Insider: Detroit's Katrina

If you thought the outlook for the OEMs was bleak, wait until you hear what's likely to happen to the supply base.

During a recent presentation on the state of the U.S. automotive and supplier industries, Daniel Cheng, vice president of consulting firm A.T.

During a recent presentation on the state of the U.S. automotive and supplier industries, Daniel Cheng, vice president of consulting firm A.T. Kearney, compared the beating the industry is taking to that of a hurricane. In his estimation, Detroit's dealing with a category 4 storm that could get stronger unless stability returns to the atmosphere. Among Cheng's dire predictions: U.S. vehicle sales could dip to 14.1 million units in 2009 while prices for certain commodities (steel, aluminum, polypropylene and copper) will continue to rise at a more modest pace (hot rolled steel prices have risen 112% since July 2007) through the same period.

What's most dire about these predictions is the likely impact they will have on auto suppliers, who continue to be battered by rising costs with little ability to pass them onto their automaker customers. Cheng says some suppliers have been able to pass through some of their rising costs, depending on whether they provide components to vehicles in growing or declining market segments-some automakers are giving 100% price increase paybacks on small car programs, with little or nothing get passed through on light trucks and SUVs. In Cheng's estimation, the average amount suppliers are getting to pass through is near 35%. This is where the scary part comes in. If Cheng's predictions of lower demand and higher costs pan out, the supply base will get hit even harder in the year to come, as the need for additional capital to support ongoing operations will reach category 5 levels in the range of $38-billion. The big question is who is going to absorb that kind of impact?

It's highly unlikely automakers will open their checkbooks-GM is burning through more than $1-billion per month, according to the New York Times and Ford went through $1.5 billion in cash during the second quarter-and the drying up of credit markets is likely to leave bankers sitting on the sidelines, holding on to whatever cash they have for investments with better returns. Likewise, foreign investors are unlikely to help, as the global economy prepares itself for impending weakness. Cheng and his team quizzed executives at OEM and equity firms in China and India to see if they had any interest in investing or acquiring automotive suppliers and they answered a resounding "no."

Is anyone hearing the warning sirens yet? Some would say that further consolidation of the supply base would help alleviate the amount of money needed to keep most of the companies afloat. Others would counter that suppliers still have a lot of overhead they can get rid of that would have little impact on the overall health of their operations. I would argue that there's little left for suppliers to trim before they hit vital parts of their organizations, and consolidation would actually be worse for their automaker customers, who would have fewer options when it comes to sourcing, which would lead to eventual price increases irregardless.

A solution can be found through out-of-the-box thinking when it comes to the relationship between suppliers and automakers. For one thing, the purchasing folks need to stop looking at suppliers as an open trough when it comes to dumping their financial responsibilities. After all, what would OEMs do without a healthy supply base? In my estimation, they'd be between a rock and a hard place. It's time suppliers and OEMs worked together to develop new technologies and reduce vehicle component complexity, instead of being at loggerheads each and every day. Automakers need to bring suppliers into the product development process even sooner, so they can address additional areas of potential cost savings and help lead toward a path of commonization across corporate lines.

The old way of doing things will no longer work and the quicker everyone realizes this, the better of our entire industry will be. Failure to act now could result in Detroit becoming another Ninth Ward in New Orleans, where homes were devastated and people died because of poor planning for the oncoming storm.