It has often been said that the actual business of assembling cars is a necessary evil for OEMs. The argument goes that – if they could – carmakers would happily design, market and sell their cars, and get someone else to carry out the complex, expensive business of building the vehicles, writes Alex Graham.
Clearly this is an overstatement, but it does accurately reflect the challenges associated with making money from making cars. It is also a useful filter through which to regard some of the rapid and drastic outsourcing decisions that have been taken in recent years.
When Ford established the original Rouge complex in Dearborn, Michigan, in the 1920s, the company’s founder Henry Ford set out to be independent of suppliers.
In its first incarnation, Rouge forged its own steel and manufactured tyres on-site, using rubber from a Ford plantation in Brazil. Rouge also produced its own glass and had its own power plant.
Since that time, carmakers have gone through several evolutions of the definitions of their core competences. A modern concept, upon which many (though by no means all) carmakers agree is that the OEM designs, assembles, markets and sell its vehicles.
Any other processes such as the design and validation of components, under this model, are to be handled by companies specialising in the relevant specific areas.
A further extension of that concept, espoused by Fiat for example in the 1990s, was that the OEM only designs, markets and sells its vehicles, leaving the assembly to other partners in the industrial network. This seems to be the high-water mark in concepts surrounding the practice of outsourcing, and it is arguable that even Fiat did not bring this concept to full realisation.
By contrast, Japanese carmakers continue to believe that no other company (and certainly no other company that has no experience of building cars) can assemble vehicles more efficiently and profitably than they can themselves. This model particularly applies to Honda and Toyota, while Nissan has taken a slightly different approach, influenced by its financial crisis in the 1990s and the subsequent alliance with Renault. In reality, every volume carmaker has found that market and corporate factors dictate a more selective policy when it comes to outsourcing: carmakers have exited many sectors, such as fuel injection systems, and as a result, suppliers are the technology leaders in those areas.
Certain components or sub-assemblies can be handed off to suppliers, not least because the labour rate differential can produce significant savings alone. But the jury is still out on the effectiveness of involving suppliers in pre-assembling large chunks of the overall vehicle – not surprising, considering that most carmakers have several decades experience behind them in screwing cars together.
Some examples of long-term outsourced components
Some component areas have been outsourced for a very long time: the suppliers of tyres and audio systems, for example, are brands that are well known to most consumers, and these are areas where OEMs do not look to operate. Such brands can in fact have a positive impact on consumer perception of a given model or vehicle brand, due to the prestige attached to such brands as Pirelli for tyres or Bose for high-end in-car entertainment.
Another area that is a longstanding example of total outsourcing is in passive safety, namely airbags and safety belts. In the large majority of cases, end consumers are unaware of the suppliers of these components in contrast to the above examples. The motivation in the instance of airbags is one of the recurrent themes in outsourcing in recent years: supplier specialisation, experience and expertise. OEMs are comfortable taking delivery of airbag systems as “black box” items. These are components, delivered ready to install as a system by the supplier, and the OEM does not oversee the management and production of control units, software, connectors etc.
Beyond those relatively static sectors, there has been a surge in the level of outsourcing carried out by the world’s OEMs over the past 15 years to 2005. In some cases, OEMs have retrenched from the extremes adopted in the initial phases, while other carmakers are still proceeding cautiously and on a case-by-case basis. In addition, the proliferation of niche models, and the pressure on resources throughout the industry has seen outsourced assembly of entire vehicles growing.
Potential benefits of outsourcing
Outsourcing offers OEMs the opportunity to gain significant cost reductions. Competition among suppliers, along with non-unionised labour can offer considerable ongoing savings in addition to the reduction in capital investment requirements. In a highly competitive environment, OEMs are also facing pricing pressure from end-consumers, with either favourable finance or equipment rates becoming increasingly common. In an instance where an OEM makes air-conditioning free as part of a special offer, clearly it needs to purchase from the supplier at a commodity rate.
This is a phase of the industry where outsourcing is higher than it has ever been, and the relationships and boundaries between suppliers and carmakers are changing extensively – so sometimes the failure of an idea is a case of simply testing what is possible.
Growing supplier capabilities: As more work is handed over to suppliers, so their revenues grow, and likewise the amount they have to invest in R&D. Suppliers in many sectors are increasingly engaged in market research on the end-consumer in order to be able to bring valuable innovations and new concepts to the attention of their OEM customers.
Product specialisation: One of the strongest prima facie arguments for the continued growth in outsourcing is that of product focus. The OEM’s product is the complete vehicle, while each supplier can focus on those components and systems where it specialises. So where the OEM needs to concentrate on delivering a vehicle that will attract the car buying public and that will sustain the required brand values, a supplier can drill down to developing the best solution for, say, a centre console or diesel injection system.
