January 8 2008: 3:49 AM EST
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Gentlemen, start your turnaround

Rick Wagoner's overhaul of GM is producing cooler cars and a glimmer of hope. A rare inside look.

By Alex Taylor III, senior editor

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Wagoner at GM headquarters with the fast-selling new Chevrolet Malibu sedan.
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(Fortune Magazine) -- From his office on the 29th floor of General Motors' headquarters complex, chairman and CEO Rick Wagoner has a killer view. He can see for miles, across the Detroit River to Canada and south to the Ohio coastline of Lake Erie. This time of year, the sky is gray, the river is icing up, and the plainspoken Wagoner, 54, is giving an economic forecast that's as chilly as the heartland below. He expects yet another tough year in 2008 for the beleaguered automaker. "We have some fairly severe headwinds: the weaker economy, high commodity and steel prices, and energy prices," he told Fortune in a rare interview. "Frankly, more headwinds, especially from the first two, than I would have hoped. We're going to be in soupy water for a while."

The season always seems to be winter for GM. Yet for the first time in years, signs of warming are emerging. Wagoner is feeling good about the automaker's progress, especially in the troubled heart of its business: making and selling cars in North America. GM's latest new-car launches - Buick Enclave, Cadillac CTS, Chevrolet Malibu - are getting enthusiastic reviews and generating strong sales. Peter De Lorenzo, a much-followed Detroit online columnist and frequent GM critic, writes, "We are now experiencing a GM the likes of which hasn't been seen since the company's glorious heyday from the mid-1950s to the early 1970s." In naming the new Cadillac its 2008 Car of the Year, Motor Trend gushed in ways surprising even for an enthusiast magazine, advising car buffs to "start practicing using the words 'General Motors' and 'celebrated' in the same sentence." The usually circumspect Wagoner is even willing to allow himself a rare pat on the back about GM's latest models: "Here in the U.S., the change in the perception from two or three years ago is astounding."

The new products are giving GM (GM, Fortune 500) a much-needed image boost in the marketplace, while Wagoner has been making huge cuts in costs on the factory floor. By slashing both the hourly and salaried workforces, boosting productivity, and reducing health-care costs, he has cut $9 billion (or 22%) out of GM's fixed operating costs. And following years of patient negotiation, he reached a historic agreement with the United Auto Workers to push responsibility for retiree health care off GM's books, a burden that has been adding about $1,400 to the cost of every car and truck GM builds in North America. Once the health-care trust, called a voluntary employees' beneficiary association, or VEBA, is fully funded (GM's contribution: $29.5 billion), the company will have no more responsibility for it. Analysts expect the new union contract to produce as much as $4 billion in annual savings beginning in 2010.

Does all this add up to a long-overdue turnaround in GM's financial health? Well, just as GM started getting its house in order, the ground underneath it began to shake. Analysts expect that a slowing economy will reduce sales of cars and light trucks in the U.S., which gives GM very little room to improve revenues in the short term. At the same time, the home-mortgage crisis has battered what had been one of GM's most moneymaking assets, the 49% stake it owns in General Motors Acceptance Corp. (GMAC), which issues home loans in its Residential Capital unit (ResCap). And GM's realization that it would be unable to make use of $38.3 billion in deferred-tax assets it carried on its books caused the company in November to charge off the entire amount in a single stroke. There was no cash involved, but it sent investors a signal that GM would not be producing significant profits in the next couple of years. The stock got hammered. After trading as high as $43.20 in October, GM shares fell to $24.50 in November and stayed there through the end of the year. With a market cap now under $15 billion, GM is the lowest-valued stock among the Dow industrials. As a result, analysts are postponing their expectations of a comeback to 2010. One of them, Brian Johnson of Lehman Brothers, advises GM to "move aggressively during a downturn to further restructure hourly headcount and rout out any remaining white-collar bureaucracy."

The bureaucrat-in-chief, who has been CEO since 2000, hasn't been afraid to change the status quo. "A lot of success in this business," says Wagoner, "is having a big plan and implementing it better than the next guy." Three years ago Wagoner put his big plan into operation when he personally took charge of product development, manufacturing, and marketing and sales for North America. His decision to put his reputation - and perhaps his tenure as CEO - on the line finally put some steel behind GM's repeated promises to become more competitive. By setting a few clear and easily understood performance targets, Wagoner has led GM to within a neck of catching up in labor productivity and cost with its No. 1 competitor, Toyota. Around GM there is growing confidence, as it prepares to celebrate its centennial year in 2008, that the company is ready to shrug off any lingering whispers of bankruptcy and reclaim its title as an industry leader even if, as many expect, it loses its global sales crown to Toyota.

Fortune has periodically looked deeply into the question of GM's survival, and at times the prospect has been bleak. In our Feb. 6, 2006, issue we published a cover story with the headline, "The Tragedy of General Motors." It looked searchingly at GM's history of making poor cars, its abysmal financial performance, and its towering burden of health-care obligations, concluding, "Bankruptcy isn't going to occur next week. But down the road - way past 2006 - its probability is high."

