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Sunday, 03 March 2013 22:00

Brave New World: Suppliers feel squeeze from capacity constraints, new launches and globalization pressures by the OEMs

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Automotive suppliers across West Michigan have no shortage of opportunities these days. Vehicle production volumes are up, new product launches are on the rise, and automakers increasingly insist that their suppliers have a global footprint.

But to take advantage of those opportunities, suppliers had better be brave — and have cash.

As suppliers and analysts look out at the automotive landscape of 2013, they see an industry that’s significantly changed.

For one, vehicles produced in North America are now mostly the same as vehicles produced in other regions. Because of that commonality, OEMs are increasingly looking for global supply chain partners to serve production in all regions. The pressure of globalization is putting the squeeze on suppliers just as they’re having to ramp up for higher production volumes and new launches – and as their cash flow becomes an issue. While going global is certainly a growth opportunity for suppliers, not all of them want the scale and risk that comes along with being a global company. 

The pace of change has also accelerated in the auto industry. Between 2012 and 2015, for example, IHS Automotive forecasts that automakers in North America will launch more than 90 new vehicles. That new model activity has translated into a flurry of new business for the supply chain, which must tool up for the new platforms. 

Adding to the pace of change is increased U.S. customer demand, as well as automakers building more vehicles in North America rather than importing them from Asia or Europe. Since 2008, automakers have added about 1.25 million units of production capacity in North America, according to IHS data.

A consensus of automotive analysts expects production levels to rise 3 percent this year and reach a volume of about 15.9 million units. If they’re right – and barring any major U.S. economic meltdown – it would equal the highest output in a decade since 2003. 

“It feels like you’re a kid on Christmas morning with almost 16 million in production volume,” said Jim Teets, president and CEO of Grand Rapids-based ADAC Automotive, a Tier I supplier of door handles and mirrors. “Unless you’re not very well situated on platforms, the rising North American volume can’t be an excuse for companies doing poorly.”

All eyes on the bottom line

The problem is not all suppliers are created equal in their ability to handle the operational and cash flow challenges inherent with the volume of new vehicle launches.

“While the new launches provide opportunities for suppliers, the changeover also could pose some cash flow issues,” said Mike Wall, director of automotive analysis at IHS Automotive in Grand Rapids. “Not only do you have the cash flow risk in the near term, but then you’ve got the execution risk and certainly the program risk that’s associated with the vehicle itself.”

Suppliers have to lock up a lot of cash in tooling costs to prepare for new vehicles, but they don’t get paid until they start producing the parts for the vehicle, Wall said. Then there’s the question of whether the vehicle will hit its projected sales figures, he added. 

The rapid pace of vehicle launches begs another question of West Michigan suppliers: Are they sitting on enough cash to react to the right opportunities? 

“That’s the billion dollar question right there,” Wall said, noting the larger, diversified international suppliers should be in a good position.

ADAC Automotive, which has plants in Muskegon, Grand Rapids and Saranac, has staffed up in the last 18 months to handle the increased production volumes, as well as expanded into newer and better paint processes, including at a new high-tech paint facility in Muskegon. But in making those moves, the company’s leadership kept a keen eye on its balance sheet, Teets said. 

“More than anything, especially being a privately held company, you have to make sure you’re really, really focused on the bottom line,” he said. “Don’t get enamored too much with top line sales, in our case, getting to $250 or $300 million in sales. Just keep an eye on the bottom line. I’d rather flat line in sales if I can have a consistent, recurrent profitability number that’s adequate to our shareholders and our owners.” 

Teets’ comments reflect the results of Ernst & Young’s Capital Confidence Barometer for the automotive industry from October. The report stated “companies are choosing to focus on the fundamentals.” The percentage of auto executives whose top priority was growth dropped from 89 percent in April 2011 to just 43 percent in October 2012.

“As automotive executives assess how to compete in an environment with lower expected growth, this shift in emphasis toward improving bottom line performance and seeking out new ways to improve performance is understandable,” the report stated. 

Only 2 percent of executives said their top priority was on survival. 

Working in suppliers’ favor is that most have a breakeven point of around 12 million units, according a January report prepared by Deloitte LLP for the Original Equipment Suppliers Association (OESA). Put another way, North American automotive production could drop by more than 25 percent and the suppliers would still breakeven.

