The global automotive industry is undergoing existential disruption as the world market tightens its embrace of electric vehicles over internal combustion vehicles and hybrids. At this point — in the early stages of the transition and with a long way still to go — some challenges facing the diverse auto parts supplier industry are becoming clearer; however, many companies are still figuring out how quickly to embrace those changes.
The market transition to electric vehicles (EVs) is gathering momentum due to advances in technologies, such as batteries and charging stations, and growing buyer interest stemming from the success of a global EV manufacturer and other electric models. The US and other governments are doubling down on commitments to transition to electric vehicles. Recently proposed emissions limits in the US would effectively require two-thirds of cars sold in the country to be electric by 2032, and California will require that all new vehicles sold in the state after 2035 be zero-emission vehicles.1
Suppliers of parts — from gas tanks to fuel injectors — that run traditional cars are already seeing their market shrink, and the decline will only get worse from here. This US $1.9 trillion industry will see a painful slowing of growth in coming years as internal combustion engine (ICE)-based product lines are phased out. About a quarter of profits are currently generated from legacy ICE components that will be the most adversely affected, resulting in a 50% decline from current levels by 2030. For some suppliers, the market will eventually resemble a game of musical chairs, with fewer and fewer safe economic places to land — and the slowest movers losing the game.
To be sure, segments of the ICE market will remain, such as parts for existing vehicles, and suppliers can continue to earn some revenue in this area long after production of new ICE models is phased out. Also, commercial vehicles have lagged passenger cars in the EV transition so far and are likely to offer another “long tail” of continuing opportunity for makers.
The impacts are hitting auto suppliers in different ways and at different velocities, depending on the parts they make and the size of the company. Many larger makers of powertrains and other ICE components, for example, whose production lines require long development lead times to transition, have embraced the need to change and have been developing transformation strategies and making operational changes, announcing new manufacturing strategies, new partnerships and new product lines. Public companies also benefit from the involvement of boards of directors and stockholders that push them to adopt transformation strategies earlier while balancing risks.
Small, medium and privately held companies, with traditional, risk-averse management styles and fewer resources tend to lag, however. Some that continue to delay adoption of an operational transition strategy may soon find themselves at risk quickly.
Julie Fream, President and CEO of the Motor & Equipment Manufacturers Association – Original Equipment Suppliers (MEMA), says that one of the biggest challenges companies face is estimating when the growing market for EV products will overtake the ICE components they are replacing. This uncertainty is causing many executives to hesitate- as they plan their company’s operational transition from ICE to EV.
“Suppliers know they need to be able to do both, but they are asking, ‘How do I know the volumes?’” Fream says. “How do they manage the crossover point, knowing that you can’t accurately predict at this point where the two lines will cross — where EV becomes dominant, and ICE becomes a secondary product line. That’s the question they are all asking.”
Companies that invest too early could end up financially overextended, with excess capacity and a market that is not ready for the new product. Late arrivals could lose opportunities completely if faster competitors beat them to the punch.
Companies seeking ways to exit ICE businesses also face challenges as certain, carved-out assets will become steadily less attractive to buyers. Without successful consolidation or divestiture, many will be forced to shut down, particularly if cost cuts and efficiency improvements are unable to keep pace with commercial declines. At the same time, suppliers wishing to embrace new technologies must invest heavily in new product and service innovations targeted at EVs. Often, these competing priorities absorb cash while also preventing the bold action that is needed in today’s market.
The PE mindset as transformation catalyst
Many auto suppliers, especially those that are small or mid-sized and often privately owned, have relied successfully on a traditional management approach of incremental improvement and risk management. This approach, however, is ill-suited for the current market upheaval. Tomorrow’s winners will be those that adopt a strong will to innovate and reinvent their whole business, embracing the entrepreneurial spirit that once helped them start.
Fortunately, a ready model for bold decision-making exists, which can provide a model for the kind of aggressive approach suppliers require — that of the private equity (PE) investor. Two aspects of the PE mindset stand out as the essential, outside-investor viewpoints that many ICE suppliers urgently need:
- The ability to make bold decisions, without attachment to unprofitable “sacred cows”
- A relentless focus on enterprise value
For companies that are saddled with habits of incremental change and need to become unstuck, the PE lens can be a catalyst for the swift cultural makeover that is needed to get moving.
“The PE mindset is something many suppliers should consider,” says Fream. “There’s a lot of money on the sidelines right now that could eventually come in. This would create some opportunities if you accurately analyze your business and understand what needs to be done.”
This is not easy, she notes. “Suppliers need the skill set to assess what’s happening in the marketplace. The PE firm is ultimately trying to drive the company to be more focused on the marketplace. Generally they don’t tolerate anything outside of that. But this can be very difficult for some suppliers, especially smaller, privately-held companies.”
Typically, PE has a variety of strategic approaches to generate profits from companies in either fading industries or startups in new technology fields. PE investors can improve enterprise value and prepare an asset for profitable sale through organic upsides — top-line growth and bottom-line improvements — as well as inorganically, through a potential portfolio play.
