4/4/2016 | 3 MINUTE READ

Becoming Shock-Proof

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This decade thus far has been a great ride with volume moving upward at a 6 percent plus compound growth clip globally. The road from the forgettable days of late 2008 through 2010, with several supplier and OEM bankruptcies, were very challenging but in some respects necessary to rid the industry of excess capacity and weak players. As light vehicle sales and production capacity growth paces slow in North America and we enjoy the seventh year of this volume growth cycle, what is next?

What does a decline look like and how does one maintain profitability?

Past columns have articulated the looming challenges to profitability over the next decade. Swift globalization, the trek toward lower emissions (and costs to reach these), automated driving, electrification, an increasingly connected (and informed) consumer, as well as a global market not performing in a uniform fashion—all of these are substantial challenges to the recent success the industry has experienced. The next decade will challenge the average supplier in all arenas: technology implementation, global design and development footprint, building affiliations, working faster and doing more with less. Maintaining a strong financial performance requires more than just riding the wave of industry volume. If a supplier had the capacity, technology and the ability to deliver, there was a market. The market will not be so compliant over the next 10 years. 

Profitability and long-term success in this capital-intensive industry are grounded in several key indices: strong customer relationships, internal efficiencies, quantifiable technologies, well-placed production facilities, integrated suppliers and a productive workforce. There are many other factors which drive profitability, but true success can be boiled down to the combination of volume and mix. For those of us schooled in finance in this industry, nothing is more important than surpassing one’s fixed cost threshold (volume) and ensuring that the combination of customers, products and subsequent margins is optimized. Strong industry volumes can paper over a sub-standard operational performance, though when volumes soften, the “mix” quickly takes over.

Let’s look a bit deeper into this idea of product mix. It encapsulates the idea of optimizing the cadence (the beginning and end of programs), use of installed capacity and resources, the gross margins achieved on each and the inherent volume stability. A supplier focused on one product for one customer with high gross margins is taking tremendous risk in not diversifying their customer set of product mix.

What if the program prematurely ends or input costs spike: how does the enterprise balance this? Each company and sector are different, but suffice it to say suppliers should be wary of focusing more than 30 percent of their revenue and resources on one customer for more than a short period of time. The ability to withstand a shock from one OEM, segment or the cost of a system input should be paramount to ensure the long-term viability of the enterprise.

Several factors will compel suppliers to review their business models going forward. Though the cost of raw material inputs to building the vehicle (steel, glass, rubber, etc.) have declined 51 percent since 2011, OEMs have taken this opportunity to add content (advanced driver assistance systems, light-weighting, powertrain, connectivity) to more than compensate for this raw material windfall. Looking forward, affordability will be critical. Increased cost of complying with stiffening global emission standards, new levels in electronic content and commodity cost which will rise at some point. Smarter suppliers are anticipating these challenges and planning accordingly. To date we have benefitted from strong volumes. Now it is time to make sure mix is up to the task.  

� Michael Robinet has been a managing director of IHS Auto-motive since 2011. Prior to that, he was the director of Global Production Forecasts for IHS Automotive. His areas of expertise include global vehicle production and capacity forecasting, future product program intelligence, platform consolidation and globalization trends, trade flow/sourcing strategies, and OEM footprint/logistics trends.