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3 Questions: Michael Cusumano on letting U.S. automakers fail

Michael Cusumano

"3 Questions" is a new series from the MIT News Office that gives members of the community the opportunity to sound off on current events in their field of expertise. In this, the first installment, Michael Cusumano, the Sloan Management Review Professor in Management in the MIT Sloan School of Management, discusses why U.S. automakers should be allowed to fail and what it will take for them to become viable again.

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Q. Do you think that U.S. automakers should be allowed to fail?

A. Yes, I think they should file for Chapter 11 bankruptcy protection under the U.S. courts and reorganize. The reason is that the decline in competitiveness of General Motors, Ford and Chrysler is a long-term problem, going back to the 1970s and 1980s, beginning with lagging physical productivity in assembling automobiles compared to the leading Japanese companies, and then in quality and also in engineering productivity for product development. I myself have done research documenting this gap (Michael A. Cusumano, The Japanese Automobile Industry, Harvard, 1985) and was involved for many years in other research undertaken by researchers affiliated with the International Motor Vehicle Program (IMVP), based at MIT and Wharton but with a research network all over the world. IMVP produced the bestseller book by James Womack, Daniel Roos and Daniel Jones, "The Machine that Changed the World" (Lawson, 1991), which documents the state of the world auto industry circa 1990 and the mounting problems of the U.S. automakers. But things have gone from bad to worse.
It is true that the U.S. automakers have improved their manufacturing productivity and quality and their product designs, but they did severe damage to their reputations in the market place during the 1970s, 1980s and 1990s by selling badly designed and manufactured products. In addition, these companies, led by GM, agreed to incredibly generous wage and benefits packages for employees and their families and retirees, despite the relative weaknesses in their competitiveness. They were always flirting with losses and so they let themselves become extremely vulnerable to the threat of strikes by the United Auto Workers union. Today, their overall costs as well as product portfolios render them noncompetitive in international competition. We can argue that Japan and European nations that have national health care systems provide an unfair advantage, and I think this is a real problem, not only for the automakers but for other companies as well. In any case, the U.S. labor contracts in the auto industry are no longer viable, and were unrealistically generous to begin with. I believe it would take a bankruptcy proceeding to restructure these agreements, like the airline industry has done.
Q. What do you think it will take to help U.S. automakers become viable again?

A. The current management of the U.S. automakers as well as the union leaders have only themselves to blame for putting GM, Ford and Chrysler in such a precarious financial predicament. We have told them for the past 20 years what was best practice in the industry and how to improve their operations, and both labor and management have been too slow to adjust. Currently, the U.S. automakers probably have about 50 percent more production capacity than they can use, because demand for their products is so low. They are only profitable in a booming market and when they can sell larger vehicles (trucks and SUVs) with large profit margins per unit. But the market reality has changed drastically and it is time to change the management of these companies as well as their labor costs and benefits structure.
I do believe that millions of Americans under the age of 60 or so are unlikely to buy an American-made car until there is overwhelming evidence that these products meet world-class standards of reliability and performance. But the prices should be right if they can get their costs down. In general, customers do respond to new products if they are truly excellent and priced right. Assuming the U.S. automakers can deliver on the design side, then, as I said before, the companies will be okay if they can restructure their costs. But also they need to change the senior management teams and bring in people who anticipate the future rather than just try to change incrementally and react in a panic when things go bad.
I also believe the U.S. government will have to help in the bankruptcy. Companies will still need financing during the reorganization period, and that will be hard to get from commercial lenders or investors. But money is one thing the U.S. treasury can provide. Also, there is considerable concern that customers will not buy vehicles from a bankrupt company because they worry about who will guarantee the warrantees or build spare parts. The airlines did not face this problem because tickets are consumed immediately when you use them. But, rather than just give money to the U.S. automakers to keep them operating, the U.S. government can provide bankruptcy financing as well as create a program to guarantee the warrantees and continued support of their products. This is a better way to spend money on the automakers. Just giving them billions of dollars now postpones the inevitable. We can't rely on the managers in these companies to change the way they think and manage. It is best to force the companies to reorganize, change the management teams and labor leaders, and do it fast.
My biggest worry is that the U.S. automakers have a major problem attracting talent. This will be very difficult to overcome. For the past 20 years, our best students at MIT, from both the engineering school and the management school, have not been joining GM, Ford or Chrysler. They have been joining companies such as Intel, Cisco, Microsoft, Hewlett Packard, Amazon, Google, etc. This is not necessarily the case in Japan or Europe, where companies such as Toyota, Honda, Nissan, BMW, Daimler-Benz (Mercedes), Volkswagon-Audi, and Renault are still seen as good or even exciting places to work. This also is not the case in Korea, China or India, which have pretty vibrant automobile industries now. I wouldn't be surprised if, within two to three years we see Chinese or Indian cars in the U.S. selling for just a few thousand dollars. All the more reason why the U.S. companies need to fix themselves and do it fast.
Q. What are the long-term economic repercussions over a potential bailout or a potential failure?

A. With bankruptcies involving companies as large as GM, Ford and Chrysler, of course there will be major economic disruptions, in many industries. Not only will many auto workers be laid off directly at these companies, but automobiles use a lot of steel, plastics, electronics, electrical good, rubber, glass, fabrics and other materials and components provided by thousands of other companies. Some of these jobs will remain at the U.S. automakers and their suppliers if the companies continue to operate in bankruptcy, which I assume they would. The foreign-owned automakers in North America (Toyota, Honda, Nissan, Hyundai, BMW) can also take up some of the slack and may rehire some of these workers and expand their own capacity. Families of retirees and laid off workers will be hurt the most as they lose their benefits. But here is where government can again play a role such as by providing unemployment insurance, retraining funds, and passing health care programs, either at the state level or the national level (Massachusetts, for example, has a new health plan at the state level).
In my view, the economic consequences will be worse in the long run for this country if we don't fix the problems of the U.S. automakers and make sure they are competitive for the future. The auto industry actually has a bright future because we will all be replacing our current vehicles someday and there are lots of exciting new developments in hybrids, all-electric vehicles, and hydrogen fuel cells. It is good to have a domestic automobile industry, but it is better to have a strong domestic automobile industry that is forward-looking and profitable both in good times and bad times.

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