You Can’t Cost-Cut Your Way to Success

You Can’t Cost-Cut Your Way to Success
MiBiz • February 6, 2006
by Jim Gillette

As an exercise, let’s say both Ford and General Motors are able to lower their North American costs to the same level as their average competitor. In terms of quality, they are close or better. Will the end result be accounting profit and market value equal to that of, say, a Honda or a BMW?

Can you cost-cut your way to prosperity? Is benchmarking your competition and copying their moves strategy?

Michael Porter has written that strategy is the sum of all those activities that enable your firm to be different from the competition. You create a competitive advantage by offering a unique set of values to the market. Only in the purest commodity markets is cutting the price considered a strategy. Endless cost-cutting begets price wars, which beget economic loss.

Being a low-cost producer is a strategy, but . . .

During the 1950s and 1960s in the United States, General Motors was the low-cost producer among domestic automakers. Because its market share was so dominant, sometimes near 50%, the strategy of Ford and Chrysler, and the niche players American Motors and Studebaker was bounded and constrained by GM’s lead. GM drove the market, so to speak, and the others ran hard to stay close behind. GM largely determined the price of vehicles to the public using cost-plus pricing.

Being the low-cost producer is a valid strategic position, but difficult to sustain as the global economy matures. Trying to move to a low-cost position from a high-cost one, however, will likely force you to walk away from customers whose need for special features and amenities cannot be met by inexpensive products.

Moving in the opposite direction is both easier and provides more profit opportunity. Hyundai, for example, moving upscale from a low-cost base is in a superior competitive position to selectively appeal to less price buyers by adding high profit margin content. Having to constantly ask, “what can we cut that the customer won’t notice or care about?” is a far less comfortable position to occupy.

GM’s struggle with homogenization of its premium Cadillac brand during the 1980s is well documented. BMW later overtook Cadillac and Ford’s Lincoln brand in the high-margin luxury segment. I haven’t heard much from BMW regarding cutting costs, yet much of its product is still assembled in one of the highest manufacturing environments in the world. Yet customers keep lining up to pay sticker.

The global auto industry is highly complex; maybe one of the most complex industries in existence. Dozens if not hundreds of variables can affect the success or failure of an automaker. An effective strategy must consider this complexity and define a desired position for each variable. Literally everything must go right to succeed in the context of today’s competitive complexity. Mark Fields and Richard Waggoner do not have enviable jobs.

We probably should give more credit to the leaders

By its nature, corporate strategy (like the military strategy it is often compared to) needs to be held as secret as possible to avoid the competition to make quick counter moves.

The public view of an automaker’s strategy may consist only of statements made by the corporate leader, crafted carefully and revealing only what is in their best interest. While the public message has often been that the automaker is diligently cutting costs, the breadth and depth of their strategy is far more extensive. The media will, of course, focus on the job losses.

If we as analysts are doing our job well, our interpretation and evaluation of an automaker’s strategy needs to depend upon observation of how the company acts in the marketplace and how it performs each of the hundreds of activities required for success.

Whether or not Ford and GM are able to mount a recovery over the next few years will depend on a lot more than closing a few factories and slashing costs. We’ll have to wait a couple of years to tell if it was strategy or rhetoric.