How did we get here

Over the past thirty years the traditional Big Three in the US have been losing market share in the US market.  First to the Japanese and then the German and Korean automakers.  It is very possible that, in the future, imports from China will become a significant factor in the US market.  During this thirty-year period there have been short intervals where the Big Three have gained market share.  These gains were primarily due to particular models or lines like the Taurus, minivans, SUVs, etc.

 

In most of these cases the U.S. companies either had a better feel for what the U.S. market wanted (minivans) or the market moved toward their strength (SUVs).  However, even through these times it was evident that the foreign owned automakers were gaining in strength and their understanding of the U.S. market. 

 

Back in the 70’s the foreign owned companies grabbed market share at the lower end of the passenger car market.  After that they made strong penetration in the mid-size market and then the luxury market.  Currently 55.1 % of the passenger cars sold in the US are made by foreign owned automakers.  In the light truck market the foreign owned automakers got their first foothold in the small pick up truck segment.  They then moved on to minivans and later to small SUVs.  Finally they have made strong inroads in the standard and luxury SUV and large pick up truck segments.   The foreign owned automakers share of the light truck market in 2004 was 27.5%.  Now there is no market segment where the Big Three are not facing competition from a number of foreign owned automakers.

 

Where are we now

 

The diminishing market share of the Big Three in the U.S. has had the greatest negative impact on the traditional U.S. based OE suppliers.  These companies have relied on their Big Three customers for most of their business and have not been able to offset the loss of business with the Big Three with an equal gain in business with the foreign owned automakers.  In many cases the traditional U.S. suppliers have not or have been slow to invest overseas.

 

As a result of these trends a good portion of the U.S. supplier base finds itself in poor financial shape and poorly positioned globally to meet the challenges of foreign owned suppliers with US facilities and foreign sourced parts.

 

The OE suppliers have been hit with a one two punch.  The increased competition in the U.S. market and decline in profitability of these operations have caused the Big Three to increase the pressure on suppliers to lower the prices they charge for their parts and component systems.  This pricing pressure is different from previous years in that the Big Three are now in worse financial shape than they have been in the past.  Add to this the fact that raw material prices have been increasing faster than the supplier’s ability to raise prices or cut other costs.  The problems the Big Three are facing are secular not cyclical.  Thus an increase in overall demand will not help their profitability as much as it has in the past and the supplier base will not be relieved from the downward pricing pressure.

 

The traditional American supplier base has had to face increasing competition from Japanese and European suppliers entering the U.S. market.  They now not only serve the German and Japanese automakers, but also to sell to the Big Three.  On top of this in the past few years each of the Big Three have put together teams of engineers and purchasing officials and sent them to China and India to identify and qualify Chinese and Indian auto parts companies.  Their needs to stay competitive with the Japanese and Korean competition are forcing them to look at all options to lower their costs.  Expanding their supplier base appears, on the surface, to be one of the easiest ways to accomplish this.

 

Whither the Relationship

 

The purchasing and engineering associates from any one of the Big Three would rather do business with you, their long time U.S. based supplier, than someone 7,000 or more miles away.  They know what you have done and can do for them.  If left to their own devices they would probably continue to do business with you.  But their employer is in serious trouble and losing market share.  They are told that they must lower costs in order to sell cars.  The only way they can do this is to get you to lower your prices and to design out costs wherever possible.  Since you have a lot invested in capital equipment and have a lot of fixed financial costs, you initially accede to these “requests”.  After a long enough period of time selling above variable costs but below total costs leads to bankruptcy.  This is exactly what is now happening as suppliers are experiencing a secular decline in business not a cyclical one.

 

If the Big Three continue to pursue their current strategy, and if the U.S. based suppliers are unable or unwilling to change their strategy, then more U.S. based suppliers will either go out of business quickly or be unable to invest in new technology and slowly lose their competitiveness.  One would think that this is bad news for suppliers and that automakers would just move to a new supplier base.  The Big Three is very likely going to have a cost to pay. 

