"Brave New World": AlixPartners Predicts Auto Market Headwinds, "Competitive Convergence," And Other Challenges

AlixPartners, the consulting firm that led GM’s reorganization efforts, has put the perennial optimism of auto industry analysts on notice, introducing its 2011 Automotive Outlook by arguing

The AlixPartners 2011 Automotive Outlook finds that while automakers and suppliers have seen profits bounce back handsomely – North American original equipment manufacturers (OEMs) posted $12.5 billion in 2010 profit on a net margin of 4.6% and North American suppliers reaped $8.2 billion on a net margin of 4.3% – no one should be tempted into thinking that things are now back to “normal,” or at least the normal defined by the consumer-incentive-induced sales levels of the past. In sync with its past annual auto studies, AlixPartners continues to predict that U.S. auto sales will climb slower, and to a lower peak, than many others are predicting. Specifically, the firm estimates U.S. auto sales will reach just 12.7 million units this year and only 13.6 million in 2012.

This is a tough moment for us: on the one hand, pessimistic economic forecasts don’t make anybody happy… on the other hand, the AlixPartner outlook is a significant validation of TTAC’s longtime bearishness. So rather than either moping or self-congratulating, let’s just take a look at why AlixPartners is so gloomy about the near-term outlook.

First, a little more on the market outlook, which predicts

13% compound annual growth rate (CAGR) for small cars and a 7% CAGR for small crossover vehicles between now and 2015 in the U.S., as large cars, SUVs and pickups are expected to see a CAGR of just 2%, respectively, in that time. The study also finds that pickup-truck sales will be hurt by the continuing housing crisis. U.S. pickup sales for 2011 are estimated to reach only 1.7 million units, well below the recent peak of 2.9 million in 2006.

But it turns out that weak demand in the US, driven by under- and unemployment, a weak housing market and a slow recovery, is only part of the industry’s challenge. John Hoffecker, managing director at AlixPartners sets the stage:

It’s a cliché, but the auto industry really does face a ‘brave new world,’ and the differentiators for winning in the world we are transitioning to will be significantly different from the past.The good news is that most of the U.S. players now have their costs in line to capitalize on a slow, steady sales recovery. On the other hand, the industry is facing some truly momentous, and momentously expensive, decisions on everything from powertrain choices to emerging markets; and for OEMs to count on a U.S. sales bubble like in the last cycle – artificially-induced to begin with – to help fund all that is wishful thinking at best.

Technologically, the auto industry could well be on the cusp of its biggest set of changes since the invention of the internal-combustion engine more than 100 years ago. This will put unprecedented pressure on all players to pick the right business models, the right legal and capital structures, and the right partners. And, this all comes at a time of potential margin erosion as the industry, in general, shifts to smaller vehicles, both for regulatory and consumer-preference reasons. Preventing that erosion will be key.

What makes a convergence of technological and sales challenges so potentially dangerous, is what AlixPartners calls “competitive convergence”:

One of the striking features of the new automotive industry is the convergence among competitors around the globe in areas including cost, quality, production processes, supply chain, management expertise and, last but not least, profitability. Profitability parity is evidenced by the fact that last year earnings-before-income-taxes (EBIT) margins for automakers globally clustered in a tight band ranging from 4.3% to 5.7% — with OEMs in China and India at 5.2%, while suppliers from China and India enjoyed an EBIT margin of 7.5%, the highest in the world.

This competitive convergence, the study says, will require big leaps forward in differentiators such as consumer-focused innovation, product-development excellence, truly strategic partnerships at various places around the globe, careful brand-building and, perhaps above all else, a general focus on speed – in achieving either first-mover advantage or fast-follower leverage.

With the bulk of sales growth shifting to emerging markets, commodity costs rising and overcapacity lingering, the US market is hardly the engine that drove the global auto business that it once was. It’s still hugely important, as the second largest national market in the world, but the case for bearish behavior in the US market is strong. The real question in my mind after reviewing this report is: how will the automakers respond? Will our debt-weakened demand be met with a malaise of underinvestment? Given the technological arms race, one would hope not, but rising costs (from technology and raw materials) and sluggish demand do not make for a great combination. Consumers have nearly as much reason for concern here as the automakers themselves…