The logic of micro factory retailing

In the automotive industry the prevailing logic is one of cost reduction through economies of scale in large factories producing at high rates of output. These large factories then require a geographically extensive market to absorb the volumes produced, and hence in turn require long logistic chains together with networks of franchised dealers in order to reach that market. In essence, micro factory retailing (MFR) refutes that logic by placing small factories within the markets they serve - and so eliminates the distinction between production and retailing. This article compares the concept of MFR as developed by the Centre for Automotive Industry Research with the traditional factory plus distribution network which, in various ways, is increasingly inadequate to the task of meeting customer needs.

First, the pressures on the existing system are outlined. Those working in the automotive retail environment are well aware of the demands being placed upon them by customers and by vehicle manufacturers, but are perhaps less aware of the difficulty of reconciling those demands within the constraints of the existing system. Second, the concept of MFR is explained - drawing on examples from other sectors where appropriate. Thereafter we show a simple comparison between the MFR business case, and that for the traditional factory plus distribution network. Finally, some of the strategic benefits of MFR are explored, although because the concept is new at this stage only indicative advantages can be shown.

Factory push, demand pull and the pressures on the existing system

The automotive industry is devoting considerable resources into improving the performance of existing distribution channels. Great effort has gone into the reduction of customer order lead times, reduced stock levels, greater flexibility of response, etc. as epitomised in the 'Three Day Car' idea - a project recently part-funded by the Research Councils and the Department of Trade and Industry under the Innovative Manufacturing Initiative (IMI). Such improvements are seen as necessary to market survival both in terms of meeting customer needs and in terms of driving down per-unit costs in order to achieve profitability.

However, the current system has at its heart an irreconcilable difference between the fluctuating demands of the market and the inflexibility of the production system that requires continuous high-volume production. Three main issues are vital here:

  • High capital cost per plant
  • High capital cost per model
  • Capital costs of the distribution system

A modern integrated high-volume car plant is a huge undertaking, and requires very large investments. Moreover, each model requires dedicated investments and considerable development costs. Much of the high investment cost is associated with the all-steel body. In the manufacturing plant the all-steel body requires a press-shop, body-framing (welding) lines, and paint-shop which together account for about 75% of the total investment in vehicle manufacturing. In terms of the model to be produced, the major investments are in the dies and fixtures used to first press the panels required and then weld them together. High volumes of output are needed to amortise these costs. An all-new contemporary car can require £700 million to £1 billion to develop, with perhaps half this cost accounted for by the steel body.

In the automotive industry, mass production of a standardised product served the industry and the market well while demand outstripped supply. Increasing market sophistication has lead to a requirement for greater model differentiation and lower per-model lifetime volumes. These lower volumes have exacerbated the problems associated with the lack of economies of scale.

The difficulties with achieving such high volumes are well established, in that the vehicle manufacturer can rapidly resort to factory-push retailing with all of the consequential problems this generates. Recourse has to be made to generous discounts and offers, bonus schemes for dealers, and the use of 'fast-churn' segments - with further repercussions for residual values. Few cars have such enduring appeal that they may all be sold without difficulty for the duration of the typical eight-year model cycle - even those which are initially 'best in class' are rapidly supplanted by new model introductions after which discounting or other incentives are virtually inevitable. Of course, the automotive industry has been assiduous in its attempts to reduce factory investment demands and the cost of vehicle development through a whole series of measures that might be termed 'lean production'. These measures at best ameliorate the short-term pressures. A recent collaborative study between CAIR and Cap Gemini found that in Europe the automotive industry in aggregate is balanced on a knife-edge of profitability. The endemic over-capacity in the automotive industry is characteristic of most capital intensive industries, and serves to create a constant downward pressure on real prices - hence the continued demand for cost reduction by the vehicle manufacturers as a pre-requisite of survival. Vehicle manufacturers have sought refuge in platform strategies in an attempt to realise 'hidden' economies of scale, but even here there is no answer to the fundamental problem of producing in such high volumes.

Not only are the investments large, they are also highly 'lumpy'. That is to say, the decision to build a new plant or introduce a new model is a major one, a very risky decision with uncertain outcomes. The high cost of model-specific investment tends to result in conservative 'evolutions' of core models in an attempt to minimise risk.

In addition, there is growing pressure on the distribution system. New car retailing is a barely profitable business for many franchised dealers, yet the current debate on the future of Block Exemption in Europe has revealed and underlined consumer dissatisfaction and government concern over retailing practice. The franchised dealer network represents a large fixed cost, traditionally independent businesses have been the ones to bear the risk of such investments. In the light of the possible non-renewal of Block Exemption, vehicle manufacturers are concerned at the possible loss of control over their retail outlets and are clearly experimenting with alternative approaches - including manufacturer-owned networks. In this sense, the vehicle manufacturers are confronted with the real costs of retailing which is causing a re-appraisal of retailing strategy.

The micro factory retailing concept

The MFR concept is not just 'normal' car manufacturing on a small scale, it necessarily involves a radically different product technology and production process in order to compete with high volume manufacturing. Despite this, the idea of factory retailing itself is not entirely new to the automotive industry and there are parallel lessons to be learned from other sectors that have already experienced some aspects of MFR in action.

