Note: This is the sixth article in my Ford series. Those interested can find the previous five articles here: 1) When Will People Understand Ford's Debt?, 2) The Ford Story Continues In Europe, 3) Ford: Opportunities Exist In South America, Asia And Africa, 4) Ford Credit Is An Important Part Of Ford, and 5) Digging Deeper Into Ford Credit.
While driving cars is fairly easy, building one is pretty difficult. That's why many new entrants to the market don't survive for long. A car has so many moving parts that so many things can go wrong during production. Ford (NYSE:F) is one of the few companies in the world that's moving toward mastering the art of building a car. In the last few years, the global and national market shares didn't change much though. In the car industry, not only is it difficult to build a car, but it is also difficult to gain market share from competitors. As time goes on, cars of the established companies look more and more like each other and the consumers don't switch cars very often.
About 100 years ago, Henry Ford's company released the Model T in large numbers so the average middle class could afford one of these. The Model T was in production from 1908 all the way to 1927. During this time, not many changes were made to the model. While GM (NYSE:GM) was releasing different models of cars, Ford continued to make only one kind of car because Henry Ford believed that everything an American family would need in a car was already present in the Model T and there was no need to change anything. As a result, Ford lost market share to its competition. Today, the market looks a lot different. There are several established car companies, mainly from three countries. The US has Ford, GM and Chrysler. Germany has BMW, Volkswagen and Daimler (also known as the Mercedes). Japan has Toyota (NYSE:TM), Honda (NYSE:HMC) and Nissan. Alternatively, car companies from South Korea and Italy are trading to make a name for themselves. Furthermore, there are Chinese and Indian car companies that address their local populations with ultra-cheap cars.
In this market is it very difficult to gain market share for particular reasons. I will list some of these reasons below.
1) People don't switch cars very often: After housing, cars are the most expensive item in most of our lives. When we buy cars, we tend to do as much research as we can and we try not to buy cars very frequently. Americans are holding on to their cars for 71.4 months on average. This corresponds to 5.95 years. In comparison, Americans replace their cell phones every 21 months.
2) People buy used cars: Not only do people hold on to their cars for a longer period of time, but many of them also tend to replace their cars with used cars. In the US, the average age of cars in traffic is 10.8 years, which means that an average car goes through at least 2 users through its lifespan. In comparison, it is very rare for people to buy user cell phones in countries like the US.
3) People are loyal to their brands: Not only do people buy new cars rarely, but they continue to stick with the same brands over time. The car industry enjoys one of the highest brand loyalties in the world, which is good and bad for them at the same time. It's good because they get to keep customers; it's bad because they have trouble stealing market share from competitors.
4) Differentiation is Difficult: As cars keep improving each year across the board, it is becoming increasingly difficult for car companies to differentiate their product from the competitors. Whenever a car company adds something innovative to its products, the competitors follow it soon after.
Differentiation is very crucial to stealing market share in the auto industry. So how can a car company differentiate its products from the competitors? There are a few ways they can do this:
1) Better gas mileage: Each year, car companies are able to increase their average gas mileage as the technology improves. The car company with the better mileage in a given year enjoys advantages over the competition. In the US, Corporate Average Fuel Economy (CAFE) looks at the sales-weighted average gas mileage of each car company's products in a given year. Usually, car companies will build smaller cars in order to bring their average down even though those cars may not see high demand in the US. Apart from the regulations, having better gas mileage is a good way for car companies to differentiate themselves from the competition and gain market share. When cars have better gas mileage, people may be willing to pay more to own these cars because they will be able to save money in the long run. Ford offers multiple types of fuel-efficient vehicles. These categories are: EcoBoost, Hybrid, Plug-in Hybrid and All Electric. Each classification has vehicles that are comparable to or better than a competitor's cars in terms of fuel economy.
2) Better Connectivity: We live in a world of ecosystems where everything is connected together. Those who own an iPhone, iPad and iMac can take advantage of one of the most user-friendly and popular ecosystems in the world. Of course, when it comes to connectivity, cars are no exception. Ford utilizes Microsoft's (NASDAQ:MSFT) Sync technology in its cars which allows the user to interact with the car using voice commands. In the future, cars will have a war of ecosystems just like smartphones, tablets and computers do. The car company with the better ecosystem can differentiate itself from the competition.
3) Good Looks: Back in the old days, good-looks were reserved for trendy sports cars. For family sedans, vans and SUVs, it was more about utility and less about good looks. In the last half decade or so, this has come to change. Now cars are getting prettier and trendier every year regardless of their specification. A car company can easily differentiate itself from the competition by designing good-looking cars. I believe that part of the reason German cars became so popular over the years was because of their attractive designs. While they were behind for years, American cars (especially Ford) have been catching up lately.
4) Availability: When car companies see supply-chain constraints, they may not be able to move cars to the dealers fast enough. If a company can't produce enough cars, it will not sell a lot of cars no matter how much demand there is.
