Market has to stumble before it can stand How many times do you hear an automotive supplier asking for trouble? Aren't things tough enough? The OEM purchasing chiefs still wield the cost-cutting ax like Paul Bunyan - except they're not fictional. The euro, of course, is a four-letter word for anyone with overseas operations. The business is challenging enough without some wise guy pretending to look forward to the downturn that the industry is convinced is on the way.

Bill Hunt isn't trying to sound cavalier. It's just that, from his perspective as ArvinMeritor Inc. president and vice chairman, all the hand-wringing serves no purpose until market conditions warrant. "For three years, we've been expecting a decline, and it just hasn't happened," Mr. Hunt says. "So it's maybe counterintuitive, but basically we're saying it has to get bad before it can get better."

The industry already has demonstrated its cyclicality, and it has proven that the cycles aren't what they used to be, partly because the economy has created unprecedented wealth and purchasing power. "These people aren't going to stop buying new cars," Mr. Hunt suggests.

So just how bad will this downturn be?

"We don't think it will be very bad. ArvinMeritor will have three markets - heavy vehicle, light-vehicle aftermarket and light-vehicle OE - that are either troubled or challenged going forward, bottoming out and heading all in the right direction at the same time," Mr. Hunt tells journalists in Las Vegas during the recent Specialty Equipment Market Assn. expo.

"It's kind of like the slot machine I played last night. You put $3 in the slot machine, and the returns are much better than if you put $1 in."

Mr. Hunt's fellow executive, Larry Yost, Chairman and CEO of ArvinMeritor, agrees. "It all sounds so bad - the light vehicle aftermarket, the commercial vehicle market, the OE business - all this gloom and doom. It's not going to be that bad if we get it behind us and start thinking positive."

A week later, in early November, positive thoughts were hard to come by among many ArvinMeritor employees, especially the 1,500 worldwide who will lose their jobs. The cuts amount to 4% of ArvinMeritor's 36,500-member workforce.

In reporting declining earnings for the quarter ended Sept. 30, the $7.7-billion supplier says it will cut its operating costs by $25 million because sales to commercial-vehicle customers dropped 19% and light-vehicle aftermarket sales slipped 16% in the quarter. Not long before, ArvinMeritor said it would cut 240 workers and eliminate another 100 vacant positions to cut costs. In all, the company will incur $90 million in restructuring charges.

Some of the cuts stem from softening markets and from the integration of two companies into one. Arvin Industries Inc. and Meritor Automotive merged on July 6, and the "integration activities" have revealed $50 million in "cost synergies" in 2001, increasing to $100 million in 2003.

ArvinMeritor may be doing the right things from a bean-counter's perspective, but Wall Street remains unimpressed - as it is with auto suppliers in general. The company's stock started trading in July at $16.50 and was down to $14 in mid-November, despite the company's purchase of 4.1 million shares of its own stock for $67.5 million. A recent study by the Automotive Consulting Group of Ann Arbor, MI, has supplier stocks undervalued as a group by some $55 billion.

That's a lot of words about one supplier, but it's an effective snapshot that reflects on the supply base at large. Look around and turmoil has gripped a number of other companies, much of it spawned by anxiety about a softening market. Several major suppliers, for instance, didn't meet analyst expectations in what turned out to be a bloody third quarter.

Richard Snell of Federal-Mogul Corp. and Johnnie Cordell Breed of Breed Technologies lost their chief executive jobs due to various missteps along the acquisition trail, partly because prospects for company shareholders weren't going to get any better in the foreseeable future.

At Federal-Mogul, the rumor mill was churning so fast that Interim Chief Executive Robert Miller Jr. had to give a speech to employees denying that the company would file for bankruptcy protection.

And several top suppliers will not exhibit at the Society of Automotive Engineers 2001 World Congress and Exhibition, usually a winter tradition in Detroit for the supplier community. It's unclear whether the suppliers would participate if there were no sign of a slowdown. Still, marketing budgets are shrinking.

Lear Corp.'s outlook for 2001 has its revenues dropping as much as 3% because of slowing U.S. car production and continuing weakness of the euro, whose value has plunged 28% since it was created in early 1999. Likewise, Lear's stock has lost more than half its value since spring 1999, when it peaked at $54 per share.

Lear executives offer a production forecast of 16.4 million light vehicles in North America in 2001, a decline of about 6% from this year's levels. Likewise, it foresees relatively flat production in Europe, at 16.4 million units.