There are, of course, several small-scale car manufacturing operations that utilise the factory as the main point of sale - although there may also be a limited distribution network. This applies to the specialist manufacturers such as Marcos, Morgan and TVR and to kit-car producers such as Quantum. Some of the features of the MFR concept are evident in these specialist manufacturers - such as a close (and often personal) relationship with customers, the use of the factory as a 'showcase' for customers, and the importance of activities such as reconditioning to the business. It is equally the case that collection of the car by the customer at the factory has long been a feature at Mercedes where the Sindlefingen plant has a purpose-built centre to handle such transactions. The 'customer collection' idea has been adopted by Audi (for the A8 model) at Neckarsulm. More recently, VW has announced its' intention to develop a large theme and retail park at the Wolfsburg plant in Germany. In all of these cases the perception is not so much that there is a cost advantage in factory retail sales or collection (though that may indeed be the case), but that through such sales the manufacturer is able to reinforce loyalty to the brand. Factory sales were also common practice in Korea up to the latter 1980s, by which time the vehicle manufacturers had established their retail and distribution networks and virtually abandoned factory sales.

We tend to assume that, whatever the sector of economic activity, the general trend is always towards large factories producing a more standardised output. These large factories achieve economies of scale which can be used to drive down price, hence squeezing out (or taking over) smaller competitors. Yet in other sectors there has already been a reversal of this trend. Two examples are worthy of mention: steel mini-mills; and micro-breweries. In both sectors the long-run process of competition has resulted in consolidation by merger and acquisition, leading to fewer but larger companies. In the case of steel production, large integrated blast furnace mills have been challenged by electric arc mini-mills. These mini-mills use scrap steel rather than iron ore, and initially competed in the very low value-added areas such as construction girders. Over time, the technology has improved and the scope of mini-mill product offerings has become broader, so undermining the volumes needed by integrated mills to achieve low per unit costs. In the case of micro-breweries, the process of competition has been slightly different because they have sought to compete with the high-volume breweries through quality and product differentiation rather than price. Again, the effect has been to erode the market share of the established dominant players by changing the terms of competition.

In the MFR case the key to being able to compete with traditional manufacturing lies in the product technology, specifically (but not exclusively) the design of the vehicle body structure and the means used to produce it. The capital-intensive all-steel car body is not viable in MFR, but plastic moulding and aluminium extrusion processes are particularly well adapted to small production volumes. Equally, highly integrated production facilities are not viable, but MFR is ideal for vertically disintegrated modular purchasing whereby vehicle manufacturers can capture external economies of scale. By utilising modular purchasing of 'commodity' components, together with low-cost body technology, the R&D costs for this type of product are an order of magnitude lower (i.e. £70-100 million) than those for the high-volume car. In this sense, the MFR concept fits the current strategy being pursued by most vehicle manufacturers whereby the focus of activity is being shifted from in-house manufacturing to assembly and retailing. That is, the vehicle manufacturers have been divesting captive components operations, while seeking to capture a greater share of the value chain in retail and distribution. MFR offers an opportunity to exploit downstream integration in a manner not previously thought possible.

MFR versus traditional manufacture and distribution

The business case for MFR has many aspects, not all of which can be captured in a like-for-like comparison with traditional manufacture and distribution. However, it is useful to consider the basic investment costs of the two. Table 1 provides a summary of a hypothetical case to produce 250,000 cars per annum.

Table 1 The investment costs of MFR compared with traditional manufacture and distribution

(Note: Assumes 500 new car sales per dealer, investment cost of £3 million per dealer and 50 staff per dealer for traditional retail. Assumes £5 million per micro factory in model specific dies, etc.)

The simple calculation in Table 1 suggests that the initial investment costs of MFR are lower than that for traditional manufacture and distribution when the cost of investing in dealerships is taken into account. In the light of concerns over Block Exemption and the emergence of a number of instances whereby manufacturers have sought to acquire direct control over retailing the cost of investment in a distribution network has become a significant issue for the vehicle manufacturers. Recent evidence from the establishment of Saturn in the US and Smart in Europe suggests that the creation of a new brand and its associated distribution network is not only expensive, but also takes many years to generate a net positive result. Mercedes now consider that Smart will not be profitable until the next model generation is introduced. In the case of Saturn, while the dealerships have shown industry-leading performance in terms of sales per outlet and customer satisfaction, and have indeed been profitable, it is unlikely that GM has generated a net profit since the brand was launched.

An interesting by-product of the MFR strategy is that it dramatically reduces the need to transport cars over long distances to reach the market. While traditional distribution accounts for around 25-35% of the retail price of a new car, it may be expected that in the MFR case this will be nearer 5-10% of the retail price.

