Sunday, December 14, 2008

The Big Three and Labor Costs, part 2

So what difference do outsized UAW contracts matter to the Big Three? Locally, Jay Bullock says "machts nichts" citing calculations that bringing the Big Three into line with the Japanese manufacturers would save $800/car. Going back to the last post, I did a back of the envelope calculation for Chrysler/Daimler that seems to bear that out. Of course, if Sherk is right, the legacy burden adds another $500 or so to that figure.

Hardly enough to bother over, says Jay. American cars, he says, are already cheaper than their Japanese counterparts. Certainly it couldn't matter if they were even less expensive? It might. An $800 to $1300 cost difference is significant even if you are already at a lower price point. No rational businessperson would imagine that it is possible to exist with labor costs that are 70% higher than the competition unless your workers are adding some substantial value that the competition's are not.

But here's the larger point. The Big Three are losing money and say they need an immediate transfusion of cash. They want the taxpayers to come up with the money because no one else will. The UAW has made some concessions but the cost of their contracts is still, as we have seen, roughly 70% over the labor costs for the Japanese nameplate manufacturers.

But let's look at the excess labor costs. The UAW says it is making concessions. But, again, by a back of the envelope calculation using Chrysler Daimler numbers, let's see what that extra $800/vehicle means. Daimler/Chrysler sold 4.7 million units in 2006. $800/unit is almost 4 billion dollars annually. If the impact is the same for Ford and GM, then noncompetitive labor costs are costing the Big Three $12billion each year and the cost of deferring labor concessions for two years (as the UAW insists upon) could be as much as $24 billion even as, if Sherk is right, the legacy costs are untouched.

It could be more. It could be less. But, when we are talking about - at least initially - $ 25 billion in loans that no rational creditor would make (otherwise there would be no need to come to DC), the deferral of concessions to 2011 is material. The UAW is, in effect, asking the taxpayers (most of whom are earning substantially less) to give them a few more years of benefits their employers can no longer afford.

So Jay wants to be taxed to permit people whose compensation is twice his to continue to enjoy their unaffordable contract for a while longer.

What's the matter with Bay View?

I concede that the Big Three's problems are not limited to ill advised labor contracts. They have too many salaried employees (who also may be paid too much), designed lousy cars and have too many dealerships. They are a mess. But I do think that all of it is rooted in the same problem and that's where we'll start tomorrow.


Peter said...

Just a few things to consider here:

1. The Big Three have problems right now with both profits and cash flow, stemming from operations revenue. All of what you, and other conservative union-busters, have been talking about is profits, when the issue the Big Three are really trying to solve right now is cash flow. Cash flow problems are coming from a downturn in operations revenue, which is linked to the lack of demand in the auto market in general, and more specifically for their given lines of autos. The lack of demand is coming from... well, I'll just leave you to read a book on New Keynesian economics to figure that one out.

2. Labor costs as a share of operations costs are something like 10% for domestic automakers. That's current wages and benefits. Trimming around the edges is not the solution to either the cash or profits problem.

3. The offset of legacy costs was coming - ironically for you union-buster, through an a side agreement amending the labor contracts between the UAW and the Big Three individually. But the cash flow problems are limiting the ability of the automakers to fulfill their obligations under the contracts. The UAW has already said that they'll defer payments in the VEBAs by the Big Three in the current bailout negotiations. Take out legacy costs and the labor costs between Detroit and international automakers are pretty much on par. Legacy costs are a matter of cash.

4. The biggest issue that Detroit has, which is at least an order of magnitude larger than their labor costs and contracts (as a side note: labor flexibility has never been a problem with the Big Three, interesting) is that their product mix has sucked. That's not just some pop observation, it's true: they are not generating sufficient operations revenue to meet their cash needs and to build a profit margin. This is a systems problem in the domestic auto industry, not a labor costs problem.

For a bunch of people who are always spouting off about business, there has been a stunning lack of understanding of how businesses, especially production and quasi-production industry businesses work.

There truly has been a textbook case of (induced) market failure for domestic auto producers. Now, the inability of Detroit to sell a product line that can generate the revenue it needs to cover cash and profits is killing it.

Jay Bullock said...

Peter has said much of what I wanted to say, but if I (for once!) could be more succinct: Why should the line-level workers be the ones to suffer following the mistakes of management? When the Big 3 said to UAW, please build these cars that no one will buy, it was not UAW's place to refuse and instead build more consumer-friendly models. UAW did what it was asked, with exemplary professionalism, and now you would punish them for doing their jobs well.

