The PACE of supplier innovation

GM just announced that it will begin selling a dual gasoline/CNG (compressed natural gas) version of its Impala – the first Chevy in years (decades!?) to get a top rating from Consumer Reports. Now such vehicles are standard in Brazil, allowing the country to take advantage of the widespread availability of natural gas. [In Brazil, such vehicles can also use any gasohol mix, from 100% gasoline to 100% ethanol – you put whatever's cheapest into your tank.] With natural gas running as low as $1.50 per gallon equivalent in the US, that's of considerable interest to fleet operators, and perhaps someday to regular consumers. And while the article makes no mention of the specifics of who supplies GM's system, the dual fuel technology comes from a supplier, Magneti Marelli. One item of note is that it is an example of the globalization of the supply base, as this is an Italian firm but the R&D was done in Brazil. The other is that this innovation – TETRAFUEL – was a 2008 PACE winner.

The PACE supplier innovation competition is now entering its 20th year; finalists for the 2014 awards were announced Saturday morning at the Society of Automotive Engineers "Global Leadership Conference" at the Greenbrier in West Virginia.^{Note 1} I've commenced a project analyzing PACE winners. I hope that will provide a window on what I believe is a gradual shift in the nature of automotive innovation (I gave a presentation on "technology roadmaps" at the Industry Studies Association in May 2013.) Another component is to see whether we PACE judges [yes, I'm one] have done a reasonably good job in evaluating which innovations matter. Of course we can't give awards to firms that don't apply, so we don't have a complete set of innovations to work from. But my sense is that we do pretty well.

Flexible fuel systems are an example of that. What Magneti Marelli did was really clever, starting from problem solving in the Brazilian context, where ethanol is cheap [unlike in the US]. Now other suppliers have to make sure that their hoses aren't soluble in ethanol, that their fittings are robust, as it's chemically different from gasoline. MM's focus was engine controls. How does the air-fuel mixture need to adapt, or ignition timing, or ... in the presence of different mixtures? And how do you measure the fuel mix? They discovered that the information they needed was already being gathered by sensors present in the burn and emissions systems; they didn't need additional sensors in the fuel line to figure out ethanol content. TETRAFUEL took it one step further: how did engine controls need to respond to natural gas? Solvable. (Again other suppliers did the work on lines and fittings; CNG storage and handling is a mature technology.) How to switch fuels? Some clever engineering utlimately led to a low-cost system that could be fitted to existing engines.^{Note 2}

You can peruse past PACE winners on the competition's web site, along with the list of 2014 finalists that this year ranges from Korea and Japan to Sweden and Germany, with a global customer base. I'll make site visits to a few as part of the judging process. Until the announcement of the winners at a black-tie event in Detroit in April 2014, though, I won't be able to say much more.

Note 1: SAE is recovering from a near-death experience, the two-plus-century-old Greenbrier resort is also recovering nicely under the ownership of a local WV businessman.

Note 2: All the detail that I provide on PACE innovations is from public sources. We judges are very careful to adhere to non-disclosure rules, which not only includes engineering, customer and financial data from suppliers relating to their innovation, but the input of customers and other outside references on an innovation relative to alternative approaches and systems from rival suppliers.

mike smitka

Bad News for Toyota? – the Detroit 3 are Back

...the Detroit 3 are returning to the midsized-car segment...

I'm tossing out back issues of Automotive News to try to fit into a corner office with more windows but less shelf space. I know, crocodile tears for this academic with his shelf-filling collection of books and journals. Anway, one headline caught my eye: "What can save the Detroit 3? Cars!" [a John K. Teahen, Jr. editorial from Sept 18, 2006, p 16].

The context was the near-exit of GM, Ford and Chrysler from the car market, which decreased monotonically from 89% of their sales in 1965 to 35% in 2005, while (correspondingly) trucks went from 11% to 65%. Now admittedly trucks were incredibly profitable on a unit basis, while small cars were a necessary evil, intrinsically unprofitable but needed for CAFE (the Corporate Average Fuel Economy mandate). But the decline at the Detroit 3 was disproportionate to the shift towards light trucks in the over US market.

One point is that ambitious designers, engineers, and senior managers all want to be associated with halo the ka-chenk of good bottom-line vehicles. Teahen argued that the Chevy Impala remained a potential money-earner, with hoped-for sales a bit above the 296,000 of 2006. In fact, on a platform basis, output was higher – 500K – reflecting the multiplication of nameplates that were in fact the same basic car, but the implication of the editorial was that it wasn't making much money. And even with the shift of the overall vehicle market towards light trucks, such sales pale besides the 1-plus-million mark hit of 1965. GM wasn't putting its heavy hitters on car projects.

I've argued before on this blog that Toyota lavishes undue attention on the Prius and on the Lexus marque, again reflecting the status of these projects within the company as a whole. Reputedly Toyota's working to correct that bias, devoting more effort to the 2012 version launched in December 2011. Time will tell if it is better executed and better selling.

