Thursday, December 04, 2008

An Adversarial Culture: Auto Industry Bailouts

New Readers' comments 12/2/08--excellent as always.

I received a thoughtful commentary on the auto industry crisis from knowledgeable reader Joe H., who works in the industry.
Since I have no deep knowledge of the auto industry to share, I'll try to add some perspective. Before we get to Joe's astute comments, I would note:

1. It's easy to be cavalier about the situation--no bailout, etc.--but since hundreds of thousands of jobs are at stake I think it behooves us to consider matters carefully before announcing "what's best for the country."
As someone who suffered from the huge swings in construction spending/employment 1973-1993, I have experienced the sinking feeling one gets when one's livelihood vanishes. There will be a lot of suffering regardless of bailout or not, and we need to be aware that this is not just dollars and cents but people's lives.

2. It seems abundantly clear that there is massive over-capacity in the global auto industry; the industry can make millions more autos than there is demand for. All the major manufacturers are global companies, and there is some truth in the observation that Ford and GM could shutter their entire North American operations and go on as non-U.S. global manufacturers.
My longtime friend G.F.B. sent me this link about the new high-tech Ford plant in Brazil--a market Ford clearly sees as growing: Ford's most advanced assembly plant operates in rural Brazil (video). A related story reads, "Special report: South of the equator, Ford and GM prosper." (from 2007)

From a global perspective the manufacturers have little choice but to cut capacity in the weakest markets for their products. If that happens to be North America, then it is simply prudent management to cut capacity to match demand. Borrowing billions from the government, or receiving a "gift" of billions will not change this business reality.

While it's easy to demonize globalization, it is undeniable that all auto manufacturers build factories near their markets for a variety of reasons both financial and political. So to blame "globalization" is somewhat specious when the entire industry is globalized. If you cannot make a car for X cost and sell it profitably in another country for a profit, then it makes no sense to make cars for that market.

In other words, we want all the benefits of globalization--low cost goods, cheap international airfares, and so on--but we want all the jobs to stay in the U.S. It doesn't work like that. If you want to maintain domestic industries with trade barriers, you cannot expect to get the low prices of globalization.

3. The American consumer is highly indebted and therefore a poor credit risk. To the degree that autos are sold with little money down, high-interest loans, then we can foresee a large and long-lasting decline in auto sales regardless of the quality of the vehicles or the wishes of consumers for new vehicles. This is reflected by Nissan sales dropping as much or more as GM's sales. Honda and Toyota sales also declined by over 30%.

4. As the Wall Street Journal noted, not all domestic manufacturers are on the edge of insolvency: America's Other Auto Industry : There is such a thing as a profitable car maker in this country.
The comments from readers are also of interest: Readers Forum: America's Other Auto Industry.

5. The American public rallied against the first $700 billion TARP bailout of the banking industry 100-to-1; supposedly the sharp decline in the stock market changed many minds. In any event, Congress passed a $700 billion giveaway with few if any actual dividends to the U.S. taxpaying public. Now a bailout of about 5% of the TARP bailout (number one of what, five? Six? Twelve? I've lost count of the banking/mortgage bailouts) is proposed for the Big 3 and the uproar exceeds the one surrounding the TARP bailout which blew away 20 times more taxpayer funds. This is not to say I agree with the auto bailout, but it's a good idea to place it in proper context.

6. The Japanese, Korean and German auto manufacturers with plants in the U.S. buy most of their parts from U.S. suppliers, and their factories are staffed by U.S. workers. This begs the question of why Big 3 autos are losing favor with consumers.

OK, here are Joe's comments:
I am torn regarding the US auto industry bailout. Full disclosure is in order. I work for General Motors.

I want to highlight a few perspectives that have been lost in the clamor.

Point one: Max Bazerman writes a great deal about negotiations and their limitations. One of those limitations is that key stakeholders refuse to accept any solution that is arrived at quickly and easily. Stakeholders believe that negotiators must crawl over a mile of broken glass and shed a gallon of blood before the maximum/optimal solution can be negotiated.

