Is There a Future for Detroit?

The Glory Days may be gone for the Motor City. But there is hope for the American auto industry, Wharton experts say.

By David Sedgwick

Photos by Paul Bednarski

Frank Fountain, WG’73, (left) calls the U.S. auto industry’s recent collapse a “cleansing exercise.”

The Detroit auto industry looks a bit like a city that has survived a great earthquake.

Ford Motor Co., General Motors and Chrysler Group LLC might still be standing. But somehow the landscape just looks different.

Thousands of dealerships have lost their franchises; tens of thousands of workers have lost their jobs; storied brands have disappeared; suppliers have gone bankrupt; the old CEOs are gone. The federal government has committed $50 billion to General Motors and $9 billion to Chrysler. Ford is toughing it out without any loans.

In the short run, the Big 3 seem likely to survive as the economy slowly recovers. In recent months, Ford has gained some market share and earned praise in a recent survey by Consumer Reports. And while sales at General Motors and Chrysler remain weak, conservative production schedules helped keep a lid on inventories and both companies said late this fall that they had enough cash reserves to continue operating.

The hemorrhaging, at least, has stopped.

Long-run prospects are murkier.

Which raises the question: Do the Big 3, now more accurately termed the Detroit 3, have the resources they need to survive and grow—or is Detroit, once America’s manufacturing powerhouse, doomed to wither and die?

John Paul MacDuffie, an associate professor of management at Wharton and one of the nation’s foremost experts in the automotive industry, says the answer is probably somewhere in the middle. Ford and General Motors probably can survive. Chrysler still looks iffy. But even if they all recover, the Big 3 will never regain their former market dominance, MacDuffie predicts.

He’s hardly alone in that sentiment.

“The competitors are too tough, and the Big 3 has lost too much ground with consumers,” explains MacDuffie, co-director of the International Motor Vehicle Program. “Some consumers will give them another chance. But others won’t look back.”

Three Companies, One Industry

As MacDuffie points out, it’s useful to remember that “Detroit” consists of three automakers. And the three companies have distinct identities, unique problems and decidedly different prospects.

Best off, says MacDuffie, is Ford. The company set itself apart from GM and Chrysler by avoiding bankruptcy, preserving its cash cushion and replenishing its product pipeline with vehicles designed jointly with corporate partner Mazda and Ford of Europe. Access to Mazda’s product development expertise, especially, “is a huge advantage for Ford,” MacDuffie says. By contrast, he adds: “I don’t think GM ever got as far along using Opel [GM’s European operation] effectively.”

Next in MacDuffie’s pecking order is General Motors, which emerged from Chapter 11 bankruptcy on July 10. The company, he says, is actually in better shape than some might suspect. That’s because GM is finally starting to produce products of higher quality—products on par, even, with the Japanese automakers.

The problem, MacDuffie says, is that the company has yet to convince consumers of that.

That’s why, for comparably equipped vehicles, Japanese automakers can charge $2,500 to $3,500 more than the Detroit 3, GM included. “General Motors has to overcome its inability to price products at a level where it can have some sustainable profit,” MacDuffie says.

The company’s decision to eliminate or sell four brands—Saturn, Saab, Hummer and Pontiac—will help the automaker to refresh the products of its surviving brands more frequently. But some critics think GM should have gone even further by eliminating Buick and perhaps even truck-centric GMC.

Worst off, of course, is Chrysler, which must soldier on with an aging lineup of models until partner Fiat can fill Chrysler showrooms in a few years with some of its signature small and mid-sized cars.

Even then, notes MacDuffie, these new Fiats aren’t likely to generate much profit in a market segment where competition is stiff. And as if that weren’t enough, Chrysler still is struggling to shed its reputation for chronically poor quality.

With no room for error, MacDuffie says, it’s unlikely that that the Chrysler-Fiat marriage will work.

“I’m pretty skeptical,” MacDuffie says. “I see it as a big gamble. Both companies have been near death a number of times, and they both have had miraculous comebacks. If they once had nine lives, each is probably down to four.”

The Great Collapse

W. Frank Fountain, WG’73, argues that reports of Chrysler’s impending death are premature.

Fountain joined Chrysler as a financial analyst just after leaving Wharton. By 1979, he had become a senior finance manager, then subsequently rose to the third ranking finance position at Chrysler. He retired last fall.

With his insider’s view of the company’s two previous near-death experiences—in 1979 and 1991—the 65-year-old Fountain has a veteran’s perspective on tough times. And he believes the company can recover again.

