Better Off Abroad

A few years ago, predicting Delphi Corp. and Visteon Corp. would face severe difficulties did not require an economics degree.

Most of their sales were to General Motors Corp. and Ford Motor Co., respectively, and both were suffering the effects of deep cuts in vehicle production.

But declaring in 2004 that Dana Corp., a fundamentally strong company, would be bankrupt within 18 months would have required the kind of crystal ball any automotive forecaster would sacrifice a pound of flesh to own.

What everybody missed back then was Dana's heavy reliance on its North American home market, which was experiencing its own turmoil. In 2004, North America generated two-thirds of Dana's $9 billion in sales. Dana sold a mere 7% of its goods to the bustling Asia/Pacific market.

Dana's travails and the troubles of dozens of other suppliers illustrate the economic realities of an industry that has embraced globalization for more than a decade and in doing so obliterated the notion of “home-court advantage” for parts producers.

In the mature markets of the U.S., Western Europe and Japan, suppliers that once showed little interest in setting up far-flung operations have discovered the hard way they actually are better off investing in new facilities overseas that will add incrementally to the bottom line than to focus heavily on the home nest.

In those mature markets, everything is more expensive: labor, land, facilities, tooling and especially engineering, which tends to be centered at home for suppliers and bolstered by regional tech centers elsewhere.

“I don't think there is such a thing as home-court advantage anymore,” Visteon Chairman and CEO Michael Johnston tells Ward's. “If you think that way, you've missed the ship.”

In Dana's home town of Toledo, OH, people wonder how the 102-year-old company landed in bankruptcy. Granted, Dana had lost money in 2001 and 2002, but it was striving for profitability.

The company had shuttered several outdated plants and divested marginal operations. Dana was attractive enough to elicit an offer of $15 per share (later upped to $18) from ArvinMeritor Inc. in 2003 — and was strong enough to stave off the attempted hostile takeover.

Most important, Dana had a diverse customer mix and — unlike Delphi and Visteon — no disproportionate reliance on one customer. Dana's biggest customer is Ford, comprising 25% of sales. It also supplies frames for the Toyota Tundra and Tacoma pickups and axles for the Nissan Titan.

Ultimately, Dana fell victim to its geographic mix and a brutal environment.

Rapid globalization has intensified competition for all domestic suppliers in the mature markets. The problem is most severe in the U.S., where the Big Three auto makers have rolled out the red carpet for parts producers from all over the world.

Established local players with Big Three supply agreements, and saddled with high legacy costs and excess capacity, live every day with the threat of losing that business to foreign-based newcomers.

They arrive with few legacy costs, local tax breaks and the inherent benefits of shiny new machines freshly configured for maximum efficiency. For them, the annual expectation from auto makers to cut component prices by 5% or more is less burdensome than for the entrenched players.

Long is the list of major U.S. suppliers enduring bankruptcy or restructuring because of their frustrating inability to achieve profitability at home: Delphi, Visteon, Dana, Lear Corp., Collins & Aikman Corp., Tower Automotive Inc. and Meridian Automotive Systems are but a handful.

The theory is valid outside the U.S. as well.

Consider Germany, where Robert Bosch GmbH, Siemens AG, Continental AG and Kolbenschmidt Pierburg AG are among suppliers whose new facilities are in Eastern Europe because of attractive low-cost labor and land. Some have downsized or restructured home-market facilities, despite political pressure to protect jobs.

“It's not a question of what you want to do. It's a question of market competitiveness,” says Kolbenschmidt Pierburg Chairman Gerd Kleinert. “In many cases, there is absolutely no chance — even for innovative high-tech products — to manufacture those products in high-cost labor markets.”

The Düsseldorf-based powertrain component supplier downsized four of its nine German factories and one plant each in France and Italy between 2002 and 2004.

Those plants now have 500 fewer workers in total and are financially stronger. The company is healthier overall due to more production facilities around the world. In the U.S., it now is expanding and adding jobs. But Kleinert admits profitability in the German home market is a constant battle.

