Introduction
Automotive suppliers will confront many of the same problems that plagued the sector in 2021, as well as a slew of new ones in 2022. Unfortunately, as with many other features of pre-pandemic life, the car industry's relative supply chain stability, which it has enjoyed for many years, is unlikely to be restored anytime soon. Suppliers must be adaptable and flexible in order to meet these new and ongoing difficulties.
Looking ahead, this article outlines several significant areas of focus for suppliers, including greater pricing flexibility and risk sharing, warehousing/inventory, and freight cost management. Suppliers should consider upgrading many of their conventional operational and contracting procedures, among other strategies, to increase flexibility in an increasingly unpredictable world. While the shifting landscape poses obstacles, it also offers chances for advancement. The suppliers who adapt the most will be in the best position to succeed in the future.
As We Approach 2022, Here's How Things Are Looking in the Automotive Supply Chain
2021 was a year marked by shortages, rising pricing, and other severe supply chain issues for several automobile suppliers. Because supply couldn't keep up with rising demand, the 2020 lockdowns swiftly gave birth to shortages of various raw materials and components. While the global shortage of semiconductors has received the greatest attention, many suppliers have also had trouble acquiring other materials like steel, resin, and foam. These shortages swiftly resulted in fast-growing prices for many suppliers, with significant price increases that were not anticipated in suppliers' bids, and in many cases were not expressly covered by their supply contracts.
Automotive suppliers faced substantial operational and logistical challenges in addition to trouble sourcing materials. Suppliers have had and continue to have trouble finding enough workers to keep their operations functioning at full capacity. Suppliers also had to deal with a slew of logistical issues, including port delays, the Suez Canal blockade, a paucity of containers, a shortage of truck drivers, and dramatically higher shipping rates. The price of transporting containers from Asia to the United States has risen by more than 500 percent in only a year.
earlier.1 Labor prices were also rising, which put pressure on suppliers. The automotive supply chain has exchanged a new round of force majeure declarations and commercial impracticability alerts as a result of these severe issues. Unlike in 2020, when the entire automobile sector shut down at the same time, such pronouncements were sometimes the source of heated debate as parties fought over who was responsible for what costs and how to keep operations running.
To make matters worse, several suppliers' efforts to govern their supply chains were confounded by their OEM clients' behavior. When faced with shortages, many OEMs responded by ramping up their releases to unrealistic levels far beyond the original EDI projections, leaving suppliers to guess what the "real" quantities would be. OEMs have also responded to the shortage of semiconductors (and other inputs) by implementing unpredictably rolling production shutdowns. Furthermore, the full impact of COVID-19's Omicron version (and possibly other variants) remains unknown. While there appears to be no enthusiasm in the United States for a return to a lockdown, lockdowns are still a possibility in many other countries. China, in particular, has adhered to a "zero-COVID" policy and has lately reinstated lockdowns in a number of cities. The risk of a more widespread outbreak in China, or other major manufacturing areas, is that the car sector will be severely disrupted.
Approaches to Addressing the Global Supply Chain's Changing Circumstances
Many automotive suppliers have been in some type of crisis management mode for the past two years as they awaited the return to "normal." However, it is becoming increasingly clear (to the extent that it wasn't already clear) that there will be no return to pre-pandemic conditions anytime soon. COVID-19 will be with us for the foreseeable future, in some form or another. The decade-long period of low inflation in parts of the world appears to be coming to an end. Companies are likely to confront a time of increased instability and volatility in the global supply chain as a result of these and other factors. So, how can businesses get out of crisis mode and adapt their business practices in order to survive, if not thrive, in the new environment? From contracting to operations, this article outlines three key strategies that suppliers should consider.
Pay special attention to pricing provisions and conditions that trigger pricing relief. Long-term contracts at a fixed price have been the standard in the automotive sector for many years (or, in some cases, requiring that the supplier provide annual price reductions). In many situations, these contracts bound the provider to an indefinite "life of the part"/"life of the program," leaving the supplier vulnerable to the whims of its OEM customer for years and a long service period. With the exception of contracts for certain raw material-intensive components, provisions permitting a supplier to request a price rise were rare. After experiencing multiple cycles of spikes and drops in raw material pricing, suppliers and OEMs realized that long-term fixed-price contracts for such components were typically unsustainable, and they used various forms of indexing or other flexible pricing for such components. Suppliers (and OEMs) are rethinking the traditional framework for component contracts in the present climate, which includes inflation and severe price volatility. Long-term contracts with a set, or even declining, price may become obsolete. Suppliers should focus (and wise OEMs will cooperate) on implementing greater pricing flexibility into their contracts to account for changing costs, whether through some form of defined indexing, a periodic opportunity to renegotiate and market test, or other creative approaches, as has been the case in the past with raw material-intensive components.
