Hunting Together for Success: A Remanufacturing Paradigm Shift Leads to New Partnerships and M&A’s
Remanufacturing – the process of restoring used products (cores) to like-new condition – occurs across a wide range of industrial sectors and is now a $43 billion in the U.S., but it was first broadly adopted in the U.S. automotive industry in its earliest days.
For most of its history, the automotive remanufacturing space operated as a largely unacknowledged, and unofficial parallel process among Original Equipment Manufacturers (OEMs) and independent remanufacturers. As the OEMs worked to design and build new and better vehicles, independent remanufacturers and distributors developed the capabilities to work with the OEM cores. This effort resulted in long-lasting relationships with second-and-third tier vehicle owners who brought their used, out-of-warranty vehicles to independent remanufacturers to keep them on the road with remanufactured parts estimated to be up to 40 percent less costly to consumers than new ones. This made remanufacturing a recession-proof industry. For example, according to the U.S. International Trade Commission, during the economic crisis of 2009 – 2011, remanufacturing posted 15 percent revenue growth, and 8 percent job growth even as auto sales hit a 30-year low, and the industry employed half as many people in 2009 as it did in 2000.
Today, however, that de facto understanding between OEMs and independents is beginning to fray. The technology that goes into cars and trucks (sophisticated electronic systems, designed by OEMs with proprietary and well-guarded intellectual property) has changed the nature of the vehicles we drive. It also has made reverse engineering them problematic (if not impossible) for the independents, of which there are approximately 2,000 – 3,000 in the U.S. This means the independent remanufacturer’s basic business model is being challenged by technological innovation and is at risk.
At the same time, automotive OEM’s see enormous growth opportunities in the estimated annual $240 billion automotive aftermarket parts market (forecast to grow at almost 4 percent CAGR through 2017), and remanufacturing is a fundamental component of this growth strategy. Tier 1 OEM's are moving aggressively into the remanufacturing space. As they do, independent remanufacturers are being squeezed. They have the OEMs on the one hand, and the gray market and counterfeiters (especially in emerging economies) on the other. Indeed, a Department of Commerce report estimated that auto suppliers lost as much as $45 billion worldwide in 2011 to counterfeiting, $3 billion in the U.S.)
However, as OEMs attempt to move into the remanufacturing space, leveraging their new proprietary technologies, and their brand power, to capture a greater part of the aftermarket and generate needed new revenues and growth, they confront significant barriers.
OEMs and Independents: “How Can We Hunt Together?”
To date, there is little evidence that OEMs can successfully capture those second- and third-tier vehicle owners, design products to be remanufactured easily, or develop the returns forecasting models that make for efficient remanufacturing processes. Moreover, for fear of diluting their brand’s value with customers who might wonder why one OEM would be providing another OEM’s parts, OEMs have long resisted the all-makes-and-models remanufacturing standard that is part of what has made the independent remanufacturing business model so successful.
Both OEMs and independents are confronting challenges and opportunities. The OEM’s challenge is to take advantage of the remanufacturing opportunity, reaching out to out-of-warranty vehicle owners who have long avoided dealerships and gone instead to independent suppliers for parts, and independent garages for repairs. Meanwhile, independents must learn to survive in this new environment.
If the OEMs eliminate the independents, the gray market will take over the aftermarket, providing no benefit to the OEMs, or to consumers who then would have no reliable guarantors of quality. And if the independents cannot work with the OEMs to access their new technologies, they will be consigned to a future product portfolio of lower-margin, lower-growth cores, such as brakes and shocks.
The solution for both OEMs and independents pursuing growth is clear. As the president of an automotive OEM remanufacturer recently put it, the question to ask is: “How can we hunt together?”
OEMs and independents must acknowledge their interdependencies, and use their combined capabilities to address customer needs faster, more efficiently, and more effectively. To do so, OEMs and independents need to join in partnerships, joint ventures, or mergers, as both have what the other needs to thrive. OEMs, however, must identify the right remanufacturing partners. That means performing due diligence that goes beyond the classic examination of financials to include the target remanufacturer’s:
- Brand reputation
- Distribution channels’ depth and breadth, product range, and customer base
- Margins and cost structures
- Reverse logistics capabilities and core management team
- Ability to work with new technologies that help companies track products, product defects, schedule work, and respond to customers
In the remanufacturing world, this work has begun.
Capturing Revenue Growth in Remanufacturing: A Case Study
Recently, a major automotive OEM was confronted with declining market share due to some planned product line exits. The OEM’s leadership wished to explore remanufacturing revenue enhancement opportunities.
The OEM put together a team that created a Growth Study [see Figure 1] and articulated its strategic goals: Access lost market share; reach new markets through partnerships; acquire companies to broaden sales, and deploy an all-makes-and-models strategy.
Figure 1. The Revenue Growth Strategy
As we see in Figure 1, the OEMs could increase revenue growth in four different ways: with current customers and current products; current customers and new products; new customers (and channels) and current products; and new customers, channels, and products.
The balance between risk, cost, and complexity varies among these options but, of course, so do the rewards. For the most risk-averse companies, the choice in the upper left quartile – current customers and products – is most attractive. New customers, new channels, and new products (in the lower right quartile) always pose the highest risk and involve the highest cost (with the greatest rewards). The best choice for entrepreneurial companies is a strategic plan that embraces all options to deliver the largest benefits while mitigating risks.
Our OEM decided to explore either a partnership, a joint venture or the acquisition of an independent remanufacturer in pursuit of its growth strategy.
The OEM identified 69 companies from an industry database of remanufacturers. It examined these firms via a two-step process to analyze both potential fit, and the alignment of strategic priorities for both companies.
