In 1922 we changed all this by setting up a consolidated cash control system. This was a new concept for a large corporation. Depository accounts were established in some one hundred banks in the United States, and all incoming receipts were deposited in these accounts to the credit of General Motors Corporation. All withdrawals from them were administered by the central Financial Staff; the divisions had no control over cash transfers from these deposit accounts.
Under this system transfers between banks could be made quickly and automatically. The Financial Staff of the corporation set fixed minimum and maximum balances for these local deposit accounts, based on the size of the bank and the activity of the account. Whenever the amount in any one account rose above the maximum, the excess over the fixed minimum was automatically transferred by Federal Reserve telegraph to one of a number of central reservoir banks. The accounts in these reservoir banks were also administered by the Financial Staff. Divisions needing cash for their own requirements could apply to headquarters for transfer by telegraph. In two or three hours excess funds in one city could be made available to a division needing them in another city at the other end of the country.
Cash in transit also was reduced by putting an end to cash payments between divisions. We set up an intra-corporation settlement procedure under which the Financial Staff at headquarters acted as a clearinghouse for the settlement of inter-divisional claims and payments. Intra-corporation settlement certificates were exchanged instead of cash.
At this time, too, we began calculating a month ahead what our cash would be each day of the month, taking into account the sales schedule, payrolls, payments for materials, and the like. Against this projected curve we compared each day the corporation's actual cash balances. A divergence of the actual curve from the projected curve would be the signal to find the reasons for such divergence and to take corrective action at the appropriate level of operations.
A side effect of the new cash system was that it broadened the supply of credit available to General Motors. By establishing good working relationships with a large number of banks we were able to develop extensive lines of credit which could be drawn on if the need arose. By reducing our cash balances in banks, this system also enabled us to invest the excess cash, principally in short-term government securities. Thus we earned an income on money formerly kept as cash and so increased the efficiency with which we used our capital.
A number of people contributed to the creation of the cash plan. The need for it was seen by Mr. Raskob. He requested the preparation of the plan from Mr. Prentis, who, with the assistance of many others, drafted its broad outline. In general the technique they developed is still used by General Motors to control cash.
Inventory Control
The worst of the emergency problems was the inventory. I have related how uncontrolled purchases of raw and semi finished materials by the division managers had reached a total of $209 million by October of 1920, exceeding the Executive and Finance committees' maximum allotment by $59 million and far exceeding the amount that could immediately be used in the plants; and how the Finance Committee, on a temporary emergency basis, had taken control of inventories away from the operating divisions and on October 8, 1920, appointed an inventories committee, headed by Mr. Pratt, who was on Mr. Durant's staff, to bring the inventories under control.
John L. Pratt was one of the finest business executives I have ever known. He was originally a civil engineer. In 1905 he joined the du Pont Company, where he worked on the layout and building of plants. In 1918 he was made head of a section of the du Pont Development Department which at that time gave assistance to General Motors. He came into close association with Mr. Durant, and in 1919, at Mr. Durant's request, came to General Motors as assistant to Mr. Durant. Mr. Pratt did a number of high-level jobs for General Motors and had a large responsibility in getting Frigidaire going and in building it up in later years. He also succeeded me as head of the accessory divisions. For many years, on the operating side, Mr. Pratt, Mr. Brown, and I worked on the same floor and were in touch with each other on all the problems that came up. Mr. Pratt was, you might say, a stand-in for me when I was president. He had a great capability for handling large problems with plainness and simplicity. He could get to the point.
"The first step of the Inventories Committee" in the crisis of 1920, Mr. Pratt later wrote to Mr. Raskob, "was to send out, under the signature of the President of General Motors Corporation, a letter instructing all General Managers to buy nothing; to stop shipment of all purchases released—until the Inventories Committee could review the situation with each individual General Manager and decide on what material would be received and what would not be received . . . most of the work was done by sitting down with the General Managers in their own offices and going over their inventory situation with them in detail."
The general managers negotiated with the suppliers, and I know of only one instance—in the tractor business, not in the automobile business—in which there was litigation. Then the divisions were put under a system of controls. The original memorandum by Mr. Pratt described the procedure as follows : "After the flow of incoming material was stopped each General Manager submitted a monthly budget to the Inventories Committee which showed estimated sales for the next four months and the estimated materials and payrolls that would be required for production to meet the estimated sales. These budgets were carefully scanned by the Inventories Committee and discussed with the General Managers, and when an agreement had been reached material for one month's production at a time was released by the Inventories Committee." In this way they gained control over runaway inventories, reduced them, and conserved cash. For example, the level of inventory was reduced from the high of $215 million at the end of September 1920 to a low of $94 million at the end of June 1922, and the turnover of inventory was increased from about twice a year in September 1920 to over four times in June 1922.