It may be that the difference in labor costs and bailout requests come close to making a neat little 1:1 ratio, but that does not suggest that the labor costs created the conditions under which the bailout became necessary.

Not to mention, scuttling a deal that could cause bankruptcies that ripple far and wide because the UAW did not jump as high as a handful of Senate Republicans demanded seems both stupid and cruel.

Dad29 said...

Jay, "sometime during 2009" (from your post/your blog) is not exactly a tight schedule for concessions; by my calculation, it's over 1 year from today.

To the point of cashflow: yes, it's a cashflow problem--and yes, to some extent that's a mangerial error.

Of course, paying employees NOT to work, with SUB on top of UIC taxes, and/or 'ready rooms'--not to mention continuing health coverage--is also a 'management problem.'

We ALL concede that the contracts, substantially negotiated in the '50's and '60's were overly generous and envisioned an oligopoly.

Now you propose that the taxpayer should shoulder the burden of propping up 1950's-model contracts?

Then perhaps you'd suggest that taxpayers should be buying 1950's-model cars, too.

With a properly-packaged Chapter XI, a lot of the white-collar people who made lousy decisions will be out, as will a lot of the line workers.

I can't speak for Rick, but I think we agree that this is not what ANYONE wants to see. On the other hand, if you think it's important to support the status quo, you can buy a helluvalotta GM stock cheap these days.

Go for it.

Jay Bullock said...

Of course, paying employees NOT to work, with SUB on top of UIC taxes, and/or 'ready rooms'--not to mention continuing health coverage--is also a 'management problem.'
All of those, excepting the health coverage, were things UAW gave up in negotiations. Health costs are what they are, and they are not unique to the B3. Toyota and Honda and Subarau are paying the same costs.

We ALL concede that the contracts, substantially negotiated in the '50's and '60's were overly generous and envisioned an oligopoly.
But the current pay at GM/Ford/DC is not more generous than Toyota/Honda. (I've read varying figures, but some suggest that Toyota line workers take home more than some B3 employees.) The difference is legacy costs, as Toyota + Honda combined have less than 3000 retirees in the US vs. the hundreds of Ks that the B3 have. The bailout in part could easily cover legacy costs for a year or two and then the only difference would be the crappy cars.

Now you propose that the taxpayer should shoulder the burden of propping up 1950's-model contracts?
The taxpayer will be paying either way, Dad, either through unemployment and job training, or by letting the B3 tread water while they retool and the economy turns around. Payments start to look bigger if the ripples are as broad as predicted, perchance leading to a full-fledged depression--or at least a longer recession than necessary.

And, again, a handful of R Senators from right-to-work states that have handed over subsidy after subsidy to foreign carmakers tanked the deal because they insisted they be allowed to re-write existing, binding contracts. The jerkitude of that cannot be overstated.

Peter said...

Dad29, a response for your thoughts:

1. Again, this is a matter of magnitude. Labor costs make up less than 10% of the operations costs for building vehicles. Poor management decision-making on the front end of what those vehicles would be like is a way bigger thing.

1a. To that end, the autoworkers in Detroit are MORE productive than their counterparts at other plants. So even with higher per unit labor costs (assuming that to be true), there is a strong likelihood that those costs are offset. This is another example of the two-edged sword of unionization. On one side, union workers have a strong premium for workers on wages, benefits, benefit incidence, etc. That's actually good for all workers, bargaining up. On the other, there is very strong evidence that union workers are, holding other factors constant, more productive than their non-union counterparts (on the firm level). In other words, being union might be what has kept Detroit going in these years of strategic mismanagement.

2. The new agreements that the UAW worked out with the Big Three in 2007 and 2008 have their big effects slated for 2010, like the VEBAs and changes to occupational arrangements (which now will include amendments for the 'job bank'). These agreements essentially eliminate the union premium on wages as compared to non-domestic producers.

3. Don't forget, foreign producers, whether located here in the U.S. for their production, or otherwise, enjoy huge government subsidies, be they U.S. state-based ones or those of foreign governments to the manufacturer. We're not exactly comparing apples to apples here without that consideration.

4. From a market power perspective, autos still operate under oligopoly structure, actually, more appropriately, monopolistic competition. Remember, the operational market for autos is not unified - there are different markets for different types of vehicles. Detroit has been operating in a market structure, because of the product line choices their managements have made, where marginal revenue might not be covering marginal costs. It might be, but I'm guessing that's not been the case in 2007 to 2008.

