Wednesday, January 27, 2010

Dead Brand Society

Saturn is dead. Pontiac is dead, too. Saab was pretty much dead until Tuesday’s email alert from Automotive News; maybe Spyker will buy it. In 2009 we lost some iconic brands; two with incredible name recognition. How could this happen, especially to Saturn? They were still selling nearly 200,000 vehicles in 2008. That’s a lot of vehicles – in fact, it’s more than Kia sold in 2008, and Kia is seen as a very healthy brand. Saturn set the industry standard for customer treatment, coddling, and satisfaction. It invented RIM – retail inventory management for distributing service parts. Customers made the pilgrimage to Spring Hill Tennessee to eat barbecue at the plant. For most of its life Saturn did what guys like Thomas Friedman think is the right thing to do: focus on making economical small cars that America wants, and not help destroy the ecosystem and spirit of American can-do competitiveness by making those big fat gas–guzzling profit-rich trucks. Hey, Tom’s got a Pulitzer. Does he deserve it? Lets see.

How could Saturn die? Easy. It was a brilliant execution of what we now know was a stupid business model. Understanding Saturn’s demise explains the plague that hit all three dead brands.

There’s a bunch of ways to look at this. One way is to nod your head right to left, say something witty, and blame it on Detroit. Or, you could use your brain and congratulate the Big Dog (GM) for doing something really smart, and maybe a little late. They shoot horses, don’t they? I’m in the latter camp; sometimes you just have to cut bait. How does a dreamboat brand get to a point where you need to pull the life support plug? It’s all about the numbers. Let me explain.

I have about 25 years of hard-knocks schooling, including three learning “segments”, that got me to where I can now welcome SaturnPontiacMaybe-Saab to the Dead Brand Society. Let me summarize.

Learning Segment 1: Market Entry Planning. In 1984 I was on the Hyundai market entry team and wrote the aftersales plan. In 1990 I wrote the entire Kia market entry plan. Now, I can take no pride in their success – all I did was to help out and say that, hey, it made sense to come into the market. Once they hired-up, they threw out the plans and brought in remarkable talent like Hyundai’s Frank Ferrara. Frank was ex-Toyota and was a part of the ex-Toyota team that made Hyundai aftersales an NASPC leader company.

OK, all this is a long wind-up to understanding the key secret make-or-break market entry number. 15%. A new distributor in the 1980s and 1990s needed to buy and sell product, support it in the market, and make money with a 15% gross margin. Let’s put this into context. If the average whole goods product wholesales for $20,000 (a today number), then you have $3,000 per vehicle to play with. Warranty costs are passed on to the factory, as well as all/most of the technical support infrastructure. You have $3,000 to play with to pay your staff, pay your rent, and do all that stuff you need to do. Some more context. If you sold 100,000 units, you made $300MM. Even if you needed a ridiculous amount of “distribution” staff, say 1,000 people, you’d still have $200MM left over to pay for advertising, IT, and company jets. 20 years ago, if you had any reasonable amount of confidence in your sales numbers, “Coming to America” was a really great deal. The distributor money was so good that I even got a chance to work with Armand Hammer on a deal.

Back then 15% was plenty.

Back then.
By the way, typical distributor agreements stipulate sales volume commitments (banded) out at least 12 -24 months, saddle the manufacturer with standard warranty costs (e.g., warranties that are not disguised incentives), and strive to push extraordinary incentive costs upstream to the manufacturer. There is some give and take here. Most distribution agreements were crafted before we understood the ultimate evolution of rebates and incentives.
Learning Segment 2: Lee Iacocca and The Catcher as a Pitchman. Lee smoked cigars on TV and told America that if you could find a better car, buy it. And once he rolled out the rebates and incentives, they certainly did buy it. OK, it was Joe Garagiola as the pitchman in 1975’s Chrysler Carnival of Savings. Iacocca changed the industry with the minivan, American Idol CEO role model, and by transforming Garagiola’s incentives Carnival into what has become a nuclear dawn for the industry. Back then, incentives could tally up to $1,000 or more.
OK, so where am I. I make $3,000 a pop on each vehicle, I sell 100,000 of them, I have a ridiculous amount of staff, and now I’ve got to pay $1,000 a vehicle to compete with Lee. That sill leaves $100MM. I’m good. Well, er, as long as it only takes $1,000 a pop in rebates and incentives to sell 100,000 units.
Thousand bucks? That turned out to be a pretty stupid assumption.

