On the Use of Generic Auto Parts and MQVP’s Suits Against LKQ Corp. and Keystone

By now you probably saw the press release issued Friday by MQVP, Inc. (Manufacturers’ Qualification and Validation Program), that the U.S. court of appeals is not reconsidering its ruling against LKQ Corp.’s (LKQX) mid-state. The release said:

MQVP Inc. maintains that Mid-State misrepresented its non-program parts as being the same as parts covered by the quality validation, traceability, safety and warranty characteristics of MQVP® program parts. Arkansas-based Mid-State was never admitted to the MQVP® program. Mid- State was later acquired by LKQ Corporation, whose participating subsidiary was expelled from the MQVP® program in October. In ruling for MQVP Inc. on appeal, the Court of Appeals points out that “[the] Lanham Trademark Act affords the trademark holder the right to control the quality of the goods manufactured and sold under its trademark . . . so MQVP® may control the services sold under its service mark.

In English (from what their attorneys tell me), it means Mid-State was claiming to have MQVP parts without being certified by MQVP. First of all, for those of you that do not read my piece daily, a quick review of a few key terms. When I say “new oem,” I am referring to new vehicle original equipment manufacturers’ parts, like a Ford Motor Company (F) made bumper. When I say alternative parts, I am discussing generic (usually called aftermarket) parts as well as salvage/recycled parts (so if a car got into an accident and ended up “scrapped” in the junk yard, they took the bumper off and re-sold it).

Now most of you have heard me say that the lawsuits by the folks at MQVP and Ford are not in the best interest of the automakers. I have held this opinion because forcing repair shops to use the more costly “new oem” parts could hurt the residual value of the vehicle and cause more vehicles to be declared total losses.

Right off the bat, I need to be clear about something: I have not found many body shops eager to use alternative (particularly generic) parts. So it is a bit misleading for me to say “force repair shops to use more costly new oem parts.” But there is a price advantage of alternative parts anywhere from 30% to 50%. Only body shops price from cost. So they are not really sensitive to pricing and more determine their parts procurement (who and where they get their parts from) on availability, deliverability, and reliability (quality).

The customer has also usually been immune to pricing, because it is the insurance company that has to pay for the repair (although they pay for it in the end with their insurance premiums). So I have argued this dynamic led to a rather high cost proposition to repair the vehicle (because of excessive parts prices). But now insurance companies that see the lower cost potential are encouraging the repair shops to use more alternative parts. And this is what I have been a big fan of. Up until the last five or ten years, insurance companies (who do care about price) had little control over where parts were procured from and what type of parts were used.

As a result, you ended up with the majority of these parts being “new oem” parts (around 70% of all collision work). I therefore have felt the insurance companies’ DRP programs are now allowing them to become the voice of the consumer (as they control mass volumes of business) and lower the overall cost of the repair. And this is why I have been such a proponent of the shift from new oem parts to alternative parts. Having said that, Ronald Loshin, the CEO of BLC Associates (consultants to the leasing industry) had this to say about my opinion:

I enjoy reading your newsletter and appreciate its content. My experience as a consultant to the leasing industry is that your statement below is in error. While it is true that some generic parts are functionally and in appearance as good as OEM parts, there are a large number of incidences as reported by my lessor clients and the auction companies where such generic equipment is not of equal quality and can effect the safety, reliability, performance and/or appearance of the vehicle. Perhaps you'd like to rethink this one and your blanket statement below. What is true is that non- OEM replacement parts that are of equal quality and made to equal (or better) standards represent good value and have a place in the market. The problem is absent some rating agency, a buyer can't tell how good a non-OEM replacement part is.

I think Mr. Loshin makes an incredibly valid criticism of my blanket view that generic parts are inherently better than “new OEM.” Generic parts are only beneficial to the customer if the quality is good, or of “like kind quality” (where LKQ’s name is derived), and the price is cheaper. If the part is of lesser quality, and the repair shop needs to go back and fix the vehicle again, or send the part back, well that has just created a bigger inefficiency to the system.

And this is one of the reasons why I have been so encouraged with national players like LKQ and Keystone (KEYS) coming on the scene. I have felt that better capitalized players could invest and implement better systems and processes to improve and guarantee the quality of the alternative parts they distribute. On the salvage (recycled) parts side of the business, customers have given pretty positive feedback to me about LKQ’s ability to fill the order (in stock rates), and provide pretty high quality parts.

On the generic parts side of the business, however I have heard somewhat less sanguine (cheerful) responses from body shop managers: “I just plan on the generic part not being the right one or fitting, and having to go back and forth with the distributor.” I was once told by a body shop manager. And this type of response and attitude is probably why Keystone needs to have local distribution points, whereas LKQ, which has primarily been on the salvage side of the business (until recently), could cover a hundred miles or so with a single facility.

