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10 The Automotive Future: Three Scenarios and Their implications At the beginning of this report we sketched out three interpreta- tions of the current crisis in the U.S. auto industry. Although we have not provided a detailed or exhaustive analysis of each, we have focused on two aspects of the situation--technology and comparative costs--that distinguish the three lines of interpreta- tion from one another. The various assumptions made and the evidence developed are summarized in Table 10.1. The evidence points to several things: a sizeable cost and quality disadvantage for U.S. producers, some new designs that appear to have wide- spread appeal, and a general ferment in technology that fore- shadows what may be radical innovation over the next several years. Table 10.1 underscores the ambiguity in the current setting. As might be expected in a period of transition, we have identified evidence that accords with some of the assumptions of all three competing explanations. Since the purpose of this report is to highlight possibilities, we draw no strong conclusions. Indeed, it is important to note that the actual course of development may not be monolithic. Maturity may characterize the industry for some time, followed by a period of fundamental change. Furthermore, one pattern of development may not describe all market segments. In light of the uncertainty clouding the future and in order to clarify the implications of alternative patterns of development, this concluding chapter of the report presents three scenarios of the industry's future, based on the three lines of interpretation. We will sketch out conditions and interactions that are consistent with the course of industry activity implied by a particular inter- pretation of the current crisis. We will discuss the management implications and the implications for alternative public policies for each scenario. The scenarios depict possible chains of events and the likely impact on those events of broad public policy options. While the scenarios are intended to offer a realistic assessment of the development of the industry under given 150
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152 assumptions, they are not based on an extensive analysis of busi- ness strategy. And although some general views about public policy are indicated, an in-depth analysis of policy options was not carried out. The strategies of particular firms and detailed policy analysis are important areas for further work but were outside the scope of this report. We draw no conclusions about the desir- ability of specific government actions; rather, we indicate how alternative actions may affect the industry within a given scenario. THREE SCENARIOS The three interpretations of the current crisis--transient eco- nomic misfortune, natural consequence of maturity, and funda- mental structural change--have different implications for the future. Any attempt to grasp those implications, however, must recognize a point that is often missed: the usual form of fore- casting the future, trend projection, is often misleading. The future typically emerges from a collision of events that are often unrelated. For example, the oil crisis of 1979 would have had little permanent effect on the U.S. automotive industry if it were not for three other events: (1) Japanese penetration of the U.S. market and their development of excess capacity, (2) the U.S. government's earlier attempt to shelter consumers by controlling oil prices and mandating fuel-economy standards, and (3) the U.S. auto manufacturers' misjudgment of the future. If any view of the future is to offer useful insight it must be more than a linear projection of simple trends; it must recognize interactions among shifting technologies, political events, and economic factors. One way to address this complicated reality is through the development of scenarios. A scenario is a depiction of possible chains of events that might occur. Their use provides insight into the various ramifications of changes in associated conditions. A. . . O ~ ~I~he three scenarios are presented in Figures 10. 1, 10.2, and 10.3. No attempt has been made to describe the course of events in great detail. Furthermore, we have assumed no changes in current government policy. Our purpose is to indicate a few main lines of development that are apt to occur under a given set of assumptions. Thus, the scenarios illustrate the consequences of d ifferent assumptions, taken jointly. The basic assumptions of each line of interpretation can b e summarized as follows: 1. Transient Misfortune: Small or negligible cost/quality disadvantage.
