The Slums of Manufacturing

Every time I write something negative about Ford, GM or the big American manufacturers the comments and email fly, decrying my lack of faith, my bad attitude and my overall crabby disposition. Let me try to explain this.

GM narrowed their losses in the first quarter and many in Detroit and Wall Street are pointing to it as the beginning of the turnaround.  They had record revenues, up 14% from last year.  Proof that things really are changing, right?  Not if you dig into the details and see that perhaps as much as 1/3 of their sales during the quarter were to car rental fleets.  None of the auto companies willingly divulge their fleet sales numbers, because fleet sales are generally not a good deal.  When they sell a few thousand cars to Hertz or Enterprise, for instance, the terms include an agreement to buy the cars back in six to nine months.  Then GM will have to sell the cars as used, competing with their own new car sales.  In short, fleet sales make the numbers look good now, but are usually a money losing proposition in the long term. (You didn’t really think it was out of patriotism and a ‘Buy American’ philosophy that all of the car rental companies have loads of Ford and GM products, but very few Toyotas, did you?)

Selling out the long term for the sake of immediate results is at the root of GM and Ford’s problems to begin with.  The ridiculous wage and benefit structure UAW members and retirees get is 100% due to GM and Ford being unwilling to take a short term strike in order to have a workable long term cost structure.  As a GM exec recently asked me, "What would you have had us do, take a strike that we thought could last over a year?"  Yes, as a matter of fact, I would.  A year, or even two, of disastrous results to get the cost structure right sure beats insolvency in the long term, doesn’t it?

The same is largely true with their weak products.  Investing in product development risks money now in the interests of long range success, which is not something they do easily.  The fleet sales figures are a pretty solid indication that GM has not really changed at all.  They are still willing to do things that are harmful in the long term in order to give good news to Wall Street now.

So here you and I are, trying to convince the big publicly traded manufacturers to commit to long term manufacturing strategies that will most certainly bring about radical improvements to their cost structures, and give them a tremendous boost in the market, but they aren’t buying it.  It makes no sense, does it?  After all, these are bright people and it can be maddening for them to fail to appreciate the obvious value of manufacturing excellence.

In order to understand it, and to understand why I hold out little hope for GM, Ford or any of the big manufacturers – why I am so ‘crabby’ and ‘negative’ – look at it this way:

Picture the execs at these companies as people living in a drafty old house with ever increasing heat bills as the cold air pours in every winter.  Picture yourself as the guy selling insulation and new windows.  You have a great product.  It won’t cost too much, and it will pay for itself in a year or two.  Yet at house after house, no one will buy a thing.  Why not?  Because the execs you are selling to are not the home owners, they are renters.  A renter is not about to make an investment in a home that takes a few years to pay off since the renter does not expect to be living in the house for that long.

But the execs are usually there for a long time, you say.  How can they be renters?  They work for the stockholders – not the employees or the customers or the communities or the suppliers – and the stockholders do not intend to be in GM, Ford or anywhere else for more than a few months.  They are just renting GM for a couple of months – not buying it.  Short term tenant stockholders do not want to spend money now for storm windows, insulation, employee training or a strike in order to get a payoff a few years down the road, no matter how great the payoff might be, since they won’t be around to collect the payoff.

Your next logical question is, if the execs and the stockholders are only renters, who is the landlord?  The execs and the stockholders would tell you that, if there is a landlord at all, it is the government.  They think the government should pay for employee training, and for investments in factories and machines, and for any number of subsidies to pay for the consequences of the renters’ behavior or the investments needed for long term viability.  That is because the government – which in our democratic society, means all of us – are the only ones with a stake in things.  The long term viability of GM and Ford is really of little consequence to the stockholders.  It is only important to the society as a whole, and the other stakeholders, in particular.   To Wall Street, so long as they are not the ones holding the stock when the music stops, the idea of GM or Ford going under in five or ten years really doesn’t matter.

