The German automakers are under some pressure. They need to have a small car in their product line-up in order to respond both to consumers’ growing preferences for smaller cars and to government pressures to reduce fuel consumption and carbon emissions. BMW has answered with its One series. Volkswagen has taken a 20% stake in Japan’s Suzuki Motor Corporation, which is a small car specialist. Mercedes Benz has decided to go an alliance route.
Recently, Daimler, the maker of Mercedes Benz automobiles, announced an alliance with Nissan and Renault to create a common line of small cars. The companies will also share engines and work together to create small commercial vans. To do this, Nissan and Renault will invest about $1.6 billion in Daimler who, in turn, will invest about $1.6 billion in Nissan and Renault. These investments will have a good pay-off. The two sides of the alliance estimate that they will each save about $2.7 billion in costs over the coming five years. This alliance creates new economies of scale for each side by increasing their productivity, as measured by units of input costs over units of output product. (See “Audio Tip #187: The Components of Productivity” on StrategyStreet.com.) In this case, they improve productivity by spreading fixed cost activity such as design of new products over more sales output.
In analyzing several thousand cost reduction approaches, which companies have employed over the last twenty-five years, we have seen two basic approaches to the task of increasing the output over which fixed costs investments are used. First, the company may acquire a similar organization to spread fixed costs over more units of sales. Second, the company may form an alliance of some kind to spread these fixed costs over more sales output. This small car alliance is an example of the second approach. In turn, we have identified three ways that companies pursue this second approach of spreading fixed cost. First, the companies may use their fixed cost with competitors who employ outsourcing. Second, the companies may combine fixed cost with competitors into separate businesses. Third, the company may use its fixed cost with new customer segments by turning some of their cost centers into profit centers. This small car alliance is an example of the second of these techniques, combining fixed costs with competitors into separate businesses.
Other examples where companies have employed this cost management approach include Sony and Sharp partnering in the flat panel TV business two years ago. Sony invested in Sharp’s plant to make LCDs. This gave Sony the option of buying the panels for its TVs while Sharp reduced the investment burden for panel production. In another example, General Mills and Land O’Lakes combined their distribution networks, improving their scale economies. In this later case, the companies were not direct competitors as are the companies in the small auto alliance.
You may find many more cost management concepts and examples in StrategyStreet.com/Improve/Costs.
Thursday, April 29, 2010
Monday, April 26, 2010
Using Finance to Reduce a Price
Dell is struggling to keep up with HP in the personal computer market. There is one part of the market, though, where Dell remains the clear leader, the small business market. Part of the reason for the company’s success in this market is its financing package. It is more generous with financial support than its competition. It may offer interest-free financing when companies purchase $25,000 or more of new computers. The company offers other creative financing deals. In one of these deals, a customer bought $30,000 of computers on a three-year lease plan that allows the customer to keep the equipment when the lease expires. Overall, Dell says that 22% of its small and medium-size business customers use Dell to finance their purchases. This 22% is up from 17% just two years ago. The company is gaining share by using its financing muscle, despite the chancy economic environment.
Offering financing, whether subsidized or not, is a way of extending the time a customer has to make its cash payment to the supplier. This is a form of discount. In our analysis of several thousand price reductions over the last twenty-five years, we have identified fifteen distinct forms of discount. The offering of financing is one of those forms. Many industries have relied on financing to build their businesses, even in difficult times. The automobile industry has used financing to offer attractive lease rates and payment plans to its customers using captive finance vehicles, like GMAC. GE has used its captive finance arm to finance customers in many of its product categories. In fact, GE has seen its captive finance arm grow into a lender in many markets where GE does not even compete as a supplier.
The home building industry has also used financing creatively. For example, last year Lennar offered special financing with no money down and a 3.625% mortgage rate for the life of its loans on purchases of Lennar’s newly built homes. Subsidized financing helped Lennar win new customers in an abysmal market. (See the Symptom & Implication, “Demand in the industry is falling” on StrategyStreet.com.)
