Recession?

Are we headed into a recession in 2016-2017?

The decline in the key drivers of economic growth say yes:

• Business fixed investment has declined by an annualized 4% over the past two quarters. Business equipment and software declined 5%. Non-residential structures dropped almost 8%.

• Employee layoffs. "U.S.-based companies announced 65,141 job cuts last month (April), up 35 percent from March.” Boeing plans to layoff  8,000 employees - 10% of its workforce. Intel plans job cuts of 12,000 - 11% of its total headcount.

• In 1980 there were 60 USA non-financial corporations rated AAA. Today there are just 2 with the recent surprise that ExxonMobil was downgraded to AA+. This will reduce capital investment and ultimately employment and GDP growth.

Business investment and employment are critical factors in economic growth.

As a result of these negatives:

• The Labor Force Participation rate dropped to 62.8% in April 2016. A 38 year low. Thus 94 million people are out of work. This is a decline over the recent several years from 66%-67%. New job creation is weak and will not improve the participation rate.

• GDP growth is in decline. It registered an anemic 0.5% increase (revised to 0.8% in May 2016) in the first quarter of 2016. In the third and fourth quarters of 2015 it was 2.0% and 1.4% respectively.

China’s struggles area concern. Its growth has consistently slowed. 2015 was its slowest year in 25years. This is a factor in the global decline in the demand for commodities and the 55% reduction in commodity prices since 2014 negatively affecting capital investment and employment. Unfortunately 2016 growth is difficult to accept as real as it has been stimulated by debt in an economy that is seriously overleveraged.

The USA’s growth prospects are muddled by an apparent decision by one of its major industries – automobiles. General Motors, Ford and Chrysler are reportedly not investing in flexible production systems as are its German and Japanese competitors. This is described as: “…technological change that stands to radically reshape the car business.”

Will this result in the Big Three’s costs being higher than its competitors? Probably. It will most likely lead to lower unit sales and lower overhead absorption resulting in lower operating profits, lower cash flows, less capital investment and lower employment.

Adding to the puzzle about General Motors’ viability is its $500 million investment in Lyft – a Uber competitor. Lyft is a business outside of GM’s vehicle manufacturing core. Is GM losing disciplined strategic focus?

Follow-up articles: 

Business Insider, May 26,2016, “Japan's prime minister is warning world leaders about a 'Lehman-scale crisis'” He interprets economic data as pointing to the reemergence of the global financial crisis of 2007-2008.

InvestmentWatch, May 26, 2016: Interview with former Federal Reserve Chairman Alan Greenspan: “Greenspan: Western World Headed for a State of Disaster”. “…have a very profound long-term problem of economic growth…(not) on the verge of a market…collapse…”

 

General Motors – Has It Lost Its Credibility?

The news is full of criticism of General Motors’ announcement that it has repaid the money it owes the United States government for bailing GM out with TARP money (Troubled Asset Relief Program).

General Motors' April 2010 announcement: “G.M. is able to repay the taxpayers in full, with interest, ahead of schedule, because more customers are buying vehicles like the Chevrolet Malibu and Buick LaCrosse.”

The facts:

General Motors' April 2010 repayment totaled $6.7 billion.

The United States government gave General Motors $49.5 billion in 2009 to finance its bankruptcy. Thus only 14% of the total aid GM received from the government has been repaid. Not a full repayment.

Further complicating the issue comes from Mr. Neil Barofsky, the Inspector General overseeing the troubled asset program, when he testified before the Senate Finance Committee on April 20, 2010 that G.M. was using taxpayer money to make the loan repayment – not General Motors’ earnings.

Apparently the $6.7 billion came from the $13.4 billion of the United States government’s TARP money that had been put in a General Motor’s escrow account when GM was in bankruptcy. Thus the company is using US government money--to pay back the US government loan.

Further complicating the issue is the General Accountability Office’s December 2009 report that: "The Treasury is unlikely to recover the entirety of its investment in Chrysler or GM, given that the companies' values would have to grow substantially more than they have in the past."

Also coloring GM’s financial condition is that:

● It has applied to the Department of Energy for a $10 billion loan to retool its plants.
● In 2009 it was unprofitable with deficit gross profits and operating losses.
● In the first months of 2010 its market share declined.

Is all of this true? If it is, the real issue is General Motors' loss of trust and credibility. Will consumers figure out that General Motor’s announcement is not true? That it was a misleading public relations ploy? If consumers do not trust a manufacturer, will they stop purchasing its product? For this short-term gain, will GM lose in the long run?

Sources:
New York Times.
Power Line.
Reason Foundation.

