The issue of bailouts have raged on Capitol Hill for the last several months, with first the financial sector and then the automotive industry showing up cap in hand pleading the case for why they need to receive bridge loans, grants or other federal funds to keep from falling into the abyss.

The question I pose to you, gentle readers, is two-fold: First, do such federal expenditures (on the order of tens or hundreds of billions of dollars) make a difference in the ability of these companies to survive the recent economic storm, and second, what are the alternatives - in terms of business, technology or changes to our societal model - that may work better (or even work at all)?

For extra points, if your particular industry or company were facing serious financial distress, what should be the role of business and/or the government, if any?

For your consideration:

http://broadcast.oreilly.com/2008/12/fract...ing-needed.html
http://radar.oreilly.com/2008/12/catch-22-...to-succeed.html
http://radar.oreilly.com/2008/10/unitended...es-of-nati.html

I realized I raised this topic, but I wanted to add a few observations based upon the events over the last couple of days, and clarify my position.

One of the things I've found over the years is that when a software project is in trouble (usually for reasons of bad code, bad design, bad architecture or shifting requirements) one of the most common tendencies in business is to throw money at it. "If we increase the budget, then maybe this will solve the problems." This is a very businessman like way of dealing with serious, endemic issues, one that can be translated into "If I increase the budget for it, then I am essentially placing the responsibility for solving this on the people I hired to do it the first time, rather than that responsibility be on me."

There are times when budget increases are warranted - initial estimates were too low based upon unknowable factors, for instance, or a change in feature set requires a change in architecture, design or previous development. These things happen, and one of the marks of a good IT manager is to know when budget requirements have changed and to plan accordingly.

However, the wholesale injection of cash into a project because the project has fallen into trouble is irresponsible at best, and potentially fatal to one's company at worst. In this sort of mode, what invariably ends up happening is that the people who tended to be the biggest bottlenecks or the most profligate spenders look upon this injection as more money to continue what they've been doing already, especially if there is comparatively little oversight on the whole process.

This process is well underway in the financial sector, where days after insurance giant AIG became a ward of the state lavish parties were being given, and one brokerage firm (I don't remember which) had started paying out bonuses to top analysts that in sum would have otherwise bankrupted the company if they hadn't just received a bailout ... though this was fortunately caught just in time.

The Big Three companies (GM, Ford and Chrysler) of the automobile industry came cap in hand to Congress recently (although in many respects it was primarily GM that was really in trouble) talking about the dire change reactions that they would face if they didn't immediately get several tens of billion of dollars of funding as well - though the CEOs of each arriving in their corporate jets didn't help their cause much.

Last week's pilgrimage, this time with perhaps a modicum more humility, brought the same warnings, and GM announcing that they would go bankrupt if help didn't arrive yesterday. A deal seemed to be working its way through Congress, until a Republican initiative (apparently brought at the behest of the executives at GM in particular) also asked that any plan would require that the union employees take significant pay cuts and that GM could effectively walk away from their pension plan obligations. When the Democrats refused to consider this, the Republicans voted en masse against it and the bill failed.

A "bridge loan" seems to now be in the works from the $700 billion set aside for the banks earlier this year, so it is likely that the automotive industry will get at least some of the funds that they're requesting, but it also raises a number of significant questions about what exactly we're doing, and whether this really is a case of bad money chasing bad design.

One of the first is a concept that's been brought up here at O'Reilly a couple of times. Does too big to fail mean that failure is inevitable? The software industry is not unacquainted with the process of consolidation and agglomeration - where, rather than choosing to invest money into R&D, a large company goes and buys a startup that has already done the innovation work, expanding the large company's portfolio while at the same time removing competition from the industry. These software behemoths usually wield a huge amount of clout, but at the same time they are also weighed down by extensive legacy which limits their mobility and means that whenever a disruptive change happens in the marketplace, they are often not able to adapt quickly enough and become increasingly irrelevant.

This raises an interesting question - are companies like Microsoft too big to fail? After all, should Microsoft go into bankruptcy, it will plunge the warranties on millions (perhaps billions) of copies of Windows into doubt, it will cause the layoff of hundreds of thousands of people and will affect third party Microsoft vendors all up and down the chain. I think even people working at Microsoft would argue that this is silly - that while they personally would prefer not to see Microsoft put into that position, there are alternatives, if not necessarily ones that are completely functionally equivalent.

An editorial disclaimer here: Microsoft is not in any danger of going into bankruptcy. It is sitting in a strong cash position and will no doubt manage to weather the current economic storm just fine. The example is provided solely to illustrate a point.