Even small businesses use the extension of financing to build their businesses. Faryl Robin is a New York company that sells high-end women’s shoes. In the expectation that it would build its business with long-time customers in a tough economy, the company offered additional financing. In 2009, it offered retail customers with whom it had a long-term relationship an additional sixty days over its normal thirty day payment period for the customer to make its full payment for shoes she had purchased.
Offering financing, whether subsidized or not, is a way of extending the time a customer has to make its cash payment to the supplier. This is a form of discount. In our analysis of several thousand price reductions over the last twenty-five years, we have identified fifteen distinct forms of discount. The offering of financing is one of those forms. Many industries have relied on financing to build their businesses, even in difficult times. The automobile industry has used financing to offer attractive lease rates and payment plans to its customers using captive finance vehicles, like GMAC. GE has used its captive finance arm to finance customers in many of its product categories. In fact, GE has seen its captive finance arm grow into a lender in many markets where GE does not even compete as a supplier.
The home building industry has also used financing creatively. For example, last year Lennar offered special financing with no money down and a 3.625% mortgage rate for the life of its loans on purchases of Lennar’s newly built homes. Subsidized financing helped Lennar win new customers in an abysmal market. (See the Symptom & Implication, “Demand in the industry is falling” on StrategyStreet.com.)
Even small businesses use the extension of financing to build their businesses. Faryl Robin is a New York company that sells high-end women’s shoes. In the expectation that it would build its business with long-time customers in a tough economy, the company offered additional financing. In 2009, it offered retail customers with whom it had a long-term relationship an additional sixty days over its normal thirty day payment period for the customer to make its full payment for shoes she had purchased.
Thursday, April 22, 2010
A Low-End Competitor with Low Industry Costs
Southwest Airlines is an unusual competitor. Since its inception, the company has been a low-end, discount competitor. What makes it an odd duck is that it provides service levels equivalent to the industry’s large legacy carriers while it also has very low costs compared to the industry’s erstwhile leaders, such as Delta, United and American Airlines. Southwest enjoys this low cost structure because it is less encumbered by onerous union work rules. Southwest has unionized employees, but their work rules are less restrictive than are those of the legacy airlines. Southwest uses this low cost structure to reduce prices and gain share against their larger legacy competitors. This has been going on for long enough that Southwest really is approaching industry leader status, if it’s not there already. Surely flying Southwest has become nearly as convenient and comfortable as flying one of the legacy airlines. The service of the legacy airlines has come to the level of Southwest, rather than the other way around.
Now Southwest has the economic where-with-all to do things that the poorer legacy airlines can not afford to do. For example, the company has made a major financial commitment to a new air traffic control system called “Required Navigation Performance” (RNP) routes. RNP is next generation technology that allows a flight to be less costly for the airline and more comfortable for passengers. (See the Symptom & Implication, “The industry is adding new, more efficient capacity in the effort to reduce costs” on StrategyStreet.com.) Airplanes can shorten their flights because they are able to use narrower and shorter descent patterns, reducing time and fuel. Passengers will find the descent more continuous, quieter and more comfortable.
This new technology will set Southwest back by $175 million. It put each of its pilots through ground school training on the new cockpit equipment and rewrote all of its flight procedures. Southwest made this investment on its own ahead of its competitors. The legacy carriers have delayed their own investments, hoping that the government will subsidize them. They can not afford this investment as easily as can Southwest. So, here we have a low-end competitor who has become an industry leader and continues to invest to reduce its operating costs and improve its performance for customers. (See “Video #46: The Place of Cost Management in Hostility” on StrategyStreet.com.) These investments slowly bleed away the advantages of the legacy carriers, adding to their economic strife.
There have been other low-end competitors who have been able to rise to industry leader status by taking advantage of the onerous work rules of their unionized competitors. The Japanese automobile manufacturers, especially Toyota, Honda and Nissan, certainly took that path. It appears that Hyundai is now following their lead in today’s automobile market.
