The bitter lesson of 'big is best'

By Institute of the Motor Industry | 16 August 2001

Just as carmakers are forming into ever bigger groups, so the major components producers have restructured into a super league of 'systems' suppliers. But, faced with relentless cost-cutting demands from vehicle manufacturers, many of the players are in trouble, prompting the question: After consolidation, will there now be a period of unbundling? Report by Arthur Way.

Recent years have seen extensive restructuring in the automotive components sector, reflecting the move by vehicle manufacturers (VMs) to source complete systems (as opposed to individual parts) from a limited number of major groups.

Carmakers - themselves consolidating into mega groups - now expect these 'Tier One' companies to be responsible for the design, development and production of these systems - ranging from transmissions to seating. They must therefore display not only technical innovation, but also have the resources to produce the goods and deliver them to worldwide assembly locations.

Some idea of the scale of this commitment is provided by Tier One producer Bosch, which estimates it has spent around $3.5bn during the past five years on bringing its latest diesel fuel injection, electronic brake control and in-vehicle navigation systems to market. Bosch allocated $1.5bn on R&D in 2000 - a 22% advance on the previous year's figure - and envisages a further 20% rise in expenditure this year to $1.8bn.

Now it would be logical to assume that the development of these powerful component groups would have tilted the balance of power away from vehicle producers and towards component manufacturers. After all, larger companies are usually less easy to menace than smaller ones and the increasing concentration of technology among suppliers suggests that they would be well placed to hold the vehicle manufacturers to ransom if they sensed an advantage in so doing.

If anything, though, the evidence points the other way. VMs profess to treat their component suppliers as 'partners' and there is no doubt that the two 'sides' necessarily are working closer together across a wide range of functions. However, carmakers still appear able to dictate the terms of business and, in particular, remain brutal over their demands for year-on-year price reductions. A notable example of late was Chrysler's call for an across the board extra 5% price cut as part of its efforts to regain profitability.

Furthermore, component suppliers are beginning to realise that, under certain circumstances, 'owning the technology' could be just as much a weakness as a strength. Vehicle manufacturers' strategy of concentrating resources on activities (such as distribution, finance, warranties and aftercare) downstream of the assembly process and evacuating upstream activities (principally component development and production) looks increasingly smart.

For a start, by allocating the responsibility for systems development to their suppliers - and by divesting their own component producing operations - VMs have gone a long way towards protected themselves from the risk of being committed to obsolete technology. This means that they will have no qualms over embracing new ideas and jettisoning old products when something better becomes available. This is especially crucial in view of the development of major new powertrain technologies along with the future availability of equipment based on electronic rather than mechanical linkages, including steer-by-wire and brake-by-wire systems.

"Though it would be logical to assume that the development of powerful component groups would have tilted the balance of
power away from vehicle producers and towards component manufacturers,
evidents points the other way

Equally crucially, vehicle manufacturers have ensured that an increasing proportion of fixed costs now resides with their suppliers. In particular, technical staffs at suppliers have grown to accommodate the new demands for greater technical input. This latter point is especially critical during a downturn which, in the context of the present softer conditions in North America and the likelihood that these will overspill into Europe, implies that the new breed of mega component groups which has developed during the past few years is about to face its sternest test so far.

Already the symptoms of distress are evident in the form of employee layoffs and cutbacks, plant closures, divestment of businesses and falling profits.

As might be expected, American companies have fared the worst in recent months with many major groups including ArvinMeritor, Delphi and TRW all reporting negative news. This has potentially serious implications for Europe's components industry because of the extensive interests that these American companies control in the region, and the probability that cutbacks across the Atlantic will be replicated here in order to pare costs.

ArvinMeritor is set to disappoint investors during the current year as falling production levels in North America have already resulted in the failure to achieve revenue and profit objectives. The company has implemented a series of measures aimed at reducing costs.

Delphi, the world's largest automotive components producer with an annual turnover of around $30bn, has announced that 11,500 employees - around 5% of its total workforce - will lose their jobs. Among the casualties, the company's plant in Southampton for the production of steering columns is to close at the beginning of next year.

TRW, meanwhile, announced at the beginning of April that it is conducting a strategic review of its objectives following fears that sales of automotive products could fall sharply during the current year. Again layoffs have been a feature of recent months and non-core activities are being sold.

In Europe, too, there are clear signs of decline, notably at Valeo which has moved into losses and is experiencing the harshest business conditions since the mid 1980s. The company is implementing a major restructuring programme which, significantly, will include asset disposals. The closure of two UK plants has been announced.

Meanwhile, GKN has warned at its recent AGM that profits during the present year are coming under threat due to lower demand for components from its American customers.

