Not `Core' Anymore?

Investment, speed-to-market pressures may take powertrains off automakers `must-do' list

The heart of the automobile or just another expensive component better farmed-out to independent suppliers?

That's the question the auto industry is wrestling with as it weighs the importance of maintaining an infrastructure for developing and building home-grown engines and transmissions against Wall Street pressures to become more dot-com-like.

The future could see automakers slowly easing out of powertrain production - or even rapidly dumping their engine and transmission operations in one fell swoop. No one seems to know for certain what will happen or when, but many analysts and industry insiders admit the powertrain landscape is changing.

Not long ago, no chief engineer worth his salt would have suggested the engine - or transmission - wasn't core technology. Jaguar fought for its own V-8 for the Lincoln-based S-Type in 1998. And when Daimler met Chrysler, brand-conscious executives made one thing clear: engines wouldn't be shared across the marques.

Even today, most auto executives argue that having engine expertise in-house remains crucial. After all, next to styling, powertrains are the biggest market "differentiator."

"There's nothing more core than engines," says General Motors Corp. Vice Chairman Harry J. Pearce.

But actions speak louder than words. And within the last decade, OEMs have done more than ever before to erode that stance. Pressured by regulatory requirements and the sometime overnight swings in consumer taste, deals to co-develop powertrain components - or simply buy them outright - are springing up faster than unlatched hoods on the autobahn. And it is causing many to wonder if the powertrain - at least in certain segments and with some marques - is becoming a little less "core" every day.

"It is what's happening in the industry, but nobody wants to talk about it - especially in Europe," says Michael Heidings-felder, partner and vice president with consultants Roland Berger & Partners LLC. "But there are a lot of examples of it already."

The reason for the priority shift? Cost, cost, cost - and, say some auto execs, speed, speed, speed. Plus a growing devotion to a new mantra - shareholder value - that the industry hopes will play better on Wall Street.

That drive, long term, could convince some OEMs to wean themselves away from high-cost powertrain development and manufacturing in order to shift that capital-intensive chore onto someone else's books.

"There are many more heavy truck manufacturers than engine manufacturers (for heavy trucks)," says Nick Lobaccaro, auto analyst for Lehman Brothers. "That's probably a good model (for the auto industry to follow)."

Car manufacturers already have sounded the call with their transmission activities. Just a few years ago, transmission engineering and manufacturing - automatics in the U.S., manuals in Europe - were endeavors automakers maintained jealously.

GM and the former Chrysler Corp. got the divestiture ball rolling back in February 1990 when they formed New Venture Gear, combining a GM manual transmission facility with Chrysler's 4-wheel-drive transfer case operations. Although it remains a joint venture owned 64% by DaimlerChrysler AG and 36% by GM, it isn't for lack of trying to off-load the operation: At least twice the partners have tried to cut loose NVG, backing off only after union resistance.

Ford took a meaningful step in October 1998, when it converted its Batavia, OH, plant into a continuously variable transmission (CVT) JV owned 51% by Zahnradfabrik Friedrichshafen AG (ZF). And in Europe, where Ford is undertaking a wholesale restructuring, it announced earlier this year it would turn a similar trick with three transmission plants and an engineering center in Germany - to be run by Getrag Getriebe-und Zahnradfabrik in a joint venture.

Others are looking to follow suit, with Volvo Car the latest to signal it may exit the manual transmission business.

Ford's current strategy may be today's most assertive, as the company searches for the proper formula for leveraging capital-intensive "core" operations against the escalating demands for quick-to-market new products that can continue to uphold brand values. There's "a significant swing in the way we look at the business," admits Jim Solberg, Ford's executive director of manufacturing operations-powertrain. "We are in a capital-intensive business. That (investment reduction) is an aspect of this. But it's more than that."

Doug Szopa, Ford director of powertrain strategy and business, adds that Ford's recent moves involve carefully considered alliances "that bring more to the equation" than simply shifting heavy investments to someone else. "We really do view these (the ZF and Getrag ventures) as partnerships," he says, citing considerations like economies of scale and the ability to provide better customer satisfaction.

With transmission work not-so-subtly transferring to operations not tightly gripped by the automakers, it appears engines could go the same route.

It has not been unusual for automakers to tap one another's engine technology and capacity from time to time, particularly in Europe - or in times of dire need, as Ford did in the dark days of 1984, when it bought diesel engines from BMW AG for the Lincoln Continental and Mark VII. Typically, though, past cross-company cooperation was sporadic and centered around niche products. The recent activity has come at an unprecedented pace and has focused on more mainstream products.