Now Southwest has the economic where-with-all to do things that the poorer legacy airlines can not afford to do. For example, the company has made a major financial commitment to a new air traffic control system called “Required Navigation Performance” (RNP) routes. RNP is next generation technology that allows a flight to be less costly for the airline and more comfortable for passengers. (See the Symptom & Implication, “The industry is adding new, more efficient capacity in the effort to reduce costs” on StrategyStreet.com.) Airplanes can shorten their flights because they are able to use narrower and shorter descent patterns, reducing time and fuel. Passengers will find the descent more continuous, quieter and more comfortable.
This new technology will set Southwest back by $175 million. It put each of its pilots through ground school training on the new cockpit equipment and rewrote all of its flight procedures. Southwest made this investment on its own ahead of its competitors. The legacy carriers have delayed their own investments, hoping that the government will subsidize them. They can not afford this investment as easily as can Southwest. So, here we have a low-end competitor who has become an industry leader and continues to invest to reduce its operating costs and improve its performance for customers. (See “Video #46: The Place of Cost Management in Hostility” on StrategyStreet.com.) These investments slowly bleed away the advantages of the legacy carriers, adding to their economic strife.
There have been other low-end competitors who have been able to rise to industry leader status by taking advantage of the onerous work rules of their unionized competitors. The Japanese automobile manufacturers, especially Toyota, Honda and Nissan, certainly took that path. It appears that Hyundai is now following their lead in today’s automobile market.
Monday, April 19, 2010
New Capacity in a Shrinking Market
Big companies are pulling out of the petroleum refining industry. In the last year, Shell, Chevron, Valero and Sunoco have put refineries up for sale or shut them down. There is simply too much capacity in the industry. But there seems to be one guy coming in through the exit doors in the refining industry. Marathon Oil just opened a new $4 billion addition to its Louisiana refinery. Further, the company announced that it made a profit in all six of its other refineries in the U.S. in 2009. 2009 was a terrible year for the U.S. refinery business. 2010 isn’t much better.
Why would anyone add capacity in a hostile market with clear overcapacity? These capacity additions turn out to be commonplace. (See “Audio Tip #103: Capacity Creep Expansion of Industry Capacity” on StrategyStreet.com.) In Marathon’s case, the company started its capacity expansion in 2007, while the refining industry was roaring along. It simply took until 2010 to bring the refinery addition online. So this addition, while large, is really the result of expansion in the good times. The new capacity shows up when times have turned bad.
But, virtually every hostile industry sees small amounts, at least 1% to 2% per annum, increases in industry capacity every year. This capacity addition is the result of companies learning how to run their existing capacity with greater efficiency and effectiveness. It is almost a free addition to industry capacity. We call this annual capacity addition, despite overcapacity, the learning curve capacity addition. We named it after the well-known Boston Consulting Group strategic concept from the early 70s. The rate of this free capacity addition depends, in part, on the rate of growth in the industry itself. The faster the industry grows, the more free capacity will come online each year due to this learning curve effect. This effect can be pernicious. In the newsprint industry, the learning curve effect added more capacity every year than demand in the newsprint industry grew. During most of the 90s, the capacity industry’s addition due to the learning curve effect outstripped the growth of industry demand. Every year, hostility got just a little worse because of it. Real prices remained under pressure the whole time. (See “Audio Tip #133: What Tells Us Prices Will be Under Pressure?” on StrategyStreet.com.)
Why would anyone add capacity in a hostile market with clear overcapacity? These capacity additions turn out to be commonplace. (See “Audio Tip #103: Capacity Creep Expansion of Industry Capacity” on StrategyStreet.com.) In Marathon’s case, the company started its capacity expansion in 2007, while the refining industry was roaring along. It simply took until 2010 to bring the refinery addition online. So this addition, while large, is really the result of expansion in the good times. The new capacity shows up when times have turned bad.
