Automotive component suppliers have struggled with customer demands for price reductions on existing business and in conjunction with new contracts since GM began the practice almost 20 years ago.
The heavy-handed technique spread to the other Detroit Three almost immediately. Foreign-owned automakers, such as Toyota and Honda, who operate assembly plants in the U.S. were slower to follow suit, but eventually adopted their own, similar programs.
The consulting firm IRN Inc. has been surveying the supply base since 1997 to track this dynamic, and the last few years have indicated that the demands are finally leveling off.
For five years now, annual price reduction requests have averaged approximately 3 percent. Survey respondents this year reported some outliers in the 6 percent to 10 percent range — and even a 15 percent reduction requested in one instance — but those came up under unusual circumstances, such as the customer that was apparently seeking to boost margins prior to the sale of this particular business unit.
Supplier responses to the requests have also stabilized, with concessions in the range of 1.2 percent to 1.5 percent on average.
It will be interesting to see how this interaction changes as growth in U.S. sales and North American production begin to taper off over the next few years.
The historical high point for price reduction requests took place not during the industry downturn of 2009 but in the year 2003 when the average price reduction request was a whopping 6.3 percent. We can speculate that during the 2009 recession, as virtually all industry participants were being forced by market conditions to severely downsize operations, customers determined that it was not the time (or would not be fruitful) to squeeze suppliers further.
By contrast, back in 2003, automakers were experiencing a sustained period of strong sales propped up by heavy sales incentives, and they turned to the supply base in an effort to shore up margins. To the extent that adverse economic conditions spurred companies to become lean, there is less opportunity to find waste to offset significant price reductions, but price reduction requests remain part of the ordinary course of business.
Much of the terrible pricing dynamic in the 2000-2009 period was the result of the poor (or nonexistent) strategies of suppliers and ignorance of their own costs. Over time, capable suppliers learned to adapt their strategies to specific customers and jobs, negotiating terms and deals that preserved their financial health.
Many of the companies who unwisely gave concessions to the point of perpetually operating at a loss closed down during the economic downturn. As a result of experience and the clearing away of weaker players, the sophistication level of the North American supply base in dealing with commercial issues with their customers has increased.
Suppliers have been on a long journey to reach a peer-level relationship with customers. Having the upper hand is rarely realistic for long in this industry (i.e. your customer will create a competitor if you get too powerful), but the ability to push back on unrealistic or unprofitable demands is a key to success.
The only way that happens is to stay on the leading edge of your competitive set and execute well.
IRN has found in its surveys that best-in-class suppliers know how to say, “No.”
The 2015 survey results indicate a number of concerning factors for the future. Respondents have observed a rising number of bidders for new business, particularly at Ford, and an increasing number of offshore competitors, particularly from Asia.
A number of respondents reported seeing poor business behavior in competitors, mainly in the form of quotes at very low prices that would not seem to cover costs.
All these factors serve as a reminder that suppliers must continually pursue operational excellence so there is no area of weakness for competitors to exploit, and at the same time, develop products or combinations of expertise that are difficult for competitors to emulate.
During most of the period from the 1990s to 2009, there was a huge discrepancy in what level of the supplier food chain made money. The Tier 1s were under the most pressure while some Tier 2s were doing well. For the last five years, all levels of the chain have been profitable.
As IRN has said for years, profitability is ultimately in the hands of the suppliers.
Customers are always going to try to push costs onto their supply base. How the suppliers respond in accepting or withstanding that pressure is the key.