The US auto industry, both management and labor, are well versed in the literature and the practical application of negotiating. US Congress is no slouch at the practice either.

---I have no inside information, so what follows is pure speculation---

One possible sequence of events would be for Congress to stiff the US auto industry once again. Then, the US auto makers would be compelled to conserve cash by ceasing operations until Congress resumes session in 2009. That is, it is conceivable that GM, Ford and Chrysler could lay off every employee on their rolls for the last three weeks of the year.

Between 50% and 75% of an automakers' cost of producing a car or truck is in the purchased parts. Ceasing production is dumb because you get slaughtered by your fixed costs. "Fixed" costs are often accounting charges to properly meter out cash out-flows that were made in the past. Day-to-day cash conservations is mainly a creature of variable cost management.

Would it hurt the car companies? GM has $25B or $30B of inventory on dealer lots. Ford and Chrysler also have huge supplies of cars and trucks. We could hold our breath for a long, long time.
Merry Christmas!
Retail would puke. A three week "trial bankruptcy" would provide the mile of broken glass and the retail crash-and-burn would provide the gallon of red ink, ah, blood.

Point two: Sloan Management Review published an article in the late 1980s (sorry, cannot remember the authors) that discussed The Cost Spiral.

Traditional economics very conveniently divides costs into two categories. Variable costs scale up proportionately with volume and down with volume. Fixed costs are fixed; that is, they do not change with volume.

The classic example is the pizza parlor. Your rent for the building is fixed. You pay $1500 a month whether you make zero pizzas, one pizza or 1500 pizzas that month. Your cost for materials (dough, sauce, etc.) is a variable cost. The material cost for making 1500 pizzas is 1500 times greater than the material cost for making one pizza.

The Cost Spiral article exposed the classic division of costs as a lie.

At some point in the production, your rented space is not large enough to accommodate the volume of business. You may need to rent a larger space and rent another pizza oven when demand is 1600 pizzas a month. That is, fixed costs act as fixed on the down-side but function as variable costs on the up-side.

A similar phenomena occurs with variable costs. Every variable cost strives to mutate into a fixed cost. It is as almost a law of nature...much like salmon swimming upstream to spawn. Labor craves stable cash flow so they demand Unemployment insurance. Suppliers seek to lock you into long term contracts. Girl-friends want to become wives. Additionally, the laws of supply-and-demand jack up prices when demand is high. So variable costs are super variable on the up-side and "sticky" or act as if fixed on the downside.

The UAW had a great deal of time to make labor, a cost traditionally identified as "variable", a sticky cost. They negotiated Supplementary Unemployment Benefits (take-home pay of about 80% of 40 hours take-home, for 48 weeks) and JOBS bank protections. Some of their internal logic was that if labor was a fixed cost, then management would be highly motivated to find real work for them. Plainly stated, management's ability to manage costs that *should* be variable costs has been nullified by UAW contractual language.

Each trip through the business cycle causes another accretion of fixed costs that ratchet up and variable costs that sticky down. Cycle-after-cycle, the arteries narrow and the organization becomes less robust, less able to rebound from external stresses.

Point three: Congress realizes that many Americans are envious of UAW represented auto workers. Many Americans are envious of line workers making 2 times the going freight for similar work. They are envious of the worker protections. They are envious of SUB pay and JOBS bank.

UAW workers have been their own worst enemy. A few, maybe fifteen in a thousand, have been know to go into BBQs, bars, and Bar Mitzvahs and BRAG how they have screwed the company. Those same few BRAG about how little work they do. They BRAG about what a crappy job they do. It is a mystery to me that the other 985 don't collar them in the parking lot and "paint a couple of dots" on their faces.