“Absolutely,” says Fountain, who now serves as chairman of the Walter P. Chrysler Museum Foundation. “I’m an optimist. … I think there is still enough talent and leadership in this company that it can survive and prosper. The industry has gone through the worst trauma in anyone’s memory, and that trauma has been a cleansing exercise. It’s setting the stage for what could be a big recovery.” Granted, Fountain says, the Great Recession of 2008-09 appears to be deeper and more damaging than any downturn since the Great Depression. That’s especially true for Detroit.

When future business historians chronicle the bankruptcies of General Motors and Chrysler, they might plausibly focus on some very bad news that broke on Oct. 1, 2008. That was the date automakers released their sales figures for September. The results? An industry-wide decline of 26.6 percent compared with the same period a year earlier. The results were so disastrous that the industry trade publication Automotive News dubbed it “The Great Collapse.”

No one was spared.

Even Toyota, Honda and Nissan—companies that always counted on market share gains when the Detroit 3 stumbled—were hit hard. They responded by slashing production and shutting down unneeded assembly plants. But for General Motors and Chrysler, mass layoffs and plant shutdowns couldn’t generate savings quickly enough. As credit markets dried up, the two companies were unable to borrow money to service their bloated debt.

In November of 2008, the two companies begged the federal government for bailouts. Despite congressional opposition, the Bush Administration gave GM and Chrysler enough money to survive until President-elect Obama could devise a long-term rescue.

Ford didn’t have to follow suit, thanks mostly to CEO Alan Mulally. In 2006, the former Boeing executive mortgaged practically everything of value to obtain lines of credit worth $23.4 billion. It was his first major decision at Ford, and one of his wisest. Unlike his peers at GM and Chrysler, Mulally chose not to seek federal aid.

“Mulally is a pretty good example of how effective a CEO can be,” MacDuffie says. “He understood the need for them to focus [on quality], and the need to have money for future product. They look very smart now.”

The Workout

Unable to match Ford’s success at securing fresh lines of credit, Chrysler was steered into bankruptcy court this spring by the Obama Administration’s automotive task force.

The company declared Chapter 11 bankruptcy on April 30, then got to work cutting costs across the board. Chrysler announced plans to eliminate 789 dealerships, negotiated pay cuts with the UAW, forged ahead with the plan to merge with Fiat SpA, and paid 29 cents on the dollar for its $6.9 billion in secured debt.

The UAW , which had agreed to defer some of Chrysler’s cash payments to its retiree health-care fund, received a 67.7 percent stake in the new Chrysler. Fiat got a 20 percent stake, the U.S. Treasury got 9.8 percent and Export Development Canada received 2.5 percent.

Backed by the Obama Administration and a friendly bankruptcy judge, Chrysler brushed aside a group of debtholders who favored a Chapter 7 liquidation. On June 10, Chrysler emerged from bankruptcy and completed its merger with Fiat.

Chrysler’s biggest challenge, MacDuffie says, is to survive until Fiat can update its product lineup. It won’t be easy. For the first nine months of 2009, Chrysler’s U.S. vehicle sales were down 40 percent, the deepest decline of any major automaker.

But Chrysler’s dealers have proven adept at surviving on used-car sales. And Congress helped them trim their inventories of new cars and trucks with the cash-for-clunkers program, which offered consumers up to $4,500 for trade-ins. Moreover, the nation’s vehicle scrappage rate of 13 million vehicles per year is actually higher than sales of new cars and trucks, which are tracking at an annualized rate of less than 10 million units. This suggests pent-up demand for new vehicles.

That’s where Fountain draws his optimism. If the economy continues to improve, auto sales could rebound surprisingly quickly, he predicts.

“We have a stronger economy, a credit system that’s been fixed and some level of consumer confidence,” Fountain said. “The industry can do quite well, and Chrysler can do quite well with the products it’s got—for a time. Eventually, you’ve got to introduce new products and keep them fresh. We have the wherewithal to do that.”

A Sense of Urgency

Chrysler emerged from bankruptcy in just 42 days. Nobody expected General Motors to match that feat after it declared bankruptcy on June 1.

General Motors is a much larger company with more brands, more creditors, more car models, more factories, more employees, more debt and a more complex corporate structure with major operations on four continents.

So industry observers were shocked when GM followed Chrysler’s lead and emerged from Chapter 11 in just 40 days after giving itself a radical makeover. Under its plan, GM announced plans to:

• Sell or kill Saab, Saturn, Hummer and Pontiac.

• Carry $17 billion in debt, down from $176 billion.

• Operate with 4,100 dealerships by late 2010, down from 5,613 at the end of 2009.

• Reduce the workforce from 91,000 employees in 2008 to 64,500 by the end of 2009.

• Eliminate one-third of its senior executive positions.

The Obama Administration pressured former CEO Rick Wagoner to resign last May, and he was replaced by company Vice Chairman Fritz Henderson, a GM lifer who has run company operations in Europe, South America and Asia.