But, virtually every hostile industry sees small amounts, at least 1% to 2% per annum, increases in industry capacity every year. This capacity addition is the result of companies learning how to run their existing capacity with greater efficiency and effectiveness. It is almost a free addition to industry capacity. We call this annual capacity addition, despite overcapacity, the learning curve capacity addition. We named it after the well-known Boston Consulting Group strategic concept from the early 70s. The rate of this free capacity addition depends, in part, on the rate of growth in the industry itself. The faster the industry grows, the more free capacity will come online each year due to this learning curve effect. This effect can be pernicious. In the newsprint industry, the learning curve effect added more capacity every year than demand in the newsprint industry grew. During most of the 90s, the capacity industry’s addition due to the learning curve effect outstripped the growth of industry demand. Every year, hostility got just a little worse because of it. Real prices remained under pressure the whole time. (See “Audio Tip #133: What Tells Us Prices Will be Under Pressure?” on StrategyStreet.com.)
Thursday, April 15, 2010
Recycling of Capacity in a Tough Market
Sweden is a small country with a proud tradition of producing tough, high-end, automobiles. We call these high-end products Performance Leaders. In a hostile market, a Performance Leader usually suffers from scale disadvantages compared to the much larger industry leaders, whom we call Standard Leaders. Often, these Performance Leaders become acquisitions for the industry’s Standard Leaders. (See the Symptom & Implication, “The industry is consolidating through mergers and acquisitions” on StrategyStreet.com.) That was the case when GM bought Saab and Ford bought Volvo.
Both of these automobile industry Standard Leaders operated their Swedish acquisitions as separate companies. However, as GM and Ford themselves faltered in the market, they both decided to jettison their foreign high-end products. Spyker Cars NV, a Dutch company, has purchased Saab from General Motors. China’s Geely Automobile Holdings Ltd. has purchased Volvo from Ford. Both the Saab and the Volvo brands, then, will continue into the future.
These purchases illustrate the sometimes difficult workings of a hostile marketplace. (See “Video #10: Industry Consolidation and Recycling of Capacity” on StrategyStreet.com.) Both Volvo and Saab were failing as stand-alone Performance Leader competitors. But they did not go out of business. Instead, larger industry Standard Leaders bought them and kept their capacity in operation. This is a first example of the recycling of brands, but more particularly, productive capacity in an industry that already had too much of it. Neither GM nor Ford was able to make a go of it with these Performance Leader brands. Rather than shut the brands and their productive capacity down, however, both the Standard Leaders found willing buyers for the brands and their industry capacity. This is the second example of recycling of the same capacity. In each case, the buyer got the company and its capacity for a cost below the book value of the original seller.
We have found this recycling of capacity to occur in virtually every industry that goes through over-capacity and hostile times. Capacity will not go away until it cannot produce cash for any owner. The recent closing of the San Francisco Bay Area Nummi plant, once co-owned by GM and Toyota, is a clear indication that the plant can no longer produce cash as an automobile plant. It may finally stop producing automobiles forever. It is worth noting, however, that this was a GM automobile plant before it became Nummi. It had already been recycled once in the mid-1980s.
Both of these automobile industry Standard Leaders operated their Swedish acquisitions as separate companies. However, as GM and Ford themselves faltered in the market, they both decided to jettison their foreign high-end products. Spyker Cars NV, a Dutch company, has purchased Saab from General Motors. China’s Geely Automobile Holdings Ltd. has purchased Volvo from Ford. Both the Saab and the Volvo brands, then, will continue into the future.
These purchases illustrate the sometimes difficult workings of a hostile marketplace. (See “Video #10: Industry Consolidation and Recycling of Capacity” on StrategyStreet.com.) Both Volvo and Saab were failing as stand-alone Performance Leader competitors. But they did not go out of business. Instead, larger industry Standard Leaders bought them and kept their capacity in operation. This is a first example of the recycling of brands, but more particularly, productive capacity in an industry that already had too much of it. Neither GM nor Ford was able to make a go of it with these Performance Leader brands. Rather than shut the brands and their productive capacity down, however, both the Standard Leaders found willing buyers for the brands and their industry capacity. This is the second example of recycling of the same capacity. In each case, the buyer got the company and its capacity for a cost below the book value of the original seller.
