On December 19, President Bush offered GM and Chrysler $17.4 billion in loans, $8 billion of which could be issued as early as December 29. It won’t be enough. These companies must not only weather the downturn in the auto market, they must significantly restructure in order to be competitive in the U.S.
Time is the variable. No one can predict with certainly just how long it will take the auto market to recover. Until the market returns, all auto manufacturers, dealers, and suppliers—not just the Detroit 3—will struggle. It will also take time to restructure. Time to negotiate new arrangements with lenders, suppliers, and labor. Time to change the product mix. Time to streamline the manufacturing process. And, time to for all these changes to take effect.
For 30 years, the U.S. manufacturers have been on a steady downward spiral in the U.S. market. Since the oil shock of 1979, they have been losing market share and per unit profit margin to foreign car makers. They have tried to adjust. To cite just one example, their workforce has declined from 1.1 million employees in 1979 to about 250,000 today. But, they have been chasing a moving target. Every improvement in quality, product offering, and manufacturing efficiency has been matched, or exceeded, by the foreign manufacturers (even in their U.S. operations).
They had plans to continue to adjust slowly over the next several years to ease the transition impacts on the companies. These were the basis of the proposals they made to Congress a few weeks ago. Although it was not clear that what they had planned to do over many years would have been enough to close the gap with their competitors, the changes they contemplated would have been smoothly implemented.
The combined fuel and finance shocks this year, however, created the need for the auto companies to implement these plans—and more—in months rather than years. And that is the heart of the question facing the U.S. government. Will we use our fiscal power to accelerate change which must occur? Or, will we use it to cushion private companies from rapid change?
President Bush has come down on the side of the former; use federal loans to accelerate needed change. He has created a structure, however, that forces President Obama to address the same set of questions just weeks after he takes office.
The Detroit 3 can make money overseas and in the sale of large cars and trucks in the U.S. They cannot make money on the sale of small cars in the U.S.; precisely the portion of the market that many see as the future of the industry.
Buying a small car represents trading off the comfort, convenience, and safety of a large car with the fuel economy of a small car. When gas prices rise, demand shifts toward smaller vehicles, only to shift back when prices fall again. Given historic fuel prices, the American consumer is not willing to pay a premium for fuel efficiency. They will do so in Europe. There, gas prices have not been below $4/gallon since 1996. (They rose as high as $10/gallon this past summer.)
Yet, the Detroit manufacturers must compete in the market in which they live, not the market they would prefer. To be competitive with those who successfully meet the demands of the U.S. market they must take several steps. Their product offerings must be streamlined to match consumer demand, with redundant and costly fringe products eliminated. The products must offer features and amenities, and be of a quality, that is fully competitive with other available vehicles. And, just as importantly, they must be built at a cost that allows them to be sold at a profit.
Detroit must accelerate the changes that it has begun to achieve a complete makeover of the way it does business in the U.S.
The President’s loan proposal is the first step in doing this. It uses the financial crisis, and the power of federal financing, to require GM and Chrysler to produce a plan by February 17th that shows how they will achieve economic viability by achieving a product mix and cost structure that is competitive in the U.S. while, at the same time, complying with all federal fuel economy standards. It outlines specific and dramatic concessions from lenders, management, and employees that must be made as a condition to the loans.
The offer, however, only gives the two companies half of what they have said they need to survive through the first quarter of next year. (They had asked for $34 billion.) And, it is silent on what will happen after March 31st when the Executive Branch will report to Congress on the status of the restructuring effort. It is also silent on the implications for Ford. Ford has not asked for assistance, and would not be required to comply with the dramatic changes being asked of GM and Chrysler. But, if those two make significant improvements in their cost structure, Ford will become less competitive if it does not match them.
By next March, we will have a new President. We will also know more about the economic state of the country and how sincere the auto companies and their stakeholders have been in making the changes they need in order to survive. Even if they have moved in good faith to expeditiously change the way in which they do business, it is almost certain that they will need substantially more financial assistance from the federal government.
The question facing President Obama will be: is the additional aid to promote increased change in the auto industry, or is it to avoid change and preserve the status quo? What will Act II reveal?
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