 

While the Big Three never had recognized formal or formalized relationships with its supplier base like the Keiretsu OE – supplier relationship in Japan, there are many relationships that are mostly unrecognized by the automaker or the public at large.  Many suppliers both large and small have had long term relationships with one or more of the Big Three.  In addition to the well-known relationship between the spun out Delphi and Visteon with GM and Ford there are scores if not hundreds of suppliers who have been doing business with the same automaker continuously for decades.  When Ford had a problem with Firestone Tire it became public that the relationship between the two companies went back to their founding.

 

The result of these longstanding company-to-company relationships is that both companies have a number of employees who have developed personal relationships with one another.  In our business culture when this type of business relationship is formed there is usually a high level of trust between employees of both companies.  This means that when one side has a problem the other side is more ready to work with them to work out the problem to their mutual benefit.  When Chrysler was near bankruptcy many of its suppliers assisted in the rescue both for their own self-interest and for Chrysler’s interest.  How easy will it be for a production line engineer at Ford or GM to pick up the phone and call the engineer at a Chinese supplier to tell him of a problem with the component being supplied to the plant by the Chinese parts maker.  When the American supplier is no longer providing design input because the company is out of business or no longer a supplier to the U.S. automaker, who is going to replace his experience.  Will the Big Three automaker hire additional engineers a few years after these people were laid off or will they expect the same level of service and understanding of the problems and issues from the Chinese or Indian supplier.  Just as the quality of GM’s cars suffered during the reign of Jose Ignacio Lopez all of the Big Three will suffer of the U.S. supplier base is crippled to the point of no return.  The only way the Big Three are going to survive in the U.S. is for their supplier base to survive.  The nature of the relationship and the number of players may change, but there must be an American supplier base for there to be a Big Three.

 

The path to survival

 

The larger U.S. based suppliers such as Johnson Controls and TRW Automotive have long seen their future as not being tied to one or two companies and one market.  Johnson Controls has been very aggressive in obtaining business with the Japanese and German owned automakers building cars in the U.S.  They have formed joint ventures with a number of foreign owned seat makers in order to obtain much of this business.  They have also followed the Big Three overseas and built plants to serve the Big Three all over the world as well as to serve their new customers outside of the U.S.  While their U.S. based sales to the Big Three are still the biggest portion of their business, this share of total sales is steadily declining and is being replaced faster than the decline in absolute business.  TRW Automotive has also long been active overseas and has been involved in both the heavy-duty market and the aftermarket.  This helps shelter them from the declining market share of the Big Three in the U.S.

 

In the recent past many companies thought size was what determined success.  As a result many companies took on additional debt in order to grow through acquisition.  But size itself is not what leads to success.  Look at the financial problems Delphi and Visteon have.  Their problems are mostly related to their over reliance on one customer.  Other companies that took on too much debt like Hayes Lemmerz, Tower Automotive, Oxford Industries, etc. had to declare bankruptcy because they could not generate the necessary cash flow to service debt and finance growth.

 

To survive and prosper in the current environment suppliers must take advantage of their strengths and put their resources in those areas.  Right now the Big Three are desperately looking for ways to survive and management does not appear to be focused on the long term.  Therefore selling the supplier OE relationship as a long-term benefit will not get one very far.  However, there is a value to that relationship and the OE recognizes it.  If you are a current supplier in good standing to one of the Big Three you have a real advantage over a Chinese or Indian supplier that is not currently supplying the Big Three.  However, this advantage is only useful if you can maintain your competitiveness with these Chinese and Indian suppliers.

 

So how do you utilize this advantage?  Well first you take stock in what makes you a good supplier.  Do you have proprietary technology that is wanted by your customers?  Are your manufacturing operations among the most efficient in the world?  Do you have a good design and engineering team?  In other words what is it that you provide to you customer that keeps him coming back to you and not to one of your competitors and will whatever it is still be the case for you in five years. 

