The Evolution of Automotive Suppliers

The Evolu*on of Automo*ve Suppliers

Bill Russo Chee-‐Kiang Lim

Gao Feng Advisory Company

The Evolution of Automotive Suppliers

Often overlooked in the history of the automotive industry is the changing role and structure of the automotive supply base. Since the automobile is a consumer product, we as users or purchasers of these products tend to pay more attention to the brands that we buy and the features and functions that they provide. It is thus not surprising that the story of the winners and losers in the global auto industry tends to focus on the Original Equipment Manufacturer (OEM) brands that deliver a tangible value proposition to the consumer.

However, over the course of several decades, automakers have grown

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Exhibit 1 Market Share of Global Auto OEM Suppliers

increasingly reliant on an increasingly smaller number of large “tier 1” suppliers to deliver the core technology and innovation that is needed in the marketplace (see Exhibit 1).

With the skills and resources to develop the critical components, along with an ability to manage a complex network of sub-component suppliers , a tier 1 supplier is arguably the most critical member of the automotive value chain. Increasingly, tier 1 companies manufacture key subsystems or modules, allowing OEMs to focus on final assembly and brand marketing.

Source: Automotive News, Financial Times, Gao Feng Analysis

40%

60%

Others (Top 11-100) Top 10

8.1% Hyundai Mobis

Continental

11.5%

8.5%

Aisin Seiki

11.4%

7.0%

Yazaki

Faurecia

ZF Friedrichshanfen

Johnson Controls

8.5%

Magna

6.0%

12.4%

12.9%

13.9%

Bosch

Denso


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This concentration of power among a select group of top tier suppliers has significant implications throughout the value chain and is a factor that automakers and suppliers must consider in their competitive strategies going forward. In this analysis, we will describe the trend, highlight the several case examples and discuss the implications for these developments.

Exhibit 2 Capabilities/Strengths of Suppliers vs. OEMs

Source: Automotive News, Financial Times, Gao Feng Analysis

through Sales & Distribution. At its peak in the 1930’s, Ford’s Rouge Complex employed over 100,000 workers and produced raw materials such as glass and steel all the way through the assembled product.

By the latter part of the last century, the competitive forces of an increasingly globalized industry forced OEMs to decentralize the various elements of the value chain, and rely more on specialized suppliers to take over responsibilities for R&D and manufacturing of certain core component technologies. Over the last 50 years, aggressive outsourcing and increasing demand for system-based solutions have shifted the burden for innovation at the R&D stage of the value chain to tier 1 systems suppliers (see Exhibit 2).

HISTORICAL CONTEXT

It is important to note that the auto industry of the early 20th Century was highly vertically integrated, where leading carmakers exerted control of the full value chain from R&D, Manufacturing



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A recent article in The Financial Times 1)

estimated that an emerging class of “Mega Suppliers” now have the capability to build 85% of a car’s internal systems, leaving little more than the engine as the sole domain of the carmaker. There are some clear and compelling benefits to this development from the’ perspective of the OEM. In addition to offloading the often capital-intensive burden of inventing and producing new technologies, OEMs can increase their focus on building and differentiating the brand and downstream sales and service experience. Vehicle design, overall system integration and branded distribution thereby become the in-house competencies of the automakers. While leading companies have resisted outsourcing of powertrain development, we can envision that alternative drivetrain technology development will be a disruptive force that can further shift power to new energy vehicle components suppliers. Leading suppliers such are Bosch are allocating as much as 10% of their revenue to R&D expenses for next generation vehicle technology. In comparison, the ratio for a typical automaker is less than 5%. Operating margins for the ten largest suppliers are on average 4 percentage points higher than that of the ten largest carmakers, and revenues of the leading suppliers are on par with leading car manufacturers.

Critical technologies for the next generation of vehicles, such as battery and electric motor management systems are almost exclusively built by leading suppliers such as Continental, Denso and Johnson Controls. The battle for dominance of the next generation of automotive technology development is intensifying, and top tier suppliers hold the high ground in the new technology development ecosystem. Tier 1 “mega-suppliers” have evolved into providers of complete systems (versus just a single component such as glass, steel, or rubber), which increase the OEMs’ dependency on them.