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153 2. Consequences of Maturity: 3. Fundamental Restructuring: Scenario 1: Transient Misfortune Central problem is lack of small-car capacity. New dominant design has emerged. Product and process technologies are stable. Large cost disadvantage. Location of production based on factor prices. Technology becomes competitively important. Continued increases in real price of oil. Introduction of radical innovations. The implications of the view that the industry is in the midst of a serious, albeit transient, misfortune are spelled out in Figure 10.1. The left column depicts some of the driving forces in the scenario: (1) protectionist sentiment growing out of declines in auto sales; (2) the mismatch of U.S. car capacity and market demands; and (3) the emergency of a broader diversity in technology and product mix. Where before V-8s had powered a largely similar fleet of U.S.-produced cars, suddenly there is an expansion of models at the bottom of the market (e.g., Toyota's Starlet) and "at the sides," with repect to the propulsion options already introduced or in process as well as with respect to other technological features. From this starting point, Figure 10.1 shows a snowball effect, as the implications of new capacity and a weakened domestic industry unfold. U.S. producers develop new models and small-car capacity, but the extra Japanese capacity leads to intense price competition. Some of the new capacity from Japanese firm s comes from U.S.-based assembly plants. The U.S. firms, with their attention focused on the most popular models, fail to meet J apanese competition in emerging niches and segments; the mini-car is an example. Although the depths of misfortune are transient, they clearly have lasting effects. U.S. firms regain some market share but overall are not financially strong enough to completely recoup their losses, nor are they able to offset Japanese penetration into new segments. The picture is brighter on a national basis. New Japanese assembly plants and new capital invested by the U.S. firms leave the country with a viable domestic industry. Because
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155 of market-share losses by domestic firms and the tendency for Japanese plants to source in their home country, the U.S. share of value-added declines, and the industry decreases in overall size. The United States loses its preeminent world position, and the domestic supplier industry is weakened. The net effect is a smaller, but viable, domestic production base. Scenario 2: Consequences of Maturity . The second scenario differs primarily in the assumption of a sig- nificant U.S. cost disadvantage and a highly stable product and process technology. In our lexicon a "mature" industry is one in which the technology of product and process is essentially em- bodied in factors of production that can be readily purchased in established markets. Assuming that the auto industry is mature in this sense has major ramifications. As Figure 10.2 suggests, the current crisis is but a continuation of a long-term restructuring of the location of production. A known and stable technology and wide cost differences imply that most cars sold in the United States will be produced in such countries as Taiwan, Brazil, or Mexico, where labor costs are much lower than in the United States and even lower than in Japan ($1 per hour in Taiwan versus S9 per hour in Japan and $18 per hour In the United States). This scenario also implies an Increasing role for suppliers who can move their plants rapidly. As events unfold, this search for low-cost production leads to a loss of production capability and know-how in the United States and an increase in third world countries. Cars produced in these countries are introduced into U.S. markets. This scenario does not assume that vehicle production moves completely offshore. Because of engineering expertise, unique market demands, and other factors associated With product differentiation, it is likely that a good fraction (e.g., 35 percent) of the cars sold in the United States will be produced domesti- cally. Added to the decline in production by the original equip- ment manufacturers (OEMs) is the loss in creative, innovative interaction among the auto and other industries and the loss in manufacturing know-how in high-volume vehicle manufacturing. Scenario 2 includes three forcing events depicted at the left- hand side of Figure 10.2: ( 1 ) the effects of the recession in _ _ . ~ _ ~ , reducing demand; (2) the continued inroads of Japanese producers based on their landed-cost (and quality) advantage; and (3 ~ a chance in amen Preferences for efficient transportation modes. The implications of the first two events are rather direct standardization, worldwide sourcing, foreign penetration. The third event means a more competitive and more varied dealer
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157 environment. with implications for distribution channels and entry . , , strategies. The net effect of industry evolution under the scenario is a vastly decreased U.S. auto production . . . . .... , , . , , , maturity base and worldwide competition based in low labor cost coun ries. One intriguing effect of foreign entry and changes in consumer pre- ferences is a radically different retail environment. U.S. firms survive by sourcing and producing most of their products offshore, while a few specialty segments are served from domestic sources. Under conditions of maturity, plant shutdowns and layoffs would continue, and the United States would likely become dependent on foreign-based technology for mass production of the automobile. Scenario 3: Fundamental Restructuring Unlike Scenarios 1 and 2, the third scenario (see Figure 10.3 assumes substantial and continuing pressure for technological innovation. Driven by rising fuel costs, innovation is efficiency oriented and is a major factor in competition. The implications of new product innovations are pervasive. Responding to a rising market demand for both fuel savings and performance, the major U.S. producers seek more innovative technologies from which to develop new product designs. As investment is turned toward new products, the degree of vertical integration declines markedl y; specialized, robust, technologically active suppliers become key sources of new technologies. During the period of transition and while new products are developed, U.S. firms lose their market shares in standard models. Unlike earlier periods, U.S. producers are unable to adequately develop a full-line production capability. Change is rapid, products are diverse, and some firms are financially weakened. As a result, a higher degree of specialization occurs, not only by producers but by country as well. OEMs tend to do the best when they focus on the technology at which they are most expert. The pace of technological innovation quickens, and specialization by technology creates strong domestic linkages; availability of sup- porting industries (e.g., chemicals, materials) becomes a critical determinant of location. The transformation of the auto industry from a mature, tech- nologically quiet industry into a hotbed of innovation and change creates opportunities for U.S. firms to attain competitive advan- tages through development of radically new products. The same, however, can be said of the Japanese and the Europeans. Whether U.S.-based production regains lost market share by creating and exploiting new markets depends on its ability to "out innovate" its competitors.