“You do like to see a low breakeven because that means you’re printing money on units over that breakeven,” Wall said. “Barring any sort of global meltdown, that’s going to be a very low-risk proposition to reach some of those breakeven numbers. That’s a great thing for the supplier side and great for the automakers themselves as well.”

Who has the wherewithal to act?

After persevering through “the dark days,” Teets said ADAC’s financial health is “back to business as normal” and able to manage through the heavy launch activity, although the company is still being picky in bidding on new business so it can manage through capacity constraints.

“There are definitely capacity issues. Obviously some of the people who were financially unstable went by the wayside in the ’09-’10 downturn,” Teets said. “But I think there’s a lot of people out there who are still a little on the ragged edge with capacity, and I’m not sure they have financial wherewithal to get out of their way.”

Further down the supply chain, IHS Automotive’s Wall said midsize companies should be well-positioned thanks to the “raft of profitability lately.” Although smaller suppliers are in a better position than they were a few years ago, many of them are having a harder time managing their cash flow in the period between tooling up for new models and production, Wall said.

“They’ve done an amazing job, too, of really balancing their cost,” he said. “The challenge is as they go looking for that financing from the banks, they’re running into more questions.”

In the January 2013 OESA Automotive Supplier Barometer report, respondents were asked about their ability to access the required levels of capital at appropriate costs over the next three months. Suppliers of all sizes reported high confidence in accessing capital for plant and tooling investments. However, their confidence in getting capital for offshore manufacturing operations was largely dependent on their size. Nearly 65 percent of large suppliers (more than $500 million in annual revenues) were “somewhat confident” or “very confident” in their ability to access capital for offshore manufacturing. By comparison, only 37 percent of midsize suppliers ($150M to $300M) and only one in three small suppliers (less than $150M) were somewhat or very confident in their ability fund offshore manufacturing. 

While credit is available, banks have gotten out of the business of writing blank checks, Wall said. Instead, they’re delving deeper into suppliers’ business plans and looking at issues such as profitability projections and volume contingencies. Some suppliers have reacted negatively because they aren’t used to being asked those level of questions, he said. 

In the Deloitte report for OESA, 71 percent of suppliers that were surveyed reported favorable relationships with commercial lenders, while another 11 percent said their banking relationships were improving.

Brian Black, senior vice president and business banking executive at Fifth Third Bank in Grand Rapids, said the bank has been working with many auto supply chain manufacturers as they navigate the period of change. 

“I think the bigger challenge is whether the companies are well-capitalized enough to be able to carry this kind of additional carrying expense, which in most cases is going to be debt,” Black said. “Those that made it through really did adjust their expense base to fit into a lower volume model. They’ve actually been quite profitable over the last 12 to 18 months, … but still you might be a little more levered than you’d like to be to take advantage of these opportunities. That’s where it’s a bit of a mixed bag. Some have stronger balance sheets and more capabilities, but a lot of them still have not totally rebuilt the balance sheet (to) pre-2009 levels.”

Luckily, Black said there are a number of new programs available to help small and midsize companies, particularly with mezzanine funding.

Guard against overcapacity

Regardless of how easy it is to access credit, one thing that is certain is that most automotive suppliers – indeed, the automakers themselves – are taking a pragmatic stance at adding any additional capacity or headcount.

“I’d much rather have an industry that’s increasing and maybe a little bit worried about not having enough capacity,” said Wall, who forecasts an era of tight capacity running for another two years. “It’s better than the alternative of (asking) how are we going to get rid of all this capacity because we overshot where we thought the market was going to go. We’re going to bump our heads against capacity shortages here and there. I don’t think it’s going to be life-threatening at the supplier level or the automaker level, but it’s going to make for some interesting times.”

Wall said he expects suppliers to incur more premium freight charges and overtime pay as they wrestle with how to keep up with demand. 

“It’s one of those prices you pay as you try to make sure you have the most flexible operation possible and you don’t overshoot the volumes,” he said. 

Jay Moore, director of purchasing at Ford Motor Co., agreed.

“I think it’s a new world order now with what happened in 2008 and 2009,” Moore said in an interview with MiBiz. “I think suppliers and OEMs are going to be a little more hesitant to suddenly cut metal and lay down capital, so you look at creative ways to manage it. What you don’t want to do is all of a sudden plan for a huge number again and then have it sitting idle. That’s not good for anybody.”

Ford’s creative solutions include initiating some new shift patterns within its assembly plants and working with suppliers to avoid unnecessary additions in capacity, Moore said. The era of constrained capacity also heightens the need for strong relationships and open communications between the OEMs and the supply chain, he said. 

Wall of IHS Automotive said in general, the OEM-supplier relationships “do seem to be reasonably good right now.” 

In its annual 2012 survey of North American OEM relations with Tier I suppliers, Birmingham, Mich.-based research firm Planning Perspectives Inc. reported Ford ranked third out of all North American automakers, ahead of both General Motors and Chrysler, both of which also improved to their highest level on record. Moore credits Ford’s strong supplier relationships for helping the company survive the downturn. 

“Those partners knew that we would be there for them, and as importantly, we knew that they were going to be there for us,” he said.

Pressure to globalize

Those generally improving relationships industry-wide come as automakers look to reduce the number of suppliers they work with and as they try to achieve more economies of scale by shifting to global vehicle platforms.

Increasingly, that means having “a common part with a common supplier across the globe,” Moore said. 

“If you have a Grand Rapids supplier that doesn’t have a global footprint right now, but they have a part that is a global commodity, what we’ll look for them to do is either set up as a global standalone or set up in region with a partner,” Moore said. 

In the case of ADAC, the company is part of the international Vehicle Access Systems Technology (VAST) Alliance with Milwaukee-based Strattec Security Corp. (Nasdaq: STRT) and Witte Automotive of Germany.

“For a company our size – approximately a $200 million company – to have the global footprint we have, we are extremely happy,” Teets said. “Really, if we didn’t have VAST and that global footprint, we probably wouldn’t have defended half of the business we have. We did it as much as a defensive move to protect our home market. About 80 to 85 percent of platforms are going to be global in nature and if you don’t have some form of global footprint, you’re not going to be able to compete in the world marketplace.”

Teets points to Ford’s global platform for the Fusion sedan as “the poster child for globalization or having a global footprint.” ADAC led the design and engineering of the platform’s exterior door handle, which it will produce in North America. Its partner Witte produces the handles in Europe for the Mondeo model built on the same platform. Likewise, the VAST Alliance will soon launch production at its Chinese facility for cars produced in the Asian market. 

“All told, that’s about a $25 million job,” Teets said. “If we didn’t have a global footprint, I doubt that we would have gotten even the North American volume.”

Getting a contract for a global platform could mean adding upwards of 4.5 million units or more to a part’s production run, which sweetens the pot for suppliers, said Wall of IHS Automotive.

“As a supplier, you may have to have some sort of answer, whether that be a joint venture or alliance or licensing your product, or maybe even a wholly owned operation in some of these markets,” Wall said. “You can exist as a regional supplier here – I do believe that – but it’s going to become challenging. There’s going to still be pressure to go global or serve global. For those suppliers that do plan and strategize to take that business global, I think they’re going to be well-positioned.”

The need to go global could also effectively serve as the driver for some smaller, family owned suppliers to sell out, rather than go through the process and the risk of developing international operations, Wall said.

Ford’s Moore said suppliers that don’t want to expand internationally would still have a place in the supply chain for platforms like the F-Series pickup trucks, the Mustang and other large executive cars that the company only sells in North America.

“We have local platforms, so there’s still plenty of opportunity,” Moore said. “It’s not going to be a mandatory requirement for every supplier to have a vastly global footprint. We recognize it’s a significant investment.”

That said, he acknowledged Ford will work with its selected international partners to drive the manufacturing, design and platforms of the future. 

“Globally is where we have to grow,” he said. 

The good news for suppliers, said Wall, is that they still have time to make the decision to become global suppliers. 

“The ship has not sailed,” he said. “(Globalization) brings in a whole lot of uncertainty, but I don’t think suppliers have missed the boat, either. 

“There’s a significant amount of opportunity for the suppliers out there.”

Read 2672 times Last modified on Monday, 04 March 2013 15:04
Joe Boomgaard

Managing Editor

jboomgaard@mibiz.com

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