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On Strategy: The Key Challenges for North American Truck Manufacturers, 2006 & Beyond

While truck manufacturers saw their businesses hit bottom not all that long ago, there has been a subsequent market expansion.

While truck manufacturers saw their businesses hit bottom not all that long ago, there has been a subsequent market expansion. For example, Paccar’s share price has outperformed the S&P 500 by 300% over the past five years. In fact, Class 8 truck sales are expected to grow by 160,000 units since 2001, more than doubling the market size to a forecast of 300,000 units in 2006. All indications are that the trucking industry is on the “up and up.” However, there are critical issues that have an impact on the industry, such as high fuel prices, concern about environmental regulations and labor unrest across the country. Roland Berger Strategy Consultants recently conducted a study to look behind the key trends that currently affect the trucking industry. Roland Berger’s extensive knowledge of the trucking industry has been achieved through successful projects with a number of major players in the industry. For example Roland Berger has helped align the strategy and the business model of a leading multinational OEM to achieve ambitious growth rates through the alignment of business processes (e.g., support of a planned complexity increase by eliminating non-value adding activities, prioritizing processes to enhance competitiveness and adapting best practices within the company). Our study shows there are tremendous challenges ahead for the trucking industry.

U.S. MARKET OVERVIEW. We focused our study on commercial trucks, especially on the manufacturers of class 7–8 trucks, which are significantly different from OEMs that produce light-and-medium duty trucks due to differences in economies of scale and the end markets served. Historically, synergies between light-and heavy-duty trucks have been difficult to realize. However, it is interesting to note that DaimlerChrysler (DCX) offers a business model that produces all truck types across the entire spectrum from class 1 through 8. On the other hand, Navistar is present in classes 6-8, Paccar in classes 7-8 and the Volvo brand, which includes Mack trucks, produces in class 8. As expected, significant volume advantages have enabled this Big Three to dominate classes 4-6, where synergies between light-and-medium duty trucks are possible.

The truck market is like any other cyclical industry, therefore a thorough understanding of the basic drivers of supply and demand is necessary. Critical supply issues that currently face truck-producing OEMs are regulatory challenges such as stricter diesel emission laws and turbulent changes in their customer base. The demand side is experiencing problems related to cost and capacity. Many of these challenges are related to inflationary pressures unleashed by sharp increases in crude oil prices. Other increasing cost factors include high insurance premiums and an organized labor force that is demanding higher wages. The result has been that 60% of freight companies experienced costs increases of more than 15% over the past two years. In addition, these freight companies have begun to experience significant capacity problems due to HOS (hours of service) regulation, as well as demographic changes, which have caused a significant decline in the number of individuals seeking employment as truck drivers. Finally, urban sprawl and related traffic congestion have caused a commensurate rise in the freight companies’ cost structures.

SUPPLY-SIDE ISSUES. Regulatory changes have significant effects on truck manufacturers. The year 2005 saw major environmental milestones in Europe (Euro IV emission regulation) and in Japan (J05 emission regulation). In 2007, the United States will follow suit and enforce the strict new emission standards for NOx (nitrous oxide) and particulate emissions. In 2010, the U.S. also will begin to regulate sulfur emissions. The technological challenges that the 2010 regulations present will not be resolved by engine manufacturers alone, but will require coordinated efforts across the value chain from the oil industry through to component manufacturers. Regulatory rules have significant impact on overall industry demand. History has shown that new engine development costs trigger significant pre-buying of class 8 trucks. Under such a scenario, it is highly conceivable that 2006 could be the best year ever for heavy truck sales followed by a sharp drop in 2007. These market reactions to regulatory rulings only increase the volatility of an already-cyclical industry. As a direct result of regulation, significant peaks and troughs can be projected to continue into 2015. Being able to predict the direction of industry cycles in time gives the opportunity for truck OEMs to adjust their high fixed-cost levels and restructure themselves before a major dip, like the one anticipated in 2007. Besides handling the direct effects of regulatory changes in emission controls, OEMs also have to closely watch trends in trucking demand that affect their primary customers, the freight companies, private and for-hire alike.

