GM & Toyota: A Tale of Two Car Companies
Kurt Brouwer December 15th, 2008
Here we have a tale of two car companies — GM and Toyota. Last year, both companies sold lots of car and trucks. In fact, total worldwide sales were almost the same so each company did pretty well.
Chart: Fundmasteryblog Data: Mises Economics Blog
This piece by Ralph Reiland at the Mises Economics Blog has the data we used to create these charts [emphasis added]:
Mismanagement at the Big Three (Mises Economics Blog, December 9, 2008, Ralph Reiland)
It was a dead heat. General Motors sold 9.37 million vehicles worldwide in 2007…Toyota sold 9.37 million vehicles in 2007…
Chart #2 shows profit or loss per unit sold between GM and Toyota:
Chart: Fundmasteryblog Data: Mises Economics Blog
Ouch. So, GM had a great year for sales last year yet it still lost money on each vehicle sold. In fact, it lost $4,100 per sale. Toyota sold approximately the same number of vehicles yet it made $1,800 per unit sold. I once saw a late night TV ad in which the huckster said something to this effect, “We lose money on every sale, but we make it up in volume.” In the real world, if you lose money on every sale, more volume equals more losses. Though you can imagine what is coming next, you will still be amazed at the magnitude of the dollar differential:
Chart: Fundmasteryblog Data: Mises Economics Blog
Just to reiterate, in 2007, on nearly identical unit sales, GM lost $38.7 billion and Toyota made $17.1 billion. That’s a whopping differential of $55.8 billion. Of course, this year GM (Toyota too) is dealing with much lower sales volume than they had in 2007 so they will probably lose even more money per unit sold. Not only is this bad from a profit and loss perspective, but it is even more critical when it comes to viability as a going concern. Reiland continues:
Collectively, Detroit’s Big Three automakers are currently losing about $5 billion per month, with Ford, General Motors and Chrysler, respectively, burning through $2 billion, $2 billion and $1 billion in cash every 30 days.
…General Motors and Chrysler added a “rush” to their latest bailout request, telling D.C.’s lawmakers that they need, respectively, an immediate $4 billion and $7 billion to ensure minimum liquidity levels, paid prior to the end of December. GM, as well, asked for an additional $4 billion for January and a third handout of $2 billion in the February/March time frame to forestall a financial calamity, plus a $6 billion line of credit from the federal government to ensure ample liquidity.
All told, GM says it needs an $18 billion taxpayer bailout, some 50 percent more than it said it needed just three weeks ago to turn things around…
As I read this, it would take about $5 billion in government handouts per month to keep these entities afloat. That’s $60 billion a year. But, the projected tab is going up almost daily so it will probably get worse. Let’s say the government does give them a loan to tide them over until next year. Does anyone think that GM can somehow muddle through this crisis with minor changes? Does anyone think that a few billion dollars is going to make any difference in how GM — or any other domestic car companies — operates? After all, if you lose money on every sale, it’s hard to make a profit.
One legitimate point in favor of the bailout is that this is a horrendous year to have GM declare bankruptcy. The shock of a bankruptcy filing would hit hard in an already difficult economic environment. In addition, once a bankruptcy filing is made, there is no telling what will happen. Those points are fair enough.
The contrary argument is that the domestic car companies’ basic business model is broken. You’ll see plenty of stories about GM’s troubles and about a potential government loan or bailout. But, what you won’t see in most articles about the company is a succinct demonstration about why GM is close to failure. However, in our effort to give you insights into the truth behind the headlines, we present the following chart which shows the total cost for U.S. workers at GM, Ford and Chrysler versus Toyota and across the spectrum of domestic goods producing industries. This includes the hourly pay plus benefits plus additional costs related to retiree pension and healthcare benefits plus the cost of the notorious Jobs Bank.In addition to management problems, quality problems and other issues, GM is stuck with very high cost production labor as you can see below:
Source: Carpe Diem
Due to very strict contracts with the United Auto Workers union, the Big Three automakers (GM, Ford, Chrysler) are saddled with labor costs that are roughly 50% higher than Toyota is paying workers at factories here in the U.S. In addition, there are silly requirements such as the Jobs Bank that requires the Big Three to pay workers that are not even working. In addition, there are strict work rules that limit flexibility, cross training and other normal business practices. For an in-depth look at this issue of employment costs at domestic auto companies, see this Heritage Foundation report.
