Five Forces and the American Automotive Industry - Research Paper Example

? Porter’s Five Forces Model for the American Automotive Industry This analysis encapsulates the conditions and prospects of the American automotive industry since the 2008 financial crisis. The prospects of the industry are described, as well as the consequences of foreign competition. The effects and arguments behind the federal relief funding for American auto manufacturers is discussed. These factors are put into perspective using Porter's Five Forces Model, in reference to the American automotive industry. Using this model, examples and applications are drawn relevant to the American automobile market. Introduction In the automotive industry or any similar business field, an essential step is to identify the critical paths and limiting factors involved in profitability. Where does the power reside in a business situation? Based on the forces of supply and demand which party can command the most advantageous bargaining position? A number of business tools and theoretical models address these and other questions; the Five Forces model is among them. When the manager has a clearer understanding of the strengths and weaknesses of all parties involved in a potential transaction, it permits him or her to leverage the situation to maximum advantage, and prepare for the most likely responses from the other party (Samuelson & Marks, 2012) Overall, it is beneficial to acquire data allowing the manager to take a longer view of holistic market forces in order to define costs and risks in terms of doing business. In any competitive environment, an inevitable hierarchy will develop, likely through a combination of simple random forces as well as actual merit. These forces are influenced by social and legal factors in a civilized environment, but within the competitive framework certain fundamental rules will remain universal. This analysis will focus upon Porter's Five Forces model as an explanatory tool to put these factors in perspective relative to the automotive industry. By 2009, the global recession crisis sent ripples through the banking sector, credit markets and then most productive industries across the industrialized world. The American automotive industry was no exception. Chrysler and General Motors were on the financial precipice, and Ford faced an uncertain future. 2008 automotive sales had plummeted to historic lows, with sharp declines in the disposable income and available lines of credit for the purchase of new vehicles. A loan process was deemed necessary in order to rescue these and other industries from total collapse, at the likelihood of further damage to the American – and potentially the global economy. Industry Definition For the purposes of this analysis, the automobile industry will be defined as the American corporations involved in the direct manufacture of automobiles, and the challenges they have faced in light of the current financial crisis. The scope of this analysis will include the interests of car production as well as sale, and the companies in the United States that perform both functions. Specifically, this will focus on what are termed 'The Detroit Three', generally understood as Ford, Chrysler, and General Motors. Industry Profile With the immediate danger of total collapse averted as a result of the federal loans, it is necessary to take stock of the situation using sound theoretical planning in order to plot the next move forward for the automotive industry. Theoretical models to identify forces and threats must be given careful consideration during the planning process. The planning process must include the prospects and profile of the 'big three' automakers as described above, specifically the damage to the economy that might ensue if they were allowed to go bankrupt and fail entirely. Structured bankruptcy agreements for General Motors and Chrysler were considered during the spring of 2009, with considerable national debate regarding the possible ripple effects from their collapse (McAlinden et al., 2009) Ultimately there were two approaches by which bankruptcy proceedings could go: a prolonged and likely a chaotic bankruptcy process that would eventually lead to the liquidation of the assets of the automakers, and thus prompting the ripple effects throughout the American economy that much of the public, as well as Washington preferred to avoid. Instead a well structured bankruptcy process was conducted swiftly in accordance with section 363 (bankruptcy). Invariably, there will be some loss, some price to be paid but the discussion logically centered on the ways in which the loss could be mitigated. At the time, the Center for automotive research estimated that by 2010, even the most optimistic measurements would have yielded a loss of 179,400 actual jobs as a total consequence of the challenges faced by the automotive industry (which by itself would have lost 80,000 jobs without government intervention). Yet that pales in comparison to the worst case scenarios projected for 2010, in which over 400,000 jobs might have been lost (Center for Automotive Research, 2010). There is some concern during any consideration of a large-scale government 'bail out' of the effects of throwing government money into what some might term a sinking ship, a flawed company that is ultimately doomed due to its own internal structure. But the three major automakers have existed for decades, and have proven profitable in the past. And the numerical estimates project that the job loss resulting from the collapse and liquidation of these manufacturers was potentially more disastrous than the cost of alleviating their financial difficulties (Werling, 2008). Industry Structure As a result of the crisis, the three Detroit automakers have experienced a sluggish stock market performance and sharp decline in share prices during 2008, although these trends have alleviated by 2009. The combinations of high unemployment and reduced availability for lines of credit diminished the ability of consumers to purchase vehicles through all available options, thus it was a fait accompli that the automobile industry would contract severely during the beginning of the economic crisis. Since 2009 a slow trend exists leading to the restoration of previous market shares that had been lost immediately following the crisis. Some improvement is still projected by government analysts (U.S. EO, 2010) The liquidation of the assets