The first seven months of 2019 were not stellar for the automotive industry, and this downward trend is expected to continue through the rest of the year.
Trade war threats, potentially punitive tariffs, uncertain UAW negotiations and the tenuous U.S. economy may place even more downward pressure on the industry, leading Cox Automotive's chief economist, Jonathan Smoke, to predict in June that "the second half will be worse" for the industry.
Although current industry indicators are less ominous than in 2009 when more than 200 suppliers went bankrupt or were liquidated, the current state of affairs does beg the question: Do downward trends indicate the risk of supply chain failures?
After more than 20 years serving the automotive industry, I contend that the answer is a solid no.
It's true: The industry experienced decreased retail sales through the first six months and a recent, second decrease to anticipated North America production by IHS Markit this year alone. According to J.D. Power, year-to-date new-vehicle prices are up 4.9 percent through June, to an average of $33,665, and until the most recent Federal Reserve rate cut, annual percentage rates on new vehicles averaged 6 percent, according to Edmunds. Further, while the total number of incentives through the first half of the year are up by 9 percent, according to Cox Automotive, the real dollar value of these incentives has decreased 3.9 percent, according to ALG.
All of these factors are placing more downward pressure on retail sales. The supply chain is beginning to express similar concerns, corroborated by the lowest sentiment in more than five years. At an index of 35, supply chain sentiment is down almost 25 points year over year, according to the OESA Automotive Supplier Barometer, Production and Planning 2019.
However, despite the downward pressure, the automotive supply base is significantly stronger and more financially savvy than it was leading up to the issues that struck the industry in 2009. The supply chain as a whole is better and more sophisticated than a decade ago. There are several reasons why.
- Elevated utilization rates and automation. According to the Original Equipment Suppliers Association, utilization rates have a median value of 80 percent, up 5 percent over six years. Some suppliers report 90 percent utilization. This is in sharp contrast to the 45 percent utilization rate in 2009 that contributed to the demise of those 200 suppliers. Increased utilization obviously contributes to increased efficiencies, but it also goes beyond that. With the increased use of automation within plants, suppliers can better scale costs and provide incremental efficiency gains.
We all recall plants where four to six operators individually completed a single process. Today, a lone operator in a production cell handles the same five processes. This was unheard of in 2009 and the preceding years. Further, the days of "build it and they will come" are gone, with suppliers extracting every square inch of usable space for production. This all leads to a better operational model, where costs are held in line and margins are maximized as much as possible.
- Better product release alignment. Alignment between production releases improved, creating a level of confidence that the releases are accurate and, more important, support the supply chain's sales and inventory goals. The weekly releases, coupled with anticipated volumes for the next two to three weeks, are more accurate and reliable across the industry than in years past. Releases also specify plant activity among the original equipment manufacturers as it relates to plant shutdowns, "super weekends" and the like.
Ultimately, 64 percent of respondents to the 2019 OESA Barometer Studies believe that current production releases are "about right," which has the net effect of better management of raw material buys, labor scheduling and inventory levels maximized through equipment use.
Better alignment is not limited to production releases, and the OE's reliance on its supply base is the highest it has ever been. With the OE's role transitioning more and more toward design, engineering and assembly firms, dependence on a healthy and profitable supply base becomes more paramount for the industry as a whole.
- Greater financial stability. Despite the OEs' continuous downward pressure on supply chain costs, suppliers are still able to maintain sufficient margins that contribute to their overall strength and the strength of the industry. Break-even production volume for the supply chain sits at 14.7 million units, compared to a current estimated North American light-vehicle production of 16.5 million units. Although this gap has tightened over the past year, it still suggests almost a 2-million-unit buffer, leading to a much stronger supply base.
- Optimized use of financial solutions. Lastly, the savviest suppliers have mastered using financial products to improve liquidity and fix costs. Access to capital, whether through traditional banks — and for those with scale, capital markets — is at a record high, and the net results are a 40 percent increase in working capital since 2016. Further, suppliers now take advantage of equipment financing to fix costs for capital equipment, as opposed to the past popular practice of burdening revolvers and impairing liquidity. Suppliers also use derivatives and hedging to control costs associated with financing at a faster clip than in years past. No longer subject to fluctuations in interest rates and commodity costs, derivatives and hedging provide a more reliable cost structure for financing.
All told, the automotive supply base is stronger than it has ever been. While the current noise in the industry needs to be addressed, pushing the panic button is a long way off.
In 2009, many marginal players were eliminated from the system, leaving a much stronger supply chain. The survivors have taken advantage of the leaner environment, learned from lessons past and changed their way of doing business — operationally and financially. These dramatic improvements minimize, if not eliminate, potential fallout from the next cycle.