The company says some plants may be closed or consolidated.

"2001 will be a transition year for the industry," says Vice Chairman James Vandenberghe. "It's the first significant decrease in North American production in more than a decade. Now we focus on assets and cash flow. Our backlog helps offset some losses. At 16.4 million, it will still be an attractive operating environment."

Lear's backlog of business is as large as it's ever been, at $3.5 billion. The company also next year will launch major interior contracts in North America for the BMW X5, Chevrolet Avalanche, General Motors Corp. large van, Ford Thunderbird and Jeep Cherokee. In Europe, it launches jobs for Ford Focus and Mondeo and the new Jaguar X-Type sedan.

A major source of consternation for many suppliers is the aftermarket, which has suffered because of improved quality and longer-lasting materials on newer vehicles.

Cars are lasting a lot longer. The median age of vehicles in the U.S. now is about 8.3 years, up from 4.9 years in 1970, 6 years in 1980 and 6.5 years in 1990, says David Peace, vice president of Visteon Corp.'s Global Aftermarket Operations.

The global market for replacement parts remains huge - about $150 billion. Still, the U.S. replacement market seems to be shrinking at a time when European and Asian suppliers are arriving and making it even more competitive, especially in remanufactured products such as rack-and-pinion gear sets, window motors, air-conditioning compressors and alternators.

Remanufactured products are one of the few bright spots in the aftermarket. They're good for the environment by conserving landfill space, and some remanufactured products have double-digit profit margins. Hence, Visteon has created a strategic business unit for such goods, some of them coming from Mexico.

"We have the advantage in that the products we rebuild now, we make in the first place," Mr. Peace says. "It's easy to assess how to get back up to original spec."

Despite a flat aftermarket in the U.S. in recent years, Mr. Peace says Visteon actually is growing in some product segments: radiators, condensers, air-conditioning parts. Plus, like others, Visteon is targeting an aftermarket niche that could prove highly lucrative: mobile multimedia and rear-seat entertainment. "These are exciting areas that didn't exist before," he says.

Meanwhile, exhaust suppliers such as ArvinMeritor and Tenneco Automotive Inc. don't have the luxury of tapping blossoming aftermarkets. On the contrary, stainless steel exhaust systems today are lasting a lot longer than conventional steel systems of a decade ago.

That's one reason Standard & Poor's in September gave Tenneco a negative credit rating due to a drop in earnings.

Weak aftermarket sales also are the reason for Dana Corp.'s layoff of 3,000 employees. Other factors are cutbacks in U.S. car and truck production and unfavorable foreign exchange rates.

"It's tough, and every supplier will tell you the same thing right now - we're being hammered like crazy," says Bill Carroll, president of Dana's Automotive Systems Group. "But at the end of the day, there is this value that we bring into play, and they do need us. We have to shift from supplier to partner."

For Dana, that means pushing the systems integration envelope even further, a strategy that expands on existing alliances and may require acquisitions in the future, he hints.

Mr. Carroll wants OEMs to hand off more advanced engineering, prototype and validation work to top Tier 1s such as Dana. "If we can do that, we can take those risks up front. But today we can't take those total risks because we don't have the control on our side," he says.

Dana's new systems partners include Motorola for electronics and GKN plc for all-wheel drive systems through the DriveTek 50-50 joint venture launched earlier this year. Mr. Carroll says the venture has won its first contract on a global passenger-car platform, likely for 2004.

In June, Dana announced it was buying a 30% stake in Getrag GmbH & Cie, the renowned German transmission producer that now is a 51% partner in Ford's European transmission operations. Dana also gets a 49% stake in Getrag Gears of North America, the company's U.S. operations. A key driver for Dana was potential opportunities in the transaxle market.

Dana also has invited Getrag to join DriveTek, the venture with GKN. Mr. Carroll doesn't see 2001 shaping up to be a "disaster by any stretch" of the imagination.

"Clearly we've had inefficiency issues. When you've got to run around the world and make sure your foundry is bringing products in, and you're paying premium freight - we've been doing it for a long time," he says. "There are clearly inefficiencies there. I would welcome some relief. What if the market falls? We did pretty well when we were at 15.8 (million units in North America)."

So the next time that cost-cutting budget meetings are wearing you down, just remember ArvinMeritor's Mr. Yost and his words about the power of positive thinking.

And if you click your heels, maybe you'll wake up in Kansas.