Do The Big Three Have a Chance?

It’s been a tumultuous year for the U.S. auto business. General Motors (MTLQQ) and Chrysler both went bankrupt, and while Ford (F) didn’t, it still had to borrow billions to stay afloat. There’s no shortage of commentators out there who maintain that both GM and Chrysler will become semi-permanent wards of the state, while Ford will settle into a smaller version of itself.

But if the (former) Big Three are to succeed, then what do they have to do? Well, here’s a clear-eyed take on why GM went into bankruptcy, from Harvard Business School’s “Financial Intelligence” column:

To us the problem with GM is very simple. GM stopped making a profit. The reason any company exists is to make a profit. When companies stop making a profit they fail. We measure profit using the income statement. The income statement simply takes what you sold in a period and subtracts the costs in the business during the same period. If sales are greater than costs or expenses then there is profit. If sales are less than costs then there is a loss.

There you have it. So for GM, Chrysler, and Ford to revive themselves, they need to become profitable again. Forget about the “build cars that people really want angle,” so popular throughout the punditocracy. The two are presumably related—cars that people want can yield profits—but don’t have to. A very profitable vehicle can be a high-end, niche ride, as GM discovered with the Cadillac Escalade. Conversely, a small, fuel-efficient car that saves people money on gas and reduces greenhouse emissions can be meagerly profitable, if at all.

So are the Big Three ever going to make money again? It depends on two major factors. First, will the U.S. auto market climb back to something that resembles its historic size? That might not mean a market of 17 million, but how about 14 million? GM is now supposed to be optimized to be profitable in a market of 10 million, so perhaps all U.S. carmakers will be forced to adapt to leaner times. Second, what will happen with the competition? At the moment, signs are actually good for the Big Three. All are seeing their U.S. market share increase, while Toyota and Honda are seeing theirs trend down. (I could provide a link to this data, except that it has disappeared from the Wall Street Journal’s site.)

For GM in particular, this is an important trend. In 2008, it saw a market-share spike at the end of the year (currently, its market share is about 20 percent). If it experiences a similar spike at the end of this year—and that’s a big if, given the current downtrodden condition of the overall auto market—then it will need to convert that gain in share into profits. And to do that, it needs to gain share with the right vehicles. Profitable vehicles. And what kinds of vehicles might those be? If you said, “trucks and SUVs,” you’d win the prize.