March 22 (Bloomberg) -- The cars at the center of General Motors Co.’s February recall were still on the drawing board when a top engineer gathered more than a dozen managers and delivered a fateful message: Build them for less.
At the time, around 2000, GM’s profit margins were shrinking as worker- and retiree-benefit costs rose and its U.S. market share leadership was eroding. GM’s grand plan to make money on small cars, by developing them jointly with Fiat SpA, was crashing.
As it became clear that GM’s planned Chevrolet Cobalts and Saturn Ions wouldn’t get made on a money-saving global design, Gary Altman, the models’ chief engineer, told the group they needed to find other ways to reduce costs, including a suggestion to pull parts from existing models, said a person who was at the meeting in the automaker’s suburban Detroit technical center.
Those same Cobalts and Ions are among 1.6 million vehicles that GM recalled last month over an ignition-switch flaw the company says is behind 12 deaths. U.S. investigators and regulators want to know what went wrong, who knew about it and why the nation’s largest automaker took so long to mount a recall of models made a decade ago.
Altman’s message, while by no means a directive to build unsafe vehicles, reflected the environment at GM: The cars were the product of a culture of cutting costs and squeezing suppliers, as described by five people with knowledge of the automaker’s engineering, management and suppliers in the decade preceding its 2009 bankruptcy.
GM also began pressing its supplier and former parts division, Delphi Automotive Plc, to shave pennies off the price of every part to match what several of the people familiar with GM called the “China Cost” -- a rock-bottom price pegged to cheap Chinese labor. If suppliers couldn’t match it, these people said, GM would threaten to outsource production overseas.
“It was a chaotic situation inside General Motors back then,” said Maryann Keller, a veteran auto analyst who has written two books on the company. “It was a company suffering from falling margins and desperate to lower costs. So engineers and parts suppliers were under extreme pressure to do whatever they could to take costs out.”
In that environment, basic components could take low priority, such as the ignition switch that GM sourced for Ions, Cobalts and other models. The right to manufacture the switch had been won by Dublin, Ireland-based Eaton Corp., according to documents from a wrongful-death lawsuit filed against GM. Delphi bought Eaton’s switch division in 2001.
The switch would cost “as little as $2 to $5 to produce,” Delphi’s current chief executive officer told analysts at a dinner this month, according to a March 11 JPMorgan Chase & Co. report.
“We’re continuing to cooperate with GM on reaching an expedited solution,” Claudia Tapia, a Delphi spokeswoman, said in an e-mail. She declined to discuss Delphi’s relationship with GM during the development and production of the Ion and Cobalt.
Inside that simple part was a spring loose enough to allow the ignition to switch out of the “on” position when bumped, a risk that would grow if the key was weighted by a heavy ring, GM has said. The turned key would then shut off the engine and power steering and disable the air bags.
The fatal flaw in the ignition switch, which GM now says its engineers discovered in 2001 while developing the Ion, has spurred the automaker’s biggest crisis since its 2009 bankruptcy and bailout. After GM began the recall Feb. 13, its shares fell by as much as 4.1 percent, reaching a low of $34.09 on March 13. They have since recovered and closed down 0.7 percent to $35.01 yesterday in New York.
“This was such an insignificant, inexpensive part to begin with, you almost have to scratch your head and say, ‘Well, why didn’t they do something about it?” Keller said. “But you’re talking about a company that was under mounting pressure to stabilize its finances, which it was not able to do, and was absolutely counting pennies.”
GM declined to comment on any meetings involving Altman or make him available for comment.
“Today’s GM is fully focused on the present,” Greg Martin, a spokesman, said in an e-mail. “Our first, guiding principle is to put the customer at the heart of all that we do. As a result, GM has its strongest vehicle lineup in generations.”
GM’s new Chief Executive Officer Mary Barra, on the job just two months, on March 18 personally apologized for the “tragic events” that resulted from the faulty switches. GM has launched an internal investigation, and she will testify before a House committee on April 1.
A Fiat spokesman declined to comment.
The origins of the crisis engulfing GM go back 14 years. Back then, GM made most of its money selling big SUVs such as the Chevy Suburban and offering car loans and home mortgages through its GMAC lending arm, according to Keller. As the 1990s SUV boom faded, the company’s net income fell from $6 billion in 1999 to $601 million in 2001, according to data compiled by Bloomberg.
GM at the time produced small cars on the cheap to meet federal fuel-economy regulations. The company lost money on each one.
Building a compact car off a single global platform could have changed that. Stamping out millions of similar models would’ve created economies of scale to allow the automaker to turn a profit on a $12,000 car, the people said.
