Promised Land Lacking Promise

Suppliers Looking to Do Business in China may want to rethink plans, as high oil prices, rising labor costs and the strengthening renminbi are impacting profits, a new study by AlixPartners LLP shows.

Depending on the component, it can be cheaper to source from Mexico than China, says Managing Director John Hoffecker, who oversaw the annual AlixPartners Global Automotive Review.

Tires, for example, saw export credits reduced 8% in China, Hoffecker tells Ward's at a backgrounder detailing the study's findings. Research and development costs grew 7.7% from 2007 to 2008, he adds.

“Because the export tax rebate was pulled away and the R&D (expenditures) moved up, there's now a 16% increase in costs for that same tire coming from China,” Hoffecker says.

Mexico may be a better bet for suppliers because the peso is tied more closely to the dollar and shipping distances are shorter, meaning rising oil prices will have less impact on transportation costs, the study concludes.

“Those factors have made Mexico relatively more attractive than it was a year ago,” Hoffecker says, adding AlixPartners predicts a slowdown in suppliers migrating to China and an increase in automotive parts business directed into Mexico.

However, China and other emerging markets still have a lot of life left in them, he says.

“Those countries are going to be in play for many years to come,” he says of Brazil, Russia, India and China. “The populations of China and India are so great, we're going to be talking about them a decade or two from now.”

Vehicle exports from China and India will increase, he says.

“Almost every country that's gotten into automotive has used it as an export vehicle,” Hoffecker notes. “They view automotive as a critical industry for their country, their (economic) health, but in addition to that (they) have export aspirations.”

Europe will see greater evidence of this than the U.S., he predicts, a result of a more favorable exchange rate between the renminbi and euro.

However, Chinese parts already are making an impact in the U.S.

In 2007, China passed Germany as the fourth-biggest exporter of automotive components to the U.S., trailing only Canada, Mexico and Japan, respectively, Hoffecker says.

India's auto makers and suppliers are growing at a slower rate, but they deliver a better return on capital than their counterparts in China, which he credits to India's lower number of manufacturers and better capacity utilization.

China's capacity utilization has dropped every year since 2003, with many auto plants operating at minimum scale, or below 60% of capacity, the study finds.

“Over the next 10 years, there will be a significant restructuring of the Chinese manufacturing side…we have way too many (OEMs in China) for the market now,” Hoffecker says.

Russia is following China and India's lead, he notes, with domestic auto sales having doubled from 2003 to 2007 and likely to continue their rise thanks to strong gross-domestic-product growth and declining inflation rates.

“It's a market that's not anywhere near the size of China,” Hoffecker points out. “But I look at the GDP growth and what's happening with inflation, (and) as long as oil stays where it is — they are a very commodity rich country — they should continue to do very, very well for many years. (That's) good for automotive production and good for automotive supplier sales.”

The study, based on a survey of 273 automotive suppliers, 45 auto makers and 22 heavy-duty truck manufacturers, also concludes rising raw-materials costs are having a bigger impact on North American auto makers and suppliers than ever before.

The spike in raw-materials prices equals $600-$900 in the manufacturing cost of every $20,000 vehicle, AlixPartners says.

“In '08, we're looking at on-average $10.5 billion (raw-materials risk),” Hoffecker says. Two-thirds of that amount is in steel, the cost of which has doubled in the last five months, partly due to a consolidation among suppliers and “bottlenecks at key locations” processing iron ore, coking coal and recycling scrap.

AlixPartners also finds European auto makers are losing up to $20,000 per vehicle manufactured in Europe and sold in the U.S. due to the weak dollar.

Private-equity firms, the study says, are facing “dramatically higher carrying costs, longer holding times and fewer exit opportunities” with their automotive investments.

Private-equity firms “must unsentimentally review products, customers, programs, footprint and strategy for revenue and cost opportunities,” Hoffecker says. “They need to challenge their business structure and operating model, and move quickly.”

Auto Makers, Suppliers Missing Full Potential of China, India
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