With 2007 behind us and our budgeting processes long completed, now the hard work begins as we kick off 2008. In what may prove to be among the most challenging economic conditions we’ve seen in recent times, now we must all go out and forge new business and retain existing work with little or no help from falling leading indicators such as housing and durable goods, or the continued spiking cost of raw materials. By all accounts, 2008 will be a tough year, and there is little hope of substantial growth. Simply reversing the expected slump in car and truck sales would be a real accomplishment. Sound pessimistic? Too conservative? Only focused on the worst? No, not in this case: As the industry continues to right-size itself in North America during 2008, suppliers should be looking for accuracy while they plan their production volumes. Accuracy matters, maybe now more than ever. Given today’s business and economic environment, automotive suppliers do not have much margin for error. Suppliers are expected to forecast and then produce to numbers furnished by their OEM and tier customers, numbers that many times are over-optimistic in light of lower demand, cannibalization due to competitive product introductions, production cuts, shift eliminations, and plant closures. Suppliers must do a better job of production planning and quoting accuracy on current and future programs if they want to have any chance of protecting let alone improving margins.
Let’s examine a sampling of costs that directly impact a supplier’s margin if an OEM or tier awards a program but then the volumes don’t follow behind the contract. If a business forecasts at certain volumes, and those volumes are not met, then production of purchased components is at a higher cost due to the lower volumes. The impact is significant. What’s more, there are additional costs that are absorbed due to inaccurate forecasting. As in:
- Amortization of tooling
- Amortization of packaging
- Inventory carrying costs, such as the costs of work-in-progress and finished goods
- Underutilization of manpower
- Underutilization of facilities and equipment
- Higher facility overhead costs
Making some assumptions and breaking down the dollars allocated to these costs may be helpful. This component part example assumes a tooling cost of $100,000 amortized over 100,000 parts a year, with a program cycle of four years. If you divide the $100,000 tooling cost by the total 400,000 parts, the result is a $0.25 allocated tooling cost per piece. The 100,000 pieces per year equals 8,333 pieces on a per month basis, and that 8,333 multiplied by the $.25 per piece cost renders a $2,083.33 per month tooling investment.
Next, we assume packaging costs of $40,000 amortized over those same 100,000 parts a year, for the four-year program period, which is a cost of $0.10 per piece. Based on 8,333 pieces per month and a $0.10 allocated cost, our packaging overhead is $833.30 per month. Taking into account inventory carrying costs isn’t easy but we might assume that finished goods have a value of $5.00 per piece. If a third of that $5.00 carry cost is tied up as work-in-progress, or $1.50 per piece, we can then assume a total finished goods value of $6.50 per piece. Thus, a monthly run of 8,333 parts held in inventory nets a total monthly carrying cost obligation of $54,165 per month.
Now we must take into consideration facility manpower costs, not an easy calculation to make because it is difficult to determine whether workers are fully dedicated to a single job or flexible across multiple programs, how downtime is factored, or how shared worker time is allocated. But if we assume an hourly worker is paid $16.50 per hour, plus benefits at 35%, or an additional $5.78, we can arrive at a total labor rate per worker of $22.28. Using a standard 8-hour per day shift, that total labor cost is $178.24 daily. If we assume that the plant has 200 hourly workers and is 10% overstaffed—at least in part because of poor forecasting—we learn that those 20 employees’ total wage of $178.24 per day times a 20-day month equals wage losses incurred of $71,296 per month.
Aggregating these five key cost categories—tooling, packaging, inventory, facility, and manpower—into a total “sunk” cost proposition is a scary number to look at, even if it reflects many assumptions and arguably the use of some “soft” inputs: $128,377 each month for an annual cost of over $1.5 million. As frenetic a pace as most suppliers keep in trying to serve their customers and still make a profit, overlooking these embedded costs can happen. Sometimes they are even ignored or rationalized. But, obviously, there are no Tier I or Tier II suppliers who can afford to give up this kind of cost overrun each year by missing their sales forecasts and budgets. When added to the huge sums suppliers are already sinking into customer investment requirements, and the huge sums they sink into global preparedness, co-location and LCC programs, it is a wonder how North American suppliers make any profit at all.