GM’s plan was to develop its Ion, Cobalt and Opel Astra cars from the same mechanical platform, code-named Delta, these people said. That called for GM’s European operations to take the lead in developing the car jointly with Fiat, in which GM had taken a 20 percent ownership stake in 2000. The thinking went that the Europeans, small-car specialists, could engineer a model with more amenities and a racier ride that would command higher prices than the no-frills Chevy Cavalier, which had been on the U.S. market for two decades.
The effort ran aground over acrimony between GM and Fiat, which slowed the car’s development and endangered the U.S. operation’s deadline. GM and Fiat would eventually part ways through a bitter split that required the American automaker to pay $2 billion to exit the marriage in 2005.
As the plan to build a profitable “world compact” fizzled, GM patched Cobalts and Ions together with some new parts parts other scavenged from other models. At the engineer meeting, Altman told attendees that GM’s U.S. compacts would share some parts with the Opel Astra, come up with some new ones and even take some from the aging Cavalier, said the person who was there.
GM also turned up the heat on its suppliers, especially Delphi, which had been spun off from the automaker in 1999 and still depended on GM for 90 percent of its business, according to a person familiar with the supplier.
GM had the worst supplier relations among major automakers from 2002 to 2005, according to an annual survey of more than 250 suppliers conducted by researcher Planning Perspectives Inc. of Birmingham, Michigan. In 2005, 85 percent of GM suppliers characterized their relationship with the automaker as “poor,” and 53 percent would “prefer not to do business” with the company or were “ambivalent” about it, according to the survey.
While automakers press suppliers to make sure that parts are developed and tested for safety, they must also struggle to make a profit, said Brian Bolton, who formerly worked as a design manager in Kirksville, Missouri, for Ortech, which was then a GM supplier.
“They operate close to break-even so they have to push suppliers,” said Bolton, who is now retired. “Suppliers and people in the industry would joke that GM makes design decisions based on three things: One was cost, two was cost and three was cost.”
GM also engaged in a practice it called forward leveraging -- which, according to the person with knowledge of the suppliers, Delphi officials referred to as “blood money.” It required suppliers to give GM an immediate price reduction on current business in order to bid on a new parts contract, this person said.
The price cuts, which ran into the millions of dollars, would continue throughout the bidding process. Those lucky enough to win a contract would then have to agree to annual price cuts of 3 percent to 5 percent off the new parts, this person said.
It wasn’t immediately clear how the pricing squeeze played out in the ignition switch made by Delphi’s Mechatronics division. The switches in the Ion and Cobalt were initially made at a Mechatronics factory in Foley, Alabama, which had an expensive union contract, said the person familiar with the supplier.
As the pricing pressures continued, Delphi sent moving trucks late one night in 2005 to pack up the Foley factory’s machinery and move it to Matamoros, Mexico, where workers were paid far less, this person said. Workers at the plant, just across the Rio Grande from Brownsville, Texas, made the equivalent of about $11 a day at the time, the person said.
By then, the ignition-switch fault was already known at GM and beyond, based on information the company provided in timelines submitted to the National Highway Traffic Safety Administration, the federal auto-safety regulators, on Feb. 24 and March 11.
Issues with the switch and its spring arose at GM as early as 2001, and engineers were aware of the issue in 2004, the automaker told NHTSA. By 2005, car reviewers, including in the New York Times, reported unexpected engine cutoffs linked to the ignition switches.
Engineers had identified the flaw and come up with solutions to fix it by late 2004, according to GM’s Feb. 24 timeline. Yet “after consideration of the lead time required, cost, and effectiveness of each of these solutions” GM closed the investigation without taking any action, the automaker said.
Engineers came up with another solution to the flaw in 2005 that “was initially approved, but later canceled,” GM said. A recall wasn’t discussed in those early years, it said.
GM will learn from its mistakes in the ignition-switch recall, Barra said March 18. She pledged to have “the most comprehensive and responsive process in the industry” for investigating safety defects.
The automaker would eventually solve its global car riddle, with the Chevrolet Cruze compact it began building worldwide in 2008. Sales of the Cruze, which has been well received by critics and car buyers, rose 4.4 percent in the U.S. last year, to 248,224 models, according to researcher Autodata Corp.
As for the Ion and Cobalt, a costly recall would have made the business case even worse, said Brian Johnson, a Chicago-based auto analyst with Barclays.
While the actual price of the ignition switch was low, a recall would have cost GM “hundreds of millions of dollars” when repair and communication expenses are factored in, added Keller.
“They had to be looking at everything in the company and saying, ‘This is a cost we don’t have to bear right now,’” Keller said. “These were cars that were not making money anyway.”
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