In the 12 years since IRN Inc. began surveying the supply base on the dynamics of price reduction requests, the results have shown a pattern of intensifying pressure from customers on their suppliers during the period from 1997 to 2003, followed by diminishing demands from 2003 to 2009. The table below shows the average annual percentage reduction in price that customers asked for, as reported in IRN's biennial supplier survey.
In 1997 a new phenomenon occurred, as customers came back to suppliers and said the price on existing business or on a new quote needed to come down by a specified percentage, notwithstanding any contracts or prior agreements. Suppliers were often surprised by the requests and not sure whether to comply. (IRN began conducting the survey in order to provide some external context for suppliers to use in developing their response strategy.) Over time, the dynamic became an all-too-familiar method of squeezing a little more margin out of the supply base by using the power of the purchasing relationship.
In recent years, it appears that the pressure has moderated. There are a variety of reasons, including the overall industry downturn in 2009, significant upward pressure on prices from raw material costs, a greater degree of co-dependency between suppliers and customers, and the fact that suppliers are, on the whole, much leaner than they were in the mid-1990s. Suppliers have indicated by their reactions that there is no more fat to cut or low-hanging fruit to harvest.
The 2009 survey respondents reported a level of concession that was basically flat with the prior survey, at 1.9%. This is consistent with the survey findings in 2007 that suppliers appear to be coalescing around the 2% figure as a reasonable amount of cost reduction to agree to, corresponding to what they feel they can offset as they travel down the learning curve on new jobs and find production efficiencies and other improvements.
In a mark of how much things have changed, it seemed appropriate in the 2009 survey to ask whether there were instances in which suppliers not only fought off an expectation of a price reduction but actually won a price increase. In fact, 31% of the respondents had obtained a price increase on existing business from a customer. This was most frequently related to raw material prices, although other rationale cited by the survey participants included low production volumes, exchange rates, and their own financial condition.
One of the most interesting aspects of the 2009 survey results was the message about how companies up and down the supply chain perceive their relative power these days. The survey asked respondents whether, compared to three years ago, their power relative to that of their customers had increased, decreased, or stayed the same. Fifty-seven percent said it had increased; 7% saw a decrease; 36% responded it had stayed the same. In a corresponding question about their power relative their supply base, about half (51%) said it had stayed the same; 36% said their power relative to their own suppliers had increased; and 13% said it had decreased (we suspect that these companies have experienced particular volatility with their raw material inputs). The burden of low vehicle demand has caused a focus on profitability as opposed to market share by suppliers and has helped level the playing field between suppliers and their customers.
It was a fascinating year to conduct the biennial survey. With the catastrophic drop-off in demand in the first half of 2009 and the bankruptcy of General Motors and Chrysler during the summer, suppliers were challenged as never before just to survive, let alone prosper. Coming out of this near-death experience, most suppliers had to completely revisit their business model.
Increased volatility is here to stay. The automotive market going forward will be more like that of the 1970s and 1980s than the recent past, when extensive use of sales incentives and the remarkable run-up in housing values propped up new vehicle purchases in a way that made people forget that this is a cyclical industry. Suppliers must become accustomed to dealing with greater swings in production. The survey results indicate that a good number of companies think they have achieved that flexibility. As North American production increases by 40 to 60% in 2010-2011, they will have an external environment that tests those beliefs.
Automotive volatility in an environment of a severe recession revealed a new source of stress and pressure for suppliers. The surveys contained numerous comments relating to concerns about cash flow, banks, financing, and credit. These concerns are likely to worsen as the market begins to recover and new programs are launched, requiring new funds. Commercial banks are looming larger as the new competitive control point. The cost and availability of credit lines, size of loans, interest rates, and commercial loan covenants may once have been viewed as somewhat external to the core day-to-day work of running the company, but no longer. Keeping in a good cash position and managing one's banking relationships will be a key to success for the foreseeable future. Although the power may be stabilizing between suppliers and customers, profitable success in the industry will not get any easier.