U.S. Automotive: Motor City Madness

With Delphi filing for bankruptcy protection, can GM be far behind?

It's Miller Time in Motor City, U.S.A. But let's be clear: hourly workers at Troy, Mich.-based Delphi Corp., the world's largest auto parts supplier, have no reason to celebrate. If they're bending elbows, it's to drown sorrows created by the US$16.5-billion Chapter 11 filing of the company's embattled U.S. operations, which is the 13th-largest U.S. corporate failure, not to mention the largest ever in the global automotive industry. After all, critics say, you'd have to be drunk to accept the massive wage cuts proposed by CEO Robert Miller just days after he gave Delphi's senior management a multimillion-dollar retention package. “If this isn't game theory in action, what else could it be?” asks independent U.S. economist Robert Brusca.

In a scathing client note issued after the Delphi filing rocked the automotive world in early October, Brusca–a former Federal Reserve system economist who dropped rear axles on Chrysler trucks as a union-card-carrying autoworker to pay for graduate school–accused Miller and Delphi's directors of losing touch with reality. “Henry Ford knew his lot was the same as his workers,” he says. “He was iconoclastic…But he knew if his workers could not afford to buy his product, he would not stay in business.” Miller, on the other hand, seems more concerned with keeping managers from jumping ship. Brusca simply can't understand why Delphi's management team deserves “$90 million in bonuses for wrecking the firm and leaving it so dire you have to ask for 66% pay reductions from your workers just to survive. Is this taught at Harvard? At Wharton? What incentives for good corporate behaviour lie here?”

Delphi–which gave the automotive world electric starters, in 1912 and the first in-dash radio, in 1936–is a US$28-billion operation that has approximately 185,000 employees in 38 countries. How did it end up on the skids? The company's brochure says it all when it states, “Where we've been has a lot to do with where we're going.” The industry giant is technically just six years old, but it has been around for ages, which is why it faces the same chronic ailments that threaten to send its former parent, General Motors Corp., into Chapter 11. Indeed, Delphi was spun out of GM in 1999 with so-called gold-plated union contracts, ones that offer generous medical benefits and full pensions after 30 years, allowing 50-year-olds to retire and collect benefits for more years than actually worked. The company also inherited a “jobs bank,” which currently has about 4,000 laid-off employees who get paid to wait for work at a company that needs to cut staff. That alone costs Delphi about US$100 million per quarter.

Miller is not new to the restructuring game. Being corporate America's Mr. Fix-It is his forte, and he plays tough when faced with crippling legacy costs and market forces beyond his control. Just ask former employees of Bethlehem Steel, where the turnaround artist oversaw a restructuring that wiped out pensions. At Delphi, Miller defends his Chapter 11 filing and demands for massive job and wage cuts by claiming the status quo for the entire U.S. auto industry is ridiculous. He points out that, like it or not, globalization has rolled over America's ability to include skilled labour in the middle class. “It boils down to this,” Miller told The Wall Street Journal. “If you want your kids to enjoy the great American dream, get them a good education. The days when manual unskilled labour can deliver a $65-per-hour wage are disappearing.”

Why go out of the way to retain managers who sank the ship? While Delphi pays “double or triple” the prevailing rate for industrial labour and market rates for salaried staff, Miller says it has under-paid executives for years. He notes nobody got a raise, and points out that the executive retention program was, in fact, extended severance deals in return for non-compete commitments, not bonuses.

Either way, industry experts say the Delphi bankruptcy filing casts a pall over the entire North American auto sector, which faces a possible domino effect caused by pressure on Delphi's suppliers, many of which are also in a very fragile state. Dennis DesRosiers, president of Richmond Hill, Ont.-based DesRosiers Automotive Consultants Inc., says failures among this supply base would create disruptions that could move back up the chain to dozens of other Tier 1 suppliers like Canada's Magna International Inc., hurting automakers of all stripes. Magna, based in Aurora, Ont., employs approximately 82,000 people in 22 countries, but it has a unique corporate culture that has kept North American operations pretty much union free. Last year, when Delphi lost US$36 million, Magna managed to post profits of US$692 million on revenue of US$20.7 billion.

The Delphi filing is also seen as a huge and direct blow to the auto workers union, which vows to fight Miller tooth and nail. “Once again,” says a statement issued by union boss Ron Gettelfinger, “we see the disgusting spectacle of the people at the top taking care of themselves at the same time they are demanding extraordinary sacrifices from their hourly workers.” The UAW, which represent about half of Delphi's 50,600 U.S. employees, had hoped General Motors would come up with some sort of rescue plan for its former subsidiary to ensure a stable supply base (GM is still Delphi's biggest customer) and prevent the automaker from having to assume up to US$11 billion in pension liabilities for its former employees.

GM has seen its credit rating plummet along with its North American market share, not to mention sales of its profitable SUVs. According to DesRosiers, the fact that GM did not ride in to rescue Delphi signals a new hardline strategy at the world's largest automaker, one that could lead to an even larger labour war in the industry. “It is a very high probability that GM and the UAW square off at some time in the future,” he says, noting a second front in the war to contain costs could open before GM's formal contract with its unionized U.S. workers expires in September 2007. DesRosier estimates that the embattled automaker could put together a US$40-billion war chest if it proceeds with recently announced plans to auction off a controlling stake in its financing unit, General Motors Acceptance Corp. And with cash in the bank, CEO Rick Wagoner may decide to risk a costly labour strike to address the legacy issues that led to Delphi's Chapter 11 filing. That, in turn, could set the stage for a more aggressive approach to fighting cost and overcapacity issues at Ford, which lost US$284 million in the third quarter.

Wagoner, of course, recently struck a tentative deal with the UAW to reduce costs. It aims to slash GM's health-care liabilities to retirees by about US$15 billion and trim annual employee health-care expenses by about US$3 billion (on a pretax basis). Analysts say the move was a step in the right direction. But while the spirit of co-operation at GM could, if it lasts, pave the way for a successful turnaround, the actual cash savings (estimated at US$1 billion annually) from the health-care deal could be wiped out by GM's exposure to Delphi. Whatever happens, the automotive giant still needs to spend some time in the garage before it will be running on anything close to all pistons.

Indeed, after watching soaring fuel costs push demand for high-margin SUVs off the cliff in September, GM posted a US$1.6-billion loss for the third quarter, down from a US$440-million gain in the same period a year ago. The Q3 results were released with a reconfirmation of plans to drive GM's North American plant capacity utilization to 100% or better by 2008. “As part of that,” Wagoner said, “we would need to close additional plants, both assembly and component, and this would entail reducing manufacturing headcount levels in the U.S. by probably 25,000 or more.”

As economist Robert Brusca points out, the state of affairs for unionized auto workers in the United States is so bad, “it almost makes you wish you worked for a major airline.”