HILTON HEAD, S.C. (March 30, 2001) — The tire and auto industries are changing rapidly, and so are the markets they operate in, according to three industry experts.
Such factors as globalization, economic cycles and the Bridgestone/Firestone Inc. tire recall are fueling those changes, the experts said at the Clemson University Tire Industry Conference, held in Hilton Head March 21-23. The companies most likely to thrive in this atmosphere are those that anticipate and plan for change.
The current economic downturn was easily predictable from past market performance and the usual behavior of managers in the tire and other manufacturing industries, according to George Dagnino, chairman of Peter Dag Strategic Money Management and former chief economist for Goodyear.
"We´ve had eight big experiences of financial cycles since 1955," Mr. Dagnino said. "Each featured one to 1.5 years of a strong economy, followed by a slowdown of about the same length."
The dot-com boom of the late 1990s was not a new economy, but merely an expansion of the old one, with a huge increase in the amount of credit available, he said. When credit started slowing down in January 1999, the slide which culminated in the official start of the downturn in November 2000 was inevitable.
Fed not as influential as you think
Although the Federal Reserve has a role to play in these cycles, it is scarcely as influential as it´s cracked up to be, Mr. Dagnino said.
"If the Fed is so powerful, why didn´t they make the credit rate a flat 6 percent and end the boom-and-bust cycles?" he asked. "If they didn´t do it in 1955, it obviously can´t be done. What they do is instigate an orderly transition, so if someone gets in trouble, they come in and help the banking system."
The stock market reacted tepidly to the Fed´s recent interest rate cut largely because lower interest rates aren´t stemming inflation, according to Mr. Dagnino.
"The only problem is inflation," he said. "As the economy overheated toward the end of 1998, inflation went from 1.5 percent to nearly 4 percent per year." Money, he added, is simply getting too cheap. "We paid for Vietnam with inflation, and we will pay for the NASDAQ bubble with inflation."
Mr. Dagnino—whose talk was a basic summary of his new book, Profiting in Bull or Bear Markets—said tire executives have to learn to make the boom-or-bust cycles work for them by looking past current market conditions.
"The reason we´re having all these cycles is because 80 percent of managers lack the guts to look through the valley because they don´t want their heads chopped off," he said.
It´s easy to sell your boss on expanding capacity during boom times, but by the time that capacity is on-stream, the market is no longer booming, Mr. Dagnino noted.
"Now is the time to think of capacity expansion," he said. "The folks at the bank are just itching to lend you their money. You have all these resources available. This is the time to think about expanding for a couple of years down the road."
Automotive industry under stress
The entire automotive industry is under extraordinary stress today, according to Michael S. Flynn, director of the Office for the Study of Automotive Transportation at the University of Michigan Transportation Research Institute.
"There is more change going on in the industry than most outside analysts realize," Mr. Flynn said. While most of the areas of change—such as product development, corporate structure and consumer expectations—have been around since the dawn of the automobile, the forms of change are new and different.
Globalization, for example, is nothing new in the auto industry, but it has become vastly more prominent in corporate planning. "When I started in the industry, Ford Europe could have disappeared, and Dearborn wouldn´t have noticed," Mr. Flynn said. "Now, they are integrating their activities across the globe."
Also, the car has fallen from its formerly pre-eminent place in the consumer hierarchy, he said.
"Twenty years ago, if you asked a consumer what he would do if he suddenly had an extra thousand dollars, most likely he would say he´d buy a new car or something for his car," he said. "But now a car is lagging somewhere near the bottom of the Top 10. Nowadays the personal computer is tops.
"In Detroit, we think everyone´s a car buff, and that´s just not true," he added.
Product development is also wreaking havoc on Detroit´s expectations, according to Mr. Flynn. Thirty years ago, there were only a few basic vehicle types for consumers to choose from.
"Now, there are 15 standard American cars," he said. "There are an awful lot of choices that didn´t used to exist. Manufacturers are in a dogfight they never foresaw."
Fuel economy a continuing concern
Product changes will be difficult to predict over the next several years, and influenced heavily by technical breakthroughs and regulatory change, he said. For example, there is renewed government pressure for increased corporate average fuel economy—something which auto makers vocally oppose.
In fuel economy, "there is no quick fix, and Detroit, Stuttgart and Tokyo do better with quick fixes," Mr. Flynn said. On the other hand, for the first time a majority of auto executives believe the government-industry "Partnership for a New Generation of Vehicles" will meet its goal of creating a production-line-ready passenger vehicle with average fuel economy of 80 miles per gallon by 2010, and that is a big change in attitude, he said.
One thing that auto makers can do to achieve better fuel economy—"though it´s not high on their list," Mr. Flynn said—is reduce tire rolling resistance and weight. "By 2009, tires will need a weight loss of 3 to 5 percent," he said. "That´s a little blue-sky, but the auto makers are thinking about weight, and as they think about weight, they´ll think about tire weight.
"You will succeed by helping them achieve their goals," Mr. Flynn added. "Their definition of a good supplier is someone who does what they want them to."
Overcapacity `rampant´ in tire industry
Meanwhile, in another market—the stock market—tire stocks have long been anathema to financial pundits. But Rod Lache, senior auto analyst with Deutsche Bank Alex. Brown in New York, thinks tire stocks are a good bet for the near future.
"Most auto analysts don´t believe tire stocks will add to their portfolios," Mr. Lache said. Tire stocks traditionally have had two strikes against them, he noted: production overcapacity and the tendency of consumers to perceive tires as a commodity, rather than a brand name.
"Today, only 37 percent of consumers replace their tires with tires of the same brand," he said. "Pricing is a function of supply and demand, and overcapacity in tires is rampant."
Tying in with these problems is the unprofitability of original equipment tires compared with replacement tires. The profitability difference between OE and replacement tires ranges around 80 percent in Europe and 50-60 percent in the U.S., according to Mr. Lache.
"No tire manufacturer in the world claims the OE market to be materially profitable," he said.
Another constant problem is the volatility of raw material costs, such as the recent rise of petroleum from $10 to $30 a barrel.
"It´s a big problem that the industry can´t pass along its increasing costs," he said. "Each dollar increase in the price of a barrel of oil represents a $75 million negative impact on Goodyear alone—and that´s 30 cents a share."
There is, however, "a little bit of structural change happening in the tire industry," Mr. Lache noted. Most of this is related to the Bridgestone/Firestone Inc. recall of 6.5 million tires. And this is why he is recommending tire stocks to his customers.
"There are 420 million units of production capacity in the U.S. tire industry, and Bridgestone/Firestone has 70 million of those units," Mr. Lache said. "If they decline, this could mean some improvement on industry returns."
But tires no longer just a commodity
Furthermore, because of BFS, tires no longer are a commodity in the U.S., according to Mr. Lache.
"A year ago, a tire was round, it was black, and people didn´t focus on it very much," he said. "Now, tire manufacturers are confident about raising prices, because pricing is not that much of a factor with consumers. They´re focusing more on brand.
"This is the first chance the industry has had in 20 years to make a price increase stick," Mr. Lache said. "It might not be permanent, but it might not be temporary either."
Although the network of Firestone stores remains strong, he noted, some individual dealers are defecting from Firestone in favor of other brands, and this may create some permanent shifts in market share.
Auto makers "will experience a really negative supply-demand situation over the next few years," Mr. Lache said. "We´re advising our clients to ditch auto stocks and buy tire stocks."