American idle

Posted by Marc Hodak on July 18, 2008 under Economics | Be the First to Comment

I often wonder what is going through the heads of auto executives. It’s a habit gained from my years of working with them. I don’t think they’re idiots. Idiocy can’t be that widespread or that sustained over such a prolonged period as the decline of U.S. auto companies. I have to think they are intelligent, educated people operating under perverse incentives. And then I see decisions like these:

1) Cutting revenues without due regard for what happens to costs. GM and Ford each tried to cutting sales to fleets in the late ’80s and early ’90s because those sales weren’t “profitable.” How did they know they weren’t? Because their cost accountants told them. They looked at the average revenues they got for the vehicles and subtracted the average costs and, voila, losses. What the cost accountants didn’t tell them was how many of those costs would remain after those revenues disappeared–the fixed costs of plant operations is remarkably high. Both companies reversed their decisions within a year after suffering what were then record losses. Now, the U.S. (but not Japanese) auto makers are again trying this management by the numbers experiment, led by Chrysler and their by-the-numbers chief. This time, the excuse is resale price maintenance, but the cash flow end will be the same. I guess sometimes the only way to know the stove is hot is to actually touch it.

2) Cutting costs without due regard for what happens to revenues. American manufacturers are the master of this. GM recently announced that they will cut $10 billion from their cost structure. That’s a lot of paper clips. The logical question, at least to a consultant with some finance savvy, is: “Why now?” If the $10 billion was there to cut, why wasn’t, say, three or four billion there to be cut last year? Or a few billion the year before? I’d be concerned about two possibilities. First, I’d wonder how much worse the cars will be after these cuts. GM cars have always seemed a little tinnier than Toyotas or Hondas. Even if the cuts don’t show up in the cars themselves, how much of this $10 billion is fat rather than muscle? Second, maybe the fat was there, but the attitude was “hey, we’re so screwed, what’s another few billion.” I’ve met many managers, and more than a few individuals outside of the business world, like this. Most of them met a bad end.