The first step was a commercial analysis to evaluate the target company using such criteria as expected market share, estimated EBITDA, and incremental sales potential. For example, if the OEM’s objective were fast revenue growth, an acquisition would provide growth immediately, whereas a distribution partnership would grow revenue incrementally over time. Keeping the company’s goals for revenue and EBITDA in mind would help it prioritize its targets.
The second step was a strategic analysis that included quality, human capital, and market risk. For example, a very competitive landscape can make it harder to create extra sales. If the landscape is less competitive, a partnership combining the OEM’s engineering talent with an independent’s well-established outside sales force can help both companies become much stronger in a given market.
These two steps reduced the initially-identified 69 companies to 16. The next stage for the OEM was to connect with the 16 companies to review the mutual benefits the companies could achieve.
As it turned out, some of those 16 were disinclined to partner, and others already were partnered with other OEMs.
The OEM identified an interested independent that had strong relationships with local and regional distributors serving second and third tier truck owners (new customers for the OEM) in the aftermarket (that is, after these potential clients’ vehicles’ original OEM warranty had expired). This satisfied some of the OEM’s strategic criteria and offered the possibility of recapturing lost market share in that segment. The OEM and the independent initiated a pilot project to monitor execution and the benefits of partnership. The pilot helped the OEM test its ability to collaborate successfully with the independent in the primary product, market, and distribution segments, with clearly-defined targets integrated into the business plan for increased revenue and the achievement of EBITDA goals.
Although it is too soon to analyze the fruits of the pilot, the OEM now has a broader and more informed foundation for pursuing partnerships (and acquisitions) that could enable it to gain ground in all four quartiles of growth opportunity identified in Figure 1.
The Barriers for OEMs
After years focusing on selling new products, a general understanding of remanufacturing, the aftermarket, and what addressing it entails, is lacking among OEMs. Often, OEMs attempting to enter the aftermarket confront push-back from their dealers who believe that a partnership between their parent and an independent remanufacturer would erode their market share and revenues.
In reality, those dealers do not have the market they fear losing. Second and third tier vehicle owners, for example, do not go to dealerships for replacement or remanufactured parts. They go to convenient local independent distributors with whom in many cases they have had long and positive relationships.
OEMs frequently are also concerned about diluting their brand by getting into the all-makes-and-models program required to support the broad array of remanufactured products that will attract customers.
Again, in reality, the all-makes strategy already has moved from an exclusively independent aftermarket offering into the mainstream of original equipment (OE) remanufacturers, and quite successfully. For example, according to Transport Topics, Navistar’s Fleetrite brand, encompassing brands from Ford to Mercedes, grew from $10 million to $150 million over the last six years. Moreover, Tier 1 component manufacturers have learned to reverse engineer other OEM products, and can now remanufacture products they did not design or develop to the same quality specifications, and in the same factories, in which they make their own.
Tier 1 OEMs that have ventured into the all-makes-and-models sphere, have increased market share without damaging their brand value.
The Barriers for Independents
Today, with the increasing electronic sophistication of almost all vehicles, customers need technical support as much, if not more, than parts. To provide that support, independents require access to proprietary technologies and information, and access to special tooling, not to mention training in both. Without that access, independents may be doomed to a low-tech, low-margin future. This looming reality should trump the independents’ fear of losing their identity by being swallowed up by large OEMs. If they wait too long to find an OEM partner, independents may find that their competitors have already made their peace with them, leaving the laggards on the outside, looking in.
That’s a dangerous place to be. The lower-technology remanufactured products those independents may be left with are under extreme price pressure. This product category increasingly is being led by the gray market and, for some product families, by foreign OEMs offering low-cost new units, further collapsing the independents’ margins and eating away their market share.
A Classic Case of Disruption
While technology has created challenges and disruption within the remanufacturing industry, technology also has brought opportunities, and real growth potential. By leveraging their combined strengths, market access, and capabilities, OEMs and independents will fully realize the potential that the automotive market offers. With new automobile and light truck sales just now returning to what they were 12 years ago, both OEMs and independent remanufacturers seeking growth need to adjust their business models accordingly. That means joining forces, each contributing their particular strengths and expertise, to collaboratively address business challenges strategically and holistically.
There is valuable – but dispersed – knowledge in the supply chain, relating to distribution and product characteristics, that needs to be captured and integrated into remanufacturing processes and go-to-market strategies to assure continued success and growth for both OEMs and independent remanufacturers. The recipe for achieving this success is a well-defined partnership between an OEM and an independent. However, those alliances must begin with a comprehensive, well defined due diligence process that looks to optimize the strengths of the prospective partners while minimizing the risk of a poor strategic or cultural fit.
There is no argument that there are significant opportunities in remanufacturing for companies, investors, and, most importantly, for society – and not just in the automotive sector. Recycling, reuse, and remanufacture, according to a 2014 Ellen MacArthur Foundation report, “Towards a Circular Economy,” could generate more than $1 trillion for the global economy by 2025, and create 100,000 new jobs in the next five years. At the same time, remanufacturing can help preserve a global environment and biosphere increasingly suffering from the depredations of the old linear manufacturing model, characterized by high energy usage, waste, and pollution.
In the automotive sector, reaping the benefits of remanufacturing will take time, effort, and a reordering of mindsets. But it will be well worth it. A carefully crafted merger or acquisition, partnership or joint operating agreement, with the strategic intent clearly defined for both parties, can provide stronger solutions, more quickly, to the remanufacturing industry. That will generate enhanced revenue and profits for all stakeholders, and provide value throughout the supply chain.