The biggest manufacturing industry in the world, in the largest single market in the world, is going for a single currency... European Monetary Union (EMU) is being actively supported by the automotive industry. The sheer size and borderless nature of a single currency will have an impact on automotive companies, regardless of whether or not their host country has embraced the euro. So what are the likely implications ?
A vehicle manufacturer (VM) can use the euro to make meaningful cost comparisons across Europe. At present, VMs practice 'currency hedging' - buying components in a currency such as sterling to offset any income fluctuations they experience in that currency. This results in the relative worth of expenditure and income being the same, thus minimizing the exposure of VMs to the risk of currency fluctuation. With the coming of the euro, the risk element due to currency fluctuations will diminish considerably for VMs, who can use a more stable currency for longer-term supplier relationships. However, if a supplier's cost base is in a currency that is not linked to the euro, does the supplier now take this risk? And will the risk be passed down the supply chain?
VMs that source components free from the influence of exchange rate fluctuations can focus on improving product quality and making real cost reductions. By sourcing components in any country without the headache of currency hedging, VMs are likely to attract suppliers from outside the European Union (EU) who will be keen to take a slice of the largest single market in the world.
Suppliers may find that the increasing globalization of their market will be accelerated, as it is more attractive to have a piece of the action in a market of 15 million vehicles than a slice of an emerging market of 1-2 million cars. A reduction in the influence of currency fluctuations will make this an easier long-term investment decision.
In a single currency, VMs can bill suppliers electronically in euros, using electronic data interchange (EDI). A salesperson for a Tier One supplier will have an open-book policy with their customers. Details of every cost element incurred by the VM will be presented - even a £0.005 sticky label (or should it now be 0.005 x 0.64 euros?). Establishing a price based on the local currency is standard practice, and converting to euros and agreeing this with the VM is not a problem. However, what happens as the exchange rate changes? The fixed price in euros remains, but the cost base changes. In effect the euro has transferred the risk and the hedging on to the supplier. The low margins prevalent in the automotive industry will quickly be eroded by even a small change in the exchange rate.
The problems get worse if the supplier is a Tier Two or Tier Three. The super-suppliers who occupy the first tier in the supply chain are multinationals, so they can play the hedging game as well as the VMs. However, it is a different story for Tier Two and Tier Three suppliers. The VM may well have selected or specified these suppliers, from which the Tier One supplier must source at a price determined by the VM. The VM uses its industrial muscle to obtain supplies of raw materials and components on behalf of the Tier Two and Tier Three suppliers, who cannot obtain significant discounts on their own. If the price is fixed in euros, and costs rise owing to exchange rate changes, who carries the risk? The VM now trades in euros, and the Tier One supplier has a fixed price. Will they absorb any increase from the Tier Two or Tier Three suppliers, or will the risk be passed down the supply chain to the smallest supplier with the least muscle and little or no hedging opportunity?
Who bears the risk?
As an increasing number of mergers and acquisitions are consolidating automotive suppliers into companies with local manufacturing plants and a central, global control base, so a financial director of a Tier Two supplier may report into an EU parent that wants to cost in euros. They intend to pay in euros and want the local plants to adopt the same approach for reasons of transparency and consistency. To what degree can the Tier Two supplier change its cost base from the local currency into euros? Will the workforce accept euros, and will the landlords and utilities trade in euros? Tier Three suppliers are perhaps worst off. Perhaps only 50 percent of their business may be generated from the automotive sector, and indeed they may even have a policy of restricting the level of automotive business that they conduct. They supply a chain that is being conditioned by the VM to trade in euros. The Tier Three supplier is unable to hedge currencies, and may even be forced to reconsider the level of automotive business it supplies.
The introduction of a single currency will have a significant impact on the ways automotive companies do business. Some of the implications of the euro are clear, others less so. Perhaps the key message is be prepared. The most forward-looking companies already have plans and systems in place to ensure they can exploit the commercial opportunities presented by EMU while avoiding the pitfalls.