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					Dr. Porter and the Auto Industry
        Baron Matthews
          Business 601
             9-29-03
                             Dr. Porter and the Auto Industry
                                         Abstract

       The automobile manufacturing industry is a large and powerful industry whose

influence can be felt all over the nation.

General Production and Sales

       The biggest producers in the industry are Ford, GMC, and DaimlerChrysler, they

are known as the Big Three.

Michael Porter’s Five Forces

       Michael Porter came up with five forces he feels significantly influence

industries. The five forces are rivalry, barriers to entry, threat of substitutes, buyer

power, and supplier power. Each firm in the industry seeks to gain a competitive

advantage over the other firms

Auto Industry Characteristics

       When using Porter’s Five Forces for analyzing the automobile industry, the most

influencing factors are barriers to entry, followed by rivalry, threat of substitutes (within

the industry), bargaining power of buyers, and lastly, bargaining power of suppliers.

Automobile Manufacturing Structure

       The automobile industry employs around 331,000 people and is one of the top

paying industries in the US with an hourly rate (average) of $25.31.

Automobile Manufacturing Barriers to Entry

       Some of the biggest barriers are economies of scale, product differential, capital

requirements, access to distribution channels, and entry deterring price. A new entrant

into the market would have a hard time matching the prices of an established firm.

While it is true that much of the capital invested by existing firms is borrowed from an

investment firm, most firms would not lend money to an un-established firm because of

the sizable risk involved.

Automobile Manufacturing Rivalry
          Most firms participate in price cuts, rebates, volume pricing, fleet pricing,

advertising campaigns, and the like to compete with each other. One firm will typically

slash the price on a car or offer rebates for a limited time and another will follow suit. It

is very important to note that the automobile manufacturing market is exceedingly

concentrated with 92.8% of the market share belonging to the top 4 firms and 98.1% for

the top 8 firms.1

Automobile Manufacturing Threat of Substitutes

          There are not many substitutes for automobiles. The real substitutes in the

automobile industry are different models on dissimilar platforms (sedan VS sport coupe)

produced by competing firms.

Automobile Manufacturing Bargaining Power of Suppliers

          Suppliers have the least influence in the automobile industry because there are so

many.




1
    http://www.census.gov/prod/ec97/m31s-cr.pdf
Introduction

        The automobile manufacturing industry is a large and powerful industry whose

influence can be felt all over the nation. They can help an economy turn around, and can

make or break entire town workforces. The automobile industry is not only an industry of

large size and power, but also it has the potential of generating tremendous revenues and

bringing prestige to an area. Dr. Porter’s Five Forces helps tell more about the industry

as a whole. It is important to know some historical facts and general statistical data about

the industry before going too far into detail about the industry in the United. For this

analysis, the scope of resolution will be limited to motor vehicle manufacturing – NAICS

code 3361 – and even more so restricted to NAICS codes 33611: automobile and light

truck/SUV manufacturing (336111 and 336112 codes respectively).2

History, in Brief

        1769 brought about a steam-powered tractor used to pull large artillery pieces at

around 2 mph but because it was very un-maneuverable, it was wrecked in what became

the first automobile accident. The United States had less then 30 firms manufacturing

automobiles in 1898 and a whopping 8,000 automobiles by 1899 that brought the ratio of

Americans who owned a motor vehicle to 1 in 9,500 just a year later.

        Ford was officially founded in 1903; 240 additional automobile manufacturing

firms were established in the next 4 years. 1908 brought about the consolidation of Buick,

Cadillac, and Oldsmobile to form GMC. The famous Model T (Ford) and Ford’s

assembly line were also introduced in 1908. In 1925, an automobile firm known as

Maxwell Motor reorganized to become the Chrysler Corporation. Ford, GMC, and

Chrysler became what was/is known as The Big Three.3 Jumping forward to the present

day finds the Big Three dominating the US auto market.4


2
  http://www.census.gov/epcd/naics02/def/NDEF336.HTM#N3361
3
  http://www.aaca.org/history/
4
  http://images.wardsauto.com/files/1004/USSalesSummary0308.xls
General Production and Sales

                      As mentioned earlier, this is an industry with 16.9 million units sold and total

expenditures – consumer and business – reaching 376 billion dollars in 2002. The

biggest producers in the industry are Ford, GMC, and DaimlerChrysler, they are known

as the Big Three. Each of the Big Three owns and manufactures many brands other than

their namesake, for instance, Ford also owns and produces Volvo, Jaguar, Range Rover,

Austin Martin, Lincoln, Mercury, and Mazda; the other two of the three also own a

similar variety of brands. There are many other firms, especially from Asia, that compete

in the United States market; several of which have production facilities located in the US.

