Strategic change driven by shareholder value

Over the last three years the largest manufacturers and suppliers to the automotive industry have generated total returns to their shareholders averaging less than 15% pa. With over US$600 billion under management in these companies shareholders expect, and indeed demand more.

A fundamental restructuring of the industry is overdue and there are signs that this is now being addressed by some of the major companies. So what are the major drivers change and how are they likely to affect merger and acquisition activity within the Automotive sector?

Although Economy of Scale strategies will continue to dominate the thinking of executives searching for greater returns to investors, the companies most likely to succeed in the Second Automotive Century will be those that innovate. Innovation encompasses the way they develop, design or deliver products and services to the consumer.

Brand Owners

Increasingly, today’s vehicle manufacturers (VMs) are exploiting the value inherent in their brand. With quality and reliability becoming less of a differentiator, VMs need to address the car buyer’s emotional and convenience needs as well as purely economic considerations.

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The logical extension to create value is for VMs to configure themselves into Vehicle Brand Owners (VBOs), re-deploying much of their manufacturing and assembly assets and resources to a few mega-suppliers.

VBO executives will be challenged to deliver superior returns to investors and create one to one consumer relationships that are the envy of their competitors. An analysis of the major M&A activity last year amongst the VMs illustrates that consolidation is continuing at some pace. We anticipate that within 5 – 10 years fewer than seven auto maker enterprises, operating with something close to a global scale (a minimum 10% share in any region), will dominate the industry.

As well as the high profile deals, the migration towards VBOs is evidenced in the direct investments made in Formula One motorsport by Ford and DaimlerChrysler, and more recently by Renault. The re-emergence of famous names such as Jaguar and, from 2001, Toyota on the starting grid is evidence of the importance placed by VMs on the continued development of the core values of their brands and the drive towards increased consumer connectivity.

Top Ten VM transactions 1999

There are a large number of other possible moves which might give the emerging VBO control over their brand. Most of these occur after the point at which the vehicle is sold and provide the opportunity for VBOs to capture a greater share of the wallet of automotive customers over the entire lifecycle of a vehicle. Recent and prospective activity in this area has included the acquisition or development of:

Interestingly we may also see further developments amongst the car rental businesses, many of which were originally formed as a means of providing new outlets for VMs.

There is considerable scope for changing the traditional formats in ownership of vehicles with mixed use or flexible leasing packages. The challenge is to provide a selection of vehicles with a suitable choice for any occasion in a convenient, user friendly way.

Reallocation of Assets

If the VMs are going to leverage the brands downstream, the suppliers are going to need to rationalise the supply chain upstream. To do this effectively there needs to be a redistribution of the assets amongst a smaller number of mega-suppliers and even greater concentration of resources on innovation in development and design.

There is some evidence from the 1999 deal statistics that the momentum is gathering pace, with TRW’s acquisition of LucasVarity for $6.5bn and Lear acquiring UTA’s interior trim business for
$2.3bn. More significant structural shifts between VMs and suppliers can be expected in the near term.

Ultimately suppliers may take over responsibility for assembly of entire vehicles. In a graphical form the possible migration trends are summarised below.

Partner selection will be crucial in delivering the transition

source: PricewaterhouseCoopers

Development and engineering assets will concentrate in a few key suppliers. Assembly operations will also ultimately follow suit. Larger segments of retailing are likely to gravitate towards todays manufacturers along with newly developed customer relationship capabilities. E-Technologies will allow members of the enterprise group to operate and interact more fluidly, rather than at arms length, and will therefore underpin the transformation of relationships as well as processes.

As suppliers now assemble larger sub-systems prior to delivery, the role of the VM is shifting to co-ordination, sequencing, final assembly and other related roles. Much of this co-ordination and sequencing responsibility would disappear with the migration to “pull” production systems. As these skills already exist amongst the suppliers it is likely that further VM assets in the areas of production planning, procurement, sequencing, line balancing, maintenance and warehousing could be redeployed to suppliers. The traditional role of the module supplier would migrate through super-modules to assembly of entire vehicles.

The changes to the traditional VM-Supplier interfaces raises interesting questions and challenges as to what are the core competencies of the enterprise of the future at each level in the value chain.

The scale of restructuring amongst the supplier base is significant, and we predict rationalisation down to just 30 mega-suppliers. The impact further down the supply chain will potentially be even more dramatic.

Potential Trend in the Numbers of Suppliers

source: PricewaterhouseCoopers

E-Business will be a key enabler of the Migration Pattern

Changes in the retail segment are going to be every bit as fundamental. There will be a proliferation of routes to market as alternative methods of capturing consumer attention are developed by the VBOs.

Of particular interest is going to be whether it is possible for specialist retailing groups of substance to emerge. The challenge is to provide genuine added value returns to shareholders in an environment when the return to the VBO from an incremental sale is always going to be greater than the direct cost of achieving the sale. A new relationship between VBO and retailer is needed to replace the historical franchise arrangements and it may prove necessary for VBOs to establish ownership of these assets directly.

The transformation of the business model from “manufacturer push” to “consumer pull”, which has been talked about for so long, is gathering momentum. VMs and major suppliers are driving change through on-line B2B and B2C initiatives.

The potential is immense – estimates of the cost savings from a truly integrated and web enabled make to order system are in excess of $3,000 per vehicle.

It is not a zero sum game. Much of the benefit will flow through to the consumer in terms of reduced prices, however the potential for reduction in supply chain costs through on-line purchasing is real and represents a significant profit opportunity across the value chain. The focus of the VMs on an industry wide Trade Exchange, and the move into the provision of in-car services is evidence of the desire to make significant gains quickly. The journey has only just commenced. The road may be long and winding but the prize, in terms of enhanced shareholder returns and market leadership, will ensure the drive fast and furious.

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