But admitting there is a problem often creates the opportunity, and this is what I saw with Keystone and LKQ. As I mentioned above, I generally get positive feedback about LKQ’s commitment to quality. So I felt their entry into the market would allow them to help raise the bar for quality on the generic side of the business. And Keystone has under gone a management transition, with CEO Rick Kiester seeming to bring an emphasis on quality and better systems and processes. Also Keystone recently hired Jeff Grey as their CFO, who came over from Advance Auto Parts (AAP), where I felt he would add the idea of “category management” to the company’s merchandising approach (something the folks at Advance are very skilled at).

However, I spent about an hour or so on the phone with the lead and Associate Attorney’s from MQVP Thursday (Ron McNulty and Erik Lindquist, respectively). Unfortunately the management teams seem to be unable to speak on the topic (I understand why they would not want to address anything that is being played out in the courts). So obviously right now I am only getting MQVP’s side of the story. But given my general view already that the advantage of these more sophisticated players coming into the market was that they are going to raise the quality level, I have to admit, I am a bit confused why there is so much controversy. At the end of the day, I think some certification program is needed. But I’m getting ahead of myself.

Let me explain very briefly what MQVP is. They were basically an offshoot of Nationwide Insurance Company. MQVP, which stands for Manufacturers’ Qualification and Validation Program. I won’t regurgitate their website overview too much, but basically they approve the part, monitor it, and as they aptly put it trace it “from cradle to grave” through the MQVP Certification system. Right now, they certify 10 manufacturers’ parts that are used by Grange, Integrity, and Shelter insurance companies and distributors like Across America Collision Parts, Richmond Bumper, and 800 Radiator.

Like I said, they came out of Nationwide, but it appears the insurance provider moved in a different direction with their qualification and validation process. So Nationwide leaves, MQVP loses a lot of business, and files for Chapter 11 bankruptcy protection. And this apparently left less of a reason for LKQ and Keystone to be in the program. Because they no longer needed to be MQVP certified to distribute to Nationwide DRP shops.

Well, one other reason. From the way the Arkansas suit was explained to me, basically the court ruled in 2003, that Mid-State could claim it had MQVP parts, just like LKQ could claim it has “like kind quality” (LKQ) parts. But on October 19, 2006, the 8th Circuit Court of Appeals over ruled the lower courts decision and said, no, if you claim you are selling “MQVP” parts, they have to be certified by MQVP. And so this is also why I think you see some of these lawsuits emerging, because the earlier court ruling basically seemed to allow the use of the MQVP name without certification. Now you’ve got a bankrupt company that is trying to recoup monies for its debtors, and they are likely to pursue these obligations (since they allege the parts were being misrepresented as MQVP) pretty vigorously.

Perhaps MQVP will emerge from bankruptcy, and new partnerships with insurance companies will encourage some sort of settlement. Neither side would likely want to battle it out in court if MQVP signs with a major insurance company, because MQVP would want to sell to certify the parts being distributed by LKQ and Keystone to that carrier, and LKQ and Keystone would want to be MQVP certified in order to sell to the insurance companies DRP repair shops. But until that becomes clear, this problem is not likely just going to “go away.”

Now I can not comment on the validity of the claim, because I don’t have a clue if LKQ and Keystone actually did lead their customers to believe they were using MQVP parts. And I actually don’t have that much of a problem with LKQ and Keystone leaving MQVP, although like I said, there clearly can be some legal ramifications. In my opinion, what matters is that the aftermarket (generic parts) industry move in some direction toward certification and/or standardization verification.

This may mean MQVP. The folks at MQVP argue that they do the best job because of their “cradle to grave” tracking approach. But they are not the only ones. Check out the CAPA (Certified Automotive Parts Association) website. Or maybe some program is developed that NADA (National Auto Dealers), ASA (Automotive Service Association), NACE (National Association of Collision Experts) coordinate, or maybe even something the automakers themselves pursue. It actually seems to make the most sense to me that it be done by some non-profit organization that is sponsored by all of the insurance companies and automakers. But the bottom line, is that if generic parts and alternative parts are going to continue to gain share, which I think is in the best long term interest of the consumer, shareholders, and ultimately LKQ and Keystone shareholder’s there needs to be some reliable validation process of the part.

I think Mr. Loshin summarized it best when he said: “The problem is absent some rating agency, a buyer can't tell how good a non-OEM replacement part is.”

As a final sidebar, I should also point out that for those of you that follow Genuine Parts (GPC), AutoZone (AZO), Advance Auto Parts (AAP), O’Reilly (ORLY) and CSK Auto (CAO), pay close attention to everything that is happening on the collision side of the generic parts market. As you know, most of the management teams on those conference calls have been discussing initiatives to increase their “direct imports” (i.e. more parts from places like China and Taiwan).

So the problems about quality you see being raised in the collision (jobber) market, may similarly appear in the more general automotive aftermarket (do-it- yourself stores and folks that distribute parts to repair shops that we call jobbers), over the next 5 – 10 years if these retailers/jobbers don’t put in some controls themselves to ensure quality. And I don’t mean the company specifically, but once again, some industry association or certification group.