5. The auto industry crisis is not happening in a vacuum. Again, the broader economic collapse that is and has been occurring provides the context of people not buying vehicles, especially those that Detroit has been producing. You can't supply your way out of this problem. Detroit has needed to change its product line for years. The big changes to their line are slated for 2010. That's why they need the cash infusion to get there.

6. Chapter 11 is not really an option for anyone in Detroit right now. I'm not even sure that it's legally an option for Chrysler, in that they're held by a private equity company. I could be wrong there. If only there were a lawyer around who could shed light on that... Regardless, Chapter 11 involves re-structuring of labor agreements and strategic decision-making. As noted above, these are already in the works. Hastening them is not as simple as waving a wand: the changes are relatively long-run (i.e. 2010 is the horizon) as the short-run in dense manufacturing like autos tends to be longer than say, pharmaceuticals. And in Chapter 11, financing must be found. You might have heard that large-scale debt financing isn't exactly abundant these days. Government as lender of last resort is already our modus operandi. It's Chapter 7 liquidation or a direct financial input. The former would be disastrous not only for Detroit, but for American in general. We cannot afford to lose 2.5 to 3 million jobs right now tied in with autos.

7. If the Big Three go under, so do the bulk of their supply chains, because the Big Three make up so much of their operational revenues. Demand for parts will not be able to made up for with foreign producers, and these suppliers will go under, hence the up-to-three-million jobs. Detroit going under means that foreign producers are not far behind.

7. It cannot be stressed enough that it has been management-level strategic errors in the business that have created the problems for Detroit. Labor has not been a part of this problem, and attributing the problem to labor is either disingenuous or ignorant. Either one gives me pause considering that about 35 of the 100 most elite political decision makers succumbed to one or the other.

8. Supporting the status quo is not even an option right now, as in, it's literally not on the table. The options are Chapter 7 (disaster) or financing of a new Detroit. The devil is in the details of how it happens.

Dad29 said...

Really? No Chapter XI? Gee, all those people who write for the Wall Street Journal must be really, really, really stupid!

I do not now, nor have I ever, implied that union labor is not 'good' labor. But it is preposterous for you to imply that 'only the UAW members' work ethic' has preserved Detroit to this point--when we all know that the 'work rules' in the contracts institutionalize inefficiency.

At the same time, I have often noted that 'one gets the IR one deserves,' specifically indicting the auto companies for horrendous labor practices. And they WERE horrendous.

Let's leave Chrysler off the table--I dont' know if they can go BK, either--as to GM, Chapter XI is very, very do-able.

There will be some dislocation, but if you really think that entrepreneurs will NOT show up to buy a Chevy-parts operation, you are bereft of reason. Same-o for Buick, GMC, and Pontiac.

Whole-goods is another question, but since no one is buying what's on the dealer lots now, who cares?

New products? Good. Another class of entrepreneurs will pick up the patents and revive the assembly plants. Maybe it will include current GM managers.

Final thought: the US Government has not been helpful, either. Besides the regulatory costs imposed on Detroit, this Government has done everything possible to make export of US cars impossible. The country chooses not to subsidize exports, not to fight currency-manipulation schemes, not to protect US patents--in short, the Gummint has protected ITS revenue stream rather than those of its domestic manufacturers.

Too bad.

Rick Esenberg said...

Brian and Jay completely miss the point. The deal fell apart because the UAW would not agree to changes that would have brought labor costs into line with the Japanese name plate manufacturers now. Let's wait until our current contract is up for further concessions, it said, and, in the meantime, the taxpayers can give the companies a bunch of money.

Why would anyone agree to that? Why should Jay Bullock be taxed in order to continue to pay an assembly line worker in Detroit twice what he makes as a teacher in Milwaukee? (And it's not just legacy costs. Look at the financials.)

Of course, the immediate problem is cash flow and, although not all of the excess labor costs are cash items, reducing those costs to what they are for Toyota and Honda would go a long way toward solving that problem.

Should the union be the only one to make concessions? Absolutely not. If the companies are trying to hang on to other inefficiencies that were adopted when they really did function in an oligopolistic environment (something that hasn't been true for years), then they need to go as well.

Companies owned by private equity firms are perfectly welcome in bankruptcy courts. Perhaps DIP financing would be unavailable and the taxpayer would still have to finance the workout, but a bankruptcy court would force restructuring and would do it with the objective of creating a going concern and not to satisfy competing political constituencies.

Whether or not the Big Three's problems are "caused" by the UAW - a claim that I never made - does not matter. If they want tax dollars, they have to get lean. That does not leave room for labor costs that are 70% higher than the competition. Even if it's only for a "little while longer."

