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backEUROtalk October, 2008

New study on automotive suppliers

Pressure on automotive suppliers worldwide has continued to increase over the last year. OEMs demand further cost cuts and pressure is building in the commodity markets due to soaring raw materials prices. This situation is further aggravated by the current financial markets crisis and the general economic slowdown in the automotive sector. Despite this, the sector was able to further increase its profitability on 2007. Mid-sized and large companies based in Western Europe and Japan in particular outperformed the market. However, many suppliers are not prepared well enough for the challenges coming up in the next few years. These are the key findings of the "Global Automotive Supplier Study" the international strategy consultancy Roland Berger Strategy Consultants has conducted for the third time now in collaboration with Rothschild investment bank. The study is based on an analysis of the financial and performance indicators of more than 400 globally active automotive suppliers for the period 2001-2007.

"Automotive suppliers are facing the most competitive environment ever," says Marcus Berret, Partner in the Automotive Competence Center at Roland Berger Strategy Consultants. "Increasing raw materials prices, competition from manufacturers in low-cost countries, OEM demands to cut costs, the call for environmentally friendly innovations – the pressure is on from all sides and will further increase in the future." Due to the severe slowdown the automotive industry experienced over the past few months, OEMs are currently being forced to cut their costs yet again by billions of dollars. So there is no relief in sight for the rest of 2008 and 2009.

Automotive suppliers still show robust profitability throughout the industry

Despite increasing competitive pressure, suppliers maintained remarkably robust profitability overall in 2007. EBIT margin and return on capital employed had even improved slightly year on year in 2007: The EBIT margin for the sector was 5.4%, while at 11.9%, ROCE was up another percentage point from 2006. However, this improvement was not spread equally across the entire industry: Suppliers based in Europe, Japan and India outperformed, while North American suppliers – and for the first time ever also Chinese – were sailing rough waters. In terms of company size, the picture was also rather varied: Mid-sized suppliers developed particularly well over the past few years, while many smaller suppliers and also a few top 20 suppliers were facing increasingly strong headwinds.

Gloomy outlook for 2008 and 2009

Given production cuts of 10% and more already announced for vehicle and truck manufacturers for the second half of 2008, the global average EBIT margin for automotive suppliers will be well below 5% for the remainder of 2008. "I would not be surprised if we saw only around 4% in 2009," said Marcus Berret. This would bring the industry back to its historic low of 2001.

Levers for future success

The study by Roland Berger and Rothschild identifies success factors for automotive suppliers: On the sales side, important factors include concentrating on future growth markets and products as well as the current product range. The goal is to achieve a market share of 20-30% in one to two market segments. At the same time, only innovative products will yield above-average margins in the future. The range stretches from new power train concepts, such as new hybrid and electric motors, to completely re volutionary vehicle designs. On the cost side, an optimal global footprint is essential for a leading competitive position. This applies not just to production, but increasingly for research & development as well. Leading suppliers outsource clearly definable tasks such as software development to low-cost locations, and are now increasingly shifting development of complete modules and systems there as well. Administrative costs can be reduced with standardization and outsourcing.

Regarding financial structure, profitable automotive suppliers are characterized in part by excellent resource management. The ways in which they accomplish this include minimizing warehouse costs with just-in-time models, extending payment periods or consistently using discounts. Resource management is especially important in the midst of the financial market crisis, since banks are increasingly ranking the business climate automotive suppliers as critical – with corresponding consequences for loans: "Right now, automotive suppliers that have secured long-term credit lines under favorable conditions have the advantage," says Thomas Kästele, Managing Director at Rothschild. "Nowadays, banks see a diversified clientele, a low-cost site location and a flexible investment plan as key factors."

Many suppliers not sufficiently prepared

In general, suppliers have in the past achieved noteworthy success. Yet many have so far not prepared themselves enough for the new challenges. For example, reducing CO2 emissions represents a key technological and financial challenge. For suppliers, this represents both an opportunity and a risk.
A further challenge, particularly for European suppliers, is expanding business with Asian OEMs. However, the study shows that the sales share of these OEMs at many European suppliers is stagnating, and in many cases is still below 10%.

The current crisis will leave behind deep scars. Many underperforming suppliers will not survive it, and more mergers and insolvencies can be expected. The best companies will emerge from the crisis stronger than before, because many competitors will fall by the wayside. Until then, these competitors will put additional pressure on suppliers by competing on price rather than innovation.

Source: Roland Berger - GAI

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