The Volkswagen Scandal: The Perils of Trying to be #1

Yesterday we learned that Volkswagen employed software specifically designed to circumvent emissions regulations.  When I heard the news, I began to think about several recent scandals in the automotive industry.   GM had the ignition switch scandal.  Toyota had the acceleration problems.  Now Volkswagen has acknowledged to tampering with technology to make it appear as though emissions were lower than they actually were.  What do all three firms have in common besides these unfortunate failures?   At one point or another over the past fifteen years, each firm has aspired to be the largest automotive company in the world.   Each company aimed to achieve the number one position in terms of market share.  I cannot help but think that such aspirations contributed to the problems that have surfaced.   Becoming number one in market share should never be the goal of a firm.  They should be striving to achieve solid returns for their shareholders, exceed the expectations of their customers, become a responsible corporate citizen, etc.   Market share should not be the ultimate goal.   What's the downside of trying to be number one in market share?  It means that you may grow faster than you are capable of growing.  You may create an organization that is too large and complex to manage effectively.   You may overlook issues and problems in an effort to grow.  I'm not saying that aspiring to have leading market share is the only cause of these scandals.  Of course, many other factors contributed to this behavior.  However, I do think these scandals illustrate how trying to be the biggest can have pernicious unintended consequences. 

A Truly Effective Open Door Policy

How many times have you heard a manager or executive say, "I have an open door policy."   By saying that, the manager attempts to convey a willingness to hear input and feedback from subordinates, an openness to meet with employees to discuss the issues and challenges that they are facing.  While well-intentioned, I think most open door policies are highly flawed.  As I tell managers frequently, "If you are waiting for bad news, dissenting opinions, or information about important risks to come walking through that open door, good luck!  You are in for a rude awakening.  Bad news does not often walk through open doors."   

For a variety of reasons, people remain reluctant to share concerns, risks, and mistakes with those more senior in an organizational hierarchy.   What then should managers do?   A truly effective open door policy means that managers make the open door a two-way street.  They leave their office, walk through that door, and go out to where the work is being done.  They engage their employees, ask questions, and solicit dissenting views.  Great managers ask, "What hidden risks could damage our business?   What assumptions that we have made could be deeply flawed?   What problems are bubbling beneath the surface?"  

This point about open doors is especially relevant today, in the wake of the report on the GM ignition switch crisis.  One can assign blame to the engineers who did not report the problems to their managers, or worse, tried to hide the issue.  One can assign blame to the managers who did not act appropriately when they learned about the concern.   However, pointing fingers at these people does not address a deeper issue.  What about all the executives at the top who claim to not have known about this issue for the past decade?   Not knowing, in a way, is just as much of a problem, as knowing and not doing the right thing.  Why didn't they know?   Did they go out and seek out bad news, or were they waiting for it to talk through an open door? 

Mary Barra at GM

The Wall Street Journal reports this morning on new developments in the GM ignition switch scandal. According to the newspaper, 

For the first time within General Motors executives will be told of vehicle safety problems when they are first reported and are now expected to expand any potential recalls if they deem it necessary, Chief Executive Mary Barra said in an interview.  "The executive team can only expand, they can never make it smaller," Ms. Barra told The Wall Street Journal. "I am trying really hard to communicate that we have made great strides to reduce the bureaucracy within GM."

Barra's comments are certainly welcome, but a key point needs to be made here.  You can't simply order lower-level employees to report all safety issues to senior executives.    You have to create an environment and a culture where people feel comfortable bringing bad news to the boss.  Moreover, senior leaders need to recognize that some people will feel hesitant to share bad news.  Therefore, senior executives at GM need to become "problem finders" who actively seek the bad news.  They have to do more than just say that they have an open door.  They have to get out of their offices and dig for problems.  They have to become seekers, rather than just receivers of safety information. 

Effective Crisis Management

Given the unfolding mess at General Motors, you might want to take a look at this excellent video from Kellogg Professor Daniel Diermeier.   In this clip, he talks about building an organization's crisis management capabilities.


Video highlight: Diermeier on Crisis & Reputation Management

Exploring GM's Decline: Trust vs. Legal Contracts

US Dept. of Commerce Chief Economist Susan Helper and HBS Professor Rebecca Henderson have written a new working paper examining the decline of General Motors.  They review many of the traditional explanations for the firm's demise, and they try to dig deeper to understand why GM failed to change sooner and more effectively in response to external threats.  Helper and Henderson base their explanation on the concept of "relational contracting" as explained here:

Here we make the case that GM struggled for so long because Toyota’s practices were rooted in the widespread deployment of effective relational contracts agreements based on subjective measures of performance that could neither be fully specified beforehand or verified after the fact and that were thus enforced by the shadow of the future and that GM’s history, organizational structure and managerial practices made it very difficult to maintain these kinds of agreements either within the firm or between the firm and its suppliers.

To step back, the scholars first argue that it was very difficult for GM to understand precisely what were the secrets to Toyota's remarkable success.   Strategy scholars refer to this barrier to imitation as "causal ambiguity."  In other words, the precise drivers of competitive advantage are not well understood by those outside the firm.  In hindsight, of course, we can explain Toyota's success with relative ease. At the time, though, the details of how the Toyota Production System worked, and how it could be imitated, were very difficult to ascertain.   Observation of the system at work, perhaps by touring the factories at Toyota, would do you no good.  Much deeper research was required.  

