Some years ago, General Motors installed industrial robots worth billions of dol

Question

Some years ago, General Motors installed industrial robots worth billions of dollars in its automobile assembly plants, believing that the robots would increase efficiency and decrease assembly costs for its manufacturing processes, hence improving profitability. In fact, General Motors lost many billions of dollars more, despite the fact that it was able to make automobiles more quickly using the robots.

Discuss the reasons for this paradox. What costs did General Motors fail to consider?

What about depreciation? Couldn't they have offset many of the costs you mention with increased depreciation costs? In your opinion, did GM's cash flow position suffer because of the decision-making on the robots? Explain.

Explanation / Answer

GM is a very interesting case. Yes, it is certainly one of the great titans of U.S. industry and it's not any fun to see them go into bankruptcy.

There have been several opinions put forward at to why this all happened:

GM stopped making profit in 2005. Since that time GM lost more than $90 billion through the 1st quarter of 2009. As Joe says in his classes, "In finance we learn that losing money is bad." GM has been very, very bad for several years. The next question, then, is, "why did those losses happen?" From our perspective, even though all of the above may be good points, the key to GM's losses has to do with sales and fixed costs.

I (Joe) have owned a small business with partners for several years. We have learned that to survive in tough times (BTW the definition of tough times in business is a drop in sales) we had to cut costs. Cutting cost is the most painful thing you have to do as an owner because it usually means having to cut jobs.

The problem for GM was that when the sales slowed down, they had trouble cutting costs because most of their costs were fixed.In other words, a lot of their costs did not go down as their sales went down. In most manufacturing companies, when sales go down, some of the bigger costs go down as well (if you aren't selling as much of your product, then you cut back on manufacturing through layoffs, through reductions in material purchases, and so on). GM has tremendous fixed costs related to their union contract. Closing a plant, for example, did not necessarily mean the workers lost their jobs. Company pensions and legacy health care costs were fixed as well. So when sales went down, many costs stayed fairly constant. And that led to losses.

As the losses mounted and the economy struggled, these losses became so significant that GM could not survive as a viable business. In spite of billions of dollars of government support, the only solution for GM is to declare bankruptcy and try to lower those fixed costs through a court process.

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