Car parts suppliers confront domino effect

Publication date: 05 May 2009

Can there ever have been a worse time to be a UK car parts supplier?

The move into Chapter 11 by Chrysler last week, questions about GM's future and Ford's continuing trading difficulties will have deepened concerns at GKN and Tomkins, the global parts suppliers listed in London, over the threat to trading volumes and profits this year.

Conditions in the UK and Europe are little better than the US, in spite of Fiat's ambition to merge its core car arm with Chrysler and GM Europe to create a publicly traded business.

Last week, LDV, the UK van maker, signalled a move into administration while UK domestic car sales fell 30 per cent in March - reflecting a continuing downturn in many other European territories.

So far, the sharp decline in car and van demand has resulted in prolonged plant shutdowns across the world as car companies have cut or delayed orders for parts used in the lean, just-in-time manufacturing systems now prevalent in the sector.

That in itself has put intense pressure on car part makers, many of which are used to making relatively modest margins during a long boom in car making that had seen many working at close to full capacity.

The deteriorating environment has already claimed at least two UK-based "tier 1" suppliers.

Last December, the highly indebted Wagon Automotive, a UK-listed company backed by Wilbur Ross, the US billionaire, was put into administration. Visteon, the parts maker spun out of Ford in 2000, has also put its main UK division into administration.

The domino effect of one parts supplier bringing down another was demonstrated by Wagon, a volume provider of panels and door parts. The failure of Wagon in the UK - though some of its European operations continue to trade or have been sold - prompted Sonas, one of its own UK suppliers, to follow it into administration.

Alastair Beveridge, partner at Zolfo Cooper, Wagon's administrators, says a 30 per cent drop in demand from key customers and a failure to secure further backing from either shareholders, lenders or customers made failure inevitable.

A key risk with which car companies have to grapple in dealing with distressed suppliers is the disruption their failure can cause. The funneling of more work through fewer tier 1 suppliers has exacerbated this issue.

"Manufacturers have created, very deliberately, operational interdependence," says Mr Beveridge. "Everyone who supplies has the option or ability to stop you making cars. If you are an OEM [original equipment manufacturer], how do you mitigate this? Often it's almost impossible to."

Carmakers and suppliers are reluctant to discuss how they might help each other. But early payment and shipment rescheduling are among tactics used to prevent supply chains breaking down. Where a supplier appears doomed, customers can work quickly with administrators to help resurrect companies and, in extreme cases, even buy these troubled suppliers out.

Ermal Faulkner, director of purchasing at Jaguar Land Rover, says the move away from monolithic, vertically integrated car making to today's complicated webs of supply and assembly means relationship management as well as constant and detailed due diligence is the key to handling convoluted chains of suppliers.

His company has had to make deep cuts in its headcount in the face of falling demand - a spectre also faced by many of his 700 manufacturing suppliers. Some of these suppliers are multinational concerns with strong balance sheets. Others are smaller and potentially more vulnerable.

"The key is trying to have discussion before the situation becomes catastrophic . . . If it's a successful company running through a rough patch, we will work with them."

However, if it is clear the company won't survive, "we need to have a different plan", he adds.

The lack of trade credit cover for many transactionswas one reason why the government decided in January to include suppliers in its £2.3bn "lifeline" to the car sector. Few UK observers see this as having had a significant effect yet.

The US Treasury, meanwhile, in March announced plans to offer $5bn (£3.3bn) of support to suppliers of GM, Ford and Chrysler.

Such support will be welcomed by UK companies such as GKN, the world's leading maker of constant velocity joints used in driveline systems, and Johnson Matthey, the largest producer of catalytic converters.

Johnson Matthey warned a month ago that the downturn in the world auto market was continuing to hit sales and profits, though it maintained underlying profits guidance following earlier warnings in November and January.

GKN, meanwhile, has continued to cut capacity to match predicted falls in demand, whatever the outcome of the government rescue plans for carmakers in the US and beyond.

Nigel Stein, chief executive of automotive at GKN, says: "When you have a short supply chain, you have to react quickly. Changes in order volumes can happen at very short notice - you have to react."

GKN has managed to take advantage of short-term working arrangements, some supported by European governments, to minimise permanent lay-offs and protect its skill base for an eventual upturn in demand.

The company has been affected by some suppliers failing or withdrawing from production in recent years, says Mr Stein, though there have been "relatively few" so far during the current automotive industry crisis.

And once the crisis is past, the drift towards lean supply chains will continue, he argues.

"We are going to see larger global suppliers, able to develop technologically superior products which they can supply to a number of competing customers . . . It's how the industry can spread costs and develop further economies of scale," he adds.

Car industry's customer and supplier relationships can be volatile

When critical parts makers move into administration, car companies can quickly find assembly lines grinding to a halt.

And administrators have sometimes been criticised for playing hard-ball with failed company's customers by refusing to supply remaining stocks of goods on previous terms - in effect holding these stocks to ransom.

Land Rover under Ford's ownership found itself in such a situation in 2001 after the failure of UPF-Thompson, which supplied the chassis for its Discovery model.

Receivers KPMG had demanded a payment of £62m to help UPF continue to trade. Alternatively, it suggested Land Rover buy it outright for £51.6m.

Land Rover described this as "unreasonable" and secured injunctions to force UPF-Thompson to continue to supply parts while a settlement was sought.

GKN eventually bought the company after Land Rover's owners Ford bought out UPF-Thompson's debts for an undisclosed sum, estimated to be £16m.

Philip Davidson, head of restructuring for Europe at KPMG, justifies such tactics as sometimes necessary to "rebalance" the relationship between customer and supplier.

"Some auto supply-chain companies have accepted year-on-year cost reductions demanded by OEMs or tier 1 suppliers," he says.

Source: The Financial Times