General Motors: A Case Study Revisited

It was announced today that GM has lost $15.5 billion - in the second quarter alone! People have wondered for decades about the future of the American auto industry. Will one of the Big Three fall? Convinced it is inevitable, some just wonder when. The SUV boom of the nineties kept them afloat until roughly 2001, when $1 / gallon gasoline went extinct. They all started hemorrhaging money for years. I was among those who were sure that one had to fall. How long could they last? Then, in July 2007, I participated in a team case study on General Motors for a required course in my graduate studies - Strategic Management and Implementation. Although I had been waiting for GM or another American automaker to fall, I became more optimistic after studying the case a little more indepth.

I identified GM's strategic group competitors to be Ford, Chrysler, Toyota, Renault-Nissan, and Honda. In examining these companies, I noticed the American automakers all had the same problems. The story was less of a GM vs. all-the-rest story as it seemed an American automaker vs. the Japanese automakers story. The statistic that stuck out was the $30 / hour, or 67%, difference in labor costs between the Japanese and American companies. The Japanese Big Three paid an average of $45 / hour to their American employees compared to the $75 / hour paid by American companies. The bulk of the difference is explained by American companies' massive retiree health benefit totalling $90.5 billion, or an estimated $1,000 - $1,800 per car sold!

This, in my opinion, is the bulk of the story. How does a manufacturing company compete when its labor costs are 2 / 3 higher? For a short run, they competed on profitable trucks and SUV’s. But those days are gone. As I was researching the case, I learned that negotiations over the next labor contract between the automakers and the United Auto Workers (UAW) would be taking place soon after the course was completed. For years, the American automakers practiced “pattern bargaining,” in which all three negotiate with labor during the same week and all three get virtually the same deal. Historically, this had the effect of removing labor costs from the realm of competition because each company could be confident they were paying their employees the same. Instead, they focused on design, quality, etc. Removing labor costs from competition put American companies at a disadvantage as they began to face global competition from less benevolent employers.

In researching labor relations at the time of the case, I found the UAW in a virtual death spiral. Auto parts companies, including Delphi, Dana Corp. and AC Delco, had recently emerged from bankruptcy and received more favorable deals from the union. In fact, every UAW negotiation leading up to the Big Three involved sweeping concessions due to manufacturers’ financial woes and tough competition from other countries or foreign firms with non-union US plants. Ex-UAW president Doug Fraser was quoted as saying that this was “the most difficult time in the history of our union. Period.” In the final presentation, I stressed the importance of gaining a favorable deal in the upcoming negotiations. I emphasized that GM needed to “hang on” financially long enough to take advantage of its opportunities.

Next, I showed several studies of consumer perceptions toward American autos. As you can guess, they were highly negative. However, I contrasted those perceptions with reality in JD Power & Associate rankings. American automakers had made great strides in closing the quality gap of the late eighties and early nineties. However perception is crucial. Perception, I contended, needs a much longer time to change when it pertains to durable goods like cars. People won’t be convinced the quality is comparable until word spreads about American cars that last ten years without major repairs. It could take ten years from when the quality is truly comparable. If GM could just “hang on” until perception caught up with reality.

In 2006, GM grew sales in emerging markets China and Brazil by double digit figures. They made plans to build a manufacturing plant in Russia while closing plants in the US and Germany. Their classic brands are particularly strong and saw solid growth in Latin America, the Middle East, and Africa. The nature of the changing world economy presented new fronts for GM to gain leads over the competition.

The price of gas, global warming, and dependence on foreign oil are on the domestic conscience more and more every day (exponentially more so in July 2008 than July 2007). While Toyota marketed the best-selling hybrid, the Prius, GM is very competitive in its green technology. They were the first automaker to market an electric car in the 1990s and announced a new all-electric car in 2010, the Chevy Volt.