“It was hard in the past and it's still hard, and I think it probably will become harder in the future,” he says.

In the U.K., domestic suppliers tread water as vehicle production has remained largely stagnant for a decade. The problem will worsen next year when PSA Peugeot Citroen closes the doors of its Peugeot 206 plant in Ryton, shedding 2,300 workers. The closure will coincide with the opening of a PSA plant in Trnava, Slovakia, next year.

Some U.K. suppliers are landing in bankruptcy because of a new accounting standard that requires companies to clearly state on their balance sheets any shortfall in their pension funds, says Paul Melville, a partner with U.K. restructuring specialist Grant Thornton LLP.

If a shortfall exists, the company must submit to the government-appointed pension regulator a viable plan to make up the difference. Because they were unable to do so, several U.K. suppliers have filed for bankruptcy in the past year. High raw-material costs and little upward movement in vehicle pricing or volumes did not help.

“The margins of the Tier 1 suppliers are just being eroded,” Melville says.

In France, where PSA and Renault SA have scaled back vehicle production, top suppliers Valeo SA and Faurecia SA have been forced to downsize, while investing in new facilities elsewhere.

Valeo reported first-quarter growth was strong in Germany, Central Europe and Asia, offsetting languishing sales in France. Likewise, Faurecia reported its sales are up 31% in North America and 37% in Asia.

While U.S. suppliers are closing or selling plants at home because they are uncompetitive, Faurecia announced in January it would open six new manufacturing sites in the U.S., creating 2,000 jobs.

Five will be in the high-wage states of Michigan and Ohio, and many of the new employees will be represented by the United Auto Workers union.

Conversely, stumbling U.S. suppliers, including several in bankruptcy, claim to be profitable (or at least stable) in Europe.

The theory that domestic suppliers strain to make money in mature markets holds true even in Japan, where OEMs are under pressure to source parts from Thailand, Singapore, China and Taiwan for a fraction of the cost of domestic production.

Suppliers to Nissan Motor Co. Ltd., Mitsubishi Motors Corp. and Mazda Motor Corp. have suffered due to declining production and sales in Japan and the loss of export profitability in the 1990s. Nissan and Mazda, however, are on the rebound.

Nissan accelerated a shakeup of its Japanese supply base six years ago, when CEO Carlos Ghosn launched a massive restructuring that closed vehicle assembly plants and slashed domestic production but ultimately saved the auto maker.

Nissan set out to dismantle part of its keiretsu — or family — of home-market suppliers and divested its share or organized consolidations in many of them.

Many Nissan suppliers were affected along the way: namely, Unisia JECS Corp., Ikeda Bussan Co. Ltd., Calsonic Corp., Kansei Corp., Ichikoh Industries Ltd., Tochigi Fuji Sangyo K.K. and JATCO Ltd. Some merged (Calsonic and Kansei), while others were bought (Ikeda Bussan by Johnson Controls Inc. and Tochigi Fuji by GKN plc).

Nissan's crisis forced the Japanese auto industry to abandon its historically insular philosophy by allowing foreign companies to acquire or partner with struggling Japanese parts makers desperate for help.

“And a number of international suppliers came into Japan and did that,” says Neil DeKoker, managing director of the Original Equipment Suppliers Assn.

In exchange, these new suppliers agreed to component price reductions of up to 20%, largely because Ghosn had studied the market and discovered Nissan was paying too much for parts, DeKoker says.

Among U.S. suppliers today trying to advance in Japan is Visteon, the former Ford-owned parts maker created in 1997 and spun off in 2000. At the time, 84% of $19.4 billion in annual sales were to Ford, and most of that was for the home market.

The geographic and customer mix proved disastrous. In five years, Visteon never posted an annual profit. Last year, Visteon gave back to Ford 23 unprofitable facilities — including 13 U.S. factories and four plants in Mexico.

