Competing for Customers and Capital

The Ultimate Honda

I posted an ad on Facebook to sell my Honda. Right click on Facebook and select "Open link in new in window" to review my ad. Here are the highlights:

• 2005 Honda Civic Hatchback Si
• Five photos taken in June, 2017
• Viewed 65 times
• One expressed interest in buying
• Several asked "Why should I pay the cost of a new one for your old Honda?"
• Zero to 60 in 7.2 seconds
• Price $25,000 Or Best Offer
• Manual 5 speed shift on the dashboard
• i-VTEC DOHC
• Only 12,800 original miles
• Been garaged most of its life
• I'm the original owner
• Have all the original papers from Honda Finance: bought on 4.26.05, paid $19,272.

The following table compares 2006 with 2005 models on all dimensions. The three-door hatchback began in March 1984 as part of Honda's NCE (New Concept Engine) program. It was motivated by Ikuo Kajitani's vision of Variable Valve Timing for Power and Fuel Economy. He "had become convinced that Honda's next engine should offer a mechanism that could alter the timing of valves." To achieve this result "...the team adopted valve timing and lift settings that were comparable to Honda racing engines in order to enhance volumentric efficiency. The improved output resulting fom that technique actually served to improve performance at high speeds. Additionally, measures were taken to reduce intake resistance. At last, the goal was reached, with a full160 horsepower at 7,600 rpm and a redline a 8,000. The VTEC engine had finally revealed its complete performance profile" ... in the 2005 three-door hatchback. It was time to move on to the next phase.

Feature/Spec	2006	2005	Difference
Vehicle Type	Coupe	Three-door hatchback	New Body Style
Wheelbase (in.)	104.3	101.2	3.1
Length (in.)	174.8	165.7	9.1
Width (in.)	68.9	66.7	2.2
Height (in.)	53.5	56.7	-3.2
Engine	2.0-liter i-VTEC DOHC	2.0-liter i-VTEC DOHC	New components
Horsepower @ rpm	197 @ 7800	160 @ 6500	+37 hp (23%)
Torque (lb.-ft.) @ rpm	139 @ 6200	132 @ 5000 rpm	+ 7 lb.-ft. (5%)+1200 rpm
Redline (rpm)	8000	6800	1200
Transmission	6-speed manual	5-speed manual	+ 1 speed
Fuel Economy city/hwy	22/31	26/31	-4
Emissions	LEV-2	LEV-2	Same
Weight (lbs.)	2877	2782	95
Tire Size	P215/45 R17	P195/60 R16	Larger wheels and tires
Passenger Volume (cu. ft.)	83	84.7	-1.7
Leg Room (in.) Front/Rear	42.6 / 30.3	42.2/33.0	0.4
Hip Room (in.) Front/Rear	53.0 / 49.2	51.2 / 48.4	2.25

My 2005 Honda Civic Hatchback i-VTEC is The Ultimate Honda ... the only remaining original vehicle with low milage and a clear genetic record. That's why its worth $25,000 or best offer.

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Time for GM to Delcare Bankruptcy?

Many people believe, and even more hope, that General Motors (GM) has a chance. As William Holstein put it in a recent Business Week article the company was on the verge of emerging as a leaner, more innovative, and more competitive company by 2010—until the financial crisis hit and paralyzed the economy.

In my last post GM's Natural Share Level an analysis of the company’s break-even market share gave it a chance to survive in the short-term if it shrank from 24% to 13% of worldwide sales – nearly half its current size – and slashed its selling and administrative costs by $2 billion per quarter. Management’s February 17, 2009 report to the U.S. Treasury Department made it clear they had no intention of shrinking the business.

Actually, GM has been underwater for over two decades and no one paid serious attention until its stock price nearly broke a dollar on March 9, 2009. Why? It’s complicated, but begins with this simple fact: Over the long haul there are really only two numbers in a financial statement that don’t give accountants plenty of wiggle room. Market cap and sales revenues are those numbers. Then it gets complicated because investors, financial analysts, and professors have yet to make a meaningful connection between market cap and revenue. Oh sure, there’s the price/revenue ratio. To which no one pays much attention because it’s idiosyncratic to the company.

