Meltdown in Motown

Last October Ray Young, chief financial officer of General Motors, realised the company wasn't going to make it.

Young had been closely monitoring GM's cash flow for months. It had lost a staggering US$70 billion since 2004, and Young knew that if everything went exactly to plan, it would probably continue to lose about US$1 billion a month until 2010. That was bad, but it was survivable, as GM had sufficient cash reserves to see it through to a year when a bunch of hot new models were scheduled to hit showrooms, and the firm would be freed of crippling retirement and health care costs - which totalled US$5.2 billion in '04 - thanks to a breakthrough deal negotiated with the United Auto Workers union in late 2007.

Only problem was, things weren't going to plan any more.

GM had burned through US$4.2 billion in the past three months alone. At that rate, it looked like the company's cash reserves would fall below the US$10 billion it needed to continue the ongoing financing of its global operations before the end of the year. Ray Young realized the unthinkable was about to happen: mere weeks after celebrating its 100th anniversary, the company that had for 80 years been the colossus of the global auto industry, and the power house of America's industrial might, was staring insolvency in the face. In early November, in a filing to the Securities and Exchange Commission, GM publicly dropped the bombshell, saying its ability to continue as a going concern was in doubt. Less than two weeks later CEO Rick Wagoner was in Washington, begging for a multi-billion dollar government loan, insisting GM would otherwise be out of business by December 31.

How had it come to this?

This catastrophic mix not only tipped mighty GM over the edge, but also ailing Chrysler, and threatened to drag Ford into the abyss as well.

The storm clouds had started gathering in early 2007 as the price of fuel began rising rapidly. American consumers had complained loudly when a gallon of unleaded popped through the US$3.00 mark briefly in 2007, but in early 2008, when it started racing towards US$4.00 a gallon, they suddenly decided en masse they wanted to drive fuel-efficient vehicles. In May, Toyota shifted a record 20,000 Priuses as dealers reported waiting lists for the quirky hybrid - remarkable in a country where even Rolls-Royce Phantom buyers prefer to drive a car straight off the showroom floor the same day. Meantime, sales of pick-up trucks and lumbering full-size SUVs slumped nearly 30 percent.

For the first time in more than two decades, Ford's F-150 was knocked off the top of the sales charts, outsold by Honda's Civic, Toyota's Corolla and Camry, and the Accord. Dealers were refusing to accept pick-ups or large SUVs as trade-ins for fear of being stuck with gas guzzlers they couldn't sell. Residuals tanked; suddenly people owed thousands more than their trucks or SUVs were worth. Worse, the finance companies began to back away from egregious deals that allowed people to finance as much as 135 percent of purchase price of a new vehicle, effectively subsidizing the loss on their old one. Insurance fraud soared as desperate owners deliberately torched, dumped or drowned late-model trucks and SUVs to get rid of them.

While everyone was hit hard - Toyota idled its near-new US$1.3 billion truck factory in San Antonio, Texas, in early August as demand for its Tundra pick-up and massive Sequoia SUV bombed - things were looking especially grim in Detroit, which had long relied on the fat profits from the cheap-to-build pick-ups and the large SUVs that shared many of their components. In 2005 GM had frozen or cancelled a number of new-car development programs, including the Zeta-based Camaro (which would survive) and the Zeta-based Pontiac Firebird, Cadillac DTS replacement, and a rear-drive Chevy sedan (which would not), to pull forward the launch of its GMT900 trucks and full-size SUVs by six months in a bid to generate additional cash flow. At the time, when trucks and SUVs commanded more than half of the US market, it had looked like a smart call. Now it looked like a massive error.

GM's sub-prime time
Credit, the life-blood of the industry, completely dried up. In 2004 GM had lost US$3.1 billion selling cars, but made US$4.3 billion financing them. However, its in-house finance company, GMAC, which had aggressively branched out into mortgage lending in the mid-'80s, was now neck-deep in the same toxic sub-prime home loans that had brought the whole American financial system to its knees. In 2007 about 20 percent of consumers in the US had leased their vehicles; now even good customers found it hard to get finance for a new vehicle. Sales plunged. Frozen credit wasn't the only problem: as the rancid mess on Wall Street rippled out into the wider economy, and job losses and mortgage defaults soared, consumer confidence collapsed. GM's October 2008 sales were 45 percent down on the same month the previous year; on a statistically adjusted basis it was the company's worst month since World War II. "It was like somebody turned the lights off," says GM vice-president of sales and marketing, Mark LaNeve.

