What is your hybrid strategy?

When Honda and Toyota launched their hybrid vehicles in 1999 and 2000, no one could have predicted that they would have such appeal for American consumers. Was it a stroke of luck or genius by the Japanese automakers? Actually, it is a combination of both--as it is with all new product successes. It involves being at the right place at the right time with the right product. The success of hybrids (which also has taken Toyota and Honda by surprise) can be attributed to five key factors:

* Rising oil prices and a strong sense of energy security following 9/11

* Latent demand among a certain section of consumers (early adopters, trendy, young, wealthy, environmentally and fuel-price conscious)

* Shrewd marketing and positioning

* Products that work seamlessly with consumers

* Tax credits offered by the U.S. government.

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Why did the U.S. and European automakers miss the beat? If one were to pass a hybrid program through a financial decision-making process, it would fail miserably (estimated developmental costs and vehicle costs would not justify the return on investment). It is one of the reasons that U.S. OEMs (which tend to be more short-term results-oriented) did not move in the direction of commercializing a hybrid program in step with their Japanese competitors. European OEMs, on the other hand, were focused on either improving diesel performance or fuel-cell development. Moreover, none of the mass-market European OEMs--except VW--have a major footprint in the U.S., where much of the demand for hybrids is emerging. At the same time, European luxury OEMs were focused on spicing up their new models with electronic features.

A LEGITIMATE OPTION. We are past the experimental phase and hybrids are now a legitimate powertrain option for mainstream vehicles--mainly driven by the Japanese, and more recently by Ford. At this point, the competitive dynamics really change. By 2012, there will be up to 40 models with varying degrees of hybrid technology coming to the U.S. market, with a combined planned annual production volume of 650,000 (about 4% of total U.S. demand). By that time, more than three million hybrid vehicles will be on the road.

The demand and success of hybrids to date has shown that there is a class of consumers in each segment who are willing to pay the premium (an average of $4,000), to have the hybrid options (even though with this price premium, fuel-economy benefits will not be offset during the average vehicle's lifespan at current gas-price levels). But for now, if an automaker's competitors offer a hybrid option in a mainstream vehicle's segment and that OEM does not, it will find itself in a defensive position.

An analogy lies in Ford's well-known fourth door minivan experience in the mid-90s. In the mid 90s, Ford decided against introducing a fourth door within its minivans (their market research had shown consumers' lack of interest for the fourth door). They were caught by surprise, however, when Chrysler's fourth-door option was well received by consumers, resulting in a record-breaking sales surge. Now, a fourth door on minivans has become a price of entry for all automakers.

The introduction of hybrids in mainstream vehicles by Toyota and Honda is driving automakers to accelerate development activity (Ford), buy full hybrid technologies (Nissan), or form alliances (GM and DCX; or Porsche and VW) to ensure a hybrid footprint. It will take one or two vehicle generations for these OEMs to catch up with Toyota and Honda's sophistication level, technologies and integration capabilities.

The key question in the minds of decision makers is whether there are conditions that could trigger a much higher proliferation of hybrids within the mainstream than what is projected--and there is no straightforward answer. OEMs have to be cognizant of several demand drivers and a combination of all or some of the factors below that can push hybrid proliferation to the next level:

* Economies of scale that would bring the hybrid price premium below $2,000 (Roland Berger Strategy Consultants analysis shows that the price premium must come down to $2,000 or below for a consumer to break even in the first five years)

* Gas prices continue to be at record levels consistently above $2.50/gallon

* Overall continued robust economic picture (positive consumer attitude)

* Branding hybrids with a unique value proposition that did not previously exist

* Continued rise of consumer environmental and social consciousness

* Regulations making it difficult or expensive for diesel engines to significantly penetrate mainstream vehicles in the U.S.

OEMs should constantly monitor these factors and be ready to scale-up their hybrid programs if the demand unexpectedly rises, as we have seen in the past. Roland Berger's analysis shows that an increase in hybrid demand can be better than expected if certain factors hold in place.

DO YOU HAVE A STRATEGY? Now that we are convinced that hybrid propulsion technology is a legitimate and relevant powertrain option (just like V-6, V-8 or diesel), the key question is: What is your company's hybrid strategy? The impact of hybrid programs are far-reaching and have touch points across all OEM functions. Some key impact areas include:

* Product planning must analyze the value proposition and define hybrid options across the entire vehicle portfolio. The value proposition must be aligned with the overall powertrain strategy

* Powertrain engineering teams must develop scalable hybrid powertrain platforms to fit all future product planning needs

* Vehicle integration teams must provide seamless integration of transaxle, battery, motors, power electronics and regenerative braking in order to meet performance requirements

* Purchasing teams need to identify a supply base that meets technological and cost requirements of hybrid programs (especially low-volume programs)

* Manufacturing engineering must adapt hybrid vehicle assembly and provide training to employees with applicable skill sets

* After-sales and dealership service centers must be trained to diagnose and repair hybrid vehicles, especially related to electrical and electronics problems

* Management should review the critical skill sets required for a successful hybrid program--there will be a greater need for electrical and electronics engineers

A comprehensive hybrid strategy must be developed by OEMs to minimize mistakes, or risk the loss of precious time and money.

The proliferation of hybrids also creates opportunities and threats for suppliers. Suppliers must review their product portfolio and customer footprint and develop an appropriate plan to minimize risks while taking advantage of opportunities. Hybrids will remain an important part of automakers' powertrain portfolio for some time to come, or at least until fuel cells become a viable mass-market solution (most likely after 2015). Hybrids will remain alongside gasoline and clean diesel internal combustion engines, and may not necessarily compete, but rather provide a choice to consumers and further slice existing segments.

All OEMs face the challenge with their current resources to develop parallel powertrains in order to "compete." Consequently, they will have to start looking into their global operations for synergies or to their competitors for alliances.

By Mahesh Lunani, Partner, Roland Berger Strategy Consultants [e-mail]