Toyota is the biggest Asian producer followed by Honda and then Nissan. The

Volkswagen Auto Group leads European car production, but falls considerably short of

the third ranked Nissan. The following graph, G1, shows how the Big Three stack up

against the top Asian producers and the top European Producer. The data in G1

represents sales data for 2003 from January to August; September sales data were not

available as of publication.

G1
                                                               2003 Car/Light Truck Sales Jan-Aug

                 3,500,000



                 3,000,000



                 2,500,000
   Number Sold




                 2,000,000



                 1,500,000



                 1,000,000



                  500,000



                        0
                              GM                    Ford           Chrysler Group(1)            Toyota    Honda   Nissan   Volkswagen
                                                                                              Auto Firm
Source is country of manufacture. Domestics are from U.S., Canada, Mexico. Imports are from overseas.
Light vehicles are cars and light trucks (GVW Classes 1-3, under 14,001 lbs.). DSR is daily sales rate.
Source: Ward's AutoInfoBank
Michael Porter’s Five Forces

       Different industries experience different profitability because of the how the

industry is structured and how certain forces interact with said industry. Michael Porter

came up with five forces he feels significantly influence industries. The five forces are

rivalry, barriers to entry, threat of substitutes, buyer power, and supplier power. All five

forces will be discussed in detail later, but it is important to have an understanding of the

base principals behind each force.

       Rivalry, as the name implies, is the way in which firms that sell comparable

products compete with each other. Each firm in the industry seeks to gain a competitive

advantage over the other firms. Rivalry is usually measured by examining the

concentration ratios – based on market share – of the firms making up an industry. The

more highly concentrated an industry is among the top four, the closer the chance there is

for a monopoly/oligopoly in the industry; thus there will be less competition in the

industry though, there are exceptions to the rule. When there are many firms with a

smaller market share they are generally very competitive.

       Barriers to entry are the reasons that make it hard for a firm to enter or exit a

particular market. Typically one would expect firms to enter a market when profits are

high and exit when they are low keeping a balance to the market, but when there are

barriers to entry, this does not happen. Some barriers to entry include start-up/production

costs, government regulations, patents, economies of scale, etc.

       The threat of substitutes deals with substitute products generally produced by

other industries, however a competing firm in the same industry may also produce a

substitute product. To determine the threat of substitutes to a particular product, the

elasticity of that products price can be examined when the price of a substitute product

changes. For example, if fewer rollerblades were sold when the price of roller-skates – a
substitute – dropped, it could be determined that rollerblades sales are very elastic

(assuming a big drop), and affected negatively by a drop in price of a substitute product.


           The power of suppliers and buyers deals with the impact they have on an

industry’s production of goods and/or services. When there is strong supplier’s power,

the supplier can set a higher price to gain more profit from an industry. A strong supplier

is generally one who has almost monopolistic control of resources used in a particular

industry. For example, DeBeers owns the vast majority of the world’s diamond mines

and supplies diamonds to sellers for a higher price then if the market was more saturated.

On the other side of the equation are the buyers. The buyers are characterized as

powerful when they can force an industry to meet their demands. They are generally able

to do this when there are significant rivals they can threaten to switch to if, for example, a

product’s price is not lowered to a certain amount.5 Because of the similarities of the

two, they are grouped together here strictly for space saving purposes.

Auto Industry Characteristics

           When using Porter’s Five Forces for analyzing the automobile industry, the most

influencing factors are barriers to entry, followed by rivalry, threat of substitutes (within

the industry), bargaining power of buyers, and lastly, bargaining power of suppliers.

While there is an intense rivalry among competitors, the most important force are barriers

to entry for new or smaller competitors which leaves the current, established firms to

worry about each other and not new competition. Below is figure one, it is a diagram

showing how the forces effect the industry.




