Friday, February 8, 2008

For Chrysler, Consolidation Makes Sense

Chrysler says it plans to cut the number of models it makes by half. It also plans to shrink its dealer network somewhat. These moves make a lot of sense.

What Chrysler is doing is consolidating. Consolidation is a way of reducing the amount of work that needs to be done by taking away some of the zones of responsibility.

When you hear about consolidation you might think of one company buying another, but that is just one scenario that can lead to consolidation. A company I was working for a few years ago did a different kind of consolidation when they replaced their telephone and computer networks with a single digital network. This saved them work in the long run by giving them just one network of wires to maintain, instead of two. While they were at it, they replaced six fax machines with just one.

Consolidating the fax machines made a lot of sense because faxing is not as important as it used to be. This company kept six fax machines busy back when fax was the primary way to send documents from one place to another. Now that they can send or receive any document by e-mail, fax is used only for unusual special cases, and their one remaining fax machine is silent most of the time.

Decline and consolidation naturally go together. When something becomes less important, you almost automatically look for ways to simplify it by having fewer things to deal with. Let’s say you go from eating breakfast cereal every day to eating it about once a week — that’s a kind of decline. It only makes sense to go from having four different kinds of cereal on the shelf to having just one. That’s consolidation. In this scenario, you don’t want to have to work so hard on breakfast cereal anymore because it is no longer such a prominent part of your life.

It is a principle of economics that you will see consolidation in declining industries. There are so many fewer companies in computer manufacturing and banking than there were a few years ago because these are declining industries. It is not that these industries are declining in importance, but technological advances have dramatically reduced the total amount of work that needs to be done to keep track of the money and make computers for everyone. Where there is less work to be done, there is less money to be made, hence the need to cut costs by consolidating.

The automobile industry, in a similar way, is no less important than it was in the past, but it is also declining because of technology. Cars last longer so there isn’t the need to make quite so many of them. But the side of the industry that Chrysler finds itself in — heavy cars that burn liquid fuel — may decline rapidly over the coming decade. Chrysler was bought out by private investors a year ago and plans to be around for a long time to come. It has to reduce its investment in its current product line so it can start making the new-generation cars that buyers will shortly come to expect.

The first step in that direction is the one Chrysler just announced. Many of the models they offer are so similar to each other that the average customer needs help telling them apart. This creates confusion among buyers and extra work for the sales staff, and that is reason enough to cut back. But it also creates extra costs along the entire process of selling cars, from engineering to advertising. These are costs that Chrysler and its dealers can save by making only models that are clearly distinct from each other.

The cuts in the dealer network are another kind of consolidation Chrysler wants to try. As U.S. consumer demand for cars declines, it would probably be impossible for Chrysler to prop up as many dealers as it has now.

Going forward, Chrysler and the other large auto makers have to be able to compete with the new car companies that make just one, two, or three models of cars. They need to cut their own costs so they are in line with those of their competitors. Chrysler is moving so quickly in part because it is now a privately held company. Unlike a public company, they cannot afford to stand their ground and lose money for years while hoping things get better. If they fail to make a profit, it is their own money they are losing. Chrysler had already started cutting costs and streamlining its operations when it was owned by Daimler but, to borrow a line from a movie, this time it’s personal.