Consolidating the Automotive Supply Chain

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The following article originally appeared in the GAPConnection, a quarterly publication of A.T. Kearney's Global Automotive Practice. The GAPConnection, which is written by A.T. Kearney consultants, explains, explores and analyzes key issues affecting the automotive industry, including supply chain management, manufacturing techniques and efficiency, changes in the retail and distribution system, financial and economic matters, globalization of the industry and other topics. 

If you would like additional information on this article or to receive the GAPConnection, contact Jay Houghton at 248-204-9067, or Sara Hogan at 248-204-9068. 

By Jim Morabito (Southfield)

For the past 10 years, North American automotive assemblers have been actively encouraging their suppliers to take on more responsibility - inviting them to take charge in designing and supplying complete modules or systems rather than just single component parts. The assemblers believed this was a way to improve profitability. By relinquishing these responsibilities they could sharpen their focus on design, assembly and marketing. 

In preparation for the day when suppliers would accept this challenge, the automakers have gradually shed their internal parts-making operations and reduced their number of suppliers. The result is an industry restructuring that has brought about unprecedented change and uncertainty in the automotive supply chain. A change in which the effects will not be fully known for at least another 10 years. Last year, at the midpoint of this restructuring, A.T. Kearney, in conjunction with the Office for the Study of Automotive Transportation (OSAT) at The University of Michigan, concluded an in-depth study to better understand the changes taking place in the automotive supply chain. The results were published in "The 21st Century Supply Chain: The Changing Roles, Responsibilities and Relationships in the Automotive Industry." In this article, we will discuss some of our findings and the ways in which the industry consolidation is affecting assemblers and suppliers - the benefits, the drawbacks and the challenges. 

A.T. Kearney/OSAT Study

When we asked supplier survey respondents to rate their most important criteria (see figure 1) for selecting suppliers, we found that the criteria have changed considerably over the years and will likely continue to change. For instance, 10 years ago only quality surpassed price in importance. But respondents predict that in the next 10 years global presence and system integration capability will become more important than price. As automakers expand globally, they will be limited to suppliers that can serve them in their new markets with capabilities throughout the world. Likewise, more contracts are now being awarded to suppliers for complete systems and only suppliers that can provide full-service capabilities are able to compete for these contracts. While most respondents agree that automakers will continue to compare viable suppliers on quality and price, global presence and system integration will ultimately become an important part of the price of entry to the global automotive industry. 

What Are System Integrators?

System integrators are suppliers that combine related components into a single product that provides increased value to the customer. Many suppliers, anxious for the opportunity to increase scope and deliver a larger share of vehicle content, have embarked on a strategy to become large system integrators - acquiring competitors and vehicle assemblers' parts operations. As large-scale system integrators, they have the resources, financial strength and capacity to serve many assemblers in all global markets. Inevitably, some large system integrators might gain a scale greater than some of the smaller original equipment manufacturers (OEMs), for example, Bosch and Lucas-Varity/Kelsey-Hayes in brakes. 

The following are the four major types of system integrators: 

  • Modular integrators. The supplier expands the scope of its product to include parts and components in the nearby physical locations. For example, instead of selling the sheet metal of a car door, the modular system integrator supplies the complete door - assembled, tested and ready to be installed. 
  • Technology integrators. The supplier furnishes in a single product all parts and components that are technically linked, for instance, the antenna as part of the rear window or the brake as part of an ABS system. 
  • Service integrators. The supplier offers a service that was previously performed by the customer. For example, some suppliers provide automakers with the machinery and tools to install their products. Or a supplier owns and manages its product inventory (product destined for the automaker) on-site at the automaker. 
  • Process/functional integrators. The supplier provides all components for a vehicle that are based on similar manufacturing or engineering capabilities, e.g., all of the glass parts of a vehicle.

Industry Consolidation

The past two years have offered a glimpse of what is to come from supplier consolidation. In 1996, more than US$17 billion was spent on automotive industry mergers in North America alone of which nearly US$2 billion was spent by interior systems suppliers seeking the Holy Grail: to be the first company with the capability to supply the entire vehicle interior. 

