MotorWorld by Alex Taylor III Column archive

Hold the applause for GM

Today's earnings are encouraging - but the automaker can't cost-cut its way to long-term profitability, says Fortune's Alex Taylor.

By Alex Taylor III, Fortune senior editor

NEW YORK (Fortune) -- While there is some genuinely encouraging news in General Motors' announcement today of $891 million in second-quarter profits, a closer look at today's earnings announcement provides a glimpse of the challenges that GM is going to face in the future.

And it isn't encouraging.

'The market is so competitive, it is like a war,' GM's design boss Ed Welburn tells Fortune's Alex Taylor. Here's his battle plan for the next four years. (Read the column.)

The problem area, as ever, is North America, source of two-thirds of GM's sales. GM's continuing issue is an inability to convince shoppers to buy its cars, and that manifested itself again in the second quarter as North American automotive revenue sank by $1.276 billion

The big picture here is clearly visible: The overall industry is running at a slightly slower rate than a year ago and GM lost market share, down 1.3 percentage points in North America to 22.6 percent.

Some of that loss in market share is deliberate. GM (Charts, Fortune 500) is weaning itself from its dependence on rental fleets to absorb excess production. Selling rental cars is a low-margin operation that impacts the prices of cars that retail customers buy and GM is smart to back away. So far this year, its percentage of fleet sales has dropped to 26.7 percent from 28.1 percent.

But GM is also getting badly hurt in its sweet spot: full-size pickups like the Chevy Silverado and big sport utility vehicles like the Cadillac Escalade. These vehicles enjoy that magic combination of high volume and high profit. But buyers continue to move away from big sport utilities because of high gas prices and changing consumer fashion. And the big pickups have been impacted by the sharp falloff in residential and commercial construction. Yesterday, GM began offering zero percent financing for sixty months on the pickups, which were totally redesigned a year ago.

Unfortunately, GM can expect more of this in the future. At the same time that it is getting its operations shipshape and its costs in line, its core business is deteriorating and undermining its profit structure.

This may serve GM well as it begins to bargain with the United Auto Workers over a new contract. The union leadership and its members may be more willing to grant a weak GM the concessions it needs to regain competitiveness.

But the change suggests that GM is going to have to overhaul its product line more quickly than it expected and reach for something that it hasn't been able to achieve in three decades: a really profitable small car.

An advance peek at this changeover is provided by the current issue of Automotive News. Its unofficial analysis of GM's future product plans is all about smaller and smarter.

Cadillac gets a new rear wheel drive sedan. Chevrolet plans for a microcar in 2011. Hummer is downsizing, putting out a Jeep Wrangler-sized SUV for 2009.

Even GM's truck division is getting more car-like. The old-style GMC Envoy, built on a pickup truck chassis, is expected to be replaced by a car-based crossover utility vehicle.

At the same time GM is expanding its green lineup by rolling out more models powered by hybrids, diesels, and eventually, fuel cells.

All that costs money, and there is absolutely no evidence that consumers will pay up. Which is why watching the revenue line at GM has become such a preoccupation.

Chief financial officer Fritz Henderson tried to put the best spin on the shift during Tuesday's conference call with analysts and journalists. He noted that every time GM introduces a new model, it gets another chance to improve the profitability of that car line.

That's why, he added, the launch of the Chevy Malibu this fall is so important to GM. The compact sedan, which carries one of Chevy's most hallowed names, has been totally redesigned and is perhaps the handsomest high-volume car GM has produced in decades.

But if it falters in the marketplace and has to be sold with special incentives or funneled into rental fleets, destroying any possibility of profits, GM's future as an automaker in North America is cooked.

GM needs to learn how to sell profitable small cars and if it can't with the Malibu, the outlook is dark indeed. Top of page