Monday, December 20, 2004


The Chickens Come Home To Roost?

Many automotive suppliers, facing ever-increasing material costs and a corresponding inability to win price concessions from their customers, are facing serious financial difficulties.

One of these, Intermet, has found itself in Chapter 11 due to the fact that its core business (castings) is highly-susceptable to these new raw-material cost pressures, and as supplier of "commodity" parts (more on this in a moment), has little leverage in the pricing game. And now that Intermet is looking to shut down a significant part of its operation, the Big 3 and other customers are in danger of getting shut down. As a result, Intermet's customers have filed suit in federal court, seeing an injunction forcing Intermet to stay in business.

Castings are a significant portion of a modern auto, having made their way from powertrain and suspension applications into nearly every other aspect of the car, and Intermet is one of a very few suppliers playing in this market. It's frankly a rather mature technology that's universally regarded as a commodity in the most basic sense - a widely-available technology with a broad supply base. In other words, the sort of parts that invite a lot of pricing pressure - after all, if anyone can supply this manufacturing technology, just ignore the capital investment required and drive the price down to the point where it's just barely - and I mean barely - worth doing business. Capitalism at its best, right?

But what eventually occurs is the sort of consolidation that we've seen everywhere in the past few years, and that results in a small number of large suppliers. Such a supplier now carries a significant burden on its shoulders; indeed, Intermet probably has "mission critical" parts in just about every domestic vehicle. This is not a situation unique to the metal casting industry, either. In just about every market in the automotive component industry, most OEMs have only two or maybe three at the most vendors that provide the vast majority of their components. Shut down any one of those, and cars don't get built.

So now we've established that we've got a very small number of vendors, operating at absurdly small margins, that are keeping the US auto industry moving along. Since the domestic auto manufacturers are operating under similarly absurd profit margins (GM and Ford taking in, on average, only a few hundred dollars in profit from each vehicle sale), there's simply no room to ask for more money.

Additionally, investment in the automotive industy just isn't attractive right now. Need to borrow money to invest in newer technology or simply ride out a rough patch? Too bad - no one's interested in investing money that they're unlikely to see again (remember, there's no profit). It's that old adage that banks are never interested in lending money to those that really need it.

What happens, then, when external cost problems arise - such as, say, an increase in material costs, or perhaps a union that's looking for more money? And what happens if the OEMs don't just want to see your margins get reduced any further - what if they actually start looking for cash kickbacks; ya know, the "cost of doing business"? Add in a sliding stock value, and you've got the perfect equation for closing up shop and walking away.

Obviously, that's not an option if you single-handedly control the destiny of, oh, a half-trillion dollars in industrial output (not bad for a company that had net sales of about $750 million). And so what we'll likely see is that they'll be forced to continue operating for the time-being. But Intermet's situation is not unique in the auto industry, and this will not be the last time such a problem arises. Really, it comes down to the domestic manufacturers' inability to make any money, and until they find it in themselves to make cars that are desirable without stacking piles of money on the hood, they put themselves, their suppliers, and quite possibly the whole US economy at risk.

I can't see any of the business-types I know reacting to this news with anything but a self-preservation instinct. This brings me back to my cardinal thought for 2004, "The worst is yet to come."
Agreed - perhaps the theme for 2005 could be "Tip of the iceberg" or something similar. There's got to be literally thousands of suppliers who find themselves in identical situations, and it's going to be just a matter of time before material and wage pressures catch up to them.

Ironically enough, it could be the transplant OEMs (Honda/Toyota/Nissan/Hyundai) that save the domestic OEMs. If one makes enough money from the transplants, it may make sense to keep the shop running to turn out production for the domestics - economies of scale and so on. That's about enough to make your head explode.
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