5
    http://www.quickmba.com/strategy/porter.shtml
                                         Rivalry
      Figure 1
                                         among
                                         exsisting
                                         firms (2)



                                          The Industry
    Substitutes                                                       Suppliers
    from firms in                                                     bargaining
    the industry                                                      power (5)
    (3)
                                         Barriers to Entry




                                        Buyers
                                        bargaining
                                        power (4)
Automobile Manufacturing Structure

           The automobile industry employs around 331,000 people and is one of the top

paying industries in the US with an hourly rate (average) of $25.31. Light trucks/SUVs

account for over 50% of the total vehicles sold in the United States, totaling over 120

billion dollars in sales. The major US manufacturers (including foreign auto makers that

sell in the US) produce everything from economy cars that sell for around $10,000

designed to appeal to the budget conscious to vehicles costing in the hundreds of

thousands of dollars aimed at those without money limits. Building a new plant can cost

anywhere from 300 million dollars – a DaimlerChrysler plant near Tuscaloosa, AL – to

1.5 billion dollars – a Nissan plant in Canton, MS.6

Automobile Manufacturing Barriers to Entry

           There are numerous barriers to entry in the highly concentrated automobile

manufacturing industry. Some of the biggest barriers are economies of scale, product

differential, capital requirements, access to distribution channels, and entry deterring

price. While there are some other barriers to entry, those are the most prominent.



6
    http://www.ita.doc.gov/td/auto/2003roadahead.pdf
        To begin with, a new firm would need to invest millions of dollars in initial

capital just to be able to have the equipment to enter the market. There are not many

corporations that can invest several hundred million dollars in a manufacturing facility.

Millions of dollars are also needed to design an auto and all the related parts (i.e. engine).

This is the biggest barrier to entry.

        Subsequently, the current auto firms are generally very large with deep pockets

and a lot of connections. They produce their vehicles on a considerable scale and buy

parts on an even larger scale. A new entrant into the market would have a hard time

matching the prices of an established firm because that firm would be able to buy all of

its parts for a much lower cost due to of the economies of scale.

        Because the automobile market is already saturated with choices for consumers, it

would be hard for a new firm to come up with something truly different. There are many

people who are loyal to certain brands and others who would not consider buying a car

from a lesser known brand, thus making it hard for an upstart firm to establish brand

identity and product differential.

        The capital requirements to simply start a new automobile company have already

been mentioned, but there are still more capital expenditures required in keeping an

automobile firm competitive. Most firms spend millions of dollars every year improving

existing factories and updating designs; these are necessary expenditures to stay

competitive and make the market for a new entrant difficult. While it is true that much of

the capital invested by existing firms is borrowed from an investment firm, most firms

would not lend money to an un-established firm because of the sizable risk involved.

        Finally, access to distribution channels limits most new competitors wishing to

enter the market. The majority of automobile manufactures sell their vehicles to dealers

rather then directly to consumers. These dealers usually only want to sell established

brands that they know will turn a profit, and it would be fairly hard for a new company to
persuade dealers to setup an additional lot (most sell competing brands on different lots)

to try out a new car company.

Automobile Manufacturing Rivalry

           Most firms, except for those like Rolls Royce that target a very select market,

participate in price cuts, rebates, volume pricing, fleet pricing, advertising campaigns,

and the like to compete with each other. These rivalries can become quite intense even in

the oligopoltic structure of the auto industry.

           In the 1990’s, the Big Three each tried various strategies to cut distribution prices

and increase profits. GM started buying up independent dealers to help consolidate their

distribution network. Ford quickly followed suit, and both companies had to rethink their

strategy almost immediately because of public outcry from dealers and others who did

not want Ford to have that much control in the market. While not uncommon, examples

such as this show the downside of rivalry for both the consumer, who would be forced to

deal with the national company rather than a local dealership, and also for the auto firm

who takes the risk of losing customers because of the negative reaction.