My main analysis of the case was that if GM could just “hang on” until (A) they become financially sound through reduced labor costs and (B) the perception of quality changes (which it will), then the company could take advantage of its main opportunities in (1) emerging markets and (2) green technology. If GM could just hang on…

Back to 2008, the price of oil has doubled in less than a year due to emerging markets’ growing demand, instability in Nigeria, and increasingly confrontational politics from oil producing countries like Russia, Iran, and Venezuela. High gas prices have all but destroyed the SUV and light trucks market (American automakers’ only real apple cart) at the same time as the subprime mortgage crisis has morphed into a worldwide economic slowdown. Subprime mortgage was on the radar in 2007, but it wasn’t projected to be what it has become (Bear Stearns, Fannie, Freddie, Countrywide). The ensuing global credit crunch has further reduced GM’s options and breathing room in staying afloat. GM lost $15.5 billion dollars in the second quarter. A month earlier, a Merrill Lynch analyst commented that a GM bankruptcy “isn’t impossible,” sending the stock tumbling to a pitiful $10 / share. Suddenly, the big qualifier in my analysis seemed a lot bigger, an obstacle almost insurmountable – “if they can just hang on…” While hanging on, GM will have to pay the costs of designing competitive, fuel-efficient vehicles while, at the same time, converting SUV and truck plants into manufacturing facilities for small cars. At the same time, it will also have to continue to lead the efforts in green technology while not short-changing investment in emerging markets. Time will tell if it is up to this tough challenge.

The Unsolicited InBev Bid For Anheuser-Busch

Last week, InBev offered $65 / share to acquire Anheuser-Busch. The combination would make the largest beer company by sales revenue in the world. Anheuser-Busch used to hold the title, until Interbrew of Belgium merged with AmBev of Brazil, creating InBev. And then South African Breweries' acquisition of Miller Brewing and other companies dethroned InBev and currently holds the spot. InBev is primarily interested in Anheuser-Busch to gain a foothold in the US market (AB keeps about a 50-share compared to InBev's 2%), but also to add the "iconic" Budweiser brand to its world market-penetrating portfolio.

Before the offer went public, Anheuser-Busch CEO (and fifth-generation family member at the helm) August Busch IV was quoted as saying that the company "won't be sold on my watch." Being from St. Louis and having worked for Anheuser-Busch for two years, I knew he wouldn't be the only one staunchly opposed to the sale. There is a mentality ingrained in the company culture and the city of St. Louis - a strong culture that I never really fit into. Recent news of regional politicians taking preventive actions against a sale also validates the widespread opinion that Budweiser, the world's best-selling beer, should remain American-owned in St. Louis, MO. Missouri governor Matt Blunt has asked the Federal Trade Commission to review the potential deal for potential anti-trust issues - a desperate and futile move given InBev's 2% market share. Similarly, Republican Congressman Kit Bond and Democrat Senator Claire McCaskill have lobbied the Department of Justice in an attempt to block the deal. Several websites have sprung up with names like "www.savebudweiser.com" and "www.saveab.com" to rally support for the company staying in St. Louis. Who do they plan to petition, I don't know. I had heard hints from St. Louis that "The Fourth" had a nuclear option up his sleeve to thwart a deal. Given that the family owns a tiny minority of shares which do not have super-voting privileges, and given the board of directors is up for election in any given year, what could that nuclear option be? It turned out the nuclear option was to buy the remaining 50% of Mexico City's Grupo Modelo (brewer of Corona) that AB does not already own. Such an acquisition would raise AB's price tag $10 billion or so, which would be difficult for InBev to secure financing for in today's tight credit market. The Mexican families which control Modelo have about as good of a relationship with the Busch family as does the InBev management, so a deal isn't likely.

Unfortunately for Anheuser-Busch upper-management, protectionist politicians, and sentimental consumers, $65 / share is a price difficult to refuse. Due to consumer preferences shifting away from macrobrews toward craft brews and imports, spirits, and wine, AB has seen sluggish growth at best. AB's stock price has hovered around $50 for almost a decade. The main reason $65 is difficult to refuse is that there doesn't seem to be an exciting new strategy for growing the business. The most impactful new product of the last five years was Bud Select, a cannibalizing brand which I can't discern in taste from Bud Light. AB secured distribution rights for Monster energy drinks and, ironically, InBev beers in the US - both moves are hardly on the scale needed to significantly boost growth for the nation's leading brewer in an increasingly competitive global marketplace. AB briefly flirted with Brazil in the nineties, only to pull out and never return. AB does own 27% in China's #2 brewer, but margins in China are razor-thin and that asset won't bear significant financial results for a long time. On the other hand, InBev out-maneuvered Anheuser-Busch by dominating Latin America while consolidating a significant chunk of Europe. Soaring food prices (rice, corn, barley and hops) and a weak US dollar combined to create a perfect storm in which InBev is in the position to acquire AB outright, as opposed to the two companies' merger talks of yester-years.