We have found this recycling of capacity to occur in virtually every industry that goes through over-capacity and hostile times. Capacity will not go away until it cannot produce cash for any owner. The recent closing of the San Francisco Bay Area Nummi plant, once co-owned by GM and Toyota, is a clear indication that the plant can no longer produce cash as an automobile plant. It may finally stop producing automobiles forever. It is worth noting, however, that this was a GM automobile plant before it became Nummi. It had already been recycled once in the mid-1980s.
Monday, April 12, 2010
Winning and Failing in a Marketplace
Analysts widely expect that Apple will offer its popular iPhone through Verizon by the end of this year. In anticipation of the loss of its iPhone exclusivity, AT&T is busy upgrading its network in an attempt to retain its current customer base in the face of the prospective Verizon competition. This story provides a useful illustration of how winning and failing works in a marketplace.
We use particular definitions for “winning” and “failing”. A “win” occurs when a company offers something that less than half of the other competitors in the industry can, or will, offer. (See “Audio Tip #34: How Does a Company “Win” in a Market?” on StrategyStreet.com.) A “failure” occurs when an incumbent supplier will not offer its customer a benefit that more than half of the industry competitors can, and will, offer that customer. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.)
Both a win and a failure can drive a change in market share. With a win, a company often offers a unique benefit, for example, a new feature for the product user. In fast-growing markets, wins are the drivers of much of the change in market share. In other markets, a failure must occur before market share will move. Once an incumbent supplier has failed its customer in some way, the customer opens its purchasing relationship to other suppliers and shifts some, or all, of the purchases it made from the failing supplier to another supplier. (See the Symptom & Implication, “Customers are adding suppliers because incumbent suppliers failed them” on StrategyStreet.com.) We call this situation, in which a supplier gains market share after an incumbent supplier has failed, a “weak win”. It is a weak win because the supplier who gained share was not able to offer something that the customer felt was a winning benefit. It simply gained its market share only after the incumbent failed.
In the early stages of the smart-phone market, AT&T had exclusive rights to the iPhone. The iPhone proved very popular, especially with consumers. This drove market share to AT&T in the smart-phone market and was a clear win by AT&T.
The iPhone brought some unique problems, however. It overwhelmed AT&T’s network and made a shambles of its capacity forecasting system. The result has been dropped calls and a deteriorating reputation with subscribers. AT&T is now failing some of the subscribers with whom it is the incumbent due to its exclusive offering of the iPhone. Many of these failed subscribers are now ready to open their relationships to another supplier, in this case, Verizon.
Verizon here is likely to be the beneficiary of a weak win situation. Without the iPhone, Verizon could not pull many of AT&T’s subscribers away from it. The Verizon benefits were not great enough to win market share in competition with AT&T’s iPhone. But, once AT&T has failed some of these subscribers and now that Verizon has the iPhone, Verizon can gain share at AT&T’s expense.
Some of the share shift is almost inevitable now. AT&T probably does not have enough time to get its network upgraded by enough to thwart the loss of some portion of its disgruntled subscribers. This is a fluid situation, though. AT&T was caught unawares by the significantly different patterns of cell phone usage among iPhone users. It’s possible that Verizon will be similarly overwhelmed. That should not be the case since Verizon could see AT&T’s problems. “Forewarned is forearmed”. If Verizon does encounter the same quality problems AT&T has had to face, it will not gain all the customers that it might have gained through AT&T’s current failure. But, in the short term, Verizon is bound to gain share from AT&T’s failure problems.
We use particular definitions for “winning” and “failing”. A “win” occurs when a company offers something that less than half of the other competitors in the industry can, or will, offer. (See “Audio Tip #34: How Does a Company “Win” in a Market?” on StrategyStreet.com.) A “failure” occurs when an incumbent supplier will not offer its customer a benefit that more than half of the industry competitors can, and will, offer that customer. (See “Audio Tip #35: How Does a Company “Fail” in a Market?” on StrategyStreet.com.)
