When I first entered the automotive business in 1980, there were approximately 30 original equipment manufacturers (OEMs) globally. While the exact numbers will vary a bit depending upon the source used, in that same year, there were approximately 35,000 automotive suppliers worldwide. Fast forward to 2006, and we have 13 OEMs and somewhere between 6,000 and 8,000 suppliers globally. While the reduction in the number of OEMs drove some of this dramatic supplier consolidation, a more significant contributing factor was the development of the supplier tiering model. The concept of a tiered automotive supply base has become so ingrained that it is almost difficult to remember when it first began impacting industry thinking.
Without getting into too detailed a history lesson, the concept of tiering the supply base was the result of some industry participants analyzing the success of the Japanese manufacturers in North America in the late 1970’s and early 1980’s. As the illustration “The 80’s and Before” shows, the traditional relationship between the OEM and supplier was basically a direct one. This resulted in tens of thousands of direct supplier relationships with the OEMs. Many people concluded that the keiretsu structure of the Japanese supply model was one of their primary competitive advantages vs. their Western counterparts. North American OEMs logically concluded that by tiering their supply base, there would be greater product innovation, better manufacturing efficiencies, and faster time to market. The Tier Ones would maintain their relationship with the OEM and all of the other suppliers would organize underneath them. Tier Twos would focus on components or sub modules, Tier Threes would focus on processes, and Tier Fours would primarily be material producers. Given the fact that America is a highly competitive society and being number one is obviously better than any other position, from the mid-1980’s to the late-1990’s, everyone raced to secure a Tier One position (as shown in in “The Traditional Automotive Tiering Model”).
During this period, I used to joke that focusing on being a Tier One was primarily a “guy thing,” and that most industry participants would do anything possible to avoid being relegated to a Tier Two or Tier Three position. That is why so many companies in the mid- to late-1990’s accepted major price concessions with their customers in order to be the Systems Integrator for a major geographic portion of the car (e.g., interior, exterior, front end modules, etc.). The obvious theory driving this “race to be number one” was that by being in the controlling position for a portion of the vehicle, eventually the Systems Integrator would have the strongest competitive position.
For the last five years, the assumption that supplier tiering would remain the dominant industry model has led many major automotive suppliers to invest heavily in front-end R & D for their major segment areas and to significantly expand their technical and program management capabilities. Some suppliers hired literally hundreds of new technical and program management personnel and set up major new design and technical centers. This was viewed as the “cost of doing business” to be a Tier One and the assumption was that all of these investments would eventually pay off as the first major programs began to launch in the 2007-2010 timeframe. The only problem with this theory is that the Systems Integrator model was never embraced by the “industry,” and there appear to be a number of fatal flaws in the overall tiering model.
The Big Three no longer support the concept. In the last 6 to12 months, it has become very clear that the Big Three are rapidly moving away from the Systems Integrator model. Just at the point where all those huge upfront investments by so many Tier One suppliers was finally going to begin paying off, their domestic OEM customers have basically said, “You know what? That Systems Integrator thing? We were just kidding. We’ve decided that giving so much responsibility to you dilutes our overall design competence and merely adds to our cost structure. We are going to go back to sourcing by component area.”
Being a Tier One is a tough place to make money. Even if the OEMs were continuing to support the tiering model, history has proven that, with very rare exception, being a Tier One or Systems Integrator is a thinly disguised grocery store financial model where the sales are great but the margins are razor thin. Most of the financial basket cases in the supplier industry are Tier Ones, and it is not clear that some of them will be able to successfully cope with this new industry structure.
Unlike the linear and mechanistic supplier tiering model, relationships between the players in the automotive supply chain are going to be much messier and less straightforward in the future. Taking a page from the organizational design theorist Meg Wheatly, we refer to the evolving model as the organic supplier model (see chart, “The Future: Organic Tiering”). This more complicated new world has significant implications in the short term.
Suppliers that fully embraced the Systems Integrator model will have a difficult time in the next 6 to 24 months. This is not a marketplace for the broadly focused generalist. Having a capability to manage large programs but having no specific technology or product competence leaves large Tier Ones very vulnerable to their more tightly focused (and frequently smaller) competitors. These Tier Ones are going to have to try to successfully capture new programs in the short term (where they will probably have to accept reduced margins), while simultaneously trying to figure out what businesses they have or can develop true world class competence.
It’s a great time to be a highly competent Tier Two or Three because the market is finally coming back to their business design. Most of them are experiencing record business opportunities. They are leaner than their Tier One customers and they frequently have deeper expertise in a specific component(s) area. The challenge for these suppliers is to take advantage of current market conditions (hopefully without burning bridges with their Tier One customers), while avoiding getting seduced into adding support resources that the OEMs want but are frequently unwilling to support.
Large Tier Ones can be successful but they have to be just as focused as the Tier Twos and Threes. Having a large-scale position (i.e., $5 billion+) is fine, so long as the sales are the result of being the leader in a particular component or process (or series of components or submodules). We refer to this as the “multiple niche” business design. What no longer works is assuming that scale-absent world-class technical competence leads to success.
As our organic model suggests, we are entering a period of high complexity and a fair amount of uncertainty in this industry. There will be multiple supplier success models, depending upon the product area, required competencies and a number of other competitive factors. The good news is that those suppliers that are creative and can manage in this complex world will have the best opportunity in years to have positive top and bottom line results.