As the number of suppliers decreases, those left must get bigger. Are they prepared for this escalating growth?
The North American automotive parts supply chain has been in a continuous state of consolidation since the mid-1980s. Based on recent announcements by the likes of Delphi, Visteon, Bosch, Lear Corporation and numerous others, it is safe to expect this will continue for the indefinite future.
What isn’t so widely understood about this consolidation trend is the tremendous stress this is going to place on suppliers and customers alike. There is substantial question about whether there are sufficient suppliers ready, willing and able to successfully execute the grand strategy that so many OEMs and Tier 1s have converged on.
Supply Base Cut in Half by 2010
Precise and reliable data is not available on the size of the North American automotive supply base. However, most industry observers peg the total parts supplier count around 3,000 enterprises. The automotive industry consultants at Plante & Moran, PLLC believe this count will decline approximately 50 percent by decade end. Liquidations and sale transactions will eliminate approximately 60 percent of today’s suppliers, offset by approximately 10 percent of new entrants from Europe, Asia and North America. We believe the composition among tier levels will approximate the following: 200 Tier 1; 550 Tier 2, and 750 lower tier — 1,500 suppliers in total. This is quite a change from approximately 10,000 total suppliers in 1988.
Fundamental Supply Base Restructuring
There are a number of fundamental factors and considerations that continue to drive supply base consolidation. These include:
- Excessive total costs incurred by customers because of overly complex, weak and fragile supply chains.
- Need to access the latest and best technology and innovation for certain commodities (e.g., powertrain, safety, infotainment, chassis and braking, electrical).
- Need to work with true low-cost producers for many commodity products (e.g., hardware, brackets, reinforcements, fasteners, spacers and many part to print body-in-white and chassis components).
- Increased sharing of parts across platforms and over geographic regions.
- Continued transferring of engineering and development responsibility deeper into the supply chain.
- The need to unify design and process engineering functions at a single supply node to enable design for manufacturability (DFM).
- Customers need to work with the best and financially strongest suppliers.
The Math is Simple, but the Situation is Not
Let us assume the North American vehicle market grows 2 percent per year. Further, we assume the average annual price reduction granted to customers is 2 percent, and there are no customer initiated insourcing/outsourcing actions related to parts and assemblies. If the supply base is reduced by 50 percent based on customer consolidation initiatives by 2010, then the average supplier must become twice as big as today by decade end.
What does this mean to the surviving part suppliers? More complexity, more plants, more geographic locations, more manufacturing technologies, more assemblies, more suppliers, more part numbers, more purchases … and the list goes on. The average supplier has substantially complicated its business based on the simple proposition of doubling in size. For most lower tier suppliers, a doubling of business represents an exponential increase in complexity, issues and difficult things to manage.
How many of today’s suppliers are ready to take on this load? It depends on their talent depth, systems maturity, IT enablement and overall leadership quality and quantity. How many suppliers have strong and stable enterprise resource planning practices and systems, robust and effective program management practices, sufficient engineers to handle the increasing product and process design work load, effective source selection and supplier management processes, capable and extra leaders who are dying to take an overseas assignment, and self-perpetuating cost reduction processes in place? This is certainly not the profile for the average North American supplier firm. In fact it is not even the profile for most of the highest performing suppliers. Today, less than 10 percent of suppliers are ready and able to double their sales in a short five-year window.
Not only do most of these enterprises lack adequate management talent, entrepreneurial vision, ambition and core business processes, but they also lack financial capital. Growth of 100 percent requires huge amounts of working and fixed capital. The fixed capital funds new plants, staff additions, product development, information technology improvements, equipment maintenance and new and more productive equipment and automation. Add to this working capital consumed by financing customer-owned tooling, inventory and accounts receivable and it really begins to mount up.
Where does capital come from in an industry that averages less than 3 percent operating margin expressed as a percent of sales? Capital could be self-generated through the operation, an infusion from the shareholders, loaned by bankers and other traditional debt sources, private equity, or possibly raised through an initial public offering (IPO). In certain cases this may be practical. But in many (and probably most) this is infeasible. Today’s lackluster 3 percent operating performance compares with a threshold level of approximately 7 percent operating margin for a privately held enterprise to retain their capital in the business over the long haul.
The only way capital is going to be attracted into this market to fund the consolidation described above is by transitioning earnings performance into substantially higher performance levels than today.
The grand plans formulated by many customers will not fully materialize without an increase in engineering and managerial talent, better use of information technology, higher returns on invested capital, and growing confidence by lenders in the prospects for the supplier industry. Those customers able to recognize this condition and get a jump on reality, build the culture, implement robust systems and processes, and begin to make supply chain management a core competency will realize a sustainable advantage relative to their competitors.
Craig Fitzgerald is a partner at Plante & Moran, PLLC and helps suppliers use strategic positioning to improve financial performance.