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Waltzing on Wall Street

The auto industry is in the midst of a major restructuring.

The auto industry is in the midst of a major restructuring. Not widely understood is a key external force reshaping it: Wall Street. After all, investors own the automakers. Their on-again, off-again love affairs with various industries profoundly impact the direction those industries take.

The auto industry is no exception. More than ever senior executives at the OEMs are setting their business strategies in direct response to Wall Street’s valuations of their companies.

Historically, auto industry stocks were considered among the best investments. Today this is far from the case. The biggest OEMs are now put on par with mid-size firms in the high-tech industry. An example is the hand-held computer maker Palm. This firm has revenues and income less than one-hundredth the size of a Ford, yet it enjoys about the same market capitalization as the true industrial giant.

Wall Street justifies these gross disparities by pointing to both the zero-growth prospects of the auto industry and its excessive manufacturing over-capacity. Excess capacity is so great that a large OEM could virtually disappear and the remaining automakers would instantly mop up its business without a hiccup. Because of these factors, Wall Street currently places almost no value on the plants, expertise, product lines, etc. of each OEM.

As the relative valuations of OEMs sink, they become more exposed to drastic changes in ownership. Even the threat of these changes can force management onto a course not of its choosing. An example is investor Carl Icahn’s moves on General Motors. OEM senior executives are consequently very sensitive if not downright skittish toward Wall Street and its attitude toward the auto industry.

Today Wall Street does love one thing about the auto industry. That is the auto industry’s huge purchasing power. Wall Street wants the auto industry to direct its enormous cash flow to help fuel the development of industries and firms that Wall Street wants to grow. Hence, it’s the purse, not the plants that Wall Street likes most about the auto industry today.

Given this situation, it is not surprising that the auto industry’s business-to-business (B2B) strategy is dominated by purchasing initiatives. Only about 30% of the total cost savings of B2B are in the purchasing area, estimates the consultancy Roland Berger (Troy, MI). Nevertheless, material, repair, and operations (MRO) procurement, trading exchanges, and so forth are at the forefront of each OEM’s B2B plans.

Furthermore, OEMs are also exposing their purchasing operations more to the outside world. They are doing so by pulling the purchasing function out of the bowels of their corporations and running them more often on the Internet, on trading exchanges, using packaged software.

In taking these actions, the auto industry is continuing its historic role serving as a “wet nurse” for emerging, external indu- stries. For instance, Sun Microsystems began by selling workstations to the auto industry. From those humble beginnings Sun’s market capitalization soared to about $170 billion today. It now equals that roughly of the Big Three automakers combined. A more recent example is Commerce One’s meteoric stock rise after General Motors announced its partnership with this firm.

It is almost as if the automakers are no longer “makers” of products. Instead, their primary roles are purchasing agents. They need to maintain manufacturing only to sustain this enormous cash flow. Indeed, this helps explain how Ford and General Motors could spin off their huge, parts businesses without much drop in market capitalizations. Their cash flows basically stayed the same.

This year OEMs succeeded in getting investor attention by concentrating their purchasing power even more—through the formation of Covisint. By touting a potential $200-billion/year spend, Covisint became too big for even Wall Street to ignore. Clearly Covisint is a consolidation and concentration of purchasing in the auto industry.

For this to occur, however, OEM middle management (and tier-one suppliers) must wholeheartedly endorse it. And here a large problem lies. OEM middle managers are generally not interested in their company’s stock price and may not share the agenda of their senior management. Middle management, indeed, has a vested interested in not consolidating. They are the keepers of the proprietary business processes that run each OEM today. Mid-level managers are certainly reticent to relinquish their hold on these OEM operations. This is true even toward a firm such as Covisint that is owned in part by the OEMs and is likely to add billions of dollars of equity to their respective companies.

Furthermore, if Covisint merely assumes operations of these proprietary processes then it will add very little value to the industry. As David Van Noord, vice president at Brain North America (Grand Rapids, MI) pointed out, the key value-add from B2B initiatives is in standardizing business practices. Implicit in doing so is retiring proprietary business processes that are the lifeblood of mid-level OEM managers.

The battles will be fought over what the standard business processes are and who will manage them. These issues will reduce to the arcane details of B2B integration, information-technology architecture, and the like. Included are the data formats, protocols, and standard “semantics” for the industry. An example would be to universally define a purchase order form. This could be in ebXML, Microsoft’s BizTalk, E-5 from the Automotive Industry Action Group, or other formats.

Without consensus on these matters, the consolidation and streamlining of the industry will not occur. Wall Street will lose interest in the auto industry. Its stock prices will continue to languish. Consequently there is much at stake here. Baring major economic upheavals, Wall Street will not soon return vehicle manufacturing to a preeminent position among industries.

Once the dust settles, senior OEM executives will return to the business of manufacturing vehicles. However, the latest attempt at raising their companies’ market capitalizations will probably be only marginally successful.

Low price/earnings ratios will continue to be the norm for the industry—until perhaps Wall Street becomes enamored with yet another emerging industry. It likely will tap the auto industry once again to serve as the handmaiden for this new Belle of the Ball. Senior OEM execs will get excited only to once again become disappointed. They’ll helplessly watch yet another wave of companies in the end waltz away with the generous price/earnings ratios that this industry so deeply covets.

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