The North American Automotive Industry in Interesting Times: Suppliers Struggle to Build a Sustainable Business Model
The North American automotive industry is now in the latter stages of consolidation much like the textile and steel industries that preceded it. Most of the factors are similar; a mature industry, excessive global capacity, new entrants to the market that enjoy a lower cost structure, slow growth except for the emerging markets of Brazil, India, China and Russia, and a technology shift driven by rising energy costs and environmental issues.
In the NAFTA region, the traditional OEM’s continue to lose market share to the newer, low-cost, innovative entrants from Japan and Korea as they brace for the arrival of product from China and India. Europe will not be immune to these trends and already supports too many regional OEMs.
The business environment has changed, favoring the more nimble, lower cost, niche oriented newcomers. There is every reason to believe that consolidation will reduce the number of global OEM’s significantly, encourage joint ventures and narrow the product focus of all but a few OEMs.
John Casesa, a former Merrill Lynch automotive analyst, points out that Asian automakers have shortened the product life cycle by spending more on product development and this, in turn, drives their increasing market share and profitability. The right product at the right time drives sales and today there is unprecedented customer choice. In contrast, Ford, GM and DCX, handicapped by high legacy costs and bureaucratic management structures, have been left to compete on price rather than product and with declining profits or in some cases, losses, there is no alternative but to narrow the product offering.
As might be expected, North American automotive suppliers are experiencing collateral damage. Those dependent on the weak OEM’s, especially those suppliers with limited or mature product or process technology, and those without global reach are suffering the most.
By some accounts, half of the major North American automotive suppliers lost money in 2005 and few earned more than 5% on revenues. Plante & Moran, industry consultants, estimate that earnings before interest and taxes (EBIT) of 8% are required to cover the cost of capital and investment in the future. Over the past two years the alarming rate of bankruptcies has been well publicized. At the recent Automotive News World Conference, Tony Brown, Ford’s top purchasing executive, commented on the excess capacity in the injection molding, interiors and metal stamping supplier segments, foreshadowing more bankruptcies in 2007. As financial results are released, it appears that 2006 was not much better than 2005. With a decline in vehicle production forecast in 2007 and base material cost at historically high levels, domestic automakers continue to pressure suppliers’ margins and act adversatively.
Global auto suppliers are faring much better according to a study by Roland Berger Strategy Consultants. A sample of 350 global suppliers showed an average EBIT of 5.9% and a return on capital employed (ROCE) of 11.3% in 2005.
Why, then, is there considerable private equity interest in this segment and a recent up-tick in automotive supplier stocks? Some see a repeat of the consolidation driven efficiency gains of other mature industries. These investors should not underestimate the purchasing leverage of the OEM’s and their commitment to promoting price competition. On the other hand, some investors recognize that this is a huge market, $950 billion worldwide, with healthy growth projections for the emerging countries. CSM Worldwide projects that the compounded annual growth rate (CAGR) over the next six years will average 9% in Asia, 6% in East Europe, 3.7% in South America and only 1% in the mature markets of North America, Western Europe and Japan. Current projections by industry experts show vehicle sales in China equal to U.S. sales by 2020!
The U.S. market still accounts for over 16 million light vehicle sales annually; the largest single market in the world! North America accounts for over 19 million light vehicle sales annually.
Those suppliers focused on safety, fuel efficiency, environmental controls and the continued proliferation of vehicle electronics will share in the 6% to 8% per year growth rate projected for these applications in all market regions. Telematic Research Group, Inc. reports that electronic dollar content per vehicle in North America will grow from 30% to 35% by 2010. This favors not only systems integrators but suppliers of sensors, electrical actuators, low current switches, driver information management and display, telematics and electronic controls and components. As these systems become more integrated and complex, software will be a larger component of the value added.
Accenture Consulting summarized a multi-year study by defining the ideal supplier’s business model for this climate:
- A low-cost producer by global standards; A combination of lean manufacturing, value chain management from the sub-supplier to the OEM, and utilization of low-cost offshore manufacturing.
- A differentiated producer; Likely focused on electronics, safety, fuel efficiency, or environmental controls with innovative product and process technology.
- An integrated customer value stream; Seamless product development and launch capability combined with continuous product life cycle management capability.
- High mix capability in both design and manufacturing; Niche vehicle content will continue to afford the best profit opportunity if the product proliferation can be managed efficiently.
I would add that a global presence in the high-growth emerging markets and a diversified customer base that mirrors the shift in OEM market share are also highly desirable.
In such a hyper-competitive market, it is hard to hold the low-cost position or continue to reduce costs indefinitely to sustain profitability. Optimizing internal efficiency and effectiveness in every customer critical process is necessary but not sufficient. Organic growth combined with aggressive product life cycle management which allows re-pricing or planned obsolescence of existing products is also required to maintain or improve profit margins. Design, development and product management are areas in which to focus process improvement, but simply reducing spending in these areas to improve the bottom line will risk yielding market position to the competitor.
A strategic acquisition program can also improve the odds for success. This is a buyer’s market and when it comes to diversifying the customer base, adding new technology and expanding global reach, acquisitions and joint ventures become the fastest track if planned and executed properly.
Sustainability in this business environment requires a comprehensive strategic plan designed to bring internal business processes to world class levels as well as targeting joint ventures and acquisitions that will add competitive advantage. Building shareholder value becomes a complex integration of cost management and entrepreneurship, cultures not usually compatible.
GGI is committed to helping you achieve your goal of sustainable profitable growth. We are prepared to participate in this process and provide the objective outside opinion necessary to avoid the natural bias and comfort with the status quo.