The Partsmaking Dilemma

Automotive Industries,  Feb, 2001  by Maryann Keller

• E-mail
• Print
• Link

Walking away from contracts, rather than building parts at a loss, is a legitimate strategy if you cannot afford to subsidize your customers.

Tensions between suppliers and automakers hit a low in the mid-1990s as General Motors Corp. implemented the "warrior" processes of its purchasing czar, Inaki Lopez. Now it seems that even worse relations are in store for auto companies and their suppliers as domestic assemblers confront lower production and mounting competition with cries for emergency price cuts.

For a brief time during the 1990s, it appeared that the auto parts industry had some chance of mitigating the extreme profit swings typically endured over an economic cycle. Those swings had been made worse by pressure from vehicle assemblers to take more responsibility for development, match output to just-in-time vehicle assembly and accept contracts with annual price cuts. Auto suppliers gained longer-term contracts, but paid a stiff price in terms of taking on more fixed costs and a constant struggle to match variable costs to price cuts.

For several years, auto parts makers had some traction with investors. Suppliers gobbled each other up in a quest to improve economies of scale. That strategy was also supposed to reduce dependence on one market or customer and enable them to supply modular assemblies to generate more higher-margin dollars per vehicle.

For a time, the capital markets believed in the concept and valued the shares of many parts companies high enough to use their stock to make acquisitions or raise cash for investment.

But now the shares of many parts producers are near 12-month lows. And the investment outlook for the parts industry may be more clouded than it is for the automakers themselves.

The U.S. is the world's largest and most profitable market. However, new price cut demands foretell a bleak financial picture for many parts producers who had existed close to the financial margin even in good times.

In a few cases, among them Federal-Mogul and Tenneco, mismanagement by former executives have exaggerated the negative undercurrents in the marketplace. For many others, acquisitions that were supposed to bring profit stability have done just the opposite. And selling modules rather than individual parts has, in general, not been able to offset the overwhelming impact of lower volume and price pressures.

Suppliers have been digging in their heels against a new round of price reduction demands. Some are threatening to walk away from contracts rather than build parts at a loss. This is a legitimate strategy for companies that cannot afford to subsidize their customers.

It's hard to have sympathy for auto companies that have failed to deliver competitive vehicles, or cut their own costs sufficiently to match the productivity and performance of Toyota. Furthermore, this industry has known for decades that the most effective relationship in reducing total vehicle costs is one where assemblers and partsmakers work together and share in the benefits. Toyota has just set a goal to lower parts prices by 30 percent by working with its suppliers on reducing the number of parts it buys, procuring more modular systems and lowering manufacturing costs.

If successful, Toyota could save $9 billion. But equally important, a stronger, more technologically sophisticated parts industry will emerge to serve Toyota's ambition to gain more market share.

By contrast, domestic U.S. parts producers face a tough environment. Their ability to invest for the future is being threatened as never before. They are being forced to strip their companies to the bone to offset price cuts.

Where will the new technology needed for future vehicles come from, if not from auto parts suppliers? Buyers of tomorrow's care will want more than OnStar or satellite radio. Unless auto suppliers have the financial muscle to perform, my fears for the U.S. auto industry will go beyond the immediate threat of a cyclical slowdown.

MARYANN KELLER is a veteran auto industry analyst and author of the books "Rude Awakening. The rise, Fall And Struggle To Recover At General Motors" and "Collision: GM, Toyota and Volkswagen And The Race To Own The 21st Century."

COPYRIGHT 2001 Diesel & Gas Turbine Publications
COPYRIGHT 2008 Gale, Cengage Learning