Today, however, the Detroit 3 are a factor. They have very different cost structures, with the removal of the millstone of legacy costs from around their neck, a function of the aging of workers "retired" under pre-2007 restructurings, the impact of the VEBA and (for GM and Chrysler) additional costs shed under bankruptcy. Labor is no longer a fixed cost. They thus no longer need to maximize revenue [which for you economics junkies is also implied by the low marginal price of labor]. Instead they can aim to make money from cars. We see that in reduced incentives, reduced fleet sales -- that is, higher prices -- and a normalization of residuals. (I can't speak of leases -- I lack knowledge and suspect that option continues to suffer from the aftershocks of the financial upheaval of 2008-9.)

What does that imply for those who remain focused on cars, particularly Toyota, Honda, and Nissan? On the one hand, they ought to benefit from less discounting. On the other hand, they are hurt by reinvigorated Detroit 3 products. The latter, I believe, dominates: from Toyota's perspective, they have two new, heavy-weight competitors in GM and Ford (and in some product categories, a 3rd in Chrysler), and while Hyundai has been around for a while, sales of the Sonata are only now such as to represent a major slice of the mid-size segment of the Camry and the Accord. If you've become a bit sloppy dare I say arrogant? the sudden appearance of new competitors can be very painful.

My prediction thus is that Toyota (and Honda) will resort to greater discounts and higher fleet sales. That should be good news for new car buyers. (Car renters will have greater choice, but price may not budge much, better residuals will work against higher initial acquisition costs for Enterprise and their rivals.) But since Toyota relies on exports from high-yen Japan for Lexus and (to a lesser extent) the Prius, they've taken a major hit to profits on that front. I'll leave it to financial analysts to pour over segment results of the major players, particularly Toyota, to see if the new competition means their US profits take a hit as well.

Mike Smitka

comments welcome, here or via email!

Toyota vs GM: Guess Who's the Dinosaur!

...economic theory says dominant firms adopt strategies that undermine their dominance ...

This isn't an enthusiast site, and I'm not a car guy. My family didn't have a second car growing up so tinkering with one never became a hobby. My attitude is horribly utilitarian: a car's function is to get me from point A to point B. So my own vehicle is 24 years old, my secondary one is 14 years old (while my wife's is only 8 years old). When I go on long trips I try to rent a car. And when I visit auto suppliers as a PACE judge or otherwise do the limited travel in which a normal academic engages, I also rent cars.

That said, I have written on this blog about the logic of a leading firm to "never be first" (in its heyday this was the case at GM, and in the past two decades became an operating motif at Toyota). Furthermore, there is an internal bureaucrat logic at large companies. I've not interviewed people about this, so I'm not being my normal careful academic self in stating it, but I surmise that if you're an ambitious engineer / designer / marketer at Toyota, you wanted to be associated with the Scion (Akio Toyoda's pet project) and with Lexus (prestige and profits). To work on the Camry would be a ho-hum posting. You wouldn't be using it as a platform to launch new technologies. It isn't a platform for future products for developing markets.

That would be quite different at a Hyundai or at today's GM. Hyundai started out with a very small market presence, both quantitatively and prestige-wise and in the size of its cars. The Sonata received a lot of attention, details well done including NHV, but I've not driven one for a couple years so don't know the new model. GM needs to reconquer the sedan market. I've driven both the Malibu and the Impala -- the latter so quiet that I had to double-check that I'd turned on the engine, and with a "clean" interior. I was impressed.

Then there's the Camry – I drove a new one with a few thousands miles on it. It was noisy, wind noise in particular. Then there was an occasional vibration from somewhere in the instrument panel, a matter of both design and (poor) build quality. Next was the instrument panel itself. I counted 12 active functions in the speedometer area, a cacophony of visual information (the mixed metaphor seems appropriate). Speed. Tachometer. Miles per gallon performance. Engine temperature. Odometer. On and on. Other than the speedometer, you really had to take your eyes off the road to decipher these functions – and it wasn't clear why a driver of a modern, automatic transmission family sedan would want a tachometer or most of the other functions. Dysfunctions, actually. There was also a large and hard-to-use LCD display -- and the gas mileage information on it didn't match that found next to the speedometer. Furthermore, the hands-free phone function didn't work consistently, particularly dialing out. The developers clearly hadn't done their homework on testing the bluetooth protocols of various phones against their system. Finally, it drove like a modestly responsive boat. That may be what older drivers want – and by older, I mean those pushing age 80. I don't think that's really their target market in theory, and in practice age 70-something drivers wouldn't be particularly receptive to the boatload of gadgets confronting them every time they got in the car.

So, this is congruent with economic theory. A dominant player plays it safe, and puts its resources into growth areas and pet projects of senior management. Over time of course they lose their dominance. But this sort of thing is not easy to turn around, viz. GM's experience. Toyota has a well-entrenched bureaucracy, structured in ways that date back to when they were an exporter of models developed in Toyoda City. On the marketing side in the US there was Toyota, and Southeast Toyota, and Southwest Toyota, rather than a national structure. And they've bought into the upmarket strategy, with profits (and internal kudos) from Lexus and not small cars. That no longer matches their actual market base and production base, and it leaves them ill-suited to tap new markets such as China and India.

I strongly suspect that this is well-known at Toyota itself; after all, there was an internal coup in Toyota that elevated Akio Toyoda earlier than planned under the normal bureaucratic progression, even before the recall scandal. The Camry suggests however that organizational dynamics are deep-seated and have to date resisted change.

Mike Smitka