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The Challenge of Returning Volume

Suppliers we queried in 2010 had different senses of how much of their cost savings would be permanent as production returned to more normal levels. Asked where they felt particular pressure to add back resources/costs, suppliers were most likely to mention engineering, followed by program management.

In the latter half of 2008, the 37% drop in North American light vehicle production from the fourth quarter of 2008 to the first quarter of 2009 probably took away the breath of more than a few supplier executives, who had already been managing six months of decline in vehicle volumes. So there was little choice but to cut, cut, and cut some more while the market languished for another six months. The responses to the 2009 IRN supplier survey indicated just how diligent they were, with over one-fifth of respondents saying that they had reduced their cost structure by more than 30%, and another 38% of respondents achieving savings of 20-30% in costs.

As production began to recover, the name of the game was to add back only what was truly required to execute the business, and achieve maximum profitability. Suppliers we queried in 2010 had different senses of how much of their cost savings would be permanent as production returned to more normal levels. One-third of the survey respondents said that 1-15% of the cost improvement was permanent, while 23% felt that they could preserve somewhere between 25% and 50% of the savings to their business. Asked where they felt particular pressure to add back resources/costs, suppliers were most likely to mention engineering, followed by program management. This makes sense, given the wave of new programs and launch activity that flowed their way after postponements and cancellations during the cyclical market trough. Some of the pressure on suppliers in this area was a result of the measures their customers had taken to scale back their own technical staffing, and the expectation that the supply base would take up the slack. Suppliers could also see the coming need to hire sales, quality, product development, R&D—areas that had been cut very deeply.

Reports on 2010 financial results have shown some evidence of how well suppliers managed the return of production volume and its accompanying support requirements. There are many factors that drive financial performance, but some companies specifically called out the benefits of the work they had done on their cost structures during the downturn.

• Federal Mogul had a good year, with sales up 17% and a gross margin that was a 27% improvement over 2009. In its February 23rd press release announcing its strong Q4 2010 and full-year results, the company said that its higher gross margin “demonstrates the company’s ability to respond to higher demand by leveraging its lean infrastructure.” Its net income was up significantly, “with the impact of improved sales and higher conversion of incremental revenue into profit through efficient cost structure management.”

•    American Axle & Manufacturing’s gross margin of 17.6% for the full year 2010 was a new company record, as was its EBITDA margin of 14.9%.

•    TRW’s year-to-year improvement in operating income was said to be driven primarily by the contribution from the higher level of sales between the two periods and the positive net impact of the company’s restructuring and cost containment actions.

•    BorgWarner chairman and CEO Timothy Manganello was quoted in that company’s earnings release as saying, “For the full year, we posted record sales and earnings, and our operating income margin was the highest it has been in several years. These are remarkable accomplishments considering they were achieved with depressed volumes and immediately following one of the most difficult periods in our history.”

We also know companies that have struggled to manage the return of volume as the market recovered. Some companies found themselves severely disadvantaged because in reducing excess personnel, they turned out not to have enough of the “firefighters” and “fixers” who had made it possible to tolerate weak systems. In their case, the growth in sales has been very difficult to execute. Other companies are facing the problems inherent with lopsided demographics. They either lost valuable expertise as a result of retirement incentives or they used seniority to retain older workers who inevitably have higher health care needs and costs.

Preserving the gains of the past two years in improved cost structure will be even more important as industrial health strengthens, because of the likelihood that all suppliers will face increased raw material costs. Goodyear Tire & Rubber already started feeling that pain in its 2010 financial results, and according to its year-end press release, the company anticipates that raw material costs in Q1 2011 will be 25 to 30% higher compared to the prior-year quarter. Many other materials—iron ore, resins, aluminum—are experiencing or signaling increases, so it’s clear there will be significant pressure on margins from raw material costs

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