Saturday, October 18, 2008

When Will They Ever Learn?

Ben Graham said it best, "Wall Street people learn nothing and forget everything." These words come to mind reading the news that Business Week believes that the rewards from putting together GM and Chrysler are "huge." This raises a few fundamental questions.

The rewards for whom? I doubt that the current and future purchasers of automobiles will be rewarded by a flowing torrent of more innovative, efficient, environmentally friendly, durable and affordable motor vehicles. These products will most likely be produced by others. Will the huge rewards accrue to employees, communities in which redundant plants are located, retirees, or small suppliers? I don't even want to go there.

Indeed, huge rewards depend on the old evergreens, cost-cutting and synergies. McKinsey research indicates that 75% of all acquisitions fail to add value. Justification of these projects smack more of alchemy than economics. Good business models don't drive into the performance band through cost-cutting.

It's interesting to see what Japanese auto executives talk about versus the GM and Chrysler executives. Honda has recently released an improved, 2009 version of the successful Fit, which features improved driveability and performance, a nicer cabin, and more safety and a quieter ride on the highway. The Japanese executives who talk about the car can hardly restrain their enthusiasm, although it is tempered through their cultural lens. On the other hand, GM execs are locked in rooms talking with people who could care less about cars, talking about debt-equity ratios. There is something fundamental at work here. If you are not passionate about your business, no matter how prosaic, then it is more likely than not that the management will come up short when cyclical or other exogenous pressures mount. By the way, there are full page ads for the GM Volt, but don't worry, no one knows what it is , but the ad copy reads well.

What has been missing in this cycle has been the Schumpeterian force of creative destruction, whereby the companies which cannot effectively create value are allowed to fail. GM still has too many dealers after decades of identifying this as a weakness. Propping up failing banks through the largesse of the Treasury and Federal Reserve imposes massive costs on the currency and on the system, but will it be able to restore confidence by itself? Jim Grant's recent essay in the Wall Street Journal gives a great overview of the issues for the banking system and the economy for which it provides the circulation.

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