SPEAKING
FREELY The limits of captive
manufacturing By Benjamin A
Shobert
Speaking Freely is an Asia
Times Online feature that allows guest writers to
have their say. Please click hereif you are interested in
contributing.
Many Asian successes
in original equipment manufacturing (an OEM firm
builds products or components that are used in
products sold by another company) have been built
on the basis of providing large US retailers with
inexpensive products. Much of this productive
capacity has been built at the request of various
retailers to parallel the production capacities of
existing vendors in North America.
But as
US retailers have grown increasingly dependent on
low-cost Asian manufacturing capacity, many Asian
OEMs are beginning to become sensitive to the
nature of their changing
relationship with such
companies as Wal-Mart, Home Depot, Lowe's, Best
Buy and others. When these retailers originally
approached many of their Asian vendors, enormous
latitude was given to bring the manufacturers up
to specification because of the potential
market-share gains at stake if the retailer could
obtain lower prices. The initial nature of this
relationship was one of gratitude and partnering -
an approach uniquely designed to build the skills
of the Asian businesses at the same time as it
accomplished the retailers' goal of low-priced
products. As with most relationships, however,
this one was prone to change.
Asian
companies are now beginning to experience an
alteration in how their retail customers view
partnering with them. Early in their relationship,
the idea of partnering was very much a shared
goal. But as the vendor grew, the retailer began
to recognize that its interests were best served
if the vendor was kept at arm's length from the US
consumer. Many Asian companies have seen their
retail customers develop alternative Asian vendors
in the same fashion as they were once originally
courted. This strategic move on the part of the
retailer affords him the opportunity to play his
vendors off against one another. Allowed to go
unchecked, this dynamic leads to a deflationary
spiral as manufacturers undercut one another's
prices in an attempt to increase market share and
use the full capacity of their factories.
This dynamic evolves over time; the actual
inflection point when it becomes destructive
depends on factors such as product complexity, the
necessary investment in manufacturing
infrastructure, and technology adaptation on the
part of the manufacturers. Each contributes to
different points in time when the partnership
relationship between a retailer and its vendor
change. This devolution of a previously mutually
beneficial relationship will be made obvious to an
Asian manufacturer when it begins its first
tentative efforts to build a brand within its
export market. It is not to the advantage of most
North American retailers to have a vendor in Asia
with a strong brand; the retailers would much
rather have manufacturing partners that are
content to be captive manufacturers. Evolving into
a position where their manufacturing base has the
ability to market and brand threatens the
retailers' price-only message.
The case
of power tools Cost-only competition is a
typical attribute of markets with broad product
parity and little perceived brand value. An
excellent example of this is the power-tool
market.
The Asian power-tool market
includes a number of competitors from developed
economies such as Black & Decker, Hitachi,
Makita and Skil-Bosch. Serving this segment of the
market are subcontractors who manufacture
sub-assemblies, such as motors, for the power-tool
OEMs. It is within the subassembly segment of the
market that deflationary price pressure is taking
on extreme forms, necessitating a push back with
respect to pricing by the subcontractors who make
motors against the power-tool manufacturers. A
number of players within the sub-assembly sector
of the market have been forced to consolidate, go
out of business entirely, or attempt to integrate
from the motor to the finished product.
The power-tool industry was stunned in
October 2003 to learn the nature of a newly
announced relationship between Hong Kong-based
power-tool manufacturer Techtronic Industries
(TTI) and US-based do-it-yourself products
retailer Home Depot. Such companies as Black &
Decker, Skil-Bosch, Porter Cable and Milwaukee
Electric had some of their worst fears realized
when Home Depot announced that TTI would
manufacture a line of proprietary power tools
under the Ridgid trade name, solely for Home
Depot's use, at what most agreed were distressed
prices. Seen by some industry insiders as a sign
of weakness on the part of TTI and Ridgid, the
consequences of this deal are still being felt
within the power-tool community as well as the
markets where Home Depot has sought to expand the
Ridgid brand.
Prior to the TTI-Home Depot
deal, Ridgid was a relatively unknown power-tool
brand name owned by Emerson Electric, a company
primarily known for its line of industrial vacuums
marketed under the Ridgid name. The Ridgid brand
was best known within the market by plumbing
professionals who had been purchasing Ridgid-brand
plumbing and heating, ventilation and
air-conditioning (HVAC) supplies for almost 80
years. Emerson was getting little value from the
Ridgid brand, and realized that its position
within Home Depot was susceptible to competitive
pressure because of its limited number of
products. To Emerson, it was probably only a
matter of time before a company such as Black
& Decker moved into its vacuum product line
with competitive products.
For strategic
reasons not explicitly revealed, but probably
having to do with TTI's recognition that it could
not compete with Hong Kong-listed Johnson Electric
(another motor manufacturer), TTI moved to
integrate vertically from motor manufacturing to
the finished power tool. Doing so irreversibly
alienated its power-tool customers from TTI, since
no power-tool company would buy motors from,
therefore effectively subsidizing, a direct
competitor, but also fundamentally repositioned
TTI within the US retail market.
TTI's
move took place at a time when Home Depot's
power-tool suppliers were beginning to gain an
upper hand in their ongoing negotiations with
their retail clients in large part because of the
emphasis North American power-tool companies had
been placing on product innovation and
direct-to-the-consumer marketing. The best example
of this trend, Black & Decker, was fighting on
literally every possible front. It had pursued a
quite successful market-segmentation strategy by
setting aside the DeWalt brand targeting the
professional user, while also developing entirely
new products for the ordinary consumer. While
Black & Decker fought the price-only battle
with retailers, it also refused to let go of its
emphasis on branding and product-development
activities.
