Last month, I concluded that the impact of low-priced, high-quality products from low-cost countries like China has the potential to change the way we do business forever.
Upon close review, the biggest difference comes not from the lower acquisition cost of the products, but in the ripple effects that their availability is having on our supply chain. That statement is not intended to diminish the profound implications the low price points are having on the North American aftermarket, because already their impact has been far reaching. Let’s consider those first and then see how their reverberations are in fact redefining the roles that trading partners have had for nearly 100 years.
The first wave of products from low-cost countries (LCCs) generally appeared in the marketplace in a manner consistent with a manufacturing-oriented company: a well-made product that was a suitable replica of its North American counterpart, but in utilitarian packaging, featuring a part number and a
less-than-inspiring brand name, but always with a compelling price point.
Over a relatively short period of time as the LCC products began to gain usage and acceptance within the technician community, the marketing and branding improved. Four-color packaging and marketing hyperbole have become commonplace. Fueled by low prices, satisfactory trial and a new focus on marketing support, customer acceptance spread quickly. And with the spread, they substantially increased their share of an already beleaguered and self-tortured market.
Fighting back with profit margin
Confronted with this new threat, North American manufacturers had to respond. Most fought the threat with the only weapon they had: profit margin.
It was a predictable tactical response and one that was effective in the short term. When a reseller confronted them with an alternative supplier featuring suitable quality and a significantly lower cost, the expedient solution was to “talk up the brand” and sacrifice a few points of margin to placate the customer. In the throes of deep denial, a few manufacturers saw too late that they were caught in a death spiral. Most other North American manufacturers are scrambling to reassess and re-evaluate their core business strategies before they slip into the same situation.
In a nutshell, North American manufacturers are faced with a tough decision: move the majority of current North American production to a LCC, or keep it in North America and become increasingly uncompetitive.
For literally decades, the prosperity that this great nation has enjoyed has afforded us abundant luxuries, mostly attributable to the great manufacturing capabilities we possessed.
Luxuries came first in the form of wages. Over the years, through collective bargaining agreements, wages rose from a mere subsistence level to one that enabled laborers to become active consumers in the economy. That participation fueled overall economic growth and enabled employers to add benefits that workers were beginning to demand, including health care and pensions.
Generally, our collective wealth allowed us to afford regulatory intervention from the government. Many of those programs were extensions of the benefits the private sector was providing like social security, unemployment or Medicare/Medicaid. Some related to the “greater good” like improved occupational safety and better environmental stewardship.
But all of these things — improved medical care, better pensions and safety and environmental programs — came with a cost.
Today, laden with those costs, the North American manufacturer is competing on an unlevel playing field.
Shoeless in the foundry
A couple of years ago, I spoke to the president of a company that manufactures pipe in the Pittsburgh area. I asked how he had managed making such a commodity in North America. He launched into an impassioned diatribe about union concessions, automation, lean manufacturing and all the attempts his company had made to cut cost.
But finally he said, “I’ve been to China, I’ve seen those plants. I pay $18 an hour, I provide health care and provide my workers with protective ear wear, eye wear and clothing; over there people make a dollar an hour and don’t wear shoes in the foundry. I know I can’t compete with that long term.”
But beyond low wages and the laissez-faire governmental approach, there are often subsidies provided by LCC governments that further reduce manufacturers’ landed cost here.
On a football field, “piling on” is a penalty; but then football fields are level. In the game of globalization, there are few rules and the concept of “fairness” is supplanted by the harsh reality of what the world will be, as huge third world countries transition into the economic mainstream.
Additionally, in China, there are over 1 billion Chinese who truly believe that being a laborer is the most noble of pursuits and come to do their jobs accordingly.
In their socialistic society/economy, citizens are “paid” if they work or not. Most prefer to work and, when presented the opportunity to do so, work with a verve that is not often seen in Western societies.
Someone relayed a story to me about workers in the Tianjian region of China. In this emerging region, proud workers are out to demonstrate that they are as dedicated and productive as those in the more traditional manufacturing regions of the country. So when production demands required overtime, the plant managers found themselves with far more volunteers than was required.
