The Motor Industry: Prescient, Prudent or Profligate?

image_pdf

2016 Global Revenues from Film, Music and Video Games

Ted Levitt, former Professor of Marketing at Harvard, coined the term ‘Marketing Myopia’ in 1960 to describe how an established business can fall into the trap of focusing on its own goals rather than its customers. So, over time, it can miss emerging market opportunities and possibilities.

Since the 1980’s the US film industry has broadly ignored the video game industry. In 2016 the gross revenues from video games at $101BN were more than double those of films, $49BN. Why did film makers not produce video games? Levitt might say, ‘marketing myopia’.

Closer to home, lack of openness towards other ‘ways of doing things’ has been blamed for the loss of market share by American car companies to Japanese brands during the 1980s. It was only after significant expenditures in research, re-training of the workforce, and redesign of production systems, that the industry partially regained its former market positions in the 1990s.

But, maybe car and film-makers were prescient? After all, they’re still here making profits. Or, perhaps, they were they profligate? Throwing good money away on yesterday’s product and production ideas. Or, maybe they were they prudent? They’re still here doing what they know. Smaller but still profitable.

In 2020, the question to vehicle makers and their dealers is this: Are they are in or out of sync with the needs of their customers? The customers are talking a lot about the environment and how it’s changing. If they are out of step…and stay that way…  wont they eventually lose their place in the market? Why could that happen and how should they car makers and dealers remedy the situation?

What is ‘sustainability’?

The impacts of environment degradation, pollution and global warming have driven the  desire for end-to-end sustainable products for the last half-century. More recently, heightened awareness of global environmental constraints has strengthened policy support for electric vehicles (EV’s) and spurred a deeper analysis of the automotive industry business model. The auto business has not been singled out for special persecution. Energy, food production, aerospace and even fashion too are all at the forefront of public attention.

2015 Updated Results of Ricardo and UK’s Low Carbon Vehicle Partnership Study, 2011

Many of us know that a US gallon of unleaded petrol  produces about 20lbs of carbon dioxide – around 9 kilos – as it’s burnt in a conventional internal combustion engine. For diesel its around 22.5lbs, 14% more. But tailpipe emissions are only one part of the environmental burden of burning fuel. To compare technology options the environmental effects of a product’s entire life cycle need to be measured. That approach spawned the idea of environmental constraints: the view that humans can only exist on this, one planet and that their actions can lead to effects that either constrain or sustain human development. ‘Sustainability’ then emerged out of the constraints idea as a political and social policy framework with three core dimensions: economic, social and environmental.  Peter Wells describes it as a journey towards economic stability, social welfare and environmental equity. As far as he’s concerned the conventional automotive business model fails on all three criteria. Unsurprising, as its business model evolved for a different set of circumstances, a different context and time. Every activity that uses carbon or produces emissions, from agriculture to zoos, are also ‘doing it wrong’. We’re not alone. So, what is that model and how could we make it ‘fit for purpose’ today?

The Traditional Automotive Business Model

The automotive industry might have a mature product and market but it’s far from mature ‘ecologically’. Although it has made significant progress on tailpipe emissions, it has taken few steps to reduce the overall environmental impact of the product. Some of the reason for this lies in the basic automotive business model.

Vehicle makers earn profits through scale economies. In many cases, traditional auto-makers now only produce two key components themselves: the all-steel vehicle body and the internal combustion engine. They orchestrate an array of other bought-in parts to produce the completed and, hopefully, competitive product. The vehicle maker is the focal point for extended supplier networks on the input side, and geographically extensive distribution networks on the output side. Profits are heavily reliant on lowering costs through scale economies created in large, centralised manufacturing facilities which can achieve constant high volume output. Competitiveness is achieved by expanding the market through lowering real prices – giving buyers more for less. Revenues require the continued sale of new cars, and profits growth requires continued expansion of the market. Up to the mid 1980’s, auto makers demonstrated little interest in the environmental and emissions impact of their products after they were sold and, outside their domestic markets, they exhibited little concern for the impact on communities when manufacturing plants were relocated or closed in the pursuit of improved cost economies.

Based on data from Morningstar

The fundamental problem is that vehicle making is insufficiently profitable in relation to the capital invested. To achieve scale economies, plants must operate continually. This in turn leads to over-supply, which in its turn generates discounting, rapid depreciation, and premature scrapping. Reliance upon continued revenue from new car sales means that it’s car finance followed by parts sales that generate the most profits. But, for the model to keep working, it needs increasing numbers of cars to be sold at cost. Add into the mix shorter model lifetimes and concentrated production centres and it becomes harder to recover capital investments while working capital requirements for stock holding drains cash.

In terms of ‘social costs and benefits’, the automotive industry has shifted over time. A century ago, conventional auto manufacturing was an anchor for manufacturing regions. It provided many high-paid, stable jobs and generated significant regional economic benefits. Motor cars provided freedom of movement for millions, widening their choices of jobs, education and, even, marriage partners. But, from the 1960’s onwards, high volume auto manufacturing has often proved to be an unreliable partner for local and regional governments because of its traditional business model. Detroit, Michigan is often cited as a ‘worst case’ where the major US car makers first created and then abandoned the city centre after the 1960’s leading to high unemployment, urban blight and decades of social unrest. The UK’s West Midlands region saw similar unemployment and urban blight following the collapse of UK car making in the 1970’s, plant relocations to new sites, such as Sunderland in the North-East and the levelling of tax treatment for EU car makers in 1978 which led to collapsing sales of UK made products.

