Lower-tier suppliers and the automotive recovery

Bottleneck ahead?

STAMPING JOURNAL® MAY/JUNE 2011

May 11, 2011

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The automotive suppliers who survived the recent economic crisis are smaller than before and their capability to add capacity has been reduced. With predictions of 15 million cars sold in 2011, this is a big concern.

As the automotive sales and production recovery continues, concerns are being raised within the industry about the risk of production disruptions caused by lower-tier suppliers' inability to fulfill more orders from their customers. At the moment only a few production interruptions have cascaded from the lower tiers to automaker assembly plants, but as sales and production forecasts become increasingly optimistic, the apprehension has been rising.

In 2010, 11.6 million vehicles were sold in the U.S. Such volumes are so far below the 16 and 17 million unit levels seen as recently as 2007 that it seems suppliers should have no trouble meeting the parts requirements of today's smaller market. After all, even when the industry was selling 17 million units annually, it was suffering from an immense overcapacity problem that prevented many of its stakeholders from being profitable even amidst booming sales. Current sales and production levels, therefore, should not be a problem—right?

It's not quite that simple, of course. The recent economic crisis drove many suppliers out of business. Even though many industry observers are pleasantly surprised that fewer suppliers disappeared than they had expected, the problem is not just in the number of firms—it's also that the surviving firms are smaller and their capability to add capacity has been reduced.

In Suppliers' Own Words

The Center for Automotive Research (CAR) recently has been interviewing executives from Tier 1 suppliers, as well as some from lower tiers, about these issues. The feedback has been remarkably revealing.

One CEO of a lower-tier supplier put it succinctly: In his opinion, if an OEM experiences a production disruption as a result of a lower-tier supplier being unable to satisfy an order, it is most likely the OEM's fault. His logic is that if the OEM were offering a reasonable price and terms on the contract, suppliers would be willing to add capacity, and just as important, banks would be willing to provide the financing necessary to put it in place. In his opinion, no crisis needs to take place if the industry can maintain the proper relationships and business terms.

This conversation yielded another critical perspective: This supplier, because it is doing well financially, had entertained four visits from banks offering loans in the two weeks before the interview. Despite reports to the contrary, ample credit appears to be available to lower-tier suppliers—but it's available only for the firms that need it least. This discrepancy threatens the suppliers who currently may not be doing well financially but would be saved by increased production orders if they could only get the loans necessary to fulfill them.

These "on-the-bubble" firms face an even greater risk: During conversations with Tier 1 purchasing executives, several expressed concern about new business gradually consolidating among the healthiest lower-tier suppliers, which would bring down many of the less healthy firms.

It's a scenario rich in irony. Out of fear of production disruptions, OEMs and Tier 1 suppliers prefer sourcing more business from lower-tier suppliers with healthier balance sheets. The remaining, less healthy suppliers still hold multiple contracts and have the capacity to disrupt multiple supply chains if they fail as a result of these changes. In trying to prevent production disruptions, the industry may create a new way of causing them.

Increasing Sophistication in Supplier Relations

The good news, however, is that purchasing departments at OEMs and Tier 1 suppliers are increasingly savvy and aware of these risks.

Across the board, purchasing executives have expressed a renewed concern about total lifetime cost and quality, as opposed to simply focusing on piece price. They also have stated that purchasing managers are being evaluated more on these parameters, as opposed to the price markdowns that previously motivated them.

Suppliers also are incorporating quality and engineering staff in purchasing teams more frequently. This gives lower-tier suppliers a better opportunity to pitch their product and its total benefits, including quality and durability, and is another means of focusing the decision on factors other than piece price.

The Stakes Are Rising

For the industry as a whole, these changes cannot come soon enough. The industry's volume recovery is not only continuing, but accelerating. Forecasters are routinely increasing their forecasts for 2011 light-vehicle sales. Only a few months ago, predictions around 12 million units were common. Today many forecasters are mentioning numbers closer to 15 million units this year and a continued rise in the years following.

If there were concerns about lower-tier suppliers meeting shipment orders in a 12-million-unit market, alarm bells should be going off when forecasts of 15 million units start appearing. Clearly, it is critical for the automotive industry to solve this issue if it is to take full advantage of the long-awaited sales recovery it is finally enjoying.

Looking Ahead

Many industry observers describe this as a good problem to have. After all, in an industry that was for decades associated with overcapacity, the prospect of having too many orders to handle is a relatively rare experience.

It appears the trick will be balancing market forces with pricing sanity and getting the banks to play along. Increasingly, it will take many stakeholders in the industry working together to achieve such a goal, as opposed to executing a given strategy at a single firm.

For the small suppliers who have weathered the storm of the last three years, it appears success and prosperity are just around the corner—if too much success doesn't prove as harmful as its absence did.



Center for Automotive Research

Bernard Swiecki

Contributing Writer
Center for Automotive Research
1000 Victors Way
Suite 200
Ann Arbor, MI 48108
Phone: 734-929-0484
The Center for Automotive Research focuses on the future of the international automotive industry. Its overall objectives are to provide industry research and analysis, communication forums, and informational resources that respond to the changing needs of the international automotive and automotive-related industries.

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