Chrysler caught in the crossfire
But things were even worse at Chrysler. Questions had surrounded the future of the smallest of the Detroit Three ever since its acquisition by secretive private equity company Cerberus Capital Management in 2007. Publicly, Cerberus said it had bought Chrysler for the long haul, but no-one believed it. Private equity companies simply don't operate that way; their usual modus operandi is to 'strip and flip' - in other words, pull out as much cost as possible, and sell off the juiciest assets at a profit. Even if Cerberus was sincere about a long-term approach, few could believe it would be more than five years, barely the life of a model cycle in car industry terms.

Cerberus had to have an end game. China seemed a likely play, especially after it hired former SAIC exec and GM China boss Phil Murtaugh to run Chrysler's overseas operations. Buying Chrysler, the theory went, would give a Chinese car maker a ready made entrée into the US market, particularly in terms of a dealer network. But Cerberus had acquired Chrysler at the top of the market. And while it didn't pay a lot of money for the company - Daimler boss Dieter Zetsche (who ran Chrysler between 2000 and 2005) was so desperate to off-load the business he let Cerberus have 80 percent of it for US$7.4 billion, one fifth the amount his former boss Jurgen Schrempp had paid for it in 1998 - Cerberus quickly discovered the car business swallows cash at a frightening rate. And despite the theories, the Chinese weren't in a hurry to buy.

Incredibly, GM took a look at acquiring Chrysler in late October. In many ways the deal made no sense whatsoever - both companies had too many workers building too many vehicles people didn't want. Both firms had too many dealers, and there was too much overlap in their product portfolios. What's more, any potential manufacturing synergy would take years to kick in. But Wagoner and chief operating officer Fritz Henderson certainly looked at it, trying to see if any deal - perhaps swapping the rest of GMAC with Cerberus for Chrysler - would work: "The adults are away talking numbers," joked GM product boss Bob Lutz at a meeting Wagoner was supposed to attend at the time.

To save money, Cerberus began hacking away at costs. The hushed, deserted, darkened Chrysler stand at the LA motor show in early November - Cerberus hadn't even paid for spotlights, just shoved a random collection of cars on the floor - looked like a mausoleum. And by the time Chrysler CEO Robert Nardelli (a former General Electric exec who missed out on the top job after Jack Welch retired) joined Rick Wagoner in Washington to plead for money, thousands of experienced senior engineers and managers were being offered redundancy packages.

Blue Oval's profits of doom
Though badly battered by the market collapse, Ford seemed in the best shape of the Detroit Three. But that was mainly because it had got lucky before it had got good. At the end of 2005, Ford was in a very bad way. Its market share had slumped from 24 to 18 percent in just five years, its North American operations were losing US$15 million a day, and US$12 billion had been wiped off the value of the company. Having fired Jac Nasser in 2001 to take over the day-to-day operation of the family business, scion Bill Ford Jr had proven he was totally out of his depth. After an embarrassingly long search for a new CEO (a number of senior industry execs were approached, but none could be enticed to work for the Ford family, which has a history of firing CEOs it doesn't like), former Boeing man Allan Mulally took over the hot seat.

Although not a car guy, Mulally quickly proved his mettle as a leader. Perhaps because he was an outsider, he was able to cut through the bureaucracy and politics at Ford and grapple with the core problem: the lack of profits. He moved decisively, mortgaging the entire assets of the FoMoCo to free up US$24billion in operating cash in late 2006, and crafting his "One Ford" strategy that would see the company sell off its costly Aston Martin, Jaguar and Land Rover acquisitions, reduce its stake in Mazda, and put Volvo on the block so it could concentrate solely on the Blue Oval brand worldwide (with Lincoln and Mercury coming along for the ride in the US).

When the perfect storm hit, Ford was therefore a smaller, leaner, richer, more nimble company than GM and much better organised than Chrysler. Mulally accompanied Rick Wagoner and Robert Nardelli to Washington, but refrained from asking for an emergency loan to keep his company afloat beyond the end of the year. Instead, he merely wanted Ford to be able access to a line of credit "if needed".

If the Detroit execs were caught out by the perfect storm, they were totally unprepared for the aftermath. Wagoner, Nardelli and Mulally flew to Washington on their corporate jets and strode straight into a PR disaster. The politicians, their antennae finely tuned to the growing public anger over the mess on Wall Street, and the way hundreds of billions of dollars had simply been handed over to financial institutions with little regard for accountability, were in no mood to bail out an industry many regarded as arrogant and out of touch. Humiliatingly, all three CEOs were sent back to Detroit empty-handed, with instructions to return in early December with a plan for how the money would be used.

