Wednesday, May 27, 2009

Musings On Organizational Strategy

First off, I’m somewhat of a heretic regarding organizational strategy. In a prior life the firm I was with had an organization strategy practice led by a wizened partner who tended a special computer program that fed on organizational survey data and spit out solutions. Double, double toil and trouble, fire burn, and cauldron bubble. Well, that’s what I thought of his program. The wizened partner’s perspective was a bit different. I always remembered him saying, “The first law of organizational strategy is that structure follows strategy.” It took me 25 years to figure out that this was a bunch of crap. That old and tired firm made a lot of money on organizational strategy because they had a system for churning out what amounted to very elaborate justifications for making the changes that clients knew they wanted to make anyway. During our internal blog review one of my brilliant German team members margin noted: “Every couple of years a new organizational strategy and structure is hyped into heaven. In late 1999, I attended my previous employer’s pan-European staff meeting in Paris. I listened to a lecture about the new titans of the dot-com age by another wizened partner. He touted Enron as the blueprint for an ‘entrepreneurial organization with flat hierarchies that foster drive and innovation’. Enron filed for bankruptcy two years later. There are things that won’t change and that are indispensable at the core - accountability and integrity.”

You can pay a lot for these justifications. One of my clients described the results of a recent organizational strategy as resembling a fall migration, “You see David, we are all McKinsey birds perched on branches. They clap their hands and we fly up and land on a different branch. Same birds, different branches.” Now, those were very expensive justifications. My favorite of all time was at another client that had to right-size. They hired the big guns and came up with a restructuring plan. Everybody in the company, who was not on the friends list, had to re-apply for the more limited number of jobs that were on the new grid. It was nothing personal; it was all business. And, worth every penny for those elaborate justifications.

I observe about five organizational re-alignments each year – so, I’ve seen about 125 of them. Expensive reorganizations tend to follow Darwin's law of survival. Basically, the most successful organizational structure eventually wins out. So while all these radical restructurings start out very unique and novel, over time small changes start to chip away at the consultant's vision of what you should look like. You end up with the most efficient structure for your organization given (a) the business you are in, (b) the culture your company has, and (c) the vision and comfort level of the people who actually run the company. Typically, five years down the road you're close to where you started and all signs of the big bad consultant's organization plan are only contained within the fossilized records of org charts of business past.

The most brilliant reorganizations have everything to do with leaders, and little to do with classical organizational strategy. Every time I hear about reshuffling, I think of Volvo’s Mitch Duncan – now retired. Mitch was brilliant in his leadership role at Volvo Cars of North America (VCNA). He was an extrovert and inordinately self confident, yet without any arrogance. Before anybody else thought to do this, Mitch organized Volvo’s service-parts entity as a separate strategic business unit – it was called Volvo Parts. It had a board of directors to give Mitch advice and hold him accountable. Mitch reorganized on a near-annual basis, typically driven by Volvo Parts’ annual planning cycle. Planning was taken very seriously there and was an enterprise activity; not compartmentalized. Initiatives were refreshed each year, people were responsible for different outcomes and outputs – in short, corporate life was very kinetic. Mitch had no boundaries. Yearly, he would reorganize around his initiatives and his people (not his strategies, because they were longer lasting). Mitch felt that his staff had different strengths that would make them, and Volvo Parts’ initiatives, more effective. This is re-organizing at its best- rather than being an exercise of box and arrow drawing, this was about maintaining an organization that could readily shift focus to meet the challenges of the day. After 25 years of knowing most of the Volvo companies, I have a lot of respect for their people, their incredible innovation, their cost effectiveness and most importantly their ability to do what they plan to do. Currently VCNA’s IT group is run by their old parts planning manager, who was recruited out of VW and trained by Mitch Duncan. He’s as good as it gets. So, structure really did not follow strategy there. Structure followed tactics (how to achieve the strategy), and people that would get them there. Reflecting on this versus the 125 or so realignments that I have observed, well, it seems to make a whole lot of sense.

The second case of brilliance I have seen is with Alan Mulally at Ford. Ford’s board brings in a guy from Boeing to run the company and he beats the pants off his counterparts. So, my take-away here is that managers need to know how to manage, and the rest of the stuff can be learned on the job. This does not mean that a good manager necessarily needs to be stupid about the industry. Rather, it simply means that a good manager does not necessarily need to know anything about cars, trucks, bulldozers, motorcycles, or tractors.

After 25 years of watching, here are my 10 laws of organizational strategy. Print these out and you can save millions, or stop reading now, become a consultant, and make millions - Double, double toil and trouble, fire burn, and cauldron bubble.

