Ford's student driver takes the wheel

(Fortune Magazine) -- Right after his company's staggering $5.8 billion third-quarter loss, new Ford Motor CEO Alan Mulally came to New York to present himself to automotive analysts and business journalists for the first time. I've seen plenty of embattled auto CEOs stick to their careful scripts, and for most of our 30-minute sitdown at a Midtown hotel Mulally stuck to his.

The boyish 61-year-old spoke softly and sincerely, and said most of the right things. But he showed little of the steel he's going to need to turn the carmaker around. Ford must streamline, cut costs and move faster, he said. How? His first big move is - hold on to your seat - a weekly business plan meeting.

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The high cost of high overhead at Ford THE HIGH COST OF HIGH OVERHEAD AT FORD 2005 Ford vs. GM 6.6 Million Worldwide vehicle production 8.3 million $57 billion Fixed costs $55 billion $15 thousand Variable cost per vehicle $12 thousand 60 percent Product-replacement rate (Forecast 2007-2010) 75 percent $8 billion R&D spending $6.7 billion 300 thousand Total employees worldwide 335 thousand Source: Deutsche Bank; Ford; GM; Harbour-Felax; Merrill Lynch

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Somewhere around minute 29, though, Mulally recounted a lecture he had delivered to his top lieutenants, a Vince Lombardi "What are we made of?" speech.

"It wasn't good enough just to say [we're going to cut costs and speed up product development], we also have to say we cannot keep going the way we're going. Continuing to do what we've been doing is not going to create a viable Ford. You might get through this downturn one more time, but it is not going to create a viable Ford where we can profitably grow, and that's the goal. And we got to the place where everyone there had a hand up, and we said, 'This is what we have to do.' "

Ford (Charts) is a mess. Unless things change bigtime, particularly in North America, it is going down the tubes. The question is, Which Alan Mulally is running the company: that mild-mannered guy with his new meeting or the impassioned and impatient coach? And can either save a profoundly dysfunctional company?

Ford has been through crises before. Something always came along to bail it out, and the company learned to wait for rescue - a hot car, a change in the economy - without fundamentally altering the way it operated. In the late '70s and early '80s, the second oil embargo sent Ford into a nosedive it didn't come out of until 1983, when it earned $1.8 billion.

Two years later Ford introduced the then-revolutionary Taurus. Bad times arrived again at the end of the 80s, and Ford was saved by another hot product, the Explorer. In the 90s, Ford rode the truck and SUV surge to record profits only to see sales fade in the face of stiffening competition, safety concerns and higher gasoline prices. Things are far worse at Ford this time, and its dismal third-quarter is only the most visible sign.

Consider:

• Ford is burning cash so quickly - $3.1 billion in the third quarter and a forecast $3 billion in the fourth quarter - that it may have to start borrowing against its plants and office buildings to raise cash for operations.
• Ford is experiencing a monumental brain drain. In the past 13 months seven executives at or above the senior VP level have left the company.
• Ford's R&D spending is very high relative to its size. It spends much more than far larger General Motors (Charts) but has fewer new models to show for it. It has the driest product pipeline for North America among its five major competitors.
• Ford is the least globally integrated large automaker in the world, which makes its enormous size a handicap, not an asset.
• Hated crosstown rival GM has now reported an operating profit for the past two quarters. It is at least a year ahead of Ford in restructuring and several years ahead in integrating its global operations.

Mulally knows all that, just as he knows he is alone - one ex-Boeing executive in a sea of 300,000 Ford Blue Ovals. He can't even hope to roll the dice on another Taurus or Explorer and see it through to launch - he'd probably be retired before it reaches market.

Goldman Sachs analyst Robert Barry writes, "Executing what will be a mammoth, multiyear restructuring in a company with a depleted talent pool, while also coping with severe volume, mix, and pricing pressures, large cash-burn rates and relentless competition, looks like a steep uphill battle to us, and so makes the plan's success far from certain, in our view."

Mulally (surely after discussions with chairman Bill Ford) is determined to go it alone. He has turned aside any talk of an alliance with Renault Nissan's Carlos Ghosn, saying restructuring Ford is "our highest priority."

One veteran auto executive says, referring to Mulally, "This industry is more complex than almost any other, with its extensive supply chain, enormous distribution networks and long decision times. It is a hard place for an outside CEO to come into."

In our meeting, Mulally, who had by then only had 12 days of on-the-job automotive experience, stressed that he had already identified Ford's basic problems - too much complexity, too little cooperation, not enough transparency - and was moving to fix them.

But in his brief tenure he's shied away from any dramatic actions: His big move to date has been that new meeting.

Within his first days at work, Mulally says he noticed that while meetings filled the week, there was no forum where everybody had to stand up and be counted. So he created the Business Plan Review (BPR), held with his 30 or so top executives every Thursday morning at eight, to go over every inch of the company's operations.

"We're holding ourselves accountable for what we do to contribute to the enterprise and also fostering much tighter teamwork." Mulally is counting on the BPR to help him weed out malcontents and underperformers.

The big-meeting concept is reminiscent of the regional strategy boards that GM put in place after its 1992 crisis, only to discover that meetings alone couldn't cut red tape or root out timeservers.