Instead of focusing America on the problems in Motown, the trip had turned into a media frenzy over fat-cat execs using private jets to come and beg for public money to save their businesses. Saturday Night Live delivered a savage comedy sketch that portrayed all three CEO as bumbling incompetents. "It was not," a GM insider confessed later, "our finest hour."

The Saturday Night Live sketch also took aim at the politicians, depicting one berating the three for not building fuel-efficient vehicles: "We've already mandated 200mpg [1.2L/100km] cars, so we've done our part." Tellingly, no-one in the audience laughed. In the weeks after the November fiasco, it was clear Motown had totally misjudged the mood of the American public: a CNN Money poll showed 61 percent of Americans opposed any bailout. And although all three CEOs dutifully returned to Washington in early December to plead their case once more (and this time all three drove - Wagoner did the last few kilometres of the trip in a Chevy Volt prototype) a few hold-out politicians still refused to budge, stonewalling a bill to provide emergency funding.

Things are tough all over
It was left to lame-duck president George Bush, whose disinterest in the American car industry had been profound throughout his presidency, to personally approve US$17.4 billion in loans from the Troubled Assets Relief Program fund (set up to bail out the banks) on December 19, less than two weeks before GM and Chrysler said they would be out of business. Thanks largely to Bush's desire not to add the collapse of American auto industry to his presidential legacy, Detroit had dodged a bullet. For the time being.

The nightmare on Wall Street hit every car maker hard. Sales were down 40 percent in the US, 37 percent in the UK, and 18 percent in Germany. Japan had its worst sales year since 1974. In November a BMW board member said his company would run out of money in two years if sales and spending continued at their current rates. The company promptly axed its CS four-door coupe program. Honda boss Takeo Fukui announced the company was pulling out of F1, then confirmed the NSX program was dead, effectively also killing off plans for a rear drive Acura RL (Honda Legend) and the company's first V8 road car engine. Even mighty Toyota was hit, postponing investments in factories and putting the LF-A supercar launch on hold as it braced to record its first operating loss (US$1.7 billion) in 71 years. But the Detroit Three were hit hardest because they were especially vulnerable. They had become the weakest car companies in the world because of a dangerous structural imbalance in their home market that was 30 years in the making.

The poorly thought out Corporate Average Fuel Economy (CAFE) regulations enacted in 1975, which favoured trucks over cars, played a key role. "Pick-up trucks got better for unrelated marketing reasons, just as cars got worse because of CAFE," noted former Wheels COTY judge Jim Hall, now head of industry analyst firm 2953 Analytics. "The psychographics of early extended-cab pick-up truck buyers were almost identical to those of people who bought the big rear-drive coupes Detroit used to build," he continued.

Detroit had grudgingly built the more fuel-efficient cars the government mandated under CAFE, but American consumers mostly ignored those and bought gas-guzzling pick-ups and full-size SUVs by the millions because cheap fuel meant they could easily afford to run them. (For almost 20 years from 1986, Americans paid just 44c a litre or less for petrol. The federal tax on petrol is still only 4c a litre, and the highest state tax just over 7c a litre.) The consequences were entirely predictable: about 10 years back a Ford product planner quietly suggested the company's future US model line wouldn't feature any cars. Everything would be a truck - SUV, pick-up, and this newfangled thing called a crossover.

Size does matter
In truth, even the Japanese and Europeans had been seduced by America's addiction to cheap fuel: Toyota and Nissan invested billions in developing their own unique-to-America full-size pick-ups and SUVs with giant V8 engines. The only reason the Porsche Cayenne, Mercedes ML, BMW X5 and the Audi Q7 exist was due to demand from Americans. But unlike the Japanese and Europeans, GM, Ford and Chrysler became overwhelmingly reliant on designing, manufacturing and selling a genre of vehicle that was totally irrelevant outside North America. They'd become the world's biggest niche-market specialists.

Arrogance, complacency, and Motown's suffocating small-town mindset compounded the problem - the Detroit Three's North American operations were still largely scaled for 1970s' market expectations rather than 21st century market realities. A small example: To the end of July 2008, GM had sold 1.8 million vehicles in the US, compared with Toyota's 1.4 million. But GM's total was spread across eight brands (Chevrolet, Cadillac, GMC, Buick, Pontiac, Hummer, Saab, Saturn) and more than 6700 dealers. Toyota, by contrast had just three brands (Toyota, Lexus, Scion) and just over 1200 dealers.

