Although this trend has been accelerating since the early 1990s, the projections for new model launches over the next five years are at historic levels in order to satisfy consumer demand. John Casesa from Merrill Lynch presented several data points during the Traverse City panel discussion that demonstrated the impact of these changes, such as one on the rate of launches (Fig.1). While there are some analysts who believe that this level of new model launch is unsustainable, accelerated model launch will clearly be the focus of the industry for at least the next five years.
As Mr. Casesa went on to demonstrate, the impact of this level of new model launch is that the average age of a vehicle in a dealer’s showroom has declined dramatically over the last 15 years (Fig. 2). While one year may not seem like much, this is a huge change over a relatively short period of time.
Finally, Mr. Casesa’s analysis suggests that vehicle age has a significant impact on the level of sales for an OEM. If his analysis is correct, then Ford and General Motors should be worried about their outlook for the next five years (Fig. 3). The good news is that it appears DaimlerChrysler is working actively to regain the new model reputation that made it such a hit with consumers in the 1990s. The question is whether DCX can do this profitably.
The acceleration in new model launch and the overcapacity of vehicle manufacturers has significant impact on how OEMs and their suppliers operate. Unfortunately, most OEMs do not appear to understand the implications of this new reality.
The Reality of the Marketplace
Consumer demand for new models is resulting in continuously shorter model lifecycles with lower annual vehicle volumes. Where it was not unusual, for example, for a new model in the early to mid 1990s to last four to five years and experience 200,000-unit-plus annual volumes, in the future, two to three year life expectancies with 100,000-unit annual volumes or less will increasingly be the norm, particularly for the higher priced portion of the market.
The growth of the New Domestic OEM vehicle offerings and market share in North America coupled with the failure of the traditional Big 3 to deal with their overcapacity problems has made it virtually impossible for car makers to raise vehicle end prices. With the announced intent of the Chinese OEMs to begin to market their vehicles in the West by the end of this decade, this cap on end vehicle pricing will probably continue for the foreseeable future.
The New Reality in the OEM/Supplier Power Equation
While 2004 will go down as one of the most difficult and intensely negative environments for automotive suppliers in the last 20 years, it may also end up being the final chapter of the dictatorial cost down business model (e.g., the Lopez factor) that has been driving this industry. Evidence of this is that, based on numerous industry discussions, it seems that for the first time, most OEMs are not meeting their annual cost reduction targets. A number of issues suggest why:
- Material price increases have moved out of the steel arena and are now impacting plastics and all other key materials. Given the continued strength of the Chinese economy and record oil prices, this upward pattern is unlikely to change. While the OEMs are claiming these price increases must be absorbed by the supply base, given the marginal profitability of so many suppliers, there is little question that a significant portion of this increase will eventually end up at the OEMs.
- While there is overcapacity in several supplier segments (e.g., stamping, shoot and ship plastics), the consolidation of the supply base has resulted in fewer, more powerful suppliers in many key commodity areas. The successful supplier’s power comes not from scale (e.g., revenue level) but the degree of uniqueness of its products and processes. As a result, a larger number of suppliers are able to better manage the cost-down requests of customers.
- Linked to the previous point, most successful suppliers have significantly increased their customer diversification and reduced their dependence on the Big 3. This also creates more supplier leverage in the cost-down negotiations with customers.
- We are on the upward slope of interest rates and overall inflationary pressures that will make continuous reductions in costs difficult if not impossible going forward.
While most suppliers still act as if they have little or no pricing power with their custo-mers, I believe it is beginning to dawn on many of the better, more sophisticated sup-pliers that the nature of their price negotia-tions with their customers is about to change.
So How do the OEMs Successfully Address These New Realities?
If suppliers will increasingly be unwilling or unable to support 5-10% annual price reduction demands from the OEMs and the OEMs are equally unable to raise end vehicle prices, how can they survive? With average Big 3 operating margins of less than 2% over the last five years, they are caught in a horrible squeeze. The only way they have a prayer of creating significant and sustainable cost reductions is to work in a collaborative way with the entire supply chain—something they really haven’t done for years. As value chain cost analysis will tell you, the only significant cost breakthroughs are when the entire value chain is addressed.
An illustrative data point of how difficult it will be for OEMs to change their behavior is the fact that it is estimated that between 1995 and 2003, over 45% of the OEM’s middle and upper management has retired. That means there is a whole generation of the current OEM leadership that only has experience with the punitive cost-down business model. Working with the supply base in a collaborative, seeking mutually beneficial solutions approach requires a completely different skill set than most current OEMs possess. It also requires a mindset of critical self-assessment (i.e., stop blaming anyone but themselves for problems) and sophisticated listening skills in order to be successful.
While the latest OEM cost-down demand will continue to dominate industry headlines, over the next few years the more important question will be which OEM’s begin to operate with a different mental model of how the OEM/supplier relationship works. Those are the companies that are likely to survive and prosper in the next decade.