Overhaul (13 page)

And I came to appreciate why automakers obsess about the total number of new vehicles sold each year (they call this the
SAAR,
the seasonally adjusted annual rate of sales). In effect, the
SAAR
is every automaker's speedometer. For any company with a competitive line of products in a business where fixed costs are high and market share tends to shift only gradually, total volume is the most important determinant of profitability. We'd started this project in the midst of the steepest falloff in sales that the auto industry had experienced since at least 1950. By January 2009, the
SAAR
had collapsed to 9.6 million. Extrapolating from this trend, many pundits issued dire forecasts for at best a slow and meager recovery.

But looking at the big picture, I'd begun to feel more optimistic about the prospects for overall sales than I had at the start. Unlike newspapers, an industry I knew all too well as a former journalist and as an investment banker, no one has invented a substitute for the automobile. The driving-age population was continuing to increase by more than 1 percent a year. "Scrappage," or the rate at which cars were junked, had dropped decade by decade, from the 1970s rate of more than 7 percent a year to about 5.5 percent, which meant that the average age of cars on the road was increasing. Car buyers could put off replacement purchases, but not forever. I recognized, of course, that strapped budgets and other factors would keep many Americans away from the dealerships for a good while—GM had nearly totaled itself with overly rosy predictions of recovery. Still, the automakers' prospects weren't all bad. A key part of our task, I realized, would be to arrive at a realistic
SAAR
forecast to incorporate into our investment analysis.

Our inquiries had led to another pleasant surprise: U.S. automakers were no longer as pathetically inefficient as people thought. We learned this from the Center for Automotive Research, an Ann Arbor, Michigan, think tank whose experts showed up to brief us during those early weeks. Listening to them one morning in our big yellow staff room, I was idly flipping through the package of charts they'd brought when I suddenly sat up and took notice. In 2007, the Harbour Report, an authoritative statistical source on automaking, had found that the Detroit Three needed just over 32 hours of labor to build a car, versus 30 hours for Toyota. That represented a huge advance over 1995, when GM had been at 46 hours, Chrysler at 43, Ford at 38—and Toyota at 29. And given that the Big Three tended to make larger, more expensive cars, the narrowing of the gap was all the more significant. Harbour had concluded, "General Motors essentially caught Toyota in vehicle assembly productivity."

Another somewhat outdated criticism involved labor costs. We'd discovered how difficult it is to compare such costs on an apples-to-apples basis because of complex calculations involving the value of employee benefits, the composition of the labor force, and more. Each stakeholder—the automakers, the union, the creditors, investors—provided different, often substantially different, estimates of labor costs. While it seemed clear that American automakers' costs remained higher than those of the transplants, progress had been made. Just in the run-up to its February 17 submission, for example, GM had succeeded in reducing active employee labor costs per hour from $60.64 to $52.89 (versus $51.62 for Toyota). GM achieved this not by reducing wages for existing workers but by trimming benefits and having new workers start at much lower wages.

There were unpleasant surprises as well. Most glaring was the continuing low opinion consumers held of Detroit's products. A page of analysis from Deutsche Bank captured that succinctly. In almost every category, GM products fetched thousands of dollars less than their Toyota counterparts. A GM "premium compact" sold for $3,814 less than a Toyota, a stunning gap for cars priced at less than $20,000. Consumer perceptions are often slow to change, and I concluded that closing this gap with Toyota could take years. As I digested these data, I also realized that as much as the Detroit Three had been pilloried for missing the small-car market, their failure wasn't due to complete stupidity. If it costs $1,000 or more in extra labor expense to build a car that could be sold for only about $16,000—nearly $4,000 less than its competitor—it would be impossible to make a profit. So why build it?