No longer a slave to its home market, Visteon has set its sights abroad. It is a leaner organization, with annual sales now of about $11 billion.

By 2008, Visteon says 38% of its sales will be in Asia, 32% in Europe and South America and 30% in North America. A mere 14% of global revenues will come from Ford in North America.

When Visteon was created in 2000, could Johnston (then president and chief operating officer) have predicted the U.S. market soon would become a minor player compared with the rest of the world?

“I think you could foresee that the Asian market was going to grow, and, in fact, we had made investments in that part of the world,” he says. “I think what probably was not contemplated was the decline in (Ford) market share in North America.”

Visteon is not abandoning its home market. “I believe our business in North America will strengthen,” he says. “We've continued to win business from transplants that are building facilities and growing in the U.S. We're also continuing to win business at Chrysler (Group) and GM.”

Already, Visteon's bottom line is improving. It lost $270 million in 2005, down from 2004's $1.5 billion in red ink.

Restructuring continues at Visteon, which has 49,600 employees worldwide. At the time of the spin-off in 2000, the company had 82,000.

Jobs are at risk as established U.S. suppliers set out to hone their product focus.

Lear, for instance, plans to consolidate or close some 25 plants — about half in North America and half in Europe (see story, p.16).

“Historically, our North American operations have performed better than our international operations,” says Douglas DelGrosso, Lear's president and chief operating officer. “That has changed.”

The $17 billion supplier reported a net loss of $1.4 billion in 2005, compared with a $422 million net profit in 2004. “We expect North America will get back to the level of performance we had in 2004,” likely by 2008, DelGrosso says.

Asia is a different story for Lear. “It is one of our strongest financially performing regions,” he says.

Meanwhile, Asian suppliers have cultivated opportunities in North America. Some, including Denso Corp. and Aisin Group, arrived in the U.S. by virtue of their close connection to Toyota Motor Corp.

Although Japanese suppliers are highly efficient, even they face difficulty profiting in the competitive U.S. market.

Aisin Group has 26 manufacturing, engineering and sales locations in North America, and 20 of them were expanded (or built from the ground up) in the past two years.

With such heavy investment in facilities, it takes time to pay for new construction, says Don Whitsitt, executive vice president of Aisin World Corp. of America.

“My understanding is we actually are less profitable here in the U.S. than we are in Japan,” Whitsitt says. “Sales are good here, but we are struggling for profitability.”

Whitsitt cannot say when the company expects to make money in North America. “We have a plan, but everyone is struggling with the plan,” he says.

Aisin Seiki Co. Ltd., the largest member of the Aisin Group, with •1.8 trillion ($17 billion) in sales, counters the idea that suppliers frequently cannot maintain profitability in their home markets.

Aisin Seiki reports 2005 operating income of ¥95 billion ($886 million), and 88% of that was derived from Japan.

Aisin Seiki remains closely aligned with Toyota, which owns 23.2% of the parts maker.

Whitsitt describes the Toyota Group of suppliers as “strong” and “conservatively run.” But being part of a keiretsu in Japan no longer guarantees stability with Japanese auto makers in the U.S. or blocks the door against global competitors, he says.

“I don't think the so-called keiretsu entitlement exists anywhere the same as it used to,” he says. “All the auto makers, Toyota included, source from many suppliers.”

In the U.S., one of the few suppliers disproving the notion of poor home-market profitability is American Axle & Mfg. Inc.

Its home is a gritty neighborhood in Detroit, and it was founded in 1994 by an investment team that purchased from GM five outdated axle, forging and driveshaft plants in Michigan and New York.

Like other suppliers, AAM does not report its earnings by region, but the company has strung together 12 consecutive years of profits since its birth.

Remarkably, about 90% of AAM's sales are to customers located in North America, and 78% of 2005 sales were to GM, a company that has lost nearly 10 points of market share in the U.S. since 1994.

At the time, 99% of axle and driveline sales were to GM, and CEO Richard Dauch saw an urgent need for new customers and markets. Expansion of manufacturing operations overseas has been steady since 1998.

