Analysts have warned that the Big Three vehicle makers have to examine and adapt their business models, or risk losing even greater market share to non-American OEMs

There is a major problem in North America: the business models of the Big Three need to be adapted or they face further doom and gloom. The shape of the industry is changing as companies other than Ford, Chrysler and General Motors capture market share and invest in new plants, away from traditional manufacturing locations.

Suppliers who have historically depended on the Big Three for most of their business are suffering too. Does the situation warrant any reason to be optimistic? The vehicle-making industry is changing enormously and in the long term, things could look decidedly more positive.

New business model is necessary

In their book, “Time for a Model Change: Re-engineering the Global Automotive Industry” (Cambridge University Press, 2004) renowned automotive industry analysts John Wormald and Graeme Maxton argue that if vehicle makers did not change their business models, they would face ‘graceless degradation’. This is described as a long-term state of rumbling pain, with a gradual slide downwards; it could have been avoided if positive (albeit painful) steps had been taken towards a new business model.

‘Graceless degradation’ is a fitting term for what the Big Three are going through now. Dr Wormald believes that these carmakers have consistently failed to adapt fully to changing demands. He claims Detroit was renowned for poor quality, and then, according to him, OEMs were forced to downsize to meet corporate average fuel economy (CAFE) regulations. “They found a way out in the light truck market that saved them financially, but this turned out to be a blind alley,” says Dr Wormald.

“Now the OEMs are trying to move back in to the car market with crossovers, but the Japanese brands are still on the rampage – it’s a struggle to regain share,” according to Dr Wormald. He claims that the American OEMs have fixed their quality problems, but they still don’t have the ruthless kaizen approach of their Japanese competitors – “and this has left them quite vulnerable.” A focus on product has not been the solution though. “GM hired Bob Lutz to develop exciting new products, but this does not solve the fundamental manufacturing and inefficiency problems,” he adds.

Furthermore, 75 per cent of the value of the car comes from suppliers, and North American supplier relations are among the worst in the world. “Chrysler was getting much better at this, and then Daimler came along and started beating suppliers over the head for cost reductions again,” according to Dr Wormald. He says the difference in approach to suppliers between Toyota and GM for example, is vast, and should not be under-estimated. Toyota communicates to suppliers what it wants to achieve and asks them to suggest how they might meet engineering, design, quality, cost and delivery criteria.

Getting the best out of suppliers

The Japanese carmaker will then work with a supplier on pre-development, which means that by the time it comes to detailed engineering, the work is more predictable. GM on the other hand, Dr Wormald suggests, fails to get the best out of suppliers. Contracts are usually won on paper, and then when the vehicle maker demands changes during the engineering phase, suppliers remove costs elsewhere to make the project financially viable for them. “The GM approach is embedded in an adversarial culture that is only found in America,” says Dr Wormald.

Because of the poor state of the industry, 2007 could be a pivotal year for the Big Three. Despite low margins there is considerable investor interest in the automotive industry. “The key challenge for OEMs is maintaining investor confidence as the industry undergoes transitions, with massive consolidations,” says John Monk, director of consultancy autopolis.

He believes that as 2007 was forecast to be flat, it will be important for vehicle makers to maintain their market share while keeping to these minimum profitability targets. Jeff Schuster of JD Power & Associates is of the opinion that annual contract negotiations this year will be pivotal, given the state of the industry and, in particular, of the Big Three. GM and Ford won some healthcare concessions from the United Auto Workers (UAW) union last year, but Chrysler did not – a fact that Chrysler management claims has contributed to the company’s worsening financial situation. In 2006, unions gave major concessions for the first time and this set a different tone to the relationship between management and unions. “Union leaders recognise that the threat of plant closures is not just propaganda. For ‘survival’ there has to be concessions and collaboration,” says Schuster.

The adversarial character of business and industrial relationships in Detroit is characterised in the relationship between the UAW and management at the Big Three. But the union has a very clear understanding of the problems facing vehicle makers and what they need to do, argues Laurie Harbour-Felax, of manufacturing consulting firm Harbour-Felax Group. However, she emphasises that unions themselves are not the problem. “They will drive a hard bargain because that is what their members want them to do, but they also want management to step up to the plate.”

What the unions really want

Not all commentators believe that union negotiations are as important this year as they have been in the past. John Monk says that smooth negotiations will assist both sides in meeting necessary accords for their futures, but he does not see this as a trouble spot for 2007. This year will be characterised by, among others, more concessions and greater flexibility in working arrangements. Most Detroit firms still use complex systems of restrictive work rules that govern the jobs a worker can and cannot do. In return, unions are looking for job security for their members, and to aim to preserve as much of their retirement and healthcare benefits as possible. Certainly, they will not be looking for increases to pay packages.

