3.2 Realization of economies of scale

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1 24 Competing in the Global Truck Industry Emerging Markets Spotlight 3.2 Realization of economies of scale Modular systems with a high percentage of non-variable parts are necessary As a result of market specifics and divergent customer demands, real economies of scale in the commercial vehicle industry can only be realized at the aggregate level. The largest leverage effect is the standardization of the drive train and the electronics architecture, to which depending on market specification a total of 60 to 70 percent of the added value of a truck is attributable. We definitely put a lot of effort into developing standardized cross-segment components for our trucks. In the end, we have to account to very specific end user requirements across all markets and these set very tight limits to standardization. Just take our Wörth plant for our heavy trucks in Germany: Not even two out of the 120,000 units we produce there every year are identical. Of course, such a high degree of differentiation is not necessary in the emerging markets. Andreas Renschler, Member of the Board and Head of Daimler Trucks Division, Daimler AG (Germany) As many non-variable parts as possible, as many individualized technologies as necessary. This requires the development of a modular system that makes it possible to use the same aggregates and components in different production series true to the principle of as many non-variable parts as possible, as many individualized technologies as necessary. The cost-relevant aggregates and components (engine, axles, transmissions, and electronics) are at the forefront in this regard. Only in this way can the necessary product differentiation be presented at the customer level. Scania is viewed as a benchmark for this kind of modular system. Daimler Trucks is striving to increase the percentage of non-variable parts from its current level of 50 percent to 70 percent. 3.3 Flexible capacity management Flexibility is necessary to master market cyclicality Market cyclicality occurs in both mature and emerging markets. To manage the up and downs, OEMs have to be flexible. Manufacturers in mature markets already have established processes and measures to increase flexibility. Nevertheless, especially for the capital-intensive manufacturing industry, market cyclicality still presents huge challenges for only internally-focused strategies like flexible employment relationships, variability of fixed costs or fractal factory concepts.

2 Competing in the Global Truck Industry Emerging Markets Spotlight 25 In order to achieve additional flexibility, it is necessary to look outside the company itself. Inter-company cooperation, strategic alliances, flexible networks or virtual organizations can all help companies to become more flexible. The in- and outsourcing of various processes can provide access to the resources, information and skills of external partners. This in turn, may help a company react more quickly to market changes, rather than relying on internal resources alone. A virtual organization, for example, has the advantage that although it is perceived as one company, it actually comprises a group of companies. Similar concepts like virtual factories also offer opportunities to build flexible networks that can cope with varying production volumes. Partnering with external parties can increase flexibility. However, few of these concepts will work in the emerging markets. OEMs therefore need to implement processes that have previously been successful in the mature markets. Current growth rates in emerging markets mean there is little urgency for OEMs to implement comprehensive strategies, but growth cannot keep up its extraordinary pace forever. Also, manufacturers should not neglect the supply chain, helping all parties to be more aware of demand changes and to react appropriately. In addition, for both markets, manufacturers need to be able to accurately forecast and comprehensively analyze market trends and demand changes. 3.4 Multi-branding In global competition, the brand offers regional differentiation potential Above all, different business models will be needed to handle mature and developing commercial vehicle markets. The business model for commercial vehicle manufacturers in Triad markets is based on a product-service bundle with technically high-quality, high-value vehicles, as well as complementary services (such as spare parts logistics, financial services and fleet management). The USP (unique sales proposition) is ultimately a minimization of the TCO, while simultaneously ensuring reliable readiness of the vehicles for use. In contrast, a successful business model for emerging markets must place the low-cost truck at the forefront. At the same time, the subsequent costs must be kept low through ease of repair. In this context, brands emphasize different points in the commercial sector than the consumer sector, but they should not be neglected. This applies primarily to the trust function of the brand, namely the respective customer promise that the brand makes. There are many arguments in favor of pursuing a multi-brand strategy in the commercial vehicle sector. However, it must be remembered that brand attributes for commercial vehicles are heavily focused on rational values such as quality, reliability and economic benefit, rather than more emotional messages typical of consumer brands. The use of multiple brands makes it possible to address regional peculiarities through different brands. Two full-line manufacturers that operate worldwide, Daimler Trucks and Volvo Trucks, are active in European markets with traditional premium brands characterized by high customer and environmental demands. In the North American market, conversely, the two companies use traditional US brands. Gaps in the brand portfolios are supplemented by European premium brands. In turn, the growing Latin American market is handled using brands from the European region. In Asian markets, known and new local brands are used, or activities are carried out through joint ventures with local manufacturers. BUSINESS MODELS Triad: Product-service bundle with technically and qualitatively high-value vehicles. Emerging markets: Low-cost trucks with low follow-up costs. The brands of global manufacturers vary in Europe, North America, India and China.