How Auto Execs see the future for EU Vehicle Production KPMG 2018

While the unwelcome environmental impacts of conventional cars are well recognised – tailpipe emissions, the manufacturing process – especially

vehicle painting, raw material usage and waste products, disposal of ‘End of Life’ vehicles and vehicle noise to name just a few – there are no ‘cost free’ alternatives yet. Electric vehicles also have environmental costs. So too did the horse and cart. The challenge for auto makers is that the conventional business model, whether making combustion engines or electric motors, generates significant costs for the natural environmental. Over-production of vehicles, ‘uneconomic’ repair and inadequate end of life re-cycling all waste natural resources. Expanding the total volume of cars in use overwhelms any improvements in tailpipe emissions.

How Auto Execs see the future for Dealer networks KPMG 2018

Franchised dealers too, have altered their business model to respond to the falling profitability per unit of the manufacturers. Their top-line sales margins have fallen. In 2017 VW revealed their plans to reduce their 3,000 dealers by 10% in an attempt to double average dealer net profits to 2%. Observers have seen world-wide consolidation as large retail chains emerge capable of funding and managing large-scale dealer hubs. According to KPMG’s 2018 Global Auto Executive Survey , most respondents think that the networks will shrink by 30% 0r more by 2025, as auto makers move into online sales and rationalize their distribution networks. Driving that change in Europe is a widely held expectation of a sharp reduction in EU vehicle production as China and south-east Asia emerge as the world’s vehicle production centre.. Smaller operators have sold up, closed down or have been written out of franchise representation plans. Survivors charge ever escalating finance rates and service prices in the face of shrinking new vehicle sales margins. Those with volume brands in particular have few options given the direction the vehicle makers own business model has developed.

Towards a revised Automotive Business Model?

So, if the existing automotive business model is profligate with resources and sustainability advocates are winning the political argument, what’s the way forward? Probably not ‘business as usual’. If legislators dictate that the use of natural resources must be controlled for the public good i.e. stop producing environmental blight, a fundamental conflict of interest would arise for auto makers, whose goal is to maximise shareholder value, often by maximising economic growth. This would leave their managers – and those in other industries that use natural resources – in an unenviable position. Keep in mind that climate activists have already convinced many politicians that an unsustainable industry cannot make a sustainable product, even if there is not yet a realistic alternative available.

Braden Allenby, co-author of ‘Industrial Ecology‘, proposed three principles that could help auto-makers and legislators redefine a company to chart a

path to a more sustainable business model.

Industrial Ecology by Graedel & Allenby

First, recognize that there is an inherent conflict between the goal of auto-makers and the requirements of sustainability. Accept the historical truth that auto-makers will meet the minimum legal requirements and evolve their organizations in response to technology and market developments, but the profit motive will remain their primary goal. If legislators focus on setting very strict limitations on the use of natural resources and environmental impacts, coupled with incentives for achieving them, auto-makers will find ways to exploit technology to meet ever rising minimum conditions. By retaining the primary profit motive, auto-makers will grow by eliminating or incorporating weaker rivals.

Second, to achieve the transition to new types of vehicle and a new business model, the rate of technological change must accelerate. Auto-makers and their supply chain will be the prime source for new technological ideas and their diffusion. Visions may come from universities but change will be delivered by the corporations. The task of legislators is to define rules that incentivise steps towards sustainability. The task of activists is to keep legislators moving forward and to help change public opinion. That in turn will change market demand.

Thirdly, change the control system by introducing KPI’s that raise awareness of environmental impacts of specific products, from cradle to grave. This forces auto-makers and consumers to consider external costs beyond initial product and service prices. The tools are well known – Life Cycle Analysis (LCA) and Design for Environment (DFE). However, most firms will only act on the results if there is a clear market and financial advantage, so results must be public and incontrovertible. Add into the mix ‘End-of-Life’ take-back policies which return some of the external costs to vehicle users and auto-makers.

Allenby cautions that the transition will not be easy. New technology is often spread through new firms, not old-established ones. But the transition requires that large firms are in place to make the change quickly and with the scale to implement globally. Start-ups just can’t deliver that. Government regulations are often rigid and can stall change rather than foster it. Bureaucratic regulators are not renowned for innovation and flexibility. They’re almost always behind the curve of change, not ahead of it. Developing and diffusing new technology requires experimentation.  How will companies achieve this in a regulatory environment “imposed by a public that is, for all intents and purposes, technologically and environmentally illiterate”. His words, not mine.

Not everyone agrees that the model is broken at all. Consultancies with large automotive practices and would-be service providers, such as Ericsson, argue that the automotive business can follow a ‘business as usual’ approach, if they just get ahead of the pack in connected cars or e-mobility. I hope that they’re right but I fear that they aren’t.

image_pdf