Nate Sez: It’s about Legacy Costs
Nate, who is more of a Michigander than I am, drew this not-pretty picture of GM’s operating margin over the last half century. He explains that this picture shows that GM has been using health care and pension promises to put off the time it registers these real costs on its balance sheet as a way to get the benefit of labor but put off paying the true costs of it.
GM was willing to cut its employees some very attractive deals in the 1950s through the 1980s — provided that they took them in the form of retirement benefits rather than salary, which wouldn’t hit GM’s books until much later and which until 1992 weren’t even required to be carried on its balance sheets all, making its financial statements (superficially) more appealing to its shareholders. That health care costs have risen so substantially in the United States have made a bad matter worse.
Nate’s absolutely right about the systemic issue underlying GM’s woes.
But I’d add another point. While his not-pretty picture doesn’t show when this happened, we know that sometime around the time when GM’s operating margin first hit zero, GM began to face stronger competitors domestically: the Japanese. And for the first decade and more after the Japanese started competing in the US, GM was competing against companies the bulk of the labor for which received cheaper health care and pensions in Japan. And even as Japanese companies opened factories in the US, it took decades before their first employees retired, meaning the Big 2.5 were paying pensions for two generations of retirees, while Japanse transplants were paying nothing, yet, in pension costs. All other factors being equal (they weren’t, but just pretend they were), that meant it has always been a lot easier for Japan to make a profit off its cars, partly because Japan pays for health care differently than we do, and partly because they entered the US market relatively recently.
In addition to making it easier to make a profit on a car, this makes it a lot easier for Japanese companies to make investments in their cars pay off.
That means that the Japanese–who in the early years were competitive with the US on hybrid technology–could forecast the profitability of the technology and decide it made sense, whereas the US companies would make the same calculations and decide it didn’t make sense. They were both making the same kind of business calculation, but the underlying numbers were different. A lot of the decisions that outsiders attack–particularly the technological ones–made sense from a business perspective when you factor in these legacy costs. The US couldn’t invest in these technologies because they had to spend money for legacy costs instead.
Here’s how the Administration’s assessment of GM’s viability described this:
As GM moves through its forecast period, its cash needs associated with legacy liabilities grow, reaching approximately $6 billion per year in 2013 and 2014. To meet this cash outflow, GM needs to sell 900,000 additional cars per year, creating a difficult burden that leaves it fighting to maximize volume rather than return on investment.
The entire current annualized volume of cars in the US right now is 9 million. The Administration is saying that one tenth of all cars sold in the US this year will go to pay for GM’s legacy costs. (This is why GM and Ford’s expansion in overseas, more profitable markets is so important, because without those profits, these numbers would have already doomed these companies.)
A lot of people (like Bob Corker) like to pretend this is only a problem the auto industry has experienced. But that’s not true. We’ve already seen the airline and the steel industry go through this, among others.
Sadly, though, aside from the mention of GM’s legacy costs, yesterday’s announcements ignored this systemic problem for what it was–one of the key underlying causes of the "bad" decisions the auto industry has made for the last two decades. Yes, Obama is pushing for health care. But the reason we need health care (and need to retain social security, among other things) is because it is killing our businesses.