Running head: TIRE INDUSTRY ANALYSIS

Tire Industry Analysis ECO/212

TIRE INDUSTRY ANALYSIS

Tire Industry Analysis The manufacture of rubber tires began as a way to smooth the ride on bicycles (General Tire, 2008). The invention of the automobile and the use of rubber tires on the new mode of transportation secured the demand for tires. Since the inception of the first rubber tire the industry that evolved has been one of dynamic changes and steady growth. The supply of tires is influenced by our companys ability to innovate the manufacturing process. Recent developments in automated systems have allowed our company to increase output, thereby increasing the supply of tires. The demand for tires in the automotive industry is composed of original equipment and replacements. Pricing of tires is highly elastic when looking at it from the perspective of supply; conversely it is not elastic from the perspective of demand. Until recently the demise of used tires was to become another type of pollution. This negative externality has been reduced with developments in recycling of tires and their basic materials. The tire industry is, as are most other industries, subject to government controls and policies. Some of these policies protect the industry from unfair foreign competition. This analysis of the passenger tire industry will show that although there is increased competition on a global scale tire manufacturers in the United States are expanding employment and remain competitive.

History of the Passenger Tire

The early days of tire manufacture were filled with innovation. Until vulcanization, a process of heating rubber with sulfur, was discovered by Charles Goodyear rubber was inflexible when cold and sticky when hot (General Tire, 2008). After the discovery of vulcanization, tires

TIRE INDUSTRY ANALYSIS

were made of solid rubber and although the tires were strong they were heavy and did little to provide a smooth ride. The next significant innovation came almost 50 years later with the invention of the pneumatic, or air filled, tire. This design required an inner air filled tube surrounded by an outer casing. These pneumatic tires called Bias Ply dominated the market for the next 50 years until the invention of radial tires. Radial tires are currently the standard for passenger vehicles and the primary focus of our business.

History of the Tire Market

Although changes in tire design have progressed at a steady rate, changes in the tire manufacture market faced several setbacks and moments of instability. During the early years of the great depression, the rubber tire industry was one of the least profitable industries in the United States (Pennock, 1997). During this period there was intense competition among tire manufacturers large and small in an effort to gain market superiority. The large manufacturers gained control of the original equipment market by winning contracts with the auto manufacturers. They initially allowed the smaller manufacturers to control the replacement market. However, as the auto (original equipment) market began to stagnate near the end of the 1920s the big tire manufacturers began to set their sights on the replacement market. What happened next was the total disruption of the replacement market. In as little as six years the small independent tire manufacturers lost over 20% of the replacement market (Pennock, 1997) to larger firms, and as a result many small manufacturers and distributors were eliminated causing an oligopoly.

TIRE INDUSTRY ANALYSIS

Supply and Demand

The supply of tires is governed by the ability of tire manufacturers in the United States to maintain a competitive edge and incorporate innovative production processes. Although the majority of the market served is original equipment for the auto industry, tire manufacturers must also consider the replacement market when planning production numbers. Technological improvements allow us to manufacture tires at reduced cost as well as improved flexibility and quality. Flexibility and quality are important to maintaining our share of the tire markets, both domestic and global. The trend in manufacturing has changed from the production of each component separately (the batch process); to a flow line system whereby all the components are made in their final shapes in sequence on a multifunctional assembly line (Brusoni & Sgalari, 2006). This innovation allows for rapid changes to the size and type of tire manufactured meeting the ever-changing demand. The demand for tires, as stated before, is primarily original equipment. In recent years we have seen an increase in the demand for original equipment tires because of the increase in automobile sales. Fluctuations in production of autos have an effect on demand because every vehicle produced needs tires. The demand for replacement tires changes based on the current market price of tires and the quality of the tires produced. If the price of tires is high consumers will wait to replace tires as long as possible. An improvement to the quality of life expectancy of original equipment tires means they will last longer and that lowers the demand for replacement tires.

TIRE INDUSTRY ANALYSIS

Pricing
Pricing is based on three components; Our cost to produce tires; this includes purchasing the raw materials, capital expended on equipment and buildings, and the labor cost. Our profit margin; the money we hope to make above the cost of manufacture. The price the consumer is willing to pay for our products. Of these three components our profit margin is the most variable. What that means is that we must be able to adjust the profit margin to absorb increases in production costs without passing those costs to the consumers. In fact we can have a different profit margin for each type of tire we manufacture as long as the market (demand) can bear the price. I am not suggesting that we never raise the price that consumers pay, but that we remain flexible and diverse enough to absorb small variations in raw material, labor, and other production costs.

