Kill the Mercury Mountaineer

I just turned in my take home final for Prices, Profits and the Market Economy. I’ve posted one of the questions and my response below. It deals with tactics Ford should employ to work its way through the current recession. If you’re interested in FoMoCo, public policy on fuel efficiency or the current turmoil with Detroit's Big Three, read on...

1. Suppose Ford Motor Company asked you to help identify one automobile (a single automobile not a brand) to stop manufacturing. Which automobile that is not already slated to be eliminated would you recommend? Make sure to provide a detailed explanation of your reasoning.

Last December, Ford spokesman Mark Schirmer announced that the company would retire the Ford Taurus X and Mercury Sable (http://tinyurl.com/csetcg). Sales never took off on the poorly-advertised Taurus X, and the Sable will be replaced by an entirely new Taurus later this year. Will these two autos be the last to see the axe?

According to Ford’s 2008 Annual Report, there is excess capacity in the US automotive industry (http://tinyurl.com/cdr6ef). In North America, excess capacity was an estimated 44% in 2008, up from around 20% in 2007. According to the Report, conditions for significant excess capacity could continue through 2011. Ford should cut redundant vehicles in the face of this continued vehicle glut. But what one vehicle should be singled out?

In terms of redundancy, the Mountaineer and Explorer top my list. The Ford Explorer and Mercury Mountaineer are essentially the same vehicle. The 4X2 4.0L base-trim Mountaineer retails for $28,700 while the 4X2 4.0L XLT Explorer retails for $28,470 (http://tinyurl.com/dmhxha). Both vehicles have the same chassis, engine, transmission, interior amenities, exterior trim (with some cosmetic differences), safety features and warranty. The Mountaineer and Explorer are both available in higher trim levels as well. The Explorer offers a model equivalent to the top-of-the-line 4.6L AWD Premier Mountaineer: the 4.6L AWD Eddie Bauer Explorer. The Eddie Bauer Explorer is priced a few hundred dollars higher than the Mountaineer but lacks third row seating standard. Its cousin, the 4.6L AWD Limited Explorer retails several thousand dollars higher than the Premier Mountaineer with the only discernible differences being a 6-disc in-dash CD player and chrome. In fact, a detailed analysis of all the “Build and Price” options available on the Ford and Mercury websites reveals the only real difference between the two: the Mountaineer’s VOGA package (http://tinyurl.com/d9hf7z). Italian for “vogue”, this package includes chrome accents, “VOGA” stitching and badging and special color pallets. Picking one of the two to cut is easy, as the Explorer is configurable to be both cheaper and more expensive than the Mountaineer. This means that Ford can target more customer segments with less vehicles.

So why does Ford support two vehicles that are so similar? At one time, Ford maintained a “good, better, best” strategy with its core brands of Ford, Mercury and Lincoln. There were dramatic differences in the vehicles, trim lines and price points offered under each brand. The typical lifetime Ford customer “graduated” from one brand to the next as his net worth rose over the years. Unfortunately, that line has become blurred in recent years. As the example above highlights, there is very little difference between Ford and Mercury models today.

In addition to the redundancy of these two models, Ford also faces a change in consumer preferences. According to Ford’s chief sales analyst, George Pipas, the SUV market is approaching its nadir (http://tinyurl.com/dfmq9q). SUV sales were 25% of the overall North American market in 2000; they now account for a mere 4% of sales. The trend towards smaller, more fuel efficient cars is not likely to reverse itself. Although gas is around $2 a gallon today, consumers still remember dropping $120 at the pump to fill up their monster SUV’s last summer.

Returning to Ford’s 2008 Annual Report we can see details on the firm’s U.S. manufacturing presence. The company currently has 24 power train, stamping, and components plants and 10 vehicle assembly plants throughout North America. Ford is in the process of converting three of the 10 assembly plants from production of large SUVs and trucks to small car production, which will result in 50% of U.S. manufacturing capacity dedicated to these smaller, lighter, more fuel efficient vehicles. Ford believes this shift in manufacturing mirrors a permanent shift in consumer preferences.

