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The Evolution of Aftermarket Product Lines: Part III

By Dave Caracci

Technology and the global economy is forcing some in the industry to ask some fundamental questions about the way suppliers and distributors address the products they make, buy and sell. In part III of a five-part series, Dave Caracci takes an honest look as some of these questions and offers some possible answers.

From the author: As mentioned in previous articles in this series, evolutionary changes in installer and distribution channel needs, global manufacturing, product transportation, Internet and e-catalog capabilities have all resulted in changes in product-line sourcing habits among distributors. This is the impact of “evolutionary rationalization” that continues to affect manufacturers, distributors, retailers and wholesalers.

During my research for this five-part series, I talked at length with many industry professionals, who collectively share hundreds of years of aftermarket experience. The following article is simply observation drawn from these conversations, combined with my own opinions and experience. The answers to the questions that follow are not the only answers; there is no ‘best’ answer or solution to these aftermarket sourcing and manufacturing issues. It is for you, the reader, to consider and combine with your knowledge to help make future decisions that best fit your particular objectives.
Change never exists as an island. It’s one of those things that seems to impact everything. In the automotive distribution business, the changes that have come about because of advances in both e-cataloging and global sourcing are changing the very fundamentals of the automotive aftermarket. They are making the industry ask some tough questions.

At the conclusion of last month’s article, I posed some of these questions. These are questions that, depending on the answers, could change the very fabric of the industry, altering the way manufacturers offer product, the way warehouses source and the relationships between the two.
In the final two parts of this series of articles, I’ll explore some of these questions. Let’s take them one at a time.

• Should a manufacturer make more SKUs or less?
As the number of parts needed to service all the makes and models continues to proliferate, it seems logical that manufacturers would need to make more part numbers. So, if the market requires more SKUs, how could a firm decide to manufacture fewer SKUs?

Considering all of the manufacturing, labor and tooling costs, the economics may no longer support the decision to manufacture a particular SKU for a given manufacturer. Let’s look at one example. The cost of tooling for a silicone oil pan gasket might be as much as $100,000, while the market price set by the OEM dealer is $11. For the parts store to sell that gasket at the OEM dealer price, using typical industry margins, the aftermarket gasket manufacturer would need to sell it to the WD for $6. If the manufacturing cost on that part (not counting tooling amortization) is $4 and if the remaining $2 gross profit was used to pay tooling cost and no overhead, the manufacturer would need to produce and sell 50,000 of that gasket at zero net profit just to pay off the tooling cost. For many manufacturers, this might not make economic sense.

Looking at potential sales volume in these manufacturing decisions is critical. As another example, consider an import car from say, Sweden. The total US vehicle population of a Swedish vehicle model might be 50,000. That would mean that if every one of those cars needed a new oil pan gasket within 100,000 miles, at 12,000 miles per year average, it would take eight years for one aftermarket oil pan gasket manufacturer to pay off the original tooling cost, with zero net profit — only if that manufacturer got 100 percent of the replacement business! For the one or two manufacturers that make the part for the car manufacturer, the volume of the original car production could pay for part, or all, of the tooling cost. For an aftermarket supplier, the tooling cost compared to volume would be prohibitive. If you were an aftermarket gasket manufacturer would you tool and manufacture an oil pan gasket that you would make zero profit on for eight years?

The decision to produce some parts is a no-brainer. A water outlet (thermostat) gasket made from paper, where the tooling cost could be as low as $250, makes manufacturing that gasket an easy decision. Using the Swedish car example, if the gasket operating profit was 2 cents, it would take fewer than 13,000 gasket sales to pay off the tooling. Plus, water outlet gaskets are replaced much more often and at lower mileage than the oil pan gasket in the first example. Now, what if OE-designed technology steps in and requires that water outlet gasket to be molded rubber or silicone? The tooling cost would jump to $5,000. Five thousand dollars divided by 2 cents means you would need to sell 250,000 gaskets just to break even. New decision, eh?

What about manufacturing fewer SKUs? Why would any firm decide to stop manufacturing something for which they already own the tooling? There are many possible reasons, but using the oil pan gasket as the example, here are the two most likely scenarios:
Let’s say that last year, Mega Distributor X added a pack of five silicone water outlet gaskets to every store. With 3,000 stores, plus DC inventory, this was a 17,000-piece sale. Now, a year later the gaskets have not sold and Mega Distributor X returns 15,000 of them to the manufacturer, leaving the manufacturer with what is probably a two- or three-year inventory. How about you, would you manufacture any more of those?

Parts popularity naturally declines over time. At the same time, the original tooling wears out, needing replacement. Typically, as part demand dies, the WD, jobber and retailer inventory in the field is returned to the manufacturer. As in the example above, this leaves the manufacturer with a huge inventory to warehouse and/or write off. There’s no need to replace the worn-out tooling because there’s a big inventory on-hand. Of course, some installer will eventually call the parts store for a gasket to fit a 1977 Thunderbird and the parts store will expect the distributor’s ‘full line’ manufacturer to not only catalog one, but to have replaced the worn-out tooling to still make the part. How about you, would you replace that worn-out tooling?

As we can see by these examples, deciding to manufacture an SKU for the aftermarket is not simply a matter of having a customer say they want it. As with all businesses, the dollars and cents count and when they are not considered, a lot of work and effort at the company may result in nothing more than a net loss.

There are considerations as to when a parts supplier should offer an SKU. This leads us into the next question.
• Should the product lines offered by manufacturers become more limited as low- or no-profit SKUs are trimmed from manufacturing and manufacturer inventories?

This question actually seems in direct conflict with the insistence by Wall Street analysts who say that the future of the major retail chains rests with their ability to service the wholesale business. As retailers drive to capture more commercial business, and the WD/jobber channel reacts to protect it, the manufacturers supplying both are driven to offer more coverage of late-model vehicles, regardless of whether or not enough sales demand for that part yet exists to make it profitable to manufacture.

