Here They Come

A casual observer surely would have scoffed if he had heard a conversation that occurred on the floor of the recent Society of Automotive Engineers World Congress in Detroit.

After a speech about the importance of global sourcing, three observers marveled at the endless opportunities for purchasing low-cost auto parts from the emerging economic powerhouse of China.

One suggested, for instance, General Motors Corp. probably pays about $150 for a headliner produced in North America. He then says the same headliner could be produced in China and shipped to the U.S. by air for less money.

It sounds like the making of an urban legend, except that the speaker isn't being flippant, and he isn't dreaming up a bogus statistic to fan contempt for a strategy that is costing U.S. factory workers their jobs.

The speaker is a grinning Bo Andersson, whose job as vice president-worldwide purchasing for the suddenly beleaguered No.1 auto maker is to find the best price possible on high-quality parts, regardless of the manufacturing location.

Chances are, there were hundreds of similar conversations during the 4-day SAE Congress, where parts makers appeared outnumbered by economic-development organizations from South Korea, China, and elsewhere eager to woo companies, such as GM, with a tantalizing business case. GM says it isn't forcing its suppliers to locate in China, but Andersson makes it perfectly clear it's a good idea for suppliers to do so voluntarily.

Andersson's headliner comment comes after a speech at the SAE that leaves no question about GM's low-cost sourcing intentions. But airlifting auto parts on a routine basis?

“If we need to transport parts, maybe we fly more because that may be where the future is,” says Andersson, who also heads up supply-chain logistics for GM. “If you work at a supplier, your competition is global. One day you may compete, even in the U.S. marketplace, with a headliner made in China.”

Desperate times require desperate measures. The Big Three auto makers, struggling at home in the face of serious-as-a-heart attack foreign competition while shackled to overwhelming health-care liabilities, seem to have no choice but contemplate sourcing patterns that would have been unthinkable 10 years ago because of opposition from organized labor and much of the buying public.

Even Big Three brass may have been reluctant to send too much work overseas, content with the compromise of low-cost parts from Mexico.But today, all bets are off. Trend lines show unmistakable growth in imported parts for the U.S., while exports are stagnant overall and decreasing for certain components.

In the U.S., the auto industry (including aftermarket) consumed $186 billion worth of auto parts for light vehicles in 1997, and 22.8% was imported. By 2002, the industry and aftermarket consumed $207.5 billion worth of auto parts, and 30.6% was imported — a startling increase of nearly eight percentage points in only five years, according to data from the Census and International Trade Commission.

“You can go back to 1995 and find that imports consistently have grown faster than U.S. production,” says Thomas Klier, a senior economist who interprets the data for the Federal Reserve Bank of Chicago. He is writing a book about automotive suppliers.

“We're seeing 10% annual growth rates for (imports of) all automotive parts, and that's a solid trend,” Klier says. “It's growing and will keep growing.” Over the past decade, the only time imports have dipped was in late 2001, after terrorist attacks forced tighter security at border crossings, hampering shipments, he says.

For this story, Ward's selected five diverse component sets (wiring harnesses, engines, tires, brake linings and seats), and Klier gathered the import and export data for each between 1997 and 2004.The data reveals meteoric increases in sourcing from China for all but engines (see chart, p.36). Until 2004, no Chinese engines were being imported to the U.S. for light vehicles.

Even that has changed, as 2004 was the year production in Canada began on the Chevrolet Equinox cross/utility vehicle, which gets it 3.4L OHV V-6 from the Shanghai General Motors Automotive Co. Ltd. plant in China.

The growth is not restricted to Chinese imports. The U.S. is getting more wiring harnesses from the Philippines, Honduras and Thailand; more tires from Korea; more brake linings from Brazil; and more seats from Mexico. Eastern Europe and India also will figure prominently in future sourcing for the world's mature markets.

The data is enough to spark protectionist sentiments that have been relatively dormant since blue-collar workers stood in line at union halls and paid $1 each to grab a sledge hammer and take out their frustrations on Japanese cars in the early 1980s.

Shipping crates of door handles, brake pads and other commodities thousands of miles is one thing, but GM's importing of Chinese engines and its contemplation of airlifting headliners from there point to a hearty embrace of global sourcing.