  1. First Non-Law. Before thinking about organization and structure you need a business strategy – do this in a manner that feels comfortable to you and your company culture. Strategy is what you want to do. After strategy you need actions – how you are going to do it. Remember that a strategy is a vision – a clear direction on where we need to be. However, you should never organize around a vision – it's much too cerebral for most people. It's extremely difficult to make that translation from vision to action. Take it one step down to an objective "what do you want me to?" level that you can organize around. A good manager with a clear directive will figure out "how to do it". If the vision is “compete through rapid product innovation” you can achieve that vision through a myriad of organizational structures – the organization structure is not essential – the only thing that is essential is “hire smart people and effectively allow them to innovate.” Give your managers that clear vision and let them figure out how to do it. There's about 100 ways to achieve a vision, but only a few good ways to achieve an objective.
  2. The Second First Law. Organizational structure follows tactics and people skills; strategy is what we want to do with a myriad of efforts. Each effort is done by people with different skills, strengths, and weaknesses. Think of it as warfare, where each battle requires a different alignment of resources.
  3. Law of Oz. If you think an expensive Harvard Wizard MBA with 2 years of consulting experience directed by a Wizard partner with ADD can pull levers, blow smoke, and develop a brilliant and sustainable organizational strategy for you, then you are dangerous around cars, trucks, tractors, and cycles. You should work for Disney. If you think that one of your peers or bosses thinks like the Wizard, well, first give her/him a knowing wink. If they wink back, then it’s OK – they still are dangerous, but are masterful at politics. No wink back? Then they are probably an alien and you should be careful when they ask you to go out to supper.
  4. Do-it-Lots Law. Reorganize frequently to refresh people, thinking, and tactics. Best case is to reorganize after key initiatives are off of life support (or DOA) – so this means shuffling in sections. When you do this frequently, people come to expect change and adapt to it more easily. They also learn the need for annual accountability – getting things done now. This is good. Letting people stay at the same task year after year also creates organizational inbreeding and defensiveness – people never get the challenge of trying something they might not know anything about. Rotation of responsibility shakes up the organization (fresh set of eyes on an old problem) and shakes up the person (old set of eyes on a new problem.)
  5. Span Law. Manager span of control of 1:10 (one manager to 10 people) is a useful benchmark. A good manager can manage at least up to 10 people; narrower spans of control reflect: (a) managers doing and not managing, (b) inefficient mangers, or (c) empire building, or (d) simple lack of backbone in someone’s inability to say “no” to a promotion. Realistically, spans can be greater or narrower. However, it is useful for managers of non-10 spans to have to formally defend their part of the pyramid and justify deviating from the “10” benchmark.
  6. The Mulally Law says that management skill and experience trumps industry knowledge and tenure. So, you do not need to head up an IT group with a long-time IT person. Marketing groups can be run by non-Marketing people; Logistics groups can be run by manufacturing folks. And, a Boeing guy can run a car company.
  7. Mitch’s Law. Go out and benchmark what other similar organizations do and with how many heads. You will find that: (a) you are doing some unimportant things that others are not doing at all, (b) you are doing some things with more resources and less effectiveness than others, (c) you are doing other things with less resources and less effectiveness, and (d) you are doing some things with fewer or more resources at normative or better performance.
  8. Redeployment Law. Before you give up resources from Law #4, redeploy them to improve your initiative success. Baseball Law Corollary. If someone doesn’t get good results in their current job, they should be traded to another team or job. Manny Ramirez, Sox slime-ball and now Manny-wood drug star proves how amazing some traded players are. (Though, he is a poor example of the desired outcome here – irresistible, but poor) New jobs, new teams, wake up hidden talent. But at the same time, don't allow yourself to mistake unwillingness to change for healthy skepticism. The healthy skeptics (believers) will engage in organizational change by looking for better solutions. They are the people to re-deploy . But there are those who are simply unwilling to buy into the strategic vision, and will spend their time resisting change and influencing others to reject it. Tolerating this behavior will poison results.
  9. Bored Law. Bored of your box-checkers and same-old been-there-dun-that’s? (BTW, every time I hear this I cringe.) Follow Mitch Duncan’s lead and create a Board of Directors for your department or division that serves for ideation and periodic external accountability. Don’t think internal politics here – think about an external view that will give you cheap excuses to change.
  10. Bronx Law. “Don’t say nuthin, fegit it!” This is all about, yes, communicating what you are doing and, no, they won’t forget any lies told in the process. Non-communication is not an option. Your organization will think you are inept if you sneak it by. Lies and ambiguity are brothers in gutting morale. I swear that life in the Bronx is a mimic of life in Tokyo, where yes can be no, and few non-natives can understand the language.
  11. Business-As-Unusual Law. Managing, even improving, “business as usual”, as hard as it is, is the easy part for an organization, but not a reason to reorganize. But only few organizations have the skills or the people to manage the exception to “business as usual” (even though some organizations may have been designed specifically for that purpose – take FEMA and Katrina …). Train people to be problem solvers and troubleshooters, especially those who you see as future leaders – solving problems will be their “business as usual”. Teach frameworks and concepts to enable “outside-the-box” thinking rather than process – blindly following “problem-solving” procedures in an unpredictable world will end in disaster.

Tuesday, May 19, 2009

The Curious Case of Slumping Sales

(Sorry for the long blog – it was impossible to talk about what’s happening with cruddy parts sales in 800 words or less. Also, we need your help – please fill out the survey and tell us if these are helpful and what content you’d like to see in the future.)

