A Different Approach

(Akron/Tire Review) Possibly the quietest, one of the most accomplished and certainly one of the most respected head of a major tyre company, Jim Micali has also had one of the longest careers, having first joined what is now Michelin North America some 30 years ago as a staff attorney. Micali worked his way up through a number of assignments, including two stints in France, before becoming chairman and president in 1996.

In 2001, Micali was appointed to the Groupe Michelin executive council, and served a term as RMA chairman in 2002. He has also served on the boards of Sonoco and Lafarge North America, and was named distinguished senior fellow in political economy and leadership management at Furman University in 2004, where he is still a guest lecturer. Micali also received the Order of Merit from the French government.

This past December, Micali sat down with Tire Review to discuss legacy and raw material costs and their impact on North American tyre manufacturing and competition, and how MNA is tackling these key issues.

With regard to manufacturing companies, what does the legacy cost issue mean to a company like Michelin North America, near-term and long-term?

“There are essentially two kinds of legacy costs: there are pensions and there’s the medical side. On the pension side, to a large degree you can control your own destiny in the sense that if you cannot afford to promise a benefit then you shouldn’t promise it. There is only one thing worse than not promising a benefit that that is promising it but not being able to deliver on it. I think a lot of North America businesses, through negotiation or otherwise, promised pension benefits they have not been able to pay. The defined benefit plan is a very good example of this, because first you have to fund it as you go forward, and even if you fund it there is an inherent risk in terms of what happens to those funds in the stock market. And then there are mortality tables and discount rates that have a huge impact on that liability. What you have seen Michelin do – and you have to do this in a very fair way – is come up with a very attractive defined contribution plan and give employees the opportunity to choose that plan now or to stay with the defined benefit plan, knowing that we are going to sunset that defined benefit plan in 10 years. I think that’s a fair compromise between providing your employees with appropriate benefits while at the same time not putting the company at undue risk because of what happens on the stock market or with discount rates.

“On the health care side, when you have a third-party payer, there is only so much in today’s system that companies can do. There are inherent market forces and so today you’ve had inflation in health care averaging 10% per year for who knows how long. I think the ultimate solution will be, and maybe Washington will do something about it, for companies is to be more active in getting their people healthy. Spending one night in even the smallest of hospitals is infinitely more expensive than spending a night in the Ritz Carlton in New York or Chicago or Palm Beach. For health care coverage for the average active employee, we spend today about $8,600 per year. And if that continues to climb, we will be priced out of the market. Now compare that to importers that don’t have as many active employees and don’t have the same retirement burden that many tyre companies have today.”

Can manufacturers pool themselves in a fashion with regard to medical premiums and also to press Washington for some kind of relief? Companies are paying pensions and comprehensive medical coverage for tens of thousands of retirees on the basis of promises made 20, 30 even 50 years ago. Are there options out there to attack the problem this way?

“Well, we’ve seen the Big 3 automakers sit down with President Bush and tell him that he needs to look at this. Now, whether or not Washington will do anything about it remains very, very problematic at best. I can tell you that what we are doing. We have gotten together with BMW and General Electric here in the Upstate (South Carolina) and are working with them on some out-of-the-box solutions with respect to hospitals and insurance companies. Here in Greenville, we have two very fine hospitals. But is there a way we can encourage them to collaborate more to, at the same time, improve the delivery of health care and reduce costs? Can we work with insurance companies so we are all getting better data to understand who is getting sick and why they are getting sick? And can we take that data and do something to reduce those risks among your employees?”

Does this start to become more of a holistic approach?

“That’s exactly the right word. You need a holistic approach that includes the employees, their families and the providers of services. You can only increase deductibles and co-pays so much, and the most recent data on the subject will tell you that. Take diabetes as an example. Treated early and often, you can manage the disease rather well. So if you increase co-pays and deductibles on the drugs and the treatments that a person needs, you discourage them from getting the treatment that you want them to get. Maybe you have to take a much more holistic approach and say, perhaps, that with diabetes there ought not to have any deductibles at all. Maybe what we ought to do is make sure we get that person in and at the same time tell that person that we will provide coverage for you but in return you have to follow this treatment regimen and diet and exercise and take care of yourself.”

Do you see the potential for the return of the days when there was an in-plant doctor and in-plant medical center?

“I don’t know that today you necessarily need somebody in place, but what I would say is that we just cannot continue down the same road we have been traveling for the last 5-10 years, not just Michelin, but every manufacturer in North America. Under the present system, you are going to have to think outside of the box. In order of magnitude, we pay $250 million to $300 million a year for medical coverage for our employees and retirees. With a 10% increase per year, that’s another $25 million to $30 million a year. I can assure you that gets your attention.”

In terms of raw material costs, everybody is suffering under that. What can you legitimately do and what creative things are you looking to do to reduce that burden?

“One of the reasons why Michelin has its deserved reputation for quality is that we have bought quality raw materials that have performed well. At the same time, without reducing that quality, I think a more intense discussion between the purchasing department, the user of the materials and the specifier of those materials – because, often, the user is not necessarily the specifier – needs to occur. You need to get those three corners of the triangle together in a room to find that sweet spot. We think there are a number of savings related to, among other thing, simplifying the specs so that there is no over-specing on something that doesn’t need to be over-speced. Or, perhaps, choosing just as good materials that might be a little bit easier on the production process than another. By doing just those kind things in a concerted fashion, maybe you can find 3% or 4%. When you buy $9 billion worth of materials and services, that 3% to 4% is some real money. We think there is 3% to 4% out there that we can find.”