On the other hand, absolving the UAW of any responsibility for the Big Three's problems goes too far and the claim that union labor is more productive than non-union labor requires one to believe that people who actually run businesses - whose money is on the line - don't understand their own self interest.

Dad29 said...

Anent ChXI, Peter, see:

Written by a LawProf/George Mason.

Jay, I can't let you get away with this: Health costs are what they are, and they are not unique to the B3.

Yup. But the EMPLOYEE CONTRIBUTION to premiums, and the co-pay/deductibles, are different.

A local (and large) union recently allowed the employer to charge $1K/year toward premiums from each employee, and, a few years back, allowed the copays/deductibles to rise (again).

That makes a VERY big difference in employer-liability, no?

Terrence Berres said...

Peter wrote "the issue the Big Three [sic] are really trying to solve right now is cash flow."

Right now? Business Week's December 12, 2005 What If GM Did Go Bankrupt... says "GM has $34 billion in cash and could free up roughly $15 billion more selling various businesses. That alone should be enough to keep the company running for a few years." And here we are those few years of negative cash flow later.

Jack Lohman said...

If the CEOs also willing to accept the wages of Japanese CEOs, I'd say go for it? Japan’s CEOs get 10 times while our CEOs make 400 times the lowest paid worker.

Jay Bullock said...

The deal fell apart because the UAW would not agree to changes that would have brought labor costs into line with the Japanese name plate manufacturers now.
But that's not true, Rick. Note that management is not out there bitching and moaning about the UAW, here, only the R Senators. You think management wouldn't be all over it if it were true? But it's not true, it's the R spin. Corker walked out a meeting where everyone was at consensus, and an hour later his caucus rejected that. That is not the UAW's doing, Rick.

The only people who had a problem with that deal were a handful of Senate Republicans. Not the execs, not the Ds, not the White House, not the bipartisan supporters of the House bill. The R Senators who represent the states that are home to the Big 3's competitors, and who are virulently anti-union, saw this as a way to kill both the Big 3 and the UAW and therefore help their own states at the potential expense of large swaths of the US economy.

Peter said...

Arrgh. Deliberate obtuseness is not the hallmark of good blogging.

1. The considered bailout is a bridge loan, not a giveaway. So no one is being taxed to give money to the Big Three to hand over to the UAW. Good lord. They want a bridge loan to cover cash needs and get over the hump to 2010, when the new product lines roll out, which happens also to be when new labor labor agreement provisions kick in.

2. Let me repeat myself, yet again. The Big Three have a strategic positioning problem, not a labor costs problem. Get. The. Net. Understand this, and I know you're a lawyer, not a corporate executive type, so it might be outside your area of expertise...the problem for the Big Three is strategic positioning, not labor costs. I'll write it again if I need to. They need to re-position themselves. That re-positioning can operationally occur over the next year or so while they roll out the 2010 product lines. But they need to get there first, thus the bridge loan.

The issue is NOT labor costs, it IS strategic positioning. Understand that this is at the core of the debate for those arguing in good faith.

3. I never said that only union workers' work ethic saved Detroit. What I said was that their productivity margins at least covered their higher per hour wage costs, and gave Detroit the operational room it needed to crank out product.

I try to maintain a civil tone when commenting on blogs, but I'm really frustrated with you folks on the right these days. Do you have a background in economics and business? Because understanding things like firm-level productivity, operations revenue, cash flow vs. profit margins, etc...that's what is key to understanding this all, not pablum-y rhetoric like "entrepreneurs will swoop in and save the day."

4. No, we don't all know that work rules in contracts institutionalize inefficiency. You're just pulling crap out of the air.

5. Dad29, you lost any and all credibility in the last paragraph. Detroit has escaped any regulatory costs (also, the regulatory costs that would be imposed are about achieving economic social market efficiency...take a public economics course) through influence peddling and the strength of the anti-regulatory conservative movement. There are virtually no onerous regulatory costs on Detroit.

From there, you proceed into a ridiculous set of anti-trade assertions that boggle the mind of this laborite. You have to understand the dynamics of the way markets actually work before you go making wild and irresponsible claims. There is not a demand for U.S. autos in the U.S. and it's supposed to come from Western Europe? Jeez. Also, there's this little thing called the WTO that would overrule any such protectionist measures as you outline.

You're just totally off the reservation here.

5. Rick, you're a smart guy from all accounts. You know that it's a distinction without a difference in this context between "making a claim" and "implying." The conservative approach to this all along is that, as Bob Corker said, unions are on the back of business, bringing them down. Baloney.

