Executive Briefings

Auto Suppliers in Financial Squeeze as Automakers Demand Deep Cost Cuts, Local Production

Automotive suppliers are under mounting pressure to satisfy two conflicting customer demands: to cut costs and to open more factories in fast-growing emerging markets so that they can be closer to their customers' production plants. Striking the right balance between cost and proximity in global manufacturing networks will be one of the industry's greatest challenges, according to a report by The Boston Consulting Group (BCG), conducted in partnership with the Fraunhofer Institute for Manufacturing Engineering and Automation IPA. The report is titled The Proximity Paradox: Balancing Auto Suppliers' Manufacturing Networks.

A recent BCG survey of auto suppliers found that an overwhelming majority of respondents - 86 percent - are under increased cost pressure from their automotive customers. Suppliers will bear the brunt of deeper-than-usual cost reductions sought by large automakers, some of which are apparently planning to cut annual spending by 4 percent to 6 percent. At the same time, suppliers are also under intense pressure from their customers to localize production. Suppliers surveyed expect to increase their number of global manufacturing sites by an average of 9 percent over the next five years. "We call the dilemma over how to balance these conflicting demands – for both cost reduction and manufacturing close to the customer – the proximity paradox," says Daniel Spindelndreier, a BCG senior partner and a coauthor of the report. "It is among the most serious management challenges that the global automotive-supply industry will face over the next few years."

The paradox is here to stay. "Pressure to cut prices is unlikely to relent, and avoiding emerging markets is not an option because they are critical to growth," says Manfred Beck, a BCG associate director and a coauthor of the report. Indeed, China surpassed the U.S. in 2009 as the world's biggest automotive market and is emerging as the engine of global growth for the industry. Nearly 60 percent of surveyed auto suppliers' total production capacity – including many core manufacturing operations for certain products – is expected to be located in emerging markets some five years from now, compared with only 45 percent five years ago. "Germany's automotive-supply industry alone is projected to lose 35,000 jobs, including highly skilled blue- and white-collar workers," adds Beck.

Auto suppliers recognize these challenges while acknowledging that their efforts to address them are insufficient. Although 79 percent of respondents stated that they are satisfied overall with the performance of their localized production facilities in emerging markets, 68 percent reported that the cost savings were lower than expected. "Every supplier surveyed agreed that it is important that it adjust its manufacturing network," says Frank Lesmeister, a BCG associate director and a coauthor of the report. "But our research found that most suppliers lack the organizational capabilities, business processes, and tools to achieve an optimal manufacturing footprint."

These insights emerged from a survey of 42 automotive suppliers from around the world. This sample comprised one-quarter of the world's 100 biggest players and a selection of mid-sized companies. The authors also interviewed dozens of auto supply executives and industry experts to understand the challenges that companies are facing and to assess how well they are prepared to deal with them.

Confronting the Paradox
"The essential paradox faced by auto suppliers is that production decisions that are intended to cut costs and those made to be close to the customer often lead to very different practical solutions in allocating products to sites," says Spindelndreier. If cost is the primary consideration, most production decisions rest mainly on the basis of total landed cost, which takes into account such factors as labor, logistics and energy. Economies of scale and the expertise and process capabilities needed to build a plant are also important considerations. The logic behind a localization demand can be different: the primary factor is the customer's requirement that parts and components arrive at the automotive assembly line at the precise time and in the precise sequence needed.

In a typical year, suppliers are asked to shave 2 percent to 3 percent off their prices. But after several years of relative price stability, the coming round of cost reductions is likely to cut much deeper. Some of the largest automakers have adopted programs to cut $2bn to $6bn in annual costs, constituting about 4 percent to 6 percent of total spending. Suppliers will bear some 55 percent to 65 percent of these cutbacks.

Meeting these cost targets will be especially difficult because they come at a time when auto suppliers' production networks have been growing more globally dispersed and more complex. In 2009, the suppliers that the authors interviewed had 66 percent of their manufacturing sites in the "triad economies" of Western Europe, the U.S., and Japan. That share is now down to 58 percent – and is expected to decline to 47 percent in 2019. The share of manufacturing sites in Canada and the U.S. is expected to drop to 21 percent in 2019, from 30 percent in 2009. The share of sites in Western Europe will also drop to 21 percent. China, not surprisingly, will see significant gains, as will Mexico.