Ford has killed off two vehicles in the last six months, the Taurus X and the Sable. Based on the current glut of industry output, Ford should continue to tighten up its line. I believe the Mountaineer should be next. It is feature-for-feature redundant with the Explorer, and therefore most certainly steals sales from its more configurable cousin. In addition, consumer demand is clearly trending away from large, gas-guzzling SUV’s, as Ford’s plant reconfiguration data shows. While this may be painful for some factory towns and Mercury fans, it must be done. There is a concept in economics called “creative destruction”. The idea is to let dying businesses die so that thriving businesses can thrive. Every penny put into the Mountaineer is a penny that could have been put into making the Explorer cheaper and more fuel-efficient. If Ford wants to survive this economic downturn without going to Uncle Sam hat-in-hand it must allocate resources to the most profitable, long-term projects and let everything else die on the vine. The company that comes out on the other side will be leaner, healthier and more profitable.

Growing into Outsourcing

Another assignment in my Marketing/Econ class at UCO was to read The World Is Flat by Thomas L. Friedman.  Much has been written about this book and its lessons for business.  I read the book to see what I could pull out of it and apply immediately in my business.  Following are some thoughts I prepared for our class discussion…

One of the main points of the book is that the technological advancements of the last few decades have made distance immaterial. Fiber optic cables, hardware and software standardization and network topologies have combined to give businesses a toolset to outsource work to all corners of the globe. Friedman’s analysis of the high-tech call centers in India is a good example of how these technologies are allowing Western companies to take advantage of well-educated, English speaking tech workers at a fraction of the cost of domestic labor.

If “outsourceable” work is not readily available, firms should seek to utilize the technologies that made this trend possible. There are a host of tools that make distance obsolete - GoToMeeting, WebEx and NetMeeting allow collaborators from across the globe to share documents and hold conversations in real-time. The savvy manager will use these tools to unify virtual supply chains. For instance, an engineering group in the United States could take control of the PC of chip designer in Hong Kong to tweak a board design. This technology puts the two engineers side-by-side at the same drafting table, a feat that would have required thousands of dollars of travel and weeks of sunk time just a few years ago. Firms could also use a tool like GoView to record video files of actions taken on a desktop for review by sales agents. This type of training can unify a company’s message and ensure tighter marketing world-wide. Lastly, managers could use technology like Skype to interact in one-on-one video chats with colleagues, suppliers or clients that are literally half a world away. The immediacy of synchronous video conferencing is the next best thing to traveling halfway around the globe to meet with someone.

As firms become more comfortable with the implementation of these tools they can begin to outsource work. Managers should look for “individual contributor” positions that can be contracted out, such as industrial design or data analysis. The reliability of video conferencing and webinars can put these resources at the fingertips of the organization even if the workers aren’t in the same building. Once management is comfortable with the notion of outsourcing peripheral activities it can start to outsource integrated support functions, like first level tech support to some of the foreign firms that Friedman visited in India. This phased approach is low cost, low risk and provides the manager with a means to grow into outsourcing.

Is Outsourcing Good?

I’ll graduate from the University of Central Oklahoma with an MBA next month (http://www.busn.uco.edu/mba/).  One of the classes I took was a hybrid marketing / economics class – Prices, Profits and the Market Economy.  We spent our time outside of class reading, writing and thinking, and then showed up to class to hash out our ideas. 

One of our professors (http://mickeyhepner.blogspot.com) asked the following question to get us ready for an in-class discussion:

“Since 2000 the U.S. has lost 5 million manufacturing jobs (nearly 30% of the total manufacturing jobs in the U.S. in 2000). This is mainly due to increased use of outsourcing. Is this a good development? "

Following is my attempt to answer this question…

I argue that this is a very good development. We've already agreed that the only reason a company would outsource work is because it is more profitable. The more money a company returns to the bottom line, the more it can invest in plant, property and equipment to expand operations, thereby creating more jobs.

To explain my point further, let’s take the shirt I just bought from Land's End. It was made in Bangladesh. I thought about how this shirt would have arrived at my door under two scenarios: manufactured in Bangladesh and right here in the US of A.

The major inputs for "shirt" are: machinery, materials and labor. We can assume that the industry for commercial garment machinery is mature. In fact, if anyone happens to be in Cologne, Germany in late April, you can visit “Textile Machinery Live” (http://www.textilemachinerylive.com/?gclid=CO_KycWwkpkCFSQMDQodYC90bA). Looks like a riot. Since this industry is mature, we can assume that the cost for commercial garment machinery isn’t an insurmountable competitive advantage from one firm to another. Of course, larger firms will purchase machinery at lower costs and have access to the most productive models, but overall, I would argue that machinery isn’t a competitive advantage. In any case, D’Avenis would argue that such an advantage is unsustainable because it is easily duplicated.

