Why GM's Plan Won't Work

...and the ugly road ahead

Slide Show >>If General Motors Corp. (GM ) were any other company, its problems would have sorted themselves out a long time ago. Logic says that when your cash holdings exceed your entire valuation in the stock market, some Wall Street shark is going to swoop in, snap up the good parts, and toss the rest. Companies with bloated factories and workforces got religion the hard way 20 years ago, in the days of "Neutron Jack" Welch. And with today's more active boards, CEOs who consistently lose ground to the competition usually don't need Donald Trump to tell them they're fired.
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But GM, of course, is no ordinary company. With sales of $193 billion, it stands as an icon of fading American industrial might. Size and symbolism dictate that its fate has sweeping implications. After all, GM's payroll pumps $8.7 billion a year into its assembly workers' pockets. Directly or indirectly, it supports nearly 900,000 jobs -- everyone from auto-parts workers to advertising writers, car salespeople, and office-supply vendors. When GM shut down for 54 days during a 1998 labor action, it knocked a full percentage point off the U.S. economic growth rate that quarter. So what's bad for General Motors is still, undeniably, bad for America.And make no mistake, GM is in a horrible bind. That $1.1 billion loss in the first quarter doesn't begin to tell the whole story. The carmaker is saddled with a $1,600-per-vehicle handicap in so-called legacy costs, mostly retiree health and pension benefits. Any day now, GM is likely to get slapped with a junk-bond rating. GM has lost a breathtaking 74% of its market value -- some $43 billion -- since spring of 2000, giving it a valuation of $15 billion. What really scares investors is that GM keeps losing ground in its core business of selling cars. Underinvestment has left it struggling to catch up in technology and design. Sales fell 5.2% on GM's home turf last quarter as Toyota Motor Corp. (TM ), Nissan Motor Co. (NSANY ), and other more nimble competitors ate GM's lunch. Last month, CEO G. Richard "Rick" Wagoner Jr. and his team gave up even guessing where they'll stand financially at the end of this year.Worst of all, GM reached a watershed in its four-decade decline in market share. After losing two percentage points of share over the past year to log in at 25.6%, GM has reached the point at which it actually consumes more cash than it brings in making cars, for the first time since the early '90s. GM, once the world's premier auto maker, is now cash-flow-negative. That's a game changer. Without growth, GM's strategy of simply trying to keep its factories humming and squeaking by until its legacy costs start to diminish is no longer tenable. If market share continues to slip, its losses will rapidly balloon.Normally a company in such straits contracts until it reaches equilibrium. But for GM, shrinkage is not much of an option. Because of its union agreements, the auto maker can't close plants or lay off workers without paying a stiff penalty, no matter how far its sales or profits fall. It must run plants at 80% capacity, minimum, whether they make money or not. Even if it halts its assembly lines, GM must pay laid-off workers and foot their extraordinarily generous health-care and pension costs. Unless GM scores major givebacks from the union, those costs are fixed, at least until the next round of contract talks in two years. The plan has been to run out the clock until actuarial tables tilt in GM's favor (a nice way of saying that older retirees eventually will die off). But with decreasing sales and a smaller slice of the market, that plan backfires -- leaving GM open to an array of highly unattractive possibilities.Hard TimesHow bad could it get? BusinessWeek's analysis is that within five years GM must become a much smaller company, with fewer brands, fewer models, and reduced legacy costs. It's undeniable that getting to that point will require a drastically different course from the one Wagoner has laid out so far. He is going to have to force a radical restructuring on his workers and the rest of the entrenched GM system, or have it forced on him by outsiders or a bankruptcy court. The only question is whether that reckoning comes in the next year, if models developed by Vice-Chairman Robert A. Lutz fall flat; in 2007, when the union contract comes up for negotiation; or perhaps in five years, when GM may have burned through its substantial cash cushion.Why is it so hard for those inside GM to see the inevitable? Take a step into the Detroit mindset. No active employee was even alive in 1930, the last time a rival sold more cars in the U.S. than GM. The idea of being No. 1 is etched into the company's DNA -- which makes it all but impossible for execs to embrace a strategy of getting smaller. And union leaders have never seen a problem that couldn't be ironed out at the bargaining table. "I think GM and the American auto industry are facing a lot of competition," says United Auto Workers President Ronald Gettelfinger. "But we've always had difficult times."Not surprisingly, GM disputes this analysis. Wagoner declined requests for an interview, but spokesman Tom Kowaleski says the company is confident it can rebuild sales momentum. "We're going to fight our way back and get more share," says Kowaleski. He also says the board is solidly behind Wagoner and that even if his plan falters, GM is prepared. "This company has a significant amount of planning in place and is looking at contingencies. Don't think that we don't have long-term plans."Increasingly, though, the solutions will slip from GM's control. At some point the laws of physics take over and, like steelmakers and airlines, GM is at the mercy of global forces. It simply cannot compete in a global economy with the enormous burden it now carries in legacy costs. It certainly cannot meet those costs for long off a shrinking sales base and negative cash flow. And distracted by those woes, it can't begin to make the investments necessary to match the Koreans on price, the Japanese on quality, and the Europeans on performance.Let's be clear: GM is not in danger of going bankrupt while it still has a cash hoard. It has a ton of liquidity -- $19.8 billion in cash, marketable securities, and money it can tap from a pre-funded retiree benefits fund. That doesn't count $8.3 billion available from bank lines and probably $5 billion GM could draw on from its profitable General Motors Acceptance Corp. (GM ) finance subsidiary. Several analysts already expect GM might have to cancel its $1.1 billion-a-year shareholder dividend; it could also raise $10 billion to $15 billion by selling GMAC's mortgage and insurance businesses.But all that cash just ensures that GM can continue its ways for a few extra years. Without a sharp course correction, GM is on a glide path to disaster. Things got downright embarrassing in April when Toyota Chairman Hiroshi Okuda raised the possibility of hiking prices to give GM breathing space, saying, "I'm concerned about the current situation GM is in." (Toyota subsequently backed off.) Wagoner has ratcheted up the urgency level in recent weeks, signaling to unions that he needs relief from GM's $5.6 billion in annual health-care costs and accelerating the delivery of new sport-utility vehicles and pickups by several months. And it now looks like he may bite the bullet and close at least a couple of auto plants to reduce GM's overcapacity. But he probably won't quickly enact a fundamental restructuring of GM's tired business model. And without that, he is relying on new car and truck models to stop the sales slide. That's a high-stakes bet that he probably can't win.If he fails to turn around sales, Wagoner probably won't be around to make the tough decisions in later years. Even GM's long-suffering board will have run out of patience by then. "It's difficult for us to see, if volumes and share continue to fall, how they're going to get the significant cost cuts necessary to stabilize cash flows," says Mark A. Oline, an analyst at the Fitch Ratings service, which has GM debt at a BBB- rating, one notch above junk, with a "negative" outlook. "Having that kind of cash drain is unsustainable over the long term."GM's remaining options involve pain for workers or investors. Here is our assessment of how the crisis might play out: