Global sourcing in the auto industry
Although the world's big carmakers have had global reach for decades,
they have been slow to take advantage of low wages in China and India
to supply inexpensive parts to their assembly plants in Europe, Japan,
and North America. The OEMs neither trusted the quality of Chinese and
Indian components nor regarded the companies that manufacture them as
any more efficient than the reliable existing suppliers in
geographically closer countries such as Mexico and the Czech Republic.
As recently as 2003, China exported just $4 billion worth of auto
parts—mostly low-quality aftermarket items rather than
original-equipment components used in the assembly of cars.1
Yet auto manufacturers are now rapidly shedding their skepticism. As
domestic car markets in China and India took off in recent years,
suppliers there made such big strides in quality and efficiency that
the best of them are close to meeting world-class standards. Moreover,
for certain components, locations such as Eastern Europe and Mexico
are no longer as competitive as they once were. Meanwhile, cutthroat
market conditions are forcing auto manufacturers into perpetual
belt-tightening mode. They have no choice but to trim their costs
constantly, since over the next ten years the price of a base-model
car is likely to remain flat in real terms—even as carmakers add
expensive new features to entice consumers or to comply with tougher
government regulations.
A company that manufactures some five million vehicles a year could
lighten the tab for parts by upward of $10 billion
Carmakers are now racing to buy as many bargain-basement parts as
possible in low-cost countries and urging the same policy on top-tier
global suppliers, such as Bosch, Denso, and TRW Automotive, which buy
thousands of parts for the large preassembled modules they deliver to
final-assembly plants. The cost savings may be enormous: carmakers
could cut their parts bills by up to 25 percent. A company that
manufactures about five million vehicles a year could theoretically
lighten the tab by more than $10 billion annually.
Realizing these savings in practice won't be easy, however; buying
auto parts is more complex than snapping up cheap shirts and plastic
toys. Carmakers and their suppliers forge multiyear relationships that
are difficult and expensive to unravel. Over time, a host of shifting
factors, from exchange rates to rising wages, can turn what might
initially have looked like a great deal into a costly mistake. It is
therefore vital to understand how costs will evolve, so that today's
sourcing decisions look smart ten years down the road.
The sourcing challenge
Compared with companies in industries such as electronics and
textiles, carmakers and their parts suppliers face difficult
challenges in global sourcing. Auto parts factories often require
large up-front investments, which are usually paid off over the five-
or seven-year life of a typical car model. Suppliers frequently spend
the year or two before a car's launch refining the design and
production process of its parts. Once assembly begins, the carmaker
expects suppliers to find cost reductions through engineering changes
or manufacturing improvements. Even after retiring a model, the
carmaker often continues to buy replacement parts for old cars still
on the road. And many parts require expensive production tools that
can't be replicated easily or shifted quickly to rival suppliers.
Moreover, the carmakers' long-lasting relationships with their
suppliers mean that traditional ways of estimating components
costs—for example, comparing current wages, energy prices, logistics
times, and shipping fees—can be inadequate or misleading. Carmakers
should judge how these factors are likely to evolve and interact over,
say, five to ten years; otherwise, a 10 percent savings may later
balloon into a 10 percent increase.
One example of the way shifting conditions can quickly alter the math
of global sourcing comes from China's aluminum industry. In just a few
years, surging demand has transformed the country from a net exporter
into a substantial importer. This development drove up the average
price of aluminum on the Shanghai spot market to $1,428 a ton in
2003—23 percent more than the average price on the London Metal
Exchange. It might have a similar effect on the cost of many aluminum
car parts, from engine blocks to suspension components. In addition,
exchange-rate uncertainty is higher than usual as US pressure on China
to uncouple the renminbi from the dollar mounts. If, as many analysts
believe, a freely floating renminbi were to appreciate against it,
most of the anticipated savings from sourcing in China would vanish.
Judgments on which parts to manufacture in low-cost countries must
therefore be made carefully and without preconceptions. Conventional
wisdom, for instance, holds that labor-intensive parts are the best
candidates for sourcing in such locations, but this isn't always true.
Consider the massive metal-stamping dies that carmakers use to bend
sheet metal into fenders and other body parts. These dies are
manufactured using expensive metal-cutting machinery. Typically, such
capital-intensive work stays close to home. But the production of dies
is shifting rapidly from North America to China because
government-sponsored access to cheap capital allows suppliers there to
buy the machinery at low cost, and it is then operated almost
around-the-clock by the country's huge workforce. In this case, China
has transformed its labor cost advantage into a capital utilization
advantage as well.
