look, how do you deal with starting at a $2,000-a-car disadvantage vs. the rest of the world?"
Just mention the word "bankruptcy" to any of GM's top executives and the mood gets frosty fast. "That's definitely not the plan," Wagoner said in a January interview. No wonder: Bankruptcy would almost certainly follow a catastrophic failure in the marketplace, or a play by a private-equity investor seeking to break up the company. In either case, management would be out on its ear.
GM's cash hoard makes a court filing unlikely -- at least for now. If it happened, though, a GM bankruptcy would boggle the mind. The auto maker would bring to a judge four times the assets of the largest case filed so far, by WorldCom Inc. in 2002. Its 324,000 worldwide employees are about 70,000 more than Kmart Corp. (SHLD) had before it filed that same year. GM could almost certainly find a judge who would allow it to dump many of its most burdensome obligations, says Lynn M. LoPucki, a law professor at UCLA. GM's pension plans are fully funded for now, but if GM's finances worsen or its pension investments sink in the coming years they might still be dumped on the federal Pension Benefit Guaranty Corp. GM also could shed its union contracts, firing anyone who didn't want to take lower wages or benefits. Ending health-care obligations to retirees alone could save $4 billion to $5 billion a year.
Imagine the uproar, though, if that happened. Even if GM could demonstrate to a judge that it had negotiated for the cuts in good faith, the UAW would certainly respond with a strike. That would burn up in a few months much of the cash that any raider coveted. And pensioners could still sue for their benefits. "If there was value, you wouldn't get away scot-free," notes Wilbur L. Ross Jr., who has taken interests in bankrupt steel, textile, and coal companies.
Bite the Bullet
Breakup or bankruptcy are the ghosts of GM's future. They become much more substantial threats if current management can't deliver on its promised turnaround over the next couple of years -- or if the board doesn't find someone who has a better idea of how to deploy GM's $468 billion in assets.
It was a former General Motors chief -- the legendary Alfred P. Sloan Jr. -- who foresaw the problems that are now tying his company in knots. "Any rigidity by an automobile manufacturer, no matter how large or how well established, is severely penalized in the market," Sloan wrote in his 1965 memoir, My Years With General Motors. Of course, Sloan was talking about a competitor, Henry Ford, and his refusal in the 1920s to change his business model to build different cars to suit the changing tastes of American consumers. But Sloan's indictment stands just as well for today's GM.
What would a healthy GM look like? It might have five fewer assembly plants, building around 4 million vehicles a year in North America instead of 5.1 million. That would slash U.S. market share to around 20%, but factories would hum with real demand, stoked less by rebate giveaways and cheapo rental-car sales. Workers would have a cost-competitive health-care plan but would fall back on government unemployment benefits when hard times demanded layoffs. Profitable auto sales and finance operations would fuel a richer research budget, tightly focused on four or five divisions instead of eight.
This new GM might make two-thirds as many models: Chevrolet, perhaps its most recognized global brand, handling trucks and mass-market cars; Saturn, behind its cool new Euro styling, selling more expensive cars with design flair. A resurgent Cadillac would parade advanced technology and luxury. Hummer would only last as long as brawny SUVs are hip. GMC, which is very profitable these days, would stick around if Chevy couldn't satisfy America's yen for trucks. Pontiac, Buick, and Saab would follow Oldsmobile to the scrap heap.
Maybe Wagoner will decide to bite the bullet and spend the billions needed to launch such a dramatic overhaul now, rather than waiting. And maybe the UAW leadership will get religion and offer more than token help. Where they decide to take GM will matter a great deal to the army of auto workers toiling away in its factories, the vast web of businesses that feed off of them, and legions of investors. As we learned a long time ago from outfits like AT&T, no company is too big to fail, or at least shrink dramatically. Not even mighty GM.
Corrections and Clarifications
"Why GM's plan won't work" (Cover Story, May 9) should have said that General Motors Corp. spent $13.7 billion on capital projects and research and development in 2004, not $7 billion. That compares with $15.3 billion for Toyota Motor Corp.
By David Welch and Dan Beucke, with Kathleen Kerwin in Detroit, Michael Arndt in Chicago, Brian Hindo, Emily Thornton, and David Kiley in New York, Ian Rowley in Tokyo, and bureau reports