To my shock, Detroit fell short of foreign automakers on most SUVs and light trucks, fetching as much as $3,500 per vehicle less in some categories. The disparity could be traced in part to memories of the decades when Detroit cars were blatantly inferior in quality. But that also was an outdated impression. For model-year 2000 vehicles, the National Highway Traffic Safety Administration received more than 12,000 complaints about GM cars, as opposed to only around 2,000 about Toyotas. By the 2009 model year, Toyota was down to slightly more than 1,000 complaints—and GM had fallen to an even smaller number. (All of this, of course, predated Toyota's massive recall in early 2010.) And while Chrysler still had none of its cars on
Consumer Reports
's recommended list, 21 percent of GM's cars appeared, a respectable increase from prior years, although a far cry from Toyota's 77 percent. Despite all this, however, consumers still had good reason for their unwillingness to pay as much for a GM car as for a Toyota: GM cars had lower resale or "residual" value. Detroit, in effect, had created a self-perpetuating disadvantage.

Of course we saw page after page of depressing statistics showing the relentless decline in market share of the three domestic automakers. The drop from nearly 100 percent of the U.S. market until the mid-1950s was gradual until the mid-1990s, when it accelerated. From 1995 through 2008, GM had lost a third of its U.S. market share. There was absolutely no justification for the increase in market share that GM had assumed as part of its viability report. Yet it was equally apparent that there could be no permanent return to profitability without reversing the continuing loss of market share. This would emerge as the company's greatest challenge.

The last big surprise was the rising tide of imported cars. Notwithstanding the presence of the transplants, the share of "pure imports" in the U.S. market had leaped from 19.7 percent in 2005 to 26.1 percent in 2008. Why hadn't this been in the headlines? When I'd covered the Carter administration in the late 1970s, imports had been a huge source of public outcry. And these figures did not reflect vehicles assembled in Mexico or Canada; under
NAFTA,
the North American Free Trade Agreement, those no longer counted as imports. I'd been a supporter of
NAFTA
and open trade, but wearing my auto cap now made me more conscious of the loss of U.S. jobs. Still, I had enough problems on my plate without volunteering to take on new ones.

All told, my accelerated immersion into the auto industry left me convinced that there was no fundamental or structural reason why Detroit couldn't compete, at least for the huge American market. To be sure, GM and Chrysler needed massive restructuring of both operating costs and liabilities, such as legacy health care. But if this could be accomplished—and if the companies, particularly GM, could be put under new management—I believed that they could be viable and even highly successful.

The morning after my swearing-in, I made the first of many trips to Capitol Hill to visit with the anxious Michigan delegation, beginning with a stop at the Rayburn House Office Building. The meetings were ceremonial, a chance for the legislators to repeat their concerns and for us to nod solemnly, as if we needed to be reminded of the gravity of the problem. Our host, John Dingell, who had served in the House since 1955, was courteous and statesmanlike, offering many rhetorical flourishes. Sander Levin, who had been in Congress a mere twenty-five years, was low-key and almost avuncular, while his younger brother Carl, also present, had the demeanor of a senior senator. Then we crossed over the Hill to the Senate offices to meet with Debbie Stabenow, who had caused me the most grief during my appointment. She nattered on pleasantly, her thoughts jumbling as she fiddled with her BlackBerry. Leaving Capitol Hill, I couldn't help but think that all that Stabenow and Carl Levin had accomplished by their carping was to delay my appointment by several weeks, making it that much harder to deliver the help that they said they wanted for their state.

My first formal encounters with the auto chiefs had come as GM and Chrysler each appeared at the Treasury for reviews of their financial viability reports. We'd decided to subject the submissions to close examination—the same kind of "due diligence" that top private equity firms apply to potential investments. With the automakers asking for more money, in effect we faced a new investment decision, and we owed it to the taxpayers to give it the best professional scrutiny. Any political considerations, we assumed, could be factored in separately.

Chrysler came first, on Wednesday, February 25. We had of course studied the company's report and found it severely wanting. It asserted that Chrysler could survive as an independent entity by hunkering down, cutting costs and reducing debt, which struck us as far-fetched. The alternative survival path—an alliance with the big Italian automaker Fiat, which Chrysler had floated with fanfare a few weeks earlier—seemed plausible. But the report gave only the sketchiest of details, not nearly enough information for us to evaluate it. Worse, Chrysler's plan did not provide for any reduction in its $6.9 billion worth of senior secured debt, an impossibly heavy burden for a company in such bad shape.

