The growing segmentation of the top tire market
As many of you know, I have been looking hard at the China tire industry for the last few months. That research has led me to an interesting conclusion, which could affect the strategic direction of some of the top tire makers. I think that the tire industry is steadily moving toward a commodity-speciality split. This is most apparent in passenger car segment, but also applies to truck and bus.
Traditionally the tire industry has divided the market into three or even more segments. Tire makers have brands to meet these different segments. These are usually characterised as Good-Better-Best, or Budget-Value-Premium. I think the middle segment is getting increasingly squeezed as the budget brands develop improved quality and performance, while the premium brands increasingly generate their profit from products where few budget brands can compete.
This model has two key consequences. First will be an impact on the sales of mid-range brands. Second will be that the premium brands will focus more on profitability and margin and less on volume and gross market share. As I said, the China market is my model for this. But the strategies adopted by the Premium tire makers in China were originally developed as a defence mechanism against low-cost imports in their home markets. I think that the business model we see today in China may well become the norm in the developed markets.
Development of tire market structure
If we look back to the 1990s in the European and US markets, the car tire market was established and slow-moving with little innovation in either technology or marketing. We had the Good-Better-Best market structure mentioned above. Gradually, during the process of seeking low-cost manufacturing and new markets the premium manufacturers acquired most of the mid-range brands, so that the Premium tire makers developed new skills in managing their brand portfolios.
As the new tire makers, first from Korea and more recently from China started entering the developed tire markets, the premium brands used the mid-range brands as a buffer against the new import brands. When import volumes were small, the mid-range brands could keep the budget brands at bay.
But volumes increased and some tire makers – notably Hankook — spent large amounts of money to raise their technology and build the brands to the point where they could easily compete against the mid-range brands and even took share from the premium brands.
As import volumes increased still further, the premium manufacturers discovered a new strategy: called price-mix.
They analysed the sell-out price of each product line and sought to focus on the product lines which brought the best prices. On the manufacturing side, this drove demand for highly flexible manufacturing machinery; low volume production runs and more sophisticated inventory management. With this new manufacturing capability and the improved product planning permitted by computers and SAP-type systems, they could work out the cost per unit of each product and so identify the most profitable products. Few tire makers in the developing world had either the manufacturing flexibility, or the internal information to identify such products. However over the last decade or so this gap has also been filled.
Attractive tire market in China
The critical difference today, is that the developing tire makers still do not have access to the marketing information which might enable them to identify which will be the most profitable products in the coming year or two. In China, none of the major international companies has a total market share more than 5%. This compares with a global market share of 20% or more. However, in terms of profitability, each of the top international tire makers sees China as by far the most attractive market. Local domestic tire makers, by contrast, see China as impossibly competitive and they operate on suicidally slim margins. The difference between the Chinese and the International companies is that the international companies mostly have OE approvals on the premium vehicles made by manufacturers such as Mercedes, Audi, BMW or GM. These vehicles often use rim diameters of 16 inches and more.
The difference in profitability of a 15-inch tire compared to an 18-inch tire is even greater in China than in Europe.
Volumes, of course, are much lower, but if we are interested in shareholder return and business risk, then it is clear that making a few highly profitable tires is much more attractive than making many low-margin products. Especially when volatile upstream raw materials pricing introduces significant business risks on low-margin products.
Rapid quality development in Chinese tires
Chinese tires are getting better. Certainly among the top 10 tire makers in China, quality and technology are improving by leaps and bounds. Marketing is also improving. But if the International companies stay ahead on the marketing front, then they stand a good chance of maintaining their high margins. And as the marketing people continue to identify the highest profit items, I believe that premium tire makers will seek not to increase their overall volume and overall market share, but instead to identify the opportunities in the top-end products while leaving the commodity end to the factories in Vietnam, China and elsewhere who make low-end products designed to be sold purely on price.
Tire IndustryResearch has recently analysed the market situation in China and published an in-depth market research report. You can find it here.