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Suppliers have been in an uphill
struggle for some time to defend
their margins. Upstream pressures
from an environment of high commodity
prices have only been partially offset by
modest upward movements in prices
paid by OEM customers. Commodity
input costs have risen at an average
annual rate of 13.5%
over the last four years
while selling prices have
risen at an average
annual rate of 1.4%.
The automakers, particularly
in North
America, have used
their market muscle to
pressure suppliers for
cost reductions. Overaggressive
use of this
tactic has produced
financial distress for
parts producers. This
situation, as bankruptcies attest, can only
be a temporary phenomenon.
The supplier base, through conscious
effort, Darwinist survival, or a combination
of both, will likely go through a period of
consolidation. The activities of Wilbur Ross,
through the creation of the International
Automotive Components Group (IAC), is
a good example of this trend.
Wilbur Ross is a well-known leveraged
buyout specialist with a knack for turning
around distressed companies in troubled
industries. He turned his attention to the
automotive supplier industry a couple of
years ago. IAC now controls Lear’s
European and North American interiors business, the European business of Collins & Aikman (C&A), as well as some other companies’ supplier assets. Using CSM’s database, we can look at the changes in power relationships between suppliers and OEMs as a result of such merger activity.
Taking a look at suppliers of door trim panels in Europe, we see the successful integration of the legacy Lear and C&A businesses had only a modest impact on the power structure there. C&A was a relatively small player, representing less than 1% of the European market. The high potential for damage during transportation means the market is largely regionalized making an analysis limited to a geographic area appropriate.
A successful purchase of C&A’s North American business, however, would represent a major consolidation by uniting the number one and number five suppliers of door trim panels in that geographic market. Currently, 14 OEMs producing door trim panels in the N.A. market are serviced by 24 viable companies.
Economists often use a simple measure called the Herfindahl-Hirschman Index (HHI) to judge the concentration of consumers and/or suppliers within an industry.
See The New Auto Supplier Consolidation
in this issue for more. The higher
the concentration, the higher the negotiating
strength attributed to that side of an
industry. A market structure with an HHI
less than 1000 is considered fragmented,
between 1000 and 1800 moderately
concentrated, and over 1800 is concentrated.
For the door trim market in North
America, the index returns a level of 1603
for the OEMs and 909 for suppliers. This
is more than enough to give the OEMs a
substantial leg up in negotiations.
CSM is able to go a few steps further in
its analysis. The CSM database has
information on the entire $14 billion portfolio
of door trim panel transactions.
Each individual supplier’s book of business
is matched to each specific vehicle
that will be produced over the next 5+
years as well as when it will be produced.
This yields a matrix of telling
interactions.
A nightmare scenario for suppliers would be a market where it is one of many small suppliers capable of delivering a particular commodity. In this scenario, there is only one large, aggressive customer who has many sources to choose from. Moreover, the supplier generally will have little or no business contracted going forward to guarantee continued utilization of the firm’s capital stock. The supplier in this instance would have little or no power to protect its margins. By contrast, in the ideal supplier world, the firm would be the only company in the market capable of providing a particular good. They would have a myriad of customers, with little dependence on any one customer to ensure continued growth. The supplier would have contracts extending into the future that are large enough to ensure full utilization of existing and future capacity. The supplier in this case would have maximum power to protect its margins.
The CSM Supplier Power Index (CSMSP Index) measures these factors, as well as others, at a granular level delivering a rating between 0 for the nightmare case and 100 for the ideal. Larger suppliers have a leg up, as their OEM customers are more likely to be asymmetrically dependent on their ability to deliver product. Successful targeting of key platform/program combinations, however, can give a relatively smaller supplier the ability to act “bigger” in its relations with OEMs. Larger suppliers can also use the tactic to further increase their standing.
CSM conducted two analyses: the first was on a base case assumption set that keeps C&A as an independent entity; the second looks at the ripples in the power structure that will occur if IAC manages to purchase C&A.
In the base case IAC has a power rating
of 44.9, below the average of 47.7 for the
top 10 suppliers in the N.A. door trim
market. This means the legacy Lear did a
poor job of leveraging its size to achieve
power. Moreover, in an important component
of the CSM-SP Index, the Dance
Card component, IAC has not booked a
significant amount of its capacity in the
upcoming sourcing window. C&A sits
somewhat lower with a power rating of
42.3. Meanwhile, Johnson Controls has
done a superior job. A strategic reshuffling
of its OE business in recent years
has proven advantageous. It is one of the
top performers in the Dance Card measure.
A merger of C&A’s North American business
into the mix, however, changes
things significantly for the better for IAC.
The power index jumps to 48.4 for the
combined entity. You will notice that for
every supplier there is a ripple effect from
the merger. They all benefit from a consolidation
of the competitive space, but
to varying degrees.
The power of this type of analysis is to help guide investors to optimal mergers and acquisitions as supplier consolidation proceeds. Comparing other potential targets, we can find superior combinations. A merger between IAC and Ford’s ACH is such a superior combination producing a result of 49.4 for the Wilbur Ross combined firm.
This method can also help suppliers choose programs more strategically by looking at the impact a particular contract will have on its power in the marketplace. The speed, ease and efficacy at which the consolidation of suppliers takes place will somewhat depend on the ability of suppliers and financiers to leverage such analysis as opposed to proceeding blindly.
Greg Mount may be reached via email at gregmount@csmauto.com.
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