Don’t you see that as something you can tackle, but that at some point you max out your options?

“You’re right, you have. But at the same time maybe you have brought down your whole cost base down. If you find $300 million in raw material reductions, you have brought your whole cost base down by $300 million. Okay, so now raw materials may continue to rise, but your whole cost base already moved down by $300 million compared to the competition.”

What kind of creative things is Michelin considering or looking at as long-term solutions? Is it going to be oriented around the traditional materials and the traditional buy, or are there other things that can be considered?

“There are some people who like to vertically integrate; they buy upstream. For us, I think, we ought to analyse how we can make it better for ourselves here in North America. In the past few years, we sold some of our textile and steel cord facilities, and we sold them to some very good companies that are more capable at making certain types of products than we are. I think you need to look at it on a case-by-case basis. Some people say, ‘Gee, why do you have to use natural rubber anymore?’ Well, the Michelin R&D chemists will tell you that for certain applications there is just no substitute for good natural rubber.”

Is there a prevailing thought that the industry is getting “done” by some of these suppliers in some segments like natural rubber?

“There was some litigation on the chemical side in the last couple of years, and I believe litigation was appropriate and that issue was resolved. The natural rubber market, in particular, is so hard to understand sometimes. Is it natural speculation that is driving prices? You know, I don’t think we have any reason to believe that anything more than market forces are driving prices. If we felt differently we’d do something about it. I look at these increases as the result of two things. The first is that in many of these industries there was underinvestment in the 2000-02 time frame because post-9/11 everyone got nervous and didn’t want to invest, which is understandable. So we got behind the curve. Then, at the same time, you have this explosion in China’s economy and raw materials demand. Their need for raw materials outstripped the available supply. So there was a combination of things, and that’s why we have seen most of these increases.”

Let’s turn our attention to labor. You had a rather smooth negotiation with the union this year. From your experience in that, is there a sense on the union side that this is a different world than three years ago, and that their side of the equation is going to have to change dramatically whether they like it or not?

“Michelin had a substantial negotiation with the Steelworkers in June and July. We spent a long time talking with one another before we entered the formal negotiations and we explained to them where we saw the industry and where we saw our business. They have some extremely intelligent, extremely capable people at the USW. And I think we had sufficient communications so that they understood what our business-needs were and we understood what their concerns were. I think that we arrived at a fair agreement, one that gives the company and our employees the productivity improvements and the cost efficiencies that we need and that it met some of their concerns. We agreed to put $100 million into the three union facilities we have, and we agreed not to close any of those facilities for the life of the agreement. We think those facilities have a very viable future provided we invest well in them and provided we execute on the contract and deliver the savings that the contract permits to occur. The proof is still in the pudding. The future and success of those plants is in the hands of our employees there. And if we can make it work, and we have every hope and aspiration that it will, those will be viable facilities. But we have to make sure that we get every dollar out of those productivity and cost improvements that are permitted by the contract. I think the USW recognised that what Michelin was saying at the table was real.

“I read somewhere that the average Chinese tyre builder was paid $3,000 per year. If you consider that the labor component is one-third of the cost of a tyre, they have a huge advantage that you, as a North American manufacturer, have to be able to close. Some of the things we’re working on I think will help us close that gap. China’s wage rates aren’t going to stay where they are, and other factors will help. But, boy, we have got to execute and deliver on what is in that agreement. We all have got to work to make that happen.”

Do you feel that MNA has a decided advantage against its North American competition because of its structure and number of non-union vs. union plants?

“Well, I don’t know that it is an advantage. What I would say is this: Our non-union facilities are non-union because our employees don’t feel they need a union. We respect their view on that, just like we respect those who want a union. But I think we have put a lot of hard work and effort into making Michelin a good place to work, and making our employees feel they are part of a 22,000-person team. I don’t mean that flippantly.

“Look, we’re up against some very good competition, not just in North America, but around the world. And people have got to understand what that challenge is, and I think it is management’s and leadership’s responsibility to get that message out so that everyone understands just what the challenges are and how high those hills are to climb. At the same time, we have to show them that if we do this and this and this we’ll be able to climb that hill and be successful. And if we are successful, the company wins, the employees win, the shareholders win, the retirees win and the customers win.

“It is a communications challenge first, and your strategy has to be sound. Ultimately it has to be able the quality of the product, your attention to the customer, treating your employees well – if you do those three you’ll be okay. If you don’t, these days, you’ll get run out of town real quick.”

Talk about OEM treatment of Tier 1, 2 and 3 suppliers.

“The only thing I will say is this: If you squeeze a supplier enough then you’ll put them out of business. And when you put that supplier out of business, you pay the consequences of what happens. People who get overbalanced with their OE presence take that risk. We’ve seen that not only in the tyre industry but other areas where we’ve seen companies go bankrupt or they have had to walk away from OE all together.”