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Newest winners get there first and flashiest
The emerging stars in tech and cars don't triumph by making products cheaper or more efficiently. They win by catching trends with leading-edge design.
By Jim Jubak
While much of the world focuses on the global manufacturing war under way, the savvy investor should turn his or her attention to the next hot spot: the new international design war brewing in the auto, wireless handset, airline and PC industries.
Take a look at the auto industry to see what I mean. After years of lagging behind, General Motors (GM, news, msgs) has pretty much eliminated the productivity gap between its car factories and the North American plants of the Japanese car makers, according to the 2004 Harbour Report on North American auto factory productivity.
But GM makes just a scant $178 profit per vehicle, while Toyota Motor (TM, news, msgs) rakes in a profit of $1,742 per vehicle and Nissan Motor (NSANY, news, msgs) is even more profitable at $2,402 per vehicle.
The bulk of the difference comes down to rebates: Detroit has to pay consumers twice as much to buy its cars as Japans automakers do. And thats because Toyota, Nissan and Honda Motor (HMC, news, msgs), which once beat Detroits brains out in manufacturing efficiency, are now winning the design wars. They are doing a better job of designing cars that customers want and will pay more for.
Too many cars, too few buyers
The auto industrys capacity problems, because they are global, may actually dwarf those besetting the airlines that I described in my last column, The next wave of airline bankruptcies.
The U.S. Big 3 auto companies are running at 81% of capacity, according to market research firm Global Insight, even though sales of cars in the United States are nearing historic highs. (A rule of thumb is that a factory needs to run at 85% of capacity to make a profit.) Industry analysts project U.S. sales of 17 million vehicles in 2004, up from 16.5 million in 2003 and on the way to 17.2 million in 2005. That would be just below the record 17.4 million sold in 2000.
Overcapacity, even in a commodity industry, doesnt affect all products equally. Even as General Motors has had to offer big rebates to move Buicks, Chevrolets and Pontiacs, its Cadillac brand has been flying off dealers lots with much lower rebates. For example, on the Kelley Blue Book Web site, I found rebates for a 2004 Chevy Malibu that began at $2,000 and went up to $4,000. Rebates for the 2004 Cadillac CTS began and ended at $2,000. By comparison, the highest rebate I found on a 2004 Toyota Camry was $1,500.
Of course, no rebate is more profitable to the car company than even a small rebate. On the Kelley Blue Book site, I couldnt find any rebates for Hondas Acura brand. The biggest incentive I found for a 2004 Audi A8L Quattro was a 4.65% auto loan. No cash back and no 0% financing.
In a commodity market, Audi has been able to differentiate its cars and convince consumers to pay a premium price. The premium isnt simply a function of market segment, either. BMW has also created products that command premium prices even as the company has moved down-market to the Mini Cooper.
How do they achieve this? With designs that hit a hot spot in the market, such as the way that the Mini perfectly fits what auto industry marketing consultants call the third-car market, or the way that the hybrid gas-electric Toyota Prius fits the current mood to do something about high gas prices (without giving up anything, of course).
Did I mention that the Prius has a waiting list of buyers in many parts of the country and sells at a premium to the sticker price?
Premium on flexibility
Reaping the extra profits that come with matching a design to the trends of the market requires very different company skills than those required to be a world-class manufacturer. Market trends move with lightning speed, so companies have to get products to market fast.
Here Detroit, which still lags the Japanese automakers in time from design to market, is at a serious disadvantage. It requires flexible manufacturing so that factory capacity can be easily shifted to new products that hit the trend and generate unexpectedly high sales. And it requires flexible management that knows how to let new ideas filter up the corporate ladder, knows how to allocate resources to promote promising ideas without either wasting money or starving promising products, and knows how to make decisions quickly and in a way that doesnt discourage the losing teams.
The challenge isnt limited to the auto industry. I can see the same process going on in the wireless handset business, where new players operating in low-cost factories are adding capacity hand over fist. LG Electronics (LGEAF, news, msgs), for example, has just announced plans to double its handset exports from India in 2005.
In the PC business, where the world is awash in commodity components that you can find inside just about every PC, design has been helping drive sales for some time.
Companies in these industries have responded in three very different ways.
First, some companies have simply ignored or missed the shift.
Second, a few companies have decided that they can be the low-cost leader in a commodity industry. Dell (DELL, news, msgs) is a prime example of a company that successfully pursued this strategy. Dell is a company built from the ground up around falling commodity prices; it is not simply a traditional company that has retooled its manufacturing and outsourcing.
Third, some companies chose to become a world-class manufacturer first and go for the design premium second. That was Nokia's (NOK, news, msgs) path to the top of the wireless handset heap. The company was ahead of competitors such as Motorola (MOT, news, msgs) in understanding that handsets were now a design and marketing business.
This third alternative is indeed the wave of the future. The globalization of commodity manufacturing will drive companies to design as a way of increasing profit margins. The companies that master the process will deserve a premium from investors in the stock markets.
A fleeting edge
But how much of a premium? Less, Id argue, than has been attached in the past to companies that mastered manufacturing when efficiency was what counted. As Nokias recent fall in market share shows, a design-created advantage is a fleeting edge. It constantly has to be recreated as market trends shift, and a company that caught the last wave correctly can miss the next wave, as Nokia has done.
And the extra profit margins that come from a design win in the marketplace almost immediately attract competitors. Apple Computer's (AAPL, news, msgs) sleek and stylish iPod, which has taken the downloadable music market by storm, is now drawing competitors by the score.
Investors have yet to come to terms with how many of the worlds industries are now producing what amounts to commodity products, and were all just starting to stumble toward an appreciation of how to value a company on its ability to read and respond to fast-changing markets rather than its ability to grind out the cheapest widgets.
The trend toward design-based commodity manufacturing is too new to put an exact formula in place. My best advice: Watch the ebb and flow of profit margins in up and down cycles for clues on which companies have begun to master the new art.
And then buy them.
3 big threats to Chinas economic miracle
In my May 7 column I tabbed the countrys energy shortage as one of the factors that could slow or even derail Chinas economic advance. It now looks like a shortage of electricity this summer could take a chunk out of growth. Chinas State Power Economic Research Center estimates that electricity-generating capacity will fall 30 gigawatts short of demand this year. Thats roughly the entire electricity-generating capacity of Norway. To fill the gap, the government has instituted blackouts, designed to conserve electricity especially during peak hours. For example, more than 6,000 factories in Beijing will take weeklong holidays this summer. Brownouts, periods when electricity flows but customers have to make due with reduced power, are expected in more than 20 or the countrys 31 provinces. Rotating blackouts, even in prime manufacturing areas, have increased from once a week to two or three times a week during peak hours. Shortages are expected to continue until sometime in 2006 when the new power plants now under construction start to come on line.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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