So, considering the retailer/distributor drive for more coverage from the manufacturers, should the decision be made to trim low- or no-profit SKUs from the manufacturers’ lines? And if so, how? From the earlier examples of manufacturing unprofitable SKUs, the answer is yes — or the independent aftermarket may truly find it difficult to compete on a price level with the OE dealer.

Fortunately, today’s technology and industry cooperation are making it more possible to determine what should and shouldn’t be offered. Point of Sale (POS) data collected by The NPD Group, as part of the Automotive Aftermarket Industry Association’s Category Management Initiative, is gathering actual sales by SKUs, by region, on many aftermarket products, from wiper blades to engine gaskets. Based on this data, a store or distributor wouldn’t need to put a given SKU in every store just to see if it sells, and then return to the manufacturer what didn’t sell a year later. If the NPD/POS data for an area says that part is not selling, there may not be the need for a distributor or retailer to demand that a manufacturer add that part to its line. In fact, the suppliers that already offer that part can use the POS data to determine when to discontinue an SKU to reduce inventory investment costs or eliminate the need for replacement tooling as the original tooling wears out. There is certainly other data to help in the product-line offering decisions that can be merged into other databases. The bottom line is that today, there is little excuse for a distributor, retailer or manufacturer to make, buy or stock an SKU based on the ‘hope’ that sales demand will materialize.

Developing efficient product line management models
Considering that the manufacturing and inventory of slow- or no-movement parts drive up the cost for the entire aftermarket, we must realize that to stay competitive with the OEM, the independent aftermarket must find ways to eliminate duplication of manufacturing and inventory efforts.

Again technological changes — if used — are providing the foundation for new business practices. Electronic cataloging systems, for example, will continue to evolve, allowing a retail chain, WD or jobber to select different suppliers by SKU. It’s no longer necessary for a manufacturer to offer a part for every vehicle. If supplier A cannot profitably supply an SKU, a store’s electronic catalog can simply show the SKU from a supplier or manufacturer that can. By recognizing the potential of new e-catalog and procurement systems, distributors, retailers and manufacturers can reduce industry costs by working together. This requires some changes. For example:
• Distributors, program groups and retailers could stop demanding that their suppliers provide complete coverage. When a buyer makes the decision to stock (or not stock) a product line because of coverage depth, that decision promotes — even forces — his supplier to add unprofitable product to the line for fear of losing business. Once the unprofitable slower-moving SKU is added, the cost or lost profit must come from somewhere or the supplier goes out of business. Eventually, the losses or costs are reflected in a cut of some other service, and/or a higher price on the fast-selling SKUs.

• The manufacturer could drop unprofitable SKUs from the product line. Although the positive effect of this will be immediate elimination of unprofitable SKUs, the negative impact would be the reduction of sales volume on the line’s total sales. Although those lost-sales dollars do not produce net profit, they may have helped pay for some fixed overhead, such as distribution centers or sales forces. Just like down-sizing a factory when unprofitable items are eliminated, fixed distribution or sales expenses can be reduced as well if their purpose is to support or promote the sales volume of unprofitable SKUs. While such “SKU rationalization” and product-line downsizing could be a short-term hit on sales, it might very well result in long-term productivity gains and increases in net profitability for the entire industry. This will help keep the independent aftermarket competitive with OE dealer parts departments and improve profitability of the independent aftermarket suppliers and distributors.

• Distributors or program groups that use specific vendors to supply specific SKUs to create a complete product offering could result in innovative and successful aftermarket product programs.
For example, a parts store chain or distributor could develop its own offering of rotating electrical for import nameplates, sourced by SKU from the original equipment manufacturers. Denso, for example, could be used as the source for SKUs where Denso supplies OE, Bosch on those SKUs where it supplies OE, Mitsubishi where it supplies OE, etc. Such a program would eliminate the need for a manufacturer to tool, produce or buy at less than profitable margins and at the same time provide the products needed by the distributor and parts store with an OE fit, form and function. One very prominent and successful WD member of a large program group has done this for several years. This WD sources individual part numbers, by application, from OEM suppliers like Bosch, Delphi, etc. to offer a product line to his installers with original-equipment fit, form and function.

The Impact on Program Group Compliance
As program groups developed over the years, market influence increased because a majority of the groups’ members agreed to source from the same suppliers. By having all or most of the group members select the same vendor manufacturers to supply a product line, the group increased its importance to that supplier while also increasing the impact the group could have on the market through such things as national advertising, promotional or even warranty programs of the same brand among all the members. The most common term for getting program group members to agree to purchase from the same supplier is ‘product line compliance.’ Buying though the group (in other words, being compliant) benefits the distributor in many ways. Compliance also significantly impacts how/which suppliers are selected by the group.

The ability to source products by SKU could be at odds with program group compliance and raises several questions. For instance:
• Does a distributor and parts store stick with one single supplier to remain product-line compliant with the group, even though that single supplier is less competitive and less profitable because it has been forced to supply the complete line?

• Does the program group approve multiple suppliers of a product line, thereby enabling WDs and parts stores to select and designate specific brands in the e-catalog by SKU?

If such selection by SKU is done by program group members, how does that affect the ability of the program group to influence suppliers through its ‘product line compliance’ policy?

As individual program-group WDs have evolved their businesses to take advantage of global aftermarket technology, the shape and policies of some program distribution groups have been altered. Just as the individual distributors, parts stores and chains must observe competition and adapt to best practices, so must the program groups to maximize aftermarket productivity gains and remain competitive with the OEM dealer.

Next month, I will address other questions, and offer some additional perspective as the industry seeks its own answers, increasingly outside US borders.

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