This Bad Old Habit Could Wreck GM

Huge sales increases powered by huge incentives. Is this the road to ruin (again)?

John Rosevear
John Rosevear
May 4, 2011 at 12:00AM

Followers of Ford (NYSE: F) were excited last month when the Blue Oval stole the monthly U.S. sales crown away from General Motors (NYSE: GM) for only the second time since the 1990s. But payback time for the General came in April: A whopping 49% increase in car and crossover sales of its cars helped push GM to an overall 27% increase in sales versus year-ago numbers, enough to drop the Blue Oval (up a solid 16%) back down into second place for the month.

Meanwhile, to the surprise of absolutely nobody, earthquake-ravaged Toyota (NYSE: TM) posted on Tuesday what will probably be the first of several months' worth of declines, with sales down 2.4%, while Honda (NYSE: HMC) managed a subdued 5.7% increase.

Clearly, the General led the pack in impressive style this month. But the real story isn't GM's strong sales numbers. It's how the company got them.

Is GM back to buying sales?
GM's gaudy April sales results come with an eyebrow-raising asterisk: GM's incentives spending once again led the pack, and not by a small margin. Edmunds estimated GM's April incentives spending at $3,016 per vehicle, down a bit from previous levels but well ahead of Ford, Toyota, and ... well, everybody else, even longtime big-spender Chrysler (now in a distant second place at $2,455).

Nearly all of the automakers have reduced incentives spending in recent months, most much more than GM, for a simple reason: For once, supply doesn't greatly exceed demand. Producing extra vehicles and foisting them on dealers in order to pad total production numbers is an old, old Detroit trick, one that led to ruinous structural problems. With supply constantly exceeding demand, the Detroit automakers had to rely on incentives -- those "cash back" and "zero percent financing" offers -- to move cars. That killed margins, which meant the automakers had to reduce their per-car costs, which in turn meant cheap-feeling interiors and peeling paint, and that meant new customers for Toyota and Honda.

That's far from the whole story of Detroit's decline, but it's an important part of it. Anyone who has talked with or listened to Ford CEO Alan Mulally knows that one of his regular refrains is his insistence on "matching production to demand." By regularly adjusting production volumes to keep inventories on the low side, Ford (and most other automakers) can get a higher price per car.

Edmunds estimates that Ford's per-vehicle incentives spending was down by 25% from year-ago levels in April, and Ford CFO Lewis Booth repeatedly emphasized the importance of "higher net pricing" when Ford reported its blowout first-quarter earnings. Yes, the biggest part of Ford's success is due to its fresh-across-the-board product line, but managing the production-versus-incentives game well has been a significant factor -- just as it has been for Toyota and Honda over the years.

Did GM not get this memo? Or is there something else going on?

Old habits dying hard?
Many GM investors (and I'm one of them) worry that the company will get complacent and fall back on the bad old Detroit way of doing things. Not so much the crushing debt and costly labor giveaways, but the habits of settling for good-but-not-great products, of not worrying too much about the numbers, of prioritizing market share over profits.

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I don't really think it's likely that GM's current management is going to go back to the worst of the company's old habits, but any hint of movement in that direction is -- has to be -- a cause for concern from investors.

In this case, I can see some legitimate reasons for a higher level of incentives spending. As I've said before, GM's product line is somewhat long in the tooth, and replacements for many key models are still a year or three away. GM's doing what it can to make incremental improvements to current models in the meantime (as I was writing this on Tuesday, GM announced that the seats in the Corvette -- a sore point, literally, for current Vette owners -- would be upgraded for 2012), and its most recent models are top-notch, but key parts of its lineup are still a step behind Ford and the best Japanese offerings.

GM's leaders may have determined that the bottom-line benefits of keeping sales high while waiting for new product justify the costs of incentives. I hope that's what they tell us when the company reports first-quarter earnings tomorrow. But as a GM investor, I still worry that not everyone at the General has learned the hard lessons of the company's near-death experience.

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