Wagoner was a cautious executive who preferred step-by-step incremental improvements. By contrast, Henderson developed a reputation in Europe as a turnaround artist who cut through red tape. It didn’t take long for Henderson to change GM’s hidebound corporate culture, says Sigal Cordeiro, who received her MBA at Wharton in 2000 and joined GM that same year. “When I joined GM, it was a shock for me,” said Cordeiro, GM’s director of global product research. “It was a huge company, and the decision making was slow.”

Cordeiro says Henderson launched periodic teleconferences—generally about an hour long—to keep other GM executives up to speed on his initiatives, and to field questions from staffers. Perhaps more important, though, were Henderson’s efforts to revive GM’s product development by adapting the company’s European vehicles to the U.S. market. That’s a strategy that GM first adopted six years ago, with mixed results. American consumers were indifferent to Saturn’s lineup, which included several European models. Nonetheless, Henderson planned to add a new generation of compact vehicles and crossovers to GM’s surviving brands: Chevrolet, Cadillac, GMC and Buick. “When gasoline prices hit $4 a gallon last year, we saw a huge shift [in consumer preferences] for the first time,” Cordeiro says. “At that moment, there was really a shift in people’s minds about how they thought about driving, and what vehicle to purchase.”

Henderson’s plans drew some praise. But ultimately, he didn’t produce enough results. He was removed by the GM board in early December, with GM Chairman Ed Whitacre Jr. saying Henderson’s reforms weren’t being implemented quickly enough. As of press time, his replacement had not been named—but the company’s biggest problems, including its tainted reputation, remained.

Focus groups react favorably to GM’s concept cars, so long as they are unidentified, Cordeiro says. Add a GM nameplate, and their enthusiasm cools. As a result, GM—along with Ford and Chrysler—has yet to demonstrate it can sell compact cars without big incentives, says MacDuffie. “They have to convince consumers to pay more and not wait for big sales and big rebates,” MacDuffie says. “They are trying to recondition consumers that were trained over a long period of time. And if they succumb to the temptation to do some heavy discounting to move the metal, they will reinforce buyers’ perceptions that they should just wait awhile and get a better price.”

The After-Shock

When behemoths like General Motors or Chrysler get into trouble, the industry’s smaller players—in this case, auto dealers and parts suppliers—take an even bigger hit.

Consider this: General Motors alone will buy $45 billion worth of components this year. The company has 1,400 parts suppliers in North America. But as the Big Three cut costs and slashed production, a number of major suppliers went bankrupt.

Mohsen Sohi, WG’98, has spent the last six years trying to prevent that from happening to his company, Freudenberg NOK, a joint venture formed in 1989 between a German and a Japanese automotive supplier. Sohi works in the heart of Big 3 country. From his office in suburban Detroit, it’s just a 22-mile drive to Ford’s world headquarters; 29 miles to General Motors’ corporate offices and 34 miles to Chrysler’s.

But over the past six years, Sohi has started to loosen the ties that bind his company to the Detroit 3, and the auto industry in general.

When Sohi was named CEO in 2003, the Detroit 3 comprised three of the company’s top five customers. Sohi soon concluded that Freudenberg—which makes powertrain seals, vibration dampers and hoses—was too dependent on automakers. The auto industry in general, he saw, was saddled with too much production capacity. And the Detroit 3 were especially vulnerable, given the import brands’ steady expansion into the U.S. truck market. “It was clear to us that the industry was going to have a lot of problems,” Sohi explains. “So we made a strategic decision to take our technology into other markets.”

Under Sohi’s leadership, the company launched new products for the medical, aerospace and oil-and-gas industries. As a result, non-automotive customers now account for half of Freudenberg NOK’s revenues. Sohi also expanded sales of automotive components to aftermarket customers.

Even so, Sohi admits the company still rises or falls with the auto industry’s fortunes. As auto sales collapsed, Freudenberg shut down four U.S. factories and eliminated 1,500 jobs in North America and Brazil. After topping $1 billion in sales 2007, sales declined in 2008 and 2009.

And yet, the diverse mix of customers allowed Freudenberg NOK to avoid a cashflow meltdown.

“Early this year, we hit the low-water mark,” Sohi says. “But I like to tell our customers that we had been preparing ourselves for five or six years.”

The bottom line, as Sohi sees it? Freudenberg NOK will never completely abandon the Detroit 3. But he also wants to loosen the bonds. General Motors, Ford and Chrysler are likely to survive for some time to come, he says.

But they will never regain the dominance that they once enjoyed.

David Sedgwick serves as Automotive Editor for the Detroit Daily Press and Editor of Autobeat Daily Europe.

Wharton Magazine - Background

Type to Search

See all results