Having grown up in Michigan, I can attest that the U.S. auto makers have had plenty of bad management decisions and design and quality problems so it is not enough to suggest that all problems stem from ultra high labor costs. In fact, Toyota generally has significantly higher quality and customer satisfaction ratings than GM or Ford or Chrysler. However, GM has made great strides in producing competitive cars recently. Examples include the Chevy Malibu, which is very competitive with the Toyota Camry. Also, GM is producing the Chevy Volt, which could be the first electric production car. GM has responded to the marketplace, but its ability to do so is certainly hampered by its legacy issues.
In this excellent piece by John Tamny, editor of Real Clear Markets, Tamny makes the argument that we should simply let GM file bankruptcy. RCM is one of the sites I visit daily because it is a great source for articles and blog posts on financial and economic issues [emphasis added below].
Time to Pull the Plug on GM (Real Clear Markets, November 11, 2008, John Tamny)
…The latest losses at General Motors reveal yet again that it is the living embodiment of managerial ineptitude, and to insure that it no longer fails its customers while harming the well-being of Americans more broadly, it’s essential to let the firm die.
Many will of course blanch at the presumed loss of jobs that would result from GM’s death, but judging by the high level of unemployment in Michigan, it would be more realistic to say that GM’s continued existence under weak management has served as a capital repellant such that capital and jobs will continue to flee the state if GM is saved with the money of others. Worse, business history, from ships to farming to mining, shows that sectors reliant on government help are invariably weakened as opposed to strengthened.
The above is the case because businesses rarely fail due to a lack of money. Instead, poorly run businesses find it hard to raise money in the capital markets. Government money allows the architects of bad decisions to continue making mistakes that cause a company to be capital deficient to begin with.
This distinction is important considering the efforts of GM’s present management to secure more funds on top of the low interest loans that Congress recently approved. Were GM well managed it would have no need to run to the federal government, but because its management has proven time and again that it lacks ability, capital is correctly searching for better opportunities.
…So in a sense there’s a moral aspect to letting GM implode. Indeed, with companies not in the auto sector presently shedding workers due to a lack of funds, how could Obama or the outgoing administration take even more precious capital from the private sector in order to keep alive a firm notorious for its prodigious misuse of the money offered it?
The better answer for a capital-starved economy would be for the federal government to once again get out of the way, and in doing so, let funds flow to the very best ideas to insure as quick a recovery as possible. Importantly, if investment proves non-existent for GM absent government largess, it’s a certainty that foreign carmakers will step in amid the firm’s bankruptcy in such a way that job losses will be much less of a problem than is often assumed.
…In the end, the state of Michigan and the U.S. automobile sector are struggling not due to back luck, but precisely because they cling to a company that investors no longer value. And with GM shares near all-time lows, those with capital are stating loudly that so long as GM remains as is, the funds necessary for job creation will continue to flee.
So rather than waste precious capital in the naïve hope of propping up that which investors don’t value, it’s essential to let GM fail. Only then will a necessary change of ownership occur; the latter change the only solution when it comes to properly utilizing assets whose misuse is presently destroying a formerly great company, not to mention the economic health of the state in which it is headquartered.
Assuming GM does go into bankruptcy, that should not have an immediate effect on employment and its normal operations as this piece from the Wall Street Journal [emphasis added] on the recent bankruptcy filing of the Tribune Company demonstrates.
Tribune Co. filed for Chapter 11 bankruptcy protection Monday, bruising billionaire Samuel Zell’s ambitious effort to rescue the media company and reshape the ailing newspaper industry.
