Journal of Economic Perspectives—Volume 28, Number 1—Winter 2014—Pages 49–72 Management Practices, Relational Contracts, and the Decline of General Motors Susan Helper and Rebecca Henderson eeneralneral MMotorsotors waswas onceonce regardedregarded asas thethe best-managedbest-managed andand mostmost successfulsuccessful fi rrmm iinn thethe world.world. However,However, betweenbetween 19801980 andand 20092009 GM’sGM’s USUS marketmarket G ssharehare ffellell fromfrom 4646 toto 20 percent,20 percent, andand inin 20092009 thethe fi rrmm wentwent bankrupt.bankrupt. ((Figure 1Figure 1 sshowshows thethe changingchanging marketmarket sharesshares ofof GMGM andand itsits mainmain competitorscompetitors overover ttime.)ime.) WWee argueargue thatthat thethe conventionalconventional explanationexplanation forfor thisthis decline—namelydecline—namely highhigh llegacyegacy llaborabor andand healthcarehealthcare costs—iscosts—is seriouslyseriously incomplete,incomplete, andand thatthat GM’sGM’s shareshare ccollapsedollapsed forfor manymany ofof thethe samesame reasonsreasons thatthat manymany highlyhighly successfulsuccessful AmericanAmerican fi rrmsms ooff thethe 11960s960s werewere forcedforced fromfrom thethe market,market, includingincluding a failurefailure toto understandunderstand thethe nnatureature ofof thethe competitioncompetition theythey facedfaced andand anan inabilityinability toto respondrespond effectivelyeffectively onceonce ttheyhey did.did. WeWe focusfocus particularlyparticularly onon thethe problemsproblems GMGM encounteredencountered inin developingdeveloping tthehe rrelationalelational contractscontracts essentialessential toto modernmodern designdesign andand manufacturing.manufacturing. WeWe discussdiscuss a nnumberumber ofof possiblepossible causescauses forfor thesethese diffidiffi cculties:ulties: pparticularly,articularly, GM’sGM’s historicalhistorical ppracticeractice ooff treatingtreating bothboth itsits supplierssuppliers andand itsits blueblue collarcollar workersworkers asas homogeneous,homogeneous, iinterchangeablenterchangeable entities;entities; itsits viewview thatthat expertiseexpertise couldcould bebe partitionedpartitioned withwith minimalminimal ooverlapverlap ofof knowledgeknowledge amongstamongst functionsfunctions oror levelslevels inin thethe organizationalorganizational hierarchy;hierarchy; aandnd iitsts faithfaith thatthat decisionsdecisions shouldshould bebe basedbased largelylargely onon well-defiwell-defi nneded fi nnancialancial ccriteria.riteria. WeWe suggestsuggest thatthat GM’sGM’s experienceexperience maymay havehave importantimportant implicationsimplications forfor ourour uunderstandingnderstanding ofof thethe rolerole ofof managementmanagement inin thethe modern,modern, knowledge-basedknowledge-based fi rrmm aandnd fforor tthehe ppotentialotential rrevivalevival ooff mmanufacturinganufacturing iinn tthehe UUnitednited SStates.tates. ■ Susan Helper is AT&T Professor of Economics, Case Western Reserve University, Cleveland, Ohio. She is currently serving as Chief Economist of the US Department of Commerce. Rebecca Henderson is the John and Natty McArthur University Professor, Harvard University, Cambridge, Massachusetts. Their emails are [email protected] and Rhenderson@hbs .edu. The views expressed are those of the authors alone. http://dx.doi.org/10.1257/jep.28.1.49 doi=10.1257/jep.28.1.49 50 Journal of Economic Perspectives Figure 1 Market Shares in the US Automotive Industry over Time 60% 50% 40% 30% 20% GM Ford Toyota 10% Honda 0% 1950 1960 1970 1980 1990 2000 2010 2020 Source: Wards Automotive, http://wardsauto.com/public-data. WWhathat lleded ttoo tthehe ddeclineecline ofof GeneralGeneral Motors?Motors? TThehe aanswernswer iiss wworthorth eexploring,xploring, nnotot oonlynly bbecauseecause GGeneraleneral MMotorsotors wwasas aarguablyrguably tthehe mmostost iimportantmportant fi rrmm ooff iitsts ttime,ime, bbutut aalsolso bbecauseecause ooverver tthehe ssameame pperioderiod ssoo mmanyany ootherther oonce-greatnce-great AAmericanmerican fi rrmsms aalsolso ssawaw ttheirheir ppositionsositions eeroderode ddramatically.ramatically. TThehe UUSS ssteel,teel, eelectronics,lectronics, aandnd aapparelpparel iindustriesndustries ccameame vveryery ccloselose ttoo ccollapse.ollapse. OOnlynly 113 percent3 percent ooff tthehe FFortuneortune 550000 iinn 11963963 wwereere sstilltill aamongstmongst tthehe 550000 a hhalf-centuryalf-century llater.ater. IIff wwee aarere ttoo ddevelopevelop aann uunderstandingnderstanding ooff hhowow UUSS mmanufacturinganufacturing mmightight bbee rrevived,evived, iitt iiss iimportantmportant ttoo understandunderstand wwhathat lleded ttoo iits decline.ts decline. IInn tthishis ppaper,aper, wwee iinvestigatenvestigate tthishis iissuessue tthroughhrough