Detroit – Monday brought the earth-shaking news that a Wall Street private equity firm has agreed to buy Chrysler, one of America’s public manufacturing icons. To understand this, consider the recent actions of two self-styled defenders of American manufacturing:
‐In the last year, while Chrysler hemorrhaged $1.5 billion and ceded its spot as the third-biggest seller of U.S. autos to Toyota, the United Auto Workers (UAW) refused to give any concession to the struggling automaker: not on wages that are 68-percent higher than the national manufacturing average; not on health-care costs; not on so-called “job banks” where laid-off workers still get paid.
‐As the owner of a 5.7-liter, 340 HP Chrysler “Hemi-C,” one of Chrysler’s most celebrated performance sedans, Democratic presidential candidate Barack Obama fits the profile of the typical American consumer. Yet in a speech last week demanding harsh fuel efficiency mandates on automakers, the Illinois senator claimed Detroit’s Big Three were failing because as demand “for fuel-efficient cars has skyrocketed,” they were “spending their time investing in bigger, faster cars.”
With friends like these, who needs enemies?
Arrogant unions and their Democratic allies were rewarded Monday when Daimler Chrysler’s board agreed to sell its American partner to liberal labor’s worst nightmare: a private equity firm outside the traditional auto culture with a ruthless attention to the bottom line.
The development has been a long time coming. Like the airline and steel industries before them, America’s automakers are facing a day of reckoning: either bring their labor costs in line with competitive standards or die. Because of its relative small size, Chrysler is particularly vulnerable: As big government — Obama government — demands ever more regulation to address environmental issues, the automobile industry will not be able to invest in technological solutions as long as its huge union contract commitments continue to eat profits.
Cerberus, an aggressive firm with a 22-percent record of return on investment, is “not a member of the Benevolent Society of Employers,” deadpans David Cole of the Center for Automotive Research, an industry research group.
Faced with declining market share and $19 billion in pension liabilities, Cerberus “is confident they can right-size Chrysler,” says Brad Rubin, an auto sector analyst with investment bank BNP Paribus. But that means they will be “expecting significant concessions from the UAW.” No wonder the union and Democratic allies like Michigan governor Jennifer Granholm had lobbied against Chrysler’s sale to a private equity group.
With crucial summer contract negotiations looming, Rubin says Cerberus will likely look for a switch to 401k retirement accounts, co-pays and deductibles on health care, and a reduction in hourly pay. While these concessions may sound familiar to most Americans, they have been anathema to a union that views high wages and full free health care as an entitlement. When added together, average UAW worker health and wage costs average $65 an hour — a staggering $30 higher than a comparable non-union worker at an American Toyota plant.
The result is that Big-Three vehicles carry $1500 more in labor costs than their Asian competitors. Not only does this mean that companies like Chrysler are forced to operate at razor-thin profit margins, it deters them from investing in small, fuel-efficient vehicles — assuming consumers like “Hemi-C” Obama even want them.
Because margins on small cars are $1500 at best, Chrysler has relied heavily on trucks, which typically average $7000 profit. Now, the new Democratic Congress wants to ratchet up fuel-efficiency standards to address climate change.
When Obama’s Senate Commerce Committee allies last week approved increasing fuel efficiency mandates by an unrealistic four percent a year, the credit ratings service Standard & Poor’s warned that such regulations “pose a real risk to global automakers’ financial performance, particularly as some [read: the Big Three] are already under pressure from razor-thin margins.”
“Chrysler is not well-suited for this new fuel efficiency marketplace,” says investment banker Rubin. “Even if they were able to shift, they would lose money unless, at the same time, they can get their fixed labor cots down.”
Enter Cerberus. It must get Democratic unions to accept draconian cuts if Chrysler can afford the costs and R&D necessary to weather a Democrat–regulated world.
If not, say analysts, Cerberus might make more earth-shaking news: It will take Chrysler, like airlines and steel companies before it, into bankruptcy court. There, a judge will either force concessions on obstinate unions or allow the company to shed its pension obligations altogether.
“This could get a lot worse before it gets better,” says Rubin.