Delphi, the largest supplier to the automotive industry, filed for bankruptcy last Saturday. This is not an isolated event – it is only the latest filing in a series of bankruptcies among American automobile suppliers. Their American customers, the large automotive manufacturers, are hardly doing much better. Both GM and Ford have achieved junk bond status as investors worry about mounting pressure on their businesses.
The business press coverage of this story has been disappointing. Almost without exception, the story has been reported as part of a broader effort within the American automotive industry to realign its cost structure. In particular, the news reports focus on the challenge of dealing with the inflated wages that American automotive workers enjoy relative to their counterparts in other countries and the legacy costs burdening American auto companies. So, if one takes these reports at face value, the problem is labor costs and the greed of workers who won’t face up to reality.
Look, there is no question that wage rates of American automotive workers are too high and painful readjustments will be required. But is that the whole story?
The Delphi story is a rich one that can be read on many levels. It provides significant insight into the mindset of a lot of American executives across many industries - not just the automotive industry - and drives home in stark form the consequences of that mindset.
At one level, this story provides insight into spin-offs. Delphi is a spin-off from General Motors. When the spin-off occurred in 1999, it was heralded as a bold move to provide more focus and flexibility for both entities. In fact, an article on "Spin-Offs That Won't Go Away" (registration required) in Business Week almost a month ago cast the spin-off (along with a similar spin-off of Visteon from Ford a year later) in a very different light:
The two parts makers remain GM’s and Ford’s largest suppliers, but there’s a bigger reason why the auto makers are still on the hook for these offspring: Except for their stock, they never completely cut all ties to make them independent companies. . . . Indeed, Delphi and Visteon . . . may have been destined to fail. GM and Ford lumbered them with huge labor costs while extracting promises from them to cut their prices.
Visteon, while it has avoided bankruptcy court so far, has lost $3.2 billion since its spin-off and survives only through subsidies received from Ford.
In retrospect, these spin-offs are much better understood as financial engineering – get under-performing assets off the books while still preserving effective control of the assets through tight business relationships. Competitive pressures are forcing an unbundling of large enterprises, but too often executives pull back at the thought of losing control and strive instead to create the illusion of independence. In some respects, the Enron debacle stemmed from exactly this inability to let go.
At a second level, the Delphi story illustrates the destructive impact of supply chain relationships in large parts of American industry. Over the past couple of decades, we have seen a pronounced trend towards consolidation of supply chain relationships by American business. Only last month, both GM and Ford announced another round of thinning the ranks of their suppliers. Why is this being done? The Wall Street Journal headlines of the stories covering these announcements cuts to the chase: “GM Unveils Cost-Cut Program to Press Suppliers, Halt Losses” and “Ford Seeks Big Savings by Overhauling Supply Systems”.
If you dig deep into the stories, you may find an occasional reference to new technology and innovation, but the headline and bottom line are clear: these are simply the next wave of efforts to squeeze suppliers. By reducing the number of suppliers, the automotive companies tighten their control over the remaining suppliers and gain more bargaining power in negotiating even deeper price concessions. In this environment, trust is in short supply and relationships become adversarial rather than collaborative.
This leads to a third level of the Delphi story. Executives in the automotive industry are reaping the consequence of decades of focusing heavily on cost cutting as the primary approach to driving profitability. Under the best of circumstances, cost cutting yields diminishing returns. But it has an even more insidious effect: it creates a zero-sum game among participants. There’s a fixed set of economic resources available and I win only if you lose. It pits suppliers against customers and labor against management. Dysfunctional friction ripples throughout the business and, in focusing on keeping what they have, people pay less and less attention to what new value they might be able to create together.
Delphi’s story can also be read as a cautionary tale regarding consolidation. Major auto companies in the US and Europe (both suppliers and assemblers) have been pursuing aggressive M&A programs in a defensive effort to bulk up and achieve further cost savings through economies of scale. If Delphi, as the largest automobile supply company with revenues of $27 billion and 185,000 employees, could not avoid bankruptcy, we might want to question how much economies of scale really help.
Delphi’s bankruptcy should be a wake-up call. Cost-cutting is absolutely necessary, but it is not sufficient – pursued in isolation, it rapidly approaches a dead-end. Economies of scale may be important, but mergers can be a distraction. The only way to succeed as competition intensifies is to find ways to create more value with less effort. Productivity determines success and innovation is required to drive productivity advances. Innovation requires people to come together, often across institutional boundaries, and discover new ways of operating. The dysfunctional friction that pervades the American automobile industry must be converted into productive friction if these companies are to survive.
Accomplishing this will require a fundamental shift in executive mindsets. We can blame the troubles on greedy workers, but that will only harden the battle lines that hamper forward movement. The only way out of this box starts in the executive boardroom. Senior management needs to challenge itself to find ways to get better faster by working with others. If senior management teams can tap into this potential for innovation, they will have a much more compelling case to make to their workers and their suppliers.
The automobile industry is on the cusp of profound transformations, as highlighted in two recent books: The Second Century by Matthias Holweg and Frits K. Pil and Time for a Model Change by Graeme P. Maxton and John Wormald. For an interesting account of the growing importance of modularity in the auto industry, see Mari Sato's essay on "Modularity and Outsourcing: The Nature of Co-Evolution of Product Architecture and Organization Architecture in the Global Automotive Industry" in The Business of Systems Integration by Andrea Prencipe, Andrew Davies and Michael Hobday. The potential for innovation, both in the cars themselves and the methods used to design, produce and sell these cars, has never been greater.
How could "reducing the number of suppliers" enable "the automotive companies tighten their control over the remaining suppliers and gain more bargaining power in negotiating even deeper price concessions"?
Isn't that contrary to the commone business sense?
Posted by: Louis | March 31, 2008 at 09:11 AM
I honestly believe that the end of the large automotive factory's is going to be the unions. The unions are long overdue to be removed from power. GM pays over 2billion every year in union medical benefits. How can they effectively compete with other manufactures such as KIA when they're making cars twice as cheap.
Posted by: Charlie | March 17, 2008 at 06:13 AM