           Pricing battles have taken place, especially with the recent low loan interest rates,

which have hurt company profits. One firm will typically slash the price on a car or offer

rebates for a limited time and another will follow suit. The first firm must either make an

even lower offer or risk losing the customer to a competitor. On the other side of that

equation, there are some firms like Saturn that offer their automobiles to customers with a

“no-hassle, no-haggle” price. In other words, customers do not expect rebates or price

breaks, but rather the price they pay is clearly posted on the car. In general, most firms,

especially the Big Three, try to offer lower rates or more incentives then their

competitors, and they will spend millions of dollars on advertising for their products to

keep what market share they have.7


7
    ftp://ftp.usitc.gov/pub/reports/studies/PUB3545.PDF
          It is very important to note that the automobile manufacturing market is

exceedingly concentrated with 92.8% of the market share belonging to the top 4 firms

and 98.1% for the top 8 firms.8 What this means is that the top four firms resemble a

type of oligopoly, they potentially have the power to determine how much they will make

per vehicle. Since automakers sell high ticket, durable goods, they are prone to be

impacted by customer demand, but only to a certain degree. Because of brand loyalties,

fears of new auto firms, and the necessity for vehicles, the automakers are able to shrug

off most customer power plays.

Automobile Manufacturing Threat of Substitutes

          There are not many substitutes for automobiles. Some may argue that public

transportation is a big substitute, but it is not really a big threat because of the limited

areas it serves in the United States. Another substitute that is produced in any real scale

is motorcycles, but the vast majority of consumers consider them either too dangerous or

impractical to replace automobiles. Therefore, motorcycles really do not pose a major

threat. The real substitutes in the automobile industry are different models on dissimilar

platforms (sedan VS sport coupe) produced by competing firms.

          Customer X may have a limited budget to work with on a new car and has done

basic research to get the retail prices within her budget. She then goes to a Chevrolet

dealership and looks at a Cavalier because it is one of the cars in her budget. When she

goes to the Ford dealership, she notices that they have a large rebate on a Taurus that puts

it in the same price range as the Cavalier. Instead of looking at a competing car in the

same category (Ford Focus), she decides on a substitute car from a different category.

This is the real driving force of substitutes in the automobile industry.

Automobile Manufacturing Bargaining Power of Buyers




8
    http://www.census.gov/prod/ec97/m31s-cr.pdf
       As it was discussed in the rivalry section, the majority of automobiles are sold to

the consumer base, and said base does have potential bargaining power, but because of

the concentration ratio of the industry, the power is limited. For instance, if consumers

decided that the Chevy Impala was too expense and stopped buying it on a large scale,

Chevy could either lower the price and risk a loss, or stop production of it and increase

the prices elsewhere to make up for any losses. That is not their only options of course,

they could respond to the consumer demand for a lower price by using cheaper parts

(creating another problem) to lower the price while still maintaining profits, or they could

act in any number of ways. Because the top few firms have such a stronghold in the

market, they could all increase their prices and change their product offerings without

fear of losing customers (assuming an across the board change) since most customers

would rather put up with a higher priced Ford then buying a cheaper Daewoo (which is

the perfect example of what customers fear about a new company since they went out of

business shortly after coming to the US market).

Automobile Manufacturing Bargaining Power of Suppliers

       Suppliers have the least influence in the automobile industry because there are so

many. Because of this large number of suppliers for the components (in general) used in

building an automobile, the suppliers do not hold a lot of power, aside from volume or

loyalty discounts, over automakers. If there were only one supplier of spark plugs it

would be different, but as the market stands now, large firms like Ford are able to shop

around and find the supplier with the best prices, rather than having a supplier dictate the

prices to Ford. For instance, Ford used Firestone Tires almost exclusively on its Explorer

line, but when the tires were found to have defects, there were a number of other brands

Ford was able to choose from to replace Firestone. They did not have to settle with an

inferior product because of any power a supplier had.

Conclusion and Recommendations
       The auto industry can generate a lot of revenue, tends to invest a considerable

amount of money, and creates a large number of jobs all in the area it builds a plant, or

production facility. Certain tax breaks and/or incentives would be a good way to attract

an automobile manufacturing firm to the area and bring all of its positive aspects to the

community. Based on Porter’s Five Forces, it is plain to see that the automobile industry

is greatly impacted by certain barriers to entry (which a state might help remove to bring

in a firm) along with a highly concentrated market of exceptional value. It is imperative

to look at the big picture, even larger then what is presented here, and weigh in external

factors as well, but in general, it would be a wise decision to do what it takes to attract an

auto manufacturer.

				
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