Supply chain crisis shifts power balance between automakers and suppliers

DETROIT -- A brutal year for automotive suppliers has had an unexpected upside.

The same problems that have pummeled their business, from soaring commodity costs to supply chain issues, have also given them a newfound power at the negotiating table with their automaker customers.

While automakers have maximized on a surge in demand by converting low vehicle inventory into record sticker prices and strong profits, suppliers have suffered the brunt of financial losses. But, the supply chain crisis has laid bare the interdependency of each tier from top to bottom and underscored the importance of players big and small.

Suppliers have arguably never had as much negotiating power with automakers, experts say. Now they are using that leverage to change the way they do business with OEMs, which are feeling the pressure to acquiesce if they want to keep getting parts to make cars, according to industry executives and observers.

"Historically, the automakers have had an enormous amount of leverage and have exerted it over the supply base," said Thomas Walters, commercial litigator at Dinsmore & Shohl LLP who represents tier one, tier two and medium-size suppliers. "I think the OEMs are in a position where they have no choice but to share in the pain with everybody else that's in the same circumstance."

Automakers have been reluctant to absorb the increased cost of parts, but over the past few months, suppliers have been turning up the call for relief. Companies including Cooper Standard Automotive Inc. have been asking customers to renegotiate contracts to recoup losses. Further down the supply chain, those requests have turned to demands as the supply crisis drags on and smaller companies fight to survive.

Prices for raw materials in the broader manufacturing sector increased 14.5 percent since the end of 2020, according to the Institute for Supply Management's Semiannual Economic Forecast, released this month. Prices are expected to increase 8.1 percent next year.

Companies have had some success in passing along those increases to customers, as indicated by the trade association's survey of about 900 industry members. Around 64 percent of manufacturing executives said they have been able to pass through price increases. Just less than half said they expect business conditions to improve next year.

Most contracts between automakers and suppliers are for the production life of a part, which can range from a few years to 10 years or more. Many deals were signed well before the COVID-19 pandemic began and the ensuing supply crisis. The general rule has been to supply the customer at all cost — unless the cost is financial ruin.

"You've got these insanely exorbitant increases on one end of the supply chain. On the other end of the supply chain, you have the automakers charging higher prices. In the middle you have all the suppliers," said Dan Sharkey, co-founder and member at Brooks Wilkins Sharkey & Turco PLLC who specializes in supply chain litigation.

Unexpected production suspensions, from Ford Motor Co.'s F-150 and Explorer to the Stellantis Jeep Cherokee, have taken big bites out of suppliers' revenue.

Capacity utilization for light duty automobiles in North America has fallen steadily and then stagnated since the second half of 2020 when plants were brought back on line after COVID-19 shutdowns. Capacity utilization was just above 60 percent in the third quarter of this year, compared with nearly 80 percent at the same period last year, according to data from the Federal Reserve Bank of St. Louis.

"The smaller companies tend to be more nimble and more aggressive because they have less to lose, right – the ma and pa's saying, 'Hey, I just lost money last month, and if I don't get a price increase next month, I'm not shipping parts,'" Sharkey said.

That resembles the language of dozens of letters sent recently to AlphaUSA, which supplies fastener assemblies and stampings to major automakers and has been outspoken about the unprecedented rise of steel prices. Nearly all of AlphaUSA's suppliers have given the company an ultimatum: Pay more or stop receiving material, said David Lawrence, executive vice president and chief administrative officer for the company.

AlphaUSA's only choice is to pay the increase, Lawrence said.

"That's their method of survival," he said of smaller suppliers. "They are going to have to demand prices to cover their cost. There's no other way for them to survive."

In turn, AlphaUSA is looking to pass those costs up the supply chain to mitigate its losses. "Tough luck" was the response from customers initially, but the tone has begun to change.

"Our customers have reluctantly started to talk to us," Lawrence said. "At this point, we have no customers standing their ground, but we have no customers that have come up with a solution yet."

The supply chain friction has kept Sharkey and Walters and others like them plenty busy. As it happens, the business of supply chain litigation has never been better.

In Sharkey's nearly three decades of work in the field, he said he has never handled so many commercial disputes at once, not even in the 2008-09 financial crisis. Walters, who's been in the business for around the same length of time, said he doesn't see the situation improving anytime soon.