Hollowed out by nine years of mismanagement by its German parent, Daimler, Chrysler had been acquired by Cerberus in 2007 at the peak of private equity mania. So now it was competing against much larger and better-positioned global rivals as a purely North American player, with that market in a historic slump. It had no significant new vehicles in its pipeline, and its current cars and trucks did not stack up well against the competition.

To turn the business around, Cerberus had installed as chairman and CEO Robert Nardelli, a gung-ho veteran of General Electric. I knew Nardelli slightly—he had spoken at our annual conference a year or two earlier. He was known on the business scene for his "take the hill" attitude. The son of a General Electric plant manager, he had risen through the ranks at GE to become one of three finalists to succeed the legendary Jack Welch. When Welch picked Jeffrey Immelt instead, Nardelli left to run Home Depot. Eventually it became apparent that retailing and Nardelli didn't mix. Home Depot grew during the six years he ran it, but it lost market share to rival Lowe's and its stock remained flat. Nardelli also attracted attention for his outsize compensation and his highhanded treatment of shareholders. When the board reportedly pushed him out in early 2007, his severance package was estimated at $210 million.

At Chrysler, though, he seemed quite different from what I had read about him. He was dogged and scrappy and ran the business in a hands-on, close-to-the-ground style that harked back to GE. Nardelli subscribed to Jack Welch's core business philosophy: Be number one or two in your market or get out. Chrysler was, of course, a distant number three in North America, not even counting the transplants. That spurred Nardelli's attempt, starting in mid-2008, to merge Chrysler with General Motors. (Another motivation was pressure from Cerberus and JPMorgan, Chrysler's lead bank, which were increasingly anxious to extricate their capital as the auto market collapsed.)

Much later I learned that GM was hardly the only alliance he'd attempted. He'd also been in negotiations with the two most successful auto executives in the world, Carlos Ghosn of Nissan and Renault and Sergio Marchionne of Fiat.

Ghosn, in the minds of many, is the best automotive CEO to emerge since Alfred P. Sloan Jr., the father of General Motors, who reigned from 1937 to 1956. The Brazilian-born son of Lebanese parents, Ghosn got his start as an executive at tire giant Michelin. Nissan, the unprofitable $56-billion-a-year Japanese automaker, recruited him as COO in 1999 to take over its restructuring plan. Promising to quit if he couldn't return the company to prosperity within two years, Ghosn ignored Japanese traditions by closing plants, eliminating poor suppliers, and laying off workers far more aggressively than was typical for an Asian automaker. By March 31, 2001, the end of the 2000 fiscal year, Ghosn had delivered on his commitment—Nissan booked a $2.7 billion profit, a $9.2 billion swing from the loss it had suffered just twelve months earlier. The turnaround won Ghosn, who became CEO in 2001, acclaim around the world, including Japan, where his exploits were chronicled in a comic book. In North America, Nissan increased its market share against longtime rivals Toyota and Honda and raised eyebrows by fending off UAW organizing efforts in its plants.

Then in 2005, Ghosn became a dual CEO, taking charge of Nissan's minority owner, the $55-billion-a-year Renault, while retaining his Nissan post. Officially a French citizen, he now lived much of his life on a corporate jet, shuttling among Europe, North America, and Japan.

He had approached Rick Wagoner as early as June 2006 about taking a 20 percent stake in GM, but Wagoner persuaded his board to rebuff the deal, in part to save his own job as CEO. Later, Nardelli and Ghosn started to talk, reaching a preliminary agreement in early 2008. The deal, which was never made public, drew on the same playbook that Ghosn had used to unite Nissan and Renault. Chrysler and Renault-Nissan would form a global alliance by sharing design, engineering, and purchasing, saving large sums of money. Each would own stock in the other, to provide added glue. Ghosn would succeed Nardelli as Chrysler's chairman (to his credit, Nardelli, in his efforts to save Chrysler, was selfless about his own titles and role).

Then, as gas prices soared and the U.S. auto market hit the skids, Nardelli tried to broaden the deal into an alliance that would enable Chrysler Financial to tap Renault-Nissan's financial resources. Ghosn agreed to this at first. But in the spring, when business conditions continued to worsen, he got cold feet and withdrew. What could have been a lifesaver for Chrysler was not necessarily good for Renault-Nissan.