Key Challenges in North America Facing Japanese Automotive Suppliers

Deloitte Consulting

Introduction

The global automotive industry continues its robust growth as competition between US, European and Asian original equipment manufacturers (OEMs) intensifies. The traditional Detroit 3 (03) of General Motors, Ford and Chrysler continue to expand into developing countries while the traditional Japanese manufacturers (J3) of Toyota, Honda and Nissan continue to build and expand their presence in North America. In most cases, the foreign markets for these OEMs also now often represent the largest and most profitable business units of their global organizations. And, while the manufacturing footprint of the OEMs continues to change and grow more complex, suppliers find themselves struggling to deliver value to the supply chain while also developing innovative products that meet consumer and environmental demands.

Navigating North American Automotive Business

Japanese suppliers in the US market face a unique and complicated situation as they look to grow and expand operations to meet the growing needs of their OEM customers. The range of these business issues and challenges are as broad as they are complex, and include pressures relative to the environment, customers, products, industry, competitors and economics. To grow profitably in this turbulent business environment, Japanese automotive suppliers must cut costs, as well as make strategic and costly investments that add to the value creation chain. The winners will develop new capabilities in four key areas:

1. Revenue Enhancement

2. Margin Realization

3. Risk Mitigation

4. Management Excellence.

Environment

The North American automotive market has reached an unprecedented level of competitiveness. Macroeconomic trends including slowing GOP, rising oil prices and the credit crunch are having significant impact on the market. From an industry perspective, factory overcapacity, flat demand, and decreasing prices further complicate the North American market.

So, what are the OEMs doing to become more competitive in this complex environment? The 03 continue to address their massive cost structure issues and have been successful in positioning themselves for future growth and profitability, most notably through the UAW contract negotiations in 2007, which transferred substantial health care costs from the OEMs to the UAW.

Korean manufacturers continue to focus on low cost manufacturing, and the J3 continue to identify methods to improve the operational and cost superiorities they currently enjoy.

Product portfolio and marketing strategies are also being impacted, with a keen focus on decreasing the product development cycle from conceptualization to market. The OEMs continue to launch a wave of new products (many of which are being marketed as "green" vehicles to meet consumer demand) and refresh existing products, which in turn is increasing the Automotive Performance, Execution and Layout Study (APEAL) industry average. New entrants such as the Koreans and Chinese, as well as low cost global sourcing for low volume cars are also driving down pricing.

And while operations, product and marketing strategies are driving industry competitiveness, the market continues to appear strong and offer opportunities for growth and profitability. Mid- and long-term consumer demographics and outlook remain positive as the purchasing power of young Gen X and Gen Y consumers continues to grow and Boomers retire and begin increasing spending on discretionary goods. Given this competitive environment, growth must come from stealing market share from competitors while continuing to cut costs and increase margins. The OEMs must continue delivering safe, fuel efficient and environmentally friendly products that meet consumer demand, while balancing investment in new technologies.

Customers

In addition to the competitive environment of today's automotive market, regional variations in global consumer demographics present a complex challenge to OEMs and suppliers. Both are challenged to continue developing efficiencies into the manufacturing process through the use of shared platforms and components while offering diverse product portfolios that appeal to regional markets.

Further complicating the environment for OEMs and suppliers is flat growth in mature markets (i.e., North America, Europe and Japan) and substantial growth in other world markets. Sales volume in North America remained flat from 1999 - 2006, and is predicted to remain flat through 2020 (Figure-1). Conversely, growth in other global markets, most notably in Asia, has risen and is expected to continue for the foreseeable future. How suppliers integrate and align with OEMs to help them capture market share on a global basis presents a complex challenge for smaller supplier organizations that often do not have the capability to operate easily on the global scale.

 
However, given the market share of the J3 in North America and Asia, Japanese suppliers are well positioned to succeed in their domestic and foreign markets. The J3 continue to grow in North America. J3 OEMs have captured 32 per cent of the North American automotive market compared to 57 per cent market share from the 03 (Figure-2). The market share of the J3 in North America, however, is expected to continue growing over the next 10 to 15 years while the J3 dominate the Asian market. D3 share in these markets is not expected to grow at the same rate, however, as J3 growth in North America.

 
That imbalance presents a challenge unique to the 03 in that competitive strategies focus on growing market share in multiple markets, while the J3 are positioned to defend their domestic markets and develop aggressive growth strategies for North America in a continued attempt to steal consumers away from the 03 (Figure-3). Japanese suppliers are well positioned to take advantage of the current situation and must make continued investments in North America to support growth strategies of Toyota, Honda, Nissan and Mazda.

