Commentary: A Contract the Big Three Can Take to the Bank

Finally, a silver lining to the cloud hanging over Detroit. After three years of watching profits weaken and market shares slide at the Big Three, the United Auto Workers agreed to a new labor deal that should help Detroit compete against foreign rivals. The union signed tentative labor contracts with DaimlerChrysler (DCX ) and Ford (F ) on Sept. 14 and 15 -- and a similar deal with General Motors (GM ) should follow. All three deals will give the carmakers much-needed relief.

The deal won't solve all of Detroit's cost problems, but UAW President Ron Gettelfinger has agreed to close enough plants and cut enough jobs to allow domestic carmakers to pull close to -- or maybe even surpass -- rivals Toyota (TM ) Motor Corp. and Honda (HMC ) Motor Co. in productivity. That would mark a major milestone for the Big Three, because they've lagged behind the Japanese in efficiency for nearly a generation. So far, the union has agreed to let Ford and Chrysler close or sell 11 plants collectively. GM is expected to get a similar deal that would allow it to cut up to 18% of its workforce.

Overall, the new pact should eventually chop about $300 per vehicle off Detroit's costs, bringing its factory labor bill roughly in line with those of the Japanese transplants for the first time. That's great news, but not quite so great as it sounds. The Big Three must still wrestle with their colossal pension and medical costs, which run about $450 more per vehicle at Chrysler -- and a staggering $1,200 more at GM -- than at their Japanese rivals. Still, "they won't be able to blame the union anymore," says Sean McAlinden, chief economist at the Center for Automotive Research, located in Ann Arbor, Mich.

GM has the best shot at surpassing Japanese productivity. Its plants need just two hours of labor more to build a car than those of Toyota and Honda. While GM has improved its productivity by 23% during the past six years, Toyota's productivity, for instance, has remained relatively flat. The auto giant, however, isn't likely to reach the level of Nissan (NSANY ) single U.S. factory, which is more efficient than all the others because it was engineered to run with a lean workforce and makes models that are less complex than those made at many Big Three plants.

Despite the new leeway from the union, Detroit must still hustle to achieve all the possible productivity gains. To match Toyota, GM will have to shed 13,554 jobs, Ford needs to lose 17,400 workers, and Chrysler Group about 12,000. Since they all have excess capacity, over time those job cuts could pull the Big Three close to Honda and Toyota. The average age of Big Three workers is 46, and half will be eligible to retire in the next five years. The domestic auto makers will replace only a fraction of those workers.

Detroit's productivity won't actually improve unless it can at least keep sales near current levels. Domestic market share has fallen almost two percentage points, to 60%, this year. If share continues to slide, then Detroit won't be able to cash in on its workforce reductions.

And overly aggressive cost-cutting, of course, can hurt quality. In 2001, for example, a supplier to GM's new Cadillac plant in Lansing, Mich., sent preassembled body parts that didn't fit the cars properly. To fix the problem, GM had to bring the work back into its own plant. Says McAlinden: "GM found there are limits to how much they can [outsource]."

The auto makers will pay a price to shrink the workforce. In addition to their roughly $15 billion in annual health and pension outlays, the Big Three granted $3,000 bonuses this year and raises of 2% and 3% in the third and fourth years of the contract. Says Cole: "Legacy costs will continue to be a problem."

That's no doubt true. In this deal, the Big Three will still be handing out big benefits to retirees. But at least Detroit is making progress cutting its famously bloated labor costs.

By David Welch

    Before it's here, it's on the Bloomberg Terminal.