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GM: The Road to Hell Is Paved with Good Incentives


Below-market financing doesn't fix problems - only postpones them.

In his op-ed column yesterday in the Wall Street Journal, Paul Ingrassia identified the 1998 auto workers' strike as the ultimate tipping point for General Motors (GM). While labor relations, or the lack thereof, clearly played a leading role, I'd offer that there was a much bigger factor that fueled GM's demise - and one which goes back as far as the early 1980s: incentive-rate financing.

Now admittedly, GMAC had played a supporting role to GM's manufacturing of automobiles long before the '80s. But as interest rates rose into the high teens during the late 1970s, GM, along with the rest of the Big 3 automakers, turned -- out of sheer necessity -- to incentive-rate (below market) financing to boost sales. Not surprisingly, given the program's success, financing incentives became a key arrow in GM's quiver against falling sales and the increased penetration of foreign car manufacturers in the United States.

During the early 1980s, rate incentives and extended terms became standard operating procedure for the auto industry. And if one goes back and looks at segment line financials for GM and the other auto makers, there's a visible migration of earnings out of manufacturing and into finance as the one hand subsidized the other.

In the mid-1980s, under the pressure of both rising car costs and lower market share, GM pulled out all stops in the incentive area, offering financing as low as 0.9% - effectively making it costless to car buyers to stretch out their payments.

Shortly thereafter, though, GM and the rest of the Big 3 realized they had a crisis looming in dealerships across the country. As car buyers were to come back to their dealer to trade in their existing financed car for a newer model, these customers would soon find themselves in the awkward position of being underwater, owing more on their existing car than it was worth. And as you might imagine, telling a ripe prospect that they can't have what they want, wasn't going to work.

And, at least to me, here's where incentives put the final nail in the car coffin. Rather than reassessing its basic business model, the US automobile industry went for the ultimate incentive: short-term leasing. And not just normal leasing, but 2- to 3-year leases with inflated residual value assumptions. As a result, cars went from being an investment to being disposable.

At that point, GM and others had completely mortgaged their future - taking on not just consumer credit risk, but doubling down with residual risk. Now GM worried not only about the profit & loss impact of new-car prices, but used-car prices as well.
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