Five Reasons for Low Auto Supplier Profits Plus Four Growth Opportunities

Low Auto Supplier Profits plus Four Growth Opportunities
MiBiz • May 5, 2005
By Jim Gillette

It’s been 25 years since Michael Porter published his seminal work, Competitive Strategy, but I still find his framework for measuring industry profit potential as useful and robust as when I read it in 1980. Porter builds a strong case that long-term profitability of any industry is primarily dependent upon five conditions being favorable:

  • Low intensity of competitive rivalry among firms operating within the industry,
  • Buyers having little power to force price reductions,
  • Suppliers having the ability retain profit margins,
  • The threat of substitute products being fairly minimal, and
  • A weak threat of new entrants.

 

It’s pretty event that the auto supplier industry on average is approaching a zero profit state these days and a quick report card based on a Porter analysis shows why. Make sure you read beyond the gloomy stuff because there are still a number of business growth opportunities here in North America. I’ll list four.

AN AUTO SUPPLIER REPORT CARD

Competitive Rivalry – F – Do I really need to comment on this point? The competitive environment among automotive suppliers is brutal.

Buyer Power – F – Readers will recognize the term oligopoly as a market containing only a few sellers where avoiding a price war is all-important. There is a related market condition called an oligopsony, where only a limited number of buyers are available. Suppliers in an oligopsony, having only a few customers from which to select, find it difficult to “say no” to a customer. Making an adequate return on investment under this condition is limited, to say the least. Consolidation in the auto industry has exacerbated the situation.

Supplier Power – D – Only in rare instances do suppliers hold the upper hand in pricing negotiations. Competitive advantage that enables high profit margins is usually short-lived.

Threat of Substitutes – C – The threat of substitution facing auto suppliers mainly involves materials and technologies. Many components have shifted from one material or technology to another due to cost, weight considerations, safety requirements, or design considerations. Two examples are intake manifolds and gas tanks moving from metal to plastic. Leading producers must either rapidly acquire new competencies or exit the component segment altogether.

Threat of New Entrants – C – Normally new entrants are drawn to an industry when the existing producers exhibit high (or economic) profits. Given that the auto industry as a whole in the US on is average profitless, you could conclude that the threat is minimal.

The threat is still real, however. Most of the entry of new players in the past as well as the threat from the next several years comes from foreign regional players seeking to become “global.” In spite of the abysmal profit situation among most metal stamping companies in North America, for example, we are still experiencing an influx of companies seeking business here.

The overall grade-point average for auto suppliers calculates to 1.0 or a barely passing D.

Growth Opportunities

But there are bright spots. In a market where the total vehicle build is growing slowly (less than 1% per year), suppliers must find ways to add more content to each car and truck made in order to bolster their top line and maximize asset utilization.

It turns out that one of the things many business owners fear, government regulation, often acts as an enabler for growth. More stringent environmental protection laws and safety regulations actually stimulate the need for innovative products and processes that create opportunities for astute suppliers. The move to improve safety, for example, is driving side airbag sales (all types) to grow from $383 million in North America during 2002 to a $1,524 billion opportunity for 2011. This represents a 15.7% compound annual growth rate (CAGR)[1]. Similarly, stability control systems are forecasted by CSM component analysts to grow at a 17.6% CAGR for the same period.

Consumer desire for better engine performance and regulatory requirements for more stringent emissions controls is increasing the demand for Variable-Valve-Timing systems. The North American market is expected to grow from $376 million in 2002 to $948 million in 2001, or a 9.9% CAGR.

Finally, consumer demand for GPS navigation systems is expected to drive that market at a 14.7% CAGR through 2011.

No doubt, auto industry conditions in North America are rough. But tough and smart suppliers can find a way to eke out profitable growth in spite of the averages.



[1] Based on a year-by-year log-linear calculation of CSM component analysts’ forecast.