…The bankruptcy filing covers Tribune’s eight major daily papers, including the Los Angeles Times and Chicago Tribune, as well as the company’s string of local television stations. Tribune’s Chicago Cubs baseball franchise, in which the company is trying to sell an interest, wasn’t included in the filing.
The filing gives Tribune breathing room to rework its debt, and Mr. Zell said the company will continue to operate normally. He added that the company expects to remain intact, but he is open to selling other assets besides the Cubs…
The Tribune Company is a large media company with multiple newspapers and other assets including the Los Angeles Times, the Chicago Tribune, television stations and even the Chicago Cubs. The point of the bankruptcy filing was to allow the company to continue normal operations while it restructures its businesses to become profitable again. Bankruptcy is not the end of the line, but rather an organized restructuring of a company. And, so far, normal operations are continuing at those Tribune subsidiaries.
Getting back to GM, from a political perspective, a bailout may be inevitable. But, a bailout won’t work over the long haul unless GM changes the cost structure shown above and the bailout plan being discussed says little or nothing about amending the union contracts. Second, why should Americans (who generally make far less than autoworkers make) be asked to pay taxes in order to preserve the jobs of overpaid autoworkers?
One big issue hangs over the domestic automakers and that is, what will happen to retirees who rely on the company for pensions and health insurance? Unfortunately, it is almost certain that a bailout will not work unless GM makes radical changes on those very issues of retiree benefits. However, even that is not enough. GM will have to make many other changes — obtaining competent leaders, improving its product line and changing its bloated dealership structure to name a few. But, the likelihood of all of those improvements being made in a timely fashion is pretty low in my opinion.
If there is a bankruptcy at GM, we should certainly do something to mitigate the pain suffered by its employees and its retirees, but dealing with that issue can wait until we find out whether or not GM joins the bailout bonanza (see Bailout Bonanza for Bad Businesses — Will it ever end?).
Update:
Nobel Laureates for bankruptcy. Now there’s a catchy phrase.
Gary Becker and Joseph Stiglitz have both have won the Nobel Prize in Economics and both believe bankruptcy is the proper solution for GM and the other domestic automakers. Becker also addresses the issues of warranties and whether or not this would be a bad time for them to go in Chapter 11. Here are excerpts from each [emphasis added]:
Here’s Becker:
I believe…that the big three auto companies should be allowed to go bankrupt. This sharp recession is actually a good rather than bad time for them to go bankrupt. The global auto industry is in a deep depression, and GM, Ford, and Chrysler have been among the hardest hit. GM said that it expects to produce about 30 percent, or 250,000, fewer cars in the first quarter of 2009 than it did in the comparable quarter of 2008. It is temporarily closing about 20 North American factories in order to make these production cuts. Since they cannot sell their cars anyway because of the depression in car demand, especially for their cars, any disruptive effects bankruptcy would have on their production actually helps them adjust their production of cars to the reduced demand for these cars.
GM and the other carmakers have claimed that bankruptcy would have a particularly big effect on sales because consumers would fear that their warranties on the cars they bought could not be honored in the future. Whether this is true or not would depend on whether consumers expect these companies to emerge from bankruptcy in the future as stronger rather than weaker companies compared to a bailout. If they expect bankruptcy to lead to better labor conditions for the company and smaller debts, bankruptcy would give consumers more rather than less confidence that their warranties would be honored in the future.
Here’s Stiglitz:
…What needs to be done is to help the automakers get a fresh start and allow them to focus on producing good cars rather than trying to juggle their books to meet past obligations.
The US car industry will not be shut down, but it does need to be restructured. That is what Chapter 11 of America’s bankruptcy code is supposed to do. A variant of pre-packaged bankruptcy – where all the terms are set before going before the bankruptcy court – can allow them to produce better and more environmentally sound cars. It can also address legacy retiree obligations. The companies may need additional finance. Given the state of financial markets, the US government may have to provide that at terms that give the taxpayers a full return to compensate them for the risk. Government guarantees can provide assurances, as they did two decades ago when Chrysler faced its crisis.