You all have deliberately and disingenuously and ignorantly and dangerously mis-stated the set of issues around this: this is NOT ABOUT LABOR COSTS. Labor costs make up a very small part of the cost structure that is causing the problems for the Big Three, comparatively. The issue is cash flow and strategic positioning. As noted above, a bridge loan is what they need to get to the horizon of change -- if they could get private financing, they would I'm sure. They can't get it because no major institutional lender can take on the risk right now. There is a larger public risk than private risk in Detroit going under, which is why the federal government must act as lender of last resort.

Again, THIS IS NOT ABOUT LABOR COSTS. Should I say it again?

So disengage from the labor costs argument and start confronting the real business and economic issues at hand.

To that end, do I really need to explain again the difference between legacy costs (which are essentially fixed costs) and operational labor costs (which are variable costs)? Again, the obtuseness is mind-boggling for people so certain - and so fellating of 'business' in their general outlook. The legacy costs are NOT PART OF LABOR COSTS in the current operations of the Big Three. So stop including them. The operations variable costs for Detroit and foreign producers in the U.S. are roughly the same. Read that sentence again.

I'm really flabbergasted trying to understand how you guys can be missing the obvious business and economic issues at hand here. You just seem to lunge at every red herring that passes by like my dog chases every squirrel running through a tree while his dinner bowl sits full right in front of him.

Rick Esenberg said...
This comment has been removed by the author.
Rick Esenberg said...

Do you have a background in economics and business? Because understanding things like firm-level productivity, operations revenue, cash flow vs. profit margins, etc...that's what is key to understanding this all, not pablum-y rhetoric like "entrepreneurs will swoop in and save the day."

Well, let's see, I took a great deal of course work in economics, both as an undergraduate and at Harvard and then spent ten years as part of the senior management of a privately held multi-national manufacturing plant with factories in five states and five foreign countries, so, you know, I guess that's not as good as being a TA in something that I hope is not economics, but I think it counts for something.

Be careful who throw your self-satisfaction at.

I'll respond substantively later

Jack Lohman said...


Guys, this IS about politics, and only about politics. It IS about who funded who's campaign. The unions funded the Dems and the corporations funded the R's. Otherwise they'd both do the right thing, which is NOTHING!

They'd force the three to consolidate into ONE and dump their unprofitable models and keep their good models. But now we're talking about EGOS, and NONE of the CEOs want to be out of a job.

*IF* they bail the three out, under either the Democrat plan or the Republican plan, we will be back talking about this six months from now, wondering why in the hell we didn't consolidate them in the first place and why in the hell we blew $50 billion of taxpayer money.

Dad29 said...

It's enjoyable to see Professor Peter yap about business--

"Cash flow", Professor Peter?

GM is burning at $1.75Bn/month. You, Herr Professor, suggest that $34Bn will support GM and Chrysler until they reach the Promised Land of 2010. Really?

And they will repay the "loan" with what? Are you telling us that US unit sales will rise to ~15 million units, again, in 2010? Or will the cost-reductions be SO significant that they will overcome the $1.75Bn/month AND afford free cash for note-repayments? Or both?

Professor Peter, someday you may understand that actual strategy includes closing dealerships, closing plants, and Lean/5S implementations, none of which GM has proposed (and damn little of which has been done.)

It's not merely marketing ploys, nor price-point competition. That's "pretty pig" stuff. Real strategy is synthetic--top to bottom--throughout the entire organism.

You gratuitously assert that the contract rules are close to irrelevant, not knowing whether they are or are not--but I know as a matter of FACT that Honda has NO such rules in Maryville and has a significant productivity advantage to any GM plant in this country.

It's even more comical to read your defense of Government's reluctance to employ the weapons of mercantilism against nations which (therefore) are winning that war by default--and at the very same time, tell us that "labor cost" is insignificant.

Ironic, that; because industry which flees this country's shores does so for only two reasons: 1) to produce at less cost; and 2) to gain volume resulting from that reduction in cost.

Maybe you have business experience; I would suggest that you need a bit more of it before you attempt to lecture Rick. And although I've only dealt with manufacturing folks as clientele for 30+ years, I suspect that my understanding of trench-warfare strategy and tactics in the sector is sufficient to support my opinions.

Dad29 said...

and operational labor costs (which are variable costs)?

Ooooohhhh. Now there's a credibility-builder.

"Variable"? How? SUB, UIC, and "job bank" are suddenly off-income-statement expenses?

Do you understand labor allocation on an income statement? Or doesn't that fit neatly into Strategic Positioning?