Many suppliers are embracing the challenge. Bosch acquired AlliedSignal's brake business and Lucas purchased VarityKelsey-Hayes to join ITT Automotive and GM's Delphi unit in supplying complete foundation and ABS braking systems. These four companies now manufacture virtually all brakes for the North American automotive industry. Moreover, Dana Corporation, a supplier of drivetrain, structural, engine and chassis sytems, added more than 10,000 jobs last year mostly through acquisitions geared toward global expansion as opposed to extending its product lines. 

Companies pursuing a niche in the system integration market know that to compete effectively they must have the capabilities to work with other suppliers - to form relationships with suppliers that provide components or other system integrators that provide parts. In short, suppliers have to take on the assemblers' role - worry about the squeaks and rattles; make sure the components fit together properly. 

Two recently awarded contracts push the envelope of system integration: GM's Delphi division is supplying a cockpit module for Mercedes in its new Alabama assembly plant; and within two years, Dana Corporation is set to furnish an entire rolling chassis to Chrysler for its Dakota pickup truck to be built in Brazil. The chassis will arrive at the assembly plant complete with frame, axles, driveshaft, wheels, brakes and suspension. While these contracts do not represent large volumes, they provide a proving ground for system integration concepts. 

The Business Case For System Integration

Japan's automakers recognized early on that they would not want to produce all of the parts of their vehicles. Today, it is standard practice among most Japanese OEMs to be less vertically integrated, and instead, to concentrate on core components. With selected suppliers of entire systems, Japanese OEMs tend to forge strong partnerships, even leading into partial equity exchange. 

The leading proponent of these principles in the United States is Chrysler. In 1996, the company posted the highest profits of the Big Three and was named Forbes company of the year. Inevitably, some of this performance comes from the reliance on lower cost supply partners to produce a larger percentage of vehicle components. The supply community typically has lower wage and benfit rates, lower overhead and less bureaucracy. However, the long-term nature of system integration allows the assembler and system integrator to act as partners. 

This partnership is further strengthened by Chrysler's quality program, SCORE. This program solicits quality improvement and cost savings ideas from suppliers and shares the financial gains of those improvements with the supplier, as opposed to Ford's total cost management (TCM) program in which savings are not shared. Magna, a system integrator and supplier to Chrysler, is a participant in the SCORE program that chooses to return all of its savings to Chrysler in the hope of winning more contracts. 

Potential Risks of System Integration

The benefits can be high for automakers that develop successful relationships with system integrators, but there is also potential risk. For instance, what if the system integrator doesn't perform well and the automaker is no longer in a position to perform the function itself. Assemblers may prefer to maintain overlapping capabilities until they have developed "proven" system integrators, which may take several years. Either the assembler must bear the additional cost of this duplication or, more likely, it will be forced to redeploy or shed duplicate resources. Further, suppliers must possess additional capabilities in engineering and supply chain management before they can become system integrators, which means suppliers may add to their overhead as they invest in additional capabilities in the hopes of landing system contracts. Suppliers and assemblers must diligently minimize this duplication of costs or risk escalating overhead and losing the benefits of system integration. Another risk emerges when suppliers acquire their own suppliers or competitors. System integration does not require that all parts of a system be manufactured by the system integrator. Yet many system integrators view control of the entire system as essential. 

Purchasing heads at Ford and Chrysler have publicly advised against excessive supplier mergers, worried that suppliers may overextend themselves by acquiring companies to buy revenue. They claim there is no need for suppliers to become larger and that most suppliers have misinterpreted their wishes. Thomas Stallkamp, vice president of purchasing at Chrysler, suggests suppliers develop loose partnerships that allow system integrators to follow advancements in technology as they occur. Suppliers must become comfortable sourcing components outside their expertise to tier two suppliers instead of buying the tier two supplier. Just as automakers need not build an entire car to sell it, system integrators need not manufacture entire systems to supply them. 

Challenges The Assemblers Face

Automakers are only now beginning to understand the consequences surrounding the changes taking place in their industry. Most have found it relatively easy to reduce their number of suppliers because it does not require a behavior change. But relinquishing responsibility for the design, development and production of a system requires a greater level of trust and partnership. The following are some of the issues assemblers will likely encounter as the industry restructuring continues: 
  • Loss of brand equity. The brand value of vehicles may become more associated with component systems and less with the vehicle label as less value added is shifted away from the OEM. While this is a bold thought, and one that might be rejected by some assemblers, it is not without precedent when you consider the heavy truck industry. Here the durability and serviceability of a big rig's engine weighs as much in the purchase decision as the truck around it. Or look at the personal computer (PC) industry. PC buyers first want the Intel chip inside; of secondary importance is the actual PC brand. Soon customers may be checking vehicle stickers for Lear interiors, Bosch braking systems or TRW electronics. 
  • Access to latest technology. With rare exception, the systems that are outsourced in their entirety will not be proprietary technology or designs - at least not for long. The nature of system integration and the resulting cost benefits almost require that investments in new technology be recovered through contracts with many customers. It may become difficult for any OEM to ensure they are the first to get the most advanced products in their vehicles. Advanced technology will be available in new products to all customers simultaneously. The speed with which assemblers bring their products to market will determine who provides new technology to their customers first. 
  • Balancing globalization and system integration. A particular system integrator may not be established in a country where the assembler is expanding. OEMs will inevitably encourage their preferred suppliers to follow them in their expansion, but this often does not fit into the supplier's strategic plans or exceeds their financial strength. Such a situation could force the assembler to import the systems (if content laws allow), select less desirable system integrators or abandon their system partners completely in that market.

Challenges The Suppliers Face

Certainly the restructuring taking place will benefit suppliers but only if they take the necessary steps to compete in this new environment. The first step is to assess their situation and the roles they want to play. 
  • Role definition. Because the various supplier roles will require different capabilities, suppliers need to define the system first (i.e., does the airbag belong to the interior manufacturer or to the steering system manufacturer?). In all likelihood, many suppliers will serve different roles for different product lines or even different customers. The nature of some product lines dictates that they will never be systems. For example, electric motors that control seats, windows and wipers will always be components of larger systems. The tier two companies or divisions will look very different from the tier ones in the functions they provide. A tier two supplier is likely to compete in a commodity market on price, while the tier one system integrator competes on design and engineering capabilities and its command of the supply chain. 
  • New functions. A supplier that manufactures parts designed by its customer from raw materials sourced by its customer will need to expand many functions if it wants to compete as a tier one system integrator. Among the capabilities it needs are engineering, global procurement and supplier development. No longer can a supplier wait for an assembler to design the part to build - suppliers must take the lead in designing next generation products and marketing them to vehicle assemblers. They must also take the lead in marketing, including market research, and product and process R&D. A supplier that has not performed these functions in the past will find adding these capabilities a significant challenge. 
  • Supplier development. Every automotive supplier has experienced Big Three efforts to ensure the parts they purchase are of the highest quality and lowest cost, either through cooperative or demanding means. Often assemblers send teams of engineers to suppliers to help them work out a quality problem or find waste in their production process. Most suppliers do not yet possess the capability to reinforce key process and product characteristics at their suppliers. 
  • Warranty responsibility. Ultimately, the OEM will hold the system integrator responsible for warranty costs. In other words, suppliers will be financially responsible for problems. Today, assemblers are asking suppliers to provide the system assembled, tested and ready to go. If anything goes wrong, the system integrator must bear the cost and determine where the problem is - in the part they manufactured, in the components they purchased, or in the assembly.

Conclusion

There are many obstacles to overcome in the automotive industry restructuring. Some OEMs and suppliers will hesitate at each barrier. Many will not make a decision. Others will wait a little too long, watching as the players tally successes in system integration and improved financial performance. The real winners will be the assemblers and suppliers that meet each obstacle head on. Those that take a risk knowing that the potential benefits are great and that the momentum for creating the future is increasing, not letting up. As such, they will be the worthy players in tomorrow's global automotive industry. 
 
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