Monday, June 13, 2005

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Why is GM still in business?

Following up on my last post, there's an interesting question to be asked about General Motors -- why is it still in business?

If that sounds heartless, it's not meant to be -- it's because I much of the past week's commentary sounds awfully familiar. For those who can remember the very early nineties, many were asking whether GM could survive -- at one point it had filed the biggest quarterly loss in the history of American business. GM may not be in great shape now -- but it's been 15 years and they're still the largest single producer of automobiles purchased in the United States.

The Economist has a story that touches on this question:

To both its admirers and its enemies, the most awe-inspiring feature of capitalism is its ruthless efficiency. In theory, poorly performing firms are shown no mercy. They are crushed and cast aside as fitter rivals come up with superior goods and services or cheaper methods of production. In fact, the system is nothing like as ruthless as it is cracked up to be. Plenty of suppliers fail to deliver goods on time. Lots of firms are slow to adopt new technology. Many managers are hopeless at motivating their staff. And badly run firms can survive for years, even in the same industry as state-of-the-art companies.

All of this has long had economists pondering two questions. First, why are there such wide differences in the productivity of competing companies? Second, why do these differences persist, rather than being squeezed to nothing by the remorseless market? They ascribe some of the gaps to differences in the quality of capital equipment, or in workers' skills, or in the development and installation of new technology. But there has long been a suspicion that quite a lot of the discrepancy between fit and flabby firms has to do with the quality of management.

The difficulty lies in putting a number on it. If economists are to explain company performance in terms of management practices, these must somehow be quantified. But how do you measure the “quality” of the layout of a shop floor, communication with workers or incentives for employees? An intriguing new study by Nick Bloom and John Van Reenen, of the London School of Economics, and Stephen Dorgan, John Dowdy and Tom Rippin, all consultants at McKinsey, attempts to do just that, and goes on to examine why badly run firms survive.

The study is based on interviews with managers at more than 730 manufacturing companies (none of them McKinsey clients), ranging from 50 employees to 10,000, in America, Britain, France and Germany. The interviewees knew only that they were taking part in a “research” project, not that their management practices were being appraised.

You can see the paper and the executive summary by clicking here. The takeaway points from the paper:

1. Product market competition, at the national sector level, plays a key role in determining the level of management practice, with higher competition likely to increase the exit rate of badly managed firms so improving average management practices. We find little evidence for any additional “effort” effect of competition in getting managers to work ‘harder’

2. Older firms, controlling for selection effects, have poorer management practices. This is consistent with the idea that new entrants find it easier to adopt the better management practices of the era they were founded than their older counterparts.

3. Stronger labour-market regulation significantly impedes good management practice, particularly in firms with longer tenured employees. This suggests that regulation impedes the adoption of new management practices.

Reason #1 would explain GM's persistence -- global competition has increased in the auto sector, but it's still not a model of perfect competition.

[Hey, wasn't this done by management consultants?--ed. In part, yes, but their methodology seems sound.]

posted by Dan on 06.13.05 at 04:52 PM


GM survives for the simple reason they produce products that consumers value in a manner that generates returns that shareholders accept.

Many forget that they have produced some of the best SUV and trucks in America (as measured by consumer choice).

I would also like to add that it was McKinsey that recommended GM switch to the organizational form that has destroyed the company.

posted by: simon on 06.13.05 at 04:52 PM [permalink]

> ... all consultants for McKinsey

In my experience, the more management consultants a company uses the worse it performs. Of the consultants, McKinsey is by far the worst: I have never seen them fail to destroy a company.

GM hires a LOT of consultants, and uses McKinsey heavily as well.

Case closed.


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

Dan, in asking why GM is still around surely you're overlooking an obvious factor: entry costs. It will take a nimble, hip manufacturer of cars a lot longer to enter the market and devour its rivals than, say, a nimble, hip coffee brewer. And a trudging dinosaur of auto-making is surely likely to take a lot longer to die than a trudging dinosaur of, say, cell phones. A car is a difficult thing to produce, and then you've got to convince your customer to entrust his or her family's life to it. An extremely long life-cycle, I'd have thought.

posted by: rlg on 06.13.05 at 04:52 PM [permalink]

And the government has done everything in its power to keep those barriers of entry to the car manufacturing business as high as possible!

posted by: spliff on 06.13.05 at 04:52 PM [permalink]

If there is anything I would think would make the difference of a well-run and a poorly run company it would be an examination of two margins. The marginal cost of improvement- rather following the 80/20 rule. If a company took the initiative to innovate, what are the chances that the market would respond, and how profitable would that change be? That's something of a management question.

The other angle is more directly related to management and promotion. What are the chances, if I work harder, that I get a promotion and power in the company?