Service parts sales declines have been a curious phenomena. No generalities seem to explain it all. Here’s what we expect**.
  • We expect that construction sales will decline along with equipment operating hours.
  • Ag sales should be stable due to spring plantings.
  • Auto parts sales should decline due to plummeting accessory sales; yet, we would expect some positive sales offsets as the fleet ages and as customers hold on to vehicles longer and invest more in repair and maintenance.
  • We expect Asians and Europeans to do better than the domestics because “import” service retention is higher than Motown’s.
  • We expect the independent aftermarket to grow off this resurgence in vehicle longevity, and we expect it to steal market share from auto dealers. This should be easy to figure out.

But, not everything we expect is actually happening. And, we should be very careful in making decisions based on erroneous simplifications.

First off, the market for Canadian auto parts is very different than the US market – OE parts sales are down a tad there, but there are a lot of moving parts that we do not think about south of the border. Exchange rates play a translation role there, customers are more “European” in behavior than American, and the aftermarket has a very different character. By European, we mean customers are generally more loyal to their dealer throughout the vehicle ownership cycle. The aftermarket is dominated by Canadian Tire, a retailer with a significant automotive focus not found in the US. We do not see a lot of parallels in market-busting solutions as we move from North to South.

The numbers make HE look like it is already in recovery, but it is too early to celebrate. Here’s what’s behind the U-turn in the numbers: HE has different wholesale sales cycles, different programs, and different sectors (Ag, lawn and grounds care, gentlemen farming, corporate farming, construction, and mining), many of which are in a up-spring cycle. Since the IAM competition in HE is much more limited, with obvious strengths in faster-moving wearable parts, all the players in this segment will move up and down with the blue collar GDP. Fast-moving stealth attacks just don’t happen here.

That leaves the car-guys, and what looks like market chaos. Some players in the “Tough Auto” segment have been nose-diving for the past year. “Middle Auto” consists of the long-timer import brands that have been here for decades – they have been least impacted by the recession. The “Growth Auto” includes the brands that have been gaining market share for the past 2 decades – these companies have seen whole goods and parts sales go down an erosive glide path for the past year. In all cases, the parts sales reductions cannot be accounted for by the recent vehicle sales declines. Most of the Market Watch data is non-warranty sales, so, outside of plummeting accessory sales, the trend lines in “feeder stock” for parts sales looks very different than new car sales.

Our first guess of what was happening was that if OEM sales were down, then retail service lane sales must be the same. So, we looked at Repair Order data for dealers in the Middle and Growth auto segments. What we saw reflected the post-October shock and somewhat of a spring recovery. These franchises for the most part did not experience near-death experiences. Instead, close inspection surfaced a “not-problem” – we did not see any sustained retail evidence of a mass exodus away from dealers to the IAM.

The next look was more forensic in nature and we probed Market Watch data. We indexed deltas in 2009 part sales per 5-year UIO for this year vs. last year (the normalizing constants were the averages for each product line across all OEMs, not the averages across all product lines for each OEM). This is pushing it, but somewhat insightful. What did we see? OEMs who were in positive territory were good at wholesale and had viable wholesale strategies – for M&R and Heavy Repair. Next, the longest bars, both good and bad, were generally in Heavy Repair. This seems to be a make or break product segment. However, it only accounts for about 10%-15% of the sales mix. Third, collision parts sales are down fairly consistently across OEMs. We believe that this is due to the severe drop in young vehicles on the road (which are much more likely to use genuine parts for any collision repairs), as well as lower residual values leading to higher use of salvage parts. A consistent trend across OEMs also suggests weather as a factor. What about M&R? Vehicle market share shifts, improved product quality, and longer warranties over the past decade and a half are working against $/UIO growth here. What helps here? Mechanical wholesale strategies; preferably dealer centric – I will get back to this in a few paragraphs.

So, what doesn’t explain recent auto sales declines?

The first bad guess is the Independent Aftermarket (IAM) is cleaning up. AutoZone sales for the most recent quarter were up 6%, but it is mostly from recession-sparked DIY sales. LKQ focuses on collision and is up around 5%, but it is very difficult to figure out how much of growth is due to the Keystone acquisition and how much growth is organic. O’Reillys merged with CSK, and reported a 10% increase in same store sales … while the premier jobber chain, Genuine Parts/NAPA showed a sales decline of 11% in its most recent quarter due to …. Pep Boys, the underdog, which was up 3%, but this includes parts and service. This all sums up to a virtual dog’s breath of strategic direction. Bottom line is that there is not any hard evidence of a significant, sustainable, competitive shift in market share to the IAM.

Hey it’s a recession. More customers who have the capabilities are doing the easy maintenance stuff themselves – so, there is a shift from DIFM (do it for me) to DIY (do it yourself.) This short term trend is accelerated by the ease and availability of getting parts via internet sources. In some cases, this means cheap parts – and these cheap internet parts are displacing IAM sales in the DIY segment. Since dealers generally are not serious players in DIY, this shift is felt the most by the OEM dealer channel.