Both a win and a failure can drive a change in market share. With a win, a company often offers a unique benefit, for example, a new feature for the product user. In fast-growing markets, wins are the drivers of much of the change in market share. In other markets, a failure must occur before market share will move. Once an incumbent supplier has failed its customer in some way, the customer opens its purchasing relationship to other suppliers and shifts some, or all, of the purchases it made from the failing supplier to another supplier. (See the Symptom & Implication, “Customers are adding suppliers because incumbent suppliers failed them” on StrategyStreet.com.) We call this situation, in which a supplier gains market share after an incumbent supplier has failed, a “weak win”. It is a weak win because the supplier who gained share was not able to offer something that the customer felt was a winning benefit. It simply gained its market share only after the incumbent failed.
In the early stages of the smart-phone market, AT&T had exclusive rights to the iPhone. The iPhone proved very popular, especially with consumers. This drove market share to AT&T in the smart-phone market and was a clear win by AT&T.
The iPhone brought some unique problems, however. It overwhelmed AT&T’s network and made a shambles of its capacity forecasting system. The result has been dropped calls and a deteriorating reputation with subscribers. AT&T is now failing some of the subscribers with whom it is the incumbent due to its exclusive offering of the iPhone. Many of these failed subscribers are now ready to open their relationships to another supplier, in this case, Verizon.
Verizon here is likely to be the beneficiary of a weak win situation. Without the iPhone, Verizon could not pull many of AT&T’s subscribers away from it. The Verizon benefits were not great enough to win market share in competition with AT&T’s iPhone. But, once AT&T has failed some of these subscribers and now that Verizon has the iPhone, Verizon can gain share at AT&T’s expense.
Some of the share shift is almost inevitable now. AT&T probably does not have enough time to get its network upgraded by enough to thwart the loss of some portion of its disgruntled subscribers. This is a fluid situation, though. AT&T was caught unawares by the significantly different patterns of cell phone usage among iPhone users. It’s possible that Verizon will be similarly overwhelmed. That should not be the case since Verizon could see AT&T’s problems. “Forewarned is forearmed”. If Verizon does encounter the same quality problems AT&T has had to face, it will not gain all the customers that it might have gained through AT&T’s current failure. But, in the short term, Verizon is bound to gain share from AT&T’s failure problems.
Tuesday, April 6, 2010
The Math Still Works
Since the year 2000, medical care has increased in cost by 49%. Food is up 32%. But automobiles are flat and apparel is down 8%. Part of the reason for the better performance of automobiles and apparel has been the extreme stress of competition both of those industries have suffered. But the growth in the cost of medical care pales in comparison with the increased cost of college tuition and fees. That’s up 92% since 2000. (See the Symptom & Implication, “The industry has been able to preserve margins by increasing prices” on StrategyStreet.com.) All of this data comes by way of the Bureau of Labor Statistics.
Some people are beginning to question whether the cost of a college education justifies the benefits. It appears they do. The average college graduate with a Bachelors Degree earns about $53,000 a year. In real terms, that’s down 1% since 2000. The average high school graduate earns about $33,000 a year. This figure is also down 1% in real terms since 2000. Clearly, the costs of college tuition and fees have gone up enormously compared to slight declines in the earnings of college graduates. Still, the difference in annual earnings is slightly over $20,000 a year. The average state school probably charges something on the order of $10,000 a year for tuition and fees. A private school would charge considerably more. Some are just crossing the $50,000 a year threshold for tuition and room and board. So, the cost of a college education, without counting opportunity costs of foregone working income, range between $40,000 and $200,000. The college graduate, then, makes up that cost with improved earnings over the high school graduate in as little as two years, or as many as ten. Even if you discount the difference in future earnings, the college graduate is better off well before he or she reaches early middle age.
The pain of high tuition and fees is just beginning to squeeze. The risk is more likely in competitive supply than it is in customer demand. (See “Audio Tip #130: The Problem with High Returns” on StrategyStreet.com.) Young people are likely to continue paying the cost of college fees and tuitions because they earn it back, even if it takes several years to do so. On the other hand, these rising fees and tuition attract new entrants into the education market. That is where the colleges and universities are likely to feel the pain and suffering that result from thirty years of tuition and fee increases greater than the rate of inflation. They are creating a price umbrella for new market entrants.
