Thursday, October 30, 2008

Evolution of Markets: Patterns in Steel, Autos and Airframe Industries

The steel, automobile and airframe manufacturing industries illustrate three different stages of the evolution of mature markets. The theme is that mature markets with strong unions eventually end up with the workforce as the only true stakeholder in the business. Everyone else is secondary, and as a result, the workforce is at real risk of permanent job losses over a period of time.

The story of Bethlehem Steel illustrates the end game in this evolution. Through most of the 80s and 90s, Bethlehem lobbied Washington to protect its business against the import of foreign steel, which it argued was subsidized and dumped in the U.S. All along, though, non-unionized companies like Nucor were gaining share rapidly in the domestic market. Bethlehem’s costs were much higher than the industry as a whole. The company suffered from very high wages compared to both foreign mills and non-union domestic mills, and from work rules that reduced the productivity of the workforce. Because the company had no profits, it could not invest in its infrastructure. This low investment yielded older and less efficient mills, compounding the company’s cost problems. As the company faltered, pension and benefit payments to retirees soared, while the active workforce shrank. The unions refused to negotiate away some of these uncompetitive cost drivers. Customers did not have to put up with inefficient costs and the slow reaction to price discounting that Bethlehem imposed upon them. They left for greener pastures. The company filed for bankruptcy in 2003. A financial investor bought the company’s assets, and negotiated new deals with unions who, chastened, gave him a sweeter deal than they gave to the company’s previous management. The retirees lost all or most of their pensions. The steel works have fewer, and lower paid employees.

Ford, and the rest of the domestic automobile industry, is just a few years behind in this same evolution. Recently, Kirk Kerkorian began selling off his investment in Ford. Kerkorian has proven himself to be a very savvy investor over these last thirty years. He sees little future for Ford. Why? Because neither customers nor investors have any true stake in the company. The company is essentially controlled by the United Autoworkers. The autoworkers stand by their demands and inefficient costs despite the fact that the domestic industry is hemorrhaging losses and reducing employee numbers at an unprecedented rate.

What is likely to change this situation? Not really anything. Yes, the government is likely to inject cash into the industry, but this will simply delay the inevitable. Costs are too high, investment and product quality are too low, customers are leaving and retiree costs are becoming a higher proportion of industry unit costs. Haven’t we seen this story before? See above.

Now we come to the airframe manufacturing industry. Boeing is the leader here. The Machinists Union at Boeing is now on strike, largely over the issue of job security. These machinists are well paid by U.S. standards. The average machinist earned an average of $65,000 a year last year, including overtime. The company’s critical issue in this strike is whether the company can turn over more of its work to outside contractors. The union argues that they have already lost too much work because of Boeing’s outsourcing to contractors.

Now, think of the union as a supplier for a moment, offering a service for a price. The union, as the leader, is losing share to emerging contractor-based workers. (See the Symptom and Implication, “New entrants are penetrating the distribution channels of the industry’s leading competitors” on The union stance here is that they do not like losing market share at Boeing to other companies who can offer the same, or better, product at a lower price. Sounds like steel and autos, doesn’t it?

Now let’s ask another question. Do you suppose that the machinists would be willing to pay a higher price for a product just because it was manufactured by union employees in the United States? Overwhelmingly, it appears that most would not. It would be interesting to know how many union employees purchased domestic made color televisions during the 70s and 80s just because they were manufactured domestically. Today, all televisions are manufactured in Asia. Union employees are just like the rest of us when it comes to being their own money. They do not want to pay more for the same product than other people have to pay. Now, back to the Boeing situation.

Boeing’s management has held tight to its position that it must be able to outsource more of its current product manufacturing. They have done this in the face of some cancelled orders and a stock price that has fallen well over 60% from its peak in 2007. Boeing’s strong financial position, high market share, and relative lack of current competition strengthens the union’s position. However, those same economics one time held for both Bethlehem and Ford somehow competition found them anyway.

There is now a tentative agreement on the table. Boeing agreed to raise wages by a total of 15% over the four years of the contract and to pay bonuses totaling $8,000 to each worker during the first three years of the contract. The union has agreed to allow Boeing to expand the use of contractors to deliver components directly to assembly lines, but no further. The strike has lasted for 52 days, costing the company about $100 million per day in lost revenue and delays. So, let’s consider the likely fall-out from this settlement.

