Late in October 2008 as the senior executives of one of America’s longest established companies mulled over the most recent financial statements it became clear that it was not going to be able to pay its bills going into the New Year.
For years, mounting losses were taken in their stride as one of the costs of being the number one auto maker in the world. The possibility of failure had never crossed the minds of these pin striped suited, highly paid executives as they examined the latest financials. However, there was something compelling about the figures.
If you subtracted the costs of operating over the next few months from the likely revenue the impact on the cash flow was such as to create a great big hole. There was a desperate need for cash and it was not going to come from revenue or from the company’s bankers (they were already in strife themselves).
To most organisations, the choice would have been clear: “Bankruptcy”. But surely, GM, the icon of American corporate success for a century could not go bankrupt! The CEO, Rick Wagoner, finally realised that figures don’t lie and in the next few months, if he signed cheques, they would bounce.
He suddenly had an idea. “Look what Uncle Sam is doing for banks that have gone belly up. Well, if those guys deserve a hand out, what about good old GM that has been the backbone of employment of ordinary Americans for a century. If Treasury or Congress doesn’t give us a bail out, the game is not fair and tens of thousands of jobs will be lost and GM will not get to build environmentally friendly cars”.
So, the luxury corporate jet was commissioned so that the lobbying could start and pressure brought to bear on the government to keep GM afloat.
Before he boarded his luxury jet, Wagoner might have profitably asked himself two questions. Firstly was the reason he was going to put forward for the bail out the real reason (was he in denial?) and secondly, would the bailout make a difference?
In his message on The Wall St Journal Channel, Wagoner put forward his reasons for the bail out. A study indicated that nearly three million Americans would lose their jobs within a year of Detroit’s collapse.
He went on to say “The impact would be devastating for the U.S. economy. The problems in the auto sector are a direct consequence of the credit crisis, which has now moved to Main Street. We certainly hope we can count on a similar kind of support from the government as we saw them give the financial sector.”
So, the reason for GM being in trouble was the state of the economy and the recklessness of the banks and the consequence would be the loss of jobs to the American economy. What an upstanding American to have such altruistic and patriotic thoughts!
It is worth examining whether, even if Wagoner genuinely believed in these arguments, they were the real reason for the collapse of his company and for the need for a bailout.
I have talked before about denial and the necessity to look ruthlessly at the facts. Before Wagoner flew in his private jet to Washington on the 20th November to plead to a House Committee of Congress for a hand out, there was a set of figures available to him and to the public at large which just might have directed him to the real problems facing General Motors and the uselessness of a $25 billion hand out.
Similar sets of figures are available to just about any business no matter how large or small and they deserve the closest and ongoing scrutiny.
Times were great in the first quarter of 2008. Things were still booming. Sales of motor vehicles were probably at an all time high. However, in that quarter, Toyota outsold GM worldwide. Its sales grew by 2.7% to 2.41 million vehicles.
General Motors sold 2.25 million vehicles but its sales dropped by1%. Its competitor was selling more vehicles than General Motors. Well, 2.25 million is a big number, so should GM be concerned? Losing market share in a growing market is a concern. Declining sales at any stage is a problem but when things are buoyant, a decline in sales is a boom- gate or a flashing red light, no matter how well you are going. You need to discover the reason for the down turn in sales. Let’s get back to that.
Money is GM’s problem so let us look at their financials. Following is a graph of GM’s sales since 2004.
The 2008 event was not isolated. As you can see, the sales revenue had been declining since 2004. So, what about profitability? Following is the graph of GM’s profitability since 2004.
This graph is not pretty. The graph discloses losses of $10.0 billion in 2005; $2.0 billion in 2006; $39.0 billion in 2007 and $42.0 billion in 2008. In one of the greatest economic expansions in history, GM pulls off some of the greatest losses in American corporate history before the financial crisis took its toll! Sure, the economic down turn is hurting GM as it is hurting other car makers around the world but is it the cause of GM’s problems?
Toyota has recently taken a hit because of the economic situation. There is no Uncle Sam for them to go to for a bail out. Will Toyota be able to ride out the storm? Following are the profit figures for Toyota for the years 2006 to 2008.
These are in billions of dollars. So, what has Toyota done to rack up massive profits when GM is amassing crippling losses and debts? Not only that, Toyota has about $20.0 billion in cash in the bank and of course, GM has to ask the government for a hand out. Toyota has assets of approximately $180.0 billion and GM has assets of minus $38.0 billion.
If you had been running General Motors, surely you would have woken up well before now that the company was in strife. What is the problem with GM? There are two. They have been in denial (and probably still are) for years and refuse to look cold hard facts in the face.
After all, they are “General Motors” and have a divine right to survive. As that wonderful statistician, Edwards Deming is reported to have said “Learning is not compulsory- neither is survival”.
At some point, quite a few years ago, General Motors got themselves in to what is called the “Bermuda Triangle”. It is a situation where the resources of a business are overtaken by customer demand. The result is a failure to meet customer demand with the further result of customer defection to competitors.