One of the most important things to understand about deflationary periods (such as the one that we're in now) is that they are a lot like the inflationary boom in reverse. Companies shrink, or go out of business altogether. Conglomerates disaggregate, with corporations spinning off the less profitable businesses so that they concentrate on their core. The less profitable businesses, on the other hand, may find that with the weight of having to coordinate their activities with the rest of the conglomerate removed they are able to become more agile and responsive to market demands.

Supply chains represent another area where the forces of deflation tend to wreak havoc. In may cases, such a supply chain typically represents satellite or vassal companies that are dependent upon the parent conglomerate while not technically being a part of that conglomerate. When the parent fails, this means that those companies in the supply chain that have signed exclusive contracts are also in trouble, because they cannot generally retool fast enough to shift towards a different manufacturer, especially if that niche is already filled by a competitor.

One of the things that emerges when this happens is that groups of supply chain companies that are all facing the same crisis find that it is a good time to talk about establishing common industry standards for these parts (something that can, and should, be helped along by government). During inflationary times, competitive pressures to build custom interfaces are high, but deflation typically leads towards establishing common interfaces, one of the key aspects of componentization. This may reduce the overall number of supply chain companies in that niche, but as an economy slows down, the benefits of maintaining twelve distinct manufacturers of starters, each with a different design, diminish pretty quickly.

Additionally, a big innovation has proved so difficult for the Big Three is the fact that they have in fact become as locked into their supply chain supplies as the supply chain providers have become synched with their hub. Successful industry innovation will ultimately come ironically by reducing the number of near identical models, consolidating on standards and communicating with other companies to insure that such standardization can move forward in a systematic way.

This model, by the way, is hardly new - in Japan, METI (the Ministry of Economy, Trade and Industry, formerly MITI) has been responsible for providing this level of coordination for years, and Japanese automobiles have generally not suffered a bit despite the standardization brought about on many parts of a car's assembly. As with effective componentization in the software industry, componentization in the automobile industry does not mean black box components, but rather provides parts that can be adapted to fit various requirements and yet do so in a standardized manner.

On the other hand, the recent setback in the Senate point to a much more uncomfortable aspect of this Schumpeterian creative destruction - if a giant company like GM goes bankrupt, lots of workers will lose their jobs (or at a minimum their pensions), and/or lots of investors will lose their dividends or even their capital investments.

Labor is almost invariably the most expensive part of any production process. Ideally, from a management standpoint, you'd like a business that was completely automated - machines can work 24/7, don't require time for lunch or breaks, and essentially represent a fixed cost - you don't have to pay a machine more the more training and experience he or she has accrued. You can replace a machine without having to worry about unemployment insurance and so forth.

Unfortunately for the owners of most companies, even the best automated system still requires people to install and inspect the machines, to design the cars, establish tests, and then handle the administration of those people. You need people to sell the cars, to set up advertising campaigns and handle financing.

Moreover, there's the great paradox of capitalism. Someone has to buy those cars that you manufacture, and to do that, they have to have a steady, reliable paycheck. As the buying power of people decline (because wages are in decline or because companies attempt to get by with fewer and fewer people) then fewer people have money to purchase your cars, even on credit. In general, the better paid people are overall, the more likely you are to sell your cars, yet the general trend in management has been to reduce salaries.

This is where unions come into the equation, as well as what will likely be collectivist organizations that don't necessarily fall into the union model. Unions establish for their members a base salary and benefits package, establish rules for overtime work and provide protection to their members. Unions have generally been beaten back dramatically in the last thirty years by successive waves of "pro-business" legislation and business-sympathetic political leaders on both sides of the aisle.

There is a problem with unions, however. Unions are, by nature, protectivist organizations - they tend to protect the job position, rather than the individual, even when the position is no longer relevant. This can play hob with a company's ability to be agile, and in some cases, such as a number of Hollywood unions, simple tasks can become inordinately complex because the union has won the right that only a particular union member can do parts of that task, even if it is something as simple as moving equipment around or replacing light bulbs.

Overall, these are relatively rare phenomena, however, and typically occur as a way of making a point when an organization's management is generally trying to reduce the influence (and by extension, the labor cost) of the union.

Ultimately, though the question that is being addressed in the bailouts is whether the goal of bailouts is to better support the American worker (similarly issues are being faced in other countries) or to attempt to make automobiles, trucks and utility vehicles more competitive both at home and abroad. My argument is that the current approach in fact does neither, but nor does the idiocy of attempting to shaft workers in the name of protecting an existing industry.

