GM's other victim.

Commentary about business and finance.
Nov. 21 2005 5:02 PM

GM's Other Victim

For years, the Big Three staved off catastrophe by crushing auto parts manufacturers. Not anymore.

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Assembly-line woes

Today, General Motors announced a far-reaching restructuring plan to close nine plants and three service and parts facilities, cut 30,000 jobs, and reduce North American production capacity by 1 million vehicles a year. Last month GM cut a deal with the United Auto Workers to reduce health benefits, while the Wall Street Journal reported last Friday that Ford plans to cut about 4,000 salaried positions in the first quarter of 2006.

What's with the sudden sense of urgency? For years, GM and Ford hewed to a basic strategy: If they could just sell enough cars, all their structural problems would be solved. If they only regained lost market share, they could keep factories humming and provide their profitable financing arms with more business. But in recent weeks, there's been a change in direction. In GM's case, it could be that ancient and impatient activist investor Kirk Kerkorian, who owns about 10 percent of the company, is putting pressure on management.

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But here's an alternative explanation. GM and the other U.S. auto manufacturers can no longer push their problems onto their suppliers. The Oct. 8 bankruptcy filing of Delphi, GM's main supplier, and the failure this year of several other parts makers, have put their biggest customers on notice.

The auto industry was once one of the great examples of vertical integration. Henry Ford's River Rouge plant, where raw materials were turned into autos with stunning efficiency, was the apotheosis of integration. Of course, different industrial eras call for different strategies. And in recent years, auto manufacturers have seen the wisdom of outsourcing the production of parts. Doing so allows companies to shop around for deals. So in 1999, GM spun off its parts unit as Delphi. Ford followed suit by spinning off Visteon in 2000. DaimlerChrysler likewise spun off portions of its parts-making capabilities.

These spin-offs started life with some advantages—they had solid relationships with giant car companies. But they also came into the world burdened by some handicaps. They inherited their former parent companies' legacy issues: excess capacity, pension commitments, and expensive unionized workforces. And even though the new companies were independent, they were somewhat captive. At Delphi, GM accounted for about 47 percent of revenues in the most recent quarter. In 2004, GM accounted for $15.4 billion of Delphi's $28.6 billion in revenues. And the bill from Delphi, which provides only a portion of GM's parts, ate up about 10 percent of GM's auto revenues for the year. In Visteon's most recent quarter, 64 percent of its sales went to Ford. Collins & Aikman *  did about one-third of its business with DaimlerChrysler and about three-quarters of it with the Big Three.

For the last several years, GM, Ford, and, to a lesser degree, DaimlerChrysler have been able to delay their day of reckoning by shifting their problems down the line to suppliers. They continually cajoled suppliers to deliver parts for less money—or else face the prospect of losing the business. In the early part of this decade, when a global slowdown led to sharp declines in commodity prices, the parts makers could deal with the pressure. But when prices for steel and oil—the main input for plastic—started to rise a few years ago, instead of compensating suppliers for higher costs, the automakers continued to demand lower prices. As the Detroit News notes, GM in 2003 kicked off a program to get suppliers to cut prices by 20 percent by 2005. For suppliers, raw materials can account for half of total costs. And when the price of oil, steel, and other metals like copper began to rise, the suppliers were out of luck.

When the parts makers appealed for help, the automakers generally told suppliers to stuff it, or threatened to move business elsewhere. After all, GM and Ford had their own problems. Since the fall of 2001, the Big Three were able to careen from discount gimmick to discount gimmick without destroying themselves—zero-percent financing, big rebates, extending employee discounts, and now free gas—only because the suppliers were choking on the cost of higher raw materials.

In August, Bo Andersson, GM's global supply chief, told Automotive News, "I see much more emotion in our supply base ... in the last two years than I've seen in my whole career." No wonder. Many of the biggest suppliers were dying. In February, Tower Automotive filed for bankruptcy. Collins & Aikman was next to go in May. Then the largest parts maker, Delphi, went bust in October.

Why is this bad news for the Big Three? If the parts makers can't make it as independent businesses, then the Big Three must help fund their upkeep, one way or another. Companies in bankruptcy can reject existing contracts and ask the courts for relief. In July, Collins & Aikman got a customer financing agreement in which the end users (i.e., the Big Three plus Toyota, Honda, and Nissan) agreed to pay more for parts. On Oct. 1, Ford took back a big chunk of Visteon's operations onto its own books, including 23 facilities and 18,000 workers—a pre-emptive bailout. And Delphi, which continues to lose money, will certainly be asking GM and all its customers for help.

In a way, the long-overdue job-cutting efforts by Ford and GM are just another sign of indirect ravages of inflation, which we are routinely assured is under control. By cramming down their suppliers, the Big Three, and especially GM, spared themselves—and consumers—from dealing with higher costs for a few years. With nobody left to stiff, and with commodity costs still high, the big automakers must increasingly look inward. The only companies they can cram down now are their own.