Mr. Bradley has observed to me that the essential thing we learned from this experience was that the only way to cut back inventories—particularly in a time of declining business— is to reduce purchases and commitments for materials and supplies. Obvious? Not entirely. Anyway it took us a long time to learn tins from experience. In those days the general managers tended to be optimists, as most executives in the selling end of the automobile business were and perhaps still are. They always expected that sales would increase and thereby bring the inventories in line. When the expected sales failed to materialize, a problem arose to which there could be no entirely pleasant solution. Hence we learned to be skeptical of expectations of increased future sales as a solution to a rising inventory problem. We took the position that actual inventories, purchases, and commitments should be reduced, knowing that we could increase them later if that were warranted by actual sales.
The emergency measures I have described established that the corporation was in charge of the corporation, so to speak. But centralization of this kind was not in accord with our ideas for permanent ways of doing business in General Motors. We soon turned again toward decentralization.
Donaldson Brown proposed a long-range policy of inventory control in a report to the Finance Committee on April 21, 1921, as follows:
It is believed that the emergency which existed at the time the Inventories Committee was formed has passed sufficiently to do away with this committee and place control of inventories where it belongs with other operating problems under the Vice President in charge of operations.
The function of the Inventories Committee has been to pass upon production schedules according to which deliveries of materials as required might be arranged for by the operating units, and in specific cases to authorize or disapprove the taking in of materials beyond the needs of current operations.
The operating units themselves must of necessity be looked to as the primary seat of control of inventories. The interposition of an Inventories Committee under the jurisdiction of the Finance Committee, with its delegated po
wers in the direction of inventory control affords a condition of dual responsibility which in normal conditions is unwholesome and objectionable . . .
In other words, it was time to abandon emergency measures in this area and to develop broad policies and practices. The important thing was to determine an inventory policy that could be expected to avoid a repetition of the 1920 crisis. To this end Mr. Brown proposed to establish a new relationship between financial policy and the operating organization. He wrote:
Insofar as the whole [inventory and commitments] involves the matter of working capital requirement the Finance Committee must have its voice reflected in the control, but this had better be by way of rules covering points of general policy rather than by any attempt at direct action. Moreover it would seem logical and sound in organization principle, for the Vice President or Chief Executive in charge of operations to be looked to to see that the divisions effectually control inventories to accord with Finance Committee policies or good business practice.
The financial department of the company is intimately concerned in the matter and should be expected to follow the situation closely at all times so that through the regular financial forecasts or by other reports the Finance Committee shall be as fully informed as possible of the company's position and prospective capital requirement.
These observations outlined the first tangible steps for a new financial-control system in General Motors. They were approved by the Finance Committee in May 1921 and so became the policy of the corporation. The Inventories Committee was disbanded and the administration of inventories was returned to the divisions. The instrumentality of control then became the divisional four-month forecast of expected business, which came to me as vice president in charge of operations; that is, it came to me after mid-1921. This forecast was the key to inventory control and it was my responsibility to review and approve it. Thus the division managers still bought the materials, but they were permitted to buy only enough at a time to make the number of cars and trucks specified in their approved production schedules.
Production Control
It should be understood, however, that conceptually and in practice these measures, growing out of the 1920-21 crisis, concerned mainly the control of unfinished goods and commitments for them. There remained to be solved the more formidable problem of controlling the inventory of finished products. This involved not only the problem of selling the cars on hand, but of controlling the level of car production. To assist in this aim we enlarged the scope of the four-month forecasts, mentioned above, to include plant investment, working capital, and outstanding inventory commitments as well as estimated sales, production, and earnings. These enlarged forecasts originated in the divisions and were to be in my hands on the twenty-fifth of each month. They covered the current month and each of the three ensuing months. After consulting with the vice president in charge of finance, I approved or modified the production schedule for each division in the light of these forecasts. For some years this arrangement brought Mr. Brown and myself into a continuous relationship, both before and after I became president. My approval of the production schedule constituted authority for the division managers to proceed with production and to purchase or contract for deliveries of materials.