3 30 Competing in the Global Truck Industry Emerging Markets Spotlight 3.6 Expansion of the value chain Downstream services can substantially contribute to increased revenues. Additional services are booming, with growing potential also in emerging markets Stronger service offerings have been used in recent decades to add value for OEMs downstream from production and distribution. There are already commercial vehicle manufacturers earning up to a fifth of their sales revenue from services and this share may double by In light of sustained price pressures, the importance of downstream activities will further increase in the commercial vehicle business. Added-value services in the commercial vehicle industry Global Cross-border-financing Eco-/driver safety trainings Buy-back-obligation Fleet management Regionalization Financing Insurance Toll management Special equipment Damage management Tire replacement Maintenance contract Leasing Project management Telematics services Maintenance & repair Local Truck, superstructure and retrofitting Used truck trade-in Breakdown service Warranty Contract hire/ short-term rental Serial-/special fittings Owner-Driver Company size Large fleet Source: Institut für Automobilwirtschaft [Institute for Automotive Research] After-sales market The after-sales market, with its sub-segments of spare parts and accessories, service and repair, as well as vehicle bodies and retrofitting, represents serious earnings potential for truck manufacturers. This is due to the rising complexity of trucks, as well as technology upgrades to comply with stricter emissions standards and retrofits to meet new safety requirements. In the commercial vehicle market in particular, prompt spare parts supply is of great importance. With a strong market presence, OEMs can achieve a competitive advantage and increase customer loyalty by ensuring low vehicle downtimes. This, of course, has long been standard practice for commercial vehicle manufacturers. Exterior and structural parts (e.g. tires) dominate the after-sales market. The medium- and heavy-duty after-sales market is led by exterior and structural components like tires, windows, mirrors, bumpers, truck roof, side fairings and trailer doors. In mature markets, these usually account for up to half of total after-sales revenue. Taking revenue potential into account, tires are exchanged most frequently, while all other parts in this category are probably only replaced after accidents.

4 Competing in the Global Truck Industry Emerging Markets Spotlight 31 Another huge truck after-sales market category (around one-third of a mature market) is mechanical parts, including engine, chassis, powertrain and suspension parts. Nevertheless, long service lives for many of these components limit their revenue potential. Lastly, electrical and electronic parts have increased in importance over the last couple of years, as the electrical content of a typical truck has risen. This is mostly due to stronger emissions controls in mature markets and in several metropolitan areas of the emerging markets. 3 Truck OEMs could further leverage the serious after-sales potential of captive online platforms to promote their services and parts. According to a 2010 automotive online aftermarket study carried out by Google in cooperation with Compete, only a small proportion (one percent) of spare parts are ordered directly from the manufacturer, whether online or offline. The majority of the business is conducted by after-sales retailers, accounting for 44 percent of offline and 52 percent online orders. This certainly offers serious space for OEMs to grow their after-sales business. OEMs can tap new revenue sources via online after-sales platforms. Although the rate of online parts purchasing and direct shipment is increasing, four out of five customers are still buying automotive parts in person at a traditional store. Nevertheless, according to the study s quantitative research, providing better information on specifications can enable OEMs to win new business, as the average online to offline purchase conversion rate for automotive parts can be as high as 85 percent for several components (e.g. batteries, brake parts). Preferences of after-sales parts purchasers Purchased Parts Online Purchased Parts Offline Aftermarket automotive retailer website 52% 44% Aftermarket automotive retailer 19% Local independent automotive shop Online independent seller 19% 17% Retailer Online retailer website 10% 7% Dealership Dealership website Direct from manufacturer website 5% 3% 6% 1% Oil change service shop Direct from manufacturer Source: The 2010 Automotive Aftermarket Study, Google & Compete 3 Medium- & Heavy-Duty Truck Aftermarket, Freedonia Market Research

