BY LARRY W. MCCURDY
President & CEO, Echlin, INC.
Before getting into the specifics about becoming a low-cost producer, let me ask you a few questions.
How competitive is your business today - on a cost basis?
Is your competition doing a better job than you?
Have you stopped the "hub-bub" of your job long enough to really understand the reasons for the extraordinary pressure to reduce costs?
The market dynamics in the car parts business are not much different than those in any other distribution business. What are you doing to meet the demands that are real, that exist, that you and I are not likely to change?
Try to focus your attention on this subject, very personally. Block out the thoughts of a telephone call to be made, a call to be returned, a trip you need to schedule. Use this time to your advantage to evaluate the points that are made versus your own experience and create a focus which will help you to lead your business with confidence.
As you do this, I will cover these broad topics:
Becoming the Low-Cost Producer
Margins Under Pressure - Why?
How Do We Adapt?
Cost is Only One Element of Profit
How Do We Get There?
Not a novel idea
Being a low-cost producer is not a new or a novel topic. Everybody talks about the need for being the low-cost producer or becoming a low-cost producer. In today's environment, I think it is a given that this is something we all seek.
Most of us are doing something in our operations - whether we are manufacturers or distributors or whatever our role may be - we are doing something to drive down our costs on a piece basis, on a throughput basis, on a unit cost basis - whatever those measurement methods may be that we use.
Now in the inter-relations between manufacturers and their customers, whether they are OE or distributor customers, some are making progress in eliminating redundancies between themselves through the benefits of "partnering." I believe this aspect of cost reduction is in its infancy - there has been a conceptual agreement of partnering, but much opportunity remains available to those who make the visceral commitment to partnering. There are many examples of this and we will touch on a few of them below.
As cost-reduction relates to individual company projects, we can control those within our own operations.
As cost-reduction relates to partnership, this requires an element of commitment that is, I think, being addressed and probably is in its formative stages of truly generating benefits for the participants. But, at the moment, I am not sure we are carefully or cogently addressing redundancies within our industry, even though I think there is an understanding of the need to do so. So, I think there are still many challenges and opportunities in front of all of us if we are serious about becoming a low-cost producer.
Now, as we think about being a low-cost producer, without question, we must be cost-competitive. However, let's not trick ourselves into believing we will be successful solely by being cost-competitive. You can save yourself into bankruptcy. So, our full meeting agenda needs to be heard and understood to provide a perspective on profitable business administration - which is a goal that each of us has for our businesses.
At Echlin, our approach to cost and profitability is quite straightforward. We try to focus, as best we know how, on listening to our customers and trying to add value to our combined businesses such that we can be in a position to deliver best value. Anyone can deliver lowest price. That does not necessarily indicate best value. Hopefully, that concept will be clear as we move forward.
The manufacturers' side
Let's look at the manufacturers' side of our industry for just a minute and discuss the profit margin pressures in fact that exist and link these observations to why we must be a low-cost provider.
First, let's talk about changing vehicle technologies. There is no question that long-life components have reduced aftermarket demand. In our company, I can give you several examples which mandate attention to cost reduction.
Electronic ignition. The advent of 100,000 mile ignition modules has eliminated nine to 10 contact set and condenser replacement cycles. What is this doing to factory utilization and cost?
Fuel injection. Longer-life fuel injectors have replaced carburetors, which needed reworking every three to four years. Even the design of the fuel system (pumps, lines, rails and injectors) impacts replacement.
Electronics in general. As increasingly more vehicle systems incorporate electronics to replace electro-mechanical parts, replacement cycles are greatly expanded because of fewer moving parts.
To cope with the needs and demands of our OE customers, each of you who is involved in the manufacturing segment is aware of the increased costs we are sustaining for research and development, engineering and the other aspects of this relationship that have been outsourced by the car factories. While this has generally given us increased sales opportunities, in most cases this has been achieved at reduced margins. Hence, another obligation to become a low-cost provider.
Capital equipment investment and tooling costs are escalating at a rapid rate as the diversity of vehicle applications and registrations expands dramatically in the manufacturing process.
This, obviously, is carried over into the distributors' hands as the parts proliferation problem puts extraordinary pressure on space, inventory investment, inventory management, etc. The question here is - how do we get a pay-back for this investment that is necessary to serve the motoring public?
Full-line or short-line?
This discussion often leads to a strategic question of being a full-line supplier providing services of engineering, sales, marketing, distribution, etc. versus being only a basic manufacturer with a short-line product offering being sold at a low price. This is an interesting and important topic that I believe is yet to be resolved within our industry. What does the aftermarket need or want from the manufacturing base?