Ford Motor Company Reports Profit – Positives and Negatives

The Positives:

“…the only major U.S. automaker to avoid bankruptcy, posted third-quarter net income of $997 million and its first operating profit since early 2008…”.

“…finished the third quarter with $23.8 billion in automotive cash, up from $21 billion at the end of the second quarter.”

“…U.S. market share increased to 15.8 percent for the first nine months, compared with 14.8 percent from a year earlier…”.

Certainly, registering a third-quarter 2009 positive profit with a market share gain are excellent and solid signals. Unfortunately it overlooks Ford’s negatives, which give pause and concern for the future.

The Negatives:

“…workers have overwhelmingly rejected contract changes that would have allowed the automaker to cut labor costs.” “Ford sought the deal to bring its labor costs in line with Detroit rivals Chrysler Group LLC and General Motors Co….”.

Bringing Ford's hourly labor costs in line with General Motor's and Chrysler's should not be the priority. The priority is to become cost competitive with USA based Japanese automotive manufacturers. Ford's, GM's and Chrysler's hourly base wage rates and benefit costs are reportedly $20 to $30 per hour higher than Japanese competitors. Doubtful these costs were reduced in the GM and Chrysler bankruptcies. This remains a huge problem.

“…workers felt they were being asked to sacrifice more than the company's executives. Ford CEO Alan Mulally made $17.7 million last year…”.

There is some justification in the Unionized Employees position on this issue. Hourly employees are well aware that officers of a major company have significantly higher incomes. This is not an issue in healthy economic times. But in poor economic periods, if Management is perceived as not sacrificing with all on board, then a disconnect is created, and polarization with contract rejection occurs.

A helpful signal for Unionized employees, to convey Management is being serious about reducing overhead costs, is if Ford has cut back on some Executive perks. Does Ford still have an executive dining room, replete with waitresses, multi-course menus, and silver finger bowls?

“He (Alan Mulally, CEO) hasn’t presided over an annual profit at Ford, which has posted three straight full-year losses totaling $30 billion.”

Other questions exist. For example, did the quarterly profit rely heavily on favorable product mix and pricing? Will these same conditions be available in future fiscal years?

The list of negatives should not detract from the solid job Mr. Mulally and his team has done in beginning Ford's turn around. The challenges are enormous, and Mr. Mulally has clearly moved it in the right direction.

The GM & Chrysler Bankruptcies

“The General Motors Corp. Chapter 11 bankruptcy marks the humbling of an American icon that once dominated the global car industry and sets up a high-stakes gamble for USA taxpayers.”

Reportedly both General Motors and Chrysler will exit from Chapter 11 Bankruptcy Court in 60 to 90 days. This sounds like wishful thinking and may involve some public relations imagery. To “correctly” restructure a significantly less complex and smaller manufacturing company, would require at least one year. The rush may produce more problems for all involved.

Regardless, one of GM’s and Chrysler’s most significant problems is that hourly labor costs are reportedly $20 to $30 per hour higher than their USA based Japanese competitors. It doesn’t appear that this most fundamental weakness has been addressed in a serious manner.

Most of the Japanese competitors have non-union hourly labor in their USA manufacturing operations. As such, their labor costs will not significantly increase over time. In addition, for the past few years, the Japanese Automakers have made higher capital investments to improve productivity. The cash strapped Big Three have not been able to match its competition.

Recent GM and Chrysler plant closings and operational restructurings have reduced their overall costs by billions of dollars, as well as their hourly headcounts by the thousands. However, the overall impact is misleading. The hourly cost for direct labor employees has not been reduced. And will continue to prove to be a vivid Achilles’ heel for the legendary USA manufacturers.

While the total of manufactured GM and Chrysler automobiles have declined significantly, the actual cost of each automobile continues to be higher than its Japanese competition. The Automakers will continue to prove unable to compete with this inherit weakness. Besides overt Labor commitments, another higher cost factor to consider is unabsorbed manufacturing overhead, since production is lower in existing plants. This is not a healthy sign.

However, the most important factor remains, has the UAW agreed to reduce the total cost for hourly direct labor employees?

Regretfully, there is no evidence of a reduction in hourly labor rates...

It is doubtful any labor cost concession will be meaningful if this is true:
"The fear at the UAW was that ownership in GM could eventually be worth very little.”

Thus, as it stands, GM and Chrysler will continue to lose money and will probably be forced to return to bankruptcy protection. We will have to wait to see what structure the FIAT buyout of Chrysler will produce. But, if there is a next time for GM in bankruptcy, it may have to execute liquidation under the Chapter 7 bankruptcy code. That is, if the US Government, which now owns 70% of the company, will allow it.

