The Detroit Automakers Should Worry About The Smaller Companies In Their Supply Chains

GM recently announced record earnings for 2021 on lower volumes. It focused production on the more profitable vehicles in its line in the face of the semiconductor chip shortages and other supply chain disruptions. The company called out higher commodity, logistics, and material costs, but was able to partially offset these with strong pricing on full-sized pickups and SUVs. Ford Motor also announced full-year net income of $17.9 billion, also a result of focusing production on more profitable models. Since they are sitting pretty, this might be a good time for these OEMs to look at some of their other suppliers, particularly mid-tier and smaller ones to which they may have less visibility. Most of them are facing the same cost pressures and disruptions. If the OEMs want these suppliers to survive and be a robust part of their North American supply chains, now might be a good time to review some of their practices.

Suppliers in the auto industry have always had to work hard. It is a highly competitive space, and the Detroit automakers constantly pit suppliers against each other seeking the lowest price. One supplier told me that the standard playbook used against them was constant threats to move their work elsewhere, or a promise of “no future work” as a way of leveraging lower prices. They include punitive terms in their supply agreements, with penalties of thousands of dollars per minute for failure to deliver materials on time and stopping a production line. Yet when they cut demand as they did during the early days of the pandemic, sometimes with as little as one day’s notice, they provide little or no compensation. This leaves suppliers to absorb the fixed costs of their operations spread over reduced volumes. One CEO I spoke with under condition of anonymity said he was forced to temporarily cut salaries up to 30% and do a series of painful layoffs.

Just about every manufacturer is facing inflationary pressures in the cost of materials, labor, and logistics. Another supplier who didn’t want to be identified told me that the price of petrochemical-based resins that they use to make plastic parts has doubled in the last year. Since resins are 40 – 50% of their product cost, they need to pass these costs on. Anther spoke of 70 – 80% cost increases in basic chemicals, and other material cost increases ranging from 9 – 35%. Such companies typically only earn single digit margins, so they have no ability to absorb the cost increases without some relief.

On top of the cost increases, one firm described how large customers were slow-paying their receivables, putting small firms under intense cash pressure. “You’re so far underwater, you have no chance,” another firm told me. “When we go in to talk to them about it, they shut the discussion down.” Another said, “They refuse to even meet with us, and just say they have a fixed price contract.” Unlike GM who could command higher prices, if these suppliers can’t get relief they will go out of business.

Adding insult to injury, Stellantis recently announced that new purchase contracts declare “all future events are deemed foreseeable” by suppliers, who would now have to bear the costs of any future disruptions. That’s like saying pandemics, bad weather, earthquakes, or acts of God are foreseeable, and suppliers should carry enough inventory to power through them. That is ridiculous because it says commercial impracticality due to unforeseeable circumstances, the meaning behind force majeure clauses in contracts, doesn’t apply anymore. The question in my mind is who would want to sell to Stellantis under these terms?

A longer term problem is that these suppliers are having a tough time attracting and retaining workers. “There is no good news in much of the automotive parts supplier industry,” the CEO of a medium sized supplier told me. “Would I want my kids working like I have to, at the mercy of an OEM who can put me out of business any day? Most people in my position would just say no!” This does not paint a picture of a healthy supply chain.

It might be instructive to look at the semiconductor chip supply shortages that have plagued the auto industry. Automakers predominantly use trailing edge technologies because the performance of chips made with them is generally sufficient, and they are inexpensive. When auto production volumes dropped in the spring of 2020, the OEMs cut back their orders. Chipmakers hate that by the way, because their products take a long time to manufacture and balancing supply with demand in the face of unreliable forecasts is always a challenge. Automakers are a small proportion of overall chip demand, so pandemic-driven demand shifts which drove sharp increases in work-from-home sectors meant there were many other customers happy to fill that sudden surfeit of manufacturing capacity. These segments are not very big profit generators for the semiconductor manufacturers, so they like to run their fabs at maximum capacity to keep cost absorption up and overall costs down. The chip manufacturers have probably underinvested in these older nodes in recent years, which contributed to the capacity crunch because they are less profitable.

As I have pointed out elsewhere, Japanese OEMs like Toyota and Honda take a more strategic, rather than a transactional view of their suppliers. Toyota makes sure they understand their supplier costs, but they value their capabilities. “I don’t make as much per unit on a contract with Toyota,” commented one company that I spoke with, “but the business I do with them is very stable. They value what we can do.” During the GM strike in 2019, some of them actually called (because they knew the company depended on GM for a significant part of their business) and offered help. That sounds like a strategic partnership designed to provide long-term supply.

These days everyone is talking about supply chain resiliency and the regionalization of production. The Detroit automakers may not realize how fragile some of their mid-tier suppliers are after two years of fighting Covid. One executive told me that a few of their domestic suppliers had already thrown in the towel, forcing them to source from China during a time of skyrocketing logistics costs. This hardly sounds like a trend that is going in the right direction. The Detroit automakers should be asking whether their smaller domestic suppliers will be able to stay in business, and whether they should invest some of those profits to ensure the health of their supply chains. That way when the inevitable next crisis arrives, those companies might still be around.