In the 1980s, the theory of “trickle down” economics suggested all levels of society benefit and ultimately thrive if the wealthiest in the food chain remain so, creating employment opportunities for everyone, including those at the bottom.

Today in the auto industry, the theory is working in reverse, as struggling North American auto makers inflict pain on Tier 1 suppliers in the form of reduced volumes, canceled vehicle programs and extreme pricing pressure.

The pain trickles down to Tier 2 and 3 parts makers and raw materials producers, although suppliers facing bankruptcy, closure or a complete overhaul of their businesses might argue the “trickle” is more of an avalanche.

“There is no question that pain is felt on all sides,” says Kimberly Davis Rodriguez, a partner with restructuring specialist Grant Thornton LLP in Southfield, MI.

“The entire supply base needs to downsize – it is something that has to happen,” says Rodriguez, who has been offering financial and operational guidance to distressed suppliers, as well as their stakeholders, for more than 20 years.

“It’s best to make decisions as quickly and as effectively as possible,” she says. “What is problematic is when decisions are not made quickly and effectively. Suppliers have to understand if they are in a commodity (role), that it is a spot that does not have a future with any one or all OEMs.”

As 2006 draws to a close, even suppliers that have been relatively profitable – namely BorgWarner Inc. and American Axle & Mfg. – are downsizing.

Veterans say they have never seen the North American auto industry in such turmoil, but that this cycle too shall pass.

“I’ve been in this industry long enough to know it will come back, so I don’t worry about that,” says Chip McClure, chairman, CEO and president of ArvinMeritor Inc., which began a round of cost-cutting last year. “Is it different? Yes. Will it make us stronger afterward? Yes.”

Rodriguez says many suppliers are suffering from “systemic distress” due to Detroit’s woes. “But a lot of people are dealing with it proactively through divestitures, sales, downsizing or even mergers and acquisitions,” she says.

She sees plenty of “carve-out opportunities” for suppliers to hone their product portfolios and manufacturing footprint. “We will see more of that as larger companies go into Chapter 11,” Rodriguez says. “That will allow others to diversify.”

Grant Thornton works for Ford Motor Co., monitoring the health of 1,600 suppliers to its North American operations. The contractor uses a Web-based system to track every supplier’s performance on material management, delivery, quality and cost.

“If the price of rubber goes up and it will cause you some distress as a supplier, we share it with Ford,” Rodriguez says. “It’s really to everyone’s benefit if both parties are well informed.”

Of the 1,600 suppliers, Rodriguez says her office tracks “a subset we consider at risk” of failing to meet Ford’s supply terms or of lapsing into financial distress.

“Anyone in bankruptcy is considered at risk,” Rodriguez says. “And a lot of companies don’t even reach Chapter 11. They just go out of business.”

On Ford’s behalf, her office has kept close watch on bankrupt suppliers Collins & Aikman Corp., Meridian Automotive Systems and Dana Corp. Rodriguez says Ford called her office in October to deal with Collins & Aikman’s refusal to ship products to its Hermosillo, Mexico, plant due to a component pricing dispute.

“It was a disappointment,” she says of the spat. “Most suppliers resolve commercial disputes in other ways. Shutting down plants hurts everyone. It is not an effective tool.”

In January, Rodriguez says Grant Thornton also will expand the supply chain management system for Ford’s suppliers globally, first in the U.K., then eventually throughout Europe, South America and Asia/Pacific.

Suppliers need to tighten their product portfolios and ditch the notion of full-service capability, says Thomas Stallkamp, industrial partner of Ripplewood Holdings LLC, a private equity fund with its eye on automotive suppliers.

“I think the mega-supplier trend is tapped out,” Stallkamp, former president of Chrysler Group, says at a recent automotive conference in Dearborn, MI.

“There are some companies like Magna (International Inc.) that can handle that and do OK,” he says. “But I think the big mega-supplier that does all kinds of things, which was the idea behind Delphi (Corp.), Visteon (Corp.) and some of the others has gone away, and there will be specialization at the Tier 1 level.”

