Friday, 4 May 2012

Industry Practice - Global VMs (Part 3) – Down-Shift Products to Scale-Up Volume & Profitability.

In contrast to the high PR impact, but low financial 'value-added' of innovative cars like the GM Volt Nissan Leaf or BMW i3, investment-auto-motives has sought to re-prompt previous strong debate about 'low cost' and 'ultra low cost' NPD and product actions, amongst both the investment community and its intersect with auto-sector.

'Far-horizon' high innovation products – typically EVs and (ICE generator “range extending”) RE-EVs – fill the pages of life-style magazines, TV advert slots and web-pages, extolling an ecological utopian future and 'halo-effect' over a brand. However, in stark contrast, the fundamentals of business and economic reality dictates that mainstream vehicle producers actually focus a far far greater portion or R&D and development budget and innovative focus toward the far less 'sexy', but singularly important, topic of cost.

Thus Far...

Part 1 explained the basic premis of global 'product convergence', itself a consequence of the reducing wealth divide between (largely western) post-industrial / advanced industrial countries and the advancing industrial countries across the globe.

In short, constrained consumerism in the west contrasted with expanding consumerism elsewhere has created a general 'purchasing parity convergence' effect. To react to this more price sensitive yet far larger global market, major VMs have sought to create more affordable passenger cars, which in turn places 'cost-down' new product development (NPD) initiatives high on the corporate strategic agenda. The outcome has been new interest in the idea and execution of the contemporary 'low cost' car, consisting of the 'recycling' of primary vehicle systems, NPD de-costing efforts and product 'de-contenting' to provide budget motoring solutions.

Furthermore, the previously ignored 'bottom-tier' of global society is increasingly explored by progressive enterprise, so as to reach into a millions / billions strong global market-place whilst also depicting corporate social responsibility.

Part 2 illustrated such attempts with the three influential case studies of: 'micro-pack retailing', the (supposed) '$20 laptop' and 'micro-finance' credit programmes. Yet whilst each has enthralled the ranks of middle management, the reality is that to date each has incurred very real business case hurdles; these born from the reality (not theory) of the 'bottom-tier' environment.

Nonetheless, a few visionary industrialists in EM regions strive onward, India given its massive yet largely poor population a prime arena. TATA Motors' Nano the poster-child of an industrial movement which takes the ideology of the 'low cost' further still, toward the 'ultra low cost' car. Bajaj Auto also having conceptually developed an aesthetically less sophisticated city-car directed at its and competitor's (ie Force Motor's) rickshaw drivers.

Although described by investment-auto-motives, the TATA Nano deserves meaningful investigation by the auto-industry, investors and business/industrial academia alike. Cynics may view the prime intent of the car programme to substantially minimise development and manufacturing costs under the banner of an ethical edict. Then at launch raising the product's price, starving the market of entry-level vehicle volume and over time raising the average / median product price to a trends-led (critically middle class) marketing influenced consumer as additional 'content' (ie specification features) are built onto the base car, thus spawning additional substantially higher priced model variants. The real intent to supplant the entrenched and massively popular Maruti 800. Nano project supporters would conversely highlight that the mission of mass-motoring is still on track – even if those real-world 'bottom-tier' headwinds hurdles do pose problems in the near-term. They cite that Nano's launch price increase the inevitably result of input costs inflation, with little left to financially squeeze from the car itself, and that the provision of more variants will ensure that the low utilisation rate of the Nano factory will be improved to in turn lower unit costs and so provide flexibility for medium-term return to the promised “1 Lakh car”.

Thus we see that for strategically well placed corporations such as TATA – typically indigenous to a large EM market with a massive conglomerate capability (like past examples of Toyota in Japan and Hyundai in S.Korea) - the 'ultra low cost' business model, when perfectly constructed, is a very attractive proposition. It will muster national popularity and draw world attention, which polishes the corporate name, it provides a rational by which to engage suppliers in R&D and strongly negotiate supplier pricing structures, and so provides valuable route toward a very low cost product solution. One which gives the foundation of a much reduced 'cost-floor' upon which which layers of unit profit-margin can be built.

