Cost cuts rattle supply chain

Like father, like son, Tier 1 automotive suppliers are adopting the brutal pricing tricks learned from automakers and, in some cases, even exceeding them.

Spurred by price-cut demands from their own customers, Tier 1 companies - including Visteon Corp., Valeo Inc., Johnson Controls Inc., Siemens Automotive Corp. and Delphi Automotive Systems Corp. - have demanded pricing breaks of their own suppliers in recent months. Visteon, in particular, has adopted a hard-edged approach. The Ford Motor Co. spinoff wants price cuts retroactive to Jan. 1, according to at least four of its suppliers, who didn't want to be identified.

The moves mark the adoption of a more dictatorial approach throughout the supply chain. To be sure, price pressures became keen long before this year. But Tier 1s in 2001 are more likely to present their plans as non-negotiable and to make unilateral demands out of the blue - even on top of annual reductions, supplier executives and consultants say

'The mentality with the industry today, and Visteon in particular, is beat them up for everything we can get out of them and leave them bloodied and dead and move on to somebody else,' a Tier 2 supplier executive said.

But squeezed by automakers, Tier 1s are turning to the most likely target to reduce their own costs. Lower production volumes and erratic factory schedules for Big 3 suppliers already have taken their toll on profitability this year. DaimlerChrysler's call for a 5 percent across-the-board cut hit the supply base especially hard.

Tier 1 suppliers to Japanese transplant automakers, meanwhile, have been less threatened by production declines and influenced by the more cooperative style of Japanese automakers. Although those automakers haven't taken the give-it-or-else approach, they continue to pressure for cost improvements.

For the smaller Tier 2 and Tier 3 parts makers, the tactics are another blow in a year when many are losing money and others are on the brink of failure.

Manufacturers of commodity parts command thinner profits, often in the low single-digit percentage range, so it's harder to grant outright givebacks, especially those of 5 percent or more. With lenders severely tightening credit to debt-laden suppliers, it also is tougher to get the money needed to invest in new technology or more efficient machinery.

The situation has spurred some to rebel against Tier 1 demands or at least trade price concessions for future business. But the pressures keep coming.

'The OEMs are doing it, so (Tier 1s) just kick the ball to the next level,' said Michael Heidingsfelder, a partner at Roland Berger Strategy Consultants in Troy, Mich. 'When you come up with pretty brutal measures from the OEM side, what other choice do you have than to push it down the supply chain because you don't have time to come up with cost savings. Not that I think this is a good idea.'

DaimlerChrysler's demand last winter, no doubt, was a key model for the Tier 1s, one supplier consultant said.

'The actual practice of turning the thumbscrews down on suppliers is not new,' noted Jim Gillette, vice president of IRN Inc. in Grand Rapids, Mich. 'This imitation of DaimlerChrysler, though ... it's copycat killing.'

Visteon approach

Visteon, the world's second-largest maker of original equipment parts, is on a cost-cutting binge, led by President Michael Johnston. He hopes to trim expenses by $700 million this year, partially through better materials management.

The company's request for retroactive price cuts especially has infuriated vendors. Not all have been approached; exempt are some suppliers who had already slashed prices on products for which Visteon had sought competitive bids through online auctions. According to several other supplier executives, Visteon has tried to dictate the retroactive cut, saying the plan would create a credit balance for future purchases. The size of the request may vary, but 3 percent was a common demand.

Visteon has a different take.

While the company acknowledges negotiating with suppliers for price breaks, even retroactive concessions, Visteon purchasing chief Paul Rad-koski says vendors have known adjustments were coming. Discussions for 2001 were delayed by Visteon's post-spinoff reorganization, he said, which centralized five purchasing units into one as of June 1.

Radkoski also characterizes the cuts as 'productivity improvements' or cost reductions through engineering changes or efficiency gains rather than outright price cuts. He said he aims to ensure that suppliers 'support our company in the same manner we agree to support the OEMs.' Visteon will reward those who cooperate with new business.

'When we win business and choose to go after the business, we understand it upfront: We are going to be expected to reduce the price,' said Radkoski, Visteon's vice president of materials management. 'What we're trying to make sure of is that our supply base has the same value system.'

Other alternatives

Some are telling Visteon they won't play the game. They instead are bargaining for lower price cuts, new business guarantees in exchange for price cuts or future price reductions through engineering changes.

'Our position is, you can either let them take you out of business, or you can go out on your own terms,' one Tier 2 supplier executive said. 'You cannot afford to run business at a loss for very long. You're better off not having it.'

Siemens, meanwhile, has told some suppliers it expects price reductions of 5 percent, plus more favorable payment and tooling terms.

'What are the Tier 1s supposed to do with their supply base? Say, 'Don't worry, boys and girls, we're going to suck this up'? How do the tiered suppliers expect this won't be cascaded to them? It will be,' said John Sanderson, Siemens CEO.

Leveraging gains

Some Tier 1s, though, have demanded price breaks of 10 percent or more, on products that carry margins far less than that, supplier executives and consultants say. Some vendors are refusing, figuring they'd rather lose the business than operate at a loss. As with Visteon, dictated plans have resulted in some negotiated solutions.

'We're tying new business awards to total price givebacks,' one supplier executive said.

Tier 2s will kick the price cut farther down the chain, as long as the size differences between customer and supplier are great enough to provide them enough leverage, said consultant Heidingsfelder. But neither Tier 1 nor Tier 2 players can pass it all off.

'If you take the average level of profitability, and let's assume they're still producing at last year's levels, (these price cuts) would most likely take away a lot of their profitability,' he said.

Fold in 2001's lower production volumes, and the pressures could trigger red ink at financially struggling parts makers. Suppliers with a technology advantage or other leverage over customers and competitors have the firmest footing.

'If they have really unique market positions, they have strengths that they can use for these negotiations,' Heidingsfelder said. 'But as we have seen in some other cases, it can only save you some time; it cannot save your life.'

Lack of trust

Discussions can be strained by lack of trust on either side.

A Tier 1 customer of one IRN client used DaimlerChrysler as a reason for its own cut, but the Tier 2 didn't supply any parts that went to DaimlerChrysler, IRN President Kim Korth said.

'That's where it starts to be a very Orwellian kind of conversation, where nobody believes the motivation for the other,' Korth said. 'They're just trying to take out the meat ax and get prices down.'

Visteon's Radkoski said his company is sympathetic to the grave challenges facing smaller suppliers.

'We are trying to work with them and help them pull out money any way we can,' he said. 'But there is a much smaller portion in that position than those that represent themselves in that position.'

And Tier 1 companies are being squeezed on both sides, some say. They must absorb the hit from automakers, yet they know can't push equivalent cost reductions or capital responsibilities off on their financially vulnerable vendors.

Figuring out a better model is the challenge of the entire industry.

Said Siemens' Sanderson: 'The pressure or responsibility has to be spread across the value chain in a more effective way.'

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