The Auto Industry From A Supplier's Perspective

Sharon Rudy, Vice-President, Spencer Stuart and Director, The Empire Club of Canada; Laurel Berkowitz, Grade 11 Student, North Toronto Collegiate Institute; The Reverend Dr. John S. Niles, Rector, Victoria Park United Church and Director, The Empire Club of Canada; Julie K. Hannaford, Partner, Borden Ladner Gervais LLP and Past President, The Empire Club of Canada; Tony Comper, Chairman and CEO, BMO Financial Group; Malcolm J. MacKillop, Partner, Borden Ladner Gervais LLP and Director, The Empire Club of Canada; Istvan Emri, Consul General, Hungary, Hungarian Consulate General, Toronto; William Harrison, President and CEO, Lift Technologies and Board Director, Linamar Corporation; and Randall Scott Echlin, Partner and National Labour and Employment Chair, Borden Ladner Gervais LLP.

Introduction by John Koopman

The great American poet and philosopher, Henry David Thoreau, once said that "things do not change, but we do." The essence of the motor car and internal combustion engine really has not changed

February 27, 2003

much in 100 years but the way our environmentalists and economists think about cars has changed dramatically.

In contemporary Canada the environmentalists tell us the automobile is the bane of the modern world and economists tell us it is at the core of the modern economy. Paradoxically in 1911 it was the environmentalists that supported the growth of the motor car and it was the economists who were skeptical about the motor car's impact.

In July 1911 a scorching searing heat wave hit New York City. In that sultry summer as New York's women glowed and the city's men perspired, its horses sweat. And in that single city, in that single month of July 1911, 1,200 horses stopped sweating and dropped dead of heat exposure on the streets of New York. The equine remains were not always removed with alacrity.

In that steaming summer of 1911, the environmental authorities of the day hailed the motor car as the clean modern-age solution to the urban problem of rancid rotting horse carcasses and the stench of disease breeding and fly-infested manure piles created by the horses that continued to sweat. With the advent of the motor car, the environmentalists said no more would our cities be plagued with insects, and our homes scarred with kilometres of sticky flypaper, insect traps and foul-smelling bug sprays.

Our friends in the dismal science were worried. The horse was an important part of the national economy. Each of the 25,000,000 horses in America at the turn of the century required 20 man-days of caring, grooming and feeding. The Chicago Tribune feared that a raft of professions from harness makers, to saddle-makers, buggy whip manufacturers, carriage builders, livery-stable operators, blacksmiths, wheelwrights, hitching post manufacturers, and an army of street cleaners would all face imminent doom.

The environmentalists won. Horses have been banished to racing tracks and hobby farms. And we all drive motor cars, the environmentally cleanest form of transportation of any significance that mankind has yet invented.

Ironically in 1911, while the motor car was still battling the horse for primacy, there were 250 domestic motor-car companies in North America. Today the motor car dominates our economy but there are only three domestic manufacturers left and these three survive only at the very tail end of a complex web of hundreds of automobile parts, components and systems suppliers.

One of those suppliers is Linamar. Like so many of Canada's great organizations, an immigrant to this country founded Linamar. Thirty-seven years ago a Hungarian immigrant named Frank Hasenfratz started the company in his garage. Linamar has since grown to over $1.2 billion in sales and there is over $60 of Linamar content in every North American vehicle. It is apparently the only company in the world that produces every machined part used in a motor vehicle.

In 1990 Linda Hasenfratz joined the company as a machine operator. This machine operator subsequently held positions in quality assurance, engineering, production materials management and finally in the ultimate self-sacrifice, as manager of an accounting department. Perhaps this leader-as-servant thing has gone a bit too far. She also has a BSc and an MBA from Western. In 1999 she assumed the company's presidency, by then probably to her own regret, one of the best-trained executives in Canada.

Ladies and gentlemen, please join me in welcoming Ms. Linda Hasenfratz, the President and CEO of this great Canadian success story to the podium of The Empire Club of Canada.

Linda Hasenfratz

Good afternoon everyone and thank you John for your kind introduction.

It is certainly a pleasure for me to be here this afternoon to talk a little about the auto industry from a supplier's perspective.

I must say I thoroughly enjoyed hearing Dieter Zetsche speak here a month ago. It is inspiring to see the passion he and his team have instilled in Daimler's Chrysler division in person. I felt it was representative of a feeling gaining momentum in the auto industry just in the last two months--a feeling of passion and excitement rediscovered for this industry. It was inspiring to hear Mr. Zetsche talk about building vehicles that "stir the soul." He also talked about the powerful emotional connection people have for motor vehicles--something I believe is absolutely true. It is true of emotions of chic innovativeness around a BMW Mini to the pure adrenalin of stepping on the gas and feeling the response of a 5.71405 hp V8 engine in a Corvette.