By the way, in China, overtime is strictly voluntary and workers receive no additional pay — just the gratification of doing the right thing. Try to imagine that scenario playing out here.
Is denial pervasive?
The reality and severity of this situation has not yet fully registered with North American manufacturers. In fact, there is great denial among those in that community. There is the Pollyanna expectation that the whole issue will just go away because, after all, Americans want things that are made in America.
But this is no longer true. Americans want high-quality products that cost less, and that includes independent automotive technicians.
Creating new strategies to cope with this dynamic change is the current and near-term frontier for North American manufacturers.
Standing pat is not an option. My assessment of the situation is that most North American manufacturers will have to accept that making the full range of everything they sell here is no longer an option.
Yes, there will be exceptions, notably among complex or high technology products, trendy parts and accessories and short production run items, but the vast majority of replacement service and maintenance items will most likely be affected.
Hence, managing the transition from “making it all here” to outsourcing most, if not all, manufacturing to LCCs is a challenge most N.A.-based aftermarket companies will have to make. And for many, a painful transition it will be.
From table scraps to the whole meal
I think there have been some “early warning” categories of this coming trend. Not surprisingly, examples can be found at both extremes of aftermarket product segments: large high-profit categories and small low-margin segments.
At the fat end, LCCs found significant opportunity in stealing table scraps from big margin brake manufacturers. They attacked a high profit, low technology segment — drums and rotors — and effectively took the majors out of that business in just a few years.
The number of non-LCC drums and rotors sold today is less than 20 percent. Think about the implications when the LCCs go after businesses like filters, engine management or belts and hoses.
At the other extreme is the area of reman products. With its relatively lower margins and higher handling costs, this segment is reeling from LCC products that can be sold new for less, without core charges, return shipping, etc.
The ultimate example is the combination of the two. If you want to see the devastating impact of the LCCs, consider ARI, who was both a brake company and a remanufacturer. The combined impact of the LCC assault on their segments resulted in a whirlwind trip from Chapter 11 reorganization to Chapter 7 liquidation in the span of about two weeks.
Bankruptcy is a tool that will be used increasingly in the struggle for survival. Many will use bankruptcy laws to restructure debt and buy time to make adjustments. Some, like ARI, will simply use it to liquidate their businesses. But others, such as Delphi, will use bankruptcy to try and change the deal with the workforce.
Borrowing a strategy that has been used with some success in the airline industry, Steve Miller, chairman and CEO of Delphi, defended his decision to file for bankruptcy protection with some facts that I found staggering. He said that his fully-loaded cost for labor in North America, including the higher wages, health care, pension and regulatory compliance we talked about above, rolls up to $75 per hour per employee.
Like my friend at the pipe company in Pittsburgh, that’s a pretty steep slope to be looking up. The problem is, there aren’t enough concessions to be gained to level the playing field.
The primary implication of this trend toward LCC goods is the inevitable loss of North American manufacturing jobs. We are confronted on almost a daily basis with news of more plant closings.
I suppose we must ask ourselves if this trend matters. Perhaps, as some argue, we are just in the transition to a service-based economy, and the loss of traditional manufacturing jobs is the logical progression. It is clear that consumers of aftermarket products don’t care where a part is made. Perhaps it will only matter when all the manufacturing has moved to LCCs.
Wise politicos always observe that America votes its pocketbook. This may be just another example. We care about jobs, but more about cheap goods.
And, as if this profound challenge to traditional North American suppliers wasn’t enough, there is a secondary subplot that is emerging.
It is a potential channel conflict where large resellers see an opportunity to vertically control more of the market by adopting the “Wal-Mart mode,” a strategy that calls for a reseller to get over to the LCC and directly source an ever-increasing range of products.
That is an example of the ripple effects that have the power to redefine the roles that aftermarket trading partners have had for nearly 100 years. They are also the implications that I’ll have to wait until next month to ponder.
In the meantime, let’s collectively think about how North American aftermarket manufacturers should deal with the new global threat that’s staring them in the face.