Detroit once had the world's most envied manufacturing supply base. Where it fits in this new environment remains decidedly hazy.

“Everyone is looking for a complete hollowing out of manufacturing in the U.S., but we will always need manufacturing plants where the cars are purchased,” says David Andrea, vice president-business development for the Original Equipment Suppliers Assn. of Troy, MI.

He says domestic production, whether in the U.S. or any other region of the world, is the best hedge against massive fluctuations in currency exchange rates. “You need your manufacturing footprint to meet your market footprint,” Andrea says.

Experts rattle off a list of modules or components that are too large, heavy or complex to ship long distances to U.S. vehicle-assembly plants: seats, instrument panels (IPs), engines, transmissions, pickup truck frames, axles, brake corner modules and door trim panels.

Although IPs are highly complex and difficult to ship, a knowledgeable source says at least one Detroit auto maker has been seeking bids for full assemblies — also from China. The idea is ludicrous and not likely to go far, the source says.

As for the fasteners, switchgear, foam, electronics, stampings and fabric necessary to manufacture IPs, seats and other bulky modules, all can come from low-cost sources — and most assuredly will, according to suppliers, auto makers and analysts.

“We will always buy seats locally,” GM's Andersson says. “The trim cover today is coming from Mexico. Tomorrow, maybe it comes from China.”

Indeed, Lear Corp., Johnson Controls Inc. and Intier Automotive Inc. produce seats at dozens of plants in the U.S. The seat frames, adjusting mechanisms, motors and other internal parts can come from anywhere.

Recently, in the wake of a harsh first quarter that cost GM $1.1 billion and took its toll on its suppliers, Lear CEO Bob Rossiter said the company is evaluating its cost structure with an eye to outsourcing more manufacturing and engineering in low-cost countries. There is a sober sense of urgency as Lear's strategy is sure to result in U.S. plant closings.

Seats are difficult to ship long distances. They are bulky and tricky to package and — unlike most auto parts — are soft and their surfaces must be adequately protected.

Generally, they are shipped in-sequence “just-in-time” so the tan seats arrive at the OEM's assembly plant as a car with a tan interior rolls down the line. The suppliers have only a few hours to deliver the completed seats after the auto makers transmit their orders, based on which models are being built. Proximity to the point of assembly is imperative.

None of that bodes well for outsourcing seats for U.S. light vehicles to low-cost Asia/Pacific. For now, Lear says its 20-plus seat plants in the U.S. are safe, but the company quickly will step up outsourcing of components for those seats from low-cost regions.

Despite the logistical challenges, the federal trade data reveals significant growth in seats imported from China, Germany, the U.K. and Mexico between 1997 and 2004. Apparently shipping seats long distances is not as onerous as it used to be.

Sourcing components from low-cost plants overseas does not always represent a threat to U.S. manufacturing.

Supplier Freudenberg-NOK General Partnership, for instance, is using a unique sourcing strategy that takes advantage of NOK's plants in Southeast Asia to augment — rather than supplant — production from the partnership's facilities in North America. NOK is Japanese, and Freudenberg is German; they operate jointly in North America and have 23 plants in the U.S.

A few years ago, the partnership's plants in North America had a healthy book of business but were at or near capacity, allowing little room for growth. Adding capacity in the U.S. made little sense.

Soon after Mohsen Sohi joined Freudenberg-NOK as CEO in 2003, he began exploring ways to capitalize on NOK's existing plants (making seals or noise-damping material) in low-cost regions.

“We do need access to capacity in China and Southeast Asia,” Sohi tells Ward's. “Once I got more familiar with our company and what we have, I went to China, Thailand, Indonesia, Singapore and Taiwan. I felt there was a great footprint there that we have access to.”

Quality, which was lacking in the past with certain goods from Asian plants, would not be a problem, Sohi says. “These are great factories,” says Sohi, who toured several plants in China, alone. “These are not in any way different from a factory in Tokyo, in Western Europe or the U.S.”

