YPN Insight
This section is for thought leadership pieces from SAA Young Professionals Network members. To submit your YPN Insight, please e-mail info@saaautoleaders.org.
Lars Luedeman, Grant Thornton and SAA Member
Chris Brower, KPMG and YPN Director
Staggered move to mirror OEMs’ global focus
The auto industry is in recovery mode. Companies are revving up production, and first-quarter earnings announcements showed signs of a much healthier industry. Many automotive companies are now benefiting from having made some difficult strategic decisions and having adapted quickly to the new economic conditions. As the industry looks ahead to a U.S. economic recovery and the associated growth in sales and production, which suppliers are poised to benefit?
The best-positioned suppliers will be those that are considered long-term partners by their OEM customers for particular commodities. But what does that mean? How do suppliers establish and communicate value in the marketplace? Value is a subjective term with attributes that include:
• technology leadership,
• competitive manufacturing and engineering footprints,
• competitive pricing,
• launch capability, and
• financial strength.
The relative importance of these factors varies depending on the OEM (and to a certain extent on the functional areas of the OEM). It is critical that suppliers understand their value propositions, because a profound turnover of vehicle and powertrain platforms will occur as GM, Ford and Fiat-Chrysler continue to shift their production strategy to a global approach.
To operate on a global scale, automakers will continue to reduce complexities in the sourcing process through consolidation of the supply base into a smaller group of key component and service suppliers. The realized benefit of these actions is an increased number of long-term relationships, closer collaboration, and improved financial performance through a more focused purchasing approach.
The largest suppliers with revenues in excess of $500 million (estimated to make up one-third of the total North American supply base) may be the best-suited to capitalize on this trend. To further strengthen the customer relationship, however, they will need to ensure that their footprint is as global as their customers. That means following the same low-cost regional approach in North America that many OEMs are embracing, whether through organic growth, acquisitions, or joint ventures and strategic alliances.
As illustrated in the table below, over the last 18 months the stock performance of some of the largest and most recognized North America-based automotive suppliers has outpaced the market since the credit crisis took hold in September 2008. It is likely that many of these firms meet the value attributes outlined above for global OEMs.
While all companies have faced challenging times during the latest downturn, these companies stand apart based on their sheer size alone — and because they maintained, in large part, strong balance sheets while focusing on core operations and leveraging their particular strategy in an uncertain market. The strategy levers were varied and included product technology differentiation, strong aftermarket presence and/or significant revenue that was not automotive-based. These suppliers’ roadmaps to survival (and those of other suppliers) included some of the following actions:
• Restructure early (and often) with a focus on preserving your core strengths. Those suppliers that did ultimately exited the crisis in a better position than when they entered because they took the opportunity to make fundamental changes to their operating practices.
• Relentlessly focus on cost-cutting actions including temporary wage or benefit reductions, in-sourcing of certain processes or services, and facility consolidation or closure. Ultimately, the survivors reduced cash outflows and lowered their break-even points to align with market demand.
• Develop more flexible contracts with your own suppliers, customers, lending institutions and other key stakeholders.
• Mitigate risk exposure through a more diversified market, customer and/or region mix.
• Maintain some level of R&D investment focused on innovative technologies that provide products that differentiate the company from its competition.
• To the extent possible, maintain new product launch cadence for your customers.
As mentioned, other suppliers performed similar actions, and though those suppliers lack the same scale as the mega-suppliers listed in the chart above, they offer valuable facilities and technologies to customers. However, many middle-market suppliers (i.e., those under $500 million) tend to have more fragmented product portfolios and are not necessarily able to deliver their products to various regions around the world because of financial, personnel or other constraints. Further, smaller Detroit-dependent suppliers that provide commoditized products (e.g., injection molding, metal stamping) will have to reassess and demonstrate a change in strategy or possibly risk being labeled noncore by key customers going forward. Actions for these suppliers to consider may include:
• creating strategic alliances with complementary companies to pool R&D costs and support OEMs’ global requirements;
• diversifying their customer base, either to Asian or European OEMs, by offering non-automotive products or moving down the supply chain to be sourced by Tier 1 suppliers; and
• managing material costs through hedging programs, OEM purchase programs or material-indexed pricing contracts.
Nearly every supplier should benefit from the forecasted year-over-year production increase. However, the shift under way toward global platforms will still leave many suppliers with revenue tied to noncore, nonglobal OEM platforms. Many of these firms will struggle in 2011 and 2012 with a diminishing value proposition from the customer’s perspective.
The future survivors have already begun assessing their strengths and weaknesses through the filter of an increasingly globalized industry. Globally capable companies, lean from the crisis, ready with innovative products, and strategically chosen by customers have the potential to provide continued positive returns as the automotive market continues to recover and grow over the next few years.
Globalization will do what the latest recession did not: Namely, reduce the size of the Tier 1 automotive supplier base by subsector — though not necessarily the aggregate total. Rather, we expect a thinning of the herd on a commodity-by-commodity basis as suppliers begin to exit specific product lines either through direct OEM sourcing decisions, divestiture of noncore operations, or re-tiering of regional suppliers to Tier 2 or Tier 3 positions.