The study also found that more suppliers based in triad economies are becoming truly global players. The number of companies in the study with lead plants (the sites of core manufacturing operations) in China is expected to double to 16 in five to 10 years, and the overall number of lead plants located there is projected to jump by 150 percent over that period. The number of lead plants is expected to rise by 29 percent in Mexico, by 50 percent in Eastern Europe, and by 50 percent in the rest of developing Asia, a region that includes India and the Southeast Asian nations. Emerging markets will not be the only ones to gain. The survey respondents also expect to increase their number of lead plants in the U.S. and Canada by 25 percent over the next five to 10 years.

"The transfer of lead plants and R&D will have a particularly significant impact on the European automotive-supply industry," says Beck. "In Germany, we estimate, 35,000 of the current auto-supplier workforce of approximately 290,000 could be affected by plant closures – including some 7,000 engineers, administrators and
support positions." About one-quarter of those jobs will be in competence centers and lead plants.

Developing Optimal Production Network
To address the proximity paradox, the authors recommend that suppliers adopt a more comprehensive approach to adjusting their manufacturing networks, one that balances the necessity to have certain production close to customers with a cost analysis that goes beyond direct factors such as labor rates, materials and shipping. A manufacturing-network-optimization program should encompass improvements to the global supply chain, organization structure and manufacturing processes. "To be really successful, these programs must be ongoing so that suppliers have the flexibility to adjust their manufacturing footprints in response to shifts in global cost, market demand and technology trends," says Lesmeister. "For many suppliers, this will require at least some transformation of their organizations."

Suppliers should start the approach by gaining a full understanding of the strengths and weaknesses of their current manufacturing network and their ability to make adjustments. The authors recommend that suppliers conduct a thorough "health check" of their optimization programs that assesses the past performance of the network and whether current capacity in a region can meet projected demand. The health check should also evaluate capabilities and managerial responsibilities across the network, examine the tools and methods used to identify and quantify improvement opportunities, and determine whether the capabilities and processes are in place to implement the strategy and adjust the network.

A copy of the report can be downloaded at the BCG web site.

Source: The Boston Consulting Group

A recent BCG survey of auto suppliers found that an overwhelming majority of respondents - 86 percent - are under increased cost pressure from their automotive customers. Suppliers will bear the brunt of deeper-than-usual cost reductions sought by large automakers, some of which are apparently planning to cut annual spending by 4 percent to 6 percent. At the same time, suppliers are also under intense pressure from their customers to localize production. Suppliers surveyed expect to increase their number of global manufacturing sites by an average of 9 percent over the next five years. "We call the dilemma over how to balance these conflicting demands – for both cost reduction and manufacturing close to the customer – the proximity paradox," says Daniel Spindelndreier, a BCG senior partner and a coauthor of the report. "It is among the most serious management challenges that the global automotive-supply industry will face over the next few years."

The paradox is here to stay. "Pressure to cut prices is unlikely to relent, and avoiding emerging markets is not an option because they are critical to growth," says Manfred Beck, a BCG associate director and a coauthor of the report. Indeed, China surpassed the U.S. in 2009 as the world's biggest automotive market and is emerging as the engine of global growth for the industry. Nearly 60 percent of surveyed auto suppliers' total production capacity – including many core manufacturing operations for certain products – is expected to be located in emerging markets some five years from now, compared with only 45 percent five years ago. "Germany's automotive-supply industry alone is projected to lose 35,000 jobs, including highly skilled blue- and white-collar workers," adds Beck.

Auto suppliers recognize these challenges while acknowledging that their efforts to address them are insufficient. Although 79 percent of respondents stated that they are satisfied overall with the performance of their localized production facilities in emerging markets, 68 percent reported that the cost savings were lower than expected. "Every supplier surveyed agreed that it is important that it adjust its manufacturing network," says Frank Lesmeister, a BCG associate director and a coauthor of the report. "But our research found that most suppliers lack the organizational capabilities, business processes, and tools to achieve an optimal manufacturing footprint."