of the automakers would create a situation where the American car market was thoroughly dominated – probably for years to come by foreign manufacturers. This would likely complicate further the recovery of the American economy through the shifting of more revenue and employment opportunities overseas. But while some analysts are generally optimistic for the future, improvement and expansion of the prospects of the automotive industry are sharply limited by the current marketplace. Expert research indicates that vehicle sales will not increase in a significant way so long as increases in the gross domestic product of the nation in question are less than 3% (Center for Automotive Research, 2010). The current economic crisis makes it difficult to reach that benchmark due to other weaknesses in the American economy, until that changes, overall growth and performance of the automobile industry will be sluggish. The restructuring as a consequence of the bailout process have shown that there is still hope for the Detroit automakers; both General Motors and Ford have demonstrated that it is possible for them to function profitably even at lower sales volumes than what they were accustomed to prior to the economic crisis. Both Ford and GM were able to post profits in excess of $4 billion in the third quarter of 2010 (Center for Automotive Research, 2010). Future Outlook The argument against bailing out any company, including the three major auto manufacturers would include the cost to taxpayers, and the apparent conclusion that if they need a bailout – then they are fundamentally flawed institutions. Therefore, one might argue that the funds are being wasted to no effect. But moving into the future, the operative word becomes job loss. The balance of evidence regarding the auto manufacturers indicates that sustaining them with mandated restructuring will result in the loss of fewer jobs than if they were allowed to enter unstructured bankruptcy followed by collapse and full liquidation of their assets. The above data from the Center for Automotive Research indicated that the downsized motor companies are still able to turn a profit through smaller organizational models even with less overall car sales. This is indicative of a long-term viability even in depressed economic times. It is reasonable to suppose therefore, that the car companies will continue to operate using a somewhat less extravagant structure until the overall economic potential (in terms of gross domestic product) of the nation rises to a level where increased vehicular sales become possible and financially significant. Five Forces Strategy Analysis as It Applies to the Auto Industry Bargaining Power of Buyers These smaller, leaner companies must fall back on time honored principles of business logic in order to justify the investment placed in them by way of the bailouts. The five forces strategy becomes a useful tool towards understanding market forces, in this case the effect car buyers must have on the future prospects of the three companies. The current crisis has depressed the ability of buyers on the upper income scale to purchase a vehicle out right, and it is also impeded lines of credit from the banking industry that would ordinarily form the backbone of automotive financing. The surviving car companies must compete for a smaller share of dollars and customers. Under the five forces model, the business manager must consider what power buyers have to drive prices down? This is an expression of fundamental forces of supply and demand, specifically the quantity of available and likely buyers as well as their importance. For each possible customer that might be in the car market – how important is each individual to any particular car company? A calculation must be made based upon the loss of an individual buyer in a statistical sense, and the ensuing financial impact. This is necessary for the manager to determine what links he or she will go to prevent the loss of a hypothetical individual customer. The other side of this equation is the cost to the buyer given the choice to switch to a competitor or some alternative not including a car sale with the company in question. If the buyer choosing not to do business with a hypothetical car company suffers a tremendous inconvenience far in excess of the company's inconvenience as losing that buyer, then prices may rise due to heightened demand. This is unlikely to be the case at any time in the foreseeable future, the average consumer has three major American companies to choose from, to say nothing of the spectrum of foreign corporations offering passenger vehicles. A depressed economy is more likely to result in fewer buyers of automobiles, thus the value of each individual customer rises. In this scenario, closer to the current situation in the American car market, the value of each individual buyer rises for any given car company. Smaller numbers of buyers increases their relative power in regards to pricing. With fewer available customers the market will drive prices down. This is closer to the current scenario, but the federal bailouts add an extra layer of complexity. If the business enterprise is employing funding from a source not related, or only distantly related to sales then they become more insulated to the power of the individual consumer. This form of insulation limits the power of the buyer, but only so long as the additional funding, or expectation of the funding remains. The manager of the business has the opportunity to squander the advantage and simply count on future bailouts, limiting the power of the buyer – or they can use the windfall granted them to remain solvent during a restructuring for greater efficiency. And it appears that the American automotive manufacturers are taking the latter option. Bargaining Power of Suppliers Under the Porter model (Porter, 1980), those that supply the essentials of production also exert considerable force on the market. The automotive companies must determine – as any corporation does, the total number of inputs required for the production (or distribution) of their cars. This may relate to raw materials, but in the modern age it may also include highly specialized components – such as computerized chips necessary for the operation of luxury conveniences in most modern cars. When the number of essential inputs is determined, the manager must estimate how many other entities he or she has to enter into agreements with