Price Elasticity
Elasticity is the measure of how much manufacturers and consumers respond to changes in market conditions. The price elasticity of demand for the tire market is low (inelastic). What this means is that because autos need tires and consumers need autos, changes in the price of tires will have a negligible effect on the demand for tires. It is crucial to understand that because there are no substitutes for tire, other than choosing a different manufacturer or style, the elasticity of demand will always be low. However, we must still be cognizant of the prices charged by the competition to maintain our own market stability. Conversely the elasticity of supply for the tire market is high. This means that if the consumers in the replacement market are

TIRE INDUSTRY ANALYSIS

waiting to replace their tires for an extended period suppliers will raise the price to compensate for the lost revenue. When the price rises we, and other tire manufacturers will increase our output to increase the supply and take advantage of the higher price.

Externalities
An externality, positive or negative, is defined as the effect an action has on another person who did not have a choice or whose interests were not taken into account (About.com, 2011). Inherent in the process of manufacturing tires is the pollution created. This pollution is

considered a negative externality. The pollution is a byproduct of the manufacturing process and causes harm to consumers and the environment. As production increases so does the output of pollution and the potential harm to the environment. Although we do not account for the cost of controlling this externality directly in our marginal cost we are still required to reduce the amount of pollution. In addition the tires become part of the pollution problem after they have fulfilled their purpose. Recent changes in technologies that create other uses are increasing every year as researchers find ways to reuse tires.

Government Controls
The United States government regulates the pollution output of the tire industry in an effort to reduce the damage to the environment and protect citizens. The government may use two ways to intervene in the tire market to reduce pollution (Carlton & Perloff, 2000). The first is by regulating the output of manufacturers (supply). Although this may be a viable option the government must be cautious when implementing this type of control because of the effect it will have on the market. The second way to control pollution is to impose a tax (tariff) equal to the marginal pollution cost. This forces the manufacturer to internalize the externality. This means

TIRE INDUSTRY ANALYSIS

that the cost of controlling the pollution remains with the manufacturer. These types of regulation can become a burden to manufacturers and increase the price of tires. Conversely, the government may impose regulations to benefit the tire market. One type of regulation that has benefitted the tire industry is the imposition of a high tax (tariff) on the import of consumer tires from China. This new tax has allowed domestic production of tire to increase more than 15% over five months compared to the same period from the previous year (Davis, 2010).

Conclusion
The tire manufacturing market has undergone some radical changes over its history, but it continues to thrive and grow. As new technology and innovation continue to change the way tires are manufactured and improve efficiency in the processes used the future of the tire market is certain to be dynamic. The demand for tires of all types, sizes, and styles will continue to increase as more countries become industrialized. As demand increases so must supply, and we are poised to ensure that we maintain our place in the market. It is inevitable that the price of tires will rise based on numerous economic factors. It is important that we closely monitor the market and adjust our pricing in an appropriate manner. Although we produce tires for the benefit of consumers we also create pollution that may harm the environment and citizens. We have a moral obligation to reduce the level of pollution and help to find ways to recycle the tires we produce. The government has programs designed to regulate our impact on the environment as well as to control the influx of tires from foreign manufacturers. These along with our commitment to superior products will secure our place in the tire market for years to come.

TIRE INDUSTRY ANALYSIS

References About.com. (2011). Definition of Externality. Retrieved from http://economics.about.com/cs/economicsglossary/g/externality.htm Brusoni, S., & Sgalari, G. (2006). New Combinations in Old Industries. Journal of Evolutionary Economics, 16(1-2), 25-43. Carlton, D., & Perloff, J. (2000). Modern Industrial Organization (4th ed.). Upper Saddle River, NJ: Pearson. Davis, B. (2010, September 13). U.S. Tire Production Rising. Tire Business, 28(12), 71. General Tire. (2008). History of the Passenger Tire. Retrieved from http://www.generaltire.com/university/history.php Pennock, P. (1997). The National Recovery Administration and the Rubber Tire Industry 19331935. Business History Review, 71(4), 543-568.