Global Implications For

(Graphic: AAIA)

Regulations in America are among the toughest in the world, not only in areas such as emissions and fuel economy, but also in the nuts and bolts of quality standards, working conditions and benefits. As automakers downsize, there has been a shift that has put more research and development in the hands of suppliers, especially in technology, but often without a proportionate increase in revenues. 

Inventory management is another area demanding attention. Given the enormous number of parts from so many different vehicle platforms, finding cost-effective ways to handle and process inventory through the supply chain with less errors is becoming a mantra for survival.

Downstream, the woes of the automakers ripple through the automotive aftermarket. OEMs squeezing their domestic suppliers is nothing new. It's been going on for years now. But this past year has seen even more pressure from them to cut even more, and in the midst of a growing competitive presence of foreign parts competition, there are headlines nearly every day that an automaker is opening a new plant for parts or vehicle manufacture in China, India, or some other country. 

This is being done not just with the intention of selling in those nations, but also to sell back here in America, where even with added transportation costs, improved profit margins can result. Given the acceleration of U.S. automaker investment elsewhere, one wonders if their demands for cost concessions from suppliers will buy loyalty in the future, or is it a short-term fix till foreign production ramps up.

Between a rock and a hard place Consolidation in the aftermarket industry - through bankruptcy, mergers or acquisitions - is the consequence of the above and other factors. Of the 5,000-plus companies in the auto parts manufacturing industry, Farber and Ropes pointed out that "just 50 of them cover over 80 percent of the total annual sales." That number continues to shrink. Hand-in-hand with the consolidation is declining total employment year over year.

The increased pressure on suppliers has pushed down their profit margins and driven some to the brink of bankruptcy protection, or worse. Delphi, Visteon and Federal-Mogul may be headliners, but there are many more companies hanging on the edge. Other firms are themselves looking to open plants in other countries, such as China, to take advantage of the huge savings potential and keep pace with automakers. 

Maintaining their intellectual property - that "edge" a manufacturer has over competition - and learning the political gamesmanship required in other nations and cultures is no mean feat. However, American suppliers are increasingly looking that direction if they can afford the investment. Ropes provided an example of one cost driver for this scenario: "The average manufacturing cost of labor in the United States is $20.32 per hour, while China's is only $0.59 per hour." Do the math.

Competitive pressures are also driving an increase in consolidation amongst the surviving firms. Mergers and acquisitions have been increasing in the automotive aftermarket, as stronger companies try to take advantage in order to buy market share, increase their core business or access new markets or new product channels that the acquired firm served. Ropes reported, "In the first half of 2005 alone, over $402 billion in mergers and acquisitions has occurred."

Also fueling the urge to merge is an abundance of cash sitting on the stock market sidelines. Private equity groups and investment banks with billions of dollars to invest or loan respectively are attracted to the industry's positive long-term trends. Couple that with participants who are feeling squeezed and finding themselves wanting to exit the industry, the opportunity for a relatively stronger and well-organized firm with the help of investment groups to capitalize on companies looking for a way out is huge. But it is not without a price to pay to the backers and not with any certainty of long-term success.

The automotive aftermarket industry faces other critical issues as well. Corrective initiatives that have a longer term to complete are hard to reconcile with company shareholders who have short-term time horizons. More immediate return on investment, a focus on short-term sales rather than sustained profits and healthy growth, the next quarterly meeting and even headlines drive behaviors and actions, although contrary to long-term sustainability. The cultural differences between the U.S. and Japanese automakers is evident here, with the latter thinking, planning and acting with a longer term perspective and focus, even if it means short-term sacrifices.

Market erosion from illegal foreign- and domestic-made counterfeit parts and increasing competition from genuine, foreign-made parts, and well as pending asbestos- related lawsuits are profit-eaters, and have the attention of federal lawmakers. Harper said, "$12 billion worth of counterfeit parts are sold annually in America." Ropes added that genuine international competition accounts for nearly 25 percent of industry sales, and it's rising. Finally, proposed asbestos legislation slated for a vote in October would require the funding of a $140 million asbestos victim fund levied on companies, some of them already on the brink of financial problems.

America's markets don't have walls around them. Increasing international competition, ethical or otherwise is impacting the industry and how it does business. It's not going away, and needs to be faced and dealt with. Farber and Ropes discussed the implications of a number of countries - Japan, Korea, Russia and India - but the focus was mostly on China.

So why China?  First, the Chinese market is huge, and with an increasing population hungry for modern products, that large market is growing. China is third behind the United States and Japan in new car sales. Ropes said, "China's annual auto sales are expected to reach 49 million new vehicles in 2010." China is also the fourth largest auto manufacturing nation in the world, and closing the gap rapidly on those ahead of it. 