Beyond that, the scholars argue that emulating Toyota, even after an understanding had developed, was very challenging.  Here they base their argument on the relational contracts concept.  They describe this problem both with regard to how GM related to its employees, as well as to its suppliers. Here's an excerpt from the working paper, focusing on the workers in GM's factories:

It was, for example, very difficult to specify under exactly what circumstances a worker should pull the andon cord, or what behaviors constituted being an effective team member. Shutting down the line for a popular model could cost $10,000 in lost profits per minute (Helper 2011), so management setting up this system needed to be confident that a worker deciding to pull the andon cord would have both the knowledge and the incentive to exercise sophisticated judgment. Conversely, workers would only pull the cord if were confident that an appropriate relational contract wasin place (Gibbons and Henderson 2013). Similarly MacDuffie’s(1997) detailed description of the practices underlying shop-floor problem solving in the industry suggests that successful process quality improvement depended on processes that allowed for the inclusion of multiple perspectives on any single problem, the use of problem categories that were “fuzzy,” and the development of a common language for discussing problems. It seems implausible that employees could be motivated to participate in these kinds of activities through the use of formal contracts that specified in advance every kind of quality problem and its appropriate response.

Why did GM have a hard time building relational contracts?  Helper and Henderson offer several reasons.   In my view, the most compelling explanation is that GM lacked the credibility to work in this very different manner with both the employee unions and the external suppliers.  The lack of trust precluded working in this manner.  Toyota management, on other hand, had developed a deep reservoir of trust from which it could work much more flexibly with workers and suppliers.  Put simply, there are two ways to make a relationship work: trust vs. traditional legal contracts.  GM relied on the latter, but emulating Toyota required the former.  It could not make the switch.

Customers Still Clamor for Trucks

When the auto industry bailouts occurred, we heard much talk about the need for the automakers to shift their focus toward smaller, more environmentally friendly vehicles.   We heard that a focus on trucks and SUVs was the reason for the collapse.  Well, where do things stand now in 2013?  Ford and GM just reported September sales.  Pick-up trucks accounted for 29% of their total vehicle sales in the past month (that does not include SUVs).   The chart below, from Bespoke Investment Group, shows Ford pick-up truck sales reaching pre-recession levels:



In the end, companies produce what consumers demand.   The evidence suggests that consumers in the US still like their trucks.   Will things change if gas prices spike once again?  Surely, they will.  How are Ford and GM positioned to respond to such a future shock?  It appears Ford is in a better position, even though it actually has the leading market share in pick-up trucks.  Ford has higher margins in the US, and thus, more room for error.  Moreover, it has several well-regarded passenger vehicles that offer strong gas mileage.  Time will tell, but the story here certainly reinforces the notion that, in the end, the customer is boss.  Companies deliver what customers want, and like it or not, many American consumers still want their trucks.  

Does GM Lose Car Sales Because of the Bailout?

Joseph White of the Wall Street Journal reports today that the Obama administration and General Motors have announced plans for the firm to buy 200 million of the Treasury’s GM shares at $27.50 a piece.   That move will begin the process of unwinding the government's stake in the firm.  White explains that the move to eliminate the "Government Motors" stigma from the company may be quite beneficial:


Once the last government share is sold, GM also can get to work unloading the pejorative “Government Motors” image that has weighed on the company in the U.S. market. It’s not clear how many potential GM customers have turned to Ford Motor Co. or other rivals out of distaste for the federal bailout. But they’re out there.

Call me skeptical, but I wonder how much removing the "Government Motors" label will really help GM sell more cars.  Are customers unhappy with the government bailout, particularly given that taxpayers will not come close to breaking even on their "investment" in the firm?   Sure, the bailout has many opponents.  Does that mean the company was losing significant sales as a result of the bailout?  I'm not so sure.  As White acknowledges, no one really knows how many customers have turned to rival car companies as a result of distaste for the bailout?  One could argue that the firm hasn't delivered the kind of attractive, high quality vehicles that it needs to produce in order to generate stronger revenue growth.   At the end of the day, the bailout may have improved the balance sheet and cost structure.  However, GM will only survive and thrive if it makes products that customers want.  I don't see a ton of evidence that the firm has become significantly better at doing that since the bailout.   

Will Saab survive?

News reports indicate that Saab may not survive much longer. Spkyer Cars bought the firm from General Motors when the American automaker went bankrupt. By the time of the sale, Saab already had been experiencing years of decline. In North America, Saab had a small following in the northeast, but little brand presence elsewhere in the country.

Why will it be difficult for Saab to survive independently? First and foremost, the firm simply does not have enough scale. By most accounts, the minimum efficient scale (MES) for an automotive assembly plant is about 200,000 cars. MES is the point at which a firm has fully exploited scale economies. If a company operates below MES, its costs will be higher than more efficient competitors. Saab sold just over 30,000 automobiles last year - far below MES. It simply cannot remain cost competitive at these volumes.

Of course, some automotive experts believe that firms must be much larger than MES to survive in the auto industry. They argue that the development costs for a new auto platform often exceed $1 billion, and thus, firms need to be substantially larger than the simple MES for an assembly plant in order to be cost competitive. Fiat CEO Marchionne has argued that auto firms must achieve scale of 6 million units to survive in the long term. I believe Marchionne may be overestimating the need for scale. The economics seem suggest that firms can be quite profitable at below 6 million units. For instance, Ford became very profitable the past two years, operating below 6 million units of production. Honda also has been a very profitable automaker despite not exceeding 6 million units.

In the past, we have seen the drive for consolidation, based on a scale economy logic similar to that espoused by Marchionne. How did that work out? Well, the results of auto mergers and acquisitions in the 1990s look pretty ugly (think Daimler-Chrysler, Ford-Volvo, Ford-Jaguar, etc.). Apparently, consolidation isn't all that it's cracked up to be. For more on the risks of global mega-mergers, I highly recommend a classic article written several years ago by Pankaj Ghemawat, "The Dubious Logic of Global Mega-mergers."