"I would say that this is definitely new territory," Walters said. "It's certainly fair to say that many suppliers have been financially stressed and may not last through this pandemic and global supply chain catastrophe."

One of them is Stewart Industries LLC, a 20-year-old minority-owned company in Battle Creek, Mich., that supplies assemblies to the automotive industry, including major customer Denso Corp. Just before Thanksgiving, Stewart Industries sent an email to clients informing them that the business would be closing and parts would stop shipping.

"Today, we are not ashamed to be deeply emotional as we write to inform you that Stewart Industries LLC, being burdened with a historic financial crisis, is discontinuing our business," said the letter obtained by Crain's Detroit Business, signed by CEO Joseph Stewart and President Erick Stewart. Crain's is an affiliate of Automotive News.

The company could not be reached for comment. Denso, through a spokesman, declined to comment. Denso, one of the world's largest auto suppliers, is partially owned by Toyota Motor Corp. and is closely aligned with the automaker.

There will likely be more suppliers that will succumb to financial troubles, as industry analysts predict the gummed-up supply chain and microchip famine will persist at least into the first half of next year. Losing a supplier unexpectedly is a headache for purchasing departments in normal times — amid a supply crisis, it could be a major blow.

"There are lessons to be learned from the '08-'09 situation and the decimation of the supply base that resulted because of that, and I think OEMs are looking at this particular situation differently as a result," Walters said.

Both Walters and Sharkey said they have also never seen automakers so willing to come to the table on deal restructuring that does not favor them. Talks have included potential concessions previously unheard of, including retroactive price increases, acceleration of payment terms, longer-term contracts, raw material price indexes and the general sharing of volatility associated with production costs.

Typically, the only shakeup would come from automakers putting pressure on suppliers to cut costs.

"It's been amazing," Sharkey said. "Some have taken a surprisingly generous view and they've been actually giving price increases. Now, there's no Santa Claus or Easter Bunny, but I've actually been surprised that some of the OEs are actually giving price increases because right now everyone's having trouble getting supply, so they want to be the supplier's favorite customer."

The lack of supply chain-related lawsuits also indicates a desire by companies to resolve disputes before litigation. Earlier this year, Stellantis NV supplier JVIS-USA made headlines when it sued NXP Semiconductors, alleging that the chip maker's failure to ship semiconductors would cause a shutdown of the Jeep plant in Detroit. The gush of similar lawsuits predicted by some has not happened amid the global microchip shortage.

Some automakers are more willing to renegotiate than others, just as some suppliers have different breaking points before asking customers for concessions. Sharkey and Walters declined to name clients.

Stellantis and General Motors declined to make anyone available to interview for this story. Ford did not respond to requests for comment.

Automakers keep purchasing strategies close to the vest, but whether and how they decide to help their suppliers absorb costs has an impact on their bottom lines, about which they must answer to investors.

"Obviously, I'm not going to go into any detail on any conversations that we're having across our supply base, but what I would say is the singular focus is making sure that we have consistency and reduce some of the volatility that we've seen in the supply chain, whether it's due to logistics or semiconductors, etc.," GM CFO Paul Jacobson said during an October call with investors.

During a call with investors last month, Toyota executives briefly discussed the topic of price negotiations with suppliers and emphasized the need to accommodate both sides.

"With regard to relations with suppliers, well, we would like to coexist with our suppliers so that we can reduce cost and enhance the competitiveness together," Kenta Kon, operating officer at Toyota, said during the call. "We would like to enhance competitiveness of suppliers, and we would like to reap the achievements fairly, together."

Several big suppliers have echoed the all-in-this-together sentiment. Robert Lee, president of Automotive Technologies Continental North America, told Crain's in a recent interview that the company is having "constructive dialogue" with customers regarding new supply deals.

"It's not a situation where there's no appetite to entertain any of this type of discussion. It's not like that at all," Lee said. "We're having those discussions, and I would say that we as an industry have to recognize that everyone needs to have value creation and make sure that there is a fair distribution of the value that's coming out of the industry."

Being able to pass price increases up the supply chain is a win for suppliers. Not so much for the consumer, who the industry is ultimately counting on to absorb the final cost.

"The most likely scenario is automakers at least sharing in these costs, and then there's going to be a need (for costs) to be passed on somewhere else," Lawrence said. "Most likely, I think it means significant increases to vehicles' sticker prices."