Part 3 -

So far, investment-auto-motives has explained the macro-level (PESTEL) shifts and micro-level (auto-sector) replies by comparing the modern notion of the 'low cost' car and the 'ultra low cost' car; which to re-iterate are distinctly different creatures

The 'low cost' car intrinsically important to globally established multi-national VMs - whether self-marketed or by way of a joint venture agreement. In the JV case, a strong commercial proffering to those large, high-potential and so understandably self-defensive BRIC nations; illustrated by VW-FAW, VW-SAIC, GM-FAW, GM-SAIC, Dongfeng-PSA, Changan-Ford, and GAC Group's affiliations with PSA, FIAT, Honda, Toyota, Mitsibushi & Isuzu and so many other Chinese couplings. Russia of course touts the Renault-Avtovaz relationship to help modernise its sector.
With very probably PSA seeking new JV agreements across MENA and the CIS regions as political and socio-economic stability increases; and quite possibly a new similar (though retrograde) JV structures inside Argentina if it seeks to continue its nationalistic ferver.

The 'ultra low cost' car thus far, though attempted and often failed by private enterprise (eg AFRICAR) is largely the ideology and domain of the indigenous EM auto-maker – either established or new - in support of a national economic agenda seeking to generate a substantial medium to long-term growth. This to be achieved partially through a 'productivity-push' itself linked to formulaic wage increase (ideally during an inflationary period ) to create an internal-market demand (akin to Ford's landmark “$5 per day” initiative), and partially through broader policy and socio-commercial efforts to financially integrate what is presently a very fragmented socio-economic 'bottom-tier'. (One such effort being Kenya's M-PESA scheme, in which local shops act as banks' deposit-taking agents and the personal mobile phone acts as a payment transferral device).

Two Very Different Routes -

Both new product development strategums form what could be described as powerful 'investment magnets', yet as demonstrated, the business model each incorporate must be considered 'poles-apart' and could be emphatically labeled as 'Darwinian' and 'Creationist'.

The 'low cost' car is a far more technically and financially “evolutionary”, small and medium step improvements in standard practice across all operational facets of an auto-maker. The practice was perhaps best illustrated by Ford's Model T, where ongoing cost absorption allowed ongoing price decreases; a lesson deployed time and time again to a less obvious degree by established VMs throughout the decades – typically seen in detail artifacts such as windscreen wipers, door-handles, quarter glass, side market lamps and such, the more expensive 'under the skin' mechanicals re-deployed to an ever greater extent given their hidden nature; this of course not publicised when advertising what is supposed to be a truly new vehicle.

Whilst the 'ultra low cost' car demands that an organisation be either radically altered to embrace the 'revolutionary' leap of faith idea, or more likely, a distinctly separate mini-organisation be created – a type of officially sanctioned skunk-works - to critically avoid any central corporate disruption, as a standalone business unit and cost centre, and to convince external bodies of its autonomy to introduce change.

From investors' perspectives, the prime distinction is not necessarily operational – though of course key to successful implementation – but the fact that here appears two distinctly different 'investment threads'.

Mapping the Vehicle Cost (& Investment) Space -

By its very nature of horizontal and vertical industrial reach, the automotive sector's cost-base is highly complex, which without the very rare event of corporate disclosure of accounting details for worldwide divisions, cost-centres and administrative departments makes the de-constructing of company workings – essentially the cost-benefits – nigh on an impossible task.

Investors, from institutional to private individual of course have a multitude of investment originated formulae and criteria by which to assess the performance of companies. And whilst many standard 'market ratio' conventions are useful by virtue of the fact that they are standard, simple, popular and so influential (eg such as p/e's, EPS, dividend rates, book values, the raft of measures across profitability ratios, liquidity ratios, activity ratios and debt ratios can lead to an infinite number of results but clouding overall conclusion, aswell as being overtly “micro-micro”.