Sourcing in low-cost countries can undoubtedly be tricky, but
carmakers have little choice, for chronic overcapacity and merciless
competition have kept a lid on auto prices in the world's main markets
for more than a decade. The inflation-adjusted price of the basic
version of one of Europe's most popular models, for instance, held
almost constant from 1999 to 2002. Yet during that period, its maker
dramatically upgraded the car's standard equipment by adding airbags,
antilock brakes, a more powerful engine, and sophisticated electronics
to help drivers maintain control when they skid. To remain
competitive, carmakers will need to reduce their components costs by
as much as 30 percent over the next decade (Exhibit 1).
Making the sourcing decision
As carmakers plan for the future, how can they negotiate their way
through this minefield of ever-changing cost variables and choose the
cheapest source for a bewildering array of parts? Which locations make
the most sense over the long haul: the carmakers' home markets, nearby
low-cost countries, or new frontiers such as China and India?2 A
sensible first step is to sort an automobile's hundreds of mechanical
parts into clusters based on characteristics such as the balance
between the cost of labor and capital, the importance of raw-materials
costs, and the technical know-how suppliers must have to produce the
parts.
Some parts are so bulky (fuel tanks) or so easily damaged
(windshields) that they can't be shipped long distances economically;
carmakers must source such items close to home. For the rest, we have
identified five main clusters: technically sophisticated parts whose
manufacture requires little labor, average parts, technically
sophisticated parts with high labor requirements, simple parts that
have a significant labor component, and parts whose cost is driven
chiefly by raw materials. Once a carmaker organizes its shopping list
in this way, each location can be evaluated according to the key cost
factors, including local wage rates, the suppliers' engineering
capabilities, and annual rates of productivity improvement. The
crucial final step involves predicting how various factors, such as
the ability of the suppliers to improve their productivity and the
quality of their parts, will change over a car model's five- to
seven-year life cycle—in each of the possible locations.
The results of such an analysis can be surprising (Exhibit 2).
Consider the example of a US carmaker looking to buy plastic radiator
fans, which cost only a few dollars. This is the kind of simple
component you would expect to be sourced from China or India almost
automatically. The truth is that added shipping charges and the higher
cost of doing business in these countries wipe out any savings from
outsourcing to them. For North American carmakers, Mexico is now the
cheapest place to buy this part, and it is likely to be the cheapest
place in ten years.
Nevertheless, savvy carmakers should plan for the day, a few years
off, when low-cost countries become competitive for certain
components. A German carmaker considering whether to buy cast-aluminum
engine blocks in India, for instance, would decide not to do so—at
least for a car model to be introduced in 2004. Engine blocks
manufactured in Eastern Europe are clearly cheaper at the moment, and
that isn't likely to change soon, because aluminum prices in India are
relatively high and unlikely to fall until new production capacity
comes on line toward the end of the decade. In addition, the
suppliers' capital costs and profit margins are higher there.
The picture is likely to look quite different for a new model brought
to market in 2010. By then, the price of aluminum in India should be
in line with levels elsewhere, and the cost of capital should fall
somewhat as liberalization and other factors push down interest rates.
The productivity of Indian suppliers is likely to improve at a much
faster pace than that of their counterparts in Eastern Europe—or
indeed in Germany itself—and this ought to help them cut their unit
labor costs and improve their capital efficiency. Meanwhile wages,
which will probably rise only modestly in India, are projected to rise
by up to 10 percent a year in Eastern European countries as they race
to catch up with their western neighbors in the European Union. A
similar increase occurred in Spain after it gained membership, in
1986.
Under these assumptions, by 2010 India will have a cost advantage for
this kind of part over both Germany and the countries near it. Despite
India's current cost disadvantage, a company might want to take the
long view, in hopes of reaping the rewards later on, by locking in
some high-quality Indian production capacity right now, at least for a
small part of the volume.
For some parts, by contrast, carmakers would be wise to move
production to China and India immediately and on a large scale. An
air-conditioning compressor valve made of machined steel is a good
example. Western European carmakers now pay about $7 for the part,
with labor accounting for about 70 percent of the cost. Thanks to low
wages in China and India, it obviously makes sense to have companies
there supply the valve; the savings are immediate even given the
likelihood that using suppliers in a distant location may involve some
higher costs, such as a 60-day cushion of inventory instead of the 14
days needed with a manufacturer close to home. Moreover, the savings
are likely to grow over the coming decade as labor costs in China and
India rise more slowly than those in Europe, Japan, and North America.
The way forward
Over the longer haul, carmakers can increase their economies from
global sourcing by adjusting their own processes and product
requirements to match the capabilities and characteristics of
manufacturers in China and India. When a company designs new models,
for example, it can adjust its engineering specifications in order to
increase the number of parts that can be sourced from low-cost
countries—for instance, by working around the suppliers' technical
limitations or replacing automated assembly processes with manual
labor. Complex components, such as brake calipers and their housings,
which are currently bought from suppliers as preassembled units, could
be broken down into single parts, some of which can be produced almost
anywhere. This approach must be executed in partnership with the
top-tier supplier, which would likely keep the responsibility for
final assembly and testing.
