Editor’s Note: “Market Analysis” is the monthly examination of the developing trends that will influence the automotive aftermarket in the near and long term by Paul McCarthy, AASA vice president of industry analysis, planning and member services. This column is the final installment in a three-part series addressing “Aftermarket Outlook 2020 Follow-up – Leveling the Playing Field.” A PDF of the full report can be accessed here.

The rise in channel power is not unique to the aftermarket, but it has hit aftermarket suppliers hard. Fortunately, there are lessons that the aftermarket can learn from other industries that have already adjusted to the reality of power shifting downstream.

Three of the most compelling of these models, drawn from successes in other industries, are highlighted here:

1. Customer-centric model: Suppliers create and capture more value by better solving channel partners’ problems.
2. The end customer insight model: Sometimes called the Coke® model, this scenario involves knowing the end customer, or value creation through deep market insight.
3. Structural leverage: Probably a necessity in any scenario, the supply base needs to structurally adjust to better reflect the realities and needs of consolidated channels. This is something that has been pursued by many successful manufacturers, including GE in many sectors and Pratt & Whitney in aero engines. It also is arguably what the most successful global original equipment (OE) suppliers have done to counter the last two decades of increasing automaker leverage.

Part 2 of this series, “The Rules Have Changed: What Do We Do About It?” focused on the first model, customer centric, and the case study of Proctor & Gamble’s success with it.

This column will focus on the two other models: end customer insight and structural leverage.

#2 – Coke Model: End Customer Insight

The pain point of limited understanding of customers’ needs leads to the second success model, the Coca-Cola model. It is all about knowing the end customer, and achieving power in the value chain through market insight.

The question came up in an AASA Executive Luncheon: “How does Coke make huge margins manufacturing colored sugar water?” After all, aftermarket manufacturers struggle to make money supplying products that are highly engineered, technology intense and often critical to consumers’ safety.

As one AASA member who used to work for Coke explained, part of the equation is that Coke’s budget to learn more about customers in a single U.S. state is likely more than market research spending by the entire aftermarket supply base.

Coke knows what consumers want. They know when demand will shift. In other words, they know what will make money for their customers better than resellers do.

The automotive aftermarket talks a great deal about “category management.” As Booz & Co. pointed out in the Aftermarket Outlook 2020 study, the term is used loosely – the aftermarket needs to be honest that it lags far behind cross-industry best practices.

In other words, Coke becomes the way that retailers and resellers make money. That’s leverage – and value and margin creation both for the manufacturer and the customer.

#3 – GE Model: Structural Leverage

The final model might be called “structural leverage,” and it’s the model pursued by GE in many sectors. Another good example is the Pratt & Whitney’s market-segment specific dominance achieved in military aero engines. And Some would argue that leading global OE suppliers have achieved this, and it has been the key to their success.

Structural leverage essentially involves market-based ways to re-balance a tilted playing field. It addresses the fact that the suppliers will always have larger customers and suppliers on either side of them on the aftermarket value chain, and will inevitably be disadvantaged from a negotiating or market leverage perspective.

This business model option was suggested by aftermarket executives pondering lessons learned from the OE side of the automotive supplier business. For the last 10-15 years, OE suppliers have lacked a level playing field with customers, leading to unsustainable margins.

However, the situation has gotten significantly better of late. Aftermarket suppliers need to look at what worked on the OE supplier side and learn from it.

OE suppliers clawed back their leverage due to an industry collapse. The last several years on the OE side have seen widespread supplier bankruptcies and restructuring, a massive loss of volume and leverage by automaker customers, and a painful reduction of excess capacity on the supplier side.

It’s an extremely unappealing scenario for any industry, but it is worthwhile to examine which OE suppliers were successful even before the crisis for lessons learned.

From a U.S. supplier standpoint, three names regularly appear on lists by Wall Street analysts as successful OE suppliers in recent years: JCI, BorgWarner, and Gentex.

JCI is a good example of the GE-type structural leverage model, showing – as did GE, P&W and other successful manufacturers – that few selling to many can be a powerful way to gain leverage in an uneven playing field with large, powerful customers. Only two players make up a majority of the market in JCI’s core OE products (batteries and seats). (A similar thing could be said for BorgWarner in turbochargers, where there were only three competitors globally, or Gentex in automotive mirrors.) This gave JCI a situation of a few selling to many, as shown in graphic #**. This gives negotiating leverage. It also means a diversified customer base, so a supplier has the power to say “no” to customers; no one customer can dictate to the business.

This result was due in part to JCI’s strategic consolidation of its sector. However, it also used consolidation to give it:

• Economies of scale and scope
• The ability to afford R&D and differentiated service and technical capabilities

These gave JCI sustainable barriers to entry, which business theory has found is the key to competitive advantage and sustainable profits (Bruce Greenwald, Competition Demystified: A Radically Simplified Approach to Business Strategy). In other words, over the last decade JCI used the benefits of consolidation to offer customers both the best service and product and the best cost. That’s powerful, both to customers’ and the company’s bottom lines. And thanks to a “few selling to many” model, they were able to capture in margin some of the value benefits they created for customers.