The other extreme is to over focus on general – or rather perceived trends – in the macro-economic picture, which can be themselves very ethereal and long-range, adding little value to the here and now of topic appreciation.

What is required is an intermediate model which combines both the micro and macro perspective, in a meaningful manner. This the real creative task of value-creation analysis

So to provide a far broader understanding of the 'low-cost' car vs 'ultra low cost' car discussion, investment-auto-motives provides an accompanying matrix diagram, which marries the two prime aspects of a vehicle's cost-base: its development methodology and its generalised production location & its specific build process type.

To this end, the diagram highlights the five different new vehicle development route options and the three regional types of location, each divided by 3 generic build approaches.

Thus the vertical shows NPD type in ascending cost order, spanning:

- All new 'ultra low' cost
- Recycled 'low cost' platform
- Standard platform evolution
- Modular systems set
- All new premium hi-cost

And the horizontal shows location and build type:

- TRIAD production base
- BRIC production base
- CIVETS / “Next 11” production base.

These sub-divided by:

- Capital intensive build methods
- Mixed cost methods
- Labour intensive build methods

Interpretation -

The diagram then depicts a very general schematic of the car production cost-base, each square effectively representing a specific cost-base environment, which either underpins or undermines any new vehicle business model.

The innate complexity of whole industrial equation, - market type relative to product type relative to production capability type - highlights historic industrial tendency to “feed the machine”.

Nonetheless, in order to create other types of non-standard (ie steel monocoque or steel chassis) vehicles, various other low-volume production methods have been developed over decades specialising in lightweight and hi-strength alternative materials including aluminium, magnesium, other alloys, and basic and advanced composites; carbon fibre perhaps the best recognised today. Used for dedicated performance and specialist products, ranging from a plethora of race-track categories, to various road-based sports cars directed the wealthy, to emergency service, agricultural, national defense and other specialist tasks on and off road.

Companies providing such vehicles tend to operate at the top of the cost-base (see top right of diagram), creating innovative structural, propulsion and task-orientated solutions; applying both hi-R&D and practical pragmatism when devising, constructing and producing their vehicles. Such operators are mostly located in the Triad countries and primarily rely upon a broad semi-skilled and skilled labour force suited to the physical fettling of prototypes and the practical demands of a largely unmechanised build process which avoids onerous capital expenditure.

However, when feasible, such companies may seek to move production, low-value elements of development (such as product testing), and indeed aspects of central services 'off-shore', to a much lower cost country (ie a “Next 11” nation) especially if close to a major foreign market. So as to lower the man/hour assembly costs of the labour intensive build process, reduce development and overhead costs. Alternatively, another company based in a low-cost location may seek to undertake manufacture and / or other activities by way of a JV partnership, or seek to sub-contract to a third party.

Importantly, the learning and methods previously deployed in this most cost extreme area has had a direct effect upon the lowest cost area (see bottom left of the diagram). The position from which various auto-industry 'disruptors' have sought to create the 'ultra low cost', going against the grain of the conventional business model. Through the decades, business start-ups seeking to offer low-priced mass-mobility to the 'bottom-tier' have well recognised the very different business model constraints - spanning market dynamics, customer income level & seasonality, and the very different general product use conditions their hypothetical, prototype and production cars should satisfy.

Yet to date, nothing has truly convinced as true competition to the omnipresence of 'grey import' or locally assembled motorcycles, rickshaws, old but durable Japanese, Korean, German passenger cars (in towns) and Japanese and Indian 2WD & 4WD LCV double-cab trucks (in rural areas).

Yet nonetheless, the basic demographic and national growth numerics offers much apparent promise.

Yet any such opportunity looks far less likely to be tapped by new entrants, typically with high ideals but shaky finances, unless as seen with electric vehicles, a whole crop of new VC community backed enterprises are born and backed; in the knowledge that but a small few may grow “from acorns into possible oak trees”. Yet recent EV history is a solemn one, with a loss of many such enterprises and no surviving company (inc Tesla and Fisker) actually having made any substantial headway into the premium space of the mass market.