Late last year, GM announced to a thunderstruck industry that it would, beginning in 2003, annually buy 90,000 V-6 engines and compatible automatics from Honda Motor Co. Ltd. BMW took up unholy alliance with DaimlerChrysler, which will supply a small Brazilian-built 4-cyl. for BMW's upcoming Mini. And Ford and PSA Peugeot-Citroen are knee-deep in a joint diesel engine engineering and production program.

"It is just getting too expensive to develop powertrains on your own - even for the largest automaker," notes Mr. Heidingsfelder.

That leads to the biggest move to date: GM's equity swap with Fiat Auto SpA that has resulted in the shotgun marriage of their powertrain engineering and manufacturing operations in Europe and Latin America. The new Turin-based JV will oversee output of 5 million engines and transmissions annually and employ 27,000 former GM, Opel/Vauxhall, Saab Automobile and Fiat workers.

For the most part, the JV is seen as a rapid way to rationalize engine development and production.

"If there are savings to be made from the higher volumes, GM and Fiat will find them," says Karl Ludvigsen, head of a U.K.-based consulting firm.

But some pundits agree there could be a longer-term plan to spin off the JV, in part so it could more easily furnish engines to other automakers, but also to make a return on net assets (RONA) impact on Wall Street.

Some say the auto industry's fascination with RONA is a reaction to the "New Economy" companies that have dazzled investors with low asset bases and potentially high returns. Others, such as GM, say the movement predates the dot-coms. Either way, efforts to lower fixed costs are solidly under way.

"You really need to be careful about the way you deploy capital," says Bill Kager, director of corporate financial planning and reporting for GM. "That's what RONA brings to the party. It's not only what earnings are, but how efficiently did I spend money on making that money."

There are two ways to jack RONA: increase profits or reduce assets. For the latter, everything from replacing existing facilities with lower-cost plants to closing or selling off operations, creating spin-offs or forming joint ventures can help take assets off the books.

In the case of JVs or other operations where a company has a partial ownership stake, it can be complicated. But in general, whether a company consolidates the assets depends on the size of its stake and who has management control. Eliminating something as expensive as powertrain plants would be a sure way to quickly goose RONA.

"At a later stage, yes, they should be thinking (about spinning off the Opel-Fiat JV)," says Mr. Heidingsfelder. "Divestiture (in general) is definitely on the agenda over the next couple of years."

And ultimately, if moving powertrain off the books in Europe and South America is a good idea, why not the U.S.?

One analyst hints there's talk about GM possibly jettisoning its venerable Hydra-matic automatic transmission division, for starters. But insiders downplay that and other persistent rumors that GM's North American powertrain operations will be spun off - either as part of or separate from the Opel-Fiat alliance.

Still, the question may be less about whether to spin off powertrain operations and more about how. There are few suppliers that would have the wherewithal to acquire an entity as large as GM's Hydra-matic. A leveraged buyout also would be difficult, analysts say. And it's not likely an initial public offering (IPO) for a stand-alone powertrain company - capital-intensive and saddled with union-driven high labor costs - would enrapture Wall Street.

Nonetheless, transmission sourcing, in particular, is moving rapidly away from the automakers, says Kenichi Sasaki, chief executive of Japan's Jatco TransTechnology Ltd., a company created in 1999 via merger of Nissan Motor Co. Ltd.'s transmission operations with Jatco Corp., Nissan, Mazda Motor Corp. and Ford's 29-year-old transmission JV.

The "very long development period and large investment in production facilities" for automatics makes it inevitable that auto-makers will outsource more, Mr. Sasaki says. "For automobile manufacturers, in-house production of automatic transmissions is becoming a larger financial burden in view of (RONA)."

With Ford and GM already having shed their parts-making operations, the next biggest overnight opportunity to take a whack out of RONA could be powertrains. GM says from an accounting standpoint, it won't have management control of the Fiat-Opel powertrain JV, meaning it won't be consolidating those operations onto its books. However, that may not change Wall Street's perspective as much as GM would like. The only way to truly get those facilities off the ledger would be a full spin-off or sale, says one New York analyst.

GM's Mr. Kager won't speculate on what's next, saying the automaker is focusing on daily actions such as lowering its inventory and squeezing down net payrolls and receivables in order to improve RONA.

And certainly there are obvious dangers in outsourcing power-trains - engines in particular - if you believe in the "powertrain-as-brand-identifier" theory. Buyers may begin to perceive fewer differences among various vehicle makes. Even carmakers that stake out ground on the supply side of the equation - such as a Honda or BMW - may suffer.