5 32 Competing in the Global Truck Industry Emerging Markets Spotlight Financial services Whereas vehicles including commercial vehicles were predominantly purchased for cash decades ago, the majority of today s vehicles are financed or leased in mature markets. It is more important than ever for companies to ensure their liquidity. Therefore, financing alternatives such as credit or leasing can be used both as a sales tool and to ensure additional income. In a mature market such as Germany, only 13 percent of newly sold trucks are paid for in cash. New trucks are financed or leased at more or less equal share of 42 and 45 percent, respectively. Penetration rates of financing for commercial vehicles in Germany 43% New vehicles Auto Truck 13% 21% 36% 42% 45% 51% Used vehicles Auto Truck 2% 10% 23% 47% 67% Financing form Financing Leasing Cash Purchase Source: puls Marktforschung (2010) In the used truck market, two-thirds of vehicles are purchased for cash. A different picture emerges for used vehicles. In this area, two-thirds of commercial vehicles are purchased for cash; only ten percent of vehicles are leased, and 23 percent of trucks are financed. It is apparent that the rate of financed used passenger cars is substantially higher than the one of used trucks. This opens up opportunities even in a saturated market like Germany to generate qualitative growth, and thus additional earning potential, by means of used commercial vehicle financing. Truck manufacturers offering financial services compete with banks, insurance companies and providers from other service sectors. Although the majority (62 percent) of lease contracts are concluded through OEM captive finance providers, non-captive providers still have the upper hand with close to 51 percent in the case of financing. A comparison with the passenger car percentages shows that the captives have a much stronger positioning in this area, with close to 70 percent. In the vehicle financing sector in particular, commercial manufacturers can tap into additional potential with attractive financing packages.

6 Competing in the Global Truck Industry Emerging Markets Spotlight 33 Market shares of captive financing companies for commercial vehicles in Germany Auto 69% 31% Financing Truck 49% 51% Leasing Truck 62% 38% Captive Non Captive Source: puls Marktforschung (2010) In the emerging markets, on the other hand, there is a great need to catch up with respect to financial services. In China, for instance, vehicle financing for both corporate and private customers is quite a new concept. Around 90 percent of all vehicles purchased in China are paid for in cash; financing accounts for the remaining 10 percent, as vehicle leasing is almost non-existent. Of course, this is largely because of cultural issues, but also due to the low level of awareness and consumer education regarding financing the Chinese government did not allow non state-owned companies to offer vehicle financing until In India, the local Mahindra & Mahindra Group already offers financial services, but their focus, beyond simple vehicle financing, is on life insurance contracts, financing business equipment or rural house construction. Financial services are almost non-existent in the emerging markets although today efforts are intensifying. Financial services do not only bear additional earning potential for local manufacturers. Manufacturers from mature markets entering such growth markets could leverage their existing know-how as a distinct competitive advantage. However, appropriate structures must first be established by both local and foreign commercial vehicle manufacturers. Recent examples show intensified efforts by established OEMs to cater to the rising demand for financial services. For instance, Volvo Trucks started to operate a financial services arm in India in November With its Indian partner, Sri Equipment Finance Pvt Limited, a leading infrastructure and construction equipment financing company, Volvo Financial Services India leverages its partner s market expertise to offer a wide range of financial programs for its commercial trucks. Likewise, Daimler recently announced that it will be establishing a subsidiary of Daimler Financial Services in India.