Some people are beginning to question whether the cost of a college education justifies the benefits. It appears they do. The average college graduate with a Bachelors Degree earns about $53,000 a year. In real terms, that’s down 1% since 2000. The average high school graduate earns about $33,000 a year. This figure is also down 1% in real terms since 2000. Clearly, the costs of college tuition and fees have gone up enormously compared to slight declines in the earnings of college graduates. Still, the difference in annual earnings is slightly over $20,000 a year. The average state school probably charges something on the order of $10,000 a year for tuition and fees. A private school would charge considerably more. Some are just crossing the $50,000 a year threshold for tuition and room and board. So, the cost of a college education, without counting opportunity costs of foregone working income, range between $40,000 and $200,000. The college graduate, then, makes up that cost with improved earnings over the high school graduate in as little as two years, or as many as ten. Even if you discount the difference in future earnings, the college graduate is better off well before he or she reaches early middle age.
The pain of high tuition and fees is just beginning to squeeze. The risk is more likely in competitive supply than it is in customer demand. (See “Audio Tip #130: The Problem with High Returns” on StrategyStreet.com.) Young people are likely to continue paying the cost of college fees and tuitions because they earn it back, even if it takes several years to do so. On the other hand, these rising fees and tuition attract new entrants into the education market. That is where the colleges and universities are likely to feel the pain and suffering that result from thirty years of tuition and fee increases greater than the rate of inflation. They are creating a price umbrella for new market entrants.
Thursday, April 1, 2010
Yep, Those Germans are the Problem
There has been much press over the last few weeks about the problems in the Euro Zone. Most particularly, we have learned more than we may want to know about the problems of deficit spending in Greece, Spain, Ireland and Portugal. Just recently, though, we may have learned that the problem is not the deficit spending in those recessionary countries. No, the problem seems to be the Germans.
Over the last ten years those nasty Germans have kept the lid on labor cost growth and have jacked up their rates of productivity. (See the Symptom & Implication, “Some competitors automate to become the lowest cost players” on StrategyStreet.com.) These simple actions have enabled Germany to compete on price despite high labor rates and competition from countries in the Euro Zone with nominal lower labor costs. Oh, those countries include Greece, Spain, Ireland and Portugal. Those inconsiderate Germans have produced a Euro 136 billion trade surplus in 2009. Spain, Greece and Portugal ran significant deficits. The Finance Minister of France has suggested that Germany’s export dependent growth model may be causing a lot of the problem in the Euro Zone. Her answer to this problem is for Germany to begin spurring domestic demand. So we see that the problem in the Euro Zone is people who do not deficit spend and who take advantage of all their poorer neighbors who do deficit spend.
This is causing turmoil in the Euro Zone that, in the long run, is almost certainly bad for the Euro. Some countries might have to exit the Euro Zone. Greece has threatened to use IMF resources to continue its deficit spending. The economic disunity in the Euro Zone is creating political disunity as well. There is a question whether the Euro Zone can continue in its present form.
We have similar situations among the states in the United States. The differences are that the states can not threaten to withdraw from the Dollar Zone, nor are they eligible for IMF financing. Our deficit financing states tend to be those with the highest labor costs. As a result, the unemployment rate in these states is higher, often much higher, than that in the country as a whole. In January of 2010, the United States national unemployment rate, as reported by the Bureau of Labor Statistics, showed an average of 10% unemployment in the country. The highest unemployment occurred in Michigan, with a 14.3% rate. Other high unemployment states included Rhode Island, California, Illinois and Ohio. In many of these states, labor costs are not only high, but they are inflexible. Companies can not change work rules, nor adjust rates of labor, to match the current economy. That’s part of the reason that jobs flee these states.
In the Euro Zone, German workers have wages and benefits among the highest in Europe. They average Euro 34 an hour, roughly $48 an hour. Recently, the German Metal Workers Union accepted a new contract with very low wage growth in order to protect their jobs in Germany.
