Thursday, 17 May 2012

Industry Practice - Global VMs (Part 4) – Down-Shift Products to Scale-Up Volume & Profitability.

The previous three web-log sections have explained why the auto investor mindset across all genres – from institutional to privateer – should recognise the renewed importance of product cost, and the rise of reduced cost vehicle manufacture; which at its farthest reached – though mechanically unconnected – results in the ideals of the 'low-cost' and 'ultra low-cost' cars.

Précis -

Throughout the last decade, and especially so since 2008, there has been a structural re-orientation of the global economy; merging the prime characteristics of those previously distinctly separate 'advanced' and 'industrialising' nations, to form an increasingly 'convergent' global economy. Thanks to globalisation the once highly visible industrial, commercial and consumer chasm which existed has become increasingly blurred.

This obviously most apparent regards the private consumption household consumables, bottled drinks, cigarettes, fast food, coffee emporiums and fashion clothing, but also, as increasing national wealth escalates incomes and credit availability, the trend has become increasingly apparent regards medium-value and high-value goods and services, including of course passenger vehicles.

Consequentially, this ongoing post-2008 worldwide economic re-shuffle has remoulded the corporate perspectives across the world, perhaps most necessarily so and drastically so in the west as historic mature markets struggle to regain traction. But also critically those of advancing EM conglomerates and sector players who themselves see the convergence as not a challenge but opportunity.

Logically, along with the trend toward 'convergent markets' comes the 'convergent product' ideal, the ambition of which is to maximise volume production of a subtly altered but near standardised item to suit the cultural and pricing dynamics of mainstream cars across a broad geographical spectrum. Thus requiring R&D, development programme and production solutions which can finely balance the internal commercial demand of mechanical similarity with the external demand of product differentiation to create discretely matched intra-regional business cases that provide a high margin 'glocal' solution.

Comparing Apples & Pears -

Via the use of previous accompanying detailed diagrams, investment-auto-motives sought to explain the primary elements and issues to the notion of 'low cost' and 'ultra low cost' cars.

From the consumer perspective, the former practically aimed at a burgeoning global middle class across EM countries and the latter still theoretically targeted at mobilising the 'bottom tier' of very low income masses.

From the industrial perspective, the former essentially the commercial re-deployment ( ie notional 'platform recycling') of previously fully or part amortised high capex tooling & plant: typically re-located from 'advanced' to 'advancing' countries; undertaken autonomously by a Triad VM where possible or increasingly so, through JV arrangement with local EM manufacturer or representative.

Whilst the latter tends to the ideal of a largely or wholly 'all new' EM-designed vehicle, encompassing a mix of technology transfer from other mobility segments (primarily motorcycles, but also 3-wheelers and small 4-wheeled quad-bikes) and innovative engineering solutions

Part 4 -

As promised, this last section seeks to provide a closer view of the business formulae for the generic 'low cost' car and the 'ultra low cost' car.

A final Part 5 to follow, will identify and plot those national, regional and world-wide manufacturers which are seeming best placed – on the basis of this weblog's very limited research – to follow each path, and indeed recognise those manufacturers that are indeed able to follow both paths.


Using basic description of the 2 prime examples seen to date: Renault's Logan and TATA's Nano. Although already much discussed, each is worthy to generally recount when set side by side to truly understand the respective prime differentiators.

How success of the inter-national 'low cost' car template depends greatly upon a VM's ability to read and integrate with the external dynamics of EM foreign affairs; with the assistance of its national government, EM regional economic development agencies and the links its own investment advisors hold, with critically the ability to forge deep political relationships.

And how success of the largely intra-national 'ultra low cost' car template is critically reliant upon the ability to orchestrate and leverage the internal dynamics of a conglomerate's own and supplier capabilities, whilst promoting the 'people's car' idiom amongst the masses to thus gain the 'wholesale backing' of the national government, integrating the project as part of the domestic and export growth agenda.

