GM: Kicking the Habit

General Motors has a monkey on its back: another monkey. Actually, three point one monkeys. Writing in the August issue of The New Yorker magazine, Malcolm “Tipping Point” Gladwell explored the possibility that GM’s need to support an enormous population of retired workers is dragging the company into the abyss. Although it’s not exactly a new idea, Mr. “Blink” applied a new tool to the job: the dependency ratio.

Economists use dependency ratios as an analytical tool to examine national economies. It’s a pretty simple concept. Imagine a single man bringing down $100k a year. Mr. Man’s got sufficient liquidity to buy a brand new Corvette. Now imagine the same guy making the same money married with 2.3 kids. He can only read about the joys of Corvette ownership (probably here, for free).

The single guy's supporting one person with one income, creating a one-to-one dependency ratio. Assuming his wife doesn't work, the married man’s living not-so-large at three-point-three-to-one. The more dependents a productive worker/economy must support, the less profitable and thus, financial viable, he/it is.

Gladwell’s article applies the dependency ratio to General Motors, casting retirees as company dependants. In 1962, GM had 464k active employees generating sufficient profits to support 40k retirees. The company’s dependency ratio was one to 11.6.

By 2005, GM had 141k active workers failing to provide sufficient profits to support 453k retirees. The General’s dependency ration has increased to a startling 3.2 to 1. In other words, every GM worker has 3.2 mouths to feed.

Productivity gains– related to just-in-time manufacturing and widespread automation– have helped mitigate the impact of GM’s retiree bulge. The General produces more cars with fewer workers than it did back in the early sixties. Unfortunately, this is a fact not a competitive advantage. Everyone in the automotive industry must do more with less. (Some automakers do it a lot better than GM, but that’s a ratio for another day.)

Ford and Chrysler are in similar straits, struggling to increase productivity (and profitability) to keep pace with their increasing dependency ratio. However, no company has as many retirees as The General. As the industry’s dependency “leader,” the enormous weight of their pension and health care obligations put the company at a huge competitive disadvantage.

General Motors would not be the first American company to collapse under the strain. Gladwell cites Bethlehem Steel as an example of a dependency ratio’s ability to destroy a business, if not an entire industry. In the ‘50’s, steel was one of America’s sturdiest, most important industries. Bethlehem stood at the top of the [slag] heap.

Competition from Germans and Japanese steel mills led to smaller and smaller proft margins. Bethlehem began to flounder. Between 1960 and 2000, the company shed 90% of its workforce. In 2001, Bethlehem Steel finally broke under its $7b pension and healthcare obligations, and filed for bankruptcy. Does any of this sound familiar?

Now the “good” news. After Bethlehem Steel’s pension fund was terminated in 2003, the company’s new owners restructured other obligations and started over. The new company’s dependency ratio sank to zero to one. The steelmaker turned a profit in six months, successfully competing against Germans, Japanese and the rest of the world.

The American auto industry in general– and General Motors in specific– understand the competitive disadvantages created by their “legacy costs.” And yet, GM, and now Ford, and soon Chrysler, are downsizing their business by offering union workers “buyouts”: lump sum payments that trim payrolls but do little to relieve their health care and pension costs.

In many ways, buyouts make sense. Cutting production and workforce lets you match supply with demand, and, hopefully, make a buck. But as the company chips away at its work force, it increases its dependency ratio. Buyouts mean fewer workers with even more people to support.

The only way out of the buyout trap: make more money per car. That’s tough to do when you’ve been selling discounts, rebates and finance programs for years, and your competitors don’t share your dependency problems. The margins in the auto industry have thinned like Kojak’s pate, especially in the low to mid-range market— GM’s unhappy hunting ground. Even the once mighty margins on light trucks and SUVs have taken a hit.

Unless GM can knock one (or ten) out of the park, the only way out of the dependecy trap is… volume. Back up two paragraphs and repeat.

Of course, GM can’t repeat. Every business cycle costs money; The General lost $8.6 billion last year. The repeat is actually a spiral; the plane without an engine kind. Spend, shed, spend more, shed more. In the end, the guy with 3.2 dependants will not be forced to ogle his single buddy’s ‘Vette. The company with 3.2 dependents per worker couldn’t afford to make it in the first place.

For most dependency problems, there’s a rehab program. For this particular affliction, it’s not twelve steps. It’s chapter eleven.