Other things are at work in the IAM sales numbers. The double-decade market share shift from the domestics to the Asians has made their car parc more attractive to the IAM. Selling prices are higher in this sub-sector, and volumes have been growing. Our guess is that if you were to look at the IAM sales increases under a microscope you’d find that much of the increase can be explained by these share shifts.

Could it be that the car-guy OEMs are losing dealer sales to the IAM – that the IAM is getting more aggressive in selling to dealers?

Nah. Let’s look at the “Tough Auto” group. Dealers are scared, dead, and/or broke. Dealers we spoke to (the usual suspects) attributed their parts purchase decisions to abject terror and/or cash flow. As a result of this, precipitous parts sales declines are just more first order effects from the Obama Task Force’s shepherding of Chrysler/GM bankruptcies.

“In Richmond, Va., Royal Chevrolet co-owner Del Mugford was slightly relieved when he sifted through FedEx packages Friday morning and hadn't received any bad news from General Motors. But he knew his future could be determined by a phone call or a piece of mail. "This is absolutely nerve wracking. It's like a death sentence. It's the worst feeling in the world," said Mugford …. (The Associated Press, May 16, 2009 –”

Jay Cremins – a Principal at Carlisle – spoke with some dealers during the week of May 11th. The following are from his notes – he has personalized them to be from a dealer’s perspective.
  • They might fire me; the auto task force is demanding drastic cuts in the number of U.S. dealers … Am I going to get cut? Will the manufacturer survive? While this question is most pressing for GM and Chrysler dealers, it is not a moot question for Ford dealers … or even some imports.
  • I might have to fire them. The franchise has gangrene … I may have to amputate soon to save the rest of my business.
  • Their store is a money sump pump … this was survivable when the other franchises were turning a profit; but it is quickly becoming unsustainable.
  • Credit is tight – feels like a supermodel with an eating disorder. Usually a dealer borrows (floor plans) funds to pay for new vehicle inventory and pays cash for parts and used vehicle inventory. There is currently no cash … I repeat no cash … none … it is gone … the summer selling season better start this month. They are currently unable to borrow funds to pay for parts and used vehicle inventory. I can either invest my little remaining capital to buy parts at the VW store or at the Saturn store. Which would you pick?
  • I (Jay speaking) can’t state strongly enough how fear is paralyzing the domestic-only dealers. Even for multi-franchise mixed domestic/import dealers, they have that pit in the stomach fear that the domestic stores may take down their whole organization. Import-only dealers, with exceptions, are merely gravely concerned.
So, it is safe to assume that much of the car-guys parts sales decline is wholesale-to-dealer-related and reflects dealer fears and lack of cash to add to inventory. Close examination of Market Watch data buttresses this conclusion with an expected spread of good, bad, and ugly results.

Can it get any worse?

Yeah, for the “Tough Auto” group – they might be in for some more of those “second order” effects. Pretty soon there will be approximately 2,000 defrocked dealers stuck with a bunch of cars and roughly $1 billion parts (valued at dealer cost), and without any obligation on the OEM’s part to buy them back. If the OEMs do not buy the parts back, market forces will price these parts at cents on the dollar, and they will be sold to the IAM and other dealers. IAM sales of these parts will displace the OE sales, as well as sales to the surviving dealers. The surviving dealers will use the parts to displace factory purchases, and will be used for parts returns (e.g., buy it for 10 cents and “return” for a dollar). So, the OEMs will buy those parts back one way or another. Hmm. Can the bankruptcy court understand all this and clear the path to buying them back in the first place?

So, what do you do?
  • Problems. Many Tough Auto dealers are dying – the simple reduction in outlets has a negative impact on parts sales. Implicit service territories for the surviving dealers need time to expand to accommodate stranded vehicle owners, stranded body shops, and stranded wholesale accounts; this will take some time. Many of these surviving dealers simply do not have the cash to buy parts and replenish their inventories. When they do invest, they are more likely to invest in parts for their “safest” franchises, at the expense of their weakest franchises. Many are scared and do not want to further invest in the unknown. Others simply can’t imagine a bank giving them credit for buying stuff from a supplier who is in bankruptcy, or close to it. Service customers of troubled franchises have the same sort of fears, but to a much lesser degree; these manifest into a gentle push to non-dealer outlets.
  • Not-problems. There really is no evidence that the pace is rapidly accelerating for the IAM making any significant long term strategic share gains into car dealers. The traditional IAM is a slave to their distribution channels, the centerpiece of which is a jobber store. They sell to independent repair facilities and DIYers. One big threat here to the IAM is cheap parts sold over the internet. There is no reasonable expectation that the incredibly fractured IAM would offer better purchase terms to threatened franchise car dealers (“damaged customers”) – they are experts at understanding bad debt, and they’d smell problems with this group. There’s no evidence that JIT service frequencies from the IAM are eating at the soft underbelly of the OEMs. RIM slows this down, terms slow this down. And, as I said, the IAM would look at some car franchises as being damaged customers.
So, what can you do that makes it through this gauntlet? Check the boxes that apply.