Today, Freudenberg-NOK is sourcing a growing number of components from the Asia/Pacific, but the shipments are not all one-way. A Freudenberg-NOK plant in California, for instance, is considered the world's best at producing a particular type of aerospace O-ring.

After a year with the strategy, Sohi says the business has been growing, meaning more work for the U.S. and foreign plants. He assures the U.S. facilities have a secure future but need to be more efficient.

Even though the company carries additional inventory as a buffer against shipping snafus, Sohi says the extra cost “does not change the balance of the equation.” For Freudenberg-NOK, Sohi figures the “landed cost” of importing parts, which includes all shipping, can be 20%-25% less expensive than sourcing from U.S. plants.

“Not every product we look at has that potential,” he admits. If that threshold is not met, then production remains locally. In some cases, the manufacturing is highly automated, eliminating the savings associated with low-wage manual labor.

“If the labor content of a product is only 3%, then it doesn't matter if you build it in China or Manhattan,” Sohi says.

But it does matter because logistical problems can be overwhelming, unavoidable and maddening, says George Perry, president and CEO of Yazaki North America Inc.

Yazaki, based in Japan, is a leading supplier of wiring harnesses, arguably the most labor-intensive assembly on a vehicle. The manufacturing process is extremely difficult to automate because every harness is different. Yazaki has 151,000 employees worldwide, and Perry says about 130,000 of them assemble wiring harnesses. Manual labor is the most cost-effective route.

For that reason, Yazaki has never produced wiring harnesses in the U.S., shipping most of them instead from Mexico. About a third of Yazaki's wiring harnesses for North America, however, comes from Asia/Pacific plants. The shipping of those products has been challenging.

“You've got to package and transport that product. It will go on a boat for three to four weeks. You have unloading time, sometimes it's late,” Perry says. “Then it spends a week on a truck.”

Negotiating shipping agreements with carriers can be tricky, too. “How do you know the parts will really get here?” Perry says. Shipping between July and October is often problematic because West Coast ports are clogged with freighters bringing goods for the start of school and the holiday shopping season. “Count on delays,” he says.

What if the OEM customer's production schedule changes while the product is on a ship from China? “You pay a freight premium,” he says. “You have to air-freight parts.”

When everything runs perfectly, Yazaki can source product from Southeast Asia more cost effectively than from Mexico. Perry declines to be specific for fear that OEMs will apply even more pressure to source from the Asia/Pacific.

To offset risks, Yazaki now uses “blended pricing.” Rather than charge one price for products from China and a higher rate for goods from Mexico, Yazaki calculates an average so customers will pay one price, regardless of build location. “That way, it's evenhanded with each customer,” Perry says.

Still, Yazaki is making its North American manufacturing operations fully aware of the pricing available in the Asia/Pacific.

“We challenged the plants in Mexico with the kind of pricing we could get,” Perry says. “And we've challenged them to achieve target levels of cost. They have the advantage of being closer to the customer.”

But an auto analyst confides: “Even Mexico is too expensive now for wiring harnesses.” Instead, that work is shifting rapidly to Honduras in Central America and Southeast Asia.

Even so, Yazaki does not envision itself outsourcing everything to low-cost regions. Just recently, it announced plans to transfer “technical expertise” for hybrid vehicles from its base in Japan to North America. Yazaki already supplies heavy-duty conduit to accommodate the high-voltage demands of current hybrid vehicles that come from Japan.

If the U.S. market for hybrids continues to grow — and eventually supports domestic production — Yazaki wants to be ready, Perry says. A new plant in North America is a possibility.

Amid the clamor over the loss of millions of manufacturing jobs, the U.S. remains an attractive place for many foreign corporations to do business.

In the South — itself a low-cost region compared with Detroit — hundreds of factories have sprouted from the soil for Asian and European suppliers that need to be close to new assembly plants for Nissan Motor Co. Ltd., Toyota Motor Corp., Honda Motor Co. Ltd., Hyundai Motor Co. Ltd., BMW AG and the Mercedes-Benz unit of DaimlerChrysler AG.

“Is the U.S. a good place to build cars and parts for cars? The Japanese and Europeans and Koreans certainly think it is,” says Walter McManus, director of the Office for the Study of Automotive Transportation, University of Michigan. “They're coming here.”

