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Bankruptcy is not a bad idea

Bankruptcy is not a bad idea
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First Published: Tue, May 05 2009. 09 05 PM IST

Image: StockXpert
Image: StockXpert
Updated: Tue, May 05 2009. 09 05 PM IST
Chrysler, the US’ third largest car manufacturer, recently filed for Chapter 11 bankruptcy protection in New York. Chrysler said it would close all its plants and that they would stay closed until the company came out of bankruptcy. Many suppliers have stopped shipping parts over fears that they would not be paid.
Even though the Barack Obama administration has said Chrysler could come out of “surgical” bankruptcy in 30-60 days, probably with Fiat as the majority owner, there appears to be a lot of apprehension among several stakeholders about the possibilities of completing such a large bankruptcy so quickly. Obama said, “It’s a partnership that will give Chrysler a chance not only to survive, but to thrive in a global auto industry.” The federal government agreed to give Chrysler up to $8 billion in additional aid and to back its warranties.
Image: StockXpert
Only time will tell whether Chrysler will re-emerge quickly as a reliable and competitive auto maker. Although filing for bankruptcy is not the end of a company, there have been companies that have gone out of business upon filing for bankruptcy.
Former General Motors chief executive officer Rick Wagoner’s legacy in the automotive industry bailout may be his very public (governmental, that is) ouster from a private corporation. Or his legacy might be his anti-bankruptcy stance for the sake of customers worried about investing in unprotected goods.
Bankruptcy is not an option for auto manufacturers, he argued, because people would not buy a car from a company that has filed for bankruptcy for fear of ending up with a lemon. Bankruptcy, he warned, would be the death of US auto makers.
However, our recent research shows that bankruptcy may not be as bad for the industry or the economy as generally thought. A 10-year snap-shot (2000-2009) of the top 200 companies that filed for bankruptcy (from www.bankruptcydata.com) demonstrates that to survive, these companies have been forced to restructure and have emerged with a renewed sense of competencies and culture to succeed in this century.
While the consumer’s concern about warranty protections isn’t to be taken lightly, the US automotive industry’s steady vehicle quality improvement in recent years has translated into fewer trips to the repair shop for consumers and warranties being viewed more as “insurance” against “unsought service”. Customers generally are happy if they don’t have to use their warranty (or insurance) and expect their product to perform as expected.
Automobile manufacturers are noticing big saving in warranty costs as well. Ford has reduced its worldwide warranty repair costs by $1.03 billion in the past two years. Ford’s quality appears to be in a virtual tie with Honda-Acura and Toyota-Lexus-Scion for the 2008 model year, according to the latest US global quality research system study.
The decline in warranty costs of major auto manufactures could be for a variety of reasons. First, the quality of the automobile has significantly improved and that improvement is perhaps the biggest factor in the significant savings for firms.
Second, there is an appreciable decrease in the reimbursement rate to dealers—a factor that has been one of the sour points between auto manufacturers and their dealerships. Third, auto manufacturers are better able to properly assign faulty components to vendors seeking reimbursement for warranty expense outlays. Finally, auto manufacturers are becoming stricter in approving warranty claims, resulting in an increase of claim denials.
Collectively then there seem to be fewer substantial reasons for the warranty issue to affect the bankruptcy decision. Indeed, with the US government providing warranty coverage in cases where the manufacturer no longer can, this would further reduce customer concern about buying a US automobile.
Our empirical study of Top 200 companies that filed for bankruptcy over the last 10 years specifically tracked their survivability. These companies were categorized into (1) consumer durables, (2) automotive related, and (3) others.
Of the 200 companies, 18 were categorized as consumer durables and 11 were automotive related companies. Of the 18 consumer durable companies, only four (22%) went out of business. Only one company (9%) of the 11 automotive related companies went out of business.
Companies that survived bankruptcy appeared to be more agile and better restructured. One example, Federal-Mogul Corp., an automotive parts manufacturer with a pre-bankruptcy petition asset base of $10.2 billion, filed for bankruptcy in October 2001. The firm reportedly implemented cost reductions and aggressive global restructuring during bankruptcy. In 2008, it reported sales of $6.9 billion, in line with its 2007 sales and despite an unprecedented decline in the automotive market.
Our research shows that most companies, including consumer durable companies, do survive bankruptcy filings. If restructuring is pursued vigorously, the firm will more likely emerge strong and agile. It’s also important to recognize that Chapter 11 bankruptcy isn’t a magic bullet that can cure all strategic mistakes. It cannot fix a broken business model, but it is one of the best alternatives available for cash-strapped companies.
Madhukar Angur is a professor of marketing at the University of Michigan, and Eric Arnum is the editor of Warranty Week. Comment at theirview@livemint.com
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First Published: Tue, May 05 2009. 09 05 PM IST
More Topics: Chrysler | Bankruptcy | Barack Obama | Fiat | Views |