Stop the panic by making sure you do not roll out programs and policies that further disenfranchise dealers. Don’t worry about the usual bad stuff that comes from rolling out creative field programs – stuff like lawsuits, death threats, calls to the CEO, dealer council sit-down strikes. More fear = less sales, and that’s very very dangerous right now.

Stimulate wholesale with attractive (tactical)terms. If the problem is credit and service really is that cash cow, then offer terms that solve the problem. Hyundai will take back the car if you lose your job. Why not offer terms on parts sales that buys back the parts in the event of a dealer bankruptcy? For healthy OEMs why not provide a floor plan guarantee on all parts sold in 2009? Why not provide an instant cash rebate of any return credit for parts sales for the next 3 months? Why not simply provide attractive terms, like buy now and pay later?

Stimulate wholesale by working with your dealers to crack into the mechanical wholesale business (I’m not talking about collision wholesale). Why not provide dealers wholesale growth incentives? Why not fund field and dealer training on implementing delivery routes, IRF account sales calls, IRF marketing, inventory stocking, etc? Why not support dealer stocking of parts for 6 to 8 year old vehicles? Why not support best practice sharing across dealers? Why not track wholesale sales by part, dealer and IRF to assess performance and communicate program information.

Collaborate in dealer wholesale with other OEMs to provide appropriate counter help, account marketing, stocking, and delivery. At the North American Service Parts Conference we identified collaborative wholesale as the single biggest opportunity out there to increase sales. The problem with anything collaborative is that it involves, well, collaboration. That means collaborating with dealers, other OEMs, and with a third-party provider. Not a lot of takers here, yet – it is the third pig’s brick house.

Fill in the blanks with technology and extend D2D and drop shipments to wholesale accounts. Assign dead geographies to existing dealers and give them a piece of the action, even if it requires no action on their part. This will help with customers in dead dealer geographies. Dealers are more willing than ever to cooperate with growth – this might be the perfect time to crash though some barriers. These sales strategies work fine for Mary K and Cutco, why not auto parts.

Think about setting up service-only franchises that are not the dream child of some imperious retail architect. Develop a cheap template that gets franchise coverage in dead areas to do both warranty and customer-pay work.

Stimulate retail by helping your dealers go after the up-tick in DIY. This includes help with web templates, possibly getting them on eBay, DIY marketing in local newspapers, in-store displays, fliers, and training.

Stimulate retail with e-marketing and e-education. At the conference we learned that most OEMs are rolling out new Google-based e-marketing strategies that will take customers right into the closest dealer appointment systems. Make sure your dealers know what to do with these “leads” – make sure they can give a quote for service that is comparable to the Firestone store. Also, make sure you take the free pass opportunity to educate customers on your websites as to Trust, Value, Cost, and Convenience.

Sell service contracts to new and existing vehicle owners with a “lose your job” insurance contract to mitigate deferred maintenance and repairs and to help the OEM and dealer generate near-term cash.

Sell service contracts and maintenance agreements through stores like Costco – tie service loyalty back to dealer.

Measure and reward dealer loyalty with a year-end bonus for all dealers that increase the percent of parts they buy from the OEM in the second half versus first half of 2009.

Inspect, inspect, inspect – dealers leave a lot of value on the table – capture this information electronically through their DMS.

Blocking and tackling - accessory packages for showroom vehicles – with discount and payment terms – maybe pay on point-of-sale.

Bottom line is that we are all in the Never-Been-There-Before Club. It is a time for extreme caution, and anxiety. Decisions will be made with less resources and more speed. I said to check the boxes above, but don’t just check them. Think. Most readers will skim the list and nod North/South. OK, if you are sure you are OK, do just three things: (1) fill out a 3x5 card and develop a list of problems that fit your company, (2) take out another card and do the same for “not-problems” – stuff both cards in your purse or wallet, and (3) read David Brooks’ op-ed in Tuesday’s NYT.


** I have left out Heavy Truck since this segment does not participate in Market Watch

Thursday, May 14, 2009

Terms of Entitlement, Endearment, or Engagement?Paul Gurizzian and Gene Metheny

Motor vehicle service-parts OEMs spend between 5% and 10% of revenue on dealer terms & conditions. For the OEM, terms & conditions are critical to driving sales growth and supply chain performance. For the dealer, terms & conditions profoundly impact profitability and fixed operations behavior. Finally, terms & conditions can be a prime determinant of the end-customer service experience. The premise of this article is that terms & conditions are important, yet for many OEMs the program has not fundamentally changed in many, many years while virtually everything else in the environment has changed.

First, a definition: By terms & conditions we mean order types, order cut-off times, order-to-delivery times, order frequency, transportation modes, transportation charges, referral patterns, return allowances, and an assortment of premiums, discounts and surcharges.

Broadly, terms & conditions strategies fall into one of three categories:
  1. Traditional Terms – an approach from the past, but still being used at roughly half of OEMs;
  2. Incentive Terms - an approach of the present and being used at roughly the other half of OEMs; and
  3. Performance Terms – an approach for the future that is being used by a few OEMs.

