Rafi Mohammed

Pricing Can Save GM Quickly and Efficiently

Posted on June 2nd, 2009 (2 Comments)

General Motors is officially bankrupt. However both the U.S. and Canadian governments have decided to bailout GM. This decision is understandable as a complete shutdown would exacerbate unemployment in our already ailing economy. I was surprised to learn how high GM’s sales are: in 2008 the automaker sold 8.35 million vehicles globally, of which 36% were sales in the U.S..

So how will the carmaker find the road to profitability? The U.S. is going to loan GM $50 billion dollars in total and Canada is going to kick in an extra $9.5 billion. Thus, the full bailout figure is expected to be close to $60 billion dollars.

These governments are approaching the problem in the wrong way. The question that I would ask is, “how many more vehicles does GM need to sell to remain viable?”

With big industrial plants and ironclad labor agreements, the automobile industry is characterized by high fixed costs. By this, I mean that these fixed costs will be incurred regardless of how many cars are produced. In these industries, profit is earned only after passing a certain capacity utilization rate, say 85%. If sales are below this target, losses occur. Once sales surpass this target utilization rate, profits per vehicle are generous.

Suppose GM needs to sell an additional million vehicles a year to be a healthy ongoing concern. A million cars is a lot to sell, so how could GM garner those extra sales? Discounts, of course. Why doesn’t the government just lend an extra billion or two to GM to spend on promotions and price cuts to sell these needed million cars? Lower prices will stimulate new demand. A billion dollars in promotions works out to be a 10K rebate for each of the extra million cars that need to be sold. Let’s be generous and say that it is going to take an additional $2 billion annually to sell these cars and that we need to do this for the next 5 years. That’s a total loan of $10 billion versus $60 billion. Additional benefits of my plan are that auto/parts workers remain employed and taxpayers in essence get a shareholder discount (via promotions on cars).

Just to be clear, I’d keep all of the reorganization controls that the Obama administration are imposing (labor, shut down brands, and so on). The only difference is that instead of offering cash to pay for the fixed costs that aren’t being covered by poor sales, my plan subsidizes consumers (who may still be paying on average 20K per car out of their pockets after the rebate) which stimulates the extra sales needed to keep GM factories thriving.

Is $10 billion in government subsidies that is targeted for price cuts unfair to rival domestic and foreign carmakers? I’d say it’s on par with transferring $60 billion into GM’s bank account.

The wrong question is how much money does GM need to keep afloat. The right question is how many additional vehicles does GM need to sell to be prosperous?

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Readers' Comments on This Blog Entry

From Ross McD on June 2nd, 2009
Would the measures you propose not cause a great deal of protest from other car manufacturers (home and abroad) who would lose out on a vast number of sales as a result? Would this not in essence remove any real competition and subsequently not actually force GM to become leaner and more efficient?
From Leo Piccioli on June 2nd, 2009
Interesting point. I would add, though, that that is a short term solution, since GM will continue being under siege from new incumbents - not paying those fixed costs. Therefore, I see two long term exit strategies for Obama & company: a) Sell out the company (in pieces) to new incumbents b) Drastically change those fixed costs (quite challenging for a government to do)