So let’s look at materials. My shirt is made of cotton, which is bought and sold on the New York Mercantile Exchange’s Food and Fiber market (http://www.nymex.com/index.aspx). Incidentally, cotton futures, like most other commodities in the current global downturn, are dropping like a rock. Most of the textiles that go into shirts are commodities, although not all are traded like cotton. Therefore, I think you have another unsustainable competitive advantage if you’re just buying cotton right.

That brings us to our last input: labor. The Bangladeshi minimum wage in US dollars is $.05. (Check out this useful interactive site I found: http://news.yahoo.com/page/minimum_wage. It lists minimum wage rates worldwide.)  If I’m making shirts, and I know I can’t gain an advantage on machinery or materials, I’m making them in Bangladesh.

Before we cry too many tears for the Bangladeshi textile worker, take note of another statistic on this site: 45% of the population in Bangladesh is unemployed. I assume that many of these folks would rather earn a few dollars a week than resort to subsistence agriculture – otherwise there wouldn’t be a textile industry in Bangladesh.

Let’s say the cost of materials and PPE allocation for this shirt is $10 and it takes an hour to make. My COGS is $10.05 in Bangladesh or $15.15 in the US.  With a keystone markup, the shirt costs me (the consumer) $20 if made in Bangladesh or $30 if made in the US.  We’re talking the exact same shirt.  So the US textile mill shuts and the clothing company maybe goes out of business.  What happens to those factory jobs?   The minimum wage workers have to get new jobs, and probably not in another mill.  The workers need to be retrained or repurposed.  This is bad in the short run because these workers have no income to spend on the goods and services produced by other workers.

But we also need to look at the clothing companies that didn’t close down when they shut their mills.  Let’s assume they shifted production to Bangladesh, helping improve the 45% unemployment there.  Let’s then assume that they started selling clothes over the internet direct to consumers, like me.  I can then take my extra $10 and buy breakfast for my kids at Panera Bread, which provides local service-sector jobs that can’t be outsourced. Panera Bread certainly needed more workers this morning…I wonder if they would be in the market for former textile mill workers?

What else was involved in the e-commerce shirt transaction?  Well, internet sales require computer hardware and software.  This demand creates high-paying jobs.  These highly-paid techies can buy their breakfast at Panera Bread too, but I bet they can afford to go every day.  Looks like more mill workers will be needed...but what else happens with this company?  Let’s say that selling clothes over the internet is a great business venture and the company expands, creating demand for more logistics jobs.  The company needs more order pullers at minimum wage and more forklift drivers at twice that rate.  There will also be increased demand for truck drivers and third-party logistics services.  More places for displaced mill workers to go.

So, to sum up my rather long-winded argument, outsourcing manufacturing jobs is good.  It shifts the work to where it can be done most efficiently.  This lowers the price of goods for consumers who have more money to spend in other sectors of the economy.  It also improves the local economies that gain new manufacturing jobs.

Dr. Hepner then wanted to know if this only applied to manufacturing jobs.  My response:

How would this story change if we outsourced white collar workers instead of blue collar workers?  Well, the net result would still be a benefit for the economies of both countries.  We must remember that the firm wouldn’t outsource the work in the first place if it wasn’t profitable to do so.  In addition, there wouldn’t be a market for the work in other countries if wage rates for the jobs weren’t acceptable.

To put this in the context of “shirt”, let’s think about the IT department in the clothing company that implement this e-commerce initiative.  Suppose they start out with a labor-intensive tech support staff that answers trouble tickets, resets passwords and troubleshoots the network for the firm’s growing staff of customer service representatives.  The next thing you know, the world is flat and an Indian call center can do the same work via WebEx for a tenth of the cost.  The IT department slashes its staff of technicians and outsources basic troubleshooting to India.

The laid-off techs could seek employment doing the same job for other companies, although the smarter ones would probably get more training in the interim.  There would still be a need for some technicians to do the physical repairs and part-swaps, and the firm would likely keep a core set of IT administrators that know the system images, network topography and customized applications.  These techs would become more important to the organization and likely command a higher wage.  This would come from the largesse spawned from outsourced IT services.  The firm could spend the remainder of these funds on new technologies to further improve customer service and operational efficiency.  This would, in turn, create new jobs in other sectors of the economy.

Looking back, outsourcing still looks like a good deal to me. 

Getting Started

Growing up, I always wanted to be a business man. I remember wanting to do that before I even knew what it meant. Well, here I am. Each day brings new challenges. Sometimes I move a few steps forward, sometimes a few steps back. I come up with new answers and new questions every day.