Thereafter, investment-auto-motives seeks to identify those publicly listed manufacturers (on global bourses) which by virtue of their current and near term product portfolio, their industrial divisions and their industrial alliances, are strategically well positioned to follow either or indeed both of the set courses so critical to medium and long-term global profitability*

[NB Though investment-auto-motives maintains that it will be the 'low cost' car, not the 'ultra low cost' car which will be the prime profit engine for regional and multi-national VMs, given the very nature of its narrower development focus, its multi-continental application, its 'middle-class' target market's greater & elastic disposable income, and its general formulaic repeatability]. .

Daimler Led the Way -

Yet before delving into both Renault and TATA overviews, the importance of Daimler's then already underway pioneering ambition must be re-stated. Having ostensibly invented the car in the 1880s, ninety years later the German company set out to re-invent it once again (ironically in near its original yet modernised form) by way of the SmartCar: and its associated business model. Other VMs, perhaps Renault and TATA most presciently, integrated learning from Stuttgart's far-reach and very brave 'live case study'.

This arguably has been the most progressive automotive industrial achievement of modern times - still to be applauded. It created of not just a whole new vehicle segment by way of the 'mass-customisable' 2-seater city-car - thus far retained to itself, but also a totally new, expansive, intelligent supplier-linked production hub; itself centred around an alternative vehicle build schematic.

Daimler's strategic recognition of its need to expand beyond premium cars and trucks, buses was met by a willingness to 'read' the far-horizon European and 'mega-city' future and develop an archetype vehicle with a well understood problematic initial gestation period until its 10 year break-even, but delivering thereafter a long-life (and arguably semi-protected) income stream to the presumable delight of institutional shareholders.

The SwatchCar / SmartCar project formally and informally broadcast its learning throughout the industry, with discrete methodological parcels across various disciplines either directly adopted by others or highly influential toward intelligent corporate practice.

The 'Low Cost' Car Template -
Renault's Dacia Logan: “The Master Class”

Though not in the same innovative vein, over the last decade pundits have applauded Renault's re-invention and scale application of conventional 'platform re-cycling' old platforms through Dacia.. With the 1989 fall of the Eastern-Bloc, Renault well recognised its position of comparative competitive advantage given its historical links with Romania.

Volkswagen Group had been the prime-mover of CEE auto-industry renewal, by acquiring interests in the former Czechoslovalia's Skoda Auto and euphemistically 'bringing it to Wolfsburg' by re-utilising older SEAT shared vehicle technology for marque renewal. In a twist of apparent fate – or more likely, the coherence of backstage CEE macro planning - VW's government tender for Skoda the company beat Renault's application, on the basis that the German company would invest more and produce higher grade vehicles in the country, versus Renault's attempt for a low-cost assembly centre. VW's plan made far greater macro-economic sense for the new lead role region with higher populace.

The Renault ambition would come to fruition in Romania with Dacia, and its sought to maximise that opportunity. Rather than simply produce its base model Twingo in a cost-efficient location - as had been the previous plan - it recognised the might of awakening EM markets across the neighbouring CEE and Russia, close-by MENA (expanding its Turkish operations), and to the further reaches of India, Mexico, Brazil, with the ideal of using these large markets as CKD hubs from which to access smaller yet fast growing regional economies.

So, with such a grand ambition, instead of simply shipping defunct tooling for gradual single local model use and decline, Renault re-deployed the recently 'run-out' X90 Clio 3 platform which has acted as the first shared technology base in the Renault-Nissan alliance. The company then maintained proprietary rights instead of typically selling them off via licence or JV so as to serve as the underpinning for the necessary low-cost programme to become Dacia Logan and its spin-off siblings. Such cost-consciousness supported by the much welcomed but still pragmatic capex refurnishing of the Mioveni plant..

