Monday, November 17, 2008

GM's bankruptcy can be Creative Destruction

GM's probable bankruptcy is in news everywhere. As GM and other automakers in Detroit line for government bailout, stocks are already down a whopping 95% this year.

Government has already spent billions of US dollars in bailout of financial institutions this year and fiscal deficit is expected to be around $2.5 trillion this year. These bailout are a liability for our children and coming generations. Fiscal deficit is piling up year by year.

So, the big question around is that "Should the government bailout auto industry too?"

Supports of bailout suggest that the bailout will save around a million jobs directly employed by automakers and indirectly by their suppliers and dealers, and 3-4 million might loose health care benefits, pension etc.




But is it correct to reward GM's bad conduct, poor performance for the last many years with this bailout?

GM has lost almost $74b since 2003. This loss hasn't happened in a single day. GM has continued with poor management and business plans. It's hasn't concentrated on its core business and made risky investments in other businesses. GM is one of the biggest holders of mortgage backed securities in US.
GM has already laid of thousands of workers.

Moreover, GM business is not going to be healthy soon. More of 50% of US households with 4 or more members have more than 3 cars. So, people are not going to cars at the same pace as they have been doing before. GM should now give reason for people to buy new cars. And that won't come easy. Toyota and Honda have spend big money on R&D of next generation hybrid cars during their heyday. And they are sound even in these tough days. When the going gets tough, the tough gets going.

US is a capitalist economy. In the free market, it's not government headache to save falling business. If White House wants to play a role, it should have drafted strict regulations for companies, forced them to invest in new fuels and technologies.

A bailout at this time will only reward bad conduct. If I lose money, I might borrow money to kick start my business again. If I lose money again, then I won't and shouldn't borrow more money. It's not about confidence but plain financial fundamentals. One more failure and I may end up destroying life of my family members and debt for coming generations. A slow recovery is better than risky one.

GM has been losing money for last many years. With future business outlook, recovery is not in sight.
And bailout will be a liability for coming generations in US.

And bankruptcy is not a bad idea. Under Chapter 11, GM will have chance to reorganize. In a bankruptcy, the debt holders line up to come up with a restructuring plan so that they can maximize the return of their loans or obligations. The shareholders get wiped out, but with GM down over 95%, that has largely been accomplished already. It has happened before with thousands of other companies. This healthy process is called Creative Destruction.

Auto Industry has a lot to learn from Tech business and startup. Think Apple. Steve Jobs turned Apple into a success story with next generation products. The products which people like, which build company's reputation. What's good in having a company around that is not able to manage its business, innovate and prepare for the future? Employment? Come on. There is no lack of creative people in US and this world. People will get unemployed once. Some creative people will kick off new businesses and employment will be generated. Even today when many wall street companies are laying off, there are companies having open vacancies. Problem is that new vacancies are less compared to lay offs. Thousands of companies have ceased to exist since start of 20th century but we are still employed with unemployment rate around 5-6%.

Toyota may be selling hybrid cars in US at very low margin (because they are costlier to build) but these hybrids help them build reputation. Toyota owns near 70% hybrid market in US. Toyota and Honda lead in compact car segment. Usually people buy compact car as their first car. This way Japanese car makers win customers which Detroit has to fight for later on.

Another example is from Honda, India. Honda has build such a strong reputation in India that it doesn't even advertise its cars on TV. It sells only from Word of Mouth Marketing. Cars they sell come at a premium to cars from other manufacturers in the same segment. Honda has been able to do that because of good performance of its cars.

Detroit needs to reinvent itself. Cars will be build in Detroit even in future. But companies there need to change their mindset. And a bailout is not going to help in this change.

1 comment:

Jason said...

The UAW needs a little tough love. It derailed the Cerberus deal at Delphi. Today GM suffers a loss of about $2,000 per vehicle sold. On the other hand Toyota whose employees are not part of the UAW earns a profit of about $1,200 per vehicle sold. If GM was able to operate with labor prices near Toyota’s it would have pocketed an additional $29,715,200,000.

GM bailout nonsense