Thursday, November 13, 2008

Tell Detroit--No More!

Reality is setting in. I voted for Obama, yet his first foray into presidential politics found him asking President Bush to help bailout the automotive industry in Detroit. Well Mr. President-elect, you are now 0 for 1.

What happened to CHANGE?

This is the same type of thinking that has wielded the scepter in this country since the industrial revolution began: no matter how strong the evidence of market failure, we refuse to believe in anything but our own permanence. So once again the automotive industry has approached the federal government with its hand out, instead of changing their products or business model (They have rather chosen to spend fortunes on lobbyists). And let us not forget that in September of 2008, Congress already gave the industry a loan totaling $25 billion. But with $50 billion more, they can turn things around.

Not if they don’t CHANGE!

This is a market economy. The auto-industry will perish, whether they get a bailout or not, if they do not change their business model.

A solid business model is the bedrock of every successful investment. If we are to invest in an industry, we need to learn how to describe and evaluate a company’s business model, in order to distinguish the great companies from the losers. This is just simple business sense. We need to look at how the company makes money. It is equally clear; we need to understand that as industries change, companies can’t always stick to the same business model. Joan Magretta, former head of the Harvard Business Review, has said that when business models don’t work, it’s because they don’t make sense and the numbers just don’t add up to profits.

When you consider G.M.’s model, it becomes clear that they don’t make money selling cars and trucks. In fact their business is based on (more than 60%) earnings from finance payments. This is a business model that has failed the test. In 2003, Ford, Chrysler and G.M. (in order to compete against foreign markets) offered customers such deep discounts and interest-free financing that they sold vehicles for less than it cost to make them. This is as a model that squeezed all the profits out of their operations.

So now we have an industry adverse to change in an environment that is in the middle of a housing slump and credit crisis. There is a drop in demand and a change in the vehicles consumers are buying. Detroit has been making large trucks and sport utility vehicles, while the foreign markets (with working business plans) are making more fuel-efficient vehicles.

Detroit and our policy makers prefer continuity to discontinuity, evolution to revolution. What has become clear is that in discontinuous times, efforts to evolve at one’s own pace will spell doom. External thoughts and actions need to keep up with the pace of external change. Economics tells us that if you are not able to cope with external pressures that demand a revolutionary approach to structure- you need a new business model.

The automotive industry has convinced the federal government that our economy revolves around it. But what I want to know is—why? Target, AT&T, GE, IBM, McDonalds Citigroup, Kroger, Sears, and Wal-Mart, all employ larger number of workers than any of the Big Three auto makers. Since 1997, thirty one steel companies have gone bankrupt, putting at risk over 62,000 jobs. The economy didn’t tank then.

The precondition of successful transformation is to close the gap between the automotive industry management’s (and our own) perception of present reality and the truth. They don’t need a bailout. What they need is—

1. Look out for major shifts in the conditions governing the marketplace, and transform their business model to fit.

2. Let the customers and their needs determine the model.

3. Be prepared to cannibalize the present, in order to preserve the future.

So Mr. President-elect, please don’t just throw more money at the problem. Think—CHANGE. Fix the problem!

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