Cost management in an uncertain automotive market

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The auto industry’s supply base has done a remarkable job of managing costs during last year’s global economic crisis. Many companies faltered, but the attrition and anticipated production disruptions have been surprisingly mild compared to the doomsday scenarios envisioned not long ago.

Now that the auto industry is reviving, even if slowly, suppliers face a new challenge: maintaining cost control even as profitability returns and customers demand increased output. Steve Patton, Ernst and Young LLP Principal and Automotive Advisory Services Leader, says the key is adopting best practices that can protect a company’s ability to maintain industry-leading profit margins even in uncertain times.

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Issues confronting car suppliers today

Perhaps the largest challenge is cost management, which is a big factor for carmakers and suppliers alike. The fact that many companies are moving into extremely profitable periods in spite of the historic sharp declines in sales indicates major cost-cutting.

Now the question is how to maintain profit margins. Suppliers divested significant capacity during the crisis. Now they are running much leaner, and they can’t ramp up additional output as quickly as in the past. In some cases - plastic molders, for example - much of the capacity is still there, but it has been reassigned to serve other industries.

Either way, the supply base isn’t as flexible as it was two years ago. Back then, many suppliers carried significant excess capacity, so they could absorb a sudden upswing in production. Today, they have less capacity, and they need to maintain high utilization.

Yet demand from the carmakers remains inconsistent. This isn’t necessarily the fault of the OEMs, which are dealing with rapid and uneven shifts in market demand. The introduction of hybrid and all-electric powertrains complicates the product mix, as does the uncertainty about the price of fuel. Everything is in transition.

Is supplier consolidation still a big factor?

It’s an ongoing issue, although it has not been as big in North America as many analysts expected. There is a continuing “silent consolidation” among tier two and tier three suppliers. In some cases, this is being encouraged by the end customer, who is brokering on behalf of tier one suppliers to buy assets from sub-tier companies to guarantee uninterrupted supply.

Actions suppliers are taking

Cash flow is a big subject at all levels. For suppliers, it’s a question of access to emergency funding. Some carmakers are accelerating payments from a monthly to a weekly schedule for distressed suppliers, while others are maintaining their standard terms, but receivables are being factored to a secondary bank to speed up payments.

We’ve also seen an upturn among suppliers in the implementation of internally shared services over the past 12 months. Some companies are outsourcing business services that had been done internally before. There also are cases where an OEM may purchase commodities such as steel on behalf of suppliers and consign the materials.

Suppliers also are wondering about long-term production needs. Production is stronger than sales in North America right now, because some OEMs are rebuilding inventories and benefiting from replacements of fleet vehicles. This cannot be sustained indefinitely, and once inventories are back in line, production volumes will naturally become more aligned with consumer demand.

Are OEM-supplier relations improving?

There’s a definite attempt by OEMs to improve their relationship with suppliers. Many suppliers today are in the position of being able to say “no” to a deal that doesn’t make good long-term financial sense. They’re not eager to commit to expansion unless they can cover the associated costs and have some relative comfort with sustained volume levels.

Perhaps more than ever before, OEMs are recognizing that collaboration is important. We think they’re also going to impose stronger quality requirements and expectations on product innovation in return for a more inclusive relationship with the OEM.

On the road to automotive recovery?

The industry is at an inflection point. If the current trending on increased vehicle volumes continues, then a significant improvement in overall profits will be more permanent - if companies are able to maintain cost reductions. But it’s a very unpredictable marketplace.

When sales volumes in the U.S. were at 16 million, it was a relatively stable business, and the system could absorb many of the current inefficiencies. That is not necessarily the case today. In many ways, a slow recovery might be better for the industry.

But continued low volume puts new strain on the supply base. If the automotive recovery stalls, we could see further attrition in the supply base among companies that have been hanging on and counting on higher volumes to improve their financial viability.

We can help

The industry is entering a phase where cost sustainability is crucial to ensure continued profit improvement. There’s a lot of hesitancy to put much infrastructure back into the system, because nobody knows where the market is going.

We’re helping companies address the complication associated with market growth, while maintaining the cost efficiencies they’ve achieved in the past year. As companies find it necessary to re-introduce costs that have traditionally been viewed as fixed, we look for ways to help them make those costs variable.