Our Interview with Patrick Anderson Robert Huebscher November 25, 2008

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1 Our Interview with Patrick Anderson Robert Huebscher November 25, 2008 See our related story, How to Fix GM, in this issue. Patrick Anderson is the principal and CEO of Anderson Economic Group LLC, a consulting firm specializing in economics, market research, public policy, and business valuation. His clients include all the major automakers, numerous state and local governments, research universities, and economic development and trade associations. Mr. Anderson has written over 100 published works, including the book Business Economics and Finance and the chapter on business valuation in the book Litigation Economics. He is also the executive editor of the State Economic Handbook, and his 2004 article "Pocketbook Issues and the Presidency" won the award for the best business economics paper from the National Association of Business Economics. We interviewed Mr. Anderson on November 21, What is the overall situation like at GM now? Are they producing the right cars for the market, and how bad is their economic situation? GM makes more products that are desirable to US auto consumers than any other company, including Toyota and Honda, but they also make a bunch of products that are only marginally desirable. They make great products, but their cost structure is such that they cannot be profitable at their current size. There is a very profitable GM contained within the current edifice. However, getting from the GM of 2008 to the GM of 2010 is going to be very difficult. Right now, the most out-of-line costs arise from labor contracts, particularly their health care and retirement benefits. Significant strides were made in the UAW contract of 2007 which will bring savings, but most of those will not appear until For example, there is still something of a Jobs Bank in their contracts, and that is completely inexplicable to most Americans. I discuss this also below.

2 What is the biggest factor adversely affecting GM s cost structure? The biggest single excessive cost factor is health care costs, which result in a cost of production that is much higher than in other countries. The pure wage cost of American auto workers is no longer out of line; it is actually less than that of a German worker. But health care costs are hugely higher in the US, and there are also labor costs embedded in the Jobs Bank and work rules. American auto workers including unionized UAW workers - have the productivity to compete internationally, provided that auto companies are paying them for their actual work making cars. What they don t have is the productivity to make cars, plus carry the health care, Jobs Bank, work rules, and legacy costs. Can you explain GM s Jobs Bank program, its history, and its economic cost? The Jobs Bank dates from the 1980s, and was originally designed as a way to allow the auto companies to make labor-saving changes in their production process, as long as they provided a guarantee to those employees who lost jobs that they would get future jobs when the company became more efficient. This would have been okay if the company kept growing, but GM s market share declined. GM ended up with large numbers of people that were paid to not work. A lot of supporters of the UAW felt this was okay, and this has driven a wedge between them and the American public. Part of this frustration was on display in Washington this week. The feeling among many Americans that the union contracts have resulted in featherbedded jobs, along with the feeling that the Auto companies have resisted building smaller cars, motivated the rude, and in my opinion largely unfair, reception they received in Washington recently. The auto companies also maintain a dealer network significantly greater than what is required by their sales volume. This is an additional cost, and one that cannot be continued if the overall sales volume and market share remain where it is today. Finally, another problem facing all the auto makers is the regulatory burden imposed by Congress. It is something that none of them can handle. The CAFE law passed late last year requires auto makers to achieve mileage targets that cannot be met with existing technology and what American consumers demand in terms of the size and safety of their

3 vehicles. Despite developments like the Chevy Volt, auto manufacturers cannot square the circle between the technology requirements now codified in law and what American consumers are demanding. For example, manufacturers can easily shave off weight to improve mileage by using titanium mufflers, thinner glass for windshields, and Balsa wood parts, but this only makes sense on an ultra-high-end car like the Corvette Z06, because it will add several thousand dollars to the cost of manufacturing. It cannot be done on a Malibu or Camry and still be cost effective for the typical US consumer. What is the economic impact of the health care and other entitlement costs that GM currently pays to its retired blue collar workers? Both current and retiree costs are killing them. But, our healthcare system, which is governed by state and federal laws, is more to blame. The ability of the US auto companies to change the cost of healthcare embedded in the UAW contract is limited. The auto industry bears a huge burden by paying healthcare costs to maintain a high level of services for current and retired employees, whereas many smaller and mid-sized companies do not offer comparable benefits, and many self-employed workers cannot afford benefits at all.. The result is an extremely expensive healthcare system in the US, fraught with spotty services. American employers are paying their own healthcare costs, and indirectly the costs of those that are uninsured. This is true of all industries, but the automotive industry bears a much larger burden. What is the economic impact of the work rules that are imposed by the current UAW contract, vis-à-vis GM s foreign competitors? Work rules are a serious problem. US workers, including unionized workers, are as productive as those of any foreign competitor. But the work rules make it very difficult to pay people for actual work. The persistence of programs like the Jobs Bank is an example of the onerous rules that prevent auto companies from adopting the efficient practices that are standard in most other industries. Some relief is coming in 2010 under the terms of the new UAW contract. How do GM s healthcare costs compare to those of its non-us competitors? Auto workers in other countries have extensive healthcare benefits, but employers don t pay for all that burden. It was actually John McCain who

4 wanted to end the connection between employers and healthcare by eliminating the deductibility of healthcare costs paid by employers. A problem in the US is the notion dating back to the World War II era - that healthcare costs should be paid by employers. The negative aspect to this is that most part-time workers and those who are unemployed don t have health insurance. That has led to systems in other countries that are less onerous on employers. Socialized medicine is not necessarily the answer. Where I am, in Michigan, we see a lot of Canadians coming to the US for healthcare, because the level of care provided under Canada s system is inferior. But there is a cost disadvantage to US companies with regard to healthcare. How do GM s R&D costs compare to those of its non-us competitors? Do those competitors enjoy an advantage because of government subsidies for their R&D? I don t believe this is a significant issue today, especially compared with the others we discussed. The US auto makers spend more on R&D than Silicon Valley. The ability to which they are active in R&D is grossly underappreciated. Our car technology is nothing like the rust belt caricature of decades ago. US cars today are very advanced, and their technology will be best improved in the future by having R&D sponsored by those automakers that also bear the cost. Is the fundamental problem with GM (and other auto US manufacturers) that their business is scaled for a market share of 50+% instead of their current share of 20%? Even with its declining market share, GM has sold as many cars as anybody in the US market. They are either number one or two worldwide in auto production. The notion that they aren t selling what people want is wrong. But GM s dealer network is bigger than what they can support. The dealer network consists of independent businesses. Each dealer bears its own risk, pays its own payroll and taxes, and hopefully makes a profit on new and used cars and services. GM has been losing dealers across the country for over a decade. As a result of the forthcoming restructuring, every mid-sized town in the US will lose a dealership, and in some cases more than one. This has an effect on GM s profitability, because it impacts their ability to give the kind of service that Americans want to receive. GM, in particular, helps with finance, training, and repurchasing

5 assets when dealers go out of business. Not all auto makers are as helpful as GM, and the auto companies are generally not obligated to make sure dealers make a profit. A lot of dealers have been unprofitable, and their numbers will continue to dwindle. How close is GM to being forced to seek bankruptcy protection? Nobody knows for sure, including GM, how much cash they need over the next six months, because the US consumer is being hit by an onslaught of bad news in the economy and faces the uncertainty of a new political administration. Consumer confidence has to return before people will by cars, even at the levels they did in mid The hearings in Washington and the discussion of a bailout has left consumers with a negative impression of the company and has caused them hold back on purchase decisions, creating a self-fulfilling prophecy of bankruptcy. It s a very dangerous situation. For a free subscription to the Advisor Perspectives newsletter, visit: