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 / Winter 2009 / Issue 57(originally published by Booz & Company)


Auto Suppliers in Crisis:
1. The Coming Shakeout

This bedrock U.S. manufacturing sector is facing consolidation, further cutbacks, and renewal.

Although auto suppliers comprise the largest single manufacturing sector in the United States, with about 400,000 workers as of July 2009 — more than three times as many employees as automobile manufacturers themselves — this sector is also one of the country’s most troubled. Indeed, that employment figure reflects a drop of 140,000 jobs in 12 months. And those job losses, unfortunately, are among the first in a radical restructuring that will rapidly change the face of the North American auto industry.

The retrenchment of the Detroit Three has pushed North American suppliers to the brink of bankruptcy. Veteran companies like Visteon, Delphi, and Lear are already in Chapter 11, and the balance sheets of TRW Automotive and Tenneco are burdened with unsustainable amounts of debt. Several smaller suppliers have filed for protection from creditors or have completely exited the business. This sectoral correction has been a long time coming; it will likely result in an industry populated only by successful, more targeted suppliers. Those that were in crisis for the last decade or so will be gone. The restructuring will be marked by the elimination of nonproductive assets and capacity, a shift in suppliers’ portfolio of products from broad to focused, and an inflow of private capital that will lead the transformation.

If American auto suppliers could relive the last quarter century, they would probably do things very differently. They tied their fortunes unconditionally to General Motors, Ford, and Chrysler and are paying dearly for that decision. But then, it wasn’t so much a decision as an evolution. As recently as the late 1980s, the Detroit Three still had an enviable 70 percent market share in North America. Yet even at that time, their overhead and legacy labor costs (particularly pensions) were clearly a burden, making it difficult for them to compete against newly aggressive Japanese and Korean competitors. To remain profitable while meeting these real and projected outlays, the U.S. automakers cut corners, sacrificing quality and design. By the start of the 21st century, their market share had begun to erode significantly; it tumbled below 50 percent in 2007.

Unable to reduce capacity, the Detroit Three swung for the fences and introduced many new models, hoping for the hit that could make up for their increasing number of unprofitable brands and styles. By 2004, they were making upward of 130 models, compared to only about 30 manufactured by Toyota and Honda together. In North America, there were 30 percent more models than the market could profitably accommodate — and most of these belonged to the Detroit Three. The automakers tried deep discounting, price wars, and rebates in a desperate effort to hold their own. None of these strategies worked, and the structural weaknesses continued to build until the onset of the global recession and credit crisis, which precipitated a 40 percent crash in sales of annual North American car and light truck units, to roughly 10 million.

Auto suppliers essentially went along for the ride, without considering the risky path charted by the Detroit Three. Companies such as Visteon, American Axle, Tenneco, and Delphi, inexorably linked to Detroit, had bet their future on high volume from the new platforms and models that were being introduced. The sales never materialized, capacity swelled, and structural problems worsened. For well over a decade, North American suppliers generated returns on investment of a mere 4 to 6 percent, not nearly enough to cover their cost of capital.

Other problems plagued the North American supplier industry as well. In some cases, new suppliers with factories in low-cost nations — predominantly China, India, and Mexico — emerged to gradually reduce the cost competitiveness of existing plants in the U.S. and Canada, and even to wrangle contracts with American automakers. Under some financial strain, U.S. suppliers didn’t have the wherewithal to shift capacity to these less-expensive locations fast enough. And selling new business to the rising number of transplant automakers in the U.S. — primarily Honda, Toyota, Nissan, and Hyundai — was not a real option. Most of these nondomestic automakers had existing relationships, often joint ventures, with suppliers in their home markets, and brought these companies with them to the United States. That, in turn, added further capacity to the already overextended North American supplier industry.

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