Not long ago, I heard almost the same words uttered by one of Mr. Zetsche's competitors, GM's Bob Lutz. He and his boss Rick Wagoner have been making speeches

all over Detroit about the North American automotive industry being on the verge of a "Golden Age." Lutz stated "the demand and attraction still exist. If the passion part of the equation has stagnated a bit--well, that's going to change." The guys in Detroit talking about passion and emotion? What's going on?

And then we have the auto shows--both here in Toronto right now and in Detroit a month ago. No fewer than 60 new products launched for North America--and some of the most exciting, interesting, passion-inspiring cars and trucks seen in many a year. In fact, we have never seen such an enormous display of attractive products. What is happening in the North American auto industry?

Well I think what is happening is a clear recognition that passion in product leads to prosperity. Having exciting products people want to drive means people are willing to pay a little more. It means you don't need to throw $3,000 at a car to sell it--something the Japanese and Germans are very aware of and something Detroit is waking up to. Lower incentives means more profitability for the automobile manufacturers, which in turn means less pressure on the suppliers to give back (and that's definitely a good thing).

I saw a study recently that showed the difference in dollars profit/vehicle for the Big Three and the so-called New American Manufacturers. In 2001, the Big-Three-profit per vehicle ranged from a low of a $2,000 loss/vehicle at Ford to a high of a $337 profit at GM. By the end of the first half of 2002, GM's profit had improved to $881/vehicle, and DCX was in the black as well.

In sharp contrast, the "new" Americans made between $1,200 and $1,700/vehicle in 2001 and more in 2002. So what is driving that $3,000/vehicle difference? The Japanese are seeing an advantage of lower sales incentives of approximately $1,500/vehicle or more; better labour productivity of $750/vehicle, lower retiree costs of $200/vehicle and less capital investment of $750/vehicle. The Big Three are closing the gap on the labour side with major improvements in the hours utilized to build a vehicle at GM and DCX over the last five years and in quality performance of all three. Eventually time will take care of the retiree costs and new ideas are taking root around more flexible capital equipment strategies to address those variances.

The big difference remains the incentives. To understand the incentives you need to understand the position of GM with respect to its cost structure. In a downturn when most people look to decrease their work force to come in line with lower production levels, GM finds itself unable to do so. Labour contracts in place mean laid-off workers still earn 95 per cent of their net working wage. The net effect is that while labour is normally a variable cost, in GM's case it is almost a fixed cost.

Cutting back on production means massive losses, resulting in an absolute necessity to maintain top-line revenues. The losses of slowing production far outweigh the cost of throwing another $1,000 of incentives at the vehicles to keep sales levels up; so the decision of what to do is clear regardless of the fact that both alternatives result in lower profits per vehicle. Production and sales levels must be maintained.

The question of course is how to keep and grow the top line in a more sustainable way, which of course brings us back to focusing on creating products people want regardless of whether they get an incentive or not. That way production levels are sustained and profitability vastly enhanced.

Product and process innovation are also the key to prosperity for the supply base. This fact is something Linamar has become increasingly aware of over the past two years. To thrive in this competitive marketplace we must bring something unique to the table to differentiate

us from our competitors. Something unique either in terms of our product design; or the way in which we produce it.

In the particular segment of the market in which we focus, that is precision-machined components and assemblies of such, huge growth opportunity exists as little of this work is currently outsourced to the supply base. In fact, only about 15-20 per cent of this work is actually done by the supply base. Linamar is currently manufacturing in one or another of our 32 global plants every machined component in the vehicle. This means we have the ultimate flexibility to grow in any direction the market turns.

What this means is we can be selective in terms of where to focus our product development dollars as we continue to compete on our overall technical strength, efficiency and broad range of capability in a growing market segment.

Product and process development are two absolutely critical elements in our strategic plan. They are elements our groups report progress on on a quarterly basis through a technical roadmap. The technical roadmap identifies for our core components what process innovations are being developed, whether they be improvements on an existing process or paradigm shift in how to produce a component. For example, process development done in the past 18 months on one operation of a transmission component being manufactured in several plants has resulted in capital costs being cut by 50 per cent from former levels and consumable tooling costs by 80 per cent for that operation.

We are also investigating unique technology completely unlike traditional methods by which a particular engine component can be manufactured for 20 to 30-per-cent lower cost than the technically comparable part. These types of projects mean we can offer our customers better costs and superior technologies to help them differentiate their products.

Product development is also tracked on our technical roadmap, whether it be by changing the metallurgy of a component or by combining multiple components into a single part. We have been quite successful in the latter. In one example we designed a casting utilizing a different type of casting process, which took the place of three separate components, saving our customer millions of dollars each year.

