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.”

But Can You Control Other Entrants?

The United Autoworkers (UAW) is on a new campaign. The union plans to organize workers in hither-to non-union foreign-owned automobile plants in the United States. This campaign may or may not work, but in the long run it will prove futile unless the union can compete in the international market, against all international auto workers.

There are 575,000 autoworkers in the U.S. Nearly 20% work for foreign-owned plants. All of these plants are non-union. The foreign-owned plants were intentionally placed in right-to-work areas, many in the South.

The UAW is likely to have some difficulty succeeding with this campaign. The non-union workers already earn highly competitive wages and benefits. To date, these U.S. workers in plants owned by Toyota, Volkswagen, Hyundai and Honda have shown little interest in unionization.

Why would the union be so interested in this initiative? To preserve its membership. The traditional problem with unions is less the rate of wages they demand and more about the work rules they impose. These work rules reduce the productivity of the unionized plants. That has certainly been the case in the U.S. auto industry. As a result, the UAW is losing membership as UAW auto plants in the U.S. close under the onerous costs the UAW plants carry. If the union can succeed in unionizing the domestic foreign-owned auto plants to the same extent they have unionized the domestic manufacturers’ plants, they will be able to impose the same work rules and produce roughly the same productivity. The result should, in the union’s eyes, be a reduction in the rate of jobs lost in the union.

But there is a problem here. The UAW has already seen that it was unable to stop new non-union plants in the U.S. How will it stop future non-union domestic plants? O.K., let’s say they can do that. Will they also be able to stop all foreign non-union plants from becoming established and growing? Certainly not. Unless the union membership can compete on an international basis with competitive costs and productivity, this unionization effort is wasted money. If it succeeds, the U.S. loses more plants to plants located offshore. Union membership still falls.

It seems that one of the problems for unionized employees is one of definition. Union members often call their compatriots in competing companies “brothers and sisters.” These are certainly not brothers and sisters. In a marketplace they are competitors. Union employees have to be able to beat, or at least stalemate, these competitors or lose their jobs. This is true as long as the UAW can not control the entrance of other less expensive competitors, either in the U.S. or elsewhere.

The long history of the DRAM semiconductor market illustrates this. The U.S. manufacturers of DRAM semiconductors faced intense competition from the Japanese in the 1980s. The domestic industry succeeded in slowing the Japanese by using the International Trade Commission. Then arose new and equally troublesome problems. These problems were DRAM semiconductor facilities in Taiwan and Korea. Eventually, the U.S. industry evolved to the point where it had only one domestic producer of DRAM chips. Intel was one of the early competitors to get out of that market to focus its resources in the more complex, and much more profitable, domestic micro-processor business. SX4MBURBCAJQ

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.

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.