Thursday, June 04, 2009

The WSJ's James Stewart's Wrong-Headed View of GM & The Automotive Sector

I've written prior posts about the Wall Street Journal's gullible personal finance columnist, James Stewart's dubious advice and opinions, such as this one. Ordinarily, Stewart confines his lunacy to investment topics.

Earlier this week, however, Mr. Stewart treated Journal readers to his lack of understanding of industry structure and business strategy, as well.

To wit, he wrote a column about why GM will rise again to be a premier auto producer. He began by writing,

"The myriad causes of its demise have been thoroughly chronicled, but to my mind one stands out: The custodians of GM simply gave up trying to build the best cars in the world. To accommodate a host of competing interests, from shareholders and bondholders to labor, they repeatedly compromised on excellence. Once sacrificed, that reputation has proved impossible to recapture.

GM has made strides in quality after decades of churning out troubled cars. Cadillac, in particular, has regained a little of its lost luster. But can anyone say GM builds the best cars in any category? Can it rival a Toyota Prius or Honda Insight for fuel efficiency and reliability? A Lexus, BMW or Infiniti for luxury and performance?

In other words, the new, government-controlled GM likely to emerge from bankruptcy faces an uphill battle in a highly competitive global market. That doesn't mean the effort is doomed. Indeed, it seems to me that the sharper the break with the past, the better.

I've been encouraged by President Obama's remarks that even though the government will own a majority stake, the new GM will be run by auto makers, and the government won't interfere to pursue policy goals that may be inconsistent with shareholder interests."

Let's stop here briefly to parse Stewart's confused logic. After admitting that GM's management failed in many areas, including product design, he then expresses a belief that the 'new' GM, staffed by the same losers, will miraculously "break with the past."

Yeah, right!

Then he compounds his confused reasoning by ignoring the evidence of the past few months and declaring that the government will, of course, keep its hands off the operation of GM. Even yesterday's Congressional grilling of auto execs about dealership closures demonstrates this is a preposterous assumption.

So you have two giant institutions, GM and the federal government, neither with a history of successfully operating profitably by serving consumers, entangled in the management of the failed car company.

Stewart continues by contending,

"I've argued before that government should act as private-equity investors in distressed assets, with the exclusive goal of turning the company around and exiting with a big profit to taxpayers in a finite period of roughly seven to 10 years. To my mind, this is the only way to approach government ownership in any industry that is consistent, fair, and recognizes a fiduciary duty to the owners, who happen to be the taxpayers. This won't be easy, but I think President Obama and his Treasury-led auto task force may be tough enough to pull it off."

Conrail was created with the expectation of becoming independent in three years. That turned out to be hopelessly optimistic. The so-called privatization of the Post Office didn't go so well, either. Add to this the contrasting public statements by the administration and GM's CEO as to how long the government will have to wait for its investments/loans to be repaid, with interest, and you have total confusion and no credibility that GM will ever be weaned from public funding.

On the basis of these suspect premises, Stewart concludes,

"Can the U.S. field a world-class auto industry? I don' t see why not. Cars aren't a commodity like steel, an industry largely lost to foreign competitors. They are complex, highly sophisticated, individualized machines that despite over a century of progress still have room for improvements in fuel efficiency, performance and safety. What U.S. companies need to recapture is an unrelenting commitment to quality. I hope the GM bankruptcy accelerates the day when a father can again hand the keys to a Cadillac to his 16-year-old with the same pride my father felt when he gave them to me."

Actually, he's completely wrong in his understanding of auto sector structure. To state that "cars aren't a commodity like steel," is technically correct in the comparison, but incorrect that they are not, still, a commodity.
Cars are may be "complex, highly sophisticated" machines, but they aren't "individualized" in the manner Stewart believes. Much, if not nearly all of the sophistication now comes from suppliers like Bosch (anti-lock brakes). Research and development into proprietary power systems is so expensive that it has driven the sector toward a classic 'Big 3' structure, in which only the largest few global producers will likely achieve necessary economies of scale to profitably innovate in the years to come.

Thus, the barriers to entry, a key aspect of industry structure, have become so low that China has had over 50 new entrants, including municipalities! Kia, from Korea, has been around for nearly a decade already. Anyone with a large bankroll could, in theory, and has, simply shopped for components from vendors, outsourced engines, if necessary, and assembled the guts beneath a unique metal skin.

Fact is, auto 'manufacture' is, and has been, for decades, more 'assembly' than manufacture. Thus, fairly low-skilled workers in other countries can capably bolt together a modern car more productively than over-priced US union workers. That's a big reason why GM failed. And will remain failed.

Stewart's piece merely showcases his lack of understanding of even a basic large industry sector such as auto production. In fact, his contentions and conclusions are almost diametrically opposed to those of another Journal writer, Holman Jenkins, Jr.

One wonders, if he's this clueless about GM, how he can be trusted to advise anyone about any investment that requires understanding a business sector. And, by the way, why the Journal still wastes ink on his column.

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