Traditional terms are the least effective in motivating dealers to achieve today’s OEM objectives, but that was not always the case. When traditional terms were first developed, the OEM’s primary objective was an inward focus on controlling costs. So, they designed terms & conditions that encouraged dealers to buy and stock lots of parts (through stock order discounts), hold on to these parts whether they sold or not (limited return allowances), and discouraged emergency ordering (surcharges and lack of discounts). Why? - Because those behaviors reduced complexity and controlled costs for OEM operations.

But times change and, therefore, OEM objectives have changed. The trouble is that in many cases terms & conditions have not changed. Over the years OEMs have expanded their views beyond focusing on their own distribution networks. There has been greater recognition of system-wide costs and impacts on the end-customer. There’s an increased appreciation for the role of dealer inventory as a critical element in enabling the total supply chain to satisfy the end-customer and support the brand. Consider, for example, the fact that about half of the OEMs in NASPC and EAC now have a Retail Inventory Management program and, as a consequence, they both control and bear the risk of dealer inventory. Finally, the need to secure higher growth from the same, or lower, terms & condition spend has increased with competition.

As OEM objectives have shifted, and the incentives designed to achieve these objectives have been added, the traditional terms have become simply holdovers with a hodge-podge of adders - in many cases, more of entitlements than effective incentives.

Incentive terms have been an effective first step at motivating dealers to help address current objectives. Rather than just offering standard stock order discounts, return allowances, etc., OEMs are now linking incentives to what they assume are good dealer practices – high stock order utilization, dealer participation in OEM training, RIM compliance, etc. By virtue of tying payments to incentive-related metrics, the objectives are made more explicit and directly rewarded. Incentive terms motivate input. Incentive terms & conditions are better than traditional, but not the best.

Most recently, OEMs are realizing that dealers could “check all the boxes” in terms of incentive compliance and still the not move the needle in terms of bottom-line revenue growth and/or efficiency improvements. To address this, some OEMs have found performance terms to be more effective in achieving OEM objectives.

Performance terms are a method of setting outcome targets, measuring dealer performance, and rewarding results. While incentive terms focus on rewarding inputs, performance terms focus on rewarding results. Think of this as paying for performance rather than paying for good efforts.

Performance terms metrics can be controlled by the parts manager (e.g., parts sales growth, dealer loyalty, etc.) or in some cases controlled by the service manager (e.g., service satisfaction, fixed first visit, etc.). Ideally, these performance metrics are a balanced set of measures that drive the right dealer behavior to satisfy the customer and grow the business.

Linking payments to performance metrics requires careful thought. While the concept is simple, for a metric to become a performance measure tied to OEM payments it needs to be filtered through a rigorous framework. The icon below is a starting framework for 1) selecting possible metrics, and 2) the availability of robust data, often from individual dealer management systems, which is a potential constraint to implementing performance terms.

By the way, performance terms do not need to be all or nothing. Some OEMs use a combination of all three, depending on objectives, dealers, and the availability of data to calculate metrics.

In closing, how do you know if you are a candidate for implementing performance terms? “Agree” responses to the following list of three litmus test statements suggest you are ready for change. On the other hand, “Disagree” responses mean incentive terms are likely the best solution for your current environment.
  1. Current terms & conditions are not driving the right dealer behaviors to encourage growth and satisfy the end-customer.
  2. OEM and dealers are ready for the change management effort and emotion associated with varying dealer payouts based on performance.
  3. Dealers are prepared to share with the OEM point-of-sale information from their dealer management systems.

Wednesday, May 6, 2009

Chrysler Bankruptcy and What It Means for Us

At this year’s NASPC we were asked by a number of participants what the impacts would be of GM’s plant closings and Chrysler’s bankruptcy. Depressing questions. Even more depressing when viewed from the perspective of the blood, sweat and tears expended by GM and Chrysler staffs in improving their operations. Looking at the top 10 most improved parts warehouse operations based on 2008 metrics, GM and Chrysler occupied 9 slots. Chrysler walked away with the single most improved warehouse. I am humbled by all this accomplishment.

Do you remember that great scene from Good Will Hunting where Matt Damon is interviewing with the CIA and he is asked why he shouldn’t go to work breaking codes for the CIA? He launches into a chillingly plausible description of the chain of events resulting from successfully breaking a code, leading to a raid on a militant camp somewhere -- eventually leading to his buddy in South Boston being unemployed. This is a perfect example of system dynamics – the study of how almost any environment can be described as a set of complex systems, with many interrelated components that all ultimately impact each other via feedback loops.

That system dynamics thinking is a perfect application for what is happening in the auto industry today. My concern is that the Obama Task Force either has not had time, or does not have the insight, to really see ALL of the effects (not just first order, but second and third order) of their efforts to turn the dials to restructure the auto industry and rebuild our economy.