 

A little over five years ago we conducted a study for an aluminum wheel company that wanted to know what their customers (GM and Ford) thought of them.  What were their strengths and weaknesses?  This company got most of their business because they offered the lowest price and most of their business at the time was in the least profitable small size segment of aluminum wheels.  In talking with the engineers and purchasing people we discovered that our client did not have a good reputation for following through on commitments.  This made everyone’s job at the OE more difficult and likely had a negative financial impact on the customer, although it may not have been recognized and quantified.  So when given the choice the engineers and purchasing people steered the aluminum wheel business to other suppliers.  It was only with regard to low priced models where cost was most important that our client was able to win business.  I doubt our client made any profit on that business.  During these discussions with the automaker officials we learned that one of our client’s competitors was viewed as being outstanding in delivering what it promised.  This company was constantly being awarded new business and higher margin business even though its prices were higher than those of our client.  What they provided the OE was a good product and excellent and reliable service.

 

We do not believe the teams of engineers and purchasing people sent to India and China are the most efficient way for the Big Three to lower their cost of sourcing while at the same time maintaining their quality and production schedules.  They just do not have the people necessary to do this job and they are not in the financial position to hire them.  The U.S. supplier is much better positioned to do this.  Even if the supplier is only making parts and not component systems, it should still think of its business as a systems integrator.  First there is the contact with the customer about potential new business.   Then the part must be designed and priced.  In doing that the supplier must determine whom it is going to choose as equipment and material suppliers as well as any process or parts suppliers it needs to make its component.  The next step is the part must be manufactured and delivered to the customer.  All during this time the supplier must be in constant contact with the customer at several levels to insure the part is delivered on time and within specifications and to insure payment is made.

 

If China is indeed the low cost area to manufacture auto parts then how can the U.S. based supplier take advantage of this situation?   The U.S. supplier does not need to build a plant in China.  In fact that is probably not the best solution.  Nike does not build plants overseas.  They keep moving production to the low cost sources.  Twenty years ago it was Korea then The Philippines and Thailand and now China.  All through this process, Nike USA maintained control over design and sales.  The U.S. supplier needs to identify Chinese or other suppliers that can produce a good part for a price significantly lower than the U.S. supplier’s internal costs. 

 

This outsourcing of manufacturing accomplishes two things.  First, it allows the supplier to provide its customer with a lower cost part.  Second it frees up capital that would have been spent on equipment to be spent on additional design & engineering resources, further systems integration and supply management.  The U.S. supplier is in a better position to work with the Chinese manufacturer than is the U.S. automaker.  The U.S. supplier is also in a better position to work with the U.S. automaker than is the Chinese supplier.  A shift like the one being suggested is not without its problems.

 

There is the question of what to do with existing manufacturing capacity and employees as well as how to reorganize the company to better undertake its changed tasks and responsibilities.  The first fact that needs to be recognized is that the long term survival of the company requires this change.  The status quo for the company will not work because their business has changed.  Their customer is losing market share and is looking to dramatically lower costs.  Therefore, some plan to de-emphasize in-house manufacturing must take place.  It may be costly in the short run but is probably preferable to all concerned over the slow and painful shrinkage that will inevitably take place.  The community will suffer as it loses some of its tax base and jobs and the displaced employees will suffer until they find a job to replace the one they lost.  There is no alternative given the facts as they exist.  The best hope is that the company succeeds in the shift and is thus able to better provide for those who were displaced.  If the company fails then everyone suffers.  The upside to the community, if the company is successful in the transition, will be a demand for higher level, higher paying jobs in design, engineering, and supply chain management.

 

Given the high costs of manufacturing in the US versus China that result from high relative labor costs, NIMBY local, state, and even Federal attitudes, stricter environmental laws, federal tarriff and quota actions, older manufacturing equipment that has yet to be fully written off, and higher taxes on property and equipment it is almost inevitable that a significant percentage of the manufacturing portion of auto parts industry will move to lower cost environments like China and India.  The traditional US supplier, in order to survive and prosper, will need to move up the food chain and become more of a systems integrator building on its relationships, design and engineering capabilities and its ability to attract and optimize the use of capital.

 

What is next

 

There are a number of suppliers that have not given adequate thought to these issues and many also do not know what steps to take to get started.  Also some may believe that either this is an over-exaggeration of the situation or another alternative approach would be better.

 

We would like to hear from those suppliers in the trenches to see what you believe and to see where you think you would like assistance.  After collecting your comments we will publish another paper laying out some suggestions on how you can turn some of these threats into opportunities.

 

You can respond directly in the comments section or send an e-mail to info@eautoportal.com.