DEMAND-SIDE ISSUES. High crude oil prices and their inflationary pressures are the most obvious trends that directly affect the trucking industry. In the past three years in the United States the cost of diesel fuel has doubled. Amazingly, the increase in diesel prices has not affected the demand for freight transportation. However, further price hikes will inevitably crimp end-demand for freight haulage. A threshold, or inflection point, does exist, but pinpointing this level is difficult. Experience in Europe, where a gallon of diesel is more than $6 (U.S. currency) in some countries, demonstrates that the market can adjust to higher oil prices. The primary method of dealing with high diesel prices in the U.S. is to utilize fuel surcharges currently approaching 20% of a customers’ total bill. As more and more customers refuse to pay for the surcharge, the truckers’ bottom line will suffer. Instead of simply trying to pass through increased fuel prices in the form of a surcharge, a new pricing structure will be necessary. Fuel costs already are approaching 30% of total costs for truckers.

Insurance premiums also have increased significantly since 9/11. The real cause, however, has two primary drivers: an increase in claim numbers and an increasing amount of damage per claim. While a significant burden, these cost increases may actually help the industry by forcing fleet companies to better utilize risk-management techniques, expand safety management practices and fine-tune the methods of training of drivers, as well as increase attention on total vehicle maintenance.

Truck drivers are in short supply and it is not difficult to understand why this is the case. Truck drivers have an unattractive lifestyle that offers compensation 20% lower than the average blue-collar worker. Bridging this wage gap is likely to put further cost pressure on trucking companies. Furthermore, the average age of a trucker is 55. These drivers will continue to move out of the job market and will need to be replaced. In light of these statistics, it is no wonder that many distributors and manufacturers would welcome the promised Mexican truck-driving labor pool that NAFTA was supposed to enable. Bottled up in government discussions concerning homeland security and the safety of Mexican trucks crossing the border, it does not appear likely that Americans will see Mexican long-haul truckers on interstate highways anytime soon, however.

Fleet productivity has experienced a significant decrease. A decline of long-term interest rates over the past 20 years has enabled the U.S. economy to expand with significant infrastructural development. However, in direct proportion to the rise in urbanization and infrastructural development, a significant rise in congestion has occurred. Delays in 1982 were around 16 hrs/year/truck and have grown to over 60 hrs/year/truck in 2005. In addition, productivity has decreased as newly introduced Hours of Service (HOS) regulations limit the hours that truckers are allowed to operate their vehicles. In fact, the Federal Motor Carrier Safety Administration (FMCSA) is unable to enforce the HOS regulation as full implementation would demand anywhere from 100,000 to 250,000 extra trucks, and another 100,000 drivers—clearly an impossible short-term scenario.

OUTLOOK & CHALLENGES. Despite all the current problems of freight companies, they will bring their purchases forward in 2006 quite possibly resulting in a record sales year for trucks. Not only do they anticipate around a $5,000 price increase due to the scheduled regulatory changes but there is an uncertainty around operating costs as well. What about 2007 and beyond? Past investments by North American OEMs resulted in capacities that enable them to meet increased demand of 2006. However, high fixed-cost levels will need to decrease for an anticipated 30-to-50% demand slump in 2007. This will be the greatest challenge for North American truck manufacturers.

Truck OEMs need to re-think their strategies especially with regard to:

  • Adjusting to demand fluctuations without significantly increasing fixed costs
  • Producing more durable trucks (especially in critically low-durability areas like air-conditioning and seats) as truckers push out life cycle
  • Producing smaller, more efficient and more specialized applications to help truckers become more effective
  • Managing their own maintenance facilities to care for specialized trucks as the number of independent repair shops decline
  • Offering value-added services. Currently offered guaranteed residual values, guaranteed cost-per-mile and second owner guarantees aren't sustainable anymore. Customers demand high-quality services, especially on the leasing side. OEMs must improve the services of the financing companies that they own.

Although cyclicality of the class 8 market can not be eliminated, heavy truck OEMs can prepare for the challenges of 2007 and have the opportunity to influence and move the market to more optimistic sales scenarios. 

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