Here is a contrast for you. In 2008, the average worker for the “Big Three” automakers earned $73 an hour in total compensation. Workers at Toyota, and other foreign makers, earned an average of $48 in their U.S. operations. These companies have located their U.S. plants in areas where labor is more flexible. The average U.S. manufacturing worker earned something less than $32 an hour in 2008. These labor cost disparities help us understand how Detroit is losing population. Nearly a quarter of its manufacturing jobs have left. The city suffers from a 50% unemployment rate. Detroit’s woes certainly have contributed to Michigan’s nation-leading 14.3% unemployment rate. But isn’t some of this woe self-inflicted? Why can’t domestic automakers make cars in the U.S. for $48 an hour?
The German unions have learned that they can sustain their high rates of pay only so long as they help their companies become more productive with every hour of labor. The workforce shares a large portion of the improvement in productivity. (See “Audio Tip #187: The Components of Productivity” on StrategyStreet.com.) Apparently, at least one of our leading labor unions does not share that calculus.
Over the last ten years those nasty Germans have kept the lid on labor cost growth and have jacked up their rates of productivity. (See the Symptom & Implication, “Some competitors automate to become the lowest cost players” on StrategyStreet.com.) These simple actions have enabled Germany to compete on price despite high labor rates and competition from countries in the Euro Zone with nominal lower labor costs. Oh, those countries include Greece, Spain, Ireland and Portugal. Those inconsiderate Germans have produced a Euro 136 billion trade surplus in 2009. Spain, Greece and Portugal ran significant deficits. The Finance Minister of France has suggested that Germany’s export dependent growth model may be causing a lot of the problem in the Euro Zone. Her answer to this problem is for Germany to begin spurring domestic demand. So we see that the problem in the Euro Zone is people who do not deficit spend and who take advantage of all their poorer neighbors who do deficit spend.
This is causing turmoil in the Euro Zone that, in the long run, is almost certainly bad for the Euro. Some countries might have to exit the Euro Zone. Greece has threatened to use IMF resources to continue its deficit spending. The economic disunity in the Euro Zone is creating political disunity as well. There is a question whether the Euro Zone can continue in its present form.
We have similar situations among the states in the United States. The differences are that the states can not threaten to withdraw from the Dollar Zone, nor are they eligible for IMF financing. Our deficit financing states tend to be those with the highest labor costs. As a result, the unemployment rate in these states is higher, often much higher, than that in the country as a whole. In January of 2010, the United States national unemployment rate, as reported by the Bureau of Labor Statistics, showed an average of 10% unemployment in the country. The highest unemployment occurred in Michigan, with a 14.3% rate. Other high unemployment states included Rhode Island, California, Illinois and Ohio. In many of these states, labor costs are not only high, but they are inflexible. Companies can not change work rules, nor adjust rates of labor, to match the current economy. That’s part of the reason that jobs flee these states.
In the Euro Zone, German workers have wages and benefits among the highest in Europe. They average Euro 34 an hour, roughly $48 an hour. Recently, the German Metal Workers Union accepted a new contract with very low wage growth in order to protect their jobs in Germany.
Here is a contrast for you. In 2008, the average worker for the “Big Three” automakers earned $73 an hour in total compensation. Workers at Toyota, and other foreign makers, earned an average of $48 in their U.S. operations. These companies have located their U.S. plants in areas where labor is more flexible. The average U.S. manufacturing worker earned something less than $32 an hour in 2008. These labor cost disparities help us understand how Detroit is losing population. Nearly a quarter of its manufacturing jobs have left. The city suffers from a 50% unemployment rate. Detroit’s woes certainly have contributed to Michigan’s nation-leading 14.3% unemployment rate. But isn’t some of this woe self-inflicted? Why can’t domestic automakers make cars in the U.S. for $48 an hour?
The German unions have learned that they can sustain their high rates of pay only so long as they help their companies become more productive with every hour of labor. The workforce shares a large portion of the improvement in productivity. (See “Audio Tip #187: The Components of Productivity” on StrategyStreet.com.) Apparently, at least one of our leading labor unions does not share that calculus.
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