The Japanese Pay the Price

The figures are in for U.S. auto sales in 2010. The biggest winners in percentage growth were Hyundai, at 24%, and Ford at 20%. Toyota lost .4% and Honda grew a mediocre 7%. The Japanese struggled in 2010.

Earlier we wrote a blog about Ford’s ascendency and Toyota’s problems (see Blog HERE). Toyota is paying the price for failing its customers. Honda appears to be getting painted with the “failure” brush, though I doubt its punishment is deserved.

I am actually using the word “fail” to mean something specific here. A company fails its customers when it is unable or unwilling to do something that at least half of its competitors can, or will, do for customers. Toyota’s troubles with accelerators, floor mats, and so forth, received extensive media coverage. This coverage clearly has had a negative impact on Toyota this year.

Toyota’s struggles illustrate the win and fail dynamic. In our terms, a “win” occurs when a company is able to do something that the majority of its competitors either can not or will not do. Wins account for a good deal of market share growth in a fast-growing market, but are less important in more mature markets. In a more mature Stable market and, especially, in all Hostile markets, failure moves a significant amount of market share.

Here is what this means. The decision to change a supplier is really two decisions. The first is the decision to leave a current supplier and the second is the decision on which new supplier to take on in your relationship. In the average Stable and Hostile marketplace, more market share moves on failure than on wins. This means that before an established customer will change suppliers, its current incumbent supplier must “fail” the relationship in some way. This failure, then, opens up the customer’s relationship to competition among other potential suppliers. Whichever supplier gains this customer’s volume really did so only after the incumbent failed. We call this gain a “weak win.” The “weak win” would not have happened on a straight-up comparison of performance and price of the new supplier versus the old. The gain only happened after the incumbent clearly failed the customer and then opened the relationship to someone new.

Toyota’s failure was largely a failure of Reliability. It clearly lost share. The companies that gained this share from Toyota, Ford and Hyundai among them, enjoyed some degree of a “weak win” in the domestic automobile market. They may have “won” market share as well, but my guess is that most of their share gains from Toyota fell to them from Toyota’s “failure.”

Situation Bad...About to Get Worse

Over the last year, the U.S. government spent $80 million to prop up General Motors and Chrysler. The intent was to save millions of American manufacturing jobs. The benefits seem to be temporary, at best.

Both Chrysler and General Motors are reducing manufacturing capacity in the U.S. and shifting some of that capacity to Mexico. Over the next decade, Mexico is scheduled to gain most of the GM and Chrysler North American production that is discontinued in the United States. The reason isn’t hard to see. GM and Ford workers in the U.S. earn about $55 an hour, including benefits. The same workers in Mexico earn something less than $4 an hour.

Some in the government are upset about GM and Chrysler opening more facilities in Mexico, while U.S. facilities close. These people simply do not understand global economics. If GM and Chrysler keep their production in North America, all that will happen is that GM and Chrysler, backed by the U.S. tax payers and current shareholders, will pay for the excess wages that the domestic UAW employees now earn. If GM and Chrysler do not move their production facilities to places where costs are lower, other companies will do it for them and take their market share with better cars and lower prices. This has been the scenario for the domestic automobile manufacturers for the last twenty years.

No matter what the U.S. members of the UAW choose to do, their future is going to get worse. (See the Symptom & Implication “Foreign competitors are expanding with low prices” on StrategyStreet.com) Workers in other countries can simply make automobiles cheaper than they can. Chennai, India is a good example. In 2010, this city will produce 1.5 million automobiles. That is well in excess of 10% of the U.S. domestic demand and more than any U.S. state produces. Many major automobile manufacturers have a presence in Chennai.

The investment there is growing much as it is in Mexico. Hyundai, Ford and Nissan are each investing heavily in facilities in Chennai. Hyundai can now produce 650,000 cars a year there. Nissan can produce 400,000 cars annually. This new capacity is coming into a market that already has significant overcapacity in global production facilities. When new low-cost competitors enter the marketplace, they squeeze out the high-cost competitors. Who are the high-cost competitors? Watch where facilities are closing. Oh oh, that seems to be the U.S., where the UAW is holding a significant price/cost umbrella over its low-cost worker competitors, among whom are the Indian and Mexican workers in this story.

This will not have a pretty ending for the United Auto Workers, neither for those working nor for retirees.

Here We Go Again

The leader of the United Auto Workers is retiring. He is leaving a union under siege. By 2009, UAW membership was about half of the level of 1995. The union has hemorrhaged members as the big three domestic automobile producers have shrunk in market share, lost billions of dollars, and closed plants.

The departing leader of the UAW claims that the industry’s difficulties never rested with the union and its rich contracts. In his view, the crisis that led to the bankruptcies of GM and Chrysler and the near bankruptcy of Ford was strictly the result of an unexpected spike in gas prices and a recession that resulted from the mortgage crisis. He believes that the fault lay not with the union and not with the industry. Following this belief, he is encouraging his successor to begin clawing back the cost-cutting concessions that the union has granted the Detroit big three domestic automobile manufacturers now that these companies are moving toward profitable operations.

The problem is that these concessions did not do enough, at least from the results they seem to have produced. The concessions really got underway in 2003, as the union reduced its wages and benefits and transferred retiree healthcare costs from the automakers to an independent trust. Despite these concessions, union membership fell parabolically from 2003 to 2009, right along with the profits in the big three. In the meantime, German and Asian manufacturers continued to be profitable. These profits included profits in U.S. domestic manufacturing facilities as well. (See the Symptom & Implication, “Some industry leaders have lower returns than the smaller competitors” on StrategyStreet.com.)