As a result, R&D can be more focused, and investment as a proportion of sales will be higher if a Johnson Controls develops seating instead of a Ford Motor Co.
Cost and price: As OEMs farm out work to external suppliers, so new markets with new competitive trends develop. In almost all major product areas, there are several global competitors chasing business from carmakers. At a time when the OEMs have to work hard to keep margins going, the price pressure that can result from encouraging competition between suppliers can help to lower overall vehicle development and manufacturing costs. This also allows OEMs to focus more on competing in the complete vehicle arena, i.e. pitching their vehicles and brands against others and allowing the suppliers to compete in their arena.
In the case of modular pre-assembly, such as cockpits and axle/suspension modules, OEMs can have a large chunk of the value of a vehicle delivered exactly when it is needed (just-in-time), removing the need to have large amounts of working capital tied up in an inefficient way.
Capacity pressure: While overcapacity is a concern for several carmakers globally in their main plants, others, including BMW, have outsourced vehicle assembly, as they simply cannot spare production resources for the assembly of new vehicles. With niche vehicles growing in popularity, OEMs are also turning over development and engineering responsibility to competent suppliers, in order to achieve a guaranteed timeframe and budget without needing to devote excessive management time to a vehicle programme.
Risk transfer: In addition to reduced working capital requirements, and lower operating costs (in most cases), outsourcing allows OEMs to devolve commercial risk to its suppliers. Any contract between OEM and supplier will discuss volume projections for a given programme, but very few if any, OEMs will guarantee those volumes, or compensate a supplier for lower than expected sales.
So, by outsourcing to a range of suppliers, the risk attached to a given programme failing is distributed among a number of commercial enterprises.
It is worth noting that carmakers that can become, and stay profitable, give themselves much more room for choice in the question of outsourcing. The most recent big moves in outsourcing were sometimes undertaken as an emergency measure to shore up the balance sheet, and divest expensive labour. Toyota looks to give itself plenty of room to make sourcing decisions over the longer term, and can afford to do so.
The fact that Toyota and Honda do in fact make use of modular pre-assembly, but are firmly against outsourcing it to another assembler sits interestingly in the context of the industry’s overall use of modules. Modules have proved to be useful in cutting assembly time, raising quality, and, when outsourced can lower costs.
But the supplier side of the equation is often not as rewarding. Without some other added benefit, such as a higher level of the supplier’s parts or early involvement in development work, the module integrator is rarely paid properly for the skills they believe they can bring to the party.
Key development themes in outsourcing 2000-2005
The wave of huge mergers that swept through the automakers through the 1990s created corporate entities with purchasing, manufacturing, marketing and sales operations in every region of the world.
These new OEM alliance groups subsequently presented significantly different challenges and opportunities for the carmakers themselves and their key suppliers. Carmakers needed to be more nimble in their manufacturing footprint, compared to the traditional high volume domestic plants that had prevailed until then.
The frantic pace of consolidation slowed almost to a stop in the period 2000-2005, both among carmakers and in the tiers of the supply base. Developments in outsourcing slowed correspondingly, and there have been some instances of OEMs retrenching in order to retain skills or get better piece prices through higher volumes.
Suppliers, or at least the top thirty or so tier 1 suppliers, increasingly needed to support their customers regionally, both with development and production, at the same time as finding ways to stay competitive globally in the face of ever tougher competition from emerging suppliers with lower cost bases. A study by German firm Cell Consulting concluded that system suppliers already contribute more to the overall value of a vehicle than the OEM does, and that further measurable change will occur by 2006.
Figure 1: Change in value contribution 2003-2006 in the average German car
click table to enlarge
“There has been a significant change in value chain contribution away from the OEM to the supplier. This has manifested itself in a number of ways, such as increased involvement by the design and development companies in the development of the car and the increased responsibility the supplier is taking in terms of module and system development,” says Michael Gartside of PricewaterhouseCoopers AUTOFACTS. “The former could well have been a necessity forced upon the manufacturers due to the fragmentation of the market and increasing number of vehicles and derivatives being developed now whilst the latter is something the OEMs are forcing on the suppliers although it is also a way for the supplier to differentiate itself.”
Modules and systems
The installation of new capacity or a major re-tooling during model change in a plant generally tends to lead a shift to modularisation. Such a shift allows OEMs to cut their capital requirements and generally results in lower overall assembly costs.
It is worth noting that some OEMs who are still perceived to be cultural holdouts have gone toward some – often fairly high – levels of modular outsourcing in new plants. BMW’s new car plant in Leipzig, Germany as well as the Mercedes-Benz light truck plant in Alabama, US are both good examples of the case-by-case approach that many OEMs prefer to take.