There’s one last piece of the JCI model worth mentioning. While JCI’s sales approach was driven by the consumer-centricity model that P&G would suggest, its approach to its strategy was driven by JCI’s objectives – not its customers’. Its customers often weren’t happy with JCI’s acquisitions, its efforts to do its own customer research and design work, and its market share levels.

One of the greatest mistakes that automotive aftermarket suppliers made was to allow their customers to define their strategy.

The mistake was understandable. Automotive has long been an industry where the key to success was when a customer said, “Jump”, a supplier said, “How high?” That is justifiably how it should be in sales and customer relations. But that can’t extend to aftermarket suppliers’ strategy, especially when the balance of power is uneven in a value chain. Otherwise, a company will jump themselves to extinction.

The objective of a corporation is to maximize its own profits, even at the expense of customers, suppliers and other transactional parties. That self-interest is at the heart of the free market system. So the supplier’s tactical interests are almost always aligned with its customer, but its strategy is not. So companies should be customer-centric – but set their own strategy.

The automotive aftermarket inevitably started to follow some elements of the structural leverage model. One example is remanufactured starters and alternators. Over the last five years, remanufacturing has moved from a fragmented market to three major players capturing two-thirds of the market.

The aftermarket has seen a lot of consolidation and M&A activity, and most observers from the investment banking community project more going forward. The acquisition of both UCI and Honeywell’s CPG business – both big players in filters – by private equity firm Rank will be interesting to watch.

As a result of these trends, AASA chose the topic for its upcoming AAPEX Executive Breakfast: Under the Hood: How Private Equity Is Changing the Automotive Aftermarket. Tony Cristello of BB&T will moderate a panel of private equity players active in transforming the aftermarket supply and distribution sectors.

It is worth noting, of course, that consolidation is not a strategy in and of itself. Consolidation is a means to an end – and one that carries considerable risk. It can be a means to better implement or afford a “P&G” or “Coke” strategy; in other words, to build capabilities to better solve channel partner and end customer needs. Successful consolidation needs to be based around capabilities first, not just market power. And, of course, consolidation entails risks, as most M&A actually destroys value due to culture conflicts, poor strategy, and/or optimistic valuations.

Clearly, the battle is product line by product line, and structural leverage needs to be obtained at that level. This results in a limited set of sustainable strategic options for an aftermarket product line.

A company can pursue leadership in a given product area, achieving a dominant market share and actively pursuing rationalized competition. Done right, this can lead to economies of scale and expertise, leading to lower costs and better products for customers, as well as some level of manufacturer bargaining power.

Given customer needs and success factors in the aftermarket sector, this leadership needs to be translated into a focus on vendor relationships; leadership that leads to a differentiated service and value proposition for customers. This is a model long pursued by other successful manufacturers like GE. It also fits the long-held business theory that a free market for a given product will migrate toward a “Rule of Three”, with two to three volume players and a set of niche producers.

Going niche is the second viable strategic option. This involves focusing on sustainable niches, such as items that have high cost barriers including shipping costs, quality or process technology; items that have a strong local focus, such as lower volume components that require significant local market insight (some full-size diesel pickup components, for example); or products that allow a high degree of differentiation, such as high technology products or branded products.

In most product segments, manufacturers need to make sure they’re not just one of the survivors, but one of the winners through one of these viable strategies.

A Winning Aftermarket Manufacturer Model

So what does all of this add up to? What does Aftermarket Outlook 2020 and follow-up analysis in the industry reveal as a winning aftermarket manufacturer model?

• A focused business model for the aftermarket
• An obsession with helping channel customers succeed
• Differentiated capabilities, particularly in terms of service
• Best cost
• Deep and unique end-customer insight
• A business model (leadership or niche) that allows sustainable returns and some degree of bargaining power

Automotive aftermarket suppliers will know they’ve arrived when they experience:

• Discussions with retailers as equals
• Improved profits across the aftermarket value chain through value creation, not value migration
• Halt or reversal of the erosion of full-service suppliers’ market share by low cost country competitors

Achieving these objectives is not only necessary, but possible.

Other industry sectors provide a successful roadmap that can be adapted to the aftermarket. This analysis contains only early thoughts and knowledge that AASA members will seek to build on going forward, both together and separately.

The key next step suggested by several member executives is to better understand how manufacturers in other industries have been able to adapt, survive and thrive in the new environment of stronger channels. Going forward, aftermarket manufacturers should build on the P&G, Coke, and GE models discussed, and find other success models. The objective would be to identify action items to create new value for both suppliers and channel partners, and take the concept of a full-service supplier to the next level.

Member companies interested in participating in this analysis effort going forward should contact Paul McCarthy.

The full article of this three part series, “Market Analysis: Aftermarket Outlook 2020 Follow-up – Leveling the Playing Field,” is available for free download as a PDF by clicking here .

Paul McCarthy
Vice President
Industry Analysis, Planning & Member Services
pmccarthy@aasa.mema.org