From Start-up to Operational Efficiency

The combination of Fiat, Chrysler and Peugeot group is creating a new holding company which is looking to merge the assets all these M&A bankers and M&A strategy consultants talk about—efficiency, synergies, etc.

By default, most mergers fail. But this merger is interesting because given the size of the asset base—the millions of cars made, the number of factories around the world—this is going to come down to operational efficiency, which is very hard to achieve.

Here’s the insight, which SCR-Advanced members can see in the operation strategy study. Going from 0% to a 90% increase in operational efficiency is obviously something to celebrate, but you need to ask yourself: Given your competition, given where you want to compete, given the price point you want to compete at, what is the operational efficiency you have to achieve?

It’s not difficult to know this. Remember the cost-volume-profit curve. The bigger your fixed cost base relative to your variable cost base, you need much more volume, but your price typically goes down a little bit. It happens to most companies over time. It may go up for a long time, but eventually, as you get enough volume, prices start dropping. As prices start dropping, it becomes an efficiency game. A 1% change in efficiency can give you that cash flow to pass on savings to the consumer so you can put out a lower priced product. If you are in the commodity segment, you are going to be competing on price.

The executives at Fiat, Chrysler and Peugeot have a lot of juggling to do because on one hand, they own the Alfa Romeo and Maserati brands. Obviously, those are high end brands. But those brands don’t have the financial muscle to set up their own supply chains and R&D facilities to manufacture everything they need at the standard to compete with other luxury brands. Invariably, there’s going to be some sharing of parts, like a chassis or a drivetrain. But if you’re sharing parts of a low end brand with a high end brand, consumers are going to notice that eventually. That means your margins overall in aggregate start falling. If that happens, you become more of a commodity band. There’s nothing wrong with being a commodity player in the automotive sector. Many companies do that. But the lower and lower you go in a price point, the more operational efficiencies become important.

The most important insight in operation strategy is that for too long, we have thought about operation strategy as how to produce more and how to debottleneck your facilities. That’s important, but it’s not the most important thing as you have greater and greater volume in your production line. For a volume producer, operational efficiency is the most important thing. As you compete with Korean, Japanese, Chinese, European and American companies, a 1% or 2% change in operational efficiency can make all the difference—and that’s what companies need to think about.

This is an excerpt from Monday Morning 8 a.m. newsletter, issue #12.