This procedure introduced the first serious effort at forecasting in General Motors. The only forecasts of any sort before the emergency of 1921 had been prepared by the treasurer for the Finance Committee. His forecasts, which covered sales, earnings, working capital, and cash position for the corporation as a whole, were useful in general financial planning. However, they did not represent the divisions' own estimates of expected operating results; indeed they did not even include divisional breakdowns. The division managers, therefore, could hardly be held accountable for fulfilling forecasts made by an authority remote from them, and so the forecasts were of little value in appraising and controlling divisional operating plans. And since the treasurer's forecasts of sales were nothing more than an assumption made at a distance from the customer, their accuracy was not great.
The new administration in 1921 likewise had very little data on which to base a production schedule, but we had to proceed anyway. In the nature of the business we had to build up stocks for spring demand. Then in June and July, three or four months before the end of the model year, we had to estimate sales for the balance of the model year, to be out of stock of cars of the current model, or nearly so, when the new model came in. This estimate could not be changed, since upon it we had to base calculations to get the right amount of materials. Our estimating procedure has evolved over the years, but in principle we still do the same thing.
The key element in the forecast, of course, was expected sales, from which the number of cars and trucks to be produced was determined. The level of production required to yield a given number of cars ready to sell on a given date, and the quantity of materials required to support that production, could be determined accurately by a purely technical calculation, relatively easy to make. The real problem was to forecast how many cars we could expect to sell.
It was in an effort to make the sales forecasts as accurate as possible that we put the responsibility for them directly on the division managers, since they were closer to the consumer and therefore the most likely to be well informed on sales trends. Beginning in 1921 I asked the division managers to give me reports of their actual unit production and sales at the factory for ten-day periods ending on the tenth, twentieth, and final day of each month. And I asked them to report, at the end of each month, how many unfilled orders for cars they had, how many finished cars they had in their plants, and how many cars they estimated their dealers had on hand. At that time such reports—although they were raw estimates of dealer stocks—were a novelty, and for a few years they provided the only factual basis for determining car-production requirements in General Motors.
The big gap in our information system at headquarters and in the divisions was at the retail level. We knew how many cars and trucks our divisions were selling to our dealers, but we did not know the current rate at which those vehicles were being resold to the public. We were not in touch with the actual retail market. The division managers gave me monthly reports on the number of cars in the hands of their dealers, but most of them estimated dealers' inventories without asking the dealers themselves to supply current data. This method—or lack of it—limited our sensitivity to changing market trends and required the staff at headquarters to base its sales forecasts on figures that were not only weak but also several weeks old. Such a time lag could be dangerous. It became, in fact, the source of a new crisis.
Beginning in 1922 I asked the division managers to submit at the end of each year estimates of their expected operating results for the year to come, along with the regular four-month forecasts. These annual estimates were really three different forecasts in one, for I requested them to predict for the coming year what their sales, earnings, and capital requirements would be on the basis of expectations that were pessimistic, conservative (that is, most likely), and optimistic. These compilations were not regarded as commitments—fortunately, for they did not prove to be very accurate. The shorter-term forecasts had a good accuracy record, and the long term forecasts were fairly good for 1922 and 1923 but proved to be much too high for 1924. Even the pessimistic forecasts for that year were too high.
There was cause. The year 1923 had been so good that some of our car divisions, particularly Chevrolet, had lost potential sales because they were unable to supply the ultimate consumer with cars when required. Most of the division managers projected this experience onto the prospects for 1924 and resolved not to miss any more sales because of underproduction. They set high production rates for the early part of 1924. Some of the division managers, toward the end of 1923, asked permission to exceed their approved production requirements during the winter for the expected spring demand. I recommended that the Finance Committee approve this request and the committee did so.
>
Although I thus shared the belief that an increase in sales was to be expected, I also held the view that some of the divisions were planning to build more cars than a moderate improvement in sales would justify. I asked several of the division managers to reconsider their production schedules. In each case their reply was that in their opinion the schedule was justified.
Signs of distress began to appear early in 1924. In a report to the Finance and Executive committees dated March 14, 1924, I pointed out that the corporation and the industry as a whole had what was probably a larger number of unsold cars in the hands of dealers, distributors, and branches than at any previous time. Comparison of unit sales and production figures for the four-month period October 1, 1923, to January 31, 1924, with the corresponding figures for the year before showed that our production had increased about 50 per cent while our sales to the ultimate consumer had declined about 4 per cent. Here the time lag entered. I did not get these figures until the first week in March 1924.
I warned the managers of the divisions of the growing danger, and at Chevrolet and Oakland I insisted upon immediate and drastic curtailment of production schedules. The division managers complied reluctantly. As late as the end of March a couple of them still held that their disappointing sales figures were entirely the result of bad weather and that, as soon as the weather improved, brisk selling would justify their original production rates.
My Years With General Motors Page 16