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.

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*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)

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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

The Auto Industry and its shortcomings

As you can see, I've been wandering about Youtube exploring videos. Normally I post about telecommunications/information technology (TCIT), but this is mainly because of my job. I'm obligated to be an expert in computer technology, but in a way, that's not the most interesting field of analysis. Computer technology is actually fairly boring because it advances through greater capacity; genuine innovation is rare.




The technology, or here, the failure to apply technology that exists, is the subject of this video. It's from 1991, another dire year for the US auto industry. Ten years later, Taken for a Ride (Jack Doyle) was published, outlining in lurid detail the numerous ways in which the gigantic US automakers battled tooth and nail against any accountability to the public. It's understandable that this industry, so large and multifarious it could be likened to a medium-sized nation, would resist outside compulsion, but it's more disappointing how it has resisted any other form of pressure to introduce technology long familiar to its overseas competitors.

In the 1980's, Japanese automakers responded to the pressures of the rising yen by transferring much of their production to the USA. The Japanese automakers might possibly have been responding to exaggerated fears of a backlash in the USA,* but the fact is that the Japanese economy faced a superabundance of investment capital, a trade surplus with the US, and massive net reserves of US dollars that had to be unloaded in a way that inflicted minimum damage to their portfolio; the Japanese population was getting older fast, which meant a dearth of industrial workers, and a steady deterioration in the relative value of the US dollar.

Japanese firms operating in the USA were to perform far better than their US counterparts, responding creatively to the peculiar challenges of the US industrial milieu. The video above does a surprisingly poor job of making its case; it compares American autos in production with a Japanese concept car, which never entered production. This might be called "comparison overreach"; Japanese firms are indeed vastly superior to their US rivals in implementing meaningful technology, and this superiority is depressingly consistent. But to compare the gas mileage of luxury cars to that of a never-built concept car is patently unfair. And why exactly do Japanese automakers excel in implementing technology of this kind?

My view is that Japanese manufacturers face a very different production-optimization function from that faced by American firms. The production-optimization function is roughly analogous to the "indifference curve" found in microeconomics, except that here, the tradeoff is between producing for different objectives: quality versus quantity.** In the case of the auto industry, quantity may take the form of features and styling changes, while quality takes the form of superior design, technology, and craftsmanship. American automakers essentially are internally optimized for making a lot of car, rather like a Soviet industrial combine, while Japanese firms traditionally have been focused on penetrating a market by achieving adequate levels of quality. Both nations' firms enjoyed lengthy periods of protected home markets from which they made forays abroad, but in the case of the US auto industry, the main objective was to promote auto use and acquistion by a public with no prior experience with cars. After the abrupt conquest of the market by Ford and GM, there was a need to differentiate products by price, while using essentially the same industrial methods for the entire lineup. Hence, instead of Cadillac offering better engineering and craftsmanship than Buick (since both were divisions of GMC), Cadillac simply heaped on features.

Here's another post on this concept.
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* In early editions of Japan, Inc. (Shotaro Ishinomori, 1988), there is a conspiratorial theme in which American CEOs of tottering industrial giants gleefully exploit mobs of seething American autoworkers. In fact, there never was much of a backlash; Americans were largely exasperated at the management of major US firms, but had no widely-shared opinion as to how to fix this shortcoming. My basis for this contention is that 1988 and 1992 were both campaign seasons dominated by trade issues and unemployment concerns; in both, the candidates with strong anti-Japanese rhetoric (viz., Richard Gephardt—'88; Sen. Bob Kerrey & Sen. Tom Harkins—'92) were trounced early in the New Hampshire primaries.

** For an introduction to the indifference curve, here's a pretty good intro. While I tend to be fiercely critical of a lot of economic inferences , I think the concept of rational utility holds up surprisingly well. However, the indifference curve is used as a snapshot of a tradeoff that people make at a moment in time. The management of a firm has a similar tradeoff between rival mixes of output (say, between "quality" and "quantity") and between rival productive outlays (say, betwen "labor" and "capital"). Here's the same website as the one I linked for "indifference curve," this time explaining the closely-related idea of a production function.

A series of economists addressing the effects of personal choices (save versus consume) over an extended period of time developed something called the Ramsey-Cass-Koopmans model (PDF). This could likewise be applied to a firm making decisions over long periods of time. Even if the person making the choice is not especially far-sighted, the effects of the decision will lead to permanently changed long-term trends.