The union got a very generous settlement that promises to hurt them in the long-term. The wage increases in the face of a stronger dollar and weakening world-wide economies will surely make the Machinists Union employees even less competitive on the world market than they were before the strike. They get money now, but far less job security in the long-term.

The company, for its part, has agreed to pay a higher price for its Machinists Union labor. It won at least part of its battle over the issue of contracting. You can bet that contracting will grow in the future, at the expense of union positions. In addition, the Machinists Union, as a supplier of a labor service in this instance, proved itself to be highly unreliable. The daily cost of the disruption is the equivalent of about three years worth of wages for each employee in the Boeing group of the Machinists Union. That is a stiff price for Boeing to pay, and will certainly play into their consideration of where to place any new manufacturing facilities in the future. Again, this will work against the creation of new Machinist Union jobs in the future.

Unions in mature industries will eventually have to think of themselves as suppliers offering a service for a price. (See the Symptom and Implication, “The industry leaders are losing share” on The steel and automobile industries join many other industries, including semiconductors, textiles and paper in suggesting that there is little likelihood that a high-priced supplier can sustain its position, even if the supplier is the workforce.

Monday, October 27, 2008

A Standard Leader Blocks the Price Leader Competitor

Enterprise Rent-A-Car is an astute, well managed company. They have grown to the number one position in automobile rental by using their management skills to beat the likes of Hertz, Avis and National. Now they are starting to close the door on a growing low-end, Price Leader, set of competitors. A Price Leader is a competitor or product that offers below industry-standard performance for a very low price. More than 50% of a Price Leader competitor's total unit volume is usually sold at price points below the Standard Leader product.

This low-end, Price Leader, part of the business is car sharing. This is a club-like service where members join and then rent cars by the hour in locations close to their home or business. The leader in this industry is Zip Car Inc. This company has 250,000 members and 8500 corporate clients. Zip Car, as well as most of the industry, exists only in the larger cities in the United States.

So what has Enterprise done to stunt the growth of Zip Car? It has gone after the largest customers in the industry, in big geographic markets, with a comparable product. (See the Symptom & Implication, “Low end products are gaining share of the market” on Enterprise has created WeCar branches at several partner businesses around the country. It plans to deal only with the largest customers, businesses. By contrast, Zip Car gets most of its business from consumers, a costlier market segment to serve. It currently has WeCar locations at Google’s office in San Francisco, Washington University in downtown St. Louis and at sporting goods retailer, REI’s offices in Kent, Washington. The company has been attracted to this car sharing price point because it is a booming business in an otherwise slow-growth industry.

In the long term, it is likely that the industry’s Standard Leaders, including Enterprise and Hertz, will be the leaders in this low-end price point. (See the Perspective, “When Product Mix Matters”, on

Monday, October 13, 2008

Avoiding Wastage of Resources

Honda has the most flexible auto plants in the U.S. It does so with simple modifications to the robots and assembly lines used to assemble its products. Of course, this high degree of flexibility is the result of significant investment over many years. Part of this investment included the company’s efforts to ensure that vehicles are designed to be assembled in the same way, even if the parts of the vehicle differ. This flexibility has become a key strategy advantage for the company as the auto market gyrates due to volatile gas prices. Honda has the capability of adjusting its production faster than any of its competitors.

Creating factory flexibility is one way that a company reduces the units of Input it requires to produce a unit of Output. In Honda’s case, the units of Input it was able to reduce with flexibility included employees and capital required to produce an automobile.

This flexible factory has enabled Honda to reduce downtime for employees and the plant assets. Downtime merely wastes the resources available for production. The auto industry has been reducing costs aggressively for many years. Honda is one of the companies who have done this well. (See the Symptom and Implication, “The industry is reducing costs aggressively” on

Here are some examples of ways other companies have reduced their unplanned downtime:

  • Allow work in process to follow multiple paths to completion to avoid delays at any waypoint

  • Break bundled supplies into their component parts where components of a bundle are used at different rates

  • Enable an employee, or a component, to serve multiple functions

  • Ensure that all required components are available at each step in the process

  • Duplicate critical components to avoid any potential shutdown of the process due to the failure of a single component

  • Have ready answers for issues that can slow or stop a process

  • Offer a service package to customers to avoid the failure of the product at the customer location. This service may also bring a price premium.