aann eexplorationxploration ooff tthehe ddeclineecline ooff GGeneraleneral MMotors.otors. WWee bbeginegin bbyy llayingaying ooutut a nnumberumber ooff aalternativelternative eexplanations.xplanations. WWee ssuggestuggest tthathat wwhilehile GGMM wwasas iindeedndeed hhandicappedandicapped bbyy hhighigh llegacyegacy ccosts,osts, iitsts ddeclineecline wwasas ddrivenriven llargelyargely bbyy tthehe ppooroor ddesignesign aandnd iinferiornferior qqualityuality ooff iitsts ccarsars aandnd tthehe llowow pproductivityroductivity ooff iitsts ooperations.perations. TThehe pprincipalrincipal ppuzzleuzzle ooff GGM’sM’s ffailureailure iiss wwhyhy tthehe fi rrmm waswas sseeminglyeemingly uunablenable ttoo aadoptdopt tthehe mmanagerialanagerial ppracticesractices tthathat eenablednabled iitsts JJapaneseapanese ccompetitors—ompetitors— pparticularlyarticularly TToyota—tooyota—to iintroducentroduce ccarsars ooff mmuchuch hhigherigher qqualityuality aandnd mmuchuch bbetteretter ddesignesign Susan Helper and Rebecca Henderson 51 aatt ssignifiignifi ccantlyantly llowerower ccost,ost, eevenven tthoughhough GGMM wwas,as, aatt lleasteast iinitially,nitially, mmuchuch rrichericher tthanhan iitsts rrivals.ivals. TThehe ppuzzleuzzle iiss ddeepenedeepened bbyy tthehe ffactact tthathat tthehe nnatureature ooff tthehe ppracticesractices uunderlyingnderlying JJapaneseapanese ssuccessuccess wwasas eextensivelyxtensively ddocumentedocumented iinn bbothoth tthehe sscholarlycholarly aandnd bbusinessusiness ppress,ress, aandnd GGMM hhadad fi rrsthandsthand eexperiencexperience wwithith tthesehese ppracticesractices tthroughhrough a jjointoint vventureenture wwithith TToyotaoyota aatt a pproductionroduction ffacilityacility iinn CCaliforniaalifornia sstartingtarting iinn tthehe mmiddleiddle ooff tthehe 11980s.980s.1 WWee iidentifydentify ttwo wo p principalrincipal aanswersnswers ttoo tthishis puzzle.puzzle. First,First, wwee argueargue thatthat thethe hhistoricalistorical ssuccessuccess ooff GGeneraleneral MMotorsotors lleded tthehe fi rm’srm’s seniorsenior managersmanagers toto denydeny and/orand/or mmisperceiveisperceive thethe nnatureature ooff tthehe tthreathreat presentedpresented bbyy JapaneseJapanese ccompetitionompetition forfor muchmuch ooff tthehe 11970s970s aandnd 1980s.1980s. TThehe ssecondecond answeranswer ffocusesocuses onon thethe ddiffiiffi cultiesculties thatthat GMGM eexperiencedxperienced iinn tthehe 1990s1990s ooncence tthehe fi rmrm hadhad mmadeade thethe decisiondecision toto adoptadopt Toyota’sToyota’s mmanagerialanagerial ppractices:ractices: wwee suggestsuggest tthathat iitt tooktook ttimeime forfor GGMM ttoo understandunderstand exactlyexactly wwhathat TToyotaoyota waswas ddoing;oing; aandnd thenthen problemsproblems iinn bbuildinguilding newnew relationalrelational contractscontracts ggreatlyreatly sslowedlowed GGM’sM’s eeffortsfforts ttoo rrespondespond eeffectively,ffectively, eithereither throughthrough innovationinnovation oror byby iimitatingmitating TToyota’soyota’s eefforts.fforts.2 WWee ccloselose wwithith a ddiscussioniscussion ooff thethe implicationsimplications ofof thisthis hhistoryistory fforor eeffortsfforts ttoo rreviveevive AAmericanmerican mmanufacturing.anufacturing. Parsing Alternative Explanations for the Decline of General Motors PPerhapserhaps tthehe mmostost ppopularopular eexplanationxplanation fforor tthehe ffailureailure ooff GGeneraleneral MMotorsotors iiss tthathat ddecadesecades ooff ooverlyverly ggenerousenerous uunionnion ccontractsontracts pputut iitt aatt aann ooverwhelmingverwhelming ccostost ddisadvan-isadvan- ttageage ((IngrassiaIngrassia 22010).010). GGMM ddidid hhaveave hhigherigher llaborabor ccostsosts tthanhan TToyota.oyota. FForor eexample,xample, tthehe AAssociatedssociated PPressress ((2007)2007) rreportedeported tthathat bbecauseecause ooff ““legacy”legacy” hhealthealth ccareare aandnd ppensionsensions oowedwed ttoo rretiredetired wworkers,orkers, llaborabor costscosts atat GeneralGeneral MMotorsotors werewere asas highhigh asas $73/hour$73/hour wwhilehile GGM’sM’s JJapaneseapanese ccompetitors’ompetitors’ ccostsosts wwereere rroughlyoughly $48/hour.$48/hour. AAnothernother ccalcula-alcula- ttionion ssuggestsuggests tthathat llegacyegacy ccostsosts aatt GGeneraleneral MMotorsotors werewere aaboutbout $$1,6001,600 pperer ccarar inin 20052005 ((WelchWelch aandnd BBeuckeeucke 22005).005). HHoweverowever ttherehere aarere sseveraleveral reasonsreasons forfor believingbelieving thatthat thisthis ccostost ddisadvantageisadvantage wwasas nnotot tthehe oonlynly iissuessue tthathat ccausedaused GGM’sM’s ddiffiiffi culties.culties. FFirst,irst, GGM’sM’s llegacyegacy ccostsosts wwereere hhighigh largelylargely because ooff GGM’sM’s ddecliningeclining mmarketarket sshare.hare.