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An Industry Black Hole


7/1/2003
By Brian Cruickshank

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Where inventory is and isnt: That's a central question facing everyone in the aftermarket, not just program groups. A recent study pegs forecasting, pricing, performance measurements, brand differentiation and operational efficiencies as lifelines the industry can use to pull itself out the excess inventory black hole.

Imagine this scenario: A customer calls to find a slow-moving "C" part. Knowing you dont have it, you tell the customer that youll have to look around for it. The customer agrees and tells you to send it over as soon as youve got your hands on it.

The customer, not wanting to tie up a bay, calls three other stores looking for the same part, all of which order it from their respective warehouses. This raises a flag in these WD inventory systems, triggering re-orders from the manufacturer. And up the chain it goes.

You eventually win the battle for the sale, but from an inventory standpoint, the industry continues to lose the war.

What started out as a demand for a single slow mover has turned into skewed and inaccurate demand for multiple parts. This information, recorded as a lost sale, is sent up the chain to the manufacturer, which in turn gears up to crank out more slow movers even though they arent really needed in the field. Historical sales data is thus rendered incorrect, causing future manufacturing and stocking forecasts to be off.

This scene, along with thousands of variations of it, is played out every day across the aftermarket, creating an inventory glut that adds to the channels glaring inefficiencies.

The inventory black hole
The problem does not stop at excess inventory. It extends to margin compression, commoditization and slack-channel operations that cost the aftermarket billions of dollars annually.

Its like an invisible black hole deep in outer space: You may not be able to see the inventory problem, but even from a distance, you can feel and measure its effect, often on store, WD and manufacturer balance sheets. And, like a black hole, mismanaged inventories and their related inaccurate pricing, brand sameness and forecasting models threaten to pull everyone down into a singularity of red ink.

Simply, there is too much inventory in the channel. No one really knows where inventory is, how much is out there and, as a consequence, how much needs to be manufactured, stocked or, worse, how to price it accurately. The data used to forecast manufacturing is generally incorrect or, at best, an educated guess. Re-boxes, changeovers and inventory shuffling only feed the black hole, making it hungrier, larger and more damaging.

"Inventory is both a blessing and a curse," said ArvinMeritors Dan Daniel. "If you dont have it, you cant sell it. The curse is that there is too much inventory in the channel and because of it, cash is drying up." Daniel, along with associations, retailers, distributors and other manufacturers, served on an inventory management study committee facilitated by MEMA.

THE STUDY
How the aftermarket manages its inventory is one of the most complex issues it faces. But before the industry can fix it, it must understand it. Individual manufacturers see their inventory levels as appropriate, yet the industry as a whole views the total inventory situation as excessive. Therein lies the problem, laying the rationale for studying and assessing the problem and ultimately fixing it.

To address this, several industry associations, including the Motor & Equipment Manufacturers Association (MEMA), the Automotive Aftermarket Industry Association (AAIA), the Automotive Warehouse Distributors Association (AWDA) and the Specialty Equipment Market Association (SEMA) commissioned Northwood University to study the problem.

Northwoods participation was a natural choice; since the 1960s, the Midland, MI-based university has had strong ties to the aftermarket. Northwoods own Automotive Aftermarket Management Program and University of the Aftermarket offer university-level and continuing education courses to future and current leaders within the industry. In fact, Northwood is the only university that offers an automotive aftermarket management curriculum one leads to a two-year associates degree and the other awards a four-year bachelors degree.

Last year, Northwoods Richard DeVos Graduate School of Management embarked on a study that many hope will shed light on the black hole of excess inventory. Very recently, the resulting study, the Automotive Aftermarket Inventory Management Study, was unveiled. Editors note: Because of Countermans participation in the study, the magazine was granted an exclusive opportunity to be the first publication to examine the study and report on it for this article.

The Results
Industries are like living, breathing things; they have natural lifecycles some are young (like computers), others are old (like the automotive aftermarket). Where each industry is in its own lifecycle often pre-determines the challenges it faces. Mature industries like the automotive aftermarket inevitably lead to waves of consolidation, such as what weve witnessed over the past several years. From there, say academics, the focus turns to increasing operational efficiencies. This is where we find ourselves today.

One of the key facets to gaining these operational efficiencies in the aftermarket concerns excess inventory. Overcoming it is a critical challenge the industry faces as it goes through its own natural lifecycle.

The Northwood study warns against a practice all too common in todays aftermarket: the shifting of costs to other levels of the supply channel. In the aftermarkets case, the costs of returns, for example, is forced backwards up the channel to the manufacturer. This, says the study, is a short-term fix at best. The best solution to gaining operational efficiencies involves everyone in the channel not by benefiting one level at the expense of another.

As a fragmented industry, these solutions are often difficult to find, but the payoffs are obvious, and the study reveals that those companies with the highest performance operate more collaboratively with both customers and vendors than those that do not.

However, shoring up operational efficiencies is only one piece of the puzzle, and is something that can lead to its own brand of problems. The study notes that operational efficiencies gained by manufacturers often lead to pricing concessions to distributors and ultimately to competitive convergence as price becomes the only differentiating element among brands or companies. Sound familiar?

According to the study, competition based on operational effectiveness alone is mutually destructive. Eventually the market becomes mired in a war of attrition that no one can win.

BRAND DIFFERENTIATION
The study says that the key to overcoming this war of attrition is differentiation. The study sums it up this way, "Improved operational effectiveness is required and will lead to short-term competitive advantages. Ultimately, only those firms that can achieve operational effectiveness and differentiate themselves from their competitors will survive and achieve satisfactory performance." In other words, success is a combined equation of two factors: branding and efficiency.