Carbon dioxide emission is not such a major issue in North America as it is in Europe, but fuel economy is.

Arguably, this is essentially the same thing by another name.

According to Sarwant Singh, a partner at industry analysts Frost & Sullivan, the biggest challenge in North America concerns fuel economy. “There is a shift in America towards smaller vehicles with smaller engines,” says Singh. Demand for petrol-guzzling SUVs, the most profitable product lines for the Big Three, is sliding, and will continue to fall, according to Singh.

Last year, Frost & Sullivan conducted a survey of consumers which examined the impact of high fuel prices on new vehicle purchase decisions. Over 60 per cent of those surveyed said that they would consider purchasing a more fuel-efficient vehicle if fuel prices continued to rise.

DaimlerChrysler’s own research showed that fuel economy was the fourth most important aspect in vehicle buying decisions in 2006, up from ninth a year earlier and eleventh in the 12 months prior to that.

Increases in corporate average fuel economy standards are being threatened. The Big Three are baulking at a proposed four per cent year-on-year increase, but according to Jeff Schuster of JD Power & Associates, a compromise is likely.

The main goal that seems to be driving legislation and the marketing of vehicles with alternative technologies is the goal to reduce US demand for oil by 20 per cent in the next decade. This is a presidential initiative and one that the Big Three have responded to in recent years by offering flexible fuel vehicles that can run on bio-fuels. Despite environmental concerns that the production of bio-ethanol uses an immense amount of land, which would otherwise be used for food production, there is a big shift towards bioethanol in America.

New products may help regain market share

Sixty-two new vehicles are being introduced during 2007 alone, according to Jim Press, President of Toyota Motor North America. He mentioned this figure during the Society of Automotive Analysts Conference in Detroit at the beginning of this year. This unprecedented level of model activity reflects the fact that Japanese carmakers are broadening their new model ranges and developing products to fit all segments of the North American market.

The Big Three have also been using platform strategies to expand their model ranges. As a result, competition for market share is fierce.

JD Power & Associates forecast that GM will continue to lose share but at a slower pace. “Towards the end of the five-year forecast horizon, GM’s share should start to level out,” according to Schuster. The main reason is the carmaker has had some success with new products. “The industry buzz surrounding GM is positive,” he adds. One successful programme is the mid-size Lambda platform models – crossover models which include the GMC Acadia, Saturn Outlook and yet-to-launched Buick Enclave. “The market has taken well to the products launched thus far, and that programme is key to GM’s future,” is Schuster’s opinion.

These models should help GM maintain customers who are thinking of downsizing their vehicles in the next few years. The company’s strategy for the emerging crossover market has been to watch developments and get the products right. “GM entered the crossover market a bit late, but it took advantage of the situation by creating products that are now having great success,” says Schuster. The outlook on Ford’s market share is not so optimistic.

“We do not see Ford bottoming out over the next five years,” says Schuster. “The company has not progressed far enough in its restructuring, which means there is greater uncertainty, and we are expecting its market share to continue downwards.” Is Alan Mulally having any influence yet? John Monk of autopolis believes that although Mulally is the right person for the job, “Unfortunately, the auto industry is a unique culture and it will take him a little time to get things going. From a quality and product development perspective, we are already seeing his influence throughout the organisation.”

Ford is also relying on crossovers to get it out of its current fix. Its new Flex crossover, a large model based on the Fairlane concept shown at the 2005 Detroit Show, will be used to replace its minivans, and will be built in Oakville, Ontario, at a rate of 100,000 units a year from September 2007. The programme – codenamed D471 – has been accelerated through product development to help replace ageing products. A Lincoln version is also expected.

Restructuring at Chrysler has been on hold for several months while it was sold off. Prior to its sale to private equity firm Cerberus Capital Management – announced in May – JD Power & Associates had pinpointed the main risk at Chrysler as being too much overlap between product ranges. “There was a lot of cannibalisation between products and brands,” says Schuster. What went wrong at Chrysler?

According to John Monk, “Few mergers and acquisitions deals really work, and the DaimlerChrysler deal had its struggles from the start. To transform the Chrysler-AMC culture with Mercedes was not correctly measured and accepted. Actually, Chrysler has always been a forward thinking organisation and considered fairly lean compared to its competition. I would say the frequent changing of the guards while implementing a new corporate culture was difficult for both sides of the organisation.”

