Vol 1 (2004) - Issue 4

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Supply Chain Risk - A Global Automotive Industry Viewpoint

Introduction

For some years, the automotive industry has focused on creating just-in-time supply lines in order to drive costs down and reduce the working capital locked in the chain. Although this has created many benefits, it has also exposed companies to the potential of being held to ransom by sub-suppliers. This increased risk is heightened where a manufacturer single-sources a component from a financially weak supplier who then becomes subject to insolvency.
The commercial intentions of an office holder in any insolvency proceeding are similar across Europe, whatever the jurisdiction or process. The office holder will seek to exploit a customer’s dependence on key components by demanding:

- An immediate cash payment to fund ongoing working capital requirements; and
- Some form of indemnity to cover any ongoing trading losses; and/or
- Increased prices to ensure profitability and enhance the potential value of the business.

The issue for the customer is that if he does not meet these requests then the company will cease supply, and production of a sub-assembly and ultimately a vehicle will stop. In essence, he is being held to ransom and has little option other than to accept the position and accede to the office holder’s demands.
There have been a number of high-profile instances of manufacturers being challenged in this way by office holders, such as the Administrative Receivers of Transtec and UPF Thomson. In Transtec, the Administrative Receivers demanded price increases from Ford, which they resisted. Ford took the matter through the English Courts but judgment favoured the Administrative Receivers. This set a precedent, in certain circumstances, to enable office holders to use commercial advantage. Creditors of insolvent companies may argue that it is the duty of the office holder to use this advantage if it will enhance eventual realizations, although there may be no absolute obligation on a British office holder to do so, depending upon the nature of the appointment.
Until fairly recently this had been mainly a British phenomenon, but there have been substantial numbers of insolvencies of smaller companies with turnover in the range of EUR 15m to EUR 80m. This has been especially prevalent in Europe and in particular Germany and France. The instances of business failures is increasing and in reaction a number of Original Equipment Manufacturers (OEMs) and Tier1 suppliers have set up insolvency teams to manage failures as they occur.

So what are the industry dynamics behind these failures?

The position of the automotive manufacturers (the OEMS)

Excess capacity combined with falling volumes is a major issue for all OEMs exposed to Western markets. The OEMs are seeking to take cost, volume risk and cash requirement out of the production and design processes. These are then being passed down the supply chain to the Tier 1 suppliers, who apply the same principles to Tier 2 suppliers etc.

Costs

- Suppliers are increasingly relocated in lower-cost countries in Eastern Europe and the Far East. This is especially the case for commodity components and/or those requiring high levels of labour or energy, which is expensive in the West. Such suppliers may be purely local or a JV with an existing global supplier. It is understood that at least one of the OEMs has now relocated over 50% of its suppliers to such low-cost countries.

- OEMs expect annual price reductions which usually are in the range of 4% to 8%. The expectation is that the supplier will find efficiencies in production. However, in the majority of cases, efficiencies are actually much lower and at least some of the reduction will be at the expense of the gross margin.

- It is very common for platforms to be shared across a number of models and sometimes between OEMs.