Farber added, "In 2004, the average cost of a new vehicle made in China was $13,000, verses $24,900 in America." While the quality of Chinese made vehicles isn't at par with current vehicles sold here, China plans to export them, as evidenced by the debut of several models at the International Auto Show in Frankfurt. With the United States being a huge market, Chinese firms plan to export here as well. Lest we forget, both Toyota and Honda entered the American market with lower quality and lower priced vehicles. Farber asked, "Where were Toyota and Honda 30 years ago verses today?"

The OE and replacement parts market in China is slightly less than $25 billion per year in sales and expected to ramp up as vehicles sales continue to rise. That in itself is motivating companies from automakers to parts makers to service firms to want to have a presence there. Farber explained, "For many firms, it isn't a question of if they're going to do business in China, but when." 

Finally, there is a $162 billion U.S trade deficit with China, the highest trade deficit in the world between two nations. Many in Congress and the industry feel that the trade deficit is more the result of China's yuan being kept artificially low by 40 percent, hence making Chinese goods cheaper to sell here, while making U.S.-produced goods more expensive by comparison. 

China competes for the same resources the American industry needs, notably oil and steel. Ropes highlighted one impact of the competing demands, citing a July 11, 2005 Business Week report, "$80 billion of raw steel production has been moved from the United States to China in the last 18 months alone." On the oil front, the recently passed Energy Bill in part stopped the proposed takeover bid for U.S.-based Unocal by the Chinese National Oil Co.

Another concern expressed within the aftermarket industry and in Washington is that China has much more relaxed laws and regulation regarding intellectual property than the United States does, leading to a proliferation of counterfeited parts. 

As a result of the trade deficit, as well as currency and counterfeiting concerns, legislation has been passed or is being considered. The proposed "Stop Counterfeiting in Manufacturing Goods Act of 2005" seeks to ensure that consumers at every level of the supply chain can be assured that the products they purchase are truly the genuine article. 

The "U.S Trade Agreement Enforcement Act of 2005" now requires the Treasury to report to Congress biannually on the recent impact of Chinese currency policy and whether there have been any violations of World Trade Organization policies. 

"House Resolution 3004" proposes further regular reporting from the Treasury on Chinese/U.S. currency exchange rates and the imposition of an across-the-board 27.5 percent tariff on Chinese imports in an effort to reduce China's unfairly undervalued currency advantage. The tariff bill's sponsors have said they will wait until Oct. 1, 2005 to see what China does voluntarily before pressing forward towards a vote. 

Lessons for the automotive aftermarket The aftermarket industry will continue to grow slowly, Farber and Ropes contend, regardless of domestic automaker problems. Key growth segments will include the Tuner market and service and repair of an increasing number of older vehicles. Asian and European automakers will continue to embrace the aftermarket for service and repair as their levels of brand loyalty (repeat customers and market share) continue to increase. Down the road, increased new vehicle market share will translate to an increasing share of the used car market. This will shift the types of vehicles repaired and service more towards imports.

Suppliers whose core business is too concentrated on domestic price-discounting automakers, who are losing market share in addition to money, are in for a continued rough ride in the short term, with no surety of being a supplier to them in the future, Farber and Ropes asserted. Rather than continue to focus core business on struggling automakers, these companies might consider building relationships with profitable foreign automakers who have an increasing share of the U.S. market or moving to less dependent, more profitable core business in other products or markets.

Technology will play a larger role in helping the automotive aftermarket gain efficiencies in cost management, especially in inventory control. Two examples given were emerging inventory management software and adoption of industry standards through the entire supply chain to reduce mistakes in inventory and cataloging. 

Rising oil prices will continue to affect the SUV market. Consumers will turn instead towards tuning, performance and aesthetics. As well, more interest in alternate vehicle fuels and technologies will become evident. One side note to the increasing desire for uniqueness in vehicles is that there are higher profit margins in this segment, which isn't the case for many other segments.

Globalization in manufacturing and service will continue, be it in China or other emerging markets such as Russia, South Korea, India or Poland. In regards to China, should tariffs be implemented, less tooling and manufacturing will leave the United States, while new vehicle prices and ongoing maintenance costs would rise dramatically because of the loss of cheaper, serviceable parts. 

The risks inherent to this resolution include that the tariff also would be applied to goods produced by U.S. companies in China as well and that China may retaliate, opening an all out trade war. Farber and Ropes cautioned companies, "The industry should consider all current and potential factors before doing business in China." 

How the aftermarket fares going forward is a matter of choice: assimilate the economics into strategic plans and implementation or put up walls and deny there's a problem or repercussions domestically. Or simply lay back and take whatever happens on the chin. 

(Sources: Grant Thorton LLP, AAIA)