Saturday, 18 August 2012

The foolhardy obsession with becoming number one

In 2008 Toyota became the world's number one automaker.  This wasn't by profit (they were the most profitable many years before that), but rather by manufacturing volume.  Making more cars than General Motors was a long-held, highly prioritized milestone for Toyota.

Toyota's euphoria was short-lived, as reports of sticky accelerator pedals that made the car accelerate even when the driver took her foot off the pedal surfaced everywhere in 2009.  Many of these reports were admittedly fabricated, but some were undisputed.  This drove Toyota to recall hundreds of thousands of vehicles worldwide.

Finally breaking his silence on the issue after several weeks, Toyota CEO Akio Toyoda had this to say:

"Toyota has, for the past few years, been expanding its business rapidly. Quite frankly, I fear the pace at which we have grown may have been too quick. I would like to point out here that Toyota's priority has traditionally been the following: First; Safety, Second; Quality, and Third; Volume. These priorities became confused, and we were not able to stop, think, and make improvements as much as we were able to before, and our basic stance to listen to customers' voices to make better products has weakened somewhat. We pursued growth over the speed at which we were able to develop our people and our organization."

Now Audi has stated it will become the number one luxury car maker by volume by "2020 at the latest," revised from an initially promised 2015.  In this race between Mercedes Benz, BMW and Audi to occupy the top spot in the luxury sector, you now find them trying to fill every possible niche with a model.  The Audi Q5 was supposed to be a smaller sibling to the large Q7 SUV, but to squeeze a few more sales they recently brought in a marginally smaller Q3.  The price difference between the Q5 and Q3 is also minuscule.  The Q3 makes no sense, but because of this race the market is being flooded by an unprecedented number of niche models with little substance to differentiate them.

Going for the number one spot is usually a matter of ego more than economic sense.  The push to become number one, once turned into a concrete company-wide objective by upper management, is typically done in haste.  This hasty push can cause latent problems for the company.

Costs go up, and overall profitability can actually decrease

Building new manufacturing facilities to cope with the increase in volume takes long, so this means takt times (the number of minutes taken to produce a vehicle) at existing facilities needs to reduce.  Every machine and person has to work faster.  More machinery, more workers and more overtime are required, meaning increased marginal costs per unit.

Don't forget too that at least 40 percent of a car comprises of components made by automotive supply companies e.g. Bosch (electrical parts), Firestone (tires), Armstrong (shock absorbers).  These suppliers will also need increased capital investment, training for new staff and new tooling for any substantial volume increase.  This gets funded by the automotive manufacturer they supply i.e. BMW, Ford, Nissan etc.  So an automotive manufacturer has to foot the bill for their own upgrades as well as their suppliers - usually a costly affair.

Due to the sharp spike in costs, profitability per unit decreases quite drastically and this means the increase in sales and production volumes can actually still result in a lower net profit.

Artificial demand is created but cannot be maintained

Manufacturing orders are demand driven, so assuming the product is on par with the competition it's mostly up to sales and marketing to create that additional demand needed to reach number one.  Now at any given time the sales and marketing guys are working as hard as they can to push cars off the showroom floor, so when they need to sell even more they resort to increasing existing incentives like offering greater discounts and easy payment terms.

Profit margins become thin for dealers but once volumes increase everybody is temporarily happy, until they realize that such margins can't go on indefinitely and normal pricing has to return.  Long term damage to your brand can occur when you consistently sell for lower prices than the people you were meant to compete directly against.  The car market is about exclusivity and perception as much as it is about value.

Then just as you as a car maker reach number one and normality slowly but inevitably returns to your pricing, your competitor just below you will then decide they want your mantle.  They then pull out all the stops that you did to achieve that temporary boost; your volumes decrease as you lose sales to them and then all that money you spent on hiring new staff, paying overtime and buying new tooling will have amounted to little more than rights to a floating trophy with Biggest Penis in the Industry inscribed on it.  The cycle keeps repeating itself as everybody jostles for this floating trophy.

Quality compromises

Because takt time decreases, there is haste throughout the manufacturing process at both automotive companies and their suppliers.  Quality checks are also sped up.  Things will inevitably slip through the cracks, sometimes to devastating consequences as demonstrated by Toyota.

Becoming number one should be incidental, not intentional

If people are buying your product because you're consistently hitting the sweet spot of value, quality and marketing better than your rivals, then your place at the top of the pile is deserved.  The climb to number one is just that: a climb.  It has to be carefully managed and sustainable.  Quickly leaping to number one in such a competitive industry usually means you did it through making short term decisions and your glory will consequentially be short lived.  Being number one should just be a perk that's incidental to a well run company: it shouldn't be an objective in itself.

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