GM'S CRASH TEST.

General Motors hits the wall in the Andean region.

FIRST THEY GAVE AWAY A FREE CHILD SEAT WITH THE sale of every car. Then they threw in a free motorcycle with the purchase of a pickup truck. Purchasers of big-ticket sport utility vehicles won a free inflatable boat lashed to the roof, with outboard motor and life vests thrown in to boot.

Finally--desperate to sell cars--all 66 General Motors' dealers in Venezuela shut down without warning or explanation for two consecutive days earlier this year. Just when curiosity peaked, they threw open the doors again with a big advertising splash and rare cut-rate prices to lure customers. The ploy was a success, but the anxious tactics underscore the hard times facing the Andean region's largest car seller.

Just two years ago, GM was celebrating record sales and it seemed the company's Andean Community strategy, with plants in Colombia, Ecuador and Venezuela, was paying off. But profits have turned to losses in short order. After a 15% drop last year, GM'S year-on-year sales over the first half of 1999 are off again by 60% in Venezuela and 42% in Colombia, the company's main markets. The carmaker's biggest Andean plant--operated by General Motors Venezolana--is operating at just 28% of capacity after laying off the second shift. Meanwhile, the company's quarterly reports show the Latin American/Africa/Mideast group turned from a US$101 million profit over the first half of last year to a $63 million loss over the same period this year.

The existence of the five-nation economic bloc has done little to staunch the flow of red ink. Cross-border auto-sector trading netted more than $600 million in 1998, the region's most important component of international trade. But that activity has ground to a halt. "We've had virtually zero activity between [the Andean countries] in the last eight months," says the head of GM Venezolana, Michael Nylin. Individual pact members are facing upheaval: Venezuela slogs through an oil glut and political chaos; Ecuador faces bankruptcy; Colombia, a civil war and a recession; Peru, a stagnant economy and shrinking wages. According to the multilateral lending agency Andean Development Corporation, average gross domestic product in the five countries is expected to fall by 2.6% in 1999. Standard & Poor's expects the region to take five years to return to 1997 car-buying levels.

Contrarian investor. General Motors largely duplicates operations at its three factories and has not created a regional supply system that could operate more frugally in hard times than the current setup. Venezuela's entire industry, for example, is worth half the output of a single assembly plant in the United States. GM's Brazil plant has enough excess capacity to serve the entire Andean region. "If tariff protection was removed overnight," says Alfredo Behrens, head of Toyota Venezuela, our automotive industry would be wiped out completely."

Despite the tough times, General Motors plans to invest at least $100 million into Venezuela through 2003 and $25 million into its Colombian operations over two years. "In this industry, you are either in the market or you're not. You cannot invest one year and pull out the next," says Nylin. "When times are bad, you batten down the hatches. In the long-term we are very bullish on the country. We've made money in Venezuela before and we'll make money here again." This is not the case in all of Latin America. In Argentina, for example, GM has delayed an investment project of $1.1 billion because of the recession and a reduction in demand from Brazil, its major client for exports.

Current turmoil aside, GM'S patchwork of plants and sales offices throughout the Andean region reveal a customs union that has failed to live up to its promise.

That was not the way things were supposed to be. The Andean Community was first conceived 30 years ago at Cartagena de Indias, Colombia. The Accord of Cartagena envisioned the five signatory nations evolving into a common market. In recent years, conventional wisdom had the hemisphere's various free-trade areas--such as Nafta, Mercosur, Caricom, the Andean Community--forming the pieces that joined into the Free Trade Area of the Americas in 2005.

Frayed relations. Unlike Mercosur and Nafta, the Andean Community has not bloomed in the free-trade decade of the 1990s. As its name suggests, logistics among the trade partners are complicated by the Andes. Political mountains loom as well. A shooting war over an obscure border region broke out in 1995 between Ecuador and Peru. More recently, frontier disputes have resurfaced between Venezuela and Colombia. The two nations account for the bulk of Andean Community trade, yet Colombian guerrilla activity has frayed nerves on both sides of the border. Further, the Venezuelan government in July prohibited Colombian trucks from entering its territory, alleging unfair competition and insecurity on Colombian roads.

In September of this year, officials from the three auto-producing nations signed their latest accord, which will make production and sale of vehicles within the three countries easier. Tellingly, the other two members of the Andean Community, Bolivia and Peru, have yet to sign the agreement.

GM's Andean strategy will focus on assembling cars and light trucks in Venezuela, more cars in Ecuador and Colombia, and heavy truck and bus assembly in Colombia. "There is no mystery to it," says Jaime Ardila, president of GM's Colombia subsidiary. "Each plant basically produces what sells most in its respective country.

The cost and logistics of shipping among Andean countries remains the principal obstacle to a regional production strategy. At $400 per unit between Venezuela and Colombia, "transportation costs within the Andes are still too high to make shipping worth it," says Nylin.

