I speak at a fair number of events across the world. It is one of the more enjoyable parts of my job. I speak about the intersection of finance and strategy and how that influences consolidation in the automotive aftermarket. Because both finance and strategy are so future focused, I’m often asked my views of what the future holds for the industry. Will there be more consolidation in the automotive aftermarket?
There are a few major themes that are impacting the entire automotive aftermarket: technology, consolidation, monetary policy. Most trends I observe have their roots in one of these three themes. Back in January I wrote about how I saw these themes impacting the North American collision repair segment. But these themes have a similar impact on paint distribution, parts distribution, manufacturing (both paint and parts), and also equipment manufacturers and distributors on a worldwide basis.
Note: I’ll be travelling again the last two weeks in September. I’ll be in Atlanta with AkzoNobel the third week in September and in Vancouver, Canada at CCIF the last week in September. Let me know if you’re in the area – it would be great to see you face to face.
A brief history of consolidation in the automotive aftermarket
Industries naturally consolidate over time. I’ve spoken about this at length in many of my presentations, and written about it considerably in my weekly notes. Consolidation in the automotive aftermarket is everywhere. In the collision industry in North America, and more specifically the U.S. there has been a strong wave of consolidation since 2012, with the largest collision operators growing aggressively through acquisitions. A renewed round of consolidation is taking place in paint distribution, with companies like FinishMaster and NCS recently making high profile acquisitions. LKQ continues to aggressively consolidate the part distribution business, acquiring both used and aftermarket parts distributors in North America and Europe, while also expanding into new sectors such as glass and mechanical parts. Fenix Auto Parts recently went public with the stated goal to also consolidate the used parts business. There has even been consolidation at the highest levels in the coatings business, with Sherwin Williams acquiring Valspar in an $11.3 billion all cash deal announced earlier this year.
Why is consolidation such an attractive business model?
Fragmented industries tend to be economically inefficient industries. Fragmentation leads to multiple layers of overhead that increases the overall cost structure of an industry. Consolidators seek to eliminate these costs through economies of scale.
Compare LKQ to a smaller regional aftermarket parts distributor, for example. LKQ can leverage its substantial purchasing power to procure parts for significantly less than a smaller regional distributor can. Part of this is due simply to LKQs purchasing power – LKQ can simply leverage its massive purchasing power in a way a smaller competitor cannot. But it is not simply purchasing power. Because LKQ has an already established distribution network, there is little additional cost in delivering incremental products to existing customers. The trucks are already in force, the warehouses already stocked, the sales force already in place.
Game Theory in Practice
I recently had a conversation with a business owner lamenting the challenges he was facing. While he has never been concerned about out-performing his competitors, he is finding it increasingly difficult to out-compete them on a dollar-to-dollar basis. His service, speed, and quality are all superior to even his largest competitors. The challenge he now faces is that his largest competitors are able to out-compete him on a price basis. Due to their purchasing power and economies of scale, he realized that his largest competitors are able to charge less than he can yet operate at higher margins than he ever will be able to given his current business structure. It is not that his current structure is inefficient. In fact, his business is one of the more efficiently operated in his industry. But as he lamented, “I can’t buy fenders by the train load”.
As industry consolidators grow in size, an often erroneous assumption is that industry consolidators are growing with the goal to create monopolistic pricing power, or to raise prices at will. In fact, the opposite is almost always true – monopolistic pricing power is nearly impossible to achieve. Consolidators are growing instead with the goal to lower prices, relying on their more efficient cost structure to continue to generate profits while others may find it difficult to do so. The strategic theory behind this is that if a business has the ability to influence industry prices downward, they can force competitors to make a choice – lose profit or lose market share (or both). Either way, the business with the more economically efficient structure (i.e. economies of scale) benefits the most (or is harmed the least).
What does this mean for your business?
In consolidating environments, pricing pressure will continue to increase. It is an economic maxim – over time price equals marginal cost, and marginal cost tends to decrease over time. In consolidating industries expect continued pricing pressures as economically efficient organizations leverage their economies of scale and use price as a strategic tool.
To compete in a consolidating environment, scale is important. In a fragmented industry there is opportunity to continue to develop scale, especially in pockets where larger consolidators have not yet directed resources. However, to develop scale requires planning, financial resources, and time. If you have a longer timeline, there is great opportunity across the entire automotive aftermarket to grow and develop scale. But, if on the other hand you have a shorter time line (5 years or less), are not inclined to re-invest the time, energy and financial resources to grow, or simply feel the risk outweighs the potential reward, now is still a great time to sell your business. There are a number of buyers and investors actively seeking attractive opportunities in the industry. But today’s environment is unique – one that will not last forever (for many more reasons than I have room to elaborate on in this week’s note).
If you are curious about growth, or want to discuss if now is the right time for an exit, use my contact page to reach me (subscribers simply hit REPLY). I’m actively helping a number of clients on both sides – both growth and exit strategies have unique pro’s and con’s to consider. All communication is kept confidential. I truly enjoy speaking with owners in an industry I am passionate about.
Until next week!