Not-so-Secret Weapon: GM's Slimmer Cost Structure Will Pack WallopBy Michelle Krebs June 24, 2010
With all the positive things that have begun accruing to General Motors as it attempts to leave 2009's bankruptcy behind, the biggest one of all has only begun to materialize: GM's fast-improving manufacturing-cost position versus its biggest foreign rivals.
That's right: GM likely has begun enjoying a new cost edge. Some analysts say that it already has reached as much as $2,000 a car over models built by Japanese competitors in the United States and that GM's overall cost advantage may soon become as much as double that amount. Other experts peg GM's improving manufacturing-cost comparison not as optimistically -- but at no worse than a draw compared with any of its major competitors at this point.
GM's costs will be much discussed at its first annual Global Business Conference June 29. GM announced Thursday that the conference will be hosted by GM Vice Chairman and CFO Chris Liddell and several senior leaders to provide updates on the company's global business. The conference clearly is a warm-up for GM's upcoming initial public offering ofits stock.
Disadvantaged to Advantaged
For a company that perpetually faced a roughly $2,000-a-car cost disadvantage for most of the last few decades versus its Japanese rivals, the turnabout is monumental. More than anything else as GM's recovery plays out, this factor could ensure that the company not only is surviving but thriving again as an independent entity within a few years.
"It means the curse they've been carrying for 20-some years is gone," said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich., and a long-time student of GM. His outfit recently estimated that GM and Chrysler each has cut the cost of making each U.S. vehicle by $5,000. "People are going to be surprised. GM is going to be right at the center again of what will be a highly profitable industry."
And among other areas, expect GM's greater cost flexibility to show up in better products. "They're already showing that they're trying to put more content into their vehicles," said Jessica Caldwell, head of U.S. industry analysis for Edmunds.com. "That's the smart thing to do: get future products in line and then worry about everything else."
Decades of Frustration
The reasons for this profound turnabout are simple, of course. By becoming wards of the U.S. government and the United Auto Workers and stiff-arming its bondholders, GM in its restructuring last year wiped out $30-some billion in debt and reduced it to under $10 billion now. And that was after GM earlier had gotten the UAW and other unions to let GM off-load its "legacy" pension and health-care costs onto a new, independent entity whose financial risks mainly fall to the unions, rather than to the company.
GM had battled the cost bugaboo fruitlessly for decades. It couldn't make a small car competitively in the United States because of the huge manufacturing-cost differential, seen in the form of a woeful labor-cost comparison and also in the efficiency advantages of the Japanese approach to manufacturing. The whole idea of launching the Saturn brand in the mid-Eighties was for GM "finally" to make a cost-competitive small car that could steal sales from the Japanese. But long before GM deep-sixed the Saturn brand last year, it gave up on that small-car pipe dream.
The company also had to cope with a manufacturing infrastructure that was older, which added costs and depressed productivity. Supporting eight brands instead of the current four - in terms of the complexity for suppliers and GM assembly plants alone - added to its relative cost burden versus competitors that fielded no more than three brands. And GM remained very dependent on Delphi, its former captive supplier of a wide range of components and systems, which has comprised a costly corporate nightmare for several years.
So, GM had little choice but to build sparse content and inferior quality into its low-end models, essentially ceding the small-vehicle market to Toyota and Honda. Ford and Chrysler, stuck basically in the same boat, played the same game of resignation to costs as GM. Through the Nineties and into the last decade, essentially the way all three stayed in business was selling high-profit pickup trucks and SUVs.
The Great Recession razed the Big Three's house of cards, of course. But it also took most of the teeth out of the monstrous cost advantage previously enjoyed by the Japanese.
Suddenly, the government-designed GM shed itself of several old plants, thousands of workers, four slow-selling brands, and obligations to debt holders - and the billions and billions of dollars of associated costs. Chrysler underwent a similar crash diet. And the UAW agreed to give each of the Big Three new future flexibility to add workers at a lower new wage-and-benefit tier than existing employees, which would roughly halve the previous hourly compensation for new production workers.
And all of that came just two years after the companies' new deals with the UAW that created voluntary employees' beneficiary associations (VEBAs) that vastly reduced their pension and benefits obligations for retired and current workers and turned management of those funds over to the union.
GM, for example, was able to discount about $50 billion in future costs down to about $35 billion, to be paid out over time, and to turn the headache over to the UAW. That change alone will be worth about $1,000 a car in reduced costs to GM, according to the Center for Automotive Research.
Analysts have been appraising the net result on GM's costs from all this activity and have broken it down into two areas: Labor costs per se are one, and in turn they are a subset of the second, overall manufacturing costs.
Their consensus is that the changes have enabled GM to pull much, much closer to even in labor costs with the U.S. operations of Toyota, Honda and Nissan but, at this point, probably not ahead. The latter may still enjoy a $5- to $10-an-hour labor-cost edge over the Big Three, whose own labor costs overall are still around $50 an hour.