More likely that any 'ultra low cost' space is to be hard fought by those well established names; if indeed more than a few are compelled to join, given the over-whelming presence of the 'low cost' model. They appear the only present viable candidates since they have the core industrial competencies and for the most part far stronger balance sheets. Of these the most likely are those EM national champions with conglomerate standing (as seen with TATA) which are in a position to design and manufacture a credible product, have a broad distribution network, can tie-in sales with other goods and services, may offer a good after-sales service and critically create a sound financing basis by which to gauge potential customers and so step-by-step popularise the vehicle.

Even so, as of today and well into the medium-term, the previously described barriers and pitfalls in serving this apparent mass-market presents substantial challenges; the willingness to absorb substantial start-up costs and 'burn cash' for years to come until the tipping-points of slow break-even and market acceptance is attained.

A wholly new realm targeting Indian and SE Asia, and the rural far reaches of China, which could in time transform from a trickle into an stream and onto a river,.

But the competitive terrain which that trickle must pass will be uphill and with broad meander as the business model is honed year after year.

Continued Prevalence of the 'Low Cost' Paradigm -

Hardly surprising is the seeming majority opposition of Triad auto-makers and their Chinese counter-parts, so as to seek to maintain general global market dominance in the sales of new vehicles, and expected increasingly control of their product in used car sales channels. To defend their prominent position, they will leverage the increasing cost-benefits that intelligent engineering will bring, and so promote the evolutional character of the 'low cost' car, which will increasingly consist not of whole cost re-engineered platforms but distinctly discrete systems modules, which themselves can be more effectively re-engineered for specific functionality. Speedier amortisation of systems and parts and so give further business boost to similar and extended future 'low cost' car ambitions.

Obviously, not directed not a the 'bottom-tier', but far more logically toward the greater near-term (and long-term) promise of an ever growing, more prosperous EM middle-class, as well as a less prosperous western middle-class.

As seen today and over the last decade, the eastward migration of western automotive technologies has provided a 'low cost' furrow for both the western corporate IPR proprietors and their EM manufacturing partners. Such ongoing 'low-cost' and 'reduced cost' vehicles will undoubtedly form a continued cornerstone in such commercial relationships. Those EM partners gain relatively advanced western engineering for national manufacturing and self-branding needs, whilst the Traid company gains from yet further rounds of NPD cost re-engineering and reduced cost manufacture.

Given that the endemic prevalence of the 'low cost' car has far greater affect upon the real-world economics of the auto-industry, and the conventional cars' economic impact across many industrial & service sectors, although some academics and management consultants are enraptured by the idea of ultra low cost cars (due to intellectual fascination with re-orientated practices), the fact remains that its very existence - in comparative terms - will be at the edges of the global automotive story, relatively fringe given the present 80 millions plus annual units of conventional vehicle produced; though undoubtedly of major lifestyle impact to those few million across the Indian sub-continent and elsewhere, if indeed proven on market, product and business bases.

Paradoxically, by default of the general status quo, at least an equal amount, if not more, auto-industry and externally sourced 'brain-power' ought to be devoted to progressing 'low-cost' car thinking, so as to vitally understand how it can better fit within conventional business practice, and how a new 'basement level' business model could operate at the Tier 0.5 level, itself created from the integrating the interests of VMs, Tier 1 (OEM) suppliers and contract manufacturers.

To Follow -

This web-log piece was intended to be limited 3 distinct sections, providing:

A. general overview of both the 'low cost' car and 'ultra low cost' car theorums.
B. these 2 distinct models within the wider global cost-base picture
C. conclusion: highlighting the overwhelming weight of the 'low cost' model

However, an important issue promised – but as of yet unaddressed - is analysis regards the strategic positioning of international, regional and national vehicle producers. So as to maximise the leverage of one, or indeed possibly both, these highly absorbing and business critical income stream models.

A Part 4 will end this series by reviewing a suite of VMs which are publicly listed across the world's major bourses.