The only rational reason the deal wouldn't happen lies in the cultural differences between the companies. InBev is known as a hyper-effective cost-cutter. They have closed centuries-old breweries in Europe and become a super-efficient holding company that just happens to sell beer. InBev management has been rumored to believe there is a potential $1.4 billion to cut from Anheuser-Busch operations. To the contrary, Anheuser-Busch is a benevolent employer known for generous employee compensation and spending top dollar on marketing initiatives - a contributing factor to its powerful brands. Brand management is Anheuser-Busch's business, core competence and passion. In my first year of employment in Contemporary Marketing, I had a $300 / week expense account for the bars. After a few months, I learned the $300 was more of a minimum than a maximum. One week I spent $1500 and didn't even receive a phone call about it. And every St. Louisan has heard the stories of AB employment perks including free beer, first-class flights, generous pay, tickets to various entertainment, etc. InBev would certainly find cuts, but would these two cultures blend? A private-equity-firm-esque, holding-company mentality and a tradition-rich, patriotic, proud character? The inevitable culture clash presents the only rational reason the two shouldn't join.

It has been reported this week that the world's richest man Warren Buffet, whose Berkshire Hathaway is AB's second-largest shareholder owning 5% of the company, supports a deal. Other large shareholders - the majority of which do not live in the St. Louis area - have been reported to support a deal as well. Aside from political reasons, there is no compelling financial or strategic reason for the deal to not happen. Anheuser-Busch has been almost exclusively focused on US market share in an age of globalization. In my time with the company, every strategic move seemed to be aimed at Miller, Coors, or boosting sales in the mature US market. Meanwhile, I can't order a Budweiser anywhere in South America. (However, I should be able to as soon as Budweiser is in the InBev portfolio.) Without considering how much imaginary value lies in the temporary economic worries of protectionist Americans or sentimentality for an "American company" (regardless how competitive it would not be in the future), the best value for the Anheuser-Busch shareholders and the best opportunity for the Budweiser brand lies in the deal with InBev.

Insightful article by a St. Louis native and financial analyst in favor of a deal:
Sobering Thought: Anheuser-Busch sale makes sense (by David Weidner)

Steve Ballmer: Victim of an Eager Press

Steve Ballmer was virtually crucified in the business press in the days after he walked away from negotiations to buy Yahoo!. At the time, I was appalled at the headlines and how they were treating the guy. Dozens of articles reported on his failure to acquire the #2 search engine. It seemed presumptive because nobody knows what happened at the negotiating table. Just because he didn't come away from the table with Yahoo! under the Microsoft umbrella doesn't mean he failed. How do we know he didn't do a prudent job? How do we know the terms weren't unreasonable? If the only acceptable outcome was in securing the deal, why even go to the negotiating table? The strongest weapon in the negotiating table is the threat to walk away. It is to be brandished and displayed. And if the terms are ridiculous, you have to use it.

Jerry Yang, co-founder and CEO of Yahoo!, appears to be emotionally invested in his company. He is worth $2.3 billion so a financial incentive to sell his company isn't there. He is probably more interested in returning Yahoo! to its pre-Google glory. There is a pending class action suit against the Yahoo! board for failing to protect shareholder interests. It seems Yang required exorbitant employee compensation for Yahoo! employees who left and who stayed. Yang also organized a massive employee walkout to protest the proposed buyout. I read that, after Ballmer abandoned the talks, high fives were exchanged among many of the executives. Under these circumstances, it seems only right that Ballmer left without a deal.

After a week of Ballmer receiving a lashing in the press, I enjoyed seeing his ultimate vindication. Ballmer himself couldn't have written a better development to the story. Carl Icahn bought several million shares and started a proxy fight. Icahn accused Yang of not looking out for shareholder interest and slated a new board, up for election in August. Icahn has stated that Yang should not be CEO regardless of how the Microsoft deal turns out. The fight has started all over again and Microsoft is in an even better position to negotiate. If Microsoft ends up paying less for Yahoo! than their final offer before walking away, Ballmer will come out in a better position than the press itself could have imagined.