How Suppliers Can Manage Risk

The outcome of the UAW strike not only will alter the longer-term nature of labor wages and benefits but also impact production volumes and operational dynamics, thereby affecting the financial stability and adaptability of suppliers. This uncertainty, and the continued progression of EV disruption, make it essential for OEMs and suppliers to proactively manage risk across key areas.

Volume Fluctuations

The automotive industry has historically experienced fluctuations in demand due to economic cycles, consumer preferences and global events. Suppliers have faced challenges in managing production capacities, workforce planning and inventory levels during periods of changes in demand.

The EV platform further impacts volume unpredictability especially as the transition to electric vehicles introduces new uncertainties in volume forecasting for automotive suppliers. EV adoption rates, government incentives and technological advancements will all further influence the demand for EVs, leading to unpredictable production volumes for suppliers.

Automakers may adjust production schedules, adopt just-in-time manufacturing or seek alternative suppliers to mitigate volume-related risks. Suppliers need to identify these deviations and be nimble enough to adapt their operations to be well-prepared for changes in OEM demand.

Margins and Financial Sustainability

Automotive suppliers operate in a highly competitive environment with tight profit margins. The nature of the industry has been leading to thinner margins.

Suppliers may bid aggressively to secure contracts, often underestimating the financial impact of the deal. This lack of financial sophistication can lead to unrealistic projections and financial challenges down the line. With the transition to the EV market and the need for expertise in bidding for contracts, suppliers must develop distinct expertise to bid effectively and appropriately for EV-related contracts. In addition, they must understand the unique requirements of EV components and that accurately pricing bids is essential to ensure financial sustainability.

Suppliers also need to strike a balance between remaining competitive and ensuring adequate profitability in EV-related projects. Overcommitting to low-margin contracts has the potential to jeopardize long-term financial stability.

Financial Metrics Warrant Close Attention

EBITDA below 6% indicates inadequate cash flow for future profitability. While standard EBITDA margins across the S&P 500 reach around 15%, the manufacturing sector, especially at the middle-market level, typically achieves around 10% for a healthy company.

Evaluating debt-to-EBITDA ratio provides insights into cash flow, with a ratio exceeding 3.5 to 1 indicating an unfavorable position to repay debt, raising concerns for investors and banks. Similarly, a debt-to-revenue ratio exceeding 1:2 implies inadequate revenue to support a high debt burden. Lastly, the current ratio, reflecting the ratio of current assets to current liabilities, should not drop below 2:1, indicating an inability to settle immediate liabilities and making suppliers and banks cautious about extending further credit. The presence of one or more of these indicators signifies business struggle, demanding immediate corrective action.

Labor and Potential Strikes

The auto industry has a very strong union and even if not directly affected by union negotiations and worker strikes, suppliers are still largely at the mercy of the unions and their impact on the OEMs.

Suppliers should be prepared to navigate the consequences of potential labor disruptions. They must put in place contingency plans to manage operations during potential strikes or labor negotiations and have the financial reserves and strategic partnerships that can provide stability in times of labor uncertainty.

Regulatory Uncertainty

Government policies, trade agreements and environmental regulations can significantly influence the automotive industry and there is presently significant uncertainty around each of these. Suppliers need to stay informed about changes that can affect their business operations and be proactive and deliberate in the actions they take to address them in a timely manner.

Suppliers should also keep in mind that tax credits and incentives for EV manufacturers can notably influence demand for EV components. As the market has already experienced, such regulation, grants and tax breaks can accelerate EV adoption, leading to shifts in OEM production volumes and supplier demands, but changes in political control and resulting policies have the potential to quickly alter that course.

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We urge suppliers to undertake a “health check,” leveraging the independent analysis of an experienced third-party consultant.  Such consultants closely review financials and operations and identify potential inefficiencies even if a company is performing well.

Undertaking this proactive step greatly helps businesses better balance leverage and margins in negotiations with OEMs; focus more clearly on financial metrics and performance during the bidding process; further diversify their offerings and expertise to align with the evolving market; and develop a robust strategy to navigate regulatory uncertainties.

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Steve Savoy (pictured, upper left) is a director at Hilco Performance Solutions, focusing on business performance improvement and supporting companies with their transformational efforts.

Ryan Gross (pictured, left) is a director at Getzler Henrich, specializing in turnaround and restructuring support services to distressed and underperforming companies and municipalities.