1) Henry Foy, “Age of Mega Supplier Heralds Danger for Carmakers”, http://www.ft.com/intl/cms/s/0/50c272c4-dce9-11e3-ba13-00144feabdc0.html#slide0, May 18, 2014

THE EMERGING NEW BREED OF SUPPLIERS

Today’s automotive supply has evolved into a continuum of suppliers playing notably different roles in the new ecosystem. Component suppliers design to specifications and must optimize their business to deliver good quality at low cost. This requires sufficient scale and oftentimes access to proprietary product or process technology. Whereas systems suppliers typically design to concept and leverage their deep understanding of customer value drivers along with their shelf of technology building blocks to


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create solutions that are deeply embedded into the value proposition to the end consumer. Becoming a tier-1 systems supplier is not a trivial task, often requiring decades of organic and inorganic business development. Achieving this requires a capability to anticipate the trends in the market, and make risky bets that might resonate with the consumer. Let’s highlight some examples. Founded in 1871, Continental AG was formerly a manufacturer of soft rubber products, rubberized fabrics and tires. By leveraging M&A and continued innovation, Continental has transformed from a traditional commodity supplier of mechanical components into a full-range technology solutions provider. As a result, Continental has grown to become the 3rd largest supplier to the global auto industry with solutions in the areas of driving safety, driving assistance, chassis dynamics, powertrain systems, hybrid and electric drive systems, infotainment and multimedia, telematics and instrumentation, tires and extended mobility systems, technical elastomer products, vibration damping and noise optimization. Today, Continental and Bosch together account for 40% of the car electronics market, according to Semicast, a research firm. In this evolutionary process, Continental evolved from a commodity supplier of rubberized products and fabrics, into a supplier of integrated mechanical systems, and finally into its current position as a leading supplier of highly

innovative intelligent mobility solutions. In short, they leveraged their deep understanding of the trends in the market, and their deeply embedded position in the new automotive ecosystem to deliver innovative solutions to their OEM clients. Having evolved into such a position, this new breed of tier-1 systems suppliers like Continental have effectively altered the balance of power in this new automotive ecosystem. Their ability to integrate system-based solutions, and their mastery of key technology domains provide them with strong bargaining power with their OEM partners. They are often in the best position to leverage economies of scale as their solutions can be sold across a broader range of products and brands. They are leveraging their profitability to invest in R&D, build plants around the world, and acquire other players in their effort to upgrade and develop their portfolio of capabilities. A recent example of this is the US$11.7 billion purchase of TRW Automotive Holdings Corp. by ZF Friedrichshafen AG. Headquartered in Germany, ZF is the 9th largest global automotive supplier specializing in transmissions and steering systems, and is a leading player in driveline and chassis technologies. U.S.-based TRW is the 11th largest automotive supplier, producing advanced safety systems. The deal, to be completed in 2015, will create the world’s 2nd largest supplier with pro-forma sales of over € 30 Billion. The combined company will be well-positioned to capitalize on favorable megatrends in the automotive industry by



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bringing together complementary product offerings and leading technology positions that serve high-growth areas such as fuel efficiency, increased safety requirements, and autonomous driving. The scale required for technology investments, and to need to offer a comprehensive portfolio of complete systems are the driving forces behind ZF’s acquisition of TRW. Deals such as this will further drive consolidation among tier 1 suppliers and further concentrate their positions of strength in the creation of innovative next-generation automotive technologies.

suppliers must understand the mindset of a tier 1 supplier and gradually build and adapt the core set of capabilities to maintain relevance in this new ecosystem. Likewise, automakers must adapt to this new balance of power and understand the trade-offs and implications for their technology sourcing decisions. 2. Continually Revisit the Business Structure Slower growth prospects going forward will generate fierce competition between OEMs resulting in downward pricing pressure for suppliers who will face even fiercer competition in the auto parts industry. On top of this, automakers and suppliers will face a new breed of competition from ambitious players from rapidly emerging markets like China and India. As a result, leading suppliers must determine how to stay ahead of the competition with product technology, customer experience or cost leadership. This will trigger a wave of further consolidation and acquisition linked to achieving differentiation in the marketplace. 3. Focus on End Customer Relationships Automakers and suppliers must align their go-to-market models with underlying customer needs so as to effectively capture the loyalty of consumers to their brands and unique value propositions. Both must recognize the potential threat from new entrants into the automotive value chain. Specifically, technology developments are creating new business models for diagnostics and repair, and other new “mobility on demand” services.


