Tuesday, July 29, 2014

Early Indications July 2014: Betting the Business

I read with great interest the recent Fortune article on the new Ford F-150 pickup. This is the best-selling vehicle in the U.S. (but sold in few other markets), and contributes mightily to the company’s profitability: it’s straightforward to manufacture, long production runs drive purchasing economies and assembly line efficiency, and option packages contribute to healthy — 40% — gross margins. In short, the light truck franchise at Ford is the one essential business that management has to get right: small cars aren’t that popular or profitable, large SUVs are out of fashion, overall car demand is flat for demographic and other reasons, and financing isn’t the profit center it once was given low interest rates.

A new model of the truck comes out this fall. Ford is reinventing the pickup, by making it mostly out of aluminum rather than steel. The weight savings (700 lb was the target) will help the automaker reach government-mandated fuel economy targets, but there are significant risks all across the landscape:

*Body shops need new, specialized equipment to address aluminum body damage. Ford had to create a nationwide network of authorized service centers, especially given how many trucks are sold in rural areas to miners, ranchers, and farmers. If owners have trouble getting repairs done, negative publicity will travel extra fast over social media.

*The aluminum supply as of 2010 was not sufficient to the need: 350,000 half-ton pickups in 2012 would be an awful lot of beer cans. Ford has to invent a whole new supply base and watch how one big buyer will move the entire commodity market. (I’ve heard this is why Subway doesn’t offer roasted red pepper strips: they’d need too many.)

*Manufacturing processes are being revised: aluminum can’t be welded the way steel can, so bonding and riveting require new engineering, new skills, new materials, and new assembly sequences.

In short, this is a really big gamble. Ford is messing with the formula that has generated decades of segment leadership, corporate profitability, and brand loyalty. Competitors are circling: Chevy would love to have Silverado win the category sales crown this year, especially given GM’s horrific year of bad publicity, and Chrysler’s Ram division was renamed solely because of their pickups’ brand equity.

It’s rare that a company takes a position of market leadership and invests in a significantly different platform, risking competitive position, profitability, and customer loyalty. Between us, my former boss John Parkinson and I could only come up with a handful: these kind of moments seem to happen only about once a decade (unless readers remind me of examples I missed).

Six US business decisions got our attention:

1) Boeing bet on passenger jet airplanes in the 1950s, launching the 707 in 1958. It was not the first such aircraft: the British De Havilland Comet won that honor, but had major safety issues related to leaks developing because of metal fatigue around window openings. Jets delivered greater power for their size, had fewer moving parts, and burned cheaper fuel. Planes could carry more passengers, fly farther and faster, and required fewer maintenance visits.

2) IBM completely departed from industry practice by announcing the System/360 in 1964. It was a family of highly compatible mainframes, allowing customers to grow up in capability without having to learn a new operating system or rebuild applications: previously, customers could buy a small computer that might soon box them in, or overspend on something too big for their needs in the hope of growing into it. Fred Brooks, who managed software development, learned from System/360 about the paradoxes of programming and later wrote the classic Mythical Man-Month, with its still-true insight: adding programmers to a late software project will make it later. Brooks’ team delivered, and S/360 helped IBM dominate the computer market for the next 15 years.

3) Few people remember that Intel has not always been synonymous with microprocessors. Until the early 1980s, the company’s focus was on memory devices. Simultaneously undercut in price by Japanese competition and alert to the rapid growth of the PC segment, Intel CEO Andrew Grove switched over to the far more technically demanding microprocessor market in 1983, followed by the famous “Intel Inside” branding campaign in 1991: it was unheard-of for a B2B supplier to build a consumer brand position. Intel stock in this period enjoyed an enviable run-up, but the success was not preordained.

4) It wasn’t a completely “bet-the-company” decision, but Walter Wriston at CitiBank wagered heavily on automatic teller machines in the 1980s, which not only cost a significant amount to develop and install, but also prompted criticism of a lack of a personal touch in client service. The decision of course paid off handsomely and revolutionized the finance industry.

5) It wasn’t a bet-the-company decision, as its failure makes clear, but Coke guessed wildly wrong on the flavor of “New Coke” in 1985 yet was able to recover.

6) Verizon made a significant investment in its residential fiber-optic buildout, but the rapid growth in the wireless business eventually eclipsed wireline in general, reducing both the risk and the impact of the original decision in 2005.

What am I missing? In what other situations have CEOs taken a flagship market offering and significantly revamped it, endangering market share, brand equity, and profitability to the extent Ford has, when the entire company’s future rides heavily on this product launch?