Companies can also reengineer parts to reduce their technical
complexity. One European carmaker found that Chinese and Indian
suppliers lacked the know-how to make a coil suspension spring. Since
bringing them up to speed would have been too costly and
time-consuming, the company's engineers redesigned the steel spring so
that it was easier to manufacture but still matched the original's
performance. They also opted for a high-heat process (rather than the
advanced cold process originally planned) because it was within the
suppliers' capabilities. These decisions yielded 20 percent cost
savings, even with customs duties and higher costs for investment,
shipping, and inventory.
Sometimes an even simpler change in the production process will do the
trick. Instead of using expensive automated assembly lines to machine
large parts such as engine blocks or cylinder heads, for example,
suppliers can rely on manual machining tools that require more labor
to operate. Because of low wage rates, the lower capital investment
more than compensates for the cost of the additional manpower.
Some carmakers take a different tack. In 1999 Toyota Motor, for
example, intervened directly to help several Indian suppliers of
steering components implement the Toyota production system. It sent
Japanese experts to teach Indian workers the techniques of lean
manufacturing, from smoothing out spikes in production volume to
error-proofing individual production steps. The results were
remarkable. Over the next four years, one ball-joint supplier cut the
number of defects from 1,000 for every 1,000,000 parts to fewer than
50—roughly equal to the defect rates of established Toyota suppliers
elsewhere. Over the same period, the supplier's labor productivity
increased by almost 50 percent (Exhibit 3).
The downside is that this approach incurs additional costs that eat
into the overall savings, since carmakers must establish permanent
local offices staffed with engineers and production specialists to
coach suppliers as they climb the learning curve. This expense is
difficult for many carmakers to justify; because of disjointed
accounting practices, it usually lands on the books of the engineering
department while the savings accrue to the purchasing department.
All in all, automakers must change their operations fundamentally if
the rush to global sourcing is to generate lasting value. Top
management should prioritize the product clusters it wishes to
evaluate, set aggressive cost-savings targets, and stick to them over
time. Purchasing departments will have a growing need not only to keep
experienced people on the ground in low-cost countries but also to
focus on developing the suppliers' capabilities rather than simply
haggling over prices. Furthermore, automakers will have to attract and
nurture talented local managers—a steep challenge given the number of
companies, in a variety of industries, fighting over a limited pool of
people with the necessary experience and language and technical
skills.
The shift to parts suppliers in low-cost countries will happen only
gradually as old car models are retired and replaced by new ones
Even the most committed carmakers will need years to wring the maximum
savings from global-sourcing initiatives. The shift to suppliers in
low-cost countries will happen only gradually as old car models are
retired and replaced by new ones. The pace will vary from one company
to another. Some of those with close-knit networks of suppliers may be
slow to shift contracts away from them. (Many Japanese carmakers will
fall into this category.) Moreover, the high cost of closing factories
and laying off workers in Japan and many parts of Europe will make it
hard to justify such moves. By contrast, the nature of the ties
between US carmakers and their suppliers may facilitate the shift to
low-cost locations as quickly as model cycles allow; already, Ford
Motor and General Motors seem to be pushing more aggressively to buy
more parts in China and India than are their rivals in Asia or Europe.
European carmakers appear to fall somewhere between their counterparts
in the United States and Japan.
In all three regions, political sensitivities about moving jobs
offshore may slow the trend, particularly for parts still manufactured
in the carmakers' home countries. But in the longer term, the
intensity of competition will prevent such considerations from
stopping the race to buy cheaper parts. Car companies that plan
carefully, move forward with deliberate speed, and adapt their
processes to suit the needs of low-cost suppliers will likely generate
savings that persist over time rather than slip away as conditions
evolve.
About the Authors
Markus Bergmann is a consultant in McKinsey's Stuttgart office, Ramesh
Mangaleswaran is a principal in the Mumbai office, and Glenn Mercer is
a principal in the Cleveland office.
Notes
1 When we speak in this article of global sourcing in the automotive
industry, we do not mean the sourcing of parts in a given country for
use in car plants there. (China's domestic parts industry is indeed
booming, along with domestic demand for cars and trucks.) This article
addresses only the purchase of parts in one country for use in the
factories of another.
2 We don't exclude the possibility that other countries, such as
Brazil or Vietnam, might emerge as low-cost options, but China and
India are likely to be the dominant players and thus receive the bulk
of our attention here.
posted by Anonymous @ 8:16 PM
3 comments
Complete light engines / LED modules 
