Why Falling to No. 2 Would Be Good for GM

Now the pressure is on Toyota. Plus, profitability is what's important, not size.

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Rick Wagoner has got to be tired of hearing the question—and it looks as if he'll have to keep answering it a bit longer. For months, people have been asking the General Motors CEO what will happen if Toyota knocks GM out of the No. 1 spot and becomes the world's biggest carmaker. Wagoner usually puts on his game face and insists that GM isn't yielding anything to Toyota. But this has been the most predictable dethroning in all of business.

The two auto giants, however, will apparently share the platform for a spell before Toyota bumps GM to second place. GM says that in 2007 it sold 9,369,524 cars worldwide—9.37 million, if you round up. Toyota also sold 9.37 million vehicles in 2007—and hasn't yet broken out its figures to a full seven digits. So for now they're tied. Let's call in the lawyers and demand a recount.

It's inevitable, however, that GM will lose the perch it has held for 77 years. Toyota's sales and market share have been surging, with the company raking in billions of dollars in profits. GM lost $12 billion over the past two years and has been shrinking in its core market, North America. Yet the new automotive order will be good news for GM. Sure, falling behind Toyota will mean a loss of pride, but executives at both companies know that being No. 1 would pose fresh risks for Toyota, while being No. 2 would give GM some welcome advantages. Here's why:

It's profitability, stupid. Being the biggest might convey certain bragging rights, but it's profitability, not size, that keeps shareholders happy and workers employed. Toyota has achieved remarkable profitability—its net income was $14 billion in the latest fiscal year—driven largely by aggressive growth worldwide. That's because Toyota has been building the kinds of cars people want, at plants that are the most efficient in the world. At GM, by contrast, size has become a liability—it has too many factories producing more cars than there's demand for, especially in North America. That practice drives down prices and profit margins while keeping costs high—which is why becoming smaller and more productive is actually a core part of GM's restructuring plan. Wagoner and his lieutenants have known for a while that GM would have to forfeit the top spot in order to get healthy. Soon they'll be able to stop acting otherwise.

The pressure will fade at GM. It still has tough profit targets to meet, but the GM deathwatch has been underway for so long that it will be a relief to many execs in Detroit to finally have the monkey off their back. At one time, the big story was the risk of bankruptcy, which GM seems to have averted. But once GM drops to No. 2, the story line could very well shift to the company's advantage: Suddenly, the huge automaker will seem like an underdog, which can make modest improvements appear to be big successes.

The pressure's on at Toyota. Being the leader puts you in the spotlight, a position where Toyota isn't always comfortable. Toyota has been extremely clever about building its muscle in the U.S. market without beating its chest or triggering a political or cultural backlash. Producing the new Tundra pickup truck in Texas, for example, gives Toyota a bit of all-American credibility, even though nearly half the cars it sells in the United States are still built in Japan.

But when you're the front-runner, there's nobody else ahead of you to deflect unwanted attention. That could magnify problems that might otherwise escape widespread notice, like the recent defection of two top Toyota executives, one to Ford and one to Chrysler. Toyota's famed quality has also slipped recently, as highlighted by ranking organizations like Consumer Reports and J. D. Power. Toyota is known for a prickly streak, and if journalists and analysts start to pick on the company, Toyota could get defensive, and the honeymoon might end quickly.

The crown could change hands again. The Toyota-GM horse race will persist for years. Toyota's rise to No. 1 showcases its success in North America, where its market share has been rising and GM's falling. But GM is performing well overseas, especially in key growth markets like China—where it sells more Buicks than in the United States and holds a sizable market share lead over Toyota. To become consistently profitable, GM must reclaim lost turf in its home market. But if it does that, strong positions in Europe, Latin America, Asia, and other developing regions could boost GM unambiguously to No. 1 once again.

Neither company will fall to No. 3. No matter which company sells the most cars, GM and Toyota are likely to be the only two auto companies with the global scale and depth of talent to compete across the board and around the world. Other automakers will be able to compete in profitable niches—like luxury and performance cars, styling standouts, and value-based economy cars—but the Big Two will drive most of the industry's technological change. There may also be a wave of consolidation, as second-tier manufacturers like Chrysler and Nissan seek partners and scale. Such a trend could favor GM, since it already has partnerships with Honda, Ford, and half a dozen others. But let's allow Toyota to enjoy its ascendancy for a few days, before starting to predict the new leader's downfall.