I'd contend, in fact, that it is time for General Motors to be split up into separate automobile companies, for these companies to agree upon the aforementioned discussions on componentization, and that these companies individually be allowed to succeed or fail. Some will and should - one of the dangers of conglomerates is that it makes for non-competitive products to remain around for years because they are subsidized by other divisions. During said breakup, the pension plans would be broken down into more manageable pieces, and possibly even broken off into its own company in much the same way that GMAC finance exists as a quasi-distinct entity today. (I'll leave health care for its own discussion later).

The result of this would be a constellation of much smaller corporations, some emerging as design firms, others becoming supply chain providers, still others providing accounting, human resources, or pension management. Government's role in that case would be four-fold:

First, provide the funds to help in the disaggregation of GM - while no doubt the senior executive management of GM would likely balk (no one likes having power taken away from them) the reality is that if GM is too large to fail, then it's too large, period. In the end, the stockholders benefit (divestments of companies typically create a number of smaller companies that, in the aggregate, have higher values over time), the unions benefit (it increases the total number of jobs and opens up opportunities that wouldn't have existed elsewhere), consumers benefit (the smaller companies, no longer tied into a larger corporate strategy, are considerably freer to experiment with new designs and technologies), and the government benefits by increasing competition in the marketplace by making it easier for those companies that aren't competitive to fail gracefully without bringing down the entire economy, and possibly by gaining a stake in shaping these new technologies.

Second, work to formally transform standards in automobile design, production and environmental integrity so that they can work across the industry, rather than just one coalition. Overstandardization can occasionally dampen innovation, but this usually comes at the end of period of consolidation, rather than the beginning (though by and large most companies will tend to argue that such standardization is bad for their respective industry at any time ... especially if they happen to be the market leader).

Third, establish goals that would provide a general guidance into the needs that the government (and the country) is seeking to accomplish. Turning GM into a number of mini-GMs really serves no purpose if each of these simply continues to perpetuate the mistakes that were made under the larger organization. In order for business and government to work together, government has to be the one establishing the mandates and direction. If a business chooses not to follow that direction, that is the decision of the management team and board of directors, but clear and demonstrable goals that will in turn become a sizeable market if the companies in question are able to achieve these respectivegoals.

Finally, demand accountability - a business incorporation license is not a license to commit fraud. Place financial barriers on CEOs and Boards of Directors that reduce their ability to attempt market manipulation of a company's stocks rather than substantive innovation. Make C-level and board member salaries contingent upon performance, and determined not by the Boards of Directors but by the shareholders themselves. Go to regular (quarterly at a minimum) electronic submissions of a company's books in XBRL or related formats in order to force some transparency into the respective industries.

Note that while this discussion has been centered upon the automotive industry, as a model it is as applicable to other domains as well, especially those that have become so centralized around one to three primary players that innovation (and hence adaptability to market conditions) has been reduced to near nothing. This ultimately gets back to competitiveness - make your company more agile and responsive to the market, establish clear but ambitious goals that don't necessarily translate into profitability this quarter but that can make such companies competitive longer term, add disincentives in the equity markets that will keep companies from growing into oligarchic behemoths that completely dominate the industry.

Government absolutely must play a role in dealing with companies that are too big to fail ... it must prevent them from reaching that point. Until that happens, real reform in business will be slow and problematic.

Kurt Cagle is an author, architect and analyst for O'Reilly media.

This post has been edited by kurtcagle: Dec 14 2008, 09:42 PM

You truly have raised a very, very complex topic!

In short:

1. No, not really. More money solves nothing.
2. Free-market - meaning no government intervention (hindrance or help). Something that has not been practiced for 100 years.
3. Government has NO role in business. Government operates in coercive manner - it charges taxes form us and decides for us what is (supposedly) best for us. It faces NO profit or loss - the mechanism of business. Profit & Loss market system is the best way to insure that consumers get what they really want and need and that resources are used for their most desirable outcome (for consumers). Without Profit/Loss no one can make informed decision. That is why socialism is an impossible market system and the solutions of government are worse that the problems they tried to solve.


http://despair.com/government.html


The long answer:

1. Why we don’t need more money.
Throwing more money at problems creates more problems than solves

Misunderstanding, that has partly led to our current financial system. The idea that “business needs more money”. What it actually needs is more credit. Meaning - someone who would lend it money, that has been saved before. And charge interest rate. Obviously, the best projects get the most money for lower interest rate. The worse the project, the higher the interest rate or even no credit.

Problems started when businessmen with these bad projects, that would not get funded, started lobbying politicians that they need more money. Special interest groups.

More business sounds good in any times, doesn’t it? So well-meaning but economically-illiterate politicians said: “Let’s give them more money. After all - we can print it for free!”