The Big Three still lag in manufacturing

Manufacturing efficiency remains a fundamental problem for the Big Three, according to Laurie Harbour-Felax of Harbour-Felax Group. In a recent report entitled “Automotive Competitive Challenges: Going Beyond Lean,” she wrote: “GM, Ford and Chrysler lag behind in many key areas – product engineering, manufacturing flexibility, labour practises, supplier relations, steep price discounting, unfavourable currency exchange rates, and high costs of health care and pensions – that still adds up to an uncompetitive overall business model.”

Haven’t these carmakers made a lot of investment in new flexible manufacturing plants? “They have made a lot of progress, but they started much later and they had many operations to transform,” says Harbour-Felax. The Big Three have high volume products that were making full use of capacity at plants, which led to a successful one-model-perplant policy. There simply wasn’t the need for such flexibility.

“There was a different approach in process engineering which didn’t grasp flexibility as readily as the Japanese, partly because they didn’t need flexibility as much as the latter,” wrote Harbour-Felax

Harbour-Felax argues that the Big Three remain dangerously uncompetitive in profit performance. The main reason is that the manufacturing solutions they are implementing haven’t yet become “routine, disciplined and universally understood aspects of their business practises and corporate cultures.” Structural issues are the main reason. For example, while GM, Ford and Chrysler are failing to achieve a profit from vehicle sales, they are also offering the highest incentives.

In flexibility, GM has made enormous progress. Because it has a diverse range of brands, it produces more models per platform than any of the other major six American manufacturers. Toyota is playing catch-up. However, GM is at the bottom of the scale as regards volume achieved per model. Toyota is at the top, even in the forecast for 2012 when it will have more models per platform.

Toyota is also at the bottom of the ranking on models per plant. The carmaker rarely produces more than one model at each US plant. GM is now producing, on average, more than two models per plant. These are traditional productivity measures that appear to contradict conventional wisdom. The contradiction is that when Toyota needs new capacity, it builds a new plant to meet demand.

It is replacing imports with domestic demand so it knows the plants will be filled. Toyota can respond to the market by scaling up or down imports as needed. The plants in Japan are flexible thus the plants in America don’t need to be.

Saving money by using standard components

The carmaker is striving to achieve commonality by means other than using shared platforms. Toyota estimates that it has saved $8 billion (€6.01 billion./£4.06 billion) over the past five years by finding ways to use standard components – such as fasteners, bearings and airbags – in a wide range of vehicles. Toyota is also working to reduce the costs of highvalue components such as brake and suspension systems by 30 per cent, by sharing product development across models.

The Big Three are starting to do this by discarding “product development systems that stood in the way of rationalising use of these across product lines.”

Restructuring processes of the Big Three have had a profound effect on the North American supplier industry.

“The supplier industry is now going through dramatic changes . . . and only the suppliers that are accepting this change will survive,” says John Monk of autopolis. Certainly some suppliers are benefiting while others are struggling to survive. “Survivors will enjoy larger production volumes with longer contracts, but must accept lower prices per unit,” wrote Felax.

Felax added that “The troubled suppliers have many things in common: poor manufacturing performance, weak leadership and a lack of engineering process.”

The future is not bleak

Despite the severe problems there are reasons to be optimistic for the Big Three. “There are some good signs within the Big Three that will assure their market positions and recovery. Most are working vigorously on their recovery. Perhaps we have not seen this type of sweat and collaborative team work in 20 years. Certainly, with the help of the supply base (now dominated by investment communities), the industry is quickly changing,” is John Monk’s opinion. Laurie Harbour-Felax is also optimistic. She does not think any of the Big Three will go bankrupt.

“The issue now is one of execution – they know what they need to do,” said Felax.

Generally, most analysts are optimistic about GM. “Rick Wagoner is doing a remarkable job for what he has been dealt,” says Monk, and adds, “No doubt, GM will survive and rebound as one of the few leaders. It has GM has plenty of mass and has an apparent need to gain further partners.

The company needs to simply continue to focus on product and market share.” For Ford, it is a matter of time – CEO Alan Mulally is making a difference, but this will take time.

Harbour-Felax believes the carmaker’s biggest problem is product,” The jury is out on Chrysler. Moving away from short-term challenges, the companies that survive long term are likely to be those that change over smoothly to new vehicle and powertrain technologies, which have less impact on the environment. With the raft of changes needed to do that gradually, that is in tune with the market and companies need to go beyond lean. There are still many question marks over whether the Big Three can achieve that.