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159 In this regard the U.S. firms have historically had an edge on the Japanese, whose advantage seems to lie in refining and manu- facturing an established technology. Many of the Europeans, how- ever, have been more performance and technology oriented than the U.S. firms and provide a strong innovative challenge. Thus, Europeans make inroads in the growing specialty segments, while Japanese maintain a strong position in standard models. U.S. firms regain some lost ground through innovation, and, overall, the U.S. share of value-added returns to its 1979-1980 level. The Scenarios Contrasted It is clear from our discussion that the future presents significant risks for the domestic auto industry no matter what scenario one picks. Obviously, the outcome in Scenario 3 is more optimistic, but it supposes that U.S. firms can "out innovate" their competi- tors and (perhaps equally difficult) survive losses of market share and financial difficulties during the period of transition. Pros- pects are even more bleak in Scenario 2, where the domestic industry is reduced to specialty production; this is effectively the "Britainization" of the U.S. auto industry. The future is not so calamitous under Scenario 1, but even here the domestic industry shrinks and becomes much less profitable than before. There are two aspects of the industry's environment that we have held constant in developing the scenarios, which may have a bearing were they to change. The first is the overall state of eco- nomic activity. We have assumed that the conditions of recession _ _ , , . . . . ., ~ . . ~ ~ ... _ (SlUgglSh, it any, growth; anemic ulnas sales' persist. ~ Ill LO normal or above-normal rates of growth would be unlikely to affect our conclusions under Scenario 2 (maturity) but may influ- ence developments in Scenarios 1 and 3. The principal effect would be to strengthen the financial position of the domestic firms, allowing them to cover more market segments or develop more new products, thus strengthening their overall market share. The second critical assumption is the absence of any policy action by the federal government. It is somewhat unrealistic to expect public policy to be on hold over the next several years. Legislation has already been proposed that would impose strong trade restrictions and reduce taxes.2 Although proponents have made various claims for such proposals, it is important to note that their effects are likely to differ under different patterns of industry development by meshing the scenarios with alternative policies, their joint implications can be made clear.
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160 IMPLICATIONS FOR PUBLIC POLICY A full-scale examination of auto industry policy measures is beyond the scope of this study. What we can do is indicate the broad differences in the industry's evolution if two kinds of general policy measures are enacted. The first general category includes "internal" measures, including deregulation, and invest- ment incentives; the second category includes "external" policies to reduce imports. We propose to examine the effects of a representative or generic policy within each category. Within the "internal" category, for example, the types of regulatory mea- sures considered include a freeze on new regulations, postpone- ment of compliance dates, or outright repeal of some regulations; tax incentives would include accelerated depreciation and an increased investment tax credit. On the "external" side, almost all current proposals are labeled "temporary" and are represented by quotas on imports; the basic thrust of such action would be to afford a measure of protection during a temporary transition period. Before considering the effect of these broad policy options on industry evolution, it is important to note that macroeconomic policy may have an important bearing on the implications of the three scenarios. Events of the last few years have demonstrated the sensitivity of automobile sales to high, real interest rates and sluggish economic growth. Since we assume that the conditions of recession will persist, any developments in macroeconomic policy that are to increase overall economic activity would affect the predicted outcomes as noted above. Likewise, macroeconomic policy that had the effect of deepening the recession. or which . . . created economic instability, could weaken the U.S. firms under each scenario. The implications of alternative policies are examined under the three scenarios in Table 10.2. The scenarios are listed in the first column, and the three policy regimes are listed across the top; we have added "do nothing" to the "internal" and "external" categories outlined above. The second column establishes a baseline by sum- marizing the scenarios developed in FIgures 10.1, 10.2, and 10.3. The third and fourth columns present likely changes in each scenario if the hypothetical policies were to be enacted. Perhaps the clearest conclusion to emerge from the analysis in Table 10.2 is that what outcome one predicts for a given policy depends on one's view of the industry's evolution. This is most clearly spelled out in comparisons of the maturing industry scenario and the other scenarios. Under conditions of maturity, neither internal policies nor temporary trade restrictions alter the long-term decline of U.S.-based production. Tax and regulatory
