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Survival of the Fittest Applies to Detroit

by Glen Meakem
 

In a recent cartoon, a very old man with a long gray beard testifies in front of a U.S. Senate hearing on the auto industry bailout.

Asks a senator: "So as an expert witness you believe a federal bailout of Detroit is a mistake?"

Replies the man: "That's correct, Senator."

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The man's nameplate reads "Charles Darwin."

The federal government must refuse to bail out the U.S. auto industry. Detroit is uncompetitive and has been for decades. The only rational path is Chapter 11 bankruptcy reorganization.

While still trailing foreign auto manufacturers, the Big Three have made improvements in quality and productivity. Unfortunately, Detroit's labor costs remain out of line. According to the Center for Automotive Research, the average pay rate for the 239,000 union workers at the Big Three, including take-home pay and benefits, is $73.21 per hour. The equivalent average hourly pay rates are $44.20 for the 113,000 Americans who work for foreign car companies and $28.48 for all American workers.

The United Auto Workers long ago extracted a rich deal for its Big Three employees. Of course, the number of these workers has decreased by 4.5 percent per year since 1992 while the number of Americans employed by foreign car companies has increased by 4.3 percent per year. If the Big Three could afford to pay these above-market wages, fine. But why should the rest of us subsidize these 239,000 workers with our hard-earned tax dollars?

In his congressional testimony, General Motors CEO Rick Wagoner said Detroit's current predicament was caused by the economic crisis and not management failures. In fact, leading auto industry analysts have been saying for a decade or more that "the business model for the industry is broken."

And, in a Stanford Business School case study from 2003, Wagoner admits he "knew the problem was bigger than cyclical market conditions." The fact is that Wagoner has been attempting to halt the inevitable demise of GM for more than a decade.

Reform efforts have failed and stories of arrogance, mismanagement and chaos abound in Detroit. One example is the story of Covisint, the automotive industry's "E-Marketplace."

In 1999, General Motors had an experimental contract with FreeMarkets, a company I founded, to supply patent-pending, Internet-deployed software and services that helped GM reduce costs from vendors.

GM paid FreeMarkets $2.5 million in 1999, and the software and services generated $100 million in savings for the automaker. That was a 4,000 percent return on investment for General Motors.

Rick Wagoner responded to this successful innovation by canceling the contract with FreeMarkets in early 2000 and forming, along with Ford and Chrysler, a new auto industry-owned competitor to FreeMarkets called Covisint.

From 2000 through 2003, the Big Three spent more than $500 million on Covisint, but failed to make the new E-Marketplace work and sustain itself. In late 2003, the Big Three sold the remnants of Covisint to FreeMarkets for $16 million.

Yes, the Big Three lost half-a-billion dollars on this one project while learning they did not have the skills to start or run an Internet business. So much for entrepreneurship and innovation in Detroit.

Two weeks ago, Detroit's CEOs flew to Washington in private jets and asked for $25 billion to survive through 2009. Last week, they drove back to the capital in hybrid cars requesting $34 billion, with General Motors needing $4 billion and Chrysler $7 billion to survive the last three weeks of 2008.

But there is no end to this since the Big Three are fundamentally broken. Their labor contracts must be canceled and renegotiated by new management. This can occur only, as it did with the airline industry, through reorganization under court-supervised Chapter 11 bankruptcy.

In previous recessions, the federal government did not bail out other failing manufacturing industries, like steel. The government allowed the painful but necessary process of failure, change and rebirth. It made our economy stronger and more efficient.

The alternative is government subsidies and ownership with management supervision by politicians like Nancy Pelosi. And if our government bails out the Big Three, then many other companies and whole industries will line up for government subsidies.

Do we want a weak, highly politicized economy like Italy's or France's?

The stock market has fallen by about 20 percent since Congress "saved us" with the ill-conceived $700 billion banking industry bailout in September. Just think how much further the stock market can plummet once it begins to digest the implications of further bailouts and socialization of our economy.

It is time to trust the competitive marketplace and our well-tested bankruptcy laws.

In this case, Charles Darwin has it right.

Glen Meakem was the founder, chairman and CEO of FreeMarkets Inc. He is co-founder and managing director of Meakem Becker Venture Capital.


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