So even though AAM's direct competitor, Dana, has a more diverse customer base, the latter ended up in bankruptcy while the former is doing well.

To be fair, American Axle has the advantage of being more nimble (about one-third the size of Dana), and new hourly workers at AAM plants in the U.S. start at much lower wages due to a 2-tier wage structure agreed to in 2004 by the UAW.

Plus, legacy costs are low because AAM has no health-care or pension liabilities that predate March 1, 1994, thanks to the separation deal Dauch negotiated with GM.

“There's no secret recipe here or magic formula,” says AAM Chief Financial Officer Michael Simonte when asked how the company has found steady profits at home.

“If you track our company's history, you'll see we've made larger investments than our competitors in product technology,” he says. AAM has poured $3 billion into new plants and equipment globally.

“Lesser successful peers are not investing as much as they should in quality operating systems and new manufacturing systems,” Simonte says in a thinly veiled reference to Dana. “They're not competitive on the shop floor, either with respect to delivery or manufacturing efficiency.”

AAM's global focus (aided by installation of new engineering centers in China, India, South Korea and Germany) helped it amass $750 million of non-GM business over the past seven years. Simonte says that number will reach $1 billion by 2010.

Although Delphi is attempting in its bankruptcy case to nullify thousands of GM parts-supply contracts it claims are unprofitable, American Axle embraces GM business as its bread and butter. GM has lost share in car sales over the past decade, but its share of the light-truck sector is down only slightly over the same period.

AAM has been GM's primary driveline supplier the entire time. AAM is the exclusive driveline producer for GM's new high-volume GMT900 fullsize trucks and SUVs.

For the outgoing GMT800 platform, AAM shared a small portion of the driveshaft and axle business with a competitor: Dana.

All five of AAM's original U.S. plants remain in operation, and each has been updated and expanded. The company has been profitable enough to build a grand new headquarters on Holbrook Avenue in the same inner-city neighborhood it has called home since the beginning.

But AAM is an anomaly in the U.S. and is thriving because it considers success overseas as vital as success at home, says Paul Haelterman, global director-market assessment at CSM Worldwide in Northville, MI.

Few suppliers can survive with a sole focus on its home market, he says. “There might be a nut or bolt guy out there, maybe some Tier 3 supplier or a limited Tier 2,” Haelterman says. “But any Tier 1 supplier or major Tier 2 has to have a global component, or it will not be in business five to 10 years from now.”

A CSM study identifies 6,000 viable auto suppliers worldwide. By 2015, consolidation will drive that number down to 1,000, Haelterman says. “The ones that will be consolidated are the ones sticking their heads in the sand, refusing to go global.”

Demonstrating this new dynamic is GM's re-assignment last November of its executive director of electronics purchasing, Akhil Puri, and 15 of his staffers from Detroit to Shanghai.

“If you want GM business in electronics, you probably should have your best sales guy in Shanghai,” Haelterman says. “Why have your purchasing organization in Detroit when most of the electronics buy is in that part of the world?”

Perhaps suppliers need to think differently about the notion of “home-court advantage,” says David Royce, director-corporate strategy North America for Siemens VDO Automotive.

“Home court needs to be redefined in terms of capability and technology,” Royce says. “A supplier can have home court only if it dominates in a particular segment, but those segments are not bound by geography any more.”

Auto makers creating global vehicle platforms and global purchasing networks have altered forever the industry landscape by nurturing those suppliers most willing to produce components wherever needed, unfettered by nationalistic pangs and legacy costs and unyielding to political pressure to keep a lid on unemployment at home.

Royce likens the scenario to a farmer planting a tree and deciding years later to move it. The more time that passes, the deeper the roots grow. “Newer trees can be moved more easily,” he says.

Likewise, the more flexible supplier is better equipped to follow the money. In the turbulent economics of the automotive supply chain, home today is wherever the heart of profitability is.
— with Roger Schreffler and William Diem