14 May 2007

Cerebus to take Chrysler off Daimler's Hands

Today, a leading story is that Cerebus Capital Management has agreed to pay $7.4 billion for the Chrysler Group. With cash infusions by DaimlerChrysler of greater than $8.1 billion (€6.0 billion), this means the future-former DaimlerChrysler is coughing up a net $700 million. In 1998, Chrysler was a robust company in its fourth year of flourishing recovery. It held 23% of the North American market for cars and trucks and was regarded as a potential white knight for tottering Korean automakers.

Instead, that year, Daimler-Benz CEO Jürgen Schrempp added the number 3 US automaker to his reliquary of overseas acquisitions. Schrempp was well-connected and famous for his iconoclastic (for Germany) practice of high-flying aggressive M&A activity. He had already bought American LaFrance (PDF) and Fokker, sunk billions of marks into the latter, and skuppered it (1996). Schrempp had led the South African division of Daimler-Benz in the early 1980's before taking over DB's airspace division, DASA, in 1989. Here, he won a reputation as the architect of DASA's transformation from a gigantic European aerospace corporation into EADS.* In 1995 he took over the parent company, Daimler-Benz; the following year, DASA gave up on Fokker.

Schrempp had promoted the M&A with Chrysler as "a merger of equals"; after telling an interviewer for the German newspaper Handelsblatt that he had always intended for Chrysler to be a division of Daimler-Benz, investor Kirk Kerkorian sued Schrempp for misleading shareholders about his intentions.** But this was the least of his worries. Nine years later, in a period of soaring share prices for the largest industrial firms, the market value of DaimlerChrysler was about the same—$44 billion—as that of Daimler-Benz had been in 1998. In between, the German titan had sunk billions on transforming DASA into EADS, into a joint venture with Mitsubishi, and into transforming Chrysler from an automotive superpower into a smouldering mass of radioactive debris. Schrempp was ousted in 2005, three years ahead of his contract expiration. He had deleted $60 billion in share value.

(This essay would not be complete without a special mention of the SmartCars, which were featured so prominently in The DaVinci Code. According to the BusinessWeek article cited above, DaimlerChrysler has lost $2500 on each vehicle.)

A problem with the merger was obvious at once: while Chryslers are much cheaper and appeal to blue collar tastes, Mercedes vehicles have an extremely illustrious reputation (Finkelstein, p.5). Daimler is cosmopolitan and revered; Chrysler is provincial and notorious. Chrysler employees tended to be paid far more than their Daimler counterparts; moreover, it would appear that Mercedes managers and dealers found the relationship appalling. In particular, dealers in Europe drew the line at stocking the US models; they probably had an accurate understanding of their customers, too. But the Daimler models, while still priced at a 25% premium relative to their Opel, Volkswagen, Renault, & Fiat competitors, actually had lower customer satisfaction ratings. The American models were cheaper, but incompatible with European tastes.

Moreover, Daimler found it impossible to integrate the two styles of manufacturing. Partly this arose from ambivalence about taking charge. Schrempp evidently supposed he was getting "cowboy bravado," but instead, created a power vacuum. Bob Eaton, the CEO of Chrylser, was left largely alone while the team that was responsible for Chrysler's success fled. Eaton himself, a primary instigator of the merger, seemed to lose interest in managing Chrysler as the company began bleeding cash.

In March 2000, Eaton retired and was succeeded James P. Holden; Holden lasted a year, during which the market for North American vehicles imploded. GMC and Ford began a gruesome slide which has lasted continuously to this day.

