Business Blog: Hoover’s Business Insight Zone

Ford reported a profit this week, which is a nice change from two years’ worth of dismal-to-horrific losses. But the company’s boss, Alan Mulally, didn’t mince words in explaining that things are going to get worse before they get better. Almost the first words out of his mouth during the earnings conference call were:

Overall, our plan is working and is showing clear signs of progress. Despite the improved results of the second quarter, however, we have a long way to go. The challenges ahead remain formidable, and we expect the second half to be difficult.

Give the man credit for telling it like it is. That’s been Mulally’s M.O. since he moved from Boeing to Ford, a move that made him the first industry outsider ever to head one of Detroit’s Big Three. At the beginning of this year, when asked what the most important things were that Ford could do in its turnaround, he said, “At the top of the list, I would put dealing with reality.”

For a few decades now, insulation from reality has been the bitter hallmark of Detroit. Once upon a time, General Motors and Ford reigned over the world’s automotive landscape — and America’s — in a way that’s hard to imagine today. But these two giants, plus Chrysler, got stuck in their ways about everything from supply chains to labor relations to fuel economy to pension plans. It took a long time, but the deep-seated insularity of the US automotive industry has at last helped to bring out the state of affairs that prevails today, when Toyota beats GM in total sales and has even edged out Ford for the #2 spot in the US market. This came to be because for too long such a world turned upside-down was unthinkable — literally unthinkable — for the insiders who ran the Big Three. What you do not imagine you will not prepare for; this is the reason that Andy Grove, the legendary former CEO of Intel, said that “only the paranoid survive” in business.

But change is afoot for Detroit’s auto makers, and this time it may be a lasting change. If so, it will be a departure from US automotive history in the past 35 years. The US auto industry responded verrrrry slowly to the Oil Embargo of the 1970s, beginning to lose market share to smaller, more fuel-efficient imports from Europe and Japan while making some of the largest cars ever produced. Changes did come over time, but usually in response to transient conditions in the market rather than changed realities underlying those conditions. A rough but fair generalization: When times got tough, the Big Three got better. When times got better, the Big Three got lax. Meanwhile, Toyota, Honda, and other upstarts got better year after year, moving upmarket while selling ever more cars across the US.

Why should the Big Three’s patterns of behavior change now? A few reasons: First, the ascendance of Asian car makers — Toyota above all — is undeniable and cannot be dismissed by anyone as a flash in the pan. Toyota has been too good for too long to think that they’ll go away anytime soon. Second, the landscape of the automotive business has changed, especially because oil prices have cut into the sales of SUVs — the Big Three’s cash cows of recent years. Oil prices are not likely to go down anytime soon, if ever. Third, losses of the magnitude suffered by Ford and GM in recent years are impossible to ignore or explain away. Fourth, two of the Big Three are under new management — already in the case of Mulally at Ford, soon enough at Chrysler once Cerberus finishes buying it from Daimler.

It seems clear that Mulally was brought in from outside the industry so that he could really shake up Ford, which had gone mostly nowhere under previous CEO Bill Ford. (The heir of Henry Ford shouldn’t get undue blame: he was just one more in a string of insiders who proved unable to provide the strong medicine needed at his namesake company.) The restructuring currently underway at the company — the one Mulally meant when he said “our plan is working” at the conference call — includes cutting Ford’s payroll by 45,000 and shuttering 16 plants. (The company has already sold off the Aston Martin marque, and plans to do the same with Land Rover, Jaguar, and possibly Volvo as well.) Mulally is well aware that these changes will leave Ford as a smaller player in the industry going forward, another one of those “unthinkable” things that probably needed to be embraced for the company to move toward steady profitability.

Chrysler could see something similar once it changes hands, based on the simple observation that buyout firms like Cerberus are used to breaking crockery when they take over companies. Who knows what portion of Cerberus’s plans to improve Chrysler focus on operational changes and what portion will rely on financial engineering, but wholesale restructuring along Ford’s lines would not be surprising. Whereas public shareholders often want incremental changes that do not impede quarterly earnings, buyout firms tend to be far more willing to sacrifice short-term gains if they see short-term, drastic change as necessary to reshape a company for long-term performance.

As for GM? We’ll see what happens, but so far I’m underwhelmed by their efforts.

The Big Three will hardly dry up and blow away anytime soon, but what happens over the next couple of years will have enormous implications in the future. From where I sit, the Detroit car makers don’t have the luxury of waiting until later if they want to regain their erstwhile high performance and reclaim the proud heritage of a US car industry that once reigned supreme.

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For more analysis of car makers and related companies, check out the Bizmology articles of Hoover’s veteran automotive industry analyst, James Bryant.