The Growth Imperative

Automotive supplier companies are used to
following orders. In the 80’s, they dutifully followed the vehicle manufacturers in their
flight to quality. In the 90s, they managed to keep their customers happy by cutting
costs. Now, the vehicle manufacturers are asking for much, much more. They want suppliers
to deliver modules, not manufacture parts; and they want their suppliers half an hour away
from any of their plants – whether the plants are in Lansing, Ruesselsheim or Shanghai.

Modularity plus globalization – two new
demands that require giant steps. Suppliers are no longer being asked for only incremental
improvements, like 3% cost cuts or defect-rate reductions. These new mandates are pulling
the supplier industry into an entirely new world, with a vastly different scale of
financial and manufacturing values.

As vehicle
manufacturers grow larger, and become true global enterprises, their increasing overhead
is forcing them to push costs – from design and development to manufacturing and service –
down their supply chain. Suppliers are now inheriting these new tasks, and the new
responsibilities they carry with them. To survive as a major automotive supplier, an
enterprise must imitate its customers. It must grow – rapidly. It must learn to innovate –
specifically in the exploding field of auto electronics. It must acquire new marketing
skills, beginning with name branding to establish its own identity.

LARGER, LONGER, RISKIER DEALS.
Vehicle manufacturers now want a few big suppliers to deliver systems and modules that are
easily purchased and “snapped” together. They used to give the supplier
blueprints and specifications; now they outline a space, and task the supplier to fill it
with a function. As the VMS attempt to shed more costs, they require their suppliers to
shoulder more R&D, while simultaneously lowering prices. This greatly increased
responsibility offers larger and longer supply agreements, greater economies of scale –
and substantial long-term financial risk.

In this new world, the VMs demand systems
and modules that require the simplest, most cost-effective purchasing and subsequent
assembly. Therefore, suppliers must increase their knowledge- and expertise-base quickly,
and the fastest way is to merge, acquire or enter into joint ventures. So the merger mania
of the vehicle manufacturers is infecting the supplier industry: fewer manufacturers with
higher volume platforms (and the modules that make them up) invariably leads to fewer,
larger suppliers.

The pace of consolidation has quickened
each year. In 1995, there were 178 supplier acquisitions or mergers, 212 in 1996, and 286
in 1997 – in North America alone. In 1998, the number of mergers and acquisitions
declined, but industry estimates show the dollar value of total supplier M&A activity
actually rose. Like the VMs themselves, the largest suppliers are no longer simply
absorbing small niche companies. They are now acquiring each other. Valeo paid $1.7
billion for ITT Automotive’s electronics to better position itself to provide complete
electronics systems. Continental Gummiwerke, in pursuit of its “four corners”
strategy, spent $1.9 billion to buy ITT Automotive’s brake business. And TRW found that
the quickest way to take advantage of the burgeoning auto electronics business, expand its
ABS business into partial front end modules, and, as a bonus, penetrate new European
markets, was to acquire Lucas Varity for $6.8 billion.

There may come a time when five or six
mega-suppliers divide an automobile into sections, or “chunks” – front end
modules, rear end modules, rolling chassis and entire interior systems, including all
electrical, navigation and safety components..

THE LABORATORY. South
America has become the VMs’ development laboratory for modularity and new assembly
techniques. In Brazil, Dana manufactures and assembles a Dodge Dakota rolling chassis
system, a module which contains the frame, with the entire front and rear suspension
systems, brakes, steering systems, wheels and tires. Dana coordinates the work of its 16
sub-suppliers, and each hour trucks the assembled rolling chassis five miles to DC’s Campo
Largo plant for final assembly. Another experiment in Brazil is Volkswagen‘s bus plant in
Resende, which is half-financed and fully managed by VW‘s suppliers. Volkswagen’s only
contribution to the plant is to provide the basic utilities – water, heat and electricity.

The obvious advantage of modularity to the
supplier is the economy achieved by spreading R&D and manufacturing responsibilities
over a larger resource base. The obvious risk is that the supplier must assume
responsibility for the R&D investment, manage the entire supply chain for its module,
satisfy the vehicle manufacturer, assume warranty responsibility – and make money in the
process.

DOWN IN THE Delta. Nothing
better illustrates that risk than Lear‘s recent experience with GMs’ Delta program. After
Lear lost the seating contract for GM’s Delta small cars, it bought United Technologies
Automotive for $2.3 billion. Lear, anxious not to be left out of this very high-volume
platform, perhaps thought it could successfully re-bid the seat and interior contract with
the added leverage of the UTA cockpit. Unfortunately, after Lear completed the engineering
and tooling, the Delta program failed at consumer clinics. GM decided to push the program
back two years, and Lear will have to wait much longer than that to show a return on its
investment.