Speaking of McKinsey, they notably revamped Xerox top to bottom in the 80s. Their prescription was that Xerox obsessively focus on customer satisfaction. The problem was that Xerox' most demanding customers had already defected. Xerox then engineered its products around the requirements of customers who cared less and thereby got leapfrogged by companies focused on innovation and future markets.

posted by: Cobb on 06.13.05 at 04:52 PM [permalink]

The only place I've seen perfect competition is in a textbook. Pity that the validity of neoclassical theory assumes perfect competition and free trade Both to be seen nowhere!

posted by: No von Mises on 06.13.05 at 04:52 PM [permalink]

I'm reminded of the non-scientific explanation for the overall failure of railroads like the Pennsy and NY Central; they lost sight of their mission as a transportation company...and viewed themselves primarily as a "railway" company. Rather than integrating trucks and even planes into their overall system, they struggled mightily against any cooperation with these "rival" modalities.

The mindset. "we're here to run a railroad", is vastly different than, "we're here to move goods and passengers where THEY need to go". GM and th eUS auto industry has similar issues. While the big-three US auto companies build great trucks and vans, they've built few cars that have been either exciting or groundbreaking on several decades. I haven't owned a US-built car for daily-use in over twenty-years, yet I'd always buy a US-built truck.

posted by: Ted B. on 06.13.05 at 04:52 PM [permalink]

> Rather than integrating trucks and even planes
> into their overall system, they struggled mightily
> against any cooperation with these "rival"
> modalities.

The railroads were forced to divest their long-distance truck lines, and prohibited from owning airlines, on anti-trust grounds. You have to remember that (a) no one trusted railroads, for reasons both sound and irrational (b) no shipper in the United States has ever been willing to pay any transportation company the full value of its services - never since 1600. When the indirect subsidies for shippers via the railroads ran out, the railroads went bankrupt. Just as the canals had done before, and the airlines would later.


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

Actually, the McKinsey report seems surprisely ignorant and unsophisticated. Maybe that's why
it's free.

Maybe it's a simpleminded puff piece intended to present propaganda: "Government intervention to protect manufacturers against competition might not be the remedy for western economies losing industries and jobs
to China,India and other low-cost countries."

As Michael Porter at Harvard Business School has noted (see book "Competitive Strategy") the reason multiple firms survive is that firms have a choice of three different strategies. A firm can
a)Produce Lowest Cost product with acceptable qualities (e.g, basic Chevrolet sedan), b)Produce a product with unique qualities but a higher price
(e.g., Mercedes sedan), or c) produce a product FOCUSED on best satisfying the unique needs of a customer subset (e.g, ambulances).

Each strategy
will yield a different share of the market and profits, but firms pursuing multiple strategies can coexist within an industry. Obviously, the company pursuing the Lowest Cost, High Sales Volume approach gets the largest market share (but not necessarily the highest profits.) The Lowest Cost producer also tends to dominate a business subsector when that subsector becomes a declining industry and a shakeout from declining revenues forces many businesses out.

Clayton Christensen at Harvard Business School, in his book "The Innovator's Dilemma", explained in detail how it is that the very management practices that make an existing firm successful are also what makes that firm fail when faced with new disruptive technologies.

Well-managed companies are biased toward:
a) listening to customers
b) Investing aggressively in technologies that give those customers what they say they want
c) seeking higher margins
d) Targeting larger markets rather than smaller ones

Yet those management practices work against success in developing new disruptive technologies because such technologies INITIALLY (a) appeal to a small subset of the customer base --and hence don't provide the large growth opportunity needed by an existing firm (b) satisfy a market which doesn't exist yet -- a market which can't be analyzed in order to have financial projections that justify investments (c) don't meld easily with existing customer's production processes/value chains

The problem is that disruptive technologies improve in performance far more rapidly than existing technologies and hence eventually supplant existing technologies. Witness the relative position of personal computer networks
versus mainframe computers with terminals in 2005 versus 1970.

Christensen also showed how the management dilemmas are impossible to reconcile within a single firm -- you have to set up two diffent firms with one maximizing the profits from the existing business and the second firm focused on succeeding in the new innovative technology.

GM did the right things -- they listened to their customers and they gave them what they wanted: Large cars to carry large families, high performance (to pass slow cars on two lane roads without the danger of head on collisions from oncoming cars), and low costs. There was no incentive to spend scarce resources on maximizing
gas mileage because gas was cheap.

So what happened: surge in baby boomer singles wanting smaller cars, fall in family sizes, extensive deployment of four lane highways lessening the need to fast acceleration, and a gas crunch. In 1979, Japan car makers were configured to make small cars with high gas mileage because they have always had to deal with high prices on oil imports and narrow streets. By contrast, GM was not.

As Christensen noted (p. 259)
"The capabilities of most organizations are far more specialized and context-specific than most managers are inclined to believe. That is because capabilities are forged within value networks. Hence, organizations have capabilities to take certain new technologies into certain markets. They have disabilities in taking technology to market in other ways."

posted by: Don the Greater on 06.13.05 at 04:52 PM [permalink]

It seems interesting that Dan bashes GM but not the US Government. After all, the government is a firm, with we citizens being the shareholders.