Due to the unquestioningly negative opinion that so much of the general public has of the old Big-3 – fueled by the generally uninformed media – most of the task force was pulled from very well educated outsiders, bankers, or consultants. For them, Chrysler and GM are approached as text book case studies, and the architects are the best and brightest that America’s B-schools have to offer. Hey, there’s no way that the automotive industry can be any more complicated than a credit default swap. Simplicity is the answer. I grew up on a farm, and I’ve heard that before. For example, growing beans is simple. As long as it is the right kind of simplicity. Getting there, can be pretty complex.

Let’s lay just a little foundation before we take a system dynamics approach to understanding the first, second, and third order effects of Chrysler’s bankruptcy – in particular the effects of that bankruptcy on the service-parts supply chain. While there may have been issues on the vehicle side, on the service-parts side, Detroit was not stupid, they really were listening and doing over the past 20 years – learning, improving efficiency, and cutting costs. Let’s just focus on costs. The answer to lower costs in the service-parts supply chain was to adopt Lean – Toyota showed us the way here. Lean goes way beyond manufacturing; it encompasses the entire enterprise. We found that we can reduce fixed and variable costs by streamlining our supply chains, reducing variability, and adopting sell-one-buy-one – smaller more predictable shipments, made with small batch manufacturing, shipped in fast milk-run delivery systems, received with tiny receiving docks, put away in tiny bins, picked in small line quantities throughout the day, and shipped to customers in just-in-time fashion. Billions of dollars of inventory was expunged from the enterprise, and it all works fine. Usually. The American version of “Lean” went further than Toyota did. It linked in aggressive purchasing methods that squeezed all the fat out of supplier contracts – and possibly even some muscle. Even during times of inflation, suppliers were required to show year-over-year net cost reductions. This “squeeze” worked its way through the extended supplier enterprise – with nips and tucks at every major cost center. Competition increased and cost cutting continued beyond Lean and into the just-plain-Mean. We have seen years of annual reductions in force and conversion of in-house staffs to contract services. A lot was outsourced - way beyond IT. Don’t get me wrong – lean is the answer, and under most conditions, works great. But it doesn’t provide much of a safety net when massive external factors change the game.

First Order Effects: Ok, Chrysler declared bankruptcy last week. How does this affect all the other companies that play in this space? On the day of the filing we saw the beginning of what system dynamicists would term first order effects. They announced a shutdown of pretty much all of their assembly plants for what could be a multi-month period of time while they make their way through the bankruptcy court. This makes sense because automobile sales are down by around 40% and there is a glut of inventory at the dealers. One very large point: this announcement was made within a week of GM’s very significant shutdown announcement. What will the impacted suppliers do? The largest ones are protected by the Obama supplier “TARP” ($5 billion) and many others will go to the front of the line in bankruptcy court to collect their receivables. The mid-tier and smaller suppliers will be treated like any other creditor and, inevitably get cents on the dollar.
  • It is reasonable to expect that the loss of cash flow from the GM and Chrysler shutdowns will push some suppliers over the brink and they will seek bankruptcy protection. This will happen to big, medium, and small suppliers.
  • Tools will be idled, held-up, or lost. OEMs will need manpower to get these tools back from bankrupt suppliers. How much of that manpower has been RIF’d away?
  • Once they get the tools, they will have to re-source the production with limited staff (that may have been outsourced) to healthier suppliers who will now have “dream” leverage in terms of costs and terms – putting even greater pressure on weaker suppliers.
  • The “outsourced” staffs at the OEMs, who need to do the work of managing tools and purchasing contracts, belong to service and manpower suppliers who are not protected by Obama’s TARP, and will not be promoted to the top of the list of “creditors.” Many of these will be hurt and go away. So the OEs have outsourced manpower, and many of those suppliers are going away. Now where do the people come from?
  • So what happens to the supply of service-parts? Most suppliers already think that service-parts production is a thankless burden that they would prefer not to have. But they are compelled to produce service-parts by agreements for production parts that require it. Now it gets interesting. If those production parts agreements become questionable during bankruptcy proceedings, will those suppliers also simply stop producing parts for service use as they shut down their production plants to mirror what is happening at Chrysler and GM production facilities?
  • Many will try to continue to service non-GM/Chrysler accounts. The problem is that the production and distribution economics are all tied together. Supply may become sporadic and quality may degrade. The best case scenario is that the service we can provide dealers will be degraded. The worst case is that some (many?) genuine parts will simply not be available at a reasonable cost.
  • On the service-parts side, it’s already been announced that about $100 million of Chrysler’s short term financing will come from selling off inventory at Mopar, with consequences for supplier orders as well as parts availability.