These insights emerged from a survey of 42 automotive suppliers from around the world. This sample comprised one-quarter of the world's 100 biggest players and a selection of mid-sized companies. The authors also interviewed dozens of auto supply executives and industry experts to understand the challenges that companies are facing and to assess how well they are prepared to deal with them.

Confronting the Paradox
"The essential paradox faced by auto suppliers is that production decisions that are intended to cut costs and those made to be close to the customer often lead to very different practical solutions in allocating products to sites," says Spindelndreier. If cost is the primary consideration, most production decisions rest mainly on the basis of total landed cost, which takes into account such factors as labor, logistics and energy. Economies of scale and the expertise and process capabilities needed to build a plant are also important considerations. The logic behind a localization demand can be different: the primary factor is the customer's requirement that parts and components arrive at the automotive assembly line at the precise time and in the precise sequence needed.

In a typical year, suppliers are asked to shave 2 percent to 3 percent off their prices. But after several years of relative price stability, the coming round of cost reductions is likely to cut much deeper. Some of the largest automakers have adopted programs to cut $2bn to $6bn in annual costs, constituting about 4 percent to 6 percent of total spending. Suppliers will bear some 55 percent to 65 percent of these cutbacks.

Meeting these cost targets will be especially difficult because they come at a time when auto suppliers' production networks have been growing more globally dispersed and more complex. In 2009, the suppliers that the authors interviewed had 66 percent of their manufacturing sites in the "triad economies" of Western Europe, the U.S., and Japan. That share is now down to 58 percent – and is expected to decline to 47 percent in 2019. The share of manufacturing sites in Canada and the U.S. is expected to drop to 21 percent in 2019, from 30 percent in 2009. The share of sites in Western Europe will also drop to 21 percent. China, not surprisingly, will see significant gains, as will Mexico.

The study also found that more suppliers based in triad economies are becoming truly global players. The number of companies in the study with lead plants (the sites of core manufacturing operations) in China is expected to double to 16 in five to 10 years, and the overall number of lead plants located there is projected to jump by 150 percent over that period. The number of lead plants is expected to rise by 29 percent in Mexico, by 50 percent in Eastern Europe, and by 50 percent in the rest of developing Asia, a region that includes India and the Southeast Asian nations. Emerging markets will not be the only ones to gain. The survey respondents also expect to increase their number of lead plants in the U.S. and Canada by 25 percent over the next five to 10 years.

"The transfer of lead plants and R&D will have a particularly significant impact on the European automotive-supply industry," says Beck. "In Germany, we estimate, 35,000 of the current auto-supplier workforce of approximately 290,000 could be affected by plant closures – including some 7,000 engineers, administrators and
support positions." About one-quarter of those jobs will be in competence centers and lead plants.

Developing Optimal Production Network
To address the proximity paradox, the authors recommend that suppliers adopt a more comprehensive approach to adjusting their manufacturing networks, one that balances the necessity to have certain production close to customers with a cost analysis that goes beyond direct factors such as labor rates, materials and shipping. A manufacturing-network-optimization program should encompass improvements to the global supply chain, organization structure and manufacturing processes. "To be really successful, these programs must be ongoing so that suppliers have the flexibility to adjust their manufacturing footprints in response to shifts in global cost, market demand and technology trends," says Lesmeister. "For many suppliers, this will require at least some transformation of their organizations."

Suppliers should start the approach by gaining a full understanding of the strengths and weaknesses of their current manufacturing network and their ability to make adjustments. The authors recommend that suppliers conduct a thorough "health check" of their optimization programs that assesses the past performance of the network and whether current capacity in a region can meet projected demand. The health check should also evaluate capabilities and managerial responsibilities across the network, examine the tools and methods used to identify and quantify improvement opportunities, and determine whether the capabilities and processes are in place to implement the strategy and adjust the network.

A copy of the report can be downloaded at the BCG web site.

Source: The Boston Consulting Group