GM and Ford in need of a big overhaul

Oct 20th 2005
From The Economist Global Agenda

General Motors and Ford have both reported heavy losses. GM has also announced a breakthrough in negotiations with its unions that will reduce the firm’s crippling health-care liabilities, while Ford says “significant” plant closures are on the way. Both firms need a radical overhaul to avoid bankruptcy

MOTORING folklore has it that a pair of women’s stockings knotted into a loop will provide a useful emergency replacement for a snapped fanbelt, keeping you on the road until a more permanent fix is available. The worse than expected losses that General Motors announced on Monday October 17th—of $1.6 billion net in the third quarter—show that something is very wrong under the bonnet at the giant Detroit carmaker. Ford's results three days later, though not quite as awful, showed it is in a similar fix.

On the same day as GM announced its dismal trading performance, it also gave details of an agreement with its notoriously truculent unions to cut health-care costs and the possible sale of a stake in GM's profitable finance arm. These may prove to be the knotted undergarment that keeps GM on the road for now—but it is clear that a more permanent fix will be needed.

GM has had its share of problems this year. They began with the firm paying $2 billion to extricate itself from a misguided deal struck in happier times that would have forced it to buy Fiat Auto, a struggling Italian car firm. Then, the firm’s poor performance led to the downgrading of its debt to “junk” status by leading credit-rating agencies (Ford suffered the same fate). Earlier this month, GM’s credit rating was cut again after Delphi, a car-parts business that GM had spun off in 1999, filed for Chapter 11 bankruptcy protection, prompting more speculation that GM could go the same way.

Disruption to GM’s supply chain is just one of the problems that Delphi’s bankruptcy could bring. Under the deal to spin off the parts maker, GM had agreed to cover some potential liabilities relating to Delphi employees’ benefits, a promise it may now have to keep. The extent of these is unclear but estimates of the cost to GM range between $1.5 billion and $11 billion.

However, a welcome side-effect of Delphi’s bankruptcy proceedings is that it may have concentrated minds at the United Auto Workers. GM has been negotiating with its main union for some time to bring down the costs of health-care provision to blue-collar workers. Delphi's fate may have prompted the unions to agree the deal.

GM says that $1,500 of the price of every new vehicle it sells goes towards health care for past and present employees. The firm’s commitments are shockingly vast. It pays the health insurance of some 1m retirees and their dependants as well as its current 200,000 American workers and their families. The deal with the UAW will provide some respite. Though not all details of the deal have been disclosed, the carmaker said it would result in a cash saving of $1 billion a year and would slice $15 billion off the firm’s health liabilities towards its pensioners.

Rick Wagoner, the chief executive, called it “the single biggest cost reduction in a single day in the history of GM”, though these cuts alone seem unlikely to be enough. Analysts’ estimates of GM’s unfunded obligations (before the cuts) are around the $70 billion mark, most of them in relation to retirees’ health costs. And the firm has promised to fund a new plan for employees affected by the cuts, costing $3 billion, delivered in three instalments beginning in 2006. So it still has a mountain of cost-cutting to climb.

GM has reiterated previous promises to shed 25,000 workers and hinted that the 2008 deadline for this may be brought forward. The unions had acquiesced to the cuts because roughly that number of employees would have left GM by 2008 through natural wastage.
Perhaps GM is confident that the health-care deal is the start of a new accommodation with its unions. Investors seem to think so: GM’s share price surged on the news. But it is unclear if the UAW will in fact countenance further or faster cost-cutting.

GM also said on Monday it might sell part of GMAC, its profitable finance arm. This might allow GMAC to improve its credit rating and thereby cut its borrowing costs, boosting its profits. The sale of a big stake would also strengthen GM’s balance sheet but would also reduce the profit contribution from the unit that has kept the parent firm afloat.

Ford, which also suffers with intransigent unions and heavy legacy costs, will no doubt hope it can do a similar deal. On October 20th, it reported net losses of $284m in the latest quarter. Though Ford is still set to make an annual profit (unlike GM,) its boss, Bill Ford, said an anxiously-awaited restructuring plan would be announced in January that would include “significant” plant closures in North America. In comments whose main target may have been the union bosses with whom he will now join battle, Mr Ford gave a warning that: “Our industry is beginning a dramatic restructuring which is sorely needed.” Even Chrysler, which was acquired by wealthy Daimler-Benz, and has not suffered such devastating sales falls as Ford and GM, will hope that it too can cut its hefty health-care costs.

However necessary are the cuts Detroit's big carmakers must make, they would do nothing to tackle their other main problem: Americans are increasingly reluctant to buy their models. In the past year GM's sales in America have fallen by almost 25% and Ford’s by more than 20%. Car buyers have continued to turn to Japanese makes: Toyota is likely to overtake GM as the world’s largest carmaker in the next few years. Honda and Nissan have also continued to gain at the expense of GM and Ford.

The Japanese firms have fewer pension obligations and more flexible workforces—and they are largely non-union. Their model ranges are also more attractive to motorists. GM and Ford have gambled heavily on the success of their sport-utility vehicles but the demand for these gas-guzzlers has faltered of late, with soaring petrol prices prompting motorists to seek fuel-efficient models. Earlier this month, Ford and GM cancelled costly special offers which let the public pay the same discounted prices as the firms’ employees. Early indications suggest the result has been a further sales slump. If so, their need to improve competitivity will become even more urgent. Unless further cost-cutting can be agreed, they may eventually find themselves with little alternative but to use the Chapter 11 route to shedding their increasingly unaffordable legacy costs.

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