Balancing Act

Dec. 21, 2004
As China's appetite for cars grows, OEM suppliers are crunching numbers and building networks to satisfy customers and stay profitable.

Forty-nine percent. That's how many more passenger cars were sold in China last year over 2002. With annual market growth in the low single digits or shrinking in the developed regions of the world, it's no mystery why automakers have been flocking to this country and the idea of 1.3 billion new consumers. As for raw numbers, single-year sales of passenger cars in China topped the 1 million mark for the first time in 2002. That milestone was shattered last year when annual sales of passenger cars jumped by 600,000 units to more than 2 million, say year-end 2003 estimates by J.D. Power and Associates. Including trucks and buses, vehicle sales in China totaled 3.7 million in 2003. As European and North American automakers ramp up their joint-venture operations to meet demand, their suppliers are right behind them. "Our entire management team views China as our No. 1 growth strategy," says Timothy R. Donovan, vice president in charge of Asian operations for Tenneco Automotive Inc., Lake Forest, Ill., a $3.5 billion supplier of shock absorbers and exhaust products. Tenneco has five joint ventures in Beijing, Dalian, Shanghai, Changchun and Chongqing, including two new alliances to supply emission control and exhaust systems for Ford, BMW and Audi vehicles. The company's revenues in the country were up 75% through the first three quarters of 2003. That's on top of a 62% increase the previous year. "Our goal is to at least try to grow with the market," says Dave Nelson, vice president of global supply management for Delphi Corp. "The market is growing so strong that if we're not growing that fast, we're losing market share, and we don't want to lose market share." Of Delphi's almost 200 auto parts facilities worldwide, it has 10 majority- and fully owned plants in China. The company employs 7,000 people in the country, including 600 engineers. Its Chinese revenues grew 36% in 2002, accounting for $732 million of the company's $27.4 billion in annual revenues. Delphi expects revenues in the country approached $1 billion for 2003. Honda Motor Co., Ford Motor Co., Toyota Motor Corp., General Motors Corp., Nissan Motor Co. and other automakers have all announced plans for expanding their production operations in China. These announcements have prompted some rumblings about "overcapacity" from the Chinese government, as well as from Volkswagen chairman Bernd Pischetsrieder, whose company currently holds the largest market share (34%), selling vehicles it assembles at long-time joint ventures with First Auto Works (FAW) and Shanghai Automotive Industry Corporation (SAIC). The overcapacity talk fails to account for the large percentage of outdated facilities, says Denton Dance, manager of Asia-Pacific forecasting with J.D. Power and Associates. You can't just overlay the announced capacity on top of projected demand and look at the gap. He expects to see further consolidation among the more than 100 carmakers currently registered in the country. Only seven of these have a market share of 5% or more, according to J.D. Power's data. "Honda can't make enough vehicles right now. GM is in the same boat just trying to keep up with domestic demand," Dance points out. No different from anywhere else in the world, if demand softens, expect OEMs to bring their announced investments online more slowly. The recent boom, in fact, begins to fulfill the market projections global automakers had when they first entered China five and 10 years ago, or 20 years ago in the case of Volkswagen. Like post-war America in the 1950s, a rising middle class-referred to by communist party planners as the "xiao kang"-with paychecks to spend is fueling the demand for new automobiles. "This middle class suddenly has a lot of money. When they had money five and 10 years ago, what they wanted to buy was white goods," says Jack Lee, a Shanghai-based general manager for FreeMarkets, a supply-chain software and services company. "They never had the washing machine. They never had air conditioning. They never had microwaves. Now they have all of that and they have to go one step up. So they're buying vehicles." Of course not everyone in China is on the road to prosperity. Unemployment-what a government news release describes as "high pressure for employment"-is undoubtedly higher than the official rate in urban areas of 4% as the once-planned economy embraces open markets and struggles to absorb millions of displaced farmers and former workers of shuttered state-owned enterprises. Still, the investment activity of the global OEMs, their Tier 1 suppliers and their joint-venture partners indicates how far China has come toward being integrated into the world economy, far enough that it's become a bargaining point in the never-ending battle over prices between the automakers and their suppliers. Representatives of GM and Ford have estimated that they each source around $1 billion from so-called "low-cost" countries. Some projections have those amounts rising to $10 billion by 2010. Company spokesman Paul Wood says Ford purchases components from a number of countries where labor costs are significantly lower than in the United States and Western Europe. Those nations include India, Korea, Malaysia and Turkey, in addition to China. "Many of the parts that are produced in China, are sourced in China, and will be used to support Ford's production in China. And many will be exported. That's the nature of a global corporation," he says. It is likely that Ford's procurement totals from these countries will grow over time, but the company has no preset targets or deadlines, Wood says, noting that $1 billion is a fraction of the $90 billion that the company spends annually on parts, commodities and services. "When we go to source we're looking for the most competitive supplier. There's a lot of things that go into sourcing decisions, including quality, ability to support the program, ability to bring technological advancement to the program, and cost," he adds. "Cost is not just the cost to manufacture the part. It's the total cost to get it to the plant." With that kind of guidance the large automotive suppliers have had to figure out a strategy that addresses China's market growth and its export potential, as well as pressure from the OEMs to set up operations near assembly facilities. "We have been running very lean in China. Our strategy has been to grow with demand rather than the 'if we build it they will come' type of strategy," says Tenneco's Donovan. He reports its Chinese operations have done well at keeping up with the volume on the production side. His biggest challenge now is putting infrastructure in place-the back-office support, including