Congress realizes that it is against Anti-Trust laws for businesses to share business plans with their competitors. Sharing business plans is called collusion. But that is what Congress chided the US auto industry leadership for failing to do when they testified before Congress in November. That is patently disingenuous.

Still, it comes down to the Max Bazerman observation that key stakeholders believe that optimum solutions are forged in the smithy of hell. My guess is that I will have a front row seat."

Thank you, Joe, for a thought-provoking essay on the situation.

Reading Joe's comments made me wonder just how much a role our adversarial culture plays in this crisis. After all, unions and management fighting it out in bloody screaming combat is considered "normal" or as Joe suggests, even required.

Our entire legal structure is based not so much on justice (though it's a good principle to establish) but on adversaries duking it out in court. The truth is never the goal--winning the case by convincing the jury or the judge that your position is stronger than your adversaries' position is the goal.

Just how culturally bound this adversarial perspective truly is can be revealed by comparing the Japanese auto industry with the U.S. industry. I think executives and workers alike at Toyota in Japan would be quite confused by the management and union behavior in the U.S. It would literally make no sense to either group in Japan to strangle the company's competitive advantages. I suspect the Japanese might view this adversarial approach as a form of slow seppuku--ritual suicide.

The results of this adversarial approach are now painfully visible. I've engaged in a spirited debate over various auto-industry issues with my friend G.F.B., and I will mention one point on which we disagree--a point which I think illustrates just the sort of cultural divide I am exploring.

I proposed to G.F.B. that the UAW might have done better to focus on improving the quality of the vehicles they make rather than squeeze more benefits from management via negotiations. G.F.B. disagreed:

"The union is not in charge of quality control, design, marketing nor direction of the company. The union does not control the design of the cars, and the build quality tolerances that are set by the manufacturers. The guy on the assembly lines job is do his job well. The UAW's job is to protect and try to improve the life of the guy working on the assembly line. The company management's job is to focus their energy on making cars which will last 20 years. Clearly, they don't think that it important as you do."

(I had suggested that Detroit would be in a better position if they made cars which lasted as long as the Japanese nameplates made in the U.S.)

G.F.B.'s position is perfectly reasonable in the context of standard U.S. labor/management relations, and indeed many analysts see virtually all the problems as managerial; but for context, read this excerpt from: How Detroit Drove Into a Ditch: The financial crisis has brought the U.S. auto industry to a breaking point, but the trouble began long ago. Paul Ingrassia on disastrous decisions, flawed leadership and what the Motor City needs to do to survive.

"On Aug. 20, 1979, 18-year-old Brad Alty, fresh out of high school in Mechanicsburg, Ohio, was driving his Gremlin to work when the car broke down. He was two-and-a-half hours late to his first day on the job at a new motorcycle factory that Honda Motor was opening in central Ohio.
For the next few weeks, Mr. Alty and his 63 co-workers did little but sweep floors and paint them with yellow lines. Then they started building three to five motorcycles a day. And at the end of each day they would disassemble each bike, piece by piece, to evaluate the workmanship. Mr. Alty hated it, and he kept getting grief from his older brother for working for a Japanese company. "I thought I had made a mistake by going to work there," he recalled recently. "It was like, 'What the heck am I doing here?' "

But Mr. Alty stuck with it, and Honda stuck with him. Honda's real goal was to build cars in America, but the motorcycle plant allowed it to test the mettle of American workers for a modest investment. The workers passed the test. Honda started building Accords in Ohio in November 1982. Ironically, some U.S. Honda dealers actually protested that they wanted to sell only Accords made in Japan. But the quality of the Ohio-made cars was soon confirmed."

Perhaps the UAW leadership tried to influence management to pursue smarter planning and to focus on higher quality as a long-term strategy to retain UAW jobs; it would probably take an insider's information to know all that transpired over the past 20 years in the industry.

But I still wonder if some measure of Detroit's structural woes--and perhaps of the U.S. economy's structural woes--are not linked to the adversarial model of our society.

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