Since then, Wagoner has systematically attacked GM's problem areas one by one. He sold 51% of GMAC for $7.4 billion to improve GM's cash position, which today stands at a relatively healthy $30 billion. And he convinced the UAW that GM's problems were real, which led to the agreement to reduce health-care costs for active and retired workers. While an actual bankruptcy didn't occur, the revolutionary deal with the UAW amounted to an out-of-court restructuring, effectively changing the rules of the game for GM. Two more issues, the bankruptcy of parts-supplier Delphi, which still has ties to GM, and complaints by the Securities and Exchange Commission over accounting problems, still dog the company.

Wagoner's biggest piece of unfinished business is to restart the growth of revenues from selling cars and trucks in the U.S. GM's market share in North America fell from 28.4% in 2000 to 23.7% in 2007, leaving in its wake bloated inventories, revenue-depleting rebates, and other sales incentives to move the stalled merchandise off the lots. But a host of indicators suggest that improvement, while slow, is underway. GM's retail market share stabilized in 2007, even after impressive efforts by the company to wean itself from incentives. Revenue per vehicle after incentives has been climbing steadily, from $18,800 in 2002 to $20,189 in 2006. (For the third quarter of 2007, vehicle revenue was up $1,410, or 7%, vs. the same quarter a year ago.) After a harrowing 2005--06, when GM piled up nearly $12.4 billion in losses, the company's global automaking operations rebounded in 2007, buoyed by strong results in Latin America and Asia. "If you look at generally the key functions of the business," says Wagoner, "I think we're running pretty well to very well in almost all of them." If the determined, patient Wagoner can succeed in rescuing GM's homeland operations and return the automaker to consistent profitability, it would be a feat of historic proportions.

Dude, where's my Cadillac?

GM's North American operations have been under more or less continual overhaul since 1984, when chairman Roger Smith (who died in December) reorganized the company's five divisions into two and started to centralize its enormous factory and engineering workforces. The resulting confusion accelerated GM's loss of market share. The company flirted with bankruptcy in 1992 and then reacted sluggishly as local rivals Ford (F, Fortune 500) and Chrysler capitalized on the SUV boom. All the while, first Toyota (TM) and Honda (HMC), and then Nissan (NSANY) and Hyundai, made steady market gains by building cars with more of the things customers wanted: reliability, economy, and style. In Wagoner's fifth year as CEO, he could see that GM was heading for a cliff. Looking at the results of a dismal first quarter 2005, in which North American operations piled up $1.3 billion in losses, Wagoner decided, as he put it, "to hop in there myself." Though he had more than enough to do as chairman and CEO, Wagoner saw a crucial moment to make major changes in the company's most entrenched, tradition-bound operations - those in the U.S. "As gas prices rocketed up, it was pretty clear we were going to be selling into a different world, and that was a world where profitability was going to be harder to come by," he said. "The other thing was, we had had a view for some time that we would be able to outrun the health-care cost. But between the pressures on the margins due to the mix shift [to smaller vehicles], and the unrelenting pressure in the annual inflation of health-care costs, it became clear we had to do something more fundamental."

In June 2005, Wagoner laid out his agenda for North America at GM's annual meeting. His four goals were so simple and direct - build great cars and trucks, revitalize sales and marketing, cut costs, and fix health care - that they made one wonder what GM had been doing for the preceding 97 years. His move practically escaped notice amid all the focus on GM's credit ratings (downgraded to junk). Wagoner was perceived as another unimaginative, risk-averse GM executive unwilling to rock the boat. Yet the onetime Duke basketball player (a hot new Corvette model was code-named Blue Devil in his honor) has a history of quietly exceeding expectations. While he may not be as inspirational as Lee Iacocca or Carlos Ghosn, he's methodical and stubborn, thinks strategically, and inspires loyalty among his subordinates. "Rick is a driver," says one of them. "He doesn't let up. He's not confrontational, but he keeps it all going."

Although things got worse before they got better - North American operations lost $8.2 billion in 2005 - Wagoner's simple, direct message began to resonate through the company. "With Rick's announcement, the focus became very crisp, the goals became very sharp, and the emphasis on execution became a necessity," says Troy Clarke, the engineer who succeeded Wagoner as head of North America in 2006. "If I ask anybody in the company, 'What are you doing with the turnaround strategy?' they feed it back to me - snap - just like that. There are four things we're working on. If you are not working on one of the four, you really need to go to your boss and get some help."

The most challenging piece of Wagoner's plan was to build cars and trucks that could stand up to a Toyota, Honda, or even a BMW. No auto company (as Ford and Chrysler are now learning) turns around in one year or even two, because new models must be designed and engineered four years before they reach market. But Wagoner benefited from a decision he'd made in 2001 to hire former Chrysler executive Bob Lutz to oversee product development. The silver-haired Lutz, who lately has been fending off rumors that he might retire in two years or so when he reaches the age of 78, gave GM's designers more power in new-model creation. "The automobile is a lust object," says Lutz. "Intellectualizing the car business is a big mistake. We've refocused on the important ingredients of style, like proportion and stance. Where we used to shoot to be competitive, we now shoot for best in class." The passionate Lutz and the buttoned-up Wagoner may be Detroit's odd couple, but Wagoner respects Lutz's design expertise, while Lutz praises his boss for never cutting back on new-model spending.

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