In the 1980s, Japanese auto makers may have been motivated by the fear of trade sanctions to build assembly plants in the U.S. Not so anymore, McManus says.

“Look at Toyota — they have lots of cash,” McManus says. “They could build (plants) anywhere they want. They don't have to build in the U.S., but they are.”

And more vehicle assembly plants are on the way — to the U.S.

A recent forecast from CSM Worldwide in Farmington Hills, MI, calls for three more Toyota plants and an additional plant each for Nissan and Hyundai/Kia Motors Corp. Honda also is expected to add a new plant and expand an existing facility.

“The development will continue to grow in the South,” says Paul Haelterman, CSM director. He says 80% of the North American growth is with the “New Domestics,” or transplants, while the remainder is brownfield renovations or greenfield plants around existing facilities, such as Ford Motor Co.'s new supplier park at its Chicago assembly plant.

Haelterman says Ford will replicate the Chicago model at its plants in Oakville, Ont., Canada, and in Atlanta, GA.

That's not to say the U.S. can compete head-on with low-cost regions. Within 10 years, Haelterman says he doubts C-segment small cars, such as the Dodge Neon, Ford Focus and Chevy Cobalt, will be built in the U.S. Already, the Chevy Aveo and Suzuki Reno are among the U.S. small cars that come from South Korea.

The impact on Big Three plants will not be pleasant. “This is an emotional issue because it affects a lot of people in a lot of ways,” says Steve D'Arcy, partner in charge of global automotive service for PricewaterhouseCoopers consulting.

“But the economics are straightforward,” D'Arcy says. “There are relatively significant portions of the automotive components market that are commodities. If you're in a commodity market, the only long-term strategy that works is to be the low-cost producer. The low-cost producer will always prevail.”

But D'Arcy has encouraging words for major Tier 1s in the U.S., Europe and Japan concerned about low-cost competition.

“For companies like Denso, Valeo, Delphi and Bosch, it will be a long time before companies in China and probably India and Russia will be able to do the things those companies can do,” he says. Suppliers in the developing markets lack distribution channels, customer relationships, engineering, brand management and sales.

“These are things Western companies are very good at,” D'Arcy says. “For that reason, I don't think it is realistic to expect manufacturing to migrate out of Western countries.”

Another factor that is changing the way parts are sourced is the fact that low-cost manufacturing plants need not be synonymous with “low quality.” ArvinMeritor Inc. has stepped up its sourcing from Asia/Pacific to take advantage of better prices and because the quality of products is high.

The Troy, MI, supplier even calls the strategy by a different name. The company buys from “leading-cost countries” because “low cost” sounds too negative.

“The reality is in some cases the quality is better than what you get from Europe and the U.S.,” says Aziz Aghili, vice president-procurement and Asia/Pacific Business Development for ArvinMeritor's Light Vehicle Systems (LVS) division, which spends about $2.8 billion per year, most of it in Europe and the U.S. That mix will change substantially within four years.

For one product line, a window regulator, ArvinMeritor has been sourcing 70% of the content from the U.S. and 10% each from Mexico, Europe and Asia. This year, 69% of that sourcing will come from the Asia/Pacific, with 3% from Europe and the remaining 28% from the U.S.

Aghili took over procurement at ArvinMeritor LVS one year ago and has set out to establish a truly global purchasing organization. Recent new hires include nine staffers in China to support global sourcing in the region. The company also has opened offices in India and South Korea, and one is being considered for Turkey.

The goal is to find capable suppliers in these regions — a daunting task, given the entire industry is doing the same thing. ArvinMeritor's requirement includes a defect rate of zero parts per million. These new suppliers also must be insured against potential warranty claims.

The Iranian-born Aghili has 15 years of experience in the Asia/Pacific region, which will help him in his new assignment. Two days after his interview with Ward's, he stepped on a plane for China. His new office is in Shanghai.

Imports Overwhelming Exports

As recently as 1997, imports and exports were relatively even for a handful of key automotive components in the U.S. In seven years, however, the value of imports has largely outpaced that of exports.