In order to reduce inventory investment and to provide better service to our customers, we are all having to find ways to reduce our run sizes and to achieve faster working capital turnover, etc. This is nothing new. Most companies are doing a pretty good job at this stage in establishing their manufacturing methods to cope with the customer needs - but have a long way to go to generate the Operating Working Capital turns that justify the investment.
Whether we like it or not, we are all investing more money in inventory. We are striving constantly to get better operating working capital turns. We are finding methods through computers, order entry systems, etc. but, at this stage, I don't know of anyone in the aftermarket who is doing a particularly good job in managing their inventories to reduce this high percentage of total investment.
One of the ways that we are attempting to address this is through sophisticated inventory systems. Here, the question is posed as to where the inventory investment is to be made - at the manufacturers' plant, the WD, distribution center, the jobber's store? Is inventory or inventory management to be duplicated throughout the system or is there a way, amongst ourselves, that we can optimize this major portion of total industry investment?
Another important event that continues to put pressure on margins relates to the evolution of program groups or buying groups. There is no question that this leverage is reducing distributor product acquisition costs. Said another way - it is reducing manufacturers' profitability and, as a result, puts additional pressures on our cost structures.
A fact of the program group expansion is the demand for financial assistance to support growth of these businesses. There is an element of logic that says this is a shared venture regardless of the ownership. Again, here is another element of added cost.
Also putting more pressure on margins, are the preferred vendor designations, which are basically "all or nothing at all" votes where distributors band together in their buying positions. The implications of this winner or loser approach will, I believe, have very long-term implications in the industry as shakeouts occur as a result of manufacturing consolidations which invariably will be the outgrowth of winners or losers in such programs.
Sharper retail customers
Our retail customers are becoming more sophisticated daily. They range from those who are extraordinarily effective to those who are using historical buying leverage approaches. But, generally speaking, the centralized purchasing functions are effective in driving down acquisition costs much as program group vendor relationships have been.
The control of distribution or store ownership is putting another form of pressure on margins through delivery systems that are obliged to support the free standing stores.
The advertising programs of the retail groups are quite focused but generally are funded in some form or another through price reductions or direct funding - another element of margin compression.
The tight inventory management of the retailers forces inventory back into the laps of the manufacturers. Once again, a cost or a margin compression event.
Tied to our marketing evolution is the explosion of private label product lines. It is interesting to note how different companies approach this. However, regardless of what the conclusion is or the reasons for the private label decision, this is an added cost to the system and to the industry by virtue of the multiplicity of products that must be labeled, packaged and inventoried.
The growth of the private label programs adds another element of concern and risk to the manufacturer - that being the undermining of brand equity. This is a topic that could be discussed for quite a long while, which is not my purpose here, other than to state that the support necessary for manufacturers' brands, coupled with the price reductions or concessions given to support private brands, is another complication for the profitability of our industry.
Off shore competition increases
Offshore competition, which has been with us for a long time but seems to be increasing significantly, is also hitting at North American manufacturers' profitability. Generally, the foreign manufacturers target fast moving SKUs and flood the market with low-priced product and provide no services. This calls to question whether the services rendered by full-line manufacturers are, in fact, needed or wanted in the aftermarket - there is a cost to be borne somewhere in the industry for such services.
This creates significant pricing confusion in the market since the foreign pricing, for whatever the reasons may be, tend to be extraordinarily aggressive as a result of no services being provided. The low prices, along with the flood of products, frequently puts the full-line domestic parts supplier at a disadvantage against such competition.
The imports frequently provide varying levels of product quality for our vehicle owners. This, to me, is of grave concern in that the car owner really doesn't know what product is being put on his vehicle when it is repaired.
There are many examples in our country today of lesser quality or maybe acceptable quality (by someone's definition) being foisted off on the American consumer as first line quality goods. I think this is a moral issue, as well as an economic issue.
With the advent of additional production coming into the U.S. market which is essentially flat, manufacturing capacity utilization issues are exacerbated which then creates another form of margin compression due to under absorption and excess or possibly idle plant capacities.
The points I have raised here are not criticisms of our industry. They are merely realities of our markets - our challenge is to address our operations to stay cost competitive.
Coping with the threat to profits
Let's move from some of the "whys" of margin compression for the manufacturing segment of our industry, to talk about some of the "ways" that we are, or should be, trying to cope with this threat to profits. This relates to cost reduction or improving the value delivered in this relationship between manufacturer and distributor.