This is a well told story, but the crucial understanding is that Renault was able to draw many strategic threads together, namely:

1. How to best exploit (and partly generate) the then new wealth effect within the CEE's then emerging economy
2. How to create a credible and sustainable entry level brand to compete against and undercut VW's Skoda & SEAT and Hyundai's Kia.
3. How to create a web of international links with the Mioveni plant as the CKD export hub
4. How to continually add / layer fully built and CKD volume capacity.
5. How to manage Mioveni to provide an anti-cyclical, 'off-set' income stream, relative to still heavy reliance upon French and W. European sales
6. How to wield a powerful procurement strategy so as to gain both usual YoY discount rates, increased volume discounts & obtain cost re-engineered parts discounts.
7. How to critically retain full control of what is viewed as the archetype 'world car'.
8. How to achieve a reported 6% unit margin (vs 2% on EU mainstream vehicles).

These few highlighted points then illustrate the near perfect alignment of corporate strategy to evolving macro-economic conditions, as 'master-planned' by CEO Carlos Ghosn and ex Head of Product Strategy and ex-COO Patrick Pelata.

[NB. The WSJ article dated 16.04.2012 (p20) quoted a financial analyst's view that “Renault's entry level products are what is saving the company”. This may not be wholly correct given the very important income contributions made by high volume Renault LCVs even in a depressed market and Nissan's passenger cars, but the margin figure stated explicitly assists in such a dour period].

Thus, given Renault's proven ability to produce a seemingly new entry-level class of 'low cost' product, offering mass-market sector leading margins, the race over the last 5 years of so has been for VMs to emulate such benchmark practice.

The 'Ultra Low Cost' Car Template -
TATA Motor's Nano

Part 2 of this web-log series provided a useful account of the hurdles facing those VMs and 'National Champions' that seek to create the 'ultra low cost' car, highlighting the truly fractured nature of personal finance and so credit provision that exists at the 'bottom-tier'.

It also provided general observation of the now legendary TATA's Nano project, illustrating how the original $2,000 vehicle price target drove a raft of considerations which necessitated the need for a wholly new product development approach. Hence creating the “4-wheeled motorbike” drew inspiration from within, but critically also external to, the car industry and so re-configuring the orthodoxy of NPD

The renowned consulting firm A.T. Kearney provided a useful synopsis of the EM affordable car topic, itself identifying the pricing regime of the 'low-cost' car at $5,000 - $7,800 whilst the 'ultra low cost' car spans $2,500 - $5,000.

[NB investment-auto-motives identified a true ultra low cost' car at $2,000 - $3,000 if it is not to be subsumed by “established incumbent” offerings or by naturally deflating used car values as a country's car parc grows].

However, the paper provides useful insight into the organisational and technical issues which enabled the Nano to move from 'vision to reality'. They include:

- Deep co-operation with suppliers
- Severe parts count reduction
- Invention over adaption
- Value chain standardisation
- New retailing model
- Organically expanded production sites

However, the paper omits TATA's self-admission that the Nano project stood on the shoulders of the previous micro-truck project, sold as 'Ace', 'Super-Ace' & 'Magic' variants. Thus whilst philosophically undoubtedly a 'clean sheet' approach, the fact that such recently developed, cost-absorbed components and systems were available (very probably 'packaged protected' or 'performance ratified' for Nano during the mini-truck programme) means that at least a degree of the 'all new' hype is unjustified.

[NB investment-auto-motives suspects that a number of core 'invisible' items such as steering rack, electrical harness, dashboard armature etc were originally designed to be dual purpose].

However, what is all new is the sales channel being used, with expectation that ever more 'mobilised' sales people will trek to the more remote towns and villages in rural India to presumably 'educate and enthral' about Nano. This then is an organic extension of the conventional sales process used in other sectors, but a first for modern automotive and more akin to sales teams that demonstrate agricultural equipment; but in itself a redeployment of the methods Ford used with his Model T.which took on various utilitarian farm and community roles.