With financial restructuring, the real assets do not disappear. Equity investors (who failed to fulfil their responsibility of oversight) lose everything; bondholders get converted into equity owners and may lose substantial amounts. Freed of the obligation to pay interest, the carmakers will be in a better position. Taxpayer dollars will go far further. Moral hazard – the undermining of incentives – will be averted: a strong message will be sent…
Those who believe bankruptcy would be a bad solution would do well to read these pieces.
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And why was so much fuss not made while doling out 30 billion into Citibank? isnt it’s management responsible for its reckless financial dealings?
Or the same for AIG?
i agree unless the fundaments are fixed, the problems will continue. But also true is that cars sell on image, built over years. Toyota took decades to build its current image.
I doubt anyone would buy a car from a bancrupt company.
Amit, as a resident of metro Denver, I can tell you that from 2002-06, as much as 70% of all flights out of DIA were on bankrupt airlines. DIA’s passenger total actually GREW during that timeframe, and with the addition of Southwest is still growing.
One thing I do have to ask about a GM or Chrysler bankruptcy, though, is whether or not those “legacy contracts” can only be voided through Chapter 11. Airlines like United and Northwest could only void their contracts through BK, which meant the Federal Pension Benefit Guaranty corporation got stuck with the tab on guaranteeing those pensions.
I’m starting to wonder if the bailout money would serve a better purpose as a means of shoring up the Federal Pension Benefit Guaranty corporation.
I favored bankruptcy over bailout as many Democrats did including economist Joseph Stiglitz and three Democratic Senators (not counting Senator Reid, who voted against it for procedural reasons). The UAW would have survived (most of their workers don’t work for GM or Chrysler anyway), and with the changes in Washington you can be sure card check is on the way. If GM and Chrysler go bankrupt it will be Cerebus, the bondholders, the shareholders, and the overpaid top executives that will probably take most of the hit, and I won’t be shedding any tears.
However, the fact that the Republicans were demanding concessions from the UAW shows how out of touch they have become. GM has lost $15 billion and took in $166 billion in revenue in the last four quarters (thus total costs were $181 billion). The total compensation paid to its 74,000 UAW workers and an unknown number of UAW retirees in the last four quarters amounted to about $10.8 billion. In other words less than 6% of the cost of a GM vehicle is due to the people who actually assemble them (or assembled them in the case of the retirees). The total cost of that compensation was less than the amount GM lost last year. Slashing union worker compensation will not solve GM’s or Chrysler’s problems. Why didn’t the Republicans demand that top executive pay get cut? The top 30 executives at GM collectively make about $100 million in compensation. Last year the CEO of GM, Rick Wagoner, made $15.7 million alone. Does anyone think he actually earned that money? By trying to bust the UAW all the Republicans did was remind everybody that they are the party of the fat cats. I’m already wondering how many seats they’ll lose in the Senate in 2010.
By the way, while we’re considering the similarities or differences between GM and Toyota, consider this. Guess how many autoworkers at Toyota of Japan are unionized? The correct answer is all of them (the Confederation of Japanese Auto Workers or JAW). The Japanese autoworkers at Toyota are not less productive because they are all unionized and in fact several research studies have concluded unionization increases productivity due to the effect of efficiency wages. All the “right to work” laws in the south have done is to succeed in setting up a system where foreign corporations can exploit our relatively cheap labor as though we were a third world country.
Also, how much do auto company executives get paid in Japan? The CEO of Toyota, Katsuaki Watanabe, only made $900,000 last year, and his company actually earned a profit. If American executive pay were truly determined competitively how do you explain Rick Wagoner’s bloated compensation package?
Even if the gov’t doles out, say, 15 billion, which it looks like they are poised to do quite soon, with the burn rate of 5 bil a month, isn’t eventual BK status all but inevitable for the “Big Three” (talk about a title that needs to be retired immediatel!).
For Nancy Pelosi to say (she did so yesterday) that BK is not an option is completely dishonest and just tells me how in bed the Dems are with the UAW.
Filing BK doesn’t mean these companies can’t exist tomorrow, it actually gives them a better chance to live another day, albeit, on a much smaller scale (which the market is demanding anyway). What the markets demand eventually will come true no matter how much the gov’t tries to run interference.