Stallkamp is optimistic, however, for prospects of smaller, more specialized suppliers lower in the food chain, especially with regard to profitability.

“If you’re really good down in the trenches, you can charge for that,” Stallkamp says. “If you have a really good specialized knowledge – some of the sensor manufacturers are an example of that – stay down in the tiers and just price the hell out of it. It’s OK.”

Stallkamp, who was head of purchasing for Chrysler in the 1990s, demonstrates little trust for OEM purchasing departments today and says suppliers must stand their ground when OEM buyers become too demanding with regard to proprietary design information.

“Right now, if I was a supplier, I wouldn’t give any information to the Big Three because I don’t know what they’re going to do with it,” he says.

Despite troubles for suppliers, Stallkamp says some, even those in bankruptcy, can emerge as viable businesses going forward.

“Just because a company is in financial trouble doesn’t mean it’s in a tailspin and won’t come back up,” he tells journalists.

To prevail over Detroit’s difficulties, suppliers must aggressively step up sales in overseas markets, says Sean McAlinden, chief economist and vice president-research at the Center for Automotive Research in Ann Arbor, MI.

He says many suppliers have been attempting to reduce their Big Three sales below 50%, and the new threshold for many is below 40%. In addition, McAlinden urges suppliers to exit businesses unless the supplier owns at least 60% of a particular component’s share in North America. “If not, they need to get out of it,” he says.

McAlinden is blunt in his description of supplier dealings with Detroit. “It’s rotten business,” he says. “What are you going to do to get GM (General Motors Corp.) business? It’s the cobwebbed dark corner of the plant.”

He considers it “a good thing” that Delphi and Visteon are “finally getting out of the way” by downsizing their bloated operations.

Ford and GM are beginning to understand that “it is in their short-term strategic interest that these businesses are successfully transitioned,” McAlinden says of Delphi and Visteon.

Last year, ArvinMeritor announced restructuring plans that eliminated 500 salaried positions and includes closing 11 plants worldwide.

CEO McClure describes the current downturn, unlike those of the past, as the byproduct of rapid globalization of the industry, with auto makers from Japan, South Korea and, soon, China affecting the dynamic of the North American industry.

“I don’t view that entirely as the glass being half empty,” McClure tells Ward’s. “I see huge opportunities for those who can work their way through it. It is different from what I’ve seen in the past, but I don’t view it as all doom and gloom.”

He says the U.S. auto industry “will be a good market, just with different players in it.”

ArvinMeritor is adjusting as GM and Ford scale back their North American vehicle production. About 7% of ArvinMeritor’s global sales is with GM North America, and 3% is with Ford in North America.

“Clearly as they change their production schedules going forward in the future, we’ve got to modify ours also,” McClure says. “They are, have been and will continue to be important customers to us, but I can’t ignore the fact that their market share here in North America is obviously continuing to go down a bit. Hopefully it will bottom out at some point.”

ArvinMeritor has new business with Ford and GM in North America and other parts of the world, McClure says.

“If you look at Europe, both of them are doing OK,” he says. “Look at China, and frankly GM’s doing great.”

For the supplier’s fiscal year, which ended Sept. 30, ArvinMeritor reported sales of $9.2 billion and income of $1.78 per share, achieving the upper end of its guidance range.

McClure says ArvinMeritor has focused heavily on debt reduction as it seeks to strengthen its balance sheet. The supplier reduced its net debt load by $501 million in fiscal 2006.

“I think that’s critical because a strong balance sheet and not having to pay off a lot of debt during these choppy water times is very important,” he says.

Divestitures have helped the cause. In 2006, the company sold additional pieces of its Light Vehicle Aftermarket business, including Purolator filters, aftermarket exhaust, motion control and commercial-vehicle off-highway brakes.

But the divestitures were not tantamount to a fire sale, McClure insists. “Those were good businesses,” he says. “We did not just take the lowest price to dump it. They were good people, good products, good customers, and we actually got a good return on it. On a few, we indicated some gains on it.”

tmurphy@wardsauto.com