5) Pricing: People have a tendency to buy the best products that they can afford. Here, the key word is "afford" because we can't buy things we can't afford (except when banks give away free money like they did from early 2000s to 2007). The car company that can offer the best quality cars for the cheapest price will be eating the cake. Also, keep in mind that the currency fluctuations can play a big role in car prices as European automakers will depend on the weakness of the Euro and the Japanese automakers will depend on the weakness of the Yen. US carmakers are in a different position as they produce and sell cars in the same region and they rarely move cars from one market to another.
6) Perception: Many times, perception is everything. It is very difficult to change public perception of certain things, especially if those perceptions were formed over a long period of time. Up until the 1980s, Japanese products were known to be low-quality (similar to how Chinese products are seen today). Since the 1990s, Japanese products enjoy a perception of great quality. I am not talking about whether the Japanese cars have improved in quality since then (and yes they did) but I am talking about the perception of people, which changed in the same direction. Sometimes perception moves in the same direction as reality, other times it doesn't. It is very important for car companies to manage the public perception in order to differentiate themselves from the competition. In 2008, when GM and Chrysler were acquired by the government, many people dumped their GM and Chrysler vehicles in order to switch to Ford and this has (along with the improving products across the board) helped the company's perception greatly at a time when its perception was on the decline.
7) Overall Quality: At the end of the day, this is where it all comes down to. A car's overall quality (along with its perceived quality) will determine its market share in the long run. Everything else will become secondary. Why? I will explain in the next section.
Why Quality Matters?
I argue that overall quality of cars will be the biggest differentiator as we move forward. When we consider that people don't buy new cars very often and that people are very loyal to carmakers, we have a better understanding of why the market share of car companies don't fluctuate much over the years. When it comes to things like affordability, availability, attractiveness and gas mileage, car companies have very similar scores. Overall quality matters because the consequences of low-quality cars can be pretty serious even though implications may not be very frequent.
Let's take a look at a concrete example. Between 1999 and 2007, Asian carmakers gained a lot of market share in the US as American carmakers lost much of this market share. During this time the Japanese carmakers like Toyota, Honda and Nissan were improving their quality rapidly while American carmakers were trailing behind.
In 2009, as Ford was improving the quality of its vehicles, something big happened. In November, there were reports claiming that some Toyota models saw unintended acceleration which was related to a problem in the accelerator pedals. The problem was serious and had deadly consequences. As a result, Toyota recalled nearly 7 million vehicles. Seizing this opportunity, Ford was able to steal a lot of market share from Toyota. The company's market share plunged from 17.0% to 12.6% within two years whereas Ford's market share increased from 15.3% to 16.5%. Of course, the earthquake in Japan and the strength of the Yen might have also contributed to these results but the recalls definitely played a big role. In the same year, Ford also had to recall a large number of cars.
Every time a company recalls one of its cars, it's causing a huge inconvenience for consumers. The consumers have to bring their cars to a nearby dealer, rent another car until their car is fixed and pick-up their old car when the task is finished, which may take weeks at times. Every time a car company has a major recall, it will lose market share to competitors because many people will not tolerate that and a significant number of people will actually lose trust in the brand.
Moving forward, there are multiple ways Ford can maintain and improve upon its market share. Many of the things done by the company under the leadership of Alan Mulally have been helping the company's market share. However, the biggest contributor has been and will be the improving quality of Ford vehicles. In the last, many people joked that Ford is an acronym for "Found On the Road Dead" or "Fix Or Repair Daily" even though we don't hear those jokes anymore. As long as Ford keeps up with the quality of its vehicles, every time a competitor stumbles, Ford will be there to pick up more market share. Every time Toyota, GM, Chrysler or Honda recalls a car, more people will turn towards Ford (as long as Ford continues to improve its overall quality). While recalls are only part of the story, they are important. The less frequently someone has to take their car to mechanic, the more likely they are to stay loyal to their car brand. At this point, Ford's goal is twofold: 1) maximize the loyalty of its current customers, 2) steal as many disloyal customers from other companies as possible.
Of course, my heavy reliance on overall quality of the cars might be an oversimplification. Consumers are very complex and a lot of things go into a buying decision. Not all consumers value the same things and not all consumers base their buying decision on the same things either. There are several things most consumers value and the car companies should benefit greatly from watching these things (which I list above). Back in 2006, when Alan Mulally was explaining his plan to save Ford, one of his strongest points was that Ford was going to build cars people actually want to own. So far, the company has been doing a good job of accomplishing this task.
As I mentioned before, the road will be somewhat slow and bumpy though. In the developed world, the market share of car companies moved very little year-over-year. I wouldn't be surprised if the market share of most car companies stayed flat for the next couple years, but this is not all that bad. Sooner or later the balance gets broken and those with the better product are rewarded. Of course, there will be larger fluctuations and more market share gains in developing countries. In countries like China, all Ford needs to do is to ramp up the production and the number of dealers in the country in order to increase its market share considerably.
I believe in Ford and its leadership. The company's current leadership has accomplished a lot and there is more to come. Unlike my last article, I wanted this to be a fun read rather than an article full of financial jargon, tables and figures. My next article in the Ford series will talk about how Ford uses technology to its advantage. Since I cover a lot of technology stocks, this should be a fun read also. Please share your questions and thoughts (or any area you'd like me to cover in my future articles) in the comments section.
Disclosure: I am long F, MSFT, OTCPK:VLKAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.