The path to this is not so much one of correct physical placements of parts, although that is the ultimate goal. The study stresses that it is more about the quality of the information companies use to make manufacturing and stocking decisions. Dana Corp.s Jerry McCabe astutely said at last years Aftermarket E-Forum in Chicago, "Its all about the data." McCabes simply stated observation casts light on a dark problem in the industry, one that McCabe himself estimates is directly responsible for 85 percent of the markets problems.

Participants in a store manager panel discussion at the recent E-Cat Conference in New Orleans estimated that 10 percent of all cataloging data is incorrect. The financial ramifications of which are immense but also consider that this is just a small part of the total bad data problem.

"The issueisnt the physical handling of parts, its the information we have available to us and how sophisticated we are in the gathering and use of that information," said Northwoods Dr. Bill Busby, who was the studys lead researcher. "That is where the gains are to be made."

The study notes three areas that are particularly ripe for improvement in the data gathering/sharing process. They are:

  • Demand forecasting;
  • Performance measurements;
  • Installer and/or counterperson knowledge.

Demand Forecasting
Demand forecasting is the first area of the data-gathering process critical to gaining better control of the industrys total inventory.

Often, demand forecasts are merely educated guesses using historical-demand data or, as in the example cited at the beginning of this article, real or imagined demand information from the field.

Unfortunately, Northwood found that demand forecasting at most aftermarket companies remains rather unsophisticated, even though the study reveals that one of the most significant differentiators between successful and unsuccessful companies is the accuracy of forecasts.

Performance Measurements
The study noted that performance measurements need improvement, such as Economic Value Added (EVA) and Return On Invested Capital (ROIC). As the study suggests, indicators such as profit, return on assets and gross margin return on inventory are adequate only if they approximate discounted cash flow measurements (such as EVA or ROIC). The study concludes that all too often emphasis is placed on the wrong performance measurements.

Additionally, the study says that there is a general lack of SKU performance tracking. The study rhetorically asks how a company can manage the operating trade-offs favorably if they dont know the net-profit impact of their decisions.

To quote the study: "Operating decisions areimplemented at the SKU level. A firm that can link those decisions to performance through the appropriate measurements has a significantly greater likelihood for improving operating effectiveness."

Installer & Counterperson Knowledge
The third area of the data-gathering process that begs for improvement is within the critical installer/counterperson relationship.

This is the meeting point that impacts the industry in significant ways, one of which is in the costly category of returns. Considering that nearly 25 percent of parts are returned, with half being a direct result of either technician and/or counterperson error, the knowledge at both the shop and the store must be improved.

The study, which included interviews and surveys of both installers and counter professionals, reveals a universal lack (or perceived lack) of knowledge at both the counter and shop levels. There is a lot of finger pointing going on across both sides of the counter: Installers complain about the lack of knowledge at the counter, and those at the counter complain about installer error in the parts ordering process. The key to resolving this issue, says the study, is for a fortified education effort directed at these professionals.

Pricing & Product Levels
The studys findings regarding pricing are perhaps among the most important and point out the painful wounds the market continues to inflict upon itself.

Of the three significant variables in price determination competition, cost/margin/profit and value to the customer the study found that the market ignores value to the customer. This means that those parts that are of greater value to the customer (slow-moving parts, for example) may very well be priced at the same level as those of less value (easy-to-find "A" numbers, for example). The study points out that the industry tends to average carrying costs across all SKUs. In essence, the market subsidizes slow movers with fast ones.

The study suggests that since the market chooses not to recognize the value of a service to the customer, margin compression is all but guaranteed. This is further complicated by the industrys poor ability or willingness to differentiate one brand or company from another. In fact, the study calls the industrys level of differentiation "abysmal." Differentiation and commoditization, says the study, are what separate the successful and growing companies from those that suffer margin compression.

IMPLEMENTATION
In the end, studies like this are only as good as the results they are able to direct and the industrys willingness to implement the recommendations. This study suggests six main points for action. They are:

  • Improved Performance Measurements Companies should move to improve measures of performance, especially at the SKU level.
  • Improved Data Analysis Data and analytical capabilities should be improved, including point-of-sale-based forecasting and regression forecasting models.
  • Improved Pricing Strategies Improved pricing strategies should be adopted that consider the full cost and value to the customer, rather than focusing on just matching or beating the competition.
  • Product Differentiation Strategic differentiation is just as essential as operational efficiencies.
  • Education Industry associations should lead in the development of educational programs that will improve the industrys ability to accurately measure performance, forecast, price and brand differentiation.
  • Collaboration Associations should act as a focal point of trans-industry collaboration in areas such as data sharing, compiling supply data and coordinating information-technology efforts.

According to Paul Foley, MEMAs vice president of aftermarket services/membership development, Northwood and the sponsoring associations have agreed to assume responsibilities for some of these tasks, particularly those that pertain to communication and education. However, as Foley points out, the real value of the study will be in how the industry uses the study to the benefit of everyone.

"Industry collaboration is essential," said Foley. "[The industry] cant do this in a vacuum; everyone needs to work together."

Editors Note: Counterman would like to acknowledge Dr. Timothy Nash, Dr. William Busby, Dr. Lisa Fairbairn and Kathleen Gadwau as co-authors of the study. One copy is free to all members of MEMA, AWDA, AAIA and SEMA. Additional copies for nonmembers are $300. Contact Paul Parks (919-549-4800) at MEMA for more information. n















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