  • Build installation instructions into a component

There are many hundreds of ideas to help a company reduce its unit costs and improve its overall productivity, measured as units of Input divided by units of Output, on (see the Improve/Costs section of StrategyStreet). But any cost reduction program should focus on the right costs. (See the Perspective, “Cutting the Right Cost” on

Thursday, October 9, 2008

Price Leaders Against Standard Leaders in Troubled Times

For once, the airline industry Standard Leaders, the legacy airlines seem to be improving their positions compared to the Price Leaders, the discount airlines. In our system of analysis, a Standard Leader is a competitor, or one of several competitors, or products that set the standard for performance and price in an industry. A Price Leader is a competitor, or product, that offers below industry-standard performance for a very low price. So far, none of the legacy airlines has gone back into bankruptcy. On the other hand, a number of Price Leader discount airlines have failed, including Frontier Airlines and Skybus Airlines. What has happened? Three things.

First, the bankruptcies of the legacy carriers helped those companies drastically reduce their high costs. Some analysts have noted that the difference in operating margins of the Price Leader discounters and the Standard Leader legacy carriers is only 2% today, down from 7% five years ago. A 5% cost advantage is not much in the way of a Price Leader’s low cost structure, which it needs in order to offer its lower prices and attract its customer segment.

In order to succeed over a long period of time, discounters always must offer a significant discount on a product that is “acceptable” in the market, if not as good as the Standard Leader product. In order to offer the substantial discounts, Price Leader competitors must have a lower cost structure. In turn, this lower cost structure is largely the result of the discounter offering fewer benefits than the Standard Leader product. We have done extensive analyses on these Price Leader companies. Our research suggests there are two separate types of Price Leaders who follow somewhat different business models (see the Perspective, “Turmoil Below: Confronting Low-End Competition” in

Second, the legacy carriers have begun selectively competing with the discount carriers on price. In many markets, the legacy carriers offer prices that are within reach of those of the discount airlines. (See the Symptoms and Implications, “As large competitors match low prices other competitors face difficulties” in In most markets, a successful Price Leader needs to offer a discount of 25% or more on its product in order to grow significantly at the expense of a Standard Leader.

Third, the discount airlines’ natural market is shrinking during these troubled times. In fact, the airline industry in general is shrinking, as measured by revenue passenger miles flown. However, the discount airlines carry a higher proportion of price-sensitive leisure travelers. This market segment is off a good deal more than is the business traveler segment, which makes up a higher proportion of the legacy airlines’ customers.

Even though today’s airline industry is seeing the discounter product become more like the legacy airlines’ product, and vice versa, these discounters still need to offer a notably lower price than do the legacy carriers. That seems to be more difficult these days.

Tuesday, October 7, 2008

Nokia in a Leader's Trap

Recently, Nokia announced that its market share was likely to fall off somewhat in the future because it was refusing to enter into a price war with others in its industry who are discounting. Nokia has decided to stand apart from the discounters in the marketplace. (See the Symptom & Implication, “Large competitors are maintaining price levels as smaller competitors discount” on Unfortunately for Nokia, these discounters include the #2 cell phone maker, Samsung, and the #4, LG Electronics. (See the Symptom & Implication, “Price wars are spreading in the industry” on The outlook on this decision is grim.

We have seen this same situation many times before. We call it the Leader’s Trap. (See the Perspective, “The Leader’s Trap” on In a Leader’s Trap, an established industry competitor maintains a price umbrella and cedes share to a discounting competitor in the mistaken belief that customers will stay loyal to the established competitor by paying a premium for his product. Over time, the company in the Leader’s Trap not only loses share, but also sees prices fall to a level near the prices established by the discounting competitor.

Nokia has announced its intention to take market share only when the company believes that the share will be sustainably profitable in the long-term. This sounds good, but won’t work. The market share the company surrenders today generates cash and, probably, profits. The major players who are discounting their prices today are, therefore, becoming stronger with the addition of more revenues and cash flows in a difficult market. On the other hand, Nokia can only become weaker. It loses cash flows. It broadcasts to all customers in the marketplace that its prices are high. How does Nokia win in this situation?

The answer: it does not. Nokia is unlikely to succeed where previous leaders, such as GM, IBM, AT&T, and many others, have failed. The Leader’s Trap always weakens the company holding the price umbrella and strengthens all the competitors underneath the umbrella. Nokia is sure to regret this tactic.