Automotive World - The illusion of scale in the global truck sector

The illusion of scale in the global truck sector

By: Oliver Dixon, Friday, July 03, 2009, AutomotiveWorld.com

Over the past six months or so the world has changed. The European truck market has plummeted, and, alongside the North American and the Japanese markets, now allows the Triad to present a unified front, and one that is singularly lacking in appeal.

This is a cyclical business, so should we regard this as merely a downturn? In the past, this would have been an entirely reasonable position to adopt. Road transport is a derived demand, and, as such, is a hostage to the fortunes of the overall economy. In good times, it’s good, and in bad times, it’s worse. This effect is transmitted across the transport value chain and is something that we should by now be used to. And, whilst it isn't doubted that such cyclicality will continue to bedevil the truck industry, there is surely more happening here.

For the past two decades, the supply side of the truck industry has been driven by two distinct factors. On the one hand, ever-tightening legislation has led to a situation in which commercial vehicles are both defined and designed as much by legislative as opposed to operational requirements. On the other, there has been a headlong rush towards the development of scale. If big is good, so goes the argument, then bigger is better, and, ultimately, biggest is best. The reason why size is so important is a simple one; the more units made, the less the unit cost, and so ultimately, the greater the profit per unit. As a result, as of July 2009, we have a situation in which a convergent legislative set has been addressed by an increasingly globalised OEM base.

But there is a third driver within the transport industry that OEMs supplying that industry ignore at their peril. In UK terms, a truck that goes into operation today is some 38% more productive than one that entered service in 1994. But, in real terms, it is not 38% more expensive. The end user now has 38% more productivity for considerably less money. It can be argued that this is positive proof of a shift towards a commoditized product, and that poses, in the light of the current business model, a problem.

Using a kitchen appliance analogy here - three decades ago, a microwave oven was a reckonable piece of technology, and occupied pride of place in a few kitchens in only the most developed of markets. Today, the microwave is almost a ubiquitous household appliance, albeit one that the majority of microwave owners would fail to recall the brand of if asked outright. Some even fail to sport any brand name. Yet that same microwave oven contains probably more technology than did its counterpart of the 1990s. Are we ashamed of our generic cooking appliance? No, it merely has to perform its appointed task, and the consumer is happy. This is also the direction that the truck is heading in. As long as it is compliant and cost effective, it’ll do. Where does the notion of scale fit in here? The rather unpalatable truth is that a truck is a lump of metal and other materials, a component part of the overall supply chain. That same supply chain is bothered about but one thing; consumer fulfilment at a minimum cost.

Do scale and commoditization sit together comfortably within this analysis? If we take as a starting point the status quo, then the answer has to be no. In fact, they are in diametric opposition to each other. This is undoubtedly a broad statement, and one that might be viewed as heresy in some quarters.

The simple truth is that some things do scale. With emissions legislation converging across the Triad, it makes obvious apparent sense to combine the R&D required to get to the 0.2 NOx level for EPA 10 and Euro 6. But this has now been achieved. In this example, scale offered a demonstrable one-time benefit, but this bonus has now been banked. Or has it? If the costs of getting an EPA 10 compliant engine to market are considered, then the scale argument would put Cummins out of business, something which patently hasn’t happened. The same argument can be made with Eaton; transmissions too should offer immediately apparent scale benefits, and yet Eaton is still a going concern. The R&D costs benefit from scale, but when it comes to fitting a Euro 6 compliant engine between the chassis rails of a Euro 5 truck, it is difficult to see how global size offers any advantage, and so scale, as it stands at present, offers a diminishing return.

And if scale offers a diminishing return today for powertrain, what then of the future for the rest of the truck? Assume the commoditized product, and the only other scale opportunities are minor; a basic body-in-white, an electronics platform, seats and suspensions sum them up, and scale here has already been achieved by the suppliers; attempting to replicate this would seem to be a case of reinventing the wheel. Its impossible to see how scale can have a positive impact upon the costs of a commodity product, when that same product is manufactured in one of the highest cost regions on earth. For scale to become a meaningful weapon, some very harsh decisions would need to be taken, and these are, we suspect, too harsh.

The same argument has to apply to what is the real battleground in a commoditized marketplace. How does one scale service support and financial offers? With some difficulty has to be the honest answer. Despite talk of a global truck industry, the bald truth is that regulations, applications and infrastructure at a regional level are too heterogeneous to permit anything approaching a meaningful benefit to accrue to the biggest. And if money is thrown at a problem that is ultimately intractable, then such a pursuit offers only a cost, not a benefit.

There can be little doubt that these words are de facto heresy in today’s truck manufacturing business. But the numbers don’t lie; if we compare the respective profitability of the two largest scaled companies – Daimler AG and AB Volvo – against the almost quaintly parochial Scania, and the slightly more internationalised Paccar, we see the latter two outshining the former – in terms of profitability – by an order of magnitude. Moreover, this is a trend that is observable right through the cycle from peak to trough. In terms of simple profitability alone, the notion of scale benefit would seem to be completely illusory.

It is time, surely, to re-evaluate this. But such a re-evaluation seems unlikely, simply because the scale argument is one that seems to be derived not from a sense of business, but from ideology. That same ideology appears to be flawed, and those same flaws can only become more magnified in terms of impact as the move to commoditization gathers momentum. The world has changed, and this change should offer the opportunity for reflection. For size to become important, it has to be leveraged into a competitive weapon. This, manifestly, has not happened yet, and the window of opportunity for it to be made so is closing fast.

Published on Friday, July 03, 2009