Inventory banks and warehousing. For decades, the automobile industry's traditional inventory management approach has been lean, just-in-time (JIT), with suppliers and OEMs alike maintaining low quantities of inventory. As long as everything runs smoothly and on time, this is a very efficient model. However, as the pandemic and supply chain concerns have demonstrated over the last two years, there is little left to soften a blow once all of the "fat" has been removed from the system. Both suppliers and OEMs must evaluate the advantages of reduced inventory against the hazards of a supply chain that is significantly less stable and predictable than it was two years ago. Many organizations have suffered considerable costs for expedited freight, overtime, shutdowns, and other charges that have far outstripped any savings and efficiency obtained from attempting to keep inventory low. As a result, both OEMs and suppliers are searching for ways to reduce risk. Many companies are rethinking their inventory models and moving to implement warehousing and larger inventory banks as a shield against shortages and disruptions, in addition to looking at reshoring and shortening supply chains (which are primarily long-term strategies with little capacity while this approach can be beneficial, it does come with its own set of consequences. When implementing such a strategy (either on their own initiative or at the request of their customers), suppliers must think hard to guarantee that costs are correctly distributed and accounted for.
Freight risk is shifting. Freight costs have become increasingly important to many suppliers during the last two years, owing to increased demand for expedited freight and quickly rising costs (and delays) for standard delivery. Most shipping costs, including expedited freight (including in circumstances of force majeure and commercial impracticability) and expenditures to send components from lower-tier suppliers, were traditionally considered the responsibility of the OEMs' suppliers. Many suppliers, on the other hand, are questioning the structure and pushing back. Several vendors, particularly those requiring components from Asia, have suffered from rising shipping costs. Suppliers should explore ways to share some of the burdens and risks of these expenses with their consumers, as outlined above in relation to pricing and costs in general. Many suppliers have also struggled with the necessity for regular (and, at times, near-constant) expedited freight to compensate for supply chain delays. Costs for expedited freight can quickly become excessive, threatening to exceed a supplier's profit margins on a programme for an entire year or perhaps longer, as most suppliers are aware. In recent years, suppliers and OEMs have seen accelerated freight expenses as a zero-sum game, with OEMs demanding that their suppliers cover all expedited freight costs, and suppliers frequently baulking and refusing to do so (even if contractually bound to do so). Given that the supply chain's problems aren't going away anytime soon, organisations should investigate new models in which suppliers and OEMs share some of the responsibility for expedited freight caused by factors beyond their control.
Distressed Supplier Strategies and Growth Opportunities
While many suppliers will undoubtedly forge through, others may encounter customer demands for assistance in the form of price rises, receivables acceleration, and even departure agreements and demands to locate a new source of supply. This may result in extra costs for many providers, but it may also result in acquisition opportunities for other suppliers eager to expand their business.
Support for suppliers who are having financial or operational difficulties. Suppliers frequently strive to pass on additional prices to their customers, while the end-customer OEM frequently refuses to bear these expenses. The following terms help to protect both sides so that parts can continue to flow through the supply chain when a customer provides financial or other support to a sub-tier supplier:
1 The supplier's promise to keep manufacturing parts for the client; if relevant, the lender's promise to keep lending to the supplier so that it can keep operating and producing parts for the customer;
2 The customer's promise to keep paying, to limit its right of setoff, and/or to set new payment terms;
3 Establish benchmarks for evaluating the supplier's performance;
4 Ownership of tools should be identified and acknowledged.
5 Provide for the customer's right of access to the supplier's facilities, if relevant.
6 Include clauses that will help the agreement "preference-proof" in the event of a bankruptcy filing.
Opportunities for acquisition. Investors (including some automotive suppliers) are focusing on opportunities to acquire promising businesses that may face near-term financial and operational challenges at lower valuations than were available prior to the pandemic, as some automotive suppliers face financial or operational headwinds. While these offers may appear to be scarce, astute investors would benefit from contemplating out-of-court acquisitions of distressed businesses.
CONCLUSION
The global supply chain has evolved, and providers must adjust to the new environment. The issues that providers faced in 2021 are likely to persist in 2022. If the year 2021 taught the industry anything, it was to expect the unexpected and use the "lessons learned" to handle future obstacles. Suppliers will have to rethink a lot of their contracting and operations in order to meet these difficulties, including how they manage the risks associated with price, warehousing/inventory, and freight costs. Contracts must be more flexible as the supply chain becomes more volatile, allowing for a bend-but-don't-break approach to resolving difficulties as they arise.
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