STRATEGIC THEMES

The landscape and power balance has clearly shifted over time, and an elite class of tier-1 mega-suppliers has clearly emerged. This has profound implications for all players in the automotive value chain. We can summarize the implications of this along four strategic themes:

1. Build Relevance in the New Ecosystem

Suppliers have evolved historically from being a source for component parts, which were integrated by OEMs, to the current structure where OEMs are branded integrators of systems increasingly engineered by tier-1 suppliers. Regardless of where they fit into the automotive supply chain, all


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Automakers and suppliers must determine their way to play in this emerging Online to Offline (O2O) business or risk losing the customer relationship to aggressive online service portals.

4. Establish Roles in the New Mobility Ecosystem A new form of connected mobility is driving new technologies in the world of navigation, analytics, driver safety, driver assistance and information virtualization. The challenge of understanding the opportunities and the threats of this new industry will set the scene for a new competitive environment for both traditional OEMs and non-traditional players looking to establish themselves as the global leaders of connected mobility2) . Automakers and suppliers must heavily invest in R&D, especially in this new mobility ecosystem, in order to create differentiated and defensible intellectual property.

SUMMARY

The balance of power in the automotive industry has been substantially altered, with the emergence of a new breed of tier-1 “mega-suppliers”. Typically the most profitable members of the automotive value chain, they often deliver the most critical innovations needed to differentiate cars in the marketplace.

Automakers face new challenges to maintain a balance of power with this new breed of supplier. Suppliers at all tier levels must establish a position of relevance in a supply chain dominated by such power players. And finally, mega suppliers must continue to anticipate the trends and developments in the marketplace and upgrade their portfolio of capabilities in order to press their advantage.

2) B. Russo, C.K. Lim, G. Pross, U. Kushnir, “How Connected Mobility Technology is Driving the Future of the Automotive Industry”, Gao Feng Insights Briefing Paper

Gao Feng Advisory Company (www.gaofengadv.com) is a pre-‐eminent strategy and management consul=ng firm with roots in China coupled with global vision, capabili=es, and a broad resources network. We help our clients address and solve their toughest business and management issues -‐-‐ issues that arise in the current fast-‐changing, complicated and ambiguous opera=ng environment. We commit to puDng our clients’ interest first and foremost. We are objec=ve and we view our client engagements as long-‐term rela=onships rather than one-‐off projects. We not only help our clients “formulate” the solu=ons but also assist in implementa=on, oJen hand-‐in-‐hand. We believe in teaming and working together to add value and contribute to problem solving for our clients, from the most junior to the most senior. Our senior team is made up of seasoned consultants previously at leading management consul=ng firms and/or ex-‐top execu=ves at large corpora=ons. We believe this combina=on of management theory and opera=onal experience would deliver the most benefit to our clients. Our name Gao Feng is taken from the Song Dynasty Chinese proverb Gao Feng Liang Jie. Gao Feng denotes noble character while Liang Jie refers to a sharp sense of integrity. We believe that this principle lies at the core of management consul=ng – a truly trustworthy partner who will help clients tackle their toughest issues.

For More Information:

Bill Russo Managing Director Gao Feng Advisory Company, Ltd. [email protected] Chee-Kiang Lim Principal Gao Feng Advisory Company, Ltd. Email: [email protected]

Note: The above authors with to thank Ms. Emily Wang for her efforts in researching and summarizing the findings of this analysis.

The Evolution of Automotive Suppliers

Automotive

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