Confessions of a Capital Addict
"We have failed collectively as an industry to deliver value commensurate with the level of capital that is being consumed." - Sergio Marchionne, CEO, Fiat Chrysler.Indeed, the performance of the automobile industry has lagged that of other industries, suggested by the historically inferior share prices of automotive manufacturers.Relative to almost every other industry (with the exception of airlines, which have suffered their own bankruptcies), the automobile industry has consistently failed to produce a sufficient return on equity for its shareholders.The Dupont Model espouses three means by which a company, or industry, can increase return on equity: increase profit margin, decrease capital intensity, and/or increase leverage or debt.The vital issue is that automakers have become commodity assemblers, ceding value-added to suppliers.Rather than truly adding unique value, automobile manufacturers are instead packaging value-added components received from suppliers: GPS devices, batteries, safety devices, you name it. To add insult to injury, said suppliers are simultaneously offering the same value-added components to all automobile manufacturers.The result? Pressure on costs, contraction of margins, and an ultimate struggle for product differentiation. Simply speaking, the efficacy of automobiles is homogenous.The solution, as told by Marchionne, is consolidation.A long-time advocate for mergers among the too many existing automotive manufacturers, Marchionne delivered a three hour presentation to Wall Street analysts last Wednesday, a final plea to lure rivals into consolidation dialogue."The overriding theme of this, which is something I have spent most of my professional life worrying about, is trying to effectively guide businesses away from mediocrity. This is an industry that has not fared well." - Sergio Marchionne, CEO, Fiat Chrysler.The hard copy presentation, tagline: An insider perspective on the cure for the industry's value-destroying addiction to capital, can be found on the company's website here. (Beware, it is 25 pages long).The reaction was varied.Some applauded Marchionne for such a blunt discourse, especially to a hungry herd of Wall Street analysts.Others questioned why Chrysler's CEO was sharing his views so publicly. Max Warburton of Bernstein Research articulated, "There are probably five or ten men who can make this (consolidation) happen, and you probably have them all on speed dial. I come away from this call thinking what exactly was that about?"There is one fundamental catalyst to the failure of any industry.Short-term thinking.The automobile industry has been plagued by this exact nearsightedness. Case in point: the recent emphasis of large cars as a result of temporarily declining oil prices. Clearly, this is not a long-term trend. We don't see Tesla abandoning their electric vehicles.Automobile industry = the walking dead?Decades of nearsightedness has led to the following reality: there is no quick and easy fix.Sergio Marchionne reasonably proclaims there are too many auto manufacturers offering the same product. Not too far away, in Palo Alto, California, Tesla Motors is dominating the battery industry. That's correct - Tesla's competitive advantage is in batteries, not vehicles. Elon Musk and the other powers that be have avoided the commoditized auto industry from the onset, instead focusing on value-added batteries, ripe with high potential margins and returns. Apple and Google are developing autonomous cars - while the two tech titans will certainly never enter the automobile industry, they will plausibly steal market share from the Chrysler's and Ford's of the world. Apple, Tesla, and Google, among others, have ascertained how to leverage the suffering automobile industry. The ultimate result for automotive manufacturers? Further destruction of value.
Truth be told, consolidation may just be one step further down the path to mediocrity.