Reasons for foreign OEMs' persistent cost edge include the fact that the Japanese "transplants" - as well as American assembly plants now operated by Korean and European automakers - benefit from paying lower-than-UAW wages in some of the newer plants in the Deep South and less-generous health-care benefits in their facilities nationwide than at Big Three plants.
"But what used to be a huge labor-cost gap has narrowed significantly," said Ron Harbour, partner in Oliver Wyman, Troy, Mich., and scion of the Wyman division originally founded by his father, which produces the most closely watched analyses of manufacturing costs across the auto industry.
In terms of costs overall, the new picture actually is even better for GM. Thanks to elimination of debt, consolidation of its manufacturing footprint since last year, and a general boost in productivity over the last few years, GM may now enjoy as much as a $400-a-car advantage in total production costs over some foreign rivals.
"They've dramatically reduced both fixed and variable costs beyond just labor," Harbour said of GM. In addition, shedding brands and closing plants "takes a lot of capital investment and more fixed costs out of the equation."
GM's fixed costs per vehicle will drop from $13,591 last year to $8,165 this year and to $6,726 by 2012, calculated Citi Investment Research analyst Itay Michaeli. Harbour declined to quantify his own cost estimates for GM and its rivals ahead of Oliver Wyman's report on those numbers later this summer. But Cole wasn't shy about predicting that the new dynamics could yield a cost advantage of $3,000 to $4,000 a car for GM in coming years, a dramatic reversal of the albatross that has burdened the company for a generation.
One reason analysts believe GM eventually could build a big cost edge over foreign rivals is the lower compensation it will be allowed to pay if and when it begins hiring workers again. Not only will their wages and benefits be significantly less, but they'll be ineligible for the defined-benefit pensions that helped put the company in its previous cost morass. "The numbers," Cole said, "won't be there to let this [labor-cost] situation blow up again."
Ford actually will be in position to take advantage of the "two-tier" wage structure sooner than GM because Ford has fewer pre-existing workers who would be entitled to rehiring as the company recovers, said David Whiston, automotive analyst for Morningstar.
That's one reason Ford will be able to stay in the same ballpark with GM and Chrysler in future manufacturing costs. True, Ford didn't access Obama administration largesse or leverage to improve its cost position last year. But visionary CEO Alan Mulally had spent the previous few years stripping costs out of the company - and improving its capital position -- more aggressively than either GM or Chrysler.
"Ford has a bigger 'mortgage,' but they were further out front in attacking some of their other fixed and variable costs," Harbour said. "What they've done in terms of rationalizing capacity and harmonizing vehicle platforms globally - they're pretty far down the road already, and no one else has done that."
Handling a Golden Egg
Of course, it's always possible for GM to squander its newfound cost prowess over the next few years - even despite the trauma required to create it. But assuming that the company's new management nurtures this refreshing advantage and even extends it, what will they do with it?
Obviously, GM can apply these cost savings to boost profits, keep prices in check, improve the content of vehicles it sells, and beef up development of future models. Analysts expect the company to do some of each. First-quarter profits for GM were a better-than-expected $865 million, for instance. And at about $3,250 per vehicle in May, GM's incentive costs were about $200 a car more than in April as it competed with Toyota's efforts to buy back market share.
But analysts predicted that GM CEO Ed Whitacre will re-invest much of the cost savings into researching, developing and manufacturing better products.
"They have a management team that understands the importance of making all products to make money, not just light trucks subsidizing a money-losing car business," Whiston said.
Whitacre already has indicated, Harbour said, that "he's allowing design people to put in better materials and spend more money particularly in terms of 'see, feel and touch' areas. He feels that if you put in, say, another $300 a car [in costs] in those areas, you will get much more than that in the marketplace in terms of improved pricing - and I think he's right."
GM soon will be able to test this theory with the launch later this year of othe Chevrolet Cruze, its first new small car since the Chevrolet Cobalt was introduced in 2004. And while Cruze was under development long before GM filed for bankruptcy, outside analysts and GM executives agree that the company's new cost environment has been enriching Cruze as it is readied for its debut.
"The level of execution is unbelievable compared with the Cobalt," Cole said. He said that an innovative suspension system that creates more trunk room is one major reason, from the Cruze design hatched a few years ago. But the addition of noise-insulation materials around the rear is an improvement that could have been added much more recently, partly as a result of vehicle managers' increasing confidence about costs.
In any event, said Ken Morris, GM's executive director of global vehicle integration, "We're very happy with where the Cruze will be against the competition when it comes out." - Dale Buss, Contributing Writer
Photo by GM
The 2011 Chevrolet Cruze goes into production at GM's Lordstown, Ohio, plant this year.