Virtual Keiretsus?
It is interesting to note that not all North American automakers are demanding
modularity from their suppliers. The major impetus comes from The Big Two, GM and Ford,
whose planned supplier structure has been called a “virtual keiretsu.” The
Japanese automakers, with actual (if slowly deteriorating) keiretsus, are not quite as
interested in modules and integrated systems.

ARE YOU GLOBAL? OR JUST OVERSEAS?
On top of the financial risk involved with becoming too large too fast, suppliers have to
worry about becoming too international too carelessly – the “Reach Vs. Grasp”
dilemma. In their race to better and more rapidly meet VM demands for systems integration,
suppliers too often make the mistake of expanding solely for the sake of being located
everywhere, without exploring the real prospects for – or installing systems that enforce
cooperation between – the transnational divisions. Using decentralized operating
structures, in which divisions are run like businesses within the whole, may help organize
complexity, but does not assure quick customer response or excellent cross-organizational
teamwork. For example, conflict of interest issues can arise when two dissimilar groups
work together to design and manufacture a module with two or more systems.

This shall be the first
commandment; thou shall optimize synergies and deliver enterprise-wide cost savings.

Thou shall increase shareholder value.

Thou shall assume more
responsibility and risk.

Thou shall honor environmental
regulations.

Thou shall be anointed a module
supplier; a systems integrator shall ye be.

One very basic, but frequently overlooked
factor in globalization is consistency of communications. Valeo is one supplier which
realized the importance of avoiding the internal communications snarls that have plagued
several conglomerates as they tried to digest new acquisitions. Therefore, Valeo
contracted with ANSYS, an engineering design software firm, to standardize its global
communications, and ensure that it can easily E-mail complex design files around the
world.

The New Electronic Frontier

The electronic revolution may be the
nearest the automotive industry will ever get to an unmixed blessing. Handled properly, it
can provide more defensible market share, greater product innovation and faster growth for
existing technology for both traditional and new suppliers. VMs will be able to increase
the options that appeal to customer demands for increased safety, security, lower
maintenance and increased amenities. These options also give VMs the opportunities to push
more design and innovation down the supply chain, by enabling both traditional and
non-traditional suppliers to use onboard computer systems both to add value to the
customer and improve automaker revenue through decreased costs.

SAFETY FIRST. In the early
1980s, cost and safety dictated the use of electronics and computers in automotive
applications: air bags were a direct result of concern over safety, and engine management
systems answered the VMs’ need to keep vehicle maintenance costs down, and meet emissions
and CAFE requirements. Today the focus has grown to include user amenities that add
features to make vehicles into rolling living rooms and offices: entertainment, Internet
access, communication and navigation. Both Ford’s Windstar and GM’s Oldsmobile
Silhouette minivans are now auditioning optional television and videocassette recorder
entertainment systems.

Thou shall merge and acquire and
serve in all the four corners of the earth.

Thou shall innovate, leveraging technology throughout the product
development cycle.

Thou shall strive to be numbered
one or two amongst all suppliers in thy field.

Thou shall honor thy labor
relationships.

Thou shall honor thy customer’s
oath to source at minority-owned companies.

COMPUTER ON BOARD. Onboard
computer systems, now segmented into safety, vehicle management/diagnostic systems,
security, communications, entertainment and navigation, will one day be tied together,
perhaps into one master computer that allows several parties – including user and dealer –
to monitor all systems simultaneously and to find and report problems quickly. GM’s
OnStar system is just the beginning. This GPS-connected system provides navigation,
security and personal cellular communication services while it monitors air bag status,
tire pressure and engine condition.

The new onboard computer systems will
provide communications service beyond personal cellular phone usage, including Internet
access and direct satellite television services. Only recently, Ford and Intel fitted an
Explorer with the latest Pentium-based computing platform for navigation communication and
cell phone service, plus Internet access through voice-activated software.

As computer capabilities, and consumer
demand for them, grow, the industry is moving to new standards. Present onboard power is
limited to 12 volts, but VMs are now planning to increase to 42 volts within the next five
years. This will allow suppliers of consumer electronics, cellular telephones, software
and Internet services to develop products tailored to a standard vehicle network. With the
Automotive Multimedia Interface Collaboration, the major VMs have adopted a common
technical standard for hardware/software for mobile entertainment, computing and
communications, with design objectives to be codified into a set of SAE or ISO
specifications. Under the new standards, consumers will be able to plug cell phones,
pagers and multimedia computers into their vehicles.

