What Goes Up

‘It's getting to a point now that the auto companies are being run by outside suppliers and all the people do on the inside is go to seminars.’

Success has many fathers, failure has none.” I don't know who said that, but they sure knew what they were talking about. You just have to look at the auto industry, if you don't believe me.

When times were good, like they were up until recently, the finance people were quick to take credit for record earnings and high stock prices. They pointed to high margins and return on capital as proof of the effectiveness of their fiscal programs. However, now that sales have turned down and the earnings forecasts have been drastically revised downward, the “chest beaters” are strangely quiet. “Failures have no fathers,” I guess.

You have to wonder how the earnings of these companies can be affected to the extent that they apparently have been when sales have not dropped that much. The answer is very apparent. Things went out of control during the good times.

Think about it: The auto industry has had record sales for several years. They didn't add any significant brick and mortar; therefore they were able to satisfy the added demand by working overtime. By working Saturday you increase your output by 20%. The offset is, of course, that you have to pay time-and-a-half. This is always cheaper than brick and mortar or hiring extra workers if permanent added capacity is not required. Also, overtime more fully utilizes your existing facilities.

If you had set your breakeven point based on a five-day operation, any added volume would be pure gravy. Any drop of volume up to 20% would be just a matter of dropping overtime accordingly. A drop of 5% or so of sales, as what has happened recently, should be just a matter of dropping some overtime, not a financial disaster.

So why does a company face a financial crisis when its sales drop a relatively small amount, like less than 10%? Companies became sloppy during the good times and relaxed their control on costs. Everyone focused on the record profits that were being accumulated and forgot about the increasing costs. Activities within the company that did not directly support production could add manpower with little justification. Increasing production volumes does not increase the workload of indirect labor — that's why it's called indirect labor. It doesn't require any more work for a buyer to order 120 pieces of something than it does to order 100 pieces.

Now, when sales start to drop, you try to pump them up with rebates, and maybe you put more money into advertising. You keep pumping out the production in hopes that sales will respond to the rebates and the added advertising. When that doesn't happen, the sale banks start ballooning. Suddenly everything is filled up and there isn't anywhere to go with the product, so the whole operation comes to a screeching halt.

How can managers let things go so far as to create this kind of crisis? That's a good question. It's not like the situation happens all of a sudden. The deterioration occurred over a relatively long period of time. I guess people like to believe if they just do this or that things will get better. However, there comes a time, after you have pulled all the levers, and the situation still continues to deteriorate, that you must face reality.

When a company's profitability gets so far out of whack, the existing top management is replaced. The new top management team invariably will take as many losses as possible in the quarter they took over and charge it to the previous management.

The next move, to show they are making hard decisions to get things back on track, is to announce across-the-board cuts, mostly involving manpower. Across-the-board cuts penalize the manager that runs a lean operation, and they lay the groundwork for budget abuses in preparation for the next downturn.

Supplementing these cuts are usually offers of early retirement. It's not unusual for these employees to accept these early retirement offers and then take their expertise and experience and do contract work for a supplier. The supplier now has an edge when bidding for work against inside sources because — for one thing — he doesn't have to pay these workers any benefits. There are some employees that have taken early retirement and then are hired back as individual contractors to do the same work as they did before.

It's getting to a point now that the auto companies are being run by outside suppliers and all the people do on the inside is go to seminars.

Stephan Sharf is a former executive vice president for manufacturing at Chrysler Corp.