finance, program management, product development-to handle the growth. It's easier for suppliers to ramp up Chinese production than their OEM customers. In addition to lower capital outlays, suppliers are less constrained by the Chinese government, which is trying to develop domestic capabilities and limit the number of automakers, according to J.D. Power's Dance. Consequently, suppliers don't have the same ownership restrictions, nor do they have to get the same number of approvals. "They're going to bring in a facility and technology, employ people, and bring in outside money-the three things the Chinese economy needs to maintain its fabulous growth rate," says Dance. The joint-venture operations many of the Tier 1 suppliers have set up vary little in terms of technological sophistication and part quality between what they do in China and the rest of the world, says Guy Bouchet, a vice president with A.T. Kearney. He recently returned to Chicago after spending five years in China. The rest of the local supply base is a different story. It's fragmented, and there's a wide spectrum of capabilities, qualifications and quality, he says. Some of these suppliers understand the multinationals' requirements and are ready to play the game. Others aren't so willing or able. "Late-comers run the risk of not being able to lock in business relationships, in whatever form, with the highest-capability guys," says Bouchet. "You have to tap into a second tier who are not as good, which means that your investment in terms of training, in terms of revamping the assets, are higher, which has an impact on your return on investment and your short-term competitiveness." Of course, 10 years ago good partners weren't available. Many Chinese manufacturers have become competitive because of the investments the global OEMs and Tier 1 suppliers have made, that and the sink-or-swim demand on Chinese businesses to improve. Today the early movers are seeing the return on their investments. "The biggest misconception is that Chinese suppliers don't play by the book. They tell you 'yes' for everything and not end up delivering," notes FreeMarket's Lee. "That's incorrect. These guys really want the business. They really want to play. They want to be in the big game and be recognized as a world player." Tenneco has been developing the capabilities of its joint ventures by applying lean manufacturing techniques, which has had the immediate benefit of freeing up people and space for new production. Donovan says the company's partners have seen the results and are applying what they've learned to make their other operations more competitive. "They're very eager to learn how to improve operations and improve quality and to bring all of their manufacturing capabilities up to world-class standards," he says. Developing these capabilities and the local supply base are important because of local content requirements and because of cost. A big proportion of Tenneco's raw materials (409 grade stainless steel) must be imported because it's currently not available from domestic sources in China. Having to import such material increases costs because of transportation, duties, inventory carrying costs and other factors, just as it does for Chinese suppliers sending auto parts back to the United States. It is this second equation . . . the threat of massive imports from China, that has people working at Tier 1 suppliers in North America, as well as their suppliers, wondering about their future. If $1 or less per hour labor and cheaper raw material can deliver a 40% or more gross savings on a per part basis, that can yield a significant savings even after transportation and other costs are factored in. Calculated correctly, this "total landed cost" includes broker fees, ocean and warehouse carrying costs, harbor taxes, palletization and other handling costs, in addition to tariffs and inland and sea freight. Such costs come into play whether the parts come to the U.S. from China or any other country. According to the U.S. Department of Commerce, total vehicle, parts and engine imports into the United States totaled $204 billion in 2002, up $14 billion or 8% from 2001. At $35.1 billion, Japan was the No. 1 import source for cars and trucks, followed by Canada at $31 billion. Parts imports alone totaled $70 billion. Mexico lead the way, exporting $19.8 billion of automotive components to the United States, followed by Canada ($17.7 billion) and Japan ($13.7 billion). By comparison, auto parts imports from China are small: $2.2 billion in 2002, which is up 30% from the previous year, according to U.S. Census Bureau reports drawn from U.S. Customs documents. U.S. exports to China of vehicles ($25.9 million) and parts ($346 million) were miniscule over this same time period. "Our goal from an economic standpoint, in all of these different countries typically speaking, [is that] the vast majority of parts are most economically sold to the car companies from our own local plants and from local suppliers that we have there. That's just the way the math works," says Nelson from Delphi. He includes in-pipeline scrap from print changes in these total cost calculations, as well as the $5,000 to $6,000 it costs to send over an engineer to fix problems when the arise. The company has a team of 30 people who very accurately track such costs on global basis. "There's a whole lot of hidden costs and we don't want to fool ourselves," he adds. "We know in a very scientific way what things cost where. We don't guess at that kind of stuff." The biggest jobs threat posed by China to the existing automotive supply industry, as recent news reports have documented, is not necessarily in the United States or Canada, where automakers and suppliers have rationalized their operations in recent years, but in Mexico. If a company moved its operations to a Mexican maquilladora because of a $2 per hour labor rate, there's little to keep it from moving operations to other even lower cost areas. For Tier 1 auto suppliers it's all part of the struggle to stay competitive and gain market share in a cutthroat industry. The key is understanding all of the cost factors wherever their customers are setting up new production operations. As Nelson states, "The total cost is more balanced than one might think." Light Vehicle Sales

Year North America Western Europe Japan China
2001 19,491,000 16,788,000 5,813,517 1,953,168
2002 19,355,000 16,310,000 5,702,828 2,855,191
2003 18,850,000 15,307,000 5,705,634 3,707,385
2004 19,219,000 15,533,000 5,817,463 4,118,876
2005 19,521,000 16,420,000 5,931,067 4,535,364
2006 19,792,000 17,253,000 6,058,175 4,988,070
2007 20,018,000 17,423,000 6,164,578 5,436,139
2008 20,208,000 17,609,000 6,268,976 5,907,591
Source: J.D. Power and Associates

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