One of the ways that many companies are coping with this is through consolidation. There is significant evidence that this trend will continue as companies reach strategic investment (or divestment) decisions.
Over the past seven years, there have been approximately 450 transactions at the manufacturer and warehouse distributor level involving merger or consolidation. This process, in itself, reduces industry overcapacity which theoretically reduces costs and improves profitability.
Consolidation frequently lowers operating costs as a result of the elimination of many redundancies. You know quite well what has been done in your own business. In our case, for instance, we have eliminated or consolidated factories. We have combined distribution centers. We have eliminated redundancies in back office activities. We have consolidated sales forces and, in most cases, this has worked to achieve our goal of reducing costs or making ourselves qualified to deliver best value.
Consolidation frequently permits improved manufacturing methods to be implemented. Frequently, the company that is being acquired, for reasons that are not always clear, has not invested capital in new manufacturing methods, equipment, or systems. With consolidation and infusion of engineering and manufacturing help, these businesses can be enhanced or, said another way, costs can be reduced.
Sometimes, the consolidations permit expansion of market opportunities or expansion into different distribution channels. While this occasionally creates concern between traditional and non-traditional customers, the fact remains that expansion of distribution is another means of enhancing manufacturing throughput, hence, keeping all customers in a more competitive position through lower acquisition cost.
Many of us are investing significantly to reduce our manufacturing and operations costs. This is done through changing manufacturing concepts to focused factories, to just-in-time production scheduling methods, to enhanced computer systems, to improved inventory management methods and a myriad of things that each of you probably are doing in in your own businesses.
We can drive down the cost of quality and we can improve product quality simultaneously through reduction of scrap and rework costs. I think we all have done a good job in this area by working with attitudes of continuous improvement in all facets of our businesses - not just the factories, but in every aspect of business administration.
Advanced information systems
Another area that I think is vital to the future is the continuing implementation of advanced information systems capabilities. To give you two examples in our business.
We have implemented world-class sales force automation projects at BWD Automotive and Beck/Arnley World parts. Each of our sales people use lap top computers to evaluate customer inventories; track customer buying patterns, growth and progress; and communicate with our own computers to provide specific information on part availability, order status, warranty returns and stock adjustments. Using computers eliminates virtually all paper that has inundated us in the past. How many of you have seen the trunk of a field salesperson's car which is loaded with bulletins and catalogs and all sorts of things, which normally can't be found when the information is really needed? We are eliminating all this redundancy at Echlin, while improving our sales support and service for our customers.
We are also implementing a major business integration project which will tie in all data for all operating functions through a common system. This was the result of an 18-month study on ways to provide better customer service, or Best Value Delivered, if you will, through integrated systems capabilities which will tie into all of our customers. We have chosen Baan as our software. This is a multi-million dollar investment but, in the long-term, it will significantly enhance our capabilities of serving our customers, again with Best Value Delivered.
We, like many manufacturers, are leveraging our purchasing power for raw materials and operating supplies. (Sounds somewhat like a WD preferred vendor program - doesn't it?) We are generating significant savings in various ways that we could not have accomplished if each of the individual units that are now part of Echlin were still discrete or separate businesses. However, with the amalgamation of many businesses into our company and with enhanced information systems, we are leveraging our capabilities - again to become more cost competitive.
Turn, turn, turn
An area that must be addressed in our company and, quite bluntly, is not being done very effectively by us is improving inventory turns. We are providing the inventory investment that is necessary for the industry but, by no means, are we achieving an adequate return on that investment at this stage. A major opportunity and challenge.
I think it is vital for each one of us to preach with a zealous attitude the continuous improvement philosophies in our operations. A prime example of this at Echlin is our electronic ignition operations in Independence, Kansas. We have conducted many kaizen events in the last several months which have effectively utilized the input of all our associates ranging from the plant management, to engineering, production supervision, and factory floor workers, so that we have substantially improved our quality, we have reduced our costs, we have managed our inventories better and our customers are served with the highest quality production that we know how to produce, delivered on time.
I am very excited about the power of worker participation as a means of generating cost reduction and service improvement that is being multiplied through all of our operations.
Now, these are just some of the cost reduction activities under way in our operations. There is probably nothing new or novel that I have covered here other than to cite some examples in the real world of things that are going on in our company today.
You must constantly focus on details of your business and must measure your performance objectively against your goals if you expect to generate the cost reductions which are necessary to keep you competitive.
The real challenge
I think it is vital to remember, however, that lower cost is just one component in the profit equation. The real question and challenge is revenue growth and how do we achieve this.