"If I can get Honda engines in other cars, why buy a Honda?" asks Nigel Griffith, an analyst with DRI in Europe.

And there's also quality and delivery control. Will automakers be willing to give up powertrain production oversight, risking new product launch delays and dissatisfied customers?

But Ford counters that's precisely why it has embarked on its recent trend-setting transmission ventures.

Ford's Mr. Solberg cites the joint venture with ZF for high-tech CVTs as a prime example: He says the venture was "a CVT-driven decision," because ZF has vital CVT expertise - and that teaming up will bring the new-age transmission to market more quickly than if Ford built and developed the thing itself.

Such is the same for Ford's release of European manual-transmission development and production to its joint venture with Getrag: "Manual transmissions also are changing quickly," says Mr. Solberg, saying that Ford believes that without the vertical integration inherent in monstrous companies, a specialist like Getrag can do it quicker.

"There are a lot of capable suppliers out there," he asserts, so why not leverage their abilities?

Analysts say exclusivity in engines isn't as important with consumers of lower-line automobiles as it may be with those who buy more expensive marques.

"(Brand differentiation) has more to do with the look and feel of the car than with what's under the hood," says Colin Couchman, another DRI-Europe analyst.

Moreover, says Ford's Mr. Solberg, savvy automakers aren't about to mess with long-established brand identifiers like engines - or the powertrain in general. "In years past, that (powertrain as a differentiator) was a big concern." He adds that although there are tangible moves toward powertrain outsourcing now, "It's not like you just divorce yourself from what's going on."

He says the company always will take pains to put the Ford "stamp" on meaningful components, and even with things like transmissions built by someone else, "We're confident we can maintain our brand identity."

"You have to accept that engines in general are in a high, similar state of development," adds Mr. Ludvigsen. "There's not that much difference (between them). The money (automakers) save on core engineering, they can spend on differentiation."

In the end it will be cost pressures and special expertise that may drive automakers toward buying, rather than building, engines. If outsourced transmissions prove to be a winner, can engines be far behind?

"It can happen," says Mr. Heidings-felder, "but in a long-term time frame, not the next couple of years. If you asked anybody a couple of years ago, they would have said transmissions, not just engines, were a core business. Today, for some ranges, they're not.

"The same thing will happen to engines."

Recent Industry Moves Away from Powertrain Manufacturing

February 1990: GM and Chrysler form New Venture Gear from GM's Muncie, IN, manual transmission plant and Chrysler 4-wheel-drive transfer case operations in Syracuse, NY.

1996: Mitsubishi Motor Corp. introduces its watershed gasoline direct injection (GDI) engine. Several automakers license the basic technology. In 1998, Volvo-badged European 40-series cars are fitted with GDI engines.

May 1997: BMW and Chrysler form Tritec, a new joint venture that will supply 1.4L and 1.6L 4-cyl. engines for Chrysler's Neon and other models and BMW's Mini. It is slated to have capacity for 400,000 engines per year.

August 1998: GM launches its first passenger-car 5-speed automatic transmission the 5L40-E. First to use it: BMW AG.

September 1998: Ford and PSA announce they will co-develop a new family of direct-injection diesel engines for Europe.

September 1998: GM and affiliate diesel-engine expert Isuzu Motors Ltd. announce their DMAX Ltd. joint venture to produce light-duty diesel engines at the site of a former GM engine plant in Morain, OH.

October 1998: Ford turns its Batavia, OH, automatic transmission plant over to a continuously variable transmission (CVT) joint venture owned 51% by ZF.

October 1999: Ford and PSA extend their engine co-development project to include research on V-6 and/or V-8 direct-injection diesels and another 4-cyl., this one 2L in displacement.

December 1999: GM agrees to annually buy 90,000 V-6 engines and automatic transmissions from Honda beginning fall 2003. Honda will buy diesel engines from GM affiliate Isuzu as part of the deal.

May 2000: Ford forms a joint venture with Getrag Getriebe-und Zahnradfabrik to design and build manual transmissions. The JV will build the transmissions in former Ford plants in France, Britain and Germany. Ford is out of the business of developing and building manual transmissions in Europe.

July 2000: GM and Fiat reveal plans to fold all Opel/Vauxhall, Saab and Fiat engine and transmission engineering and manufacturing operations for Europe and Latin America into a joint venture.

August 2000: Volvo unveils its new S60 sedan featuring a new Volvo designed and built 5-speed manual transmission. But the automaker says it is studying whether to get out of the transmission business altogether.