At Linamar we are trying to be innovative in the ways we run our business as well as our products and manufacturing processes. Three years ago, in an effort to ensure we are keeping existing programs at the leading edge of processing effectiveness, we instigated our successful CAT or Cost Attack Team, process. CAT was born out of a discussion in which my senior team, myself and the founder of our company, my father Frank Hasenfratz, were reflecting on how the combination of all our knowledge could benefit our plants in improving costs. We took the idea and developed a very detailed process by which a team of experts could review and brainstorm inputs for every cost driver imaginable in a program from purchasing to logistics to machine programming and tooling.

The results have been fantastic, with typically 8 to 10-per-cent cost improvements identified in every review. The program has been a great success, not just in reducing costs but also as a learning experience for everyone involved.

Similarly successful has been our innovative Technical Review Board (TRB) process. I was concerned by situations in which enthusiastic young engineers requesting major capital expenditures approval were demotivated when they discovered, after much work done researching and pricing equipment that the process they were proposing was perhaps not the best option.

My team and I came up with the idea of doing a tech review with expert technical advisors from various Linamar plants familiar with the products being processed at the outset of a program's planning. We brainstorm the very best way to process the part, discuss optimal types of equipment and analyze the resultant project Internal Rate of Return. Once fully optimized, the team is authorized to research and purchase equipment in accordance with the plan and budget set. The process gives maximum accountability and authority to our plant teams while ensuring our company-wide pool of technical knowledge kicks the program off with the very best plan we can. It also guarantees that targeted Return on Investment goals are met on a project-by-project basis.

Another area we have created an innovative system in is in our goal setting and performance-measurement systems.

An issue that came to light shortly after my arrival at the corporate office was the need for a common measurement and goal system, which everyone could understand and strive for.

We were having our regular weekly management meeting and began discussing the performance of various plants. Our CFO at the time, George Sims, noted an employee had commented to him recently that he could certainly match the quality performance of a particular plant, but it would be to the detriment of his financial performance. We all thought this fellow was crazy as the plant he cited not only was one of our best performers in quality but also financially. It made us realize he made the statement because he did not know that this plant should be a benchmark in many areas. We decided we needed a system which would provide our plants not just with goals to strive towards but a picture of who was the best in key performance areas.

Our corporate philosophy of balancing customer, employee and financial satisfaction symbolized by a three-legged Stepping Stool seemed a natural place to start. We took this philosophy of balancing customer, employee and financial satisfaction and endeavoured to identify measurables, which we felt defined satisfaction for each of those stakeholders. We assigned ranges of performance for each, colour coded green for acceptable, yellow for fair and red for unacceptable. A scoring system was applied yielding a potential score of 15 points for each leg.

Each month, every plant worldwide reports on their performance, yielding a report card that at a glance identifies areas of concern, both by stakeholders and by indicators. Scores are compiled and reports generated showing how all plants rank against each other both by leg of our stool and on overall score. The ranking has created a great sense of competition among the plants as they strive to be number one (and not number 32!). As my COO, Jim Jarrell puts it: "If you're red, you're dead." Twice a year, we create an animated film depicting the competition as a truck race. The employees love it.

We also hold a Stepping Stool banquet once per year where we award top-performing plants. The Stepping Stool has become an essential part of our culture that emotionally ties people to strive for performance in the areas in which we wish to excel. We have a link between creating an emotion, driving performance and ultimately prosperity. Every employee receives a bonus for meeting Stepping Stool goals!

The key to all of this innovation leading to success is execution. We have done a CAT on every program in Linamar and are starting round two. TRBs are mandated for every new product; I won't spend $1 on new capital unless it is done. Product and process innovation are two elements in a six-point strategy plan. I report on our progress on all six elements quarterly to our Board. Strategic initiatives such as acquisitions are grouped around the six elements--if it doesn't fit, we should not

be pursuing it. Customer, employee and investor presentations all detail the six elements and how our actions relate to such.

We have identified the six core values Linamar believes are the success factors in running our business; and the six core ideas or initiatives we need to make a reality to be a success (I guess six is our lucky number). Every employee's annual performance review and resultant increase is based on how well they exemplify our core values and their efforts to make our core initiatives a reality.

Our business plan is also centred on the core initiatives. Succession planning too is based on the values and ideas; if you don't exemplify the core values and show commitment to the core ideas you will not be promoted at Linamar.

Basically we have set a plan about what we want to achieve and how we can achieve it and deploy that in every element of running our business. We have worked hard to establish clear expectations and strategies, which we are now carefully assessing adherence to and consistently deploying across the company. I feel in 2003 we are now at the point of starting to see the fruits of our work in both top and bottom-line growth.

I am thrilled to hear Lutz and Wagoner talk about the impending "Golden Age" of the automotive industry because at Linamar we are truly ready to embrace it.

Thank you all for your attention.

The appreciation of the meeting was expressed by Tony Comper, Chairman and CEO, BMO Financial Group.