Learning Segment 3: Whole Goods Revenue Management. I spent 3 years at an OE figuring out how to price cars and trucks. I learned that there were a lot of moving parts to this process. I also learned 4 important things:
  1. Historically it was hard to make money on small cars, because the Asians have great product in this segment, pour a lot of money into product refreshment, and have/had lower enterprise cost structures. They also have materially lower R&D costs.
  2. But, everybody knows that you have to be competitive in small car, because it is the first rung of the step-up ladder. You first buy used; first new is small and cheap; end up being buried in a Caddy.
  3. It costs more than a billion dollars just to develop a new transmission. Wow. And there are a whole lot more parts in a vehicle than a transmission.
  4. Just because a truck or Coup de Ville is a lot bigger than an Aveo does not mean that the R&D and production costs are proportionate to the retail price differences. You make your profits on the big stuff.
Bottom line, outside the simple tasks of “distribution”, it is hugely expensive just sustaining a presence in our highly competitive market. If your product line is broad enough and you have enough product in the high-margin sweet spot (large car and truck), you can make some good money. That explains why Toyota and Nissan built truck plants in the US.

Remember, nobody makes much of anything making small cars.

Fitting the puzzle pieces together. Well, it is all about four numbers. (1) fixed costs associated with production, (2) variable production costs, (3) distribution incentive costs, and (4) R&D return on investment expectations. Incentives started skyrocketing in the 1990s. At times, high-end brands like Saab spent more than $5,000 a unit to push the car. Mainstream brands went through cycles where they spent thousands of dollars per unit in a myriad of incentives – neatly tucked into some exploding piles. Like subvented lease car programs that completely missed the mark in estimating residual values. The Coming To America assumption of a thousand dollars a pop was blown out of the water.

Unfortunately, part of Saturn’s DNA was non-negotiable one-price selling. This pretty much prevented rebates – but did not prevent some forms of dealer incentives that eroded margins. Classic pricing elasticity went into effect and the net impact of competitive incentive spending made Saturns appear more expensive … so, sales volume fell. Saturn’s economic business case collapsed like a house of cards. The market really is efficient. The only way Saturn was going to get the volume necessary to make its business case pencil was to vastly lower its transaction prices … and that would not leave sufficient margin to make sense continuing the Saturn experiment. Furthermore, lowering MSRPs erodes residual values, so when you lower prices for this model year it translates into a 3-5 year cumulative effect … especially for lease cars. Checkmate. GM’s pretty smart. If something doesn’t work, try something else. They did that with Saab for 20 years and came to the conclusion that there was no “else” there. Same with Saturn and Pontiac.

Endgame. Saturn’s shrinking sales numbers increased the fixed cost apportioned to each sold unit, and there were not enough manufacturing economies to accommodate this. All this gouged distribution and manufacturing margins and made the R&D ROI look lousy. Voila, a dead brand. The same thing happened to Pontiac and Saab, with a somewhat different twist. Pontiac and Saab maintained competitive incentive spending, which propped up volumes somewhat (in 2008 Pontiac sold over 250,000 vehicles). But, the end result was the same. Bad R&D ROIs; dead, or almost dead, brands.

But, why couldn’t Roger Penske save Saturn? Let me make some guesses. Remember, he’s a pretty smart guy. The Saturn product development ROI was terrible for GM and they would be hard-pressed to provide product beyond a certain, fairly short, contract horizon. The numbers simply were not there. So, Roger went to Paris and looked for another manufacturer. Thus, he could join the group “Coming to America” and become a simple distributor … and live off his 15%. But, he could not broker a deal. My guess is that Roger was pretty tough on forcing warranty costs back to Paris (French cars do not have a Toyota-like quality reputation in the US), as well as being pretty tough on ensuring that a lion’s share of incentive costs be directed to the factory; this mitigated risk. The Saturn dealer network needed 150,000 vehicles a year to be healthy, and that’s a good portion of an annual assembly plant’s production. But, that’s a lot to sign up for. Signing up for the cost of product development was a lot, too. The numbers just did not work. He should have gone to India, Korea, or China. Dead brand.

Bottom Line. Saturn and Pontiac both had cancer and were destined to die in last year’s economic plague. It is important to understand why they died, and why it was inevitable. Otherwise, we will think about it, use our hearts to place the blame, and walk away with something that we will have to un-learn. We might have to unlearn any misplaced beliefs that Detroit was really dealt a full house with Saturn, Pontiac, and Saab … and they simply blew it. Saturn was a brilliant creation that will persist as a benchmark for the industry to chin up to. Including Toyota. The reality is that you can still Come to America and make a fortune, but, you can’t always Build In America and hope to win. Cost differentials are simply too big. That’s why Levis are not made here any more. That’s why global sourcing is big and here to stay. These brands died because their business models would not, in any way, pencil. The shame of it is that they did not die sooner. GM might have had billions of dollars, sooner, to invest in different products with better business models.

How many brands, strategies, beliefs, and legacies do we all have that need to be put out of their miseries because they no longer pencil? My guess is a lot.

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