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


Auto Suppliers in Crisis:
1. The Coming Shakeout

As the auto suppliers fight through the turmoil of the next few years, the biggest change in the industry will be the transformation of large, unwieldy suppliers with multiple product lines into streamlined companies that make parts for only those markets in which they have strong competitive and manufacturing positions. Decisions about which product lines to support will be based mainly on development costs: the skills required to design and engineer an item; production economics, such as manufacturing scale, the location of factories, labor costs, and logistics and distribution complexities; and market relationships.

One relatively easy way to untangle the coming consolidation and restructuring in the North American supplier market is to break down the industry’s products into two categories: commoditized and technology driven.

Product development costs for commoditized items, such as brakes and batteries, are extremely low, so the market structure is driven primarily by the least expensive freight costs for equipment made by the least expensive labor coupled with manufacturing scale. For products that can be shipped inexpensively (relatively lightweight supplies such as brake calipers and pads, for example), freight costs are minimal compared to production, so suppliers will more likely be global operations making these items in low-cost countries. When freight costs are somewhat higher but not extravagantly so (for example, for batteries), suppliers will attempt to set up regional plants, close enough to the automakers to minimize shipping expenses but far enough away to enjoy beneficial labor rates and production efficiencies. And when freight costs far outweigh the price of production (as with stamped products like body panels and roofs), suppliers will, in effect, co-locate with their customers.

For technology-driven products, development costs must be balanced against production economics. In automotive electronics, for example, R&D and design expertise and costs far outstrip manufacturing and logistics in both importance and price. Consequently, there will be a limited number of surviving suppliers (Bosch, Conti, and Denso are the current leaders) with factories that are essentially engineering shops providing products for global markets. By contrast, when the benefits of scaled production and high-volume output can offset high development costs (as in air-conditioning compressors), regionally concentrated markets will dominate. And when production must be local and initial investments are high (for example, in car seats), a concentrated two- to four-player structure will be the likely result. These suppliers will have to mix global reach for some products and regional reach for others to gain enough worldwide bargaining power to cover the investment costs of the locally produced items.

Simply put, North American suppliers should gird themselves for the wholesale consolidation of good assets and the purging of bad assets within each product line. In many cases, private capital may be the best source to fund such a complex restructuring, in large part because a public enterprise, with its fragmented ownership structure, is unlikely to easily swallow the execution risk, successfully manage the dozens of acquisitions and asset sales, and have enough patience for the long-term process — perhaps as long as five years — that the restructuring of the industry will require.

By contrast, private capital is much more drawn to the undervalued assets that the suppliers are holding, and private capital firms have the funding ability to liquidate noncompetitive business units and factories, write down liabilities, delink good product lines from bad, and consolidate suppliers and their core talents. In addition, private capital firms have the means to provide management with incentives to create long-term value. As overcapacity and excess players are cleaned out of crowded sectors of the supplier market, and as more sensibly organized niches with sustainable profit potential are created, the payoff may be sizable. When the restructuring is complete, slimmed-down, better-targeted suppliers could be candidates for very successful public offerings.

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