In addition, salaried headcounts appear too high. While this can be dealt with outside of the bankruptcy process, GM and Chrysler should analyze their salaried organizations and adopt Toyota’s performance target of 10% improvements in salaried productivity every year.

Regardless, neither company should exit from bankruptcy protection until the operations are restructured to allow a competitive, best cost manufacturing operation to emerge. We shall see, both GM and Chrysler face enormous challenges for survival.

Have two of the Big Three suffered such a loss in reputation over the years, their brands are too damaged beyond repair for today’s marketplace?

No, quality management can turn anything around with the right strategy, capital, cost structure, and culture. But it requires the tools needed to compete. Anything is possible.

Mitt Romney Advises: “Let Detroit Go Bankrupt”

Governor Mitt Romney offers some interesting advice regarding the Big Three in his November 18, 2008 New York Times Op-Ed “Let Detroit Go Bankrupt” summarized as follows:

“If General Motors, Ford and Chrysler get the bailout that their chief executives asked for yesterday, you can kiss the American automotive industry goodbye. It won’t go overnight, but its demise will be virtually guaranteed.

Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check.

First, their huge disadvantage in costs relative to foreign brands must be eliminated. That means new labor agreements to align pay and benefits to match those of workers at competitors like BMW, Honda, Nissan and Toyota. Furthermore, retiree benefits must be reduced so that the total burden per auto for domestic makers is not higher than that of foreign producers.

That extra burden is estimated to be more than $2,000 per car…But if this cost penalty persists, any bailout will only delay the inevitable.

Second, management as is must go. New faces should be recruited from unrelated industries…

In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check.”

Governor Romney is correct.

In a July post on my blog I opined that running out of cash may be the trigger that puts them into bankruptcy, but it will be a blessing in disguise. My reasoning is that the Big Three’s hourly labor costs are reportedly $20 to $30 higher than their USA based Japanese competitors. In my experience as a Turnaround CEO, this will not be reduced in a voluntary agreement with their union. If it is not corrected, they will continue to decline and probably will not survive.

Chapter 11 Bankruptcy protection does not mean the end. The companies will continue to operate. While it will be a severe shock to the USA, it is not liquidation. It will allow modification of the factors contributing to losing money - including the high cost labor contracts.

Click here to review my July 28, 2008 post: “Bankruptcy – The Fate of General Motors, Ford and Chrysler?”

Bankruptcy - The Fate of General Motors, Ford and Chrysler?

General Motors, Ford and Chrysler may have to enter into Bankruptcy to reduce their hourly cost of labor. Running out of cash may be the trigger that puts one or all of them into bankruptcy, but it will be a blessing in disguise.

One of their most significant problems is that their hourly labor costs are reportedly $20 to $30 per hour higher than their Japanese competitors. Some of the differential will be reduced with the UAW’s assumption of retiree health care with VEBA -- Voluntary Employee Beneficiary Association – beginning in 2010. This could reduce employee health insurance costs by one-third but will only produce a relatively small reduction in hourly labor costs. This won’t be enough - including consideration of the two-tier wage structure.

Most of the Japanese competitors have non-union hourly labor in their USA manufacturing operations. As such, their labor costs will not significantly increase over time. In fact, they will probably decrease because of higher capital investments with more effective productivity improvements.

By comparison, GM, Ford and Chrysler are at a distinct disadvantage. They are strapped for cash which severely limits their ability to invest capital for operating improvements. Recent plant closings and operational restructuring have reduced their overall costs by billions of dollars, as well as their hourly headcounts by the thousands. However, the overall impact is somewhat misleading. The hourly cost for direct labor employees has not been reduced. While the number of automobiles manufactured by the Big Three have declined in dramatic fashion, the actual cost of each automobile continues to be higher than its Japanese competition.

Will they be able to negotiate “voluntary” hourly labor cost reductions with the UAW?

One negative example from my turnaround experiences:

I was CEO of a legally insolvent, severely distressed manufacturing company. We asked the local union members to accept minor “voluntary” changes in the union labor contract. Specifically, we needed a delay in the contracted 3% increase in the base wage rate and an increase in the co-pay percentage for health insurance. These proposals were rejected by the local union leaders, although we had the International’s support for the changes. The local labor leaders proved indifferent to the company’s condition and were hostile to essential requests needed for the restructuring required to help save the company.

Admittedly this distressed company was not the size of GM, Ford or Chrysler. However experience suggests the UAW will not “voluntarily” agree to the significant reductions needed in hourly labor costs. (Which may require cuts as large as $10 per hour or more). Thus, the Big Three will be forced to attempt to terminate the labor agreement in Bankruptcy Court. If they fail to do so, they will continue to decline. And their future will offer even more desperate operating and financial conditions.