[NB Here is the greatest achilles heel for Nano, the fact that it has limited utility compared to a mini-truck or regular pick-up. Presumably TATA's expectation being that it will in time sit amongst the plethora of TATA and other micro-trucks and bought for general parts and service compatability].

As for the last highly important item listed, the company plans to 'mass customise' Nano and provide complimentary services to better serve 'bottom-tier' needs, thus able to add feature and service value.. This will be rolled out on a “micro-factory retailing” basis, where CKD & semi-complete vehicles are delivered to strategically positioned satellite mini-factories, where each ordered Nano will be assembled and taken to the buyer. This supported by a central warehouse of spare parts and accessories.

If this comes to pass, then TATA will have truly applied the type of new-age assembly process re-invention initiated by Daimler's SmartCar: using pre-coloured replaceable skin panels for late-stage configuration. If however, those pan-Indian regional configuration site are superseded by the building of standard factories then the great potential for process revolution will have been lost.

A.T. Kearney's paper begins and ends by citing a provocative question aimed at prodding the strategic thinking of established VMs. Whether to with relation to the 'ultra low cost' “Preserve & Protect or Participate and Prosper”. (Such a statement implicitly conveying the consulting firm's overt enthusiasm about the transformational impact of the 'ultra low cost' car).

investment-auto-motives remains more cautious given the challenged faced by even those best placed such as TATA Motor. But emphatically hopes to see a continued focus by TATA on its parallel 'smart-thinking' for the good of its bottom-line, broader industry learning, re-bouyed market-capital values and obviously the promise of improved shareholder returns.

Not Such A Simple Choice -

The previously mentioned consultant's paper posits a choice for auto-makers: whether should continue with 'business as usual' or make a leap of faith toward the 'ultra low cost' vehicle. Of course such 3rd parties have intrinsic interests in citing provocative black & white questions.

The reality is of course, as well understood by automotive CEOs and CFO's, is that simplistically described idioms pertaining to general trends must be met with highly considered and detailed plans which themselves require near flawless execution. Truly meaningful strategic insight and strong operational capability are mutually necessary simply to competitively maintain an enterprise as complex as those in the auto-sector; each of which of course sits in its own very particular set of macro and micro circumstances.

To morph from being simply reactionary to socio-economic and market forces, to becoming an proactive, perception moulding, leading industrial vanguard typically takes not only a mind-shift of corporate outlook but also deep vertical and horizontal value-chain links and a suitably strong balance sheet.

Yet the sector lives in a constrained business environment. The very fact that the majority auto-sector participants survive from the innate stable conservatism required in a smoke-stack industry to attract share-based equity, maintain a stable credit rating, to enable corporate bond issuance, retain revolving credit sources to ultimately meet or beat quarterly, half-year and annual earnings expectations.

A large automotive company's operational complexity is often equally matched by its financing complexity and its long-term obligations to both mid and long-term bond-holders and its pension obligations.

Thus corporate radicalism of the central mindset relating to products, services, markets or manufacturing is only ever typically seen when a company faces either near extinction, or when it can financially afford to expend time and effort to generate a distinctively new competitive advantage, or when it has implicit/explicit national backing.

The verge of extinction radicalised Chrysler in the early 1980s to re-create itself as 'avant garde' and regained N. American popularity. It was a combination of solid corporate finances and recognised need for a long-term USP that prompted Daimler to create SwatchCar / SmartCar. And it was conglomerate industrial reach and echoes of India's 1947 “national promise” that set TATA on its course with Nano.

Thus three different motivational catalysts to actively mould the future.

To Follow -

In Part 5, investment-auto-motives very simplistically evaluates the prime national, regional and global automotive manufacturers, to better understand the present strategic perspective of each.

So as to ascertain the likelihood of following a single-path 'low cost' car route, or a far more demanding dual-path 'low cost' (LC) and 'ultra low' (ULCC) cars development route. The general picture is given greater conjectural content by the inclusion of other possible 'new entrant' companies which could theoretically alter the state of play if able to develop far lower cost non-traditional cars.