The TTI deal allowed it to
accomplish its goal of vertically integrating into
the power-tool market, but at a cost of a serious
blow to the price structure of the entire
industry, given the concessions in its Home Depot
contract. Some have suggested that the TTI deal
may prove to be an early example of Asian
businesses' mortgaging their futures for
short-term gains, a trend that could continue for
a decade or more. Seen most simply, the TTI-Ridgid
deal provides Home Depot with a long-term supply
contract at price points existing North American,
Japanese, European and even other Asian power-tool
OEMs cannot match.
In reality, the TTI
move is even more strategic for Home Depot than
this cursory analysis suggests. For Home Depot,
the TTI deal represents its assertion that, as
with Wal-Mart, customers' loyalty lies with Home
Depot - its brand name and product expertise - not
with the power-tool manufacturer. Believing this,
Home Depot and other retailers like it are moving
to brand increasingly sophisticated products as
their own proprietary in-house products. As
retailers have grown more sophisticated, they have
begun to demand more than proprietary colors and
labels, as in the past: they are increasingly
demanding proprietary designs, brands and pricing
as well.
Will anything stop this trend?
The short answer is no - unless savvy
manufacturers eventually perceive that rates of
return will diminish to zero if they have no brand
of their own. Fortunately, Home Depot's experience
with the Ridgid product line is quickly developing
into a classic cautionary tale of brand dilution.
The Ridgid name, known for its quality plumbing
and HVAC supplies in concert with the vacuum
cleaner carrying its brand, has now degenerated
into a brand that means little, as Home Depot
slaps "Ridgid" stickers on everything from
wood-handled shovels to pipe wrenches.
It
seems obvious that Ridgid's success will become an
example of what happens when Asian manufacturers
tie their fortunes to one retail outlet instead of
managing a market in broader terms with more
all-encompassing strategies.
The larger
implications What happens in the power-tool
market will have ripple effects and parallels in
many other consumer-products sectors, where
companies' success is intimately tied to their
relationship with the retailer. Among these
questions is whether Home Depot's move will force
other power-tool makers into a pure price-cutting
phase, or whether manufacturers begin to rely on
increasingly innovative products whose commercial
success depends on more than one retail outlet,
making the proprietary TTI-Home Depot relationship
inefficient and unstable.
On the other
hand, if the additional opportunities for product
development are somehow incremental and do not
allow the consumer truly to differentiate between
brands, the likelihood that the consumer
power-tool segment will come under increasingly
intense deflationary pressure may prove accurate,
with the long-term results being additional market
consolidation, fewer competitors, and stagnant
market-development activities.
The
retailers' motives in pitting competitors against
themselves are clear. They believe that if they
can continue pushing prices lower, they will be
able forever to keep consumption growth at its
current level. The underlying belief that
retailers can forever sustain their growth models
on the basis of ongoing lower prices overlooks
questions of market saturation and consumers' need
for innovative products that add value if they are
to continue purchasing.
Allowed to go
unchecked, the competitive price pressure US
retailers place their vendors under will lead to
additional broad consolidations. While this
process may only reduce a larger group of
inefficient businesses into a smaller group of
much more efficient businesses, if a market is
allowed fully to engage in a deflationary spiral,
with the only companies left standing those that
met the increasing demands of the market at the
cost of product innovation, brand-name-building
activities and customer service, then the
likelihood that the product itself will remain
viable is small. This is the unforeseen danger in
the dynamic evolving among Asian manufacturers,
their North American competitors, and the retailer
who believes that by setting this all in motion
it, and in turn the consumer, will benefit with no
detriment.
The way out of this spiral is
not immediately clear to many, and it is as simple
to say as it is complex to escape. To take
seriously the possibility for a cruel deflationary
spiral is to go back to the idea of innovation as
absolutely essential for saving all involved - the
manufacturers, the retailers, and the consumers -
from ultimately unsatisfying market consolidations
and economic stagnation.
Businesses must
learn to navigate into a position where they have
some leverage over their retail customers. This is
a dynamic evolution fraught with peril and can
only be successful if two elements are present in
business plans: first, a continued emphasis on
being a cost-competitive producer, and second, an
ability to create new products that the retail
customer needs. As this balancing act finds
equilibrium, a manufacturer can then begin to
focus on additional intangibles that will further
enhance its leverage over the retailer, such as
marketing activities and building a domestic brand
in the North American market.
Most useful
for the global economy would be for large North
American retailers to focus less closely on low
prices when sourcing products and more on finding
OEMs that can innovate and manufacture products
consumers are engaged with. This type of change
could even give manufacturers in North America a
breather from the past decade of deflationary
pricing schemes and an opportunity to focus on
their customers, whose needs they know much better
than their Asian competitors.
A mass
change of perspective by retailers could very well
become a key factor in stabilizing incestuous
manufacturing sectors, characterized by rampant
overcapacity built with improperly secured credit
to chase markets whose viability will soon require
more than only a cost advantage. Only the future
will tell if this change is one that benefits only
a select group of manufacturers, or presents a key
transition for the global economy, developed and
developing countries alike.
Benjamin
Shobert is the managing director of Teleos Inc
(www.teleos-inc.com), a consulting firm dedicated
to helping Asian businesses bring innovative
technologies into the North American market.
(Copyright 2006 Benjamin Shobert. Used by
permission.)
Speaking Freely is an
Asia Times Online feature that allows guest
writers to have their say. Please click hereif you are interested in
contributing.