No wonder, therefore, that component manufacturers have taken a battering on world stockmarkets with many hovering around their low for year and, in some cases, standing on derisory ratings. Continuing financial losses at Tenneco Automotive have prompted the company to cease paying dividends to shareholders, and one of the worst performers is the formerly go-getting Federal-Mogul whose share price shows a loss of around 80% during the past 12 months.

Although conventional wisdom has dictated the need to be big for survival, it is clear that some of the more ambitious expansion moves have produced results which have been less than appropriate and Federal-Mogul's experience provides a salutary lesson for other component groups tempted to embark on a strategy of headlong expansion.

Under its former head, Dick Snell, Federal-Mogul embarked on a blizzard of acquisitions during the past few years with the aim of boosting turnover and joining the major league. Among the 14 or so takeovers of the past couple of years has been the British jewel T&N, a world leader in engine parts. In the event, though, Federal-Mogul has become saddled with a high level of debt and retrenchment is now the order of the day. Operations are being divested and more than 1,000 employees are being cut from the workforce.

An important trend concerns the severance of component manufacturing activities by diversified groups. The hiving off of Rockwell Automotive from the Rockwell group led to the formation of Meritor which, subsequently, joined forces with Arvin to form ArvinMeritor. The merger of Smiths Industries and TI Group was conditional on the divestment of TI Automotive. More recently, Textron Corporation has indicated an intention to sell Textron Automotive and GKN is splitting into two in a move which will see its automotive interests separated from industrial services.

This trend has been paralleled by vehicle manufacturers which have been selling their component operations on a piecemeal basis for many years. A new and more dramatic twist to this process occurred following the decision of both General Motors and Ford to float their component manufacturing activities into free-standing independent operations to establish Delphi and Visteon respectively.

"In Europe, too, there are clear
signs of decline, notably at Valeo which has moved into losses and is experiencing the harshest business conditions since the mid-1980s

After so much change, it would be reasonable to anticipate the component manufacturing sector reaching a state of equilibrium in which corporate structures would settle down in a period of relative stability. Even in the absence of the debilitating effects of the current downturn, though, this seems unlikely and already there are the first clues of a fundamental rethinking over the sector's future mode of organisation. After the consolidation, will there be a period of unravelling?

Magna has provided a strong pointer to the possible way ahead by embarking on a process of splitting itself into a number of separate companies on the premise that what matters is not being the biggest but the best. The theory is that large groups become lumbering and top heavy in bureaucracy, whereas smaller units are nimble, have more of an entrepreneurial spirit and will generate faster sales and profits growth. As a consequence of this new approach, Magna has established three new companies - Decoma International (exterior trim), Tesma International (engine, transmission and fuel systems) and Intier Automotive (vehicle interiors).

Another form of unbundling occurs when two companies see the merit of combining their interests in a specific product group into a single operation. A prime example is evident from the establishment of Automotive Lighting which has united the automotive lighting interests of Bosch and Magneti Marelli.

As the cost of developing new technology rises, more and more component groups are setting up joint ventures as a means of entering the marketplace. GKN and Siemens formed Emitec to exploit the growing opportunities in emissions control, while earlier in the year two German companies, Hella and Leoni, announced that they were establishing a 50/50 partnership (known as Inteldis) to develop and market completely new intelligent wiring harness systems for automotive applications.

Whatever the component sector's ultimate structure, it is unlikely that the pressures placed upon individual companies by VMs will moderate. The requirement to provide technical input and support will continue and closer involvement could occur if vehicle manufacturers succeed in persuading component suppliers to provide the labour for the fitment of their systems on the assembly lines.

All the while, component groups will need to accommodate the demands for lower prices, not least as customers concentrate their purchasing functions. The decision, for example, of Renault and Nissan to set up a joint purchasing organisation means that the two marques will enjoy enhanced clout when discussing prices with their suppliers and the same will apply to the GM/Fiat alliance in Europe.

However, the rewards for those who succeed could be substantial as chosen suppliers are awarded long term, single sourced contracts for models with massive production runs. Ford's decision to develop a single platform for models in the lower-medium segment of the Ford, Mazda and Volvo marques will result in a high degree of common componentry, including engines and transmissions, suspension systems and safety equipment. In similar manner, it is probable that Chrysler and Mercedes-Benz will share an increasing number of components, beginning with joint systems for their four-wheel-drive models.

For component manufacturers, the key objective now is to sharpen their management skills to ensure that the wider marketing opportunities afforded by their customers' growing scale of operations are translated into satisfactory margins. It is a challenge which may be compromised by the increasingly international nature of consumer markets which is placing all vehicle manufacturers under substantial pressure to provide better specified cars and commercial vehicles for the same price.

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