Second Order Effects: The above First Order Effects (FOE) are child’s play compared to the Second Order Effects (SOE). The FOE is like a bad sunburn. The SOE are the resulting melanoma, where the danger of metastasis is directly correlated with the length of time that Chrysler is in bankruptcy. Here’s the tip-of-the-tip of the iceberg.
  • Chrysler’s sales will continue to plummet during bankruptcy as their brand images sour and customer confidence in their products erodes even further.
  • This leads to snowballing of already increasing dealership bankruptcies. Yes, GM, Chrysler, and Ford all needed to reduce dealer count, but they needed to do it surgically – this process will not be surgical.
  • Reduced dealer counts will further reduce ability to retain service customers – dealers will be further apart (less convenient), and customers will be even less confident in the viability of dealer service and OE warranty coverage (Obama’s pledge that the federal government will back OE warranties notwithstanding).
  • That service retention loss will put more dealers in financial danger, reducing both service revenue and further eroding vehicle repurchase loyalty – this is a classic death spiral for dealers.
  • Outsourced and contract services that are used to run the operations, interface with dealers, and fix problematical IT will degrade as these business arrangements become nebulous, and these suppliers become extinct. Replacing them needs effort, and this effort needs people. Where will all this come from?
  • More jobs will be lost from the extended enterprise – and the rate of job losses will be proportional to the length of time that Chrysler is in bankruptcy.
  • Job losses, Dow-doldrums/depressions, and sensationalist headlines will cause consumer confidence to drop. Again.
  • We will remain longer in the Keynesian Paradox of Thrift. All related sectors will remain in the penalty box longer.

Third Order Effects: Since these are at the bottom of the deck, they are already unrecognized casualties of war. But longer term, these third order effects could have the greatest impact on what the industry looks like when we eventually come out of this mess.
  • The vehicle service business will shift substantially.
  • The AAIA has been pushing the pro-aftermarket legislation with incompetent, but good-enough, research. They succeeded. Three Democrat representatives birthed HR 2057 recently – the Motor Vehicle Right-to-Repair Act. Recession troubles have gutted OEM lobbying budgets and, now that GM and Chrysler are controlled by the government, this sort of spending is frowned upon. It is hard to believe that the industry can field any sort of meaningful resistance to this bill. So, look to see increased aftermarket competition as a 3rd order effect that will take a bite out of 2010 and beyond.
  • Take this to the logical conclusion and perhaps the independent aftermarket takes a real run at trying to provide warranty service for OEs. By taking on the role of guaranteeing vehicle warranties, the Federal government may be opening the door for this (even if they don’t realize it yet). This further hits dealer viability.
  • It gets worse, at least for the Detroit companies. Service technicians have been a constrained resource for years. As Chrysler, GM (and Ford) dealerships go out of business this constraint will be less binding – but worse, as the best technicians move from Dodge and Chevy to Toyota and Honda, the Detroit companies' ability to compete degrades further.
  • But of course, some of those excess technicians will go to the aftermarket. This will improve the quality of aftermarket repairs and drive up the demand for genuine parts and genuine diagnostics and tools in the aftermarket. If an OE is set up to serve this wholesale market, this could actually be an opportunity.
  • With gutted staffs, clawing out of the recession with growth programs will be difficult. IT budgets are being slashed, field organizations are being pared down, and contract staff is being released. This will again accelerate the market dualities that exist between stronger and weaker OEMs, and between well funded aftermarket aggressiveness and the normally placid, now emasculated, OEMs. Again, 3rd order impacts in 2010 and the out years.

So, What Do You Do? The Crystal Ball future state does not look very good unless Chrysler emerges from bankruptcy very very soon. If you are not Chrysler or GM, what should you do?
  1. Understand your non-parts vulnerabilities – identify and talk with service suppliers who get the lion’s share of their revenues from Chrysler and GM (packaging, engineering, call centers, transportation carriers, dealer trainers, survey staff, 3PLs, HR, agencies, marketing services, IT services, etc.)
  2. Understand your vulnerabilities with your dealer customers – most vulnerable will be dualed dealers and dealer groups that are heavily invested in Chrysler and GM.
  3. Understand where you are most vulnerable in terms of parts: (a) current model production, (b) smaller production runs, (c) at bigger supplier plants that also supply GM and Chrysler.
    • Run, don’t walk, to your fastest moving parts suppliers that are also Chrysler and GM suppliers and ask them what they are going to do.
    • Do contingency planning - plan for the worst case from your most vulnerable suppliers.
    • I hate to say this, but stock up on aftersales parts from your most vulnerable suppliers and try to figure where to stock them (yes, violate all the laws of lean in the process).
    • Understand where you are in key parts inventories with your dealers, on a global basis, and think of contingency terms that will encourage more D2D and discourage hoarding.
    • And as a possible long-shot, think about whether this might be the right time to “in-source.” Are their key suppliers out there that are distressed, but might offer a good long-term investment for OEs that have the necessary cash, access to capabilities, and, most importantly, the right competencies to run them effectively long term?

But system dynamics works both ways – the down often keeps going down, but the up can keep going up. You just have to hang on and get to the potential upside to all of this. Can you see the following happening? Around 2012 or 2013 (or so), household income and wealth will return to trend levels. So vehicle demand could return to 16 or 17 M units a year because the real price of cars will continue to fall and the US population will continue to grow. By this time, roughly 1 M to 2 M units of production capacity will have been rationalized. Meaning that demand will be high, and supply reduced. Meaning that the automotive OEMs left standing will print money in the US market! How do you like them apples?