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Capacity Shortages Loom for Lower Tier Suppliers

The recipe for collaboration requires key ingredients that are not yet in place.

Many of you reading this headline may either be wondering has this guy lost his mind or is there possibly a typo in the headline. It is neither, and let me present the logic that has led me to this conclusion. But before we go there, let’s review conventional wisdom.

Conventional Wisdom

Capacity utilization is obviously different for different manufacturing process technologies. North American stamping capacity utilization is estimated at approximately 65 percent, the injection molding industry averages about 55 percent, while the mold-making segment averages less than 50 percent. So with these types of numbers how can one possibly believe there is capacity shortage looming? The answer resides in the criteria used by customers to make sourcing decisions. The three-dimensional cube (see Figure 1) represents a depiction of several of the critical criteria used by typical customers in making sourcing decisions.

Sourcing Is Multi-Dimensional

It starts with sourcing work to your best performing suppliers, typically a subset of the total supply base. Even better yet is sourcing the work to a strategic supplier with special knowledge and capability in the particular component or module being sourced. Dimension two relates to the “right” capacity including things such as tonnage, bed size, speed, secondary processing capability, and obviously the right processing technology (e.g., insert molding, casting, OBI press). The third dimension of the sourcing cube relates to geography. Is the required capacity available close enough to the customer plant to be competitive or provide a transportation savings to the customer?

Based on the notions reflected in the cube, the question now becomes, “Does a strategic supplier with the right equipment in a favorable location have capacity that the customers needs?” The answer to this question is mostly “No,” in today’s North American supply chain. Let’s take the process technology “progressive stamping” as an example to illustrate these points. The average capacity utilization rate based on supplier-defined operating pattern in North America approximates 65 percent for automotive stampers. Is there substantial mid-bed size 400-ton capacity available in Detroit, Chicago and Cleveland?

Absolutely, there are tens of thousands of hours waiting to be utilized, and generally at very attractive prices. Is there 1,200 ton, 28- strokes-per-minute, 240-in. x 96-in. transfer capacity available within 250 miles of Lexington, Kentucky? I think not. Then if we add the condition we want the supplier in our supply base, and we greatly prefer a strategic supplier, then the answer becomes “highly unlikely.” This is the relevant context in which sourcing decisions are made every day by hundreds of OEM and Tier 1 customers.

Strong Suppliers Continue to Add Capacity

Continuing with the stamping example, I am aware of nearly a dozen stampers who in the last year alone placed orders for presses each with a price tag of $1 million or more. These presses were generally big bed, large tonnage, relatively fast progressive and transfer presses. These press orders were placed without exception by suppliers who were top performing (i.e., top 20 percentile in financial performance), generally with desirable customer arrays, strong balance sheets, capable operators, many executing a geographic expansion strategy. For these suppliers business is good right now. For many of these suppliers their biggest challenge is making sure business scale-up is being effectively managed and controlled.

For suppliers and customers there may be excess total capacity, but there is a shortage of needed capacity. Many of the suppliers with comparatively low capacity utilization rates are holding on by a thread. They have what everybody else has, excess capacity in segments that people don’t need and where pricing is ultra competitive. For these suppliers the clock is ticking, and capacity will eventually be removed from the system.

What is the long-term implication of this capacity shortage? It provides effective operators and financially strong enterprises with a substantial opportunity to improve their positioning relative to other competitors. They are installing new capacity desired by the marketplace in locations where it is most needed. This equipment is the most reliable, the fastest, and in most cases the most agile and flexible. Where new equipment (i.e., capacity) is being installed, it becomes very difficult for the old installed capacity to compete with this new technology. It simply is faster, more flexible, more reliable and produces a lower cost per hit than the less efficient even fully depreciated competitor’s equipment. The strong are getting stronger, and the weak are holding on, at least for now.

Capacity Disequilibrium

What we more accurately have is capacity disequilibrium. We have too much capacity A, B and C and too little X, Y and Z. Further, suppliers with capacity in A, B and C segments do not have the option to sell the excess equipment and replace it with needed X, Y and Z capacity. Why? Because these suppliers typically do not have the required balance sheet, management talent and best-in-class performance that its customers demand. Many of these suppliers are in a doom loop.

Customers are dealing with this situation in business-like and predictable ways. In sectors with excess capacity, aggressive pricing practices are being used to lower purchase costs. In areas where there is inadequate capacity, suppliers are awarding work to their long-term strategic suppliers with the financial and people resources to make the investments required by the customer.

Most of the supply chain’s available capacity exists in pockets with little customer demand. Capacity truly needed by customers is in short supply and highly coveted. High performing suppliers (comprising approximately 20 percent of total suppliers) are accelerating their investments in capacity desired by their “customers of choice.” These suppliers are building further competitive advantage and making it progressively harder for the remaining suppliers to sustain their businesses.

Craig Fitzgerald is a Partner at Plante & Moran, PLLC and helps suppliers use strategic positioning to improve financial performance.

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Wed. November 29th, 2023

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