So how is the US government performing as a firm?
Is senior management behaving in an irresponsible way -- running up huge debt on poor investments?
Ignoring and Covering up huge problems (baby boomer retirement) in order to duck responsibility for addressing those problems?
Focused on making easy gestures which have high PR payoff while letting big problems get worse?
Screwing the small shareholders in order to curry favor with a few big wealthy shareholders?

What does the Firm's Balance Sheet tell you?
As I noted earlier, the federal debt projected for 2010 is now
$11.1 TRILLION. That is $4.4 TRILLION more than the $6.7 Trillion
that Bush
promised only 4 years ago, in his Feb 2001 release of the
2002 budget.
(a) Bush's 2006 budget release at ,
Table S-14 (bottom of page),
Entry "Debt outstanding at end of year", subentry "Total,
Gross Federal Debt
(b) Bush's 2002 budget release at ,
Table S-18, entry "Debt Outstanding End of Year", subentry
"Total, Gross Federal Debt"

posted by: Don the Greater on 06.13.05 at 04:52 PM [permalink]

> As Michael Porter at Harvard Business School has
> noted (see book "Competitive Strategy") the reason
> multiple firms survive is that firms have a
> choice of three different strategies.

Porter's work is always worth reviewing. But there are plenty of industries where there are 3, 5, 11, 17 competitors who could go after one another hammer-and-tongs, and they don't. Some of them even have managers who have read Porter ;-) That I think is one of the questions Dan is getting at.


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

McKinsey has never failed to destroy a company, huh? In that case, I guess the real question isn't how GM survives, but how McKinsey manages not only to survive but thrive despite such an absolutely dismal record of results for its customers. Someone should study that.

posted by: euskaria on 06.13.05 at 04:52 PM [permalink]

> Someone should study that.

And who exactly would you hire to do that ;-)

Less snarkily, you have the same problem as when a person is hired in for a very high-level position: those who would have to sit in judgement on his performance are the ones who made the decision to hire him in the first place. Guess what conclusion they will reach?

Whereas from my insignificant "individual contributor" position I once watched a consortium of consultants burn through $500 million and "assist" a company in missing a critical industry shift altogether - one which every employee below VP was predicting. Must have been fun for the partners!


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

"When the indirect subsidies for shippers via the railroads ran out, the railroads went bankrupt. Just as the canals had done before, and the airlines would later"...if it's impossible for transportation carriers to charge enough to survive, then why are the railroads doing as well as they are in recent years?

posted by: David Foster on 06.13.05 at 04:52 PM [permalink]

> why are the railroads doing as well as
> they are in recent years?

1) Unit coal trains (2) captive chemical shippers (3) abandoning 80% of the milage that existed in 1920 (4) abandoning all passenger service (5) consolidation of truck lines, leaving shippers with fewer alternatives (6) higher oil prices, which force trucks to raise prices faster than rail.

Those should explain the operating results. However, I believe the last time a US railroad earned enough to be capable of regenerating its capital plant was around 1925.

Now, the rail industry is clearly changing. If the expected "super merger" takes place, the dream of JP Harriman will finally be realized and the railroads may have some pricing power. But it hasn't happened yet.

Industries _can_ change after they hit the breaking point; Southwest Airlines is a case in point.


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

All good points, except possibly (5)...why would consolidation of truck lines discourage shipment by truck? Also, I think railroads have an economic moat which is quite strong...given today's environmental restrictions (and land prices) the possibility of anyone being able to put together a right-of-way of significant length is pretty low.

posted by: David Foster on 06.13.05 at 04:52 PM [permalink]

simon...could you kindly expand on McKinsey and the GM organization structures? I'm guessing that you're referring to the centralization which replaced the older "federally decentralized" structure. Any links or further comments would be great.

posted by: David Foster on 06.13.05 at 04:52 PM [permalink]

> why would consolidation of truck lines
> discourage shipment by truck?

Major rate increases and service decreases by the remaining national truck lines over the last 18 months have forced shippers to look at rail as an alternative, even those who swore they would never use rail again. This has give the railroads some pricing power on carload freight for the first time since the 60s.


posted by: Cranky Observer on 06.13.05 at 04:52 PM [permalink]

Management consultant:

A guy who knows 50 ways to make love to a beautiful woman but is too geeky to get a date.

posted by: save_the_rustbelt on 06.13.05 at 04:52 PM [permalink]

I'm not generally one to defend management consultants, but there is another explanation for the failure correlation Cranky pointed out: companies tend to hire expensive management consultants when they're in deep trouble. So the high correlation between hiring management consultants and business failure may well be a sign of deeper structural issues rather than of the idiocy of the consultants.

On the other hand, one the worst thing you can probably do when you've got financial problems is to spend a lot of money on expensive consultants to tell you things you already know.

posted by: Independent George on 06.13.05 at 04:52 PM [permalink]

Also, consultants are often used to produce reports for intra-company political battling.

posted by: anon on 06.13.05 at 04:52 PM [permalink]

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