The union is heading back to trouble and will take its unionized facilities with them. In an earlier blog (See Blog HERE), we described the hourly cost differences in wage rates between a unionized and non-unionized domestic facility. These cost differences are unsustainable in the longer term. No one can expect that an automobile plant with $73 dollar an hour labor will be profitable enough to compete with another domestic plant producing similar automobiles at $48 an hour. Despite recent troubles, the Asian manufacturers still command a premium price over their big three competitors for their products. So, Toyota and Honda get a higher price and produce with a lower costs. (See “Video #1: The Two Best Consultants in the World” on StrategyStreet.com.) Tell me how GM, Chrysler and Ford can produce an equivalent or better car with these economic conditions. The claw-backs will only make things worse.

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.

Reliability in Tough Markets

The stats for the light vehicle sales in the U.S. during the month of February are out. Of course, Toyota’s sales shrank by nearly 9%. The surprising big winner was Ford, whose sales increased 43%, far more than anyone else. Its nearest competitor, Nissan, had a sales increase of 29%. GM’s sales increased by 12%. What may be driving this superb performance from Ford?

We often use the Customer Buying Hierarchy to evaluate a company’s performance against its competitors. The Customer Buying Hierarchy argues that customers buy Function, Reliability, Convenience and Price, in that order. Customers continue to cycle through their alternatives until they have chosen one supplier who offers something important to the customer that no one else offers. As we have noted before, in tough marketplaces, high Reliability is a hallmark of the best industry performers. (See the Symptom & Implication, “Competitors are emphasizing reliability in product quality” on StrategyStreet.com.)

Ford’s reliability is impressive today. (See the Perspective, “Reliability: The Hard Road to Sustainable Advantage” on StrategyStreet.com.) The National Highway Traffic Safety Administration measures the complaints it receives about automakers and their products. Their measure is number of complaints per 100,000 vehicles sold. Honda is the leader here, with about 64 complaints. Ford follows at 81, then Toyota at 91 and GM at 104. So, Ford’s quality seems to be somewhat better than Toyota’s today. That is at least one reason why Ford is in the ascendant, and while Toyota is falling off the pace.

One Up, One Down, One Sideways

Three of the leaders of the automobile industry are presenting some interesting new stories. First, General Motors. The new Chairman of General Motors is Edward Whitacre. He is not a car guy. He came from the telecommunications industry, most recently as Chief Executive at AT&T. The Chairman recently asked the head of engineering at GM to call all the customers who had turned in their new cars under a recent quality program. This program offered customers a 60 day money-back guarantee. It allowed a customer who was unhappy with his automobile to turn it back to GM for a full refund. The head of the engineering group charged with calling the new customers noted that the focus on customer satisfaction was new at GM…and long overdue. This is a hopeful development for GM.

GM, for years, has had a poor reputation for reliability and durability. That problem seems slow to change, as witnessed by the recent quality survey by Consumer Reports. This survey criticized the company’s quality, finding it lower than the models from Ford, Honda and Toyota.

If the new top management attention to quality takes hold of the company, it is bound to improve its fortunes. It should move up with this development.

Fortunately for GM, its main competitor, Toyota, seems to be moving down, at least for now. Toyota became the leader in the automobile industry because of its reliability, but that reputation has begun to falter under the blows of recalls for rust problems and sudden acceleration in several models.

In a surprising upset, Hyundai Motors passed Toyota in J.D. Power & Associates survey measuring how many problems an automobile has in its first three months. A few years ago, Hyundai’s reputation for quality was equivalent to Madonna’s reputation for virginity. However, the Korean company instituted stringent measures to improve its quality, measures that seem to be paying great dividends today with their improved reputation and fast-growing market share. (See our blog on the quality changes at Hyundai HERE)

Ford seems to be moving sideways. On the one hand, its 2009 automobiles are getting good reviews from critics and the marketplace. The company is gaining market share. It also reported its first quarterly profit in four years. So, sideways, you ask? Yes, because Ford has a real problem with its cost structure. In October, the UAW refused to grant Ford the same contract terms that it had previously granted to Chrysler and General Motors. The most important part of the better terms that GM and Chrysler won was relief from the many work rules that restricted the work that an individual employee could do on the production line. These work rules make employees inefficient and idle. They reduce the company’s productivity. Not even Ford can face down a cost structure that is higher than those of its domestic and international competitors. Many of these competitors produce in non-unionized plants in the U.S., where work rules do not hinder productivity.

So, Ford is heading sideways until we see what it does to overcome this cost disadvantage. If the company follows the old GM approach of cheapening its fits, finishes and styling, it will lose market share and plunge into big losses. If, on the other hand, the company maintains the style and quality of its new cars, then it has a chance to address its longer term cost problems in ways that might be somewhat less disruptive to the UAW. (See the Perspective, “Achieving the Low Cost Position” on StrategyStreet.com.)

Ford’s situation is not promising. Many industry leaders, when faced with high and fixed labor costs in their industries, cheapen their products in order to eek out some profitability in the short-term. This always hurts them in the long-term. (See “Video #54: Cost Reduction by Winners vs. Losers in Hostility” on StrategyStreet.com.) The plight of the legacy airlines serves as an ample reminder of this tendency and its results.