I think you have to listen to your customers and try to identify their real needs, and try to satisfy them. These may differ between customers, even in the same channel, by virtue of how each customer chooses to go to market to gain its competitive advantage. The days of a national manufacturing program or take-it-or-leave-it attitude from the manufacturing sales force, I think, are for the most part gone. We must have tailored programs that meet the needs of the particular customer in a particular market.
The real challenge to this approach, however, is - how do you maintain pricing equity between comparable customers by mixing and matching programs you have available to your customer with out providing disadvantage to another customer who may not choose to use that program.
I think we have to look for new market opportunities. Again, why? The broader use we have of our manufacturing facilities, permits the lower cost we can provide to each customer that we serve. Ways to accomplish this would be to look for other channels of distribution domestically and, in our case, parlaying our established overheads of engineering, technical support, and manufacturing processes, to expand internationally. We are finding some great opportunities throughout Europe utilizing our existing operations in various countries.
We are moving into many emerging countries. We have several joint ventures underway in China and India. We export to Taiwan, China and Japan to penetrate their aftermarkets. And, we are moving into many other emerging markets where historically we have not spent much development time.
Again, this uses existing capabilities which helps us then to drive down costs for all customers.
How do we achieve the goals?
Now, to achieve these nice-sounding goals of becoming a low-cost producer and providing Best Value Delivered, how do we do really it? What is required? First, you must have cost-effective, high-quality manufacturing capabilities. This requires a major investment of money and of human resources to stay with the world-wide competition. Over time, only a few companies, in my opinion, will achieve this goal.
Why do I suggest this? The capital costs for sophisticated, efficient manufacturing equipment continue to rise. Tooling demands for full product coverage versus the unit volumes for amortization are becoming very costly. This, coupled with major consolidation of supply positions, is creating a wide gap between those manufacturers with access to capital who may also have major supply positions versus those companies who find themselves on the other side of the equation. Over time, these dynamics, which are really market driven, will cause further industry consolidation.
I also think it is vital to have a service-oriented, creative sales and marketing organization. I think it is a given that most of us can produce quality goods at a reasonably competitive costs. The differentiation for success still, whether you are a manufacturer or a distributor, is to distinguish yourself in the eyes of your ultimate consumer as providing a value - again, Best Value Delivered.
In our case, we think technical training through people, programs and facilities is vital. We continue to do this in our sales organizations through ASE certification of our sales people, through technical training clinics, through tech vans that roam our country daily, and nightly, and through state of the art training facilities which serve the needs of the installer, jobber, and WD customers.
Next, speed is vital. Rapid, innovative, and responsive product development is required. Speed to market, whether it be for products or for services is an important differentiation. We must flush out all redundancies in our own operations and in our customer support systems to strive for improved service. Again, a Best Value Delivered element that can distinguish you from your competition.
Customer service in its broadest sense - not just in order fill rates but in every aspect of your company ranging from the person who answers the call (hopefully, it won't be a machine that answers every time) through the order entry process, through the factories, through the distribution centers, through the accounting department, and processing credits, on, and on, and on. Customer service, again, is an element of Best Value Delivered.
Now, if we are successful in identifying the need for cost reduction, if we are successful in establishing how we believe we can become more cost competitive through Best Value Delivered, if we believe we truly can understand our customers - what will this do for us?
In our company, we think it will do this - if we focus on the customer and understand that when our customer wins, we win, this then gives us the opportunity to be of continuing service to the customer for the long term.
And, if we are, in fact, going to provide the Best Value Delivered at all times to our customers, this means we must provide the best quality products to our customers every single day. We must provide the best in service to our customers in all aspects of our business administration and the best way to do this, in my opinion, is through the emphasis on continuous improvement in each aspect of the business.
The bottom line
Now, if we are Delivering Best Value to our customers, I think then we have reached the final conclusion we are all driving for - which is to provide our shareholders with a better than average return on investment.
All of this says that to be successful and profitable there is more involved than just being the low-cost producer - but, in the absence of being the low-cost producer, I don't think you can even get into the game to be the Best Value Delivered company, neither can you deliver best returns to your shareholders.
So, with this rambling discourse on low-cost production, I want to remind you of something I said above. Everybody talks about low-cost production. Most of us are doing something about it.
The challenge for all of us is to constantly strive for improvement in every aspect of our business administration and to focus on being in the game with low costs - but remembering we win the game with Best Value Being Delivered products and services.
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Low-cost producing becomes the norm
