Model Planes for Troubled Autos

The automakers have long shied from bankruptcy but could learn from the airlines' restructurings.
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Say the word "bankruptcy" in the auto industry, and people cringe. Say the same word in the airline industry and people just shrug.

Maybe that helps to explain why the U.S. auto industry is collapsing while the airline industry is experiencing one of its periodic golden ages.

In both cases, proud legacy companies have been challenged -- and often surpassed -- by lower-cost challengers. But while high labor costs, entrenched business methods and inefficient distribution channels continue to plague the legacy automakers, legacy airlines have -- at least for the moment -- put those problems at bay.

Each of the six remaining legacy carriers has benefited from bankruptcy.

United

(UAUA)

cut costs by $7 billion.

Delta

(DALRQ)

cut costs by $3 billion and remade itself into an international airline.

Continental

(CAL) - Get Report

, just rated the most admired airline by

Fortune

magazine, declared bankruptcy twice.

American

(AMR)

never filed. But it came within hours of doing so in 2003, forcing labor concessions. Facing off against its peers -- all of which are bankruptcy beneficiaries -- has made American one of the most strategic and innovative airlines.

By contrast,

Ford

(F) - Get Report

lost $12.8 billion in 2006.

General Motors

(GM) - Get Report

lost $3 billion in the first nine months of last year and is revising fourth-quarter results. Chrysler, a unit of

DaimlerChrysler

(DCX)

, lost $1.5 billion in 2006 and is up for sale.

A year ago, bankruptcy talk permeated the auto industry. In a February 2006 article about GM,

Fortune

described the automaker this way: "It is a car company doing poorly, and it is an insurance company engulfed by obligations way beyond its ability to pay. Such an enterprise probably cannot escape bankruptcy."

For the moment, such talk has subsided. GM may be fixing itself. In 2006, it eliminated a third of its workforce, reduced costs by $9 billion annually and raised capital by selling assets. Ford is in the early stages of a turnaround plan, shedding half of its hourly workers and borrowing $25 billion to fund restructuring. Chrysler is in the even earlier stages of a turnaround.

Still, the task of restructuring seems formidable enough that automakers ought not to dismiss an option that proved so valuable to a comparable industry.

Chapter 11 Censure

Why do the Big Three seem so unwilling to consider bankruptcy?

"It would kill sales," says Gerald C. Meyers, a former American Motors chairman and CEO and a University of Michigan business professor. "You don't warranty an airline seat, but you do warranty a car. You have to stand behind it and service it. People aren't going to buy a car if a company won't stand behind it.

"You have to believe me on that," Meyers adds. "I lived it. I know what it is like when the future of the company is in question and you're trying to sell cars." In the 1970s, troubled American looked at bankruptcy. "The dealers were having a terrible time, with just the smell of trouble," Meyers says. There was no filing; instead, Meyers sold controlling interest in American to Renault in 1980.

Industry fears are justified, says economist Steven Szakaly of the Center for Automotive Research in Ann Arbor, Mich. Consumers fear "the thought of purchasing a vehicle that costs thousands of dollars, as opposed to an airline ticket that might cost $1,000 at most, and then being without a support network," he says.

"It's hard enough to get people to understand domestic brands have the initial quality and that they have durability," he says. "The question of bankruptcy, of whether they will be there in the future, adds one more piece."

In the 1980s, airlines had similar fears about filing for bankruptcy protection.

"There certainly was apprehension," says George Brennan, senior vice president for marketing at Eastern Airlines when it sought bankruptcy protection in 1989. "And some people did book away, absolutely. The hard part was getting the frequent heavy business flier to remain committed.

But we had no problem driving business with price. We filled our planes with cheap fares. And eventually, passengers got used to it."

Emotions complicated Eastern's bankruptcy. Unions, which had representation on the creditors' committee, abhorred Frank Lorenzo, chairman of the parent company. Eastern trustee Martin Shugrue convinced the judge that the airline should keep operating when many creditors wanted it to shut down. The various conflicts periodically resulted in public pronouncements predicting liquidation. It was the L-word, rather than the B-word, that scared passengers, Brennan says.

Of course, Eastern failed after 22 months in bankruptcy, its shutdown triggered by high oil prices after Iraq invaded Kuwait. But today, Brennan says, operating in bankruptcy is barely an impediment. "Bankruptcy is like divorce, for crying out loud," he says. "Half of everybody out there does it now. It's like an outpatient procedure."

A New Perspective on Bankruptcy

Outside experts generally agree that automakers should at least consider bankruptcy. "It might be unthinkable to them now," says John Kasarda, a University of North Carolina business professor. "But the cost structure in the auto industry is still too high, and bankruptcy is an option for getting it down."

Hal Sirkin, senior vice president at the Boston Consulting Group, adds: "The U.S. consumer has come to grips with the fact that bankruptcy does not mean liquidation. Everybody that I know of, who has gone through bankruptcy, always agonizes over it, but for the most part they've done reasonably well."

The auto industry, however, is famous for not seeing what others see. "Detroit has been king of the hill for so long, they could ignore the

trends," Szakaly says. Declining market share is part of the landscape. Since 1965, GM's U.S. market share slipped to about 25% from 50%, while imports soared to 45% from 5% and Ford dipped to 17% from 26%, according to Edmonds.com. By contrast, in the airline industry, the Sept. 11, 2001, attacks meant "there was a shock, and then there was action," Sirkin says.

While Big Three market share has dropped, health care costs have soared. Rating firm Fitch recently found that, assuming inflation of 6.5% in the cost of health care this year, the cost for each U.S.-built vehicle will climb to $1,064 at Ford and $1,783 at GM. And increases will likely continue.

Another auto industry curse is an expensive dealership-based distribution system. Auto dealers, like travel agents, are middlemen. In general, they provide a car-buying experience that consumers disdain, while their costs are inflated by a perceived need to maintain high inventories, a practice most businesses have eliminated.

From the outside looking in, the problems seem fixable, says aviation consultant Robert Mann. In the '90s, airlines began to squeeze travel agents by reducing commissions. "People said it was blasphemous to get rid of agents," says Mann. "But look at all the things that have flowed from doing that, including electronic ticketing and airport kiosks."

Additionally, airlines cut health care costs through negotiations and bankruptcy. "In this industry,

health care plans are contributory, rather than free," Mann says. "And a lot of retiree health care got whacked in bankruptcy."

Of course, there are barriers. Auto dealers are protected by state laws, a result of the automakers' Depression-era effort to force cutbacks. Meyers says occasional efforts to buy out dealers have failed, because "owning some of them is worse than owning none of them."

Meanwhile, automakers are working with the United Auto Workers union to reduce labor and health care costs. Union involvement has meant most job cuts have been costly but humane: Many workers have collected sizable buyouts. "The legacy of the UAW is 'we protected workers,'" Szakaly says.

It remains to be seen whether the industry's problems can be fixed outside of bankruptcy. GM's progress has raised hopes. Today, Meyers says, the foreign companies that control half of the domestic auto market are "very efficient and very profitable." The domestic companies, which still have the other half, "are working like crazy to become efficient and profitable," he says.