Students of the auto industry are aware that the economic state of General Motors has been precarious for years. It has been widely understood that GM could not withstand a prolonged downturn in the economy. General Motors has operated below break-even in a number of recent years, and when the company did make money it did not operate far above break-even — not a “safe” investment with its low, average safety margin coupled with high operating leverage.
GM’s bankruptcy resulted from a confluence of interrelated problems:
Insufficient cash reserves. Considering the volatility in the transportation market and the magnitude of GM’s operating costs, GM did not maintain an adequate cash buffer. The firm should have had ready access to at least enough cash to sustain operations from 18 to 24 months under a 20 percent to 40 percent revenue reduc-tion. Its liquid asset-to-operating expense ratio was too low, given the dynamics of the industry.
Short-term profit priority. GM decision-making erred toward immediate gratification rather than what is best for the longer term. Stockholders demanded returns on investment now, not later. GM executives wanted to show profit while they were in power. They didn’t much care about alien future regimes and the attendant un-certainty of profits over an extended time horizon. Giving priority to the short run and neglecting the long run eventually became disabling.
Obsession with market share. GM execs focused on short- as opposed to long-term profits but concurrently gave more importance to maintaining market share than to profitability. Growth can keep you profitable but maintaining market share at all costs — beating Toyota by exorbitant advertising, rapid world expansion into unproven markets, and wanton price slashing — doesn’t lead to economic soundness. It seems GM executives often saw product popularity and world dominance in the marketplace as more prestige-generating than success on the bottom line.
Comparatively low efficiency. GM did not operate efficiently. GM became burdened with large administrative structures serving each of its various divisions. It contracted to give expensive lifelong benefits to thousands of retirees. It was slow to embrace the reduced costs of robotic assembly. The company continuously rolled over to labor’s pressure for the highest wages in the corporate community. It supported an expansive and expensive productive capacity, which was frequently underused. With respect to communication and decision-making, the company suffered from severe diseconomies of scale. Because GM could not get its cost per unit down, it struggled to compete on pricing.
Excessive subsystem independence. GM functioned fairly well for years with numerous semi-independent divisions — each division producing and marketing a different make of vehicle. But technology got to the point where sharing expertise, plant capacity, administration and so on was crucial for low-cost, quality produc-tion. The GM divisions couldn’t do it. Their long-term indoctrination in decentralization became dysfunctional. They competed with one another to the detriment of the aggregate organizational system. Their product promotional campaigns conflicted. They duplicated one another’s research and development. Their efforts at coordi-nating and synthesizing divisional plans were minuscule.
Improper allocation of engineering skills. GM did not put its vast engineering talent to optimal use. It assigned the brightest college-university trained minds to relatively menial tasks. Engineers spent more time on bells and whistles, styling, and getting out a myriad of distinctive models than they did on improving quality and furthering critical green objectives. They often spent their time and energy on pet, marginal-yield projects, such as wheel hub design, while big payoff projects, such as fuel conversion tests, queued up.
Cost structure inflexibility. Perhaps paramount among GM’s problems was its inability to ratchet down costs when product demand curves were left-shifting. Successful firms keep flexible in turbulent economic times staying solvent over a wide range of volumes. GM tried outsourcing and rental to achieve flexibility, but it wasn’t enough to offset the immense fixed costs wrapped up in plant and equipment and labor contracts. In the words of Paul Samuelson, GM became a “welfare institution” — guaranteeing everybody that the company would take good care of them. Such commitment cannot hold up when product demand cannot be guaranteed.
GM is not the only company that has caved because of one or more of the above. Hopefully, General Motors will emerge from bankruptcy with a clearer focus on what it takes to be profitable over the long haul. What’s sad here is that Washington’s intrusion was not necessary for bankruptcy proceedings and, as a socialistic strategy, this intervention could diminish the profit motive.
Phil Grant of Birch Harbor is a management professor at Husson University. His latest book is “The Mathematics of Human Motivation.” He may be reached at pcgrant@myfairpoint.net.