Regional tariff breaks do not make up for mountain passes and poor roads. Tax breaks for importing from other Andean countries are "only marginal" says Marcelo Andrade, GM sales manager for Peru. Andrade calculates that he would only save 1.2% of Peru's standard 12% import duty on passenger cars--while production and shipping costs of GM vehicles from Japan, Mexico and Brazil are lower than Colombia and Venezuela can produce. Faced with steep competition from Korean car builder Daewoo, Andrade cannot afford to sell Andean-made cars.

Common woes. That's bad news for GM's Andean production managers. Last year, the Bogota plant exported approximately 4,000 vehicles to Ecuador and Venezuela. This year, the number has fallen to about 1,500. The strength of the recession across the region has meant cutting its Colombian workforce in half from 2,000 jobs last year. In Venezuela, the entire second shift--some 1,200 workers--was laid off last year.

This is not the first time GM faces such turmoil in the region. V.H. Coello, head of GM Venezolana between 1990 and 1994, sums up the rapid change and volatility of those years. "We lived through economic growth, import-substitution policy, devaluations, exchange and price controls, inflation, coup attempts, numerous automotive policies, and lately, opening of the markets," Coello says.

Fall-out from an escalating civil war is taking its toll on the Colombian economy. GDP is expected to fall by 2% in 1999. Ecuador, long enmeshed in political strife, is seeing its worst economic performance since the Great Depression of the 1930s. A devastating financial crisis has mushroomed and the government defaulted on its foreign debt obligations.

In Venezuela, uncertainty resulting from far-reaching constitutional and state reform under the government of President Hugo Chavez has frozen private investment and exacerbated an economic recession triggered by oil production cuts and a price fall in 1998. The economy is expected to end the year with one of the worst performances in history, an estimated negative GDP growth of around 7%.

Things could still get worse. Further currency devaluations in the region would increase car prices and further stagnate growth. Amid recession, soaring interest rates and an uncertain political climate, sales are expected to drop in 1999 to their lowest level in three years.

Clean sweep. The recession brought Draconian belt-tightening measures. "We are trying to be brutal on expenses--travel, telephone, copies. If it doesn't keep the line running or improve quality for the customer, it doesn't need to be done," says GM Venezolana's Nylin. At the same time, Nylin is using the lull in sales to "scrub the ship's decks." Although he would obviously prefer higher revenue, Nylin says such measures pay off in the long run and are hard to implement when a plant is operating at full capacity. "When the economy does come back, we'll be in a much stronger competitive position and have a more disciplined and trained work force," he says. While Nylin admits his returns are probably stuck in the red this year, he says the cost-cutting and efficiency measures will allow him to make at least a small profit next year even if sales do not recover considerably.

Going elsewhere. Across the border in Colombia, Nylin's counterpart Ardila is taking similar measures. "The idea is to take advantage of the recent devaluation," he says. Cars have more locally made parts. Local content is up from 70% to 90%. The devalued peso makes using homemade parts cheaper than imported ones. That, and the company's size, says Ardila, means GM will beat out vehicle-importing competitors. "We have a larger chain of distributors and salespeople throughout the country, and we are financially more robust than vehicle importers," he says. "That gives us an enormous advantage for seeing the bad times out and winning more market share." Unlike in Venezuela, GM is growing its share of the pie in Colombia.

In Ecuador, the company has just sold one of its two assembly plants. But investment continues in the bigger plants in Colombia and Venezuela. Colombian executives are earmarking $25 million over the next 2 years for retooling, adding new models to production and boosting wastewater treatment. GM will spend far more in Venezuela, starting with a new $42 million paint shop. Nylin says it has less to do with rosy sales forecasts than ensuring a quality paint job. "The old one is quite literally rusting away," says Nylin, and is causing additional costs and problems. The new paint shop will save on the bottom line and "enable us, from a quality standpoint, to be a very viable exporter not only to the Andean region but also elsewhere."

The Venezuela plant may start exporting outside of the Andean Community within the next two years to Africa or the Middle East.

Even though per unit assembly costs are higher in the Andean region than in Brazil or the United States, Nylin argues, the spare capacity could be used to fill demand for low-volume cars and allow other plants to focus on hot-selling products.

Weathering out the current storm, concludes Nylin, is much less costly than packing your bags and reentering the market later on. "It would have to get pretty bad--near anarchy--before we walk away. We believe in the country. We are here for the long haul," says Nylin.

                       MARKET SHARE BY MANUFACTURER
         1994 1999
GM        23%  21%
FORD      18%  18%
TOYOTA    10%  12%
CYRYSLER   2%   5%
DAEWOO     6%   7%
OTHERS    41%  38%
Source: Standard & Poor's/DRI