Leaner suppliers win pricing power
Tight parts capacity yields better contract terms
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."
Now that production schedules are rising, many suppliers -- mainly those in capital-intensive industries -- can often pick and choose their customers and command higher prices.
Chrysler Group purchasing chief Scott Kunselman said suppliers' plant shutdowns during the recession have caused spot shortages of parts.
"For many commodities, we had a dramatic reduction of capacity and now we're facing some barriers," Kunselman said. "One of our biggest problems is getting capacity for certain components."
Grede Holdings, a suburban Detroit producer of iron castings for steering knuckles, control arms and other components, illustrates the trend. 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."
Grede’s Grimm: Tough decisions
Before the Great Recession, automakers often had the upper hand in price negotiations. Suppliers were plagued by overcapacity and money-losing operations.
The recession forced suppliers to take action. Some visited bankruptcy court, while others closed plants, sold unprofitable divisions and sought new markets outside the auto industry.
The survivors emerged with fewer factories, fewer products and less patience for unprofitable contracts.
Now, to ease production bottlenecks, automakers are offering vendors better terms, say supplier and automaker sources. Suppliers are getting:
Contract guarantees that they will be paid for increases in raw material costs.
More no-bid contracts from automakers.
Quicker compensation for tooling.
It's difficult to quantify price fluctuations because suppliers and automakers don't publicly discuss parts prices. Moreover, prices are affected by a host of variables, such as shifting raw material costs and contracts with annual productivity price cuts.
But industry analysts have noted that suppliers are enjoying higher profits. Last month, Roland Berger Strategy Consultants analyzed 50 publicly traded suppliers headquartered in North America.
In the first six months of 2012, their average operating profit -- or earnings before interest and taxes-- rose to 6 percent of sales, up from 5 percent a year earlier.
"The suppliers are running close to full capacity, and they are able to get some higher prices," said Thomas Wendt, who authored the report.
In an Oct. 24 interview, Kunselman told Automotive News that Chrysler has had some spot shortages of tires, brake rotors and iron castings.
Shortages of iron castings may persist for a while. Grimm says the survivors of the recession 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 in general 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.
Time and money
High rubber prices have been a major headache for tire makers, which have passed costs along to their customers.
But lack of production capacity, not availability of rubber, has caused tire shortages. During the recession, tire makers shut down their least efficient factories.
The companies are starting to replace them, but that takes time and lots of money. Continental AG, for instance, is spending $500 million to expand its tire factory in Mount Vernon, Ill., and build a plant in Sumter, S.C.
The Sumter plant, which launches production in early 2014, will make 4 million tires a year, but it won't reach full production until the end of 2016.
"The gap still exists" between supply and demand, said Jochen Etzel, CEO of Continental Tire the Americas. "We are working very hard to close the gap, but it won't happen overnight, I'm afraid. You don't build a tire plant overnight."
In the new climate, automakers cannot issue take-it-or-leave-it price demands to their tire suppliers. That's because the tire replacement market generates 80 percent of sales, says analyst Bruce Harrison of IHS Automotive.
Michelin, Bridgestone, Continental and Goodyear dominate the sector, and automakers cannot easily get what they need from off-brand suppliers because tire technology has become so sophisticated.
Automakers want a wide variety of tire sizes. They want good fuel economy without sacrificing traction and they want tires that can monitor their own air pressure.
"The barriers to entry are pretty high," Harrison said. "The mature markets demand a high-quality product. Tires are not just round and black. Those days are gone."
North America's vast tire replacement market gives suppliers additional pricing power because they don't depend on automakers for all their revenue.
That's true for other sectors, too, and the competition for limited supplies creates shortages and price spikes.
Take nylon 12, used to make fuel and brake lines. A decade ago, demand for nylon 12 was modest. But sales soared when the photovoltaic industry started using it.
Last April, automotive supplies ran short after a nylon factory in Germany exploded. Automakers scrambled to find substitutes for nylon 12.
Because North America's 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."
In January, Toyota confirmed that it was monitoring 10 to 20 suppliers that were struggling to produce enough parts and urging some to add capacity rather than 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."
• Suppliers closed underused factories during the Great Recession.
• With demand now exceeding supply, suppliers are choosier about contracts.
• Newly profitable suppliers are reluctant to build expensive new plants.
You can reach David Sedgwick at email@example.com.