 
Industry

The global automotive original equipment parts industry, worth $782 billion in 2005 (Figure-4) including aftermarket sales, is an exciting industry with significant opportunity for growth; but performance is mixed. Of the top 20 global suppliers, whose revenues totaled $411.6 billion in 2005, North American suppliers dominated the industry and captured 47 per cent of market share. Japanese suppliers ranked third behind European suppliers with 23 per cent. Large players like Robert Bosch GmbH, Johnson Controls and Denso Corporation dominated the landscape. Industry and market trends present Japanese suppliers with significant opportunities. OEM reliance on suppliers will continue to grow as these companies turn to their supply bases for more innovative and technologically advanced products that drive down manufacturing costs and meet consumer demand. Suppliers already develop and build 65 per cent of the average vehicle, but this average share should increase to 77 per cent over the next decade as suppliers assume more engineering and production of the body, paint and other components (Figure-5).

 
Over the next eight to 10 years, value creation in the manufacturing process will continue to shift towards suppliers, who are expected to increase contribution from $500 billion in 2002 to an estimated $840 billion by 2015. Conversely, the share of value creation by OEMs is expected to decline on average from 35 per cent in 2002 to 23 per cent in 2015. However, there will be variations from one OEM to another.

 
 
To meet OEM demand for increased value creation from suppliers, automotive components companies are moving towards delivering plug and play modules (Figure-6). Supplier manufacturing processes are shifting towards module fabrication and assembly. Those suppliers that do not currently have capabilities to deliver complete modular assemblies are building capacity through acquisition or other strategic investments to compete in a new part of the value chain.

 
Take, for example, Magna. Historically, the supplier had capabilities in metal stamping, automotive plastics and electronics. Through its acquisitions of Donnelly and CTS Fahrzueg-Dachsystems, Magna quickly gained access to mirror, lighting, glass, and advanced electronic and roofing systems. As one integrated organization, Magna was quickly able to meet the demand of its OEM customers and begin delivering complete interior, closure and roofing modules. Another positive trend for suppliers is the shift towards electronic content in vehicles. Electronic content in vehicles is expected to rise to 40 per cent by 2010 (Figure-?) as measured against total value of vehicle parts. Key drivers of this increased demand for electronics include safety, infotainment, and power train innovations, which are expected to generate a $45 billion market opportunity by 2011.

Industry Consolidation

As Japanese suppliers take advantage of market opportunities, they must confront several industry challenges. As OEM demand for complete modular assemblies increases and suppliers build capabilities through acquisition, the number of global automotive suppliers will also likely decrease. Estimates show that the reduction could be as much as half of the number of global automotive suppliers from 5,600 in 2000 to about 2,800 in 2015. The rate of consolidation in the automotive supplier space, however, is expected to decline in the future. Between 1988 and 1998, the number of suppliers reduced from 30,000 to 8,000, which was reduced to 5,600 in 2000 (Figure-8). Despite the anticipated decline in deals, M&A continues to be an important strategic option for geographic expansion and capability acquisition.

 
Consolidation activity has accounted for over 40 per cent of M&A deals in the automotive parts segment in the past three years, as measured by all deals valued over $100 million (Figure-9), and has been driven by a shift towards providing diverse product offering and the need for geographic expansion. Leading examples of this trend include Robert Bosch, which acquired Troy to the enter US market, as well as Asahi Tec's acquisition of Metaldyne, Leoni AG's acquisition of Valeo's wiring harness unit, Magna's acquisition of Hyundai supplier Shin Young Metals, and Continental AG's acquisition of Danish Roulund's rubber group.

 
M&A activity involving Japanese firms have contributed to 20 per cent of large (defined as $100 million or above) deals from 2003 to 2007. Only five out of 118 large global M&A deals over the last five years involved overseas acquisitions by Japanese suppliers (Figure-10). Non-Japanese Tier-1 suppliers such as Magna, Continental and Valeo have been more active in terms of large acquisitions. Japanese suppliers have not acquired their fair share, and the result is significant opportunity for these companies to use acquisition strategies as a means for developing modular capabilities and increasing geographical footprints in North America.

 
Another view of industry restructuring is the evolution of Japanese automotive companies' pyramid structure (Figure-11). Some Japanese suppliers are working with multiple OEMs and others are looking to become new entrants to the supply base. These trends, however, create a number of issues with the strategies adopted by many Japanese suppliers, including the challenge of developing equal partnerships with OEMs, supporting multiple OEMs and managing global operations.

Competitors

Japanese automotive suppliers, responsible for 16 per cent of all automotive parts exports to the US in 2006, will begin feeling pressure as other Asian automotive suppliers enter and expand in North American.

Automotive parts exports to the United States from China, Korea and India have grown 20 per cent in the last seven years. At current growth rates, China will be the second largest exporter of automotive parts to the US by 2011. That growth will be primarily driven by drive train and electronics parts (Figure 12).

 
And as consumer demand for advanced electronics continues to grow, new suppliers that develop infotainment, navigation and hybrid technologies will have opportunities to compete and seize market share from Japanese suppliers.

Non-traditional automotive players like Nokia, who acquired a digital map maker company for in-car navigation products and Microsoft, who has recently launched the "Ford Sync" entertainment and communications system available beginning with the 2008 model year, are two leading examples of how the demand for electronics has opened the door for some established global technologies companies to being developing leading-edge products for next generation vehicles (Figure-13).