THE NEW COMPETITORS. Of
course, software and semi-conductor companies like Intel and Microsoft, which
traditionally have few or no products related to automotive, as well as software and
semiconductor/chip makers who already earn revenue from automotive-related businesses,
like Hitachi and Motorola, could become serious supplier-competitors. All are presently
evaluating automotive opportunities. The proliferation of onboard systems will also
provide entry opportunities to telecommunications providers like AT&T, MCi and Sprint,
and satellite radio providers like CD Radio. But by acquiring a small software company,
and having it partner with a giant like Intel, both VMs and suppliers can obtain access to
leading-edge computer systems with minimum investment, increasing their knowledge of the
industry’s technology-base while maintaining control over their own business.

The Name Game

In search of a marketing edge, suppliers
are discovering consumer market branding. Anecdotal evidence suggests that branded auto
parts and systems can be a strong influence in the buying decision, sometimes bettering
vehicle performance on consumer preference lists.

Who’s Captive To Whom?
VM pressure on suppliers to consolidate for system integration purposes seems to point
to a long term strategy by VMs to exit the business of automobile production altogether
and simply market, sell, finance and service vehicles. (That would explain Ford’s recent
moves to buy up automobile graveyards.) The advantage for the automakers would be that
labor issues, aging factories and R&D costs would be pushed down the supply chain.
Their risk? They could lose too much control to suppliers with respect to cost, design
capabilities and manufacturing expertise. Were the supplier base to shrink too much,
competition among suppliers would decrease and the VM-supplier captivity model could go
into reverse.

Vehicle manufacturers have long used Bose
sound systems, Pirelli tires, Recaro seats and even entire vehicle packages to create a
product image that can be used to target and market vehicles to particular buyers at a
premium. In effect, the VM borrows the prestige of the supplier brand in a symbiotic
marketing relationship that enhances the value of both brands. Tire and audio
manufacturers were the first to exploit brand-borrowing systematically, using their own
brand equity to enter a new market supported by the brand equity and wide market
penetration of a VM. Probably the most successful brand-borrowing has been with
entertainment electronics. Alpine, Bose and Sony are world-renowned brands, and Audis with
upscale Sony and Bose systems command a premium of over $1,000 per option.

Clothiers and luggage makers have partnered
with VMs in marketing their vehicles to consumer micro-segments. Vehicles are now
“custom made” to fit a specific buyer and image, allowing VMs to capture more
buyers with vastly different tastes while using the same vehicles/platforms, lowering the
cost and selling at a premium.

HIKERS AND BIKERS. Ford’s
Eddie Bauer models best illustrate this trend. Eddie Bauer is not only associated with
casual outdoor clothing and hiking boots, but is now synonymous with a trim package on
Ford’s Explorer at a premium of between $3,000 and $4,000. The campaign has been so
successful that Ford extended the package to its larger SUVs and even its F150 pickups.
Toyota‘s ad campaign for its Lexus luxury brand, which features free Coach leather seating
and a luggage set with the purchase or lease of a Lexus ES300, adds more up-scale brand
distinctiveness to the Lexus brand.

Another brand-borrowing program has been
extremely successful for Volkswagen. Using superbrands Trek mountain bicycles and
Rossignol skis for specially equipped cars, VW provides an outdoors activity package for a
targeted market segment.

Brand borrowing increases name awareness
and market reach for everybody involved. Non-traditional suppliers, like clothiers and
consumer electronics firms, can now leverage their own consumer appeal and market reach to
increase economies of scale by selling more products to more people in more markets.

Because VMs can quickly change interiors
and add-on packages while keeping the basic vehicle design unchanged, the risks associated
with supplier branding in the automotive industry lie mostly with the suppliers
themselves. If the supplier can’t offer a brand-name marketing advantage to the VMs, it
may run the risk of losing contracts to other suppliers not because of engineering design
or cost, but because of a lack of consumer market appeal. Suppliers also face the
challenges of reducing costs throughout the automotive supplier chain while offering
products that have mass-market appeal. But serious cost problems may arise when they
partner up with companies traditionally not involved in the automotive industry, companies
that have never experienced the cost cutting, quality or performance standards that
automotive companies constantly face.

ESCAPE FROM ANONYMITY: THE Bosch
MODEL.

Brand-borrowing may be just the beginning.
Suppliers now face the opportunity – and expense – of consumer-branding parts of the
vehicle consumers can’t see or feel. For instance, TRW could explore ways to induce
car-buyers to make a vehicle purchase decision based on its TRW Supplemental Restraint
Systems.

Therefore, many supplier marketing
departments have begun studying the Bosch marketing and branding strategy. Bosch’s
“Motronic” fuel injection systems have long been prominently displayed in Audi
and VW marketing literature, and are perceived to add substantial value to any vehicle
that features them. Their success will induce major component suppliers to roll out
similar marketing and branding campaigns in the next decade.

Ike Anyanwu-Ebo, PricewaterhouseCoopers