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161 changes do strengthen the domestic financial position of firms, and trade measures slow migration of capacity. But unless permanent and restrictive quotas are adopted, the long-ter m prognosis is little changed. In the other two scenarios, internal policy options generally strengthen the domestic firms, although the extent of such strengthening is hard to determine without far more specific orooosals. Moreover, there are important short-run differences ~ . . . ~ ~ ~ ~ between Scenarios 1 and 3. Under transient misfortunes, tne transition period is characterized by increased capital spending, but the assumed parity of new U.S. products implies that market- share losses will not be substantial. In contrast, Scenario 3 envisions a longer transition period in which domestic firms will be under relatively intense pressure because of their cost position. We have assumed that the changes in internal policies are sufficient to reduce the risk that marginal competitors and product lines will be shut down because of financial weakness. Under both Scenarios 1 and 3, the domestic firms are placed in a somewhat stronger position vis-a-vis foreign competitors, although the migration of standard components is more extensive In Scenario 3. In effect, imports and other market pressures maintain strong incentives for change (i.e., new capacity in Scenario 1; new products, capital, and organization in Scenario 3), while policy changes ease the financial pressure of the transition. External measures are assumed to have similar effects on the financial side but raise new risks in their impact on competition. We have assumed that a temporary quota raises domestic market shares and prices and thus offers financial support under both Scenarios 1 and 2. The risk is that a reduction of imports will ease competitive discipline and reduce the urgency of change. Take Scenario 3, for example. Without the strong, immediate pressure of import competition, the domestic firms (and their partners) may make the transition in terms of new capital investment and new products but may fail to undertake changes in organization and management that are necessary for long-term viability. It is our view that the temporary nature of the external measures and the strong demands for the market mitigate the competitive cushion offered by trade restriction. We expect Scenario 3 with external policy measure to result in a strong viable domestic industy, somewhat larger than would be the case under no change in policy. N evertheless, the risk of organizational slack is real and must be weighted in the balance when asessing the options and their impacts. 1 ~ . ~ ~ r _ ~ I_ · _ ~~ 1:_~:~__ God.. ~ ~ 1~ It Is clear from thlS discussion that prealcllons about tile efficacy of policy must rest on a particular view of the industry's development. Particularly in the case of trade policy, there is no guarantee that temporary action will have its intended effect. If
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164 the maturity scenario prevails, only long-term measures will preserve a large domestic industry. Yet permanent policies would not be neutral in their effects on adaptation under Scenarios 1 and 3. Especially in the case of Scenario 3, a policy of permanent quotas, essential to retention of domestic production under m aturity, would likely slow the industry's adjustment, both in organization and in technology. The result could well be a weaker industry in terms of performance and technical leadership than would be the case with temporary trade measures. I MPLICATIONS FOR MA NAGEME NT: IN THE STARS OR IN THEMSELVES? The policy options examined in this section may have an impor- tant bearing on the evolution of the industry, depending on what scenario or mix of scenarios turns out to be true. We have seen that where change and adaptation are required, public policy can increase the industry's flexibility and freedom of action. While public policy thus has a critical supporting role to play, a role likely to be focused on mitigating risks and facilitating necessary changes during the transition period, the long-term future of the industry is by and large in the hands of its participants. This is not to minimize the challenges they face nor the impacts of external factors. It is only to reaffirm the central role of the productive confederation--the firms. the unions. the !sr~nolier~__in charting the industry's course. -, ~ - fir r~~~~ ~'& ·O This report identified a number of implications for manage- ment in the auto industry, implications that hold out the prospect of substantial changes in the way the business is managed. Some of our conclusions are generally applicable, while some depend on a particular scenario. Under "maturity" for example, the key to competition is the ability to manage a worldwide production and distribution system, with worldwide sourcing and technical , ~ . innovation that extends and refines existing concepts. In the case of a "fundamental change," however, the competitive tasks are twofold: (1) improvements in quality and productivity in existing models and (2) the development and introduction of new concepts in products and processes. These two scenarios m~v th'ic rim different organizational and managerial capabilities. TV t ~ ~ 1 ~ whatever the specific path of development may look like, there are several irr~plications for management that appear to be generally applicable. While the evidence in this report suggests some room for improvement in automation and new-process tech- nology, the bulk of the productivity-quality gap lies in established m anufacturing practices (including design and production), methods of organization, manufacturing systems, and the manage-