In retrospect, it's not hard to see why. Here's a speech given by Bob Easton on 17 July 1997, explaining the need for the merger in the first place:
On July 17, 1997, Chrysler CEO Bob Eaton walked into the auditorium at company headquarters in Auburn Hills, Michigan, and gave the speech of his life. Instead of reveling in four years of rapid growth, he warned of trouble brewing on the horizon. His urgent oratory, adapted from the nonfiction bestseller The Perfect Storm, a tale of three fishermen caught at the confluence of three potent storms off the Canadian coast, warned that a triad of similar factors threatened to sink Chrysler in the coming decade. "I think," Eaton said, "there may be a perfect storm brewing around the industry today. I see a cold front, a nor'easter, and a hurricane converging on us all at once." The cold front was chronic overcapacity, the nor'easter was a retail revolution that empowered buyers, and the hurricane was a wave of environmental concerns that threatened the very existence of the internal combustion engine.
[Sydney Finkelstein-p.2]
While Easton's diagnosis of the problems facing Chrysler in '97 was not a bad one, it's hard to see evidence that his proposed treatment (viz., merger with a large European multinational) offered any promise.
  1. The problem of overcapacity is not a new one for the US auto industry; there is ample historical record of companies leaving the industry, or scaling back their exposure to it, in a deliberate way (e.g., Kaiser; Hudson; International Harvester [Navistar]).
  2. Likewise, Chrysler's concerns about "empowered consumers": it would seem that the real issue was improving quality so that the Chrysler could compete on its reputation for quality, not merge with an incompatible firm. I doubt there is any example in the history of business in which a company improved its reputation for product quality by merging with another firm, ever. Chrysler's problem going into the '00's was that its hottest lines were still plagued with defects.
  3. While it was fortunate that Eaton recognized environmental concerns posed a challenge to his company, the entire product culture at Chrysler was oriented towards "hot products" that were unrepentant gas guzzlers. Examples include the "Challenger," the "Firepower," the "Trailhawk," the "Viper," ME 412, 300C/Magnum, and so on. While I can appreciate the loveliness of something like the "Chronos," it's unfortunate that the "skunk works" of a major auto firm was so absorbed in adolescent fantasies.
Sure, when I was in the 8th grade I constantly sketched comparable machines from my imaginary autoworks. But designing V-10 coupes for the 2008 model year indicates a petulant relationship to reality. And it seems unlikely that Mercedes was the firm to instill a more philosophical one; its vehicles may be "refined," but they are first and foremost a maker of prestigious luxury goods, of the sort that have always been enjoyed by the elite even when the chips were down.
*EADS is the result of a merger of the largest aerospace firms in Continental Europe, including Daimler-Benz's DASA, Aérospatiale-Matra, Dessault, and CASA (of Spain). It also has a connection to virtually every surviving aerospace firm in the EU, and many in Japan, North America, and Latin America. It owns 100% of Airbus Industrie, Astrium, and Eurocopter.

As such, it is essentially the space exploration, civil, and military aviation company of Europe. The actual merger took place in 2000, five years after Schrempp took over as head of Daimler-Benz.

Despite their self-image as politically progressive and anti-capitalist, my experience has suggested that Western Europeans are far more likely to be boosters for European companies per se than is the case with Americans; the latter, being consumer-oriented, tend to have an ambivalent attitude towards US-based firms. The citizens of EU member states have an infinitely stronger emotional stake in the success of "their" corporations, even if the particular citizen is a soi-dissant Marxist or Green. When Schrempp cobbled together a pan-European behemoth like EADS, the entire population of Europe cheered. Schrempp was therefore somewhat analogous to, say, Jack Welch (the superduperstar CEO of General Electric).

** Kerkorian lost (NYT, April 2005). But Schrempp's remarks were, "The Merger of Equals statement was necessary in order to earn the support of Chrysler's workers and the American public, but it was never reality." (Finkelstein, p.6)
ADDITIONAL READING & SOURCES: "Daimler pays to dump Chrysler," CNNMoney, 14 May 2007; "Zetsche legacy at stake as DaimlerChrysler wilts," MarketWatch, 14 February 2007; "The Man Whose Job It Is to Put the Shimmer Back Into Mercedes-Benz's Star," Edmunds Inside Line interview with Dieter Zetsche, 21 November 2005; "The Nine Lives of Jurgen Schrempp," Fortune/CNNMoney, 10 January 2005; "Eaton, ex-directors back DaimlerChrysler deal; defend joining Daimler-Benz," Detroit News, 20 February 2003; "Chrysler's Rescue Team," BusinessWeek, 15 January 2001; "Rebate Debate Opens Zetsche's Reign At Chrysler," Ward's Dealer Business, January 2001; "Bracing for the Inevitable - James P. Holden of Chrysler Group ," Ward's Dealer Business, Dec 2000;

"Bob Eaton’s Reign of Terror: Life From Eaton to Zetsche" (anonymous ex-Chrysler employee, 2006); readers please be advised that I am not assuming the opinions expressed in the article are correct.

"The DaimlerChrysler Merger" (PDF), Prof. Sydney Finkelstein, Dartmouth College, 2002



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