The problem is perhaps the most serious that a business can encounter (we will talk about it in length in a later chapter). In short, however, once you lose a customers, it is hard to get them back if they are satisfied with the offering of the competitor.
General Motor’s problem was a poor and expensively manufactured product coupled with denial. It simply could not look reality in the face of falling sales, defection to a successful competitor which was stealing market share in a market it once dominated, coupled with ongoing crippling losses. It was General Motors for heaven’s sake! Everyone for a century had been buying the American icon of motor cars. Who didn’t buy a Chevrolet or a Buick or a Cadillac?
American cars drank too much gas, cost too much and lacked the quality and value added components of German and Japanese manufacturers. Every car they produced was digging a bigger hole in the ground. And now, mercifully, a saviour has come along; the good old economic crisis. How wonderful to have something we can blame for our misfortune so that we can have a plausible reason for going to the government for a bail out!
Toyota is experiencing a down turn in sales and profitability as are most businesses. How is it coping? Toyota is experienced in having to cope with recessions. Japan has been in recession for the best part of ten years. It realises the necessity to constantly improve on quality, to exceed customer expectations and to improve efficiency, so as to reduce the cost of production. It has $20.0 billion in the bank and a huge capacity to borrow if it ever becomes necessary.
What should we be looking at on a daily basis in a business? Sales, profit and cash are the starting point. We need to know, not only what we are doing today but what we have done over say, the past five years. In fact, what I find interesting if the statistics are available is the history of sales over a fourteen year period. The reason for this has to do with the Bermuda Triangle because something mysterious happens to many businesses over that period.
Anyway, the longer the period, the better the information. Has the sales graph grown consistently over the period or has there been a tendency for it to level off or even decline?
What about profit and by that I mean cash profit (about which I will have more to say in a later chapter). Has profit increased proportionately to sales? If not, why not. If you have a good steady improvement in sales and profit, then theoretically, things should be fine.
So, what about debt? Has the bank balance improved over the years? If it has improved along with sales and profit, then the business is in pretty good shape but if it hasn’t, then survival is going to be much more difficult in times of economic downturn. (Later on we will talk about the difference between the bank balance and debt. A company can have a healthy bank balance while its debt is increasing. Indeed, increasing debt is sometimes the reason for the improvement in the bank balance. For now we will just talk about debt)
Following is set of ideal graphs of a company’s growth over the past eight years.
This is a company that has experienced steady growth of 10% in sales and revenue for the period. In turn, the growth has been converted into a similar growth in profit. At the same time, the company which started off with debt has steadily reduced that through retaining 20% of its profits and has gone from being in debt to cash rich.
All the signs are that this company has high product acceptability and increased sales despite competition and is improving revenue at the same rate of sales. It has a cautious financial management and has prudently retained profits to build a tidy amount which is available for a variety of purposes such as riding out a recession, retaining and recruiting quality staff, investing in research and development or f or embarking upon an acquisition.
However, a less attractive scenario is represented in the following graph. This is what I call the GM graph.
What has happened here is that the company’s sales have gone with a bang for a while, levelled off and then declined as has its revenue. Down a bit further on the graph you will see that its profit went up with sales and then dropped. In the meantime, the debt has increased despite the increase in the profit.
Something is seriously wrong with this company. It is losing sales to its competitors, its revenue and profit is dropping and its debt is increasing, despite its apparent profitability. This company has problems and will not only have difficulty in weathering down turns but in creating value in the longer term.
When people look at graphs like this, there is a tendency for them to immediately go into denial and to come up with explanations that justify the graphs. These explanations often have nothing to do with the fact that the problems are internal. “We always have periods like this, we simply have to ride out the storm and the good times will come again!” The graphs tell a different picture and to ignore their message is to put oneself in denial.
If management looks at the data ruthlessly and objectively, while ignoring the belief that the company and its products are the best thing since sliced bread, the response is going to be “Hell, we need to find out what has gone wrong and what we need to do to turn the ship around before it is too late”
The immediate temptation is to borrow more money and that is the trap into which GM fell a long time ago. The likelihood is that you would be digging a bigger hole. The more effective approach is to realise that survival in the past has been dependent upon increasing debt. If the company cannot go forward without increasing debt, then it might be the lesser of two evils to stop digging, as they say. These are all signs of uncompetitive products either through lack of competitive quality, price or service. One classic denial response in this situation is that “our marketing is at fault”. Add that to your list.
There will be a range of scenarios in between the two extremes I have demonstrated. However, if you visit these basic statistics and examine them in the cold light of day, it will be a great start to the next stage of the business, no matter where the company is in the business cycle.
The number of companies that get into difficulties in times of downturns suggests that in many cases, management is not casting its eyes daily on the basic indicators of health in the business and have a closed mind to the forces that are conspiring to bring the company to disaster.
Louis Coutts left law and became a successful entrepreneur. His blog examines the mistakes, follies and strokes of genius that create bigger, better businesses. Click here to find out more.
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