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165 ment of workers. These aspects of the firms are as much a capital resource as buildings and equipment. As we noted in Chapter 7 in our discussion of workforce management, change requires investment, not only in procedures or structure but also in habits, relationships, and even basic concepts of the business. It is the investments in such activities rather than the more publicized investment in new plants that hold the key to regaining competitive parity with the Japanese. The thrust of these investments in capital, people, and organization is more than a change in the product mix--it is to achieve superior manufacturing performance, to make manufac- turing a major competitive factor. We have examined changes in the management of people, the need for a more open agenda between firms and employees, and a move to engage the work force in the competitive activities of the enterprise. But other equally fundamental changes also may be required. At the same time that the domestic firms are faced with a competitive challenge in the cost and quality of established products, the importance, even the necessity, of significant product innovation may grow over the next few years. If so, competitive advantage in the mid- to late 1980s and 1990s will depend on the ability to develop and implement new design concepts in a relatively uncertain environment. Competition in these terms would confront the existing domestic producers with the need for different organizational capabilities than those that have been developed over the past 40 years. In an environment where products were standardized and innovations incremental, the successful firms excelled in exploit- ing economies of scale, in incremental innovation, and in coordi- nation and control. Entrepreneurship and brilliant but risky projects became increasingly dysfunctional, while the structure of organization became more hierarchical and its processes more bureaucratic. Contrast this state of affairs with an organization that excels at innovation and at coping with uncertainty. It is likely to be guided by individuals willing to take risks when precise calcula- tions cannot be made and to utilize organizational structures that are highly interactive and adaptive, where negative feedback is likely to be acted upon promptly.3 This is, of course, an ideal type, and there is as yet no reason to suppose that the successful auto producers will function like hi-tech electronics firms. But achieving radical innovation would seem to require an organiza- tional setup different from that appropriate for efficient produc- tion of an established design. One need only look at Ford in the 1920s to see that technology- based competition may require significant innovation in organiza- tion and management as well as in products and processes. As an
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166 example of the kind of changes required, consider the role of research. In a period of technical ferment, new ideas and new concepts are vital to competitive success. Yet for the most part the research organizations in the auto industry have not been tied in to the basic competitive activities of the business, simply because innovation that required research was not essential to competitive success. An R&D organization that operates in its dominate mode as an applied engineering group tends to relegate basic or even applied research to the back seat; it is likely to be different from the organization one would design to generate new, competitively significant and viable concepts. Not only would the lines of communication and the reporting relationships be differ- ent, but changes would be likely in the types of people employed, the process for project selection, funding, and so forth. Other examples could be cited. The point is that the organiza- tion, the people, the concepts that are likely to be essential to competitive success in the auto industry in the 1980s and 1990s are different from those that have prevailed in the postwar period and different from those that prevail today. We have emphasized the magnitude of the challenge but have not underscored the strengths in the industry or the "window of opportunity" that the current crisis has opened. The critical element in the industry's efforts to tap resources and exploit its considerable strengths appears to be strategic vision, the ability to see the future, to see the business in a way that is different from the way it has been seen in the past. Given the central importance of change and adaptation to the industry's future, it is perhaps fitting to con- clude this report with Alfred Sloan's commentary on Henry Ford, long after General Motors had established its dominance in the marketplace. Mr. Ford's concept of the American market did not fit the realities after 1923. tHe] failed to realize that it was not necessary for new cars to meet the need for basic trans- portation.... Mr. Ford, who had had so many brilliant insights in earlier years seemed never to understand how completely the market had changed from the one in which he had made his name.... The old master failed to master change.4 N OTES 1. It is important to remember that our perspective is a national industry perspective. We do not attempt to judge the impact on specific producers, nor are we explicitly concerned with the future of U.S.-based companies. Our focus is on U.S.-
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167 based production and the U.S. share of value-added in the industry. 2. The recent "voluntary" restrictions adopted by the government of Japan establish a short-term barrier to further penetration; the trade issue may well be raised once they are lifted. 3. This characterization of the dynamic enterprise is based on work by Burton Klein. See Klein (1977) for a full statement of his views. 4. Sloan (1972), pp. 186-187.
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Representative terms from entire chapter: