The Tough Get Going

Feb. 12, 2005
As consolidation in automotive supply chains continues, and OEMs hand off more R&D and production to Tier Ones, manufacturers are responding with a heightened level of collaboration.

Collaboration. That's the one word description of the rapidly evolving business practice that increasingly defines success for automotive suppliers.

Some Tier-One suppliers, such as Michael J. Burns, chairman and CEO of Dana Corp., Toledo, Ohio, describe the emerging need for collaboration as an epochal event in the evolution of the automobile industry. Boston-based Jim Champy, chairman of consulting at Perot Systems Inc., goes further. He says the significance of the emerging collaboration requirement overshadows even the past watersheds of Henry Ford's mass production and lean manufacturing.

The issue is not that OEMs and Tier-Ones never cooperated -- rather it is the growing magnitude of what's needed to add ever more value to the OEM. "To succeed, today's supplier has to bring more to the table," Burns says. For example, Dana's contribution to the 2006 Corvette, the ZO6, is not a casual collection of parts -- it is a sophisticated laser-welded aluminum underbody that delivers comprehensive competitive value to the brand.

Defining, developing and delivering such elaborate modules increases a supplier's R&D responsibility for both process and product. In addition the supplier selection process becomes more important, says industry analyst David Cole, chairman, Center for Automotive Research, Ann Arbor, Mich.

Burns sees supplier efforts of the future as being ever more critical to the success of the vehicle. "Early supplier participation in setting specifications and limits translates into a significant competitive tool for an OEM's product development efforts."

That early collaboration with OEMs is also a very effective mechanism for getting the design right -- in terms of cost and performance. The easiest and most effective cost reductions occur when designs are still ideas -- before any investment or production commitments.

"The challenge for suppliers is marked by an increasing emphasis on sharing responsibilities and delivering deeper value," Burns observes. That process is dramatically reshaping the automotive sector by driving new business designs, notes a study by Boston-based Mercer Management Consulting, the Fraunhofer Society for Production Technology and Automation, and the Fraunhofer Society for Materials Management and Logistics.

For example, the study predicts that by the year 2015, automotive suppliers will be responsible for 80% of vehicle R&D and production versus about 63% today. The important drivers include new technologies, the growing complexity of automobiles, and the exploding diversity of vehicle models.

"Another key finding of the study is that brand image has become as important as performance and price for automakers," says Mercer's Ralf Kalmbach, managing director and head of the firm's automotive industry practice. He predicts OEMs will increasingly be focusing on brand-specific elements such as design, customer experience and service strategies.

Burns, who led GM Europe before joining Dana last March, says the operative question is "are we [Tier-Ones and OEMs] better off working individually, essentially representing our own interests or working together on important issues and benefiting from the strength of the world's most significant industry. I believe the answer is clear. We must work together."

Burns' conclusion is supported by how the Mercer/Fraunhofer study translates new forms of collaboration into per-vehicle cost savings. It estimates savings between $750 and $1,250 per vehicle. In addition, the study estimate that both OEMs and suppliers will be able to improve their EBIT margins by around 3%.

Kalmbach says those benefits are based on a variety of collaboration-inspired business models such as system cooperation ventures, production cooperation ventures, engineering service providers, spin-offs and private label production. Increasingly, supplier business success will depend on identifying the most promising business model in order to capture competitive advantage. The challenge for OEM management will be in determining which areas of competency to strengthen and which to hand off.

But if collaboration is the challenge, the opportunity it represents is being missed by U.S. automakers, charges John W. Henke Jr., a consultant at Planning Perspectives Inc., Birmingham, Mich. That contention comes from his annual studies of the business relationships of OEMs to the Tier-One supplier community. Henke says collaboration problems began to show up in his 2003 study, but gained significant momentum in 2004. He says effective collaboration suffers as U.S. automakers continue hammering their suppliers for price reductions and multimillion-dollar cash givebacks. "Suppliers are responding by giving them less support."

Burns vocally disassociated Dana from those conclusions at January's Automotive News World Congress: "Let me also be blunt in saying that I'm personally pretty tired of all the moaning about how difficult it is to work with certain OEM customers.

"At Dana we work with virtually all of the world's OEMs. Of the 23 vehicles first launched at this year's auto show, we have product on 19. I think that's pretty impressive. But, we want to make it 23 of 23.

"So my attitude is that if someone else doesn't like working with the traditional U.S. 'Big 3' or any other OEM -- I'll be happy to take their business."

Meeting Global Demands

The OEM's growing global business model adds a supplier challenge to the collaboration issue. "The vehicle manufacturers have become increasingly global in terms of their basis of manufacturing and their technical centers," observes Auburn Hills, Mich.-based John Sanderson, president and CEO, Siemens VDO Automotive. Likewise, key suppliers must be able to support their main customers on a global basis in order to provide local expertise and support in terms of development and supply.

Over time, Sanderson has concluded that the most successful OEMs establish a global footprint for both R&D and manufacturing in order to improve their competitiveness and to establish capabilities closer to the key regions of the world.

Sanderson emphasizes that it is no longer reasonable to assume that one can be successful by operating in only one or two regions of the world. "And for Siemens and VDO, it certainly helps that Siemens AG -- of which we are a part -- is present in over 190 countries of the world."

Accompanying globalization is an intensified focus of supplier collaboration in R&D, Sanderson adds. He says technologically-leading suppliers -- Siemens VDO included -- are responsible for about 25% of the R&D cost of new automotive components and systems. "This has brought suppliers into the OEM design phase much earlier, and in some cases, at the very beginning of a vehicle's design cycle."

Played right, that strengthens OEM brands and leads to better product differentiation, says Sanderson. By 2010, he expects a 50/50 split in R&D between suppliers and OEMs. "That will bring OEMs and suppliers closer together in a true partnership role."

Collaboration does not come without risk, he warns. For example, Sanderson notes that for many suppliers, chronic profit and price reduction pressures will challenge any increased R&D allocation.

Sanderson sees a rapidly growing opportunity -- and challenge -- as IT and electronics converge with the automobile. First the opportunity: automotive electronics is a $250 billion industry that continues to be the fastest-growing segment of the auto industry. "About 25% to 30% of the cost content of an average sedan is electronics." For some luxury models he says the cost content can be as high as 40%.

The challenge is in the differing pace of the product development cycles. "Comparatively, the auto industry's 36-month production cycle cannot keep pace with the rapid evolution of information technology and electronics, including consumer electronics," says Sanderson. The convergence of technologies is forcing change in the way automakers not only work with suppliers of these technologies, but in the way automakers adapt new technologies into vehicle platforms that are three years away from production. During those three years, several generations of electronics will have evolved.

"Our OEM customers do not have -- nor can they afford to have -- extensive expertise in consumer electronics. This is why they are coming to partner more with suppliers who have the expertise and extensive knowledge of this market segment. It's more important for suppliers today to understand the needs and demands of their customers' customers."

Sanderson sees the dimensions of opportunity going beyond the infotainment approach of audio, navigation and rear seat entertainment systems. He stresses the less obvious areas including electronic throttle control, occupant sensing, traction control, tire pressure monitoring, braking and steering. "Ultimately, all mechanical and hydraulic functions in a vehicle will be replaced or enhanced by electronic control -- further reducing weight, complexity and cost -- while increasing reliability, and all at a reduced cost."

Challenging The Numbers

Across all suppliers the ranks are thinning out, say analysts. For example, the Original Equipment Supplier Association, with 8,000 current members expects numbers to fall to 5,000 by the end of the decade. That's less than half the membership total reported in 2000. The Association says the increasing consolidations, which go beyond merger mania, reflect the actions of the system integrators. That's a reference to Tier Ones, such as Visteon and Delphi, cutting back on the number of suppliers, says the Association.

The Mercer-Fraunhofer study cites a similar percentage reduction, but suggests that opportunity still exists despite pricing pressure from OEMs, high material costs, a drop in Big 3 production and globalization. The study's thinking: OEM's will be attracted to downstream investment in sales and service, which require less investment in technology and production equipment and which promises significantly higher returns. The obvious conclusion: Development and production will be shifted increasingly to the automotive suppliers.

But even that conclusion is far from safe. For example, last year GM announced that it would begin to emphasize a global parts-sharing strategy. While some suppliers may benefit, others could lose large contracts as GM seeks greater parts commonality among vehicle architectures. In GM's past, parts-sharing largely occurred within architectures.

Just how tough is the supplier environment? IW posed the question to Philip Fioravante, recently appointed CEO of Magneti Marelli Powertrain USA Inc. He answered by referring to his ambitious plan (for a small supplier) for nearly doubling his U.S. sales from $120 million in 2003 to $200 million in 2005. His operation is a unit of Milan, Italy's Magneti Marelli, S.p.A., a global supplier giant with revenues of $4.5 billion (2004).

Fioravante is supporting Powertrain's growth strategy with in-sourcing -- adding plastics injection molding capacity. Currently 40% of Powertrain's revenue comes from such OEMs as the Chrysler Group, GM, BMW and Volkswagen. Another 40% is powersports -- Harley-Davidson, boat engine-maker Mercury Marine and MerCruiser. The remaining 20% comes from after-market performance-sport sector which includes Edelbrock and Interco.

Fioravante tempers his optimistic goal by admitting "there's no question that the cost and pricing demands of the North American OEMs is at an ever increasing level for the last four to five years." He says the cost-give-backs increase the challenge of being technologically prepared for an OEM's future process and product needs. "It's a very delicate balancing act for a supplier."

At first, Fioravante says the temptation is to favorably generalize about the superior Asian performance when it comes to dealing with suppliers. "But then you have to realize that the Asian OEMs in North America have nowhere near the legacy issues of under-funded pension and lifetime health-care obligations." He says North American OEMs are increasingly aware that their performance depends on the business success of their suppliers. "The sensitivity level is growing." He says one positive sign is Daimler/Chrysler's decision to do more of an upfront collaborative effort with their supply base.

Fioravante is also encouraged by a General Motors supplier outreach program, where his business unit was invited to exhibit. Called Tech World, the event is essentially a private internal trade show the OEM schedules for its automotive engineers, designers and other decision-makers. Held at the GM Technical Center in Warren, Mich., the event invites suppliers to exhibit their latest technologies, and GM staffers are encouraged to attend. Typically fewer than a dozen suppliers are invited to exhibit, and the last event had over 2,000 viewers, says GM's Jeff Boyer, executive director advanced purchasing.

"We started Tech World in 1998 and are now scheduling the three day events twice annually in North America and once a year in Europe. We seek game-changing technologies that could impact GM's products, processes and services," Boyer adds. Product features originating at Tech World include the magnetic ride control technology adopted by Cadillac and Corvette and adaptive cruise control. GM also uses the event to seek technology that can make special features more affordable for broader usage, Boyer says.

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