Outsource It All

Imagine that you ran your own car company. Wouldn't you love to increase your sales and marketing budget by $1 billion? Or pour an additional billion dollars into research & development? Or add another $1 billion to your cash reserve? Or enhance shareholder value by buying back $5 billion in stock? Of course you'd love to. In fact, you'd want to do it all at the same time.

And you can. And so can every other automaker in the business. Not only is it entirely possible, I believe it will happen.

The reason it will is that each of the world's largest automakers has almost $8 billion locked up inside its annual budget. It's called the capital budget and represents all the money it spends on new factories, plant expansions and new equipment.

The question is: How do you free up all that capital investment? And the answer is: Don't spend it! Instead, move that capital burden off your books and onto suppliers' books. How? Outsource all manufacturing operations to the supplier industry. Let suppliers make all the engines and transmissions and assemble all the cars.

You don't think it's possible? We're already starting to see it happen. The industry is taking steps toward unloading its capital burden onto suppliers. Ford Motor Co. gave its transmission plant in Batavia, OH, to German supplier ZF. And it's turning its Windsor and Essex aluminum casting plants over to its joint venture, Nemak.

General Motors Corp. and Ford both unloaded Delphi and Visteon, respectively, in good part because they didn't want to have to keep investing their hard-earned capital into making components. DaimlerChrysler AG allowed Dana Corp. to build a rolling chassis for it in Brazil so that it could reduce its capital investment at its plant at Campo Largo. All three automakers now are forcing their molding and stamping suppliers to bear all the cost for developing new molds and dies. And the list goes on and on.

Automakers want to avoid capital spending because they want to reduce the cost of raising that money (by borrowing, selling bonds, or issuing stock). These companies also are using new ways to measure the performance of their managers that discourages those executives from spending money to acquire new assets. Whether it's EVA (economic value added) or RONA (return on net assets), managers know they are being measured by - and know their careers now hinge on - how judiciously they spend the shareholders' money.

They have to do this because Wall Street has beaten auto stocks down to deplorable price-to-earnings ratios - in large part because automakers have such large amounts of fixed assets. Investors know that in any downturn these companies still will have to spend huge amounts of money to run and maintain their facilities, unlike the New Economy companies, which are knowledge-intensive, not capital-intensive.

So automakers are searching for ways to become less capital-intensive. And they've recognized that outsourcing this capital burden to suppliers is the fastest, easiest way to pull it off.

Most importantly, suppliers have the wherewithal to do it all. They can make virtually all the parts needed on a car, and even do the final assembly. In fact, many automakers already source some of their engines, transmissions, bodies, chassis and interiors to suppliers. Some of them even outsource the final assembly of some of their cars. Now they just have to bite the bullet and outsource all of it.

Undoubtedly, unions will object. But they've already shown a reluctant willingness to go along with major outsourcing moves as long as their members maintain their union contract and are able to protect their wages and benefits. That's how GM was able to spin off Detroit Diesel, American Axle, Delco Remy and Delphi. Ford was able to spin off Visteon by keeping those workers as its employees.

One way automakers could offload the capital-intensive side of their business would be to take their manufacturing operations and spin them off as separate companies. Imagine a General Motors Mfg. Co., or Ford Mfg. Co. that would be free to manufacture and assemble products for any automaker (or supplier), just as Delphi and Visteon are now free to sell components to anyone. In fact, this could do more to rationalize the excess capacity that now exists in the industry than anything an individual automaker could do.

As I've written before, automakers only have to keep three core competencies in house: 1. Design the product. 2. Manage the program. 3. Market the brand. Everything else can be outsourced.

Naturally, the automakers that are the benchmarks in manufacturing will be the last to outsource these operations. But I believe that ultimately they will. After all, at some point in time they're going to have to unlock all that money tied up in their capital budgets to be able to compete with those who already have.