To Amit:
You say — “I doubt anyone would buy a car from a bancrupt company.”
The airlines have been in chapter 11 multiple times - have you bought an airplane ticket lately? If you understand the various bankruptcy procedures, you wouldn’t make that silly statement…unless you were a union hack, or a democrat congressman.
Great comments everyone. I’ve enjoyed reading them.
The fact is that the “total compensation per hour” number is total BS. The average Toyota USA assembly line worker gets paid $31 per hour. The average GM USA assembly line worker gets paid $29 per hour. These numbers are from actual salary surveys done by payscale.com, not theoretical numbers ginned out of the fertile imagination of right-wing think tank number crunchers. The only real difference in “total compensation per hour” between the two is that Toyota USA has no retirees (since they’ve been open in the USA for less than 30 years) thus has no retiree health care or pension fund expenses. But the UAW is taking over all Big Three retiree health care expenses starting in 2011, taking that out of the “total compensation per hour” number, and the U.S. taxpayer will end up paying for those retiree pension benefits if GM declares bankruptcy (via the U.S. Pension Benefit Guaranty Fund, which has a direct line to the U.S. Treasury), so I don’t get the advantage of having GM declare bankruptcy rather than just bail them out up front. We pay either way.
So why did GM lose $4,000 per car sold? Well, the main reason is not labor costs, although according to the Harbour Report the Big Three’s labor costs (including those pesky retirement benefits that Toyota USA doesn’t have to pay yet) average $606 per car more than Toyota USA’s. Rather, the biggest reason is that they sold each car for $4,000 per car less, on average, for comparable cars, than Toyota did. Yep. They underpriced their vehicle below its cost to build in order to maintain volume. Why did they do this? Bad management. They did not know how many cars they should build to meet their demand, so they just kept building cars until the cars piled up on the factory and dealer lots, at which point they had to heavily discount them to get them off the lots. The quality of their cars isn’t good enough to maintain premium pricing on the volume that they make, and they can’t make money at $4,000 less per car (on average) than what Toyota gets for a car. For that matter, *TOYOTA* would be losing money if they sold cars for the same price as GM. I don’t think Jesus himself could make money selling cars for the price that GM sold cars for last year.
As the above numbers show, while there is a problem ($606 difference per vehicle), the biggest problem isn’t the UAW or labor costs. It’s a production and product mix problem, compounded this year by the collapse of GMAC during the subprime crisis (cutting off financing for GM cars). None of which has anything to do with labor costs, although GM has to do something about retiree costs if they ever expect to make money in the future even after they do have their production and product mix problems resolved. Luckily the retiree health care costs go away in 2011 (when the UAW takes them over)… if we can get GM limping along under new management until then. Or we can simply have GM declare bankruptcy and dump all those people upon Medicaid. Yeah right, as if that saves the U.S. taxpayers any money…
@Ted : your comparison is not an appropriate parallel. you might buy a plane ticket with the expectation of flying about a month to 6 months in advance and at the cost of anywhere from $100 to $1500 depending on where you are going. think about buying a car that you intend to use for maybe 3 to 5 years or longer and at a much greater cost and you may worry about whether or not your warranty will be valid next month. “no one will buy” may be a stretch, but certainly you would think twice about buying from a bankrupt automaker when a better built, similarly priced alternative can be had at the non-bankrupt automaker dealer across the street.
eqwitty — I think your comparison is accurate to the extent that potential buyers might be nervous about future warranty service. That simply affects the price someone would be willing to pay. Service would be a concern for a GM or Chrysler product, not a Toyota product.
Presumably, that means that you would pay less for a GM vehicle that you would pay for an equivalent Toyota vehicle. As an anecdote, I know someone who just bought a Chrysler Town & Country minivan and is thrilled with the vehicle because they got a great price.
[…] at GM for example. When you are losing approximately $4,100 per vehicle sold it’s no wonder you can’t compete with Toyota or Honda. A big reason for this was […]