More physical money means cheaper and easier to get credit - messing up the whole system. Each “new” dollar lowers the value of dollar, thus rising prices and eroding the value of savings.

But nobody needs “more money”! Think about it - why do we want money? Because we can buy what we really need and want with money. Same with business - they need money to buy resources, pay workers etc. But more resources, more workers, more buildings, more machinery can not be printed for free!

Printing more money dilutes its purchasing power (value) - inflation - which results in increasing prices.

Easy and cheap credit means that lousy projects get funded (dot.com anybody?). They in turn bid up prices of resources - for everyone, even the good companies.

When the music stops - raised interest rates, harder to get credit - they go out of business. For their business was failed before it even began. Enter Recession.

Think of it this way - when an athlete uses steroids, he can get incredible results fast. Even if he was below-average before. But steroids have their consequences. Stop using them and fall below the results you began with.

So yes, bailout is throwing good money after bad money.

2. Free-Market
Almost a Panacea

Free-market means that there is no intervention from government. No regulations, licensing, restricting etc, as well as no help, no subsidies, no special loans, no big contracts.

Free-market is the most effective market system. It’s real simple - if a business is good at predicting and satisfying consumer wishes, it makes a profit. If it fails at this, it suffers a loss. Thus consumers get what they most want, and resources are used to satisfy what consumers most want. Win/win.

About business getting “too big”.
The irony is that no business can get “too big” (or form a monopoly) without the help of government. It’s impossible! If others saw that industry X is a very lucrative one, they would enter it - creating competition. Only by government “regulation” can a business become “too big”.


3. An Elephant in dishes shop
The role of Government in Business

Profit/Loss system is what signals entrepreneur whether he/she is making good choices and satisfying consumer wishes properly. Without it there is no way to tell whether consumers really want what I have to offer. There is no way to sort out the good entrepreneurs from the bad ones.

Profit/Loss system is the basis of free-market. It keeps it together and operating. And it ensures that resources are used for the most sought after goal - what consumers value the most. Thus best businesses (meaning - the ones who are the best at satisfying consumer wishes consistently) get the most resources for the cheapest price.

Government has no Profit/Loss system. It gets its revenue by force - taxing its citizens. And spends it on projects that are called for most loudly - lobbying by interest groups. Even if they are “well-meaning” unions. In short - interests of few are satisfied at the expense of others.

So, if government can not suffer a loss and make a profit - how can it know which projects to fund? How can it know what consumers (citizens) really want? The answer is - it can’t. Government projects are always a wild shot. Ineffective.

What about bail-outs?
The reason they get so much attention is because they employ huge numer of people.

Have you noticed how government usually takes on huge projects, that involve enormous amount of labor? Creating jobs? But wait, isn’t human labor the most expensive part of any project?

Too often government projects are given the green light based on new jobs that it will “create”. Thus the least-effective projects are executed. Because “new jobs” is something that can be bragged about, something that the society and unions will love. It is what is directly seen.

What is not seen - raised taxes (our money), jobs not created in other industries (they didn’t get the money), raised prices for resources (your house cost more because of that) etc.


Standardization
Again, government has no role to play in this. People can find solutions that satisfy both sides - a win/win situation. The more power we give to government, the closer we get to totalitarian system.

Allowing (or asking) others to make decisions for us can no way be in our best interests. Only we have the full knowledge of our particular circumstances, our wishes, our beliefs, values, goals. Thus only we can make the best decisions for us.

This brings up a very good rule-of-thumb when it comes to economics and politics - if it is sound, wise and good for a single human being, it can be good for society. Because society is made up of people.

If I and my competitor can come up with a good standard for our industry, then good for everyone. If not - no one can force us to do so, in the name of “good for all”.


In Summary:
There is no one right answer, no rules. But one thing is for sure - if left to their own devices, people always figure out what to do, what is best for them. And nobody else can come up with a better solution for them.

In my opinion bailouts can be a good thing or bad. On the good side it can give a legitimate company a helping hand when times get bad, but on the bad side when the dime gets put on people that have no idea where the money is going it can hurt.

The right way but the companies which are applying for it should be more tested and closer observed after they got the money.

Bailouts are a double edged sword. Imagine if America lost their biggest companies, and what that would do to American business. On the other hand you are supporting failure in business and wasting tons of money. It's a case of choosing the lesser of two evils.

Bailot was necessary, if the financial system collapsed it is back to the barter system, and that is highly inefficient. Clearly though the system needs to be changed so that the incentives are more long term and better aligned so that this does not happen again to such a large scale.