Ford has faced the same issues for at least 30 years: excess capacity, inefficient operations, a powerful and richly compensated union and robust foreign competition. Its recovery from each downturn has been weaker and weaker. U.S. market share has tumbled for 11 straight years.

Lots of the blame falls on Ford's culture. The executive ranks are characterized by careerism, vicious turf battles, and high turnover. A spirit of confrontation and can't do-ism infuses the company.

Finance and engineering teams have repeatedly clashed over a finance requirement that each new-car program cost less to engineer than the one it replaces.

"The finance staff has the company by the balls," complains one product manager. A plan to totally modernize the high-profit Lincoln Town Car was shelved because, among other things, engineers couldn't come up with a cost-efficient way to redesign the doors.

That lack of cooperation extends to Ford's regional units. A joke around the company a few years ago had it that if the head of Ford Europe said it was snowing out, the head of North America would put on his bathing suit.

When it came time to update the compact Focus in 2003, North America decided to refresh the existing model while Europe went with an all-new version. The opposed solutions scuttled any potential for economies of scale.

Meanwhile, product planning throughout the company is erratic. Model runs get terminated prematurely. Nine of the 11 cars sold under the Ford brand ten years ago have been replaced or eliminated, including such well-known nameplates as Escort, Taurus and Thunder-bird.

It's as if Procter & Gamble had stopped producing Crest and Tide. The same is true at Lincoln-Mercury, where only the Grand Marquis and the Town Car carry over from the ten cars sold a decade ago. Contrast that with Toyota (Charts) and Honda (Charts), where models like Corolla, Camry, Civic and Accord are constantly redesigned, and develop a cadre of repeat buyers.

Making Ford's product lineup competitive again will be Mulally's toughest job - and the one he is least qualified for. Each new vehicle requires thousands of decisions, any one of which can be critical.

When Ford lagged competitors a decade ago in adding a fourth door to its Windstar minivan, for instance, sales stalled, and the model was eventually cancelled.

Ford executives like North American design boss Peter Horbury is one of several executives trying to bring Mulally along quickly. "There are terms like 'tumblehome' (the convex curvature on the side of the body) and 'A-pillar' (the roof support on the sides of the windshield) that we're familiar with and he isn't," says Horbury.

A longtime Ford insider says "He's going to make some howling mistakes, but that's part of learning the business." Expensive too.

Mulally says he is ready to make a contribution to product development now. "My career has been built on developing commercial airplanes," he points out. "The process is very similar: making the judgment call about the way the world is going to develop - gas prices, emission regulations, consumer trends - and having a point of view about that."

It'll be a while, however, before his input shows up on the lots. Ford's big effort - the redesign of its full-sized pickup trucks, which account for nearly 30 percent of its U.S. volume - won't hit the market until 2008, more than a year after GM and Toyota launch their redesigned trucks.

Mulally also has to figure out how to plug a huge hole in Ford's product lineup: small cars for North America, where Ford sells half its vehicles. Particularly with gasoline prices volatile, the small-car segment is too important in attracting entry level customers for any full-line manufacturer to ignore.

Yet small cars seldom yield profits because they are expensive to build and pricing is tight. Mulally says he is leaning toward a quick, low-cost solution: redesigning the aging Focus once again and scouring Ford's global product portfolio for a subcompact that can be sold in North America.

So far Mulally has offered few hints about how he plans to get a handle on Ford's luxury-car operation. At a time when sales of upscale cars are booming, Ford's Premier Automotive Group lost nearly $600 million in the third quarter, and Ford wrote down the assets of Jaguar and Land Rover by $1.6 billion. Both brands operate out of aging facilities in Britain, and Jaguar has been unprofitable for most of the 17 years Ford has owned it. Mulally says neither is for sale, but hasn't said how he'll fix them.

Even the good news at Ford is bad news these days. In mid-October, Ford's North America head, Mark Fields, introduced a new crossover called the Edge and gave it a splashy debut in San Francisco. Although it comes to market well behind competing Japanese entries like the Nissan (Charts) Murano, the Edge enters a fast-growing segment of vehicles that combine the best characteristics of passenger cars and SUVs.

Yet while the Edge will liven up dealer showrooms, it won't add much to the bottom line. At the beginning of production, profit margins will be a fraction of the roughly $8,000 a traditional truck-based SUV like the Explorer made early in its model run.

And unlike a decade or two ago, when Ford controlled a quarter of the U.S. market and could depend on selling 300,000 units or more of the Explorer, it expects to sell only about 130,000 units of the Edge and its sister car, the Lincoln MK-X per year.

Mulally knows the numbers: Ford measures its per-vehicle cost disadvantage with Toyota in thousands of dollars. "Our cost structure is driven by our complexity: models, production system, plants. We have to restructure so we can operate profitably at lower volume and change the model mix between trucks and cars. The second part is to accelerate our product plan so we can increase commonality. We start right away."

They'd better. Ford now expects its North American operations to lose another $1 billion in the fourth quarter and not to return to profitability until 2009. As Shelly Lombard, an analyst for bond analysts Gimme Credit, wrote, "This company is up the proverbial creek with a very small paddle."

Or to pick an even more relevant metaphor, Ford is in a tailspin. Whether the guy now sitting at the controls will be able to pull it out looks like a long shot.

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Ford's net loss widens to $5.8B