Is Bigger Better?

Automotive Industries, July, 2001 by William Pochiluk

Not everything you believed during the 1990s "merger mania" is true. For suppliers, the key to increased volume, higher prices and fatter margins is more than just size.

As suppliers face increasing pressure from investors and Wall Street to increase shareholder value, the key question being asked is, "Is bigger better?" Typically, efforts to grow organically have not produced sustainable and rapid growth. Large-scale mergers and acquisitions, with the resultant consolidations, have not achieved the promised gains from critical mass and scale effects.

If size is indeed the issue, perhaps the winning formula is somewhere in the middle. There is a new view that smaller deals, creative alliances/partnerships, and restructuring for focused critical mass may produce the desired results.

How did we get here and what have we learned? Since 1980, automotive suppliers have gone through three distinct phases in the pursuit of growth to improve shareholder value. The first two phases had some notable early strategic successes, but proved to be unsustainable. The third phase has emerged in response to a complex mix of constraints.

Throughout this entire period, the need for cost reduction has been persistent, varying in intensity as vehicle manufacturers passed through various stages of urgency. Overall, suppliers have become far better masters of cost reduction than masters of profitable revenue growth.

Are You an Endangered Species?

Trying to improve the revenue portion of the equation, automotive suppliers have played with the price and volume levers through a range of creative strategies.

Winning price increases for engineering changes has been a major contributor to earnings growth in the past, but much less so now and in the foreseeable future. Brutal and unrelenting downward price pressure forced the move to systems and modules, with the largest suppliers getting stronger and gaining economic power. Small, traditional parts manufacturers began looking like endangered species.

In the 1980s, supplier mergers and acquisitions were relatively small and aimed at gaining vehicle manufacturer penetration, or in effect, buying customers and market share. This also acted to offset or disguise automotive downturns and left the impression of sustained growth. The emergence of the Lopez-effect on the automotive supplier community was quick, direct and painful Cost reduction as an imperative had arrived.

In the 1990s, the presumed economics of consolidation became a clear and accepted strategy to deal with cost reduction and the need to gain the critical mass to compete. The dynamics created discontinuities and unexpected situations.

Very few mid-size and large-size merger and acquisition examples produced positive results. The Johnson Controls Inc. acquisition of Prince Corp. became an industry best-practice where JCI gained access to the innovation engine at Prince. However, this was an exception. The mania to acquire suppliers peaked in 1998 at approximately $30 billion, collapsing in 1999 and 2000.

The drive for globalization to meet vehicle manufacturer needs became the struggle for global integration. Technological change forced price wars for high-tech products that were expected to retain a price premium. Included in the list of technologies were air bags, ABS and a variety of electronics.

Differentiated high-tech products began to look and behave like commodities; for example, safety products. Innovations in supply-chain management produced significant gains, but faced resistance from unions and frequently required high levels of capital investment to produce the gains.

The emergence of trade exchanges, culminating in the creation of Covisint, threatened to make the automotive supply-chain upstream of vehicle assembly a buyers' market.

The dot-com mania dried up investment funding for much of the traditional economy, including automotive suppliers, with comparatively weaker potential for stock price appreciation.

The best North American light vehicle market in history generated marginal profitability for most of the automotive supply base. Ironically, the relatively strong level of automotive demand in 2001 represents a disaster for many suppliers.

Stated simply, the traditional techniques to grow revenue through price and volume by acquisition/merger, technology-driven innovation, and positive price adjustments from improved technology and engineering changes, hit a wall by the end of the 1990s.

Core Competencies Rule

Creative attempts by automotive suppliers to positively impact price and volume have concentrated on aligning productive assets for improved revenue growth as a driver for improved shareholder value.

Automotive supplier strategic alliances/partnerships have become particularly interesting. As mergers and acquisitions became impractical from a funding standpoint, strategic alliances/partnerships emerged to fill the vacuum. This approach brings many benefits. The venture participants concentrate on what they do best. Investment requirements are reduced and the need for capacity growth is mitigated. The need to directly invest in rapidly developing technologies (for example, electronics and materials) with short productive lives can be eliminated for some system integrators. Risk is shared; for example, in foreign markets. Agreements are typically around specific business opportunities with a known product life, and as such, automatically terminate.