We believe that government exists as the umpire of the game, not to come down and take a bat, but to see that the other fellows play the game according to the principles of fairness and justice. — Nicholas Longworth
For the past several weeks we have seen the US automotive industry and it’s union pleading before Congress to give them a bat to play with. Whatever the final bailout package will look like, it will not have consideration for one of the major players in the industry that was not even at the table — the automotive suppliers.
The automotive supply base is the backbone of the industry; the suppliers employ approximately 673,000 people compared to 186,000 workers in the final assembly automotive plants. The true ratio of parts-to-assembly employment is even higher than three to one because more than one fourth of the parts purchased in 2006 came from overseas factories and were not included in the previous comparison. (1)
The total value of all parts delivered by Tier 1 suppliers to final assembly plants averaged $13,600 per vehicle in 2006, compared to $11,100 in 2000, an increase of 22.5% over six years. (2) In comparison, the average expenditure on a new car increased only 10% during that period, from $20,600 in 2000 to $22,650 in 2006. (3)
The visibility of the industry that provides 80% of the workers and 60% of the value of the vehicles was non-existent in the bailout discussions, but is reflective of their overall subservient position in the industry. The invisibility is played out with the general public as well. This is only natural when you consider that of the 15,000 various parts that go into an automobile, very few of the items — other than some items radios, tires, and batteries — have the actual supplier’s name on the part.
Similarly, there is little local visibility for the automotive supplier industry as their plants are now scattered through the United States, Canada, and Mexico, in approximately 3,200 plants where the median employment is only 220 employees.
As noted in a recent Detroit Free Press article, "With or without federal loans to the Detroit automakers, many of the companies that supply the automakers with door handles, gear shifters, and other parts, are already edging closer to bankruptcy in the suffering economy. So even if the automakers get the $34 billion that they seek, collapsing parts makers could cause parts shortages that threaten the automakers production schedules. That, in turn , could derail or slow any auto industry turnaround."
Parts makers, who already operate on razor thin margins, have been suffering accelerating increases in raw material pricing as well rapidly falling production requirements. They have seen their margins become non-existent.
All of this will come as surprise to the various publics and pundits who sought a simple way through this current malaise, who called for having the automotive companies declare Chapter 11. Such a declaration would be the financial meltdown for the supplier industry as a whole. Should a typical Chapter 11 bankruptcy be declared, all of the automakers under the bankruptcy laws would be given a 60 day claw back to deny payment for any of the goods that they received from suppliers during the last 60 days. To dimensionalize this for the reader, General Motors, alone, currently owes their suppliers $28 billion dollars. At this juncture, it would appear that the provisions for the bailout bill will not include any type of direct credit support to stop the pending insolvencies within the supplier base, as the government will have it’s hands full just dealing with the three automakers.
Subsequently, it is doubtful that the huge, financially marginal, US automotive supplier base — that provides the modules, systems, and components that represent 60% of the value of the average automobile — is capable of providing the necessary technology support for their automotive customers to improve and realize their mileage requirement goals by continuing the existing supplier /OEM relationships. If they do, the suppliers will need to go to Congress, as well, to appeal for funding to retool their factories, purchase new equipment, and expand their capability for new demand, just as the automotive manufacturers have done. In doing this, the suppliers will, along with their customers, fail in the end as this current adversarial model is no longer sustainable in today’s highly competitive environment.
Conversely, we see that many of the fastest growing and most financially secure suppliers are more than willing to set up shop at the request of the Japanese automakers as described in a recent McKinsey report. That Toyota and Honda make sure that their suppliers are able to earn a profit is, and has been, a key part of their formula for success.
Read the full report from McKinsey, "Profitable suppliers are able to develop technologies that give customers an advantage."
The Right Moves
Changing Detroit’s supplier relationships and restoring the industry to profitability is just as important as all of the other strategic moves that the Detroit automakers must make, such as reducing the number of dealerships or the number of vehicle models that are currently being offered. But the suppliers have yet to be included in any of the Detroit three turnaround plans that are currently being offered.
Including and utilizing the talent and resources in any supply chain makes the end user a much different and competitive company, more so than the companies who are mired in the continued price confrontations for which the automotive industry is noted. However, habits are hard to change and we should expect that Detroit will repeat the past and will attain essentially the same results.
There is a bright side to all of this. Professor Christopher Ruhm, an economist at the University of North Carolina at Greensboro, has found "that people are physically healthier in times of recession." Professor Ruhm’s findings indicate, "Death rates fall, people smoke less, drink less, and exercise more. Traffic fatalities go way down, heart attacks go down, and back problems go down. People have more time to prepare healthier meals at home. Also when the economy weakens, pollution falls".
If this is the case, then Detroit has really done something important to control health care costs. We should expect this health benefit to continue for some time, as Detroit is always has been set in their ways. We will be healthier although not happier.
Notes
(1) W.E. Upjohn Institute for employment research
(2) Merrill Lynch 2007
(3) Ward’s Automotive Group 2007