7 34 Competing in the Global Truck Industry Emerging Markets Spotlight Contract hire/short-term rental Mobility solutions will become increasingly popular in the commercial vehicle market. Innovative mobility solutions in the form of contract hire/short-term rental are also playing an increasingly important role. For example, commercial vehicle providers in Europe and the US offer individually structured mobility packages for commercial vehicle operators. For instance, Mercedes Benz CharterWay, the international commercial vehicle financial services, contract hire and fleet management arm of Daimler AG, combines leasing or financing arrangements with a variety of addedvalue services in a single package based payment. CharterWay was founded in 1992 and has offered contract hire and rental services for commercial vehicles since Essentially, such packages occur in three variants: Firstly, commercial vehicles can be offered for short- to medium-term rental. This enables road hauliers to flexibly increase their transport capacities for peak periods on an ad hoc basis, without capital commitment or risk. In a more service-oriented approach, hauliers can furthermore combine a needs-based bundle of services, sometimes including maintenance and repair services. If necessary, this can include a replacement vehicle by the service provider. In a third variant, such a short- to medium-term mobility package can be expanded to a full-service contract including fuel cards, insurance and fleet monitoring Used vehicle trade Just like the used passenger car business, which is in many cases professionally operated by car manufacturers, the used commercial vehicle market opens up further revenue potentials for truck OEMs. The used vehicle trade in the commercial vehicle sector has developed as an attractive business model. Many commercial vehicle OEMs already operate professional online commercial vehicle exchange platforms, in which customers can search for suitable vehicles worldwide according to price classes, vehicle age and kilometer reading, as well as body and payload. For some manufacturers, the business involving used commercial vehicles is operated similarly to the passenger car business under a special used vehicle brand with a comprehensive concept Fleet management solutions and telematics services With fleet management solutions (FMS) and telematics services, large vehicle fleets can be better controlled with respect to the economic efficiency and optimization of logistical, informational and organizational processes. Technological advances in communication and information technology are favoring the further development of FMS because they have lowered the costs of implementing systems, providing real-time control and information. To benefit from fleet management services, network infrastructure has to be implemented on a wide scale. FMS in developing markets trail behind due to lower technology level and road density. In emerging markets many of these new services cannot be offered on a large enough scale due to bad network coverage. Besides the lack of efficient IT systems, the sheer size of China, India and Russia limits the implementation of professional fleet management services. However, demand will increase as road infrastructure improves, customer expectations rise and more sophisticated IT networks develop. Today, one of the first global players engaging in fleet management services in the emerging markets is General Motors. GM introduced its Onstar in-vehicle security, communications, and diagnostics system for its passenger vehicles in China, and will most probably expand its services to the commercial vehicle domain.

8 Competing in the Global Truck Industry Emerging Markets Spotlight 35 The service portfolios of the various manufacturers generally include the following: Services relating to vehicle management include, for example, deployment analyses with driving style evaluation, trip recording, service plans and condition inspections. Reporting tools which offer the possibility of clearly laying out the extensive telematics data for the addressee (management, vehicle fleet manager or drivers). Service management, including sending online data from the vehicle to the service shop, for planning service schedules. Transport management, such as tour planning and monitoring, shipment tracking, order management, navigation, barcode scanners or digital signatures. Other tools support, for example, commercial vehicle operators in complying with legal requirements, such as logging drivers work and driving hours, or temperature monitoring for cold goods. In addition, some companies also offer training for vehicle fleet managers, administrators and drivers. In particular, sharply rising total costs of ownership are expected to boost demand for these services in the years to come. Fleet management solutions, for instance, offer vast opportunities to increase fleet fuel economy through telematics and vehicle management (e.g. avoiding traffic congestion, efficient tour planning). In addition, companies can use telematics to enhance driver productivity or maximize cargo space by efficiently allocating fleet vehicles. To counteract rising repair and maintenance costs, vehicle diagnostics and preventive maintenance tools can also avoid engine and other core component failures, which can lead to significant downtime and profit losses.

9 kpmg.com/automotive Contact us Global Automotive contacts Dieter Becker Global Head of Automotive T: E: Simone Beutel Global Executive for Automotive KPMG in Germany T: E: Regional Automotive contacts ASPAC Chang Soo Lee Samjong KPMG in Korea T: +82 (2) E: The Americas Gary Silberg KPMG in the US T: E: EMA Dieter Becker KPMG in Germany T: E: The views and opinions expressed herein are those of the survey respondents and do not necessarily represent the views and opinions of KPMG International or KPMG member firms. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG International Cooperative ( KPMG International ), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Competing in the Global Truck Industry Emerging Markets Spotlight Publication number: Publication date: September 2011 Image on page 16 is used with kind permission of Daimler Trucks Division, Daimler AG