The roaring 20s have barely started, and already they have thrown more curve balls than other years in recent memory. Everyone from individuals to the biggest corporations has been left scrambling to simply get their bearings and look for next steps. Unfortunately, suppliers aren’t the exception to this rule and, in many cases, may even be among the hardest hit by the recent turbulence. Suppliers are now finding themselves on the line for massive fines charged by OEMs, as well as shifting future trends and unstable labor markets. Fortunately, there are real steps that suppliers can take to improve their lot, regardless of how difficult the situation may be.
There is a slow but sure tidal shift from ICE (Internal Combustion Engines) vehicles to EVs (Electric Vehicles). Some of this is motivated by government regulation, but more importantly, much of it reflects actual consumer demand and market sentiment. This is not currently an existential threat to suppliers, but the proverbial writing is indeed on the wall. The flow of investments into R&D of ICE components is slowing to a trickle or has stopped completely in some instances. Many of the “powers that be” have pinpointed the year 2030 as a crucial year for the manifest development and implementation of green technology and a greater shift to EVs. Given the 7 – 10 year development timeline for ICE vehicles and components, investments no longer appear to be ROI-positive.
In response to this, many suppliers are re-purposing equipment to ride the EV wave. Additionally, many suppliers are moving their operations abroad (but not too far abroad) to lower-cost Latin American countries. Suppliers that end up being early movers will inevitably gain market share as astronomical inputs slowly pick away at the competition’s profitability.
Turnover & Employee Churn
No industry is untouched by the current labor market volatility. Inflation pressures are generally first felt by consumers and the base level of labor which incentivizes them to seek work wherever the compensation is highest. Government subsidies have also added, in many cases, an indisposition to work. Companies are forced to compete with a real option to stay home with family and still receive enough resources to get by.
Because of this, both OEMs and suppliers are having difficulty attracting and retaining labor. Not infrequently, the starting wage at a supplier is competitive with less-strenuous jobs like a gas station attendant or a receptionist. This creates a turnover-rich environment that exists all up and down the supply chain. To make matters worse, training is expensive, and training quality may also suffer if the employer believes that the trainee may leave in a few months anyway. This creates a foundation for a self-fulfilling prophecy fueled by a vicious cycle.
Suppliers and OEMs need to realize that training and turnover costs will quickly surpass the cost of other attraction and retention strategies. Some successful suppliers have started, for example, to pay significant bonuses based on attendance, timeliness, overtime, and more. Other suppliers and OEMs have improved the work environments with gyms, different cafés, higher quality food in the cafeteria, and generally improved working environments. Essentially, the supplier’s and OEM’s time preference needs to shift to the long-term; more engaged and dedicated employees will lower costs and raise productivity.
Cost breakdowns for OEMs are increasing because of the inflationary environment that currently reigns. White-collar workers are demanding raises in annual compensation commensurate with the rate of inflation. Because general and administrative cost breakdowns are most scrutinized by OEMs, suppliers often feel pressured to eat that cost which makes them less profitable internally.
To solve this problem, suppliers need to be open and transparent with OEMs and do their due diligence to identify and solve the root issues that are causing price increases. In some cases, issues like white-collar wage inflation and rising energy inputs are out of the supplier’s control and may not even appear as line items on the cost breakdown even though they contribute to rising manufacturing costs.
Some of these problems may be caused by inefficiencies or outdated manufacturing practices, and others may be the result of actual cost increases. Suppliers must make good faith attempts to solve these problems before approaching OEMs to transparently re-negotiate the relationship dynamics. If the OEM sees that the supplier has done their due diligence to identify and resolve the issues, suppliers will have a better chance of reaching a positive resolution with the OEM.
Cash flow from OEMs to tier 1 and lower-tier suppliers is negatively affected by late and incomplete payments from OEMs. Suppliers frequently have shorter payment terms with the OEM, and tier 2 suppliers have longer terms leaving a reasonable buffer for coverage. However, OEMs have been paying 6 to 9 months late which creates a liquidity problem for lower-tier suppliers. This leaves tier 1 suppliers with two different options: default on payments to tier 2s until the OEM pays or take out a line of credit on which they need to pay interest and could be called at any time.
In order to avoid delays in payment to lower-tier suppliers, many tier 1 suppliers have been running make-or-buy analyses to bring production in-house. The partial vertical integration by making parts rather than buying parts may help suppliers to become more profitable and competitive regardless of the macroeconomic conditions. However, each company needs to evaluate its own part production approval process as the investment may exceed the savings.
OEM Releases Unreliable
Due to the increase in critical suppliers, OEMs have shut down from time to time in order to save on labor and other inputs when a supplier is unable to deliver. Unfortunately, this creates bottlenecks for other suppliers who manufacture based on the OEM’s apparent schedule. OEM shutdowns ripple through the supply chain and can cause other shutdowns in suppliers unrelated to the initial bottleneck. Additionally, when the OEM decides to resume the original production schedule, suppliers must be ready with enough material to avoid further OEM shutdowns and large fees.
The best way to solve this problem is by intelligently continuing production even while the OEM is shut down. One company recently reviewed order history from an OEM to determine the frequency of each order type. In doing so, they were more easily able to anticipate the type and quantity of each order and therefore mitigate the risk of scrapping materials and workforce interruptions. There was still a certain amount of risk involved, but this approach helped the supplier to stabilize the workforce and better anticipate OEM orders.
None of these problems (or solutions) are unique to the automotive industry. Just as OEMs rely on tier 1s, and tier 1s on tier 2s, so is the entire supply chain reliant on those who produce raw materials and ship them for refinement. Breakdowns at the lower levels are affecting other industries like medical device manufacturing, aerospace, construction, and more.
Regardless of the industry, the solution to survive turbulent market conditions is a healthy dose of creative thinking, antifragile flexibility, and a willingness to negotiate fiercely. In time, new systems will emerge that will help stabilize manufacturing and macroeconomic conditions that will lead to new levels of growth. However, the way to enjoy the fruits of the long-term is to get creative and resilient in the short term.
Companies must do their due diligence in order to discover the whole truth of the situation. Once this foundation is established, suppliers can understand if an internal recovery plan is possible. In the event that it is outside of the supplier’s control due to raw material shortages or logistics issues, it can help them approach the OEM again. The OEM may be able to help provide solutions in some circumstances, or at least it would provide proof to the OEM that every option was exhausted and there truly is no path forward. At Seraph, we have the tools to dig deep and understand each angle, are trusted by OEM’s and suppliers and provide the necessary visibility to those issues for you to take the necessary steps to resolve.
Seraph is led by operations consultants who have worked in the biggest OEMs and Tier 1 suppliers in the world and know the business inside and out. Seraph has helped some of the biggest companies like Faurecia, Webasto, Mercedes-Benz, Nissan, and more, navigate the market since 2009. Our creative solutions have equipped companies with the tools necessary to not only survive but thrive in the midst of market turbulence. To learn more about Seraph or to schedule a discovery call with one of our advisors, please visit our information page for more information.