in order to supply these inputs. How important is each? What alternatives exist for a particular enterprise? Competitive Rivalry in the Industry Similar to the power of buyers, the number of competitors controls the power of any one company to set prices (Porter, 1979). The recent economic crisis affected the three major American auto manufacturers in similar fashion. But foreign competition in recent decades has forced an end to the possibility of total domination of the American car market by the three Detroit companies. Where there was very limited competition for the Detroit three, it was possible for each of them to collude with the other and form agreements concerning pricing, quality, or the reliability of their products (Porter, 1985). In recent decades, that has not been a viable strategy with competition for the American car buyer from Germany, Japan, as well as Korea. When the number of competitors increases, in accordance with Porter's model – the power of any individual company is diminished; as long as quality remains equivalent. Adding competitors has decreased the price setting power of the American companies, yet it might be argued that the consumer benefits due to the increased competition. Threat of New Entrants Any enterprise must be concerned not only with the present competition, but with the likelihood of future competition taking advantage of market opportunities (or weaknesses). In considering the question of whether or not an upstart company will rise from nowhere and challenge the positions of the Detroit automakers, one must consider the cost of entry. How difficult/expensive is it for a new company to enter a particular industry? This depends upon startup costs, and access to proprietary technologies. If a product or service depends upon a closely guarded invention or rare technical understanding than the ability of an upstart company to enter that industry is impeded. Automotive technology in a general sense is widespread, but the barriers in this industry exist more in terms of economies of scale. It isn't difficult to figure out how to build an automobile, but actually building enough for a general consumer market would require a spectacular level of startup capital in order to manufacture and distribute enough to make the venture worthwhile. While small business garages with the ability to repair automobiles are common, some sort of neighborhood automobile manufacturer is highly impractical. The costs inherent in producing a car are great enough that a business must have the capacity to reach millions of potential buyers to remain competitive. In the current market, it is unlikely that a new competitor will succeed under the current depressed economic conditions without a revolutionary technology or pricing capability. As shown above, there are hard limits in terms of gross domestic product to the number of vehicle purchases possible. A car is not an impulse item (at least not for the vast majority) the demand is real, but sharply limited. These factors pose considerable barriers to new entrants in the industry. Under these circumstances, a near miraculous breakthrough in performance or the ability to lower prices would seem to be necessary. Threat of Substitution The car is a necessity in the lifestyles of many consumers. But that does not mean that no substitutions are possible. Some consumers may be able to avoid the car market entirely through the use of motorcycles or various forms of scooters – but the market for these vehicles operate under similar constraints. Other external factors may influence the substitution of the automobile: the price of gasoline, for instance. Some consumers may find a much smaller vehicle meets individual transportation needs without the gas consumption of a sedan or coupe. The ability of the consumer to substitute the product for an alternative weakens the power of the company. But anyone who will need to transport luggage or families on demand to an arbitrary destination must consider the automobile market. Conclusion In a competitive hierarchy, the party with the strongest position must always be mindful of threats to that position, whereas new entrants into the competitive environment must always be mindful of opportunities to advance their station. These competing needs can be subdivided further into delineations of powers and threats. The powers can be said to represent pressure from environmental (or in the case of business) market forces, and the threats to the position of any player within the competitive hierarchy arises from the entrance of new competitors as well as new competitive strategies. The interplay between these threats and forces is a subject encompassing limitless treatises from business experts, and will remain fertile ground for future business research. For now, the American marketplace in terms of automobiles has contracted, but the need is real and automakers have demonstrated the ability to run profitable operations under smaller sales volumes. This bodes well for the prospects of the three Detroit auto manufacturers to remain smaller but stable until the economy improves to allow for greater expansion. References Center for Automotive Research (2010). The impact on the U.S. economy of the successful automaker bankruptcies. CAR Research Memorandum. Retrieved from www.cargroup.org. McAlinden, S.P., Dziczek, K., & Cooper, A. (2009). CAR research memorandum: The impact on the U.S. economy of successful versus unsuccessful automaker bankruptcies. Center for Automotive Research. Retrieved on May 26, 2009 from http://www.cargroup.org/pdfs/impact.pdf Porter, M.E. (1979). How competitive forces shape strategy. Harvard Business Review: March/April 1979. Porter, M.E. (1980). Competitive strategy. The Free Press, New York, 1980. Porter, M.E. (1985). Competitive advantage. The Free Press, New York, 1985. Samuelson, W.F., & Marks, S.G. (2012). Managerial economics (7th ed). Hoboken, NJ: John Wiley & Sons. U.S. EO. (2010). A look back at GM, Chrysler and the American auto industry. Executive Office of the President of the United States. Retrieved on April 21, 2010 from www.whitehouse.gov/sites/default/files/rss_viewer/one_year_later_autos_report.pdf Werling, J. (2008). Potential job losses from restructuring the U.S. auto industry. University of Maryland, In Forum Economic Summary. Retrieved on December 9, 2008 from http://inforumweb.umd.edu/organization/conferences/outlook2008/outlook2008.html. Read More