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