Can Motown get its mojo back?
The lessons of California, where the Japanese and European car companies established their beachheads in the US decades ago, and the profound demographic changes in southern states, where Japanese and European firms established their own US manufacturing sites, were largely ignored. Cocooned in a company town most of their working lives, many of Detroit's top executives simply failed to realise there were now thousands of consumers who'd grown up riding around in the back of Toyotas, Hondas and Nissans rather than Chevrolets, Fords and Dodges, and thousands more who had been appalled by the poor quality of Detroit's cars during the 1980s and '90s. Almost without realising it, Motown had lost two whole generations of American car - as opposed to truck - buyers.

So, what now? Is Detroit doomed? The future is uncertain.

The cost of a comeback
"We only needed a couple of okay years to get us though to 2010," said one senior GM insider. But what passed for "okay" in late 2007 is certainly not going to cut it in early 2009. For most of the past decade new vehicle sales in the US averaged somewhere between 16 and 17 million units a year. In 2008, sales totalled 13.4 million units, and the predictions for 2009 and 2010 range from just 10 million to 12 million units. Both General Motors and Chrysler have until March 31 to present viable long-term business plans, or they must repay the loans authorized under George W. Bush. President Barack Obama has stated he does not intend to allow the American automotive industry to fail. But no-one really knows what a viable US auto industry will look like. One thing is certain - having taken public money, neither GM nor Chrysler now control their own destinies.

At GM work has been slowed on almost everything. The exceptions are the Chevy Cruze, the slightly-larger-than-Astra sedan built off the new Global Delta architecture and powered by a 1.4-litre turbocharged four-cylinder engine, and the eagerly anticipated Chevy Volt, the Global Delta-based hybrid-electric hatchback with its 1.4-litre range-extending internal combustion engine. The launch of the new Camaro muscle car has slipped back to March; the Cadillac CTS coupe is on hold and the Cadillac CTS wagon delayed.

Chrysler is in desperate trouble; few expect it to survive in its current form. A large number of highly experienced engineers and managers took the redundancy deals offered to them and ran in November, taking years of institutional memory with them, and leaving everything from product development to purchasing to marketing in something approaching total disarray.

"The [redundancies] were announced on the first of November, but the details were not released until November the 20th and the deadline to accept was only ten days later," said one newly bought-out manager who still happens to be in almost daily contact with the engineering team he left behind, helping out. "In a lot of cases there was not enough time to do a proper hand-over."

Of the three, Ford looks in the best shape. But there are real questions over whether it can survive the dramatic contraction that's occurred in the market without resorting to government money. And not everyone is convinced Americans want a small, economical, Euro-style car like the Fiesta, which is scheduled to go on sale in the US in 2010, especially as the price of petrol has dropped to US$2 a gallon, and truck sales, admittedly boosted by deep discounts, are picking up. While other markets are prepared to pay for a small car that's technologically advanced and well-equipped, Yanks have proven time and again they won't. Ominously, Prius sales are barely 40 percent what they were in May, against a 32 percent drop in total Toyota sales. Obama's administration faces a huge task if it wants to retool, reinvent and re-imagine Detroit for the 21st century. Estimates put the true cost of fixing Motown at between US$75 and US$125 billion, and given much of the rhetoric from politicians during the hearings last year, any bailout will come with strings attached, including a push for greater fuel efficiency. New CAFE regulations that will mandate car makers' fleets average 6.7L/100km by 2020 look almost certain to be adopted. In his final weeks in office, Bush handed over responsibility for setting interim fuel-economy standards to the Obama administration.

In GM's case the new regs equate to 7.4L/100km for trucks and 5.9L for cars by 2020, according to powertrain chief Tom Stephens, a big jump from the current levels of 10.2L and 8.5L. That effectively means the end of high-volume V8s and large cars, and investments in fuel-saving tech (hybrids, diesels, direct injection) and weight-saving materials that will increase the price of new cars and trucks. But CAFE didn't cause consumers to stampede Toyota dealers looking for a Prius last summer - US$4 a gallon did. Unless politicians are willing to tax fuel at a point where buyers demand fuel efficiency, the Big Three could be destined to repeat a crucial mistake.