Pricing power shifts to suppliers
Photo credit: GREDE
With North American vehicle production headed toward 15 million-plus units next year, automakers are encountering a new breed of supplier: the one that says "no."
To automakers' chagrin, some suppliers -- mainly those in capital-intensive industries -- can pick and choose their customers. With capacity short and production schedules rising, suppliers can afford to accept the contracts and customers they want, and reject those they don't want, whether because of prices or the broader terms of doing business with certain customers.
In short, the balance of pricing power has shifted to the supplier.
Consider Grede Holdings, a suburban Detroit producer of iron castings for steering knuckles, control arms and other components.
Over the past three years, Grede (GRAY'-dee) bought some foundries and shut others, dismantling unprofitable plants despite customers' pleas to restart them. Now the company is juggling competing demand from customers in its three product sectors: light vehicles, commercial trucks and industrial components.
"We've dropped customers across all three markets," said CEO Doug Grimm. "We had to make some tough decisions. Some customers were working more closely with us, and others wanted to go back to the old business model."
Chrysler Group, which was not dropped by Grede, confirms that plant shutdowns during the recession have caused some spot shortages of parts.
"For many commodities, we had a dramatic reduction of capacity and now we're facing some barriers," said Scott Kunselman, Chrysler's purchasing chief. "One of our biggest problems is getting capacity for certain components."
To ease production bottlenecks, Chrysler and other automakers are offering vendors better terms. Suppliers are:
Securing contract guarantees that they will be paid if raw material prices rise.
Winning more no-bid contracts from automakers.
Getting quicker compensation for tooling.
Grede CEO Doug Grimm: "We had to make some tough decisions. Some customers were working more closely with us, and others wanted to go back to the old business model."
In an Oct. 24 interview, Kunselman told Automotive News that Chrysler has experienced some spot shortages of tires, brake rotors and iron castings.
Tire shortages should abate over the next couple of years, now that tire makers are building factories. But shortages of iron castings may persist.
With 800 suppliers of iron castings in North America, the industry remains fragmented, and Grimm says the survivors are reluctant to build foundries at a cost of more than $100 million each.
Other product sectors are experiencing similar shortages, said Kim Korth, principal of IRN Inc., a Grand Rapids, Mich., consulting firm. During the recession, suppliers eliminated 20 to 30 percent of their production capacity, and they haven't added it back, she said. That is translating to richer contracts.
"Suppliers are putting on third shifts, trying to figure out how to get more production," Korth said. "They can't support the demand that they have now, so why should they settle for a 2 or 3 percent gross margin?"
Newly emboldened suppliers are demanding, and getting, better terms from their customers. According to an IRN survey published in July, half of the suppliers polled said they had negotiated price pass-throughs -- whereby suppliers pass a portion of higher costs through to customers -- for raw materials, up from virtually zero three years ago.
Because the auto industry is short of capacity, automakers are closely watching suppliers for signs of trouble.
Chrysler, for instance, is monitoring suppliers that are running their plants around the clock to meet demand. At any given time, Chrysler's list of maxed-out suppliers fluctuates from a dozen to 20 companies, Kunselman said.
"We work with those suppliers to make sure they don't skip key quality steps or even preventive maintenance," Kunselman said. "You have to look extra hard to make sure they keep a tight rein on quality."
Chrysler's problems are not unique. In January, Toyota confirmed that it was monitoring 10 to 20 suppliers that were struggling to produce enough parts, and urging some to add more capacity rather than to continue to rely on extended overtime.
Given the potential for disrupted production, automakers inevitably will pay more for key components. Says Kunselman: "If I can build another car, am I willing to pay a couple of pennies more for a part? Absolutely."
You can reach David Sedgwick at email@example.com.