Roland Berger: Study Helps Navigate Turbulent Waters for Auto Suppliers

November 5, 2008 // Published as a news service by IHS

This situation is further aggravated by the current financial markets crisis and the general economic slowdown in the automotive sector.

Despite this, the sector was able to further increase its profitability in 2007, analysts said. Mid-sized and large companies based in Western Europe and Japan, in particular, outperformed the market. However, many suppliers are not prepared for the challenges ahead.

"Automotive suppliers are facing the most competitive environment ever," said Marcus Berret, a partner at Roland Berger.

"Increasing raw materials prices, competition from manufacturers in low-cost countries, OEM demands to cut costs, the call for environmentally friendly innovations - the pressure is on from all sides and will further increase in the future."

Due to the severe slowdown the automotive industry experienced over the past few months, OEMs are being forced to cut their costs yet again by billions of dollars. Analysts said there is no relief in sight for the rest of 2008 and 2009.

Despite increasing competitive pressure, suppliers maintained remarkably robust profitability overall in 2007. Earnings before interest and taxes (EBIT) margin and return on capital employed (ROCE) even improved slightly year on year in 2007, analysts said. The EBIT margin for the sector was 5.4%, while at 11.9%, ROCE was up another percentage point from 2006.

However, this improvement was not spread equally across the entire industry. Analysts said suppliers based in Europe, Japan and India outperformed, while North American suppliers - and for the first time ever also Chinese - were sailing rough waters.

In terms of company size, the picture was also rather varied as mid-sized suppliers developed particularly well over the past few years, while many smaller suppliers - and also a few top 20 suppliers - were facing increasingly strong headwinds.

Given production cuts of 10% and more already announced for vehicle and truck manufacturers for the second half of 2008, the global average EBIT margin for automotive suppliers will be well below 5% for the remainder of 2008.

"I would not be surprised if we saw only around 4% in 2009," said Berret. This would bring the industry back to its historic low of 2001.

Analysts said there are several success factors for automotive suppliers. On the sales side, important factors include concentrating on future growth markets and products, as well as the current product range. The goal is to achieve a market share of 20%-30% in one to two market segments.

At the same time, only innovative products will yield above-average margins in the future. The range stretches from new powertrain concepts, such as new hybrid and electric motors, to completely revolutionary vehicle designs.

On the cost side, an optimal global footprint is essential for a leading competitive position. Analysts said this applies not just to production, but increasingly for R&D as well. Leading suppliers outsource clearly definable tasks, such as software development to low-cost locations, and are now increasingly shifting development of complete modules and systems. Administrative costs can be reduced with standardization and outsourcing.

Regarding financial structure, profitable automotive suppliers are characterized in part by excellent resource management. The ways in which they accomplish this include minimizing warehouse costs with just-in-time models, extending payment periods or consistently using discounts.

Analysts said resource management is especially important in the midst of the financial market crisis, since banks are increasingly ranking the business climate for automotive suppliers as critical, with corresponding consequences for loans.

"Right now, automotive suppliers that have secured long-term credit lines under favorable conditions have the advantage," said Thomas Kästele, managing director at Rothschild. "Nowadays, banks see a diversified clientele, a low-cost site location and a flexible investment plan as key factors."

In general, suppliers have in the past achieved noteworthy success. Yet, analysts said many have so far not prepared themselves enough for the new challenges. For example, reducing carbon dioxide (CO2) emissions represents a key technological and financial challenge. For suppliers, this represents both an opportunity and a risk.

A further challenge, particularly for European suppliers, is expanding business with Asian OEMs. However, analysts said that the sales share of these OEMs at many European suppliers is stagnating, and in many cases is still below 10%.

The current crisis will leave behind deep scars, analysts said. Many underperforming suppliers will not survive it, and more mergers and insolvencies can be expected. The best companies will emerge from the crisis stronger than before, because many competitors will fall by the wayside. Until then, these competitors will put additional pressure on suppliers by competing on price rather than innovation.

Source: Roland Berger Strategy Consultants.