This renter mentality is what drives GM, Delphi and the rest to pay dividends to stockholders even as bankruptcy stares them in the face.  It drives them to give away the store to avoid a strike, then have massive layoffs to temporarily avoid the consequences.  It drives them to demand tax incentives and outright cash in order to make any investments in plant and equipment.  It drives them to outsource to a low cost country now in order to reap quick cost reductions.  It drives them to think like Bill Ford – that the government should subsidize Ford’s work on vehicles that use alternative fuels in a highly efficient manner.

When I write about the detrimental impact of the DuPont ROI formula as a management device, the staunch defenders of the financial status quo are quick to point out that lean reduces both inventory and costs, which generates a favorable ROI.  True, but it takes a while to make that happen.  If you want a short term ROI kick, the best way to do it is to build inventory.  The worst thing to do in the short term is to reduce inventory.  To renters, those short term ROI effects are all that ever come into play. 

So long as the execs are renters instead of homeowners, they are not going to become very good at manufacturing or product development or anything else that requires even a minimum amount of short term sacrifice.  The problem with having the government as the landlord is that, for one, they are not very good at it.  The government is not any good at much of anything, so any hope that they are going to effectively assure the right long term investments for the big manufacturers is folly. Second, the government is tired of being pushed into the landlord’s job.  The renters at GM and Ford have broken out all the windows and punched holes in the walls too many times and the government is tired of cleaning up the mess.  While Toyota and Honda are consistently good tenants, taking good care of the property and asking the landlord for very little, GM and Ford continue to trash the place.

None of the plans proffered by GM or Ford give any indication that they have identified and corrected the root cause of their problems.  The labor cost fiasco is not the result of one terribly flawed agreement with the UAW.  It is the result of hundreds of bad agreements going all the way back to the 1950’s.  The mistake has been repeated over and over for far too long for them to be errors in judgment.  They are clearly the result of a terribly flawed decision making process.  Why on earth should anyone think that either company is going to make those decisions any differently once they get out of the swamps of their current crises?

The same is true with the idea that bad product decisions have caused their problems and better product decisions will get them out of the swamps.  Between them, Ford and GM have 91 different models displayed on their web sites – and all of them are the result of errors in judgment?  The downward slide has been relentless for twenty five years.  Since then, they have made a handful of good products and a few thousand such errors in judgment?  Not hardly. The basic process for making new product investment decisions is clearly not working, and the process has to be fixed if anyone is to have much faith that the next twenty five years are going to be much different from the last ones.

So how do we get Wall Street and the execs that do their bidding to start acting like homeowners, rather than renters in a run down trailer park?  And how do we get the government out of the role of industrial slumlord?  Change the tax code – in particular, the Capital Gains Tax.

The Republicans argue that the money invested by stockholders has already been taxed, and the profits from the companies in which they invest has already been taxed, and to tax the gain stockholders realize from investment in stock represents double or even triple taxation.  Further, reducing, or even getting rid of, the Capital Gains Tax will spur greater investment in business.  The Democrats argue that Wall Street and the execs are looting the companies, taking millions out of the system at the expense of the workers, and that the rich investors should pony up some of the loot they are taking from the system.

The solution is to accept neither argument, or both, depending on how you look at it.  The solution is a sliding Capital Gains Tax over a five year period.  The tax rate ought to be somewhere in the 80-90% range for the first year – you buy stock in GM and cash it out within a year then you pay just about all of the profit to the government.  That way the government has the dough to pay for the broken windows and cigarette burns in the carpet a short term renter like you left behind.  You hold onto your stock for five years or more and your gains over that period are tax free.  You have been a good custodian of the property and you deserve to get all of your damage deposit back.  Slide the scale in between. 

It really is not that radical an idea.  After all, employees usually have plow their money into the 401K program for at least five years before they are vested and can cash in the stock.  It’s just telling the investors that they need to be ‘vested’ in the company too.

That simple solution will turn the stockholders into people with a property owner’s point of view, which in turn will push the execs into a long term perspective.  Until this changes, however, don’t hold your breath waiting for the publicly traded manufacturers to become particularly lean, or to start putting out products that reflect any vision.  Instead, look for them to go the way of Cabrini Green.