One way to make a meaningful comparison between market cap and sales revenues is with a risk-adjusted strategic score that simultaneously tracks the performance of a company against competitors in the markets for both customers and capital. In Competing for Customers and Capital I defined just such a score. In economic-speak it’s the “risk-adjusted value-revenue differential.” Statistically speaking it’s a “standard normal control variable with mean zero and standard deviation one.” In practical  terms, think of this metric as a “standardized performance score” [SPS].

The chart above shows how GM stacked up against TM over the last 8½ years on the SPS. In this chart the standardized performance score of a company is bounded by upper and lower control limits. These control limits define the normal range in performance between plus and minus two standard deviations from the mean. The mean of this score is exactly zero for an individual company. Over most of their live cycles, the lions share of companies in all industries operate within these limits and revert toward a mean SPS of zero.

Here’s the first takeaway from this article. If a company’s SPS is greater than +2 over a long period of time investors have rewarded management with a huge premium in its share of market value over and above its share of sales revenue. In short, when this happens, as it has for TM over 36 quarters, the company is in the business of continuous value creation.

Here’s the second takeaway. If a company’s SPS is less than -2 over a long period of time, this means that investors have punished management with a huge discount in its share of market value far below and beyond its share of sales revenue. In short, when this happens, as it has for GM over 36 quarters, the company is in the business of harvesting its base and destroying market value.

The number and size of companies included in this analysis matter very little – the SPS is insensitive to both the number and size of companies included. For example going all the way back to 1990 Toyota’s score ranged between +2.0 and +6.0, whether the analysis included a single small competitor or six of all sizes. TM scores were the same then as they have been in the last 8½ years. GM’s scores were in a range between -2.0 and -5.0 whether Chrysler and Nissan (NSANY) were included or not. And GM operated in the same range during that decade, as they have in the last 8½ years.

GM’s plight did not suddenly worsen in the past year. Investors have been telling GM management they were harvesting their base and destroying value ever since 1990.

What can GM learn from United Airlines?
When you’re running a high fixed cost business weighted down with union contracts, pension commitments and overwhelming health-care costs maybe it’s time to clean the slate by declaring bankruptcy. That’s what United Airlines (UAUA) did after delivering similar standardized performance scores year after year over the decade from 1994 through 2003. The following chart tells the story. If you want the details on how this analysis works, review my 19 minute audio slide show Y’all Buckle That Seat Belt.

Is there any other way out for GM at this point? What do you think?

Thank you for visiting. As always, your comments are welcome.

~V

GM's Natural Share Level

After weeks of debate in the press and the U.S. Congress, few concrete recommendations about how to insure the future of the big three U.S. auto makers have surfaced. Lost in the noise is the following insight about the General Motors Corporation (GM: NYSE) in a Bloomberg News interview of Jerry York:

As I look at the GM numbers, they’ve actually done 22.3% of the U.S. market year to date. But when you look at their level of fleet sales and the very heavy level of incentive spending to move product, their natural share level is down in the 15 to 17 % range.

One way to define a company’s “natural share level” is the point at which the last dollar earned just equals its cost. Based on this definition, Mr. York’s estimate is a bit on the high side. GM’s natural share level was 12.7% of the $160.3 billion combined worldwide revenues of GM, Ford Motor Co. (F: NYSE), Nissan Motor Co. Ltd. (NSANY: NASDAQ) and Toyota Motor Co. (TM: NYSE) at the close of the 2nd quarter 2008. There is another famous company -- whose name happens to rhyme with GM -- which was forced to lose market share in order to remain afloat.

IBM’s NATURAL SHARE LEVEL
You may remember Jerry York from his days as CFO of International Business Machines (IBM: NYSE) in 1993. He’s the guy who figured out that IBM had a $7 billion dollar problem. Fixing that problem required massive downsizing. For a brief account of these events see my March 13, 2007 post Make an Elephant Dance.

Over the years from 1993 through 2000 Lou Gerstner took IBM from the brink of failure to what I define as its natural share level. I trace the history of this extraordinary journey in my 14 minute audio slide show The Battle for Your Desktop. This chart tells the story.