Of course it is the case that 'traditional' ways of making and selling cars will not simply disappear, and also that there is a constant evolution of the established system in response to the pressures outlined above. The vehicle manufacturers have experimented with 'super-lean' plants for instance, have adopted platform strategies to achieve underlying economies of scale, and have developed new product designs. An interesting instance is the Fiat Multipla. This car uses a novel steel space-frame structure built from roll-formed steel sections, an approach which virtually halved total investment costs and allowed a break-even volume of around 40,000 per year. The car is still sold through the normal distribution and retail system.

The strategic advantages of MFR

Perhaps more important than the simple investment cost comparison are the many strategic possibilities which flow from MFR. A few potential advantages are listed below:

  • Investments in productive capacity can be incremental, and thereby expand or contract in line with the market.
  • The incremental expansion of capacity can also have a geographic component in that new plants can be added to develop new markets.
  • New products can also be introduced incrementally, on a factory-by-factory basis.
  • The factory also becomes the location for repair, spare parts, in-use modification (e.g. external panel refresh) which allows the manufacturer to benefit directly from profitable aftermarket activities.
  • The factory can undergo a transition over time from an essentially new car production focus, to one more involved in service and repair. That is, the factory does not depend absolutely on the continued sale of new cars.
  • Customers can be taken around the plant, can meet the people who will make their car, and can thereby feel 'closer' to the product.
  • There is no conflict of interest between production and retailing. The vehicle manufacturer can have direct control over the retail business and captures a greater share of the downstream value chain.
  • The inherent flexibility of MFR is the practical basis upon which new levels of customer care can be built. MFR makes possible flexible response, shorter lead times, and late configuration.
  • The MFR concept takes advantage of the possibilities offered by the internet, which becomes the main medium by which customers order vehicles, spares, etc.
  • Stronger worker commitment to the product and to customers. These small factories escape from the 'mass' culture of traditional high volume manufacturing.
  • MFR is the best means to take advantage of modular supply strategies combined with commodity or off-the-shelf purchasing. In transport terms, it is more efficient to move components and sub-assemblies rather than complete vehicles.
  • Product can be customised to local market conditions.
  • Manufacturing processes have a lower environmental impact compared with traditional high-volume manufacturing.
  • MFR does not require a large, flat dedicated site with extensive support services. A modern car plant occupies several square kilometres of land. Compared with this, MFR requires a classic 'light industrial' facility.
  • The MFR concept clearly resonates with social and political objectives in Europe by creating local employment in high-value manufacturing activities.
  • A version of the MFR is therefore also ideally suited to investments in emerging markets. In these markets the investment costs of a major plant would be prohibitive. MFR could replace the existing approach of kit-assembly in such locations.
  • Through duplication of the MFR substantial investment savings could be realised through the multiple ordering of machines and equipment and the use of a standardised layout.

In fact, the MFR concept could be exploited in entirely different ways. For example, a 'vehicle manufacturer' could franchise the entire operation to third parties. Compared with the lumbering structure of huge car plants and unwieldy distribution networks, the MFR concept is full of possibilities. Clearly, questions remain. Of particular note is the issue of maintenance and repair where it is well established that consumers are resistant to travelling long distances to avail themselves of such services. A partial answer to this problem may lie with mobile service support, or perhaps a link with a multi-brand service chain as illustrated by the case of Daewoo and Halfords in the UK market.

Of potentially equal importance, the MFR concept is particularly appropriate to the exploitation of niche markets. In Europe considerable political effort is being expended on creating viable niche markets for environmentally friendly vehicles. To date, most vehicle manufacturers have had to resort to electric versions of their mainstream models, with the inevitable result that the vehicle is less than optimally designed for the application. The most recent attempt to attack this niche by a major vehicle manufacturer - in the form of the DaimlerChrysler subsidiary Micro Compact Car 'Smart' - uses all of the latest thinking on high-volume manufacturing and retailing, yet is unlikely to be profitable within the first model generation. There is a market for Smart, but to date it has simply not been large enough to support a high-volume factory.

MFR additionally offers a means to produce purpose-built vehicles which, as a result, will be better performing and hence more attractive. Of course, vehicle manufacturers may embrace micro factory production but also utilise the existing distribution network (or selected parts of that network) as happens currently with models such as the Renault Spider and the Audi A8. To do so makes considerable sense in terms of existing sunk investments in distribution and retailing. However the purchase by Ford of TH!NK Nordic AS suggests that at least some established vehicle manufacturers are prepared to countenance a radical departure from prevailing practice.

Conclusions

It is unrealistic to expect that MFR will transform the automotive industry overnight. There is however an emerging market space which MFR is far better suited to fit than traditional manufacturing. MFR is of particular value to the launch of an entirely new brand, but need not be confined to this area.

Inevitably, the very development of MFR will intensify efforts to improve the existing manufacturing plus retail approach. Greater efforts will be made in terms of reducing break-even volumes in vehicle manufacturing - the FIAT Multipla is a good example. Greater efforts will be made to tighten the logistics chain to the customer and find new ways to match product demand with the ability of the factory to produce. Collectively and cumulatively, these efforts may indeed be sufficient to negate some of the advantages of the MFR approach. However, the MFR concept means that if there is any market gap available there is now a means for that gap to be exploited.

Dr P Wells and Dr P Nieuwenhuis