by Donald V. Potter

In 1990, the New York Times observed that “There are already too many cars chasing too few customers in the automobile rental industry”. Two years later, car rental companies are still chasing too few customers.

Low air fares increased the volume in the travel industry this past summer, but car rental companies are still having to cut costs to make profits, while simultaneously adding services and dropping prices to attract customers. Rental companies are displaying the classic symptoms of the toughest stage in the evolution of an industry: “hostility.” A few companies will emerge as large and profitable concerns, most will fail.

Some years ago, we noticed that successful strategies in hostile industries seemed to fly in the face of conventional wisdom. We began to study the evolution of more than 40 industries as they faced overcapacity, falling margins, and management turmoil. We wanted to understand why “Motherhood and Apple Pie” thinking does not necessarily make winners out of companies in these environments. From the histories of these very different industries, patterns of success and failure have emerged.

We identified these recurring and predictable phases of intense competition as the evolution of a “hostile” industry and can apply what we’ve learned to other industries undergoing similar evolutions. What can car rentals expect as they move through the stages of hostility? This article examines recent developments and their implications for their future of the industry.

Margins Under Pressure

Demand in the car rental industry during the 1980’s grew better than 13 percent a year. This rapid demand is now slowing – although it remains just under 5 percent – and margins are under pressures. Most analysts point the finger at slowing demand as the cause for margin squeeze; on the contrary, it is the growing number of competitors which is putting pressure on industry margins.

The last decade was a profitable time for the car rental industry. Ironically, those strong profits are what lead to the weakening profits of recent years. Attracted by good returns and low levels of competition, existing competitors expanded aggressively and new entrants gained substantial ground. Companies like Alamo, Thrifty, Dollar, General, and Value began to make their presence felt beyond their previously limited markets. Established industry giants, even the largest and most successful, watched as their share in the U.S. eroded.

Since 1982, U.S. market share has actually de-consolidated, with the result that more companies hold significant share and the largest market share owners have lost some of their dominance. The trend of larger independent companies joining franchises indicates that share is still on the move. As long as significant chunks of market share continue to shift, profit margins will remain under pressure.

Margin relief will not occur until market share actually consolidates in the hands of two or three major players. In the meantime, each auto rental company will be competing fiercely to ensure that it is one of the few left standing.

Price Cuts Common

Persistent excess capacity has inclined some rental companies to adopt price discounting to build business. The industry waits for the “majors” to raise rates but in hostility, price competition is almost certain to last for several years, although it gradually loses its effectiveness. Even though the industry faces higher vehicle acquisition prices in 1993 and plans to pass those increases along to the consumer, it will be tough to sustain those higher price levels in a state of hostility. Praying for rain does not usually end the drought.

Price cuts are not usual in hostile markets. In the early stages of hostility, price discounting can successfully move market share, especially when industry leaders do not match the discounts. Market share shifted to discounts a few years ago, when some of the major rental companies refused to match the discounts. Those major competitors have yet to recover their lost share.

Price wars train customers to focus their purchase criterion on the least attractive aspect of the benefits an auto rental company offers. Customers learn to choose products based simply on price, rather than on more important differentiating factors such as features, quality, or ease of purchase. Unfortunately, rental cars are regarded as a “commodity” product, a way of thinking which focuses on price.

As the industry evolves through hostility, price cutting becomes less effective as a share gaining strategy. Competitors, like Hertz responding to Alamo’s Great American Rates earlier this year, learn to match discounts and keep products undifferentiated on the basis of price. Eventually, after competitors learn to deal with discounters, price competition simply causes all competitors to suffer but brings little share change.

Aggressive Cost Reduction

In response to slowing demand and increased price competition, the pressure to reduce costs intensifies. At the beginning of the year, for instance, National Car Rental announced a restructuring of its administrative functions to reduce costs. Cost cutting, while critical, must be done with great care. If not, absolute costs go down in the near term, but unit costs rise shortly thereafter.

In an environment of slowing demand, margins decline because costs are highly fixed, particularly in the overhead areas, as volume declines. This margin squeeze causes companies to make cost cuts which are deeper than they would when rental demand is rising. The result can be a reduction in service performance which is visible to the customer. When service deteriorates, the company cuts its costs at the customer’s expense.

There are several common, mostly unfavorable consequences of this kind of cost reduction. For example, in an effort to cut costs, the car rental company may fail to copy the latest industry innovations. The choice to participate in frequent flyer programs, for instance, has been a difficult one for car rental companies.

As pressure to cut costs increased, some companies opted not to provide this benefit and undoubtedly suffered some market share loss as a result. The operation of on-airport sites presents a similar quandary: the added expense of leasing fees versus the added convenience for a set of customers. The quality of some car rental companies’ facilities and service has declined; this kind of cost reduction, choosing to skimp on training or remodeling, is self-defeating. Cost reductions which lower performance will cause sales to fall.

These performances changes may reduce total costs in the short term but spell higher unit costs in the long term. The reduction in customer benefits causes sales to fall at the same time that costs go down. Often the cost reduction becomes self-defeating because it leads to additional share loss. As share shrinks, fixed and semi-fixed costs increase, and unit costs rise.

What To Do

The outlook for competitors in hostile markets may sound pretty grim. In fact, we have found that companies can benefit from the successful management policies developed by managers in other industries who have confronted tough times and survived.

Many of these managers have done better than simply survive – they have led their companies to real prosperity. Hostility defeats many but rewards a few with tremendous opportunity to gain share and produce long-term profits.

Among successful management policies for hostility are the following:

  1. Act as if hostility will never end. Devise strategies which consider intense competition as a given over the long term. Tough-minded, long term thinking encourages competitive focus and cost control that can only serve a car rental company well, even when things do get better.
  2. Put customers first and cost structures second. In a hostile market, a company has a natural tendency to reduce costs as its first priority. If cost reduction results in lost customer volume, then the reduction is self-defeating. A company can always reduce its unit costs once it has the customer base, but it can’t always get the customers once its cost structure appears under control.
  3. Refuse to believe your product is a commodity. The best companies know that customers base purchase decisions on a range of factors, of which the actual service – the opportunity to use an automobile, is only one. The quality of the relationship between the customer and the rental company is extremely significant to a customer. A company which consistently keeps the promises it makes to its customers will find that customers consistently prefer to rent its cars, no matter how much of a “commodity” they are.

(Note: This Perspective was written in the context of the economy in 1992. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)

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Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.