Automotive suppliers: preparing for transformation

Automotive suppliers are under acute pressure to transform. This has been the case for a while, of course, but the 2020 pandemic is further accelerating the dominant trends and drivers. Obviously, the main issue is the phase-out of the internal combustion engine (ICE). Drive train components make up around one-third of the material costs for a standard volume ICE car, and most of these components are obsolete in electric vehicles. According to current projections, up to 40 percent of ICE component suppliers should be starting their transformation right now. Their very existence is at stake.

Transformation is all the more necessary given the added pressure of the industry’s financing dynamics. Suppliers will be forced to refinance significant amounts of debt with maturities in the medium term, while investors are looking to lower their carbon exposure.

Trends, drivers and the current corporate agenda

The electrification of the drive train is a secular trend, but it is only one of the drivers that were already changing the industry even before the pandemic. Other factors include digitalization, vehicle connectivity, autonomous driving and car sharing. When COVID-19 hit, we saw massive disruption in supply chains, production stops and slagging demand. This in turn caused companies throughout the automotive industry to take on even more debt. OEMs and suppliers are under pressure to optimize cash conversion and to invest in new business models at the same time. Suppliers will therefore have to optimize their operations and evaluate the profitability of their respective plants across regions. But that may not be enough to quickly improve the balance sheets of this capital-intensive industry. Many companies will also have to look at divesting parts of the business or merging the top group.

Strategic business options

Several strategic options exist for both OEMs and suppliers, with the following as the main pathways:

1a – Separate and divest: A lot of companies are likely to choose this option when it comes to business segments in need of transformation. Some ICE-related businesses are still highly attractive in profitability terms, and listed suppliers may also be able to spin off entities to existing shareholders.

1b – Separate and restructure with external partner: Partnering with a “special situation” private equity fund is an interesting restructuring option. This path doesn’t always resonate well with the broader public, but for some it may be the only realistic alternative to closure.

2a – Harvest: The stability of value chains is an extremely important issue, even when markets are declining. Pursuing a “harvesting” strategy gives suppliers with a strong market position the opportunity to maximize cash returns from specific products by limiting capital expenditure and running production as efficiently as possible for as long as they can.

2b – Consolidate: Companies active in a declining market could look at merging with a competitor as a viable way to generate cost savings. As an added bonus, this would also help to expand market share and, according to the “last man standing” concept, give the company additional pricing leverage.

3 – Adapt: Some companies may opt to develop products or plants in ICE-related areas, e.g., in the aftermarket space. However, these opportunities are increasingly rare and may be unattainable without radical innovation.

4 – Acquire: Attempting to organically develop a new market segment can be difficult and time-consuming. One alternative could be to acquire a business and shift existing production capacities for a declining product into this new market segment.

5 – Close down: Though closing down is not attractive from a financial point of view, it is a feasible solution that doesn’t require an external partner. Suppliers may be able to postpone closure by maintaining the status quo and gradually winding down the business.

Preparing for transformation

The preparations needed to implement these strategies vary significantly and many are both important and urgent. The first key aspect to consider are the employees. As employee representatives play an increasingly important role in many European countries, the impact of an HR solution could be a critical factor in the decision about which businesses to realign, and how. Early involvement of the relevant committees, transparent and open communications, but also a focus on mitigations for the workforce are all necessary elements of a successful transformation. Another key group of stakeholders are banks and financing partners. As syndicated loans become more prominent in the industry, all of the parties involved will have a say in strategy development. Companies will also have to adapt their organizational and financial reporting structures, with monolithic structures forced to give way to a more modular system, e.g., with a view to “carving out” a business. And, finally, suppliers will also have to take the impact on tax matters and customer supply chains into account.

The consolidation dynamic

We have already seen several waves of consolidation in the automotive supplier industry, often focusing on so-called “hot” growth segments, such as automotive electronics or ADAS-related products. And with a limited number of target partners, mergers among competitors become more likely. Geography, customer split and technology are key issues for any merger decision. We advise suppliers to take action in the first wave of consolidation, as the options in the second and third waves become less and less attractive. The typical agents driving consolidation are investors ranging from suppliers (“last man standing” strategy) and private equity funds (“roll-up” strategy) to new market entrants with a focus on low valuations (“value play” strategy). The situation facing the industry reminds us of a game of musical chairs: early movers have the best chance to succeed, because the last best opportunity might be gone faster than you anticipated.

Transform with Deloitte: Our vision and expertise

Deloitte is here to help you transform your business and tackle difficult decisions. Our experts are at home in the automotive industry and have established a wide range of long-standing relationships. They combine deep insight into the sector agenda with the experience and expertise of a global network, standing at the ready to support you on your transformation journey. As advisors and visionary partners, we look forward to guiding you through the entire transformation process. Because we believe: success does not come to those who wait; only those ready to tackle the task and embark on the journey ahead will meet the challenges of today and tomorrow. We look forward to working with you to shape the coming transformation – with a multi-disciplinary team of experts at the European as well as the global level and deep experience in financial and management consulting and tax & legal advice.

Download our Point of View to read more about our experts' perspective on automotive supplier transformation.

Automotive Supplier Transformation: Our current publications on trends, drivers and strategic options

• Automotive smartWorkforce Transformation as a critical success factor
  An industry in flux: With issues such as technological change, the economic crisis and the skill shortage coming to a head, established automotive OEMs and suppliers are under massive pressure to change course. But what is the right strategy when faced with such adversity? In a new Point of View, Deloitte’s experts explain why they are advocating for a smartWorkforce Transformation. It starts with re/upskilling your employees, because they will likely play a leading role in your repositioning – ultimately, you need the right workforce to put your plan into action.
• Global Supplier Risk Monitor 2021
  The pandemic has hit the automotive industry hard. Suppliers not only have to face the effects of this crisis, but are also challenged to drive the transformation of the automotive value chain. It is essential to know the various corporate and market risks in this challenging environment in order to be able to initiate countermeasures at an early stage. These are the key findings of Deloitte's latest Global Supplier Risk Monitor. The risk analysis framework for automotive suppliers identifies the greatest challenges in this sector for specific vehicle components and shows possible solutions.
• The future of the automotive supplier industry: Four industry scenarios for 2030
  The automotive industry is facing fundamental change. But what exactly can we expect from the coming revolution – and how will this impact suppliers? In our Point of View, we recommend a scenario-based approach. The first automotive scenario study published by Deloitte in 2016 has been updated with four new scenarios for the year 2030, providing industry leaders with a framework to master nearly any conceivable outcome.
  
• The Future of the Automotive Value Chain: Supplier Financial Transformation
  The "Supplier Financial Transformation Model" supports automotive suppliers in their realignment by making your key decision criteria tangible and quantifying the financial impact on your income statement, balance sheet and cash flow. Based on this, you can better evaluate your strategic options and make informed decisions.
  
• Financing the gap: a challenge, particulary for mid-sized suppliers 
  With players along the entire automotive value chain under pressure to transform, medium-sized suppliers are facing a dilemma. They have limited product portfolios and global representation as well as high margin pressure and financial constraints. How can mid-market suppliers position themselves for transformation?
  
• Human Capital Trends 2021
  The global crisis triggered by the pandemic is having a profound impact on the entire world of work. Companies therefore need to structure their work and support their employees in such a way that they can best master the challenges posed by disruption. The current Human Capital Trend Report 2021 examines how this change can be shaped.