The red schedule in this chart is IBM’s actual market share in a group with Compaq Computer Corporation, Dell Inc. (DELL: NASDQ) and Hewlett-Packard Company (HPQ: NYSE) from 1991 through 2000. The green schedule is IBM’s natural market share over the same period. In 1991 IBM’s actual share was 76.6% of $84.6 billion in group revenues. In that year the company’s natural share level was 58.2%. An over reach of 17.4 share points.

IBM’s actual sales revenues in 1991 were $64.8 billion. Its natural sales revenues were $49.2 billion. In other words, fifteen months before Gerstner and York took over, IBM had $15.6 billion in unprofitable revenues. IBM had billions in unprofitable revenues as a result overspending on everything required to sustain that 76.6% market share. John Akers, the previous CEO, planned to break the company into eight parts. Gerstner reversed that decision in favor of searching for IBM’s natural share level … and found it.

By the close of business in 1999, Gerstner and York had led IBM to the point where actual and natural market share were nearly equal: 43.7% vs. 43.2%. At that point the company’s actual and natural sales revenues were $87.5 vs. $86.5 billion respectively. In that year IBM’s actual and natural EBITDA were virtually the same -- $16.234 vs. $16.238 billion. The results were much the same in 2000.

What did investors think of this dramatic drop in market share? IBM’s market cap was $28.7 billion when Gerstner took control. By the end of 2000 its market cap was $148.1 billion. Here’s the punch line: when a company’s actual and natural market share are equal, investors’ reward management by bidding up the share price.

GM’s NATURAL SHARE LEVEL
In his Bloomberg interview, Jerry York gave an intuitive name to a metric in Competing for Customers and Capital: maximum earnings market share. That’s the unknown share of revenues at which earnings from the next share point equal the cost of acquiring it. The concept is simple, but the name “maximum earnings market share” was descriptive only  in the arcane language of microeconomics. This chart shows the natural share level for GM in June 2008: the share of revenues where marginal earnings equal marginal costs per share point.

 

The green horizontal line in this chart is GM’s marginal earnings per share point. The marginal earnings schedule is constant, because this static analysis assumes there is no change in the company’s underlying capital structure or cost of goods sold. The red line in this chart is GM’s marginal cost per share point. This schedule rises sharply in recognition of the fact that the marginal cost of a share point increases. It costs more at the margin to gain the 23rd share point than the one before it – even accounting for scale and scope efficiencies.

With the phrase “natural share level” Mr. York (unknowingly) gave intuitive meaning to the point where marginal earnings equal marginal cost per share point. Turns out that GM’s natural share is almost half its actual share of revenues.

GM’s income statement clearly documents the problem. The company’s cost of goods sold in June was $36.7 billion. Its sales revenues were $38.2 billion. So, on average it cost GM nearly $0.94 to produce $1.00 in sales. This is the legacy of those fleet sales and incentive spending that Jerry York mentioned in his Bloomberg interview. Discounted fleet sales and heavy incentives largely were responsible for driving down the average revenue per vehicle almost to its manufacturing cost. In addition, GM’s spending on advertising, selling and administrative staff added a layer of enterprise marketing costs that were a little over $2 billion more than required at their natural share level of 12.7%.

GM’S BREAKEVEN SHARE LEVEL
At this period in the company’s history its natural share level and breakeven share are equivalent. This is due to its inflated capital structure and bloated cost of goods sold. This chart documents the effect of reducing administrative costs to their breakeven level.

If management were to cut its selling, general and administrative expenses by $2 billion per quarter it would breakeven at 12.7% of group revenues. This would save enough cash to stay afloat. As Mr. York said in his Bloomberg interview “You just quit spending every possible way that you can. You comb through every account.”

This is just the first step. In order to achieve a sustainable long run position GM’s capital structure and manufacturing operations must be transformed. A discussion of such restructuring and transformation is beyond the natural scope of market share analysis.

CAN GM BE LIKE IBM?
Like IBM in 1991, GM in 2008 finds itself unable to sustain its market position. The question is: Who is willing to search for GM’s natural share level and take the actions necessary to achieve it?

Thanks for visiting. As always, your comments are welcome.

~V