Suppliers Battle a New Set of ILLs

Slammed by ‘black swan’ events, the global auto supply base now faces a severe cost crunch.

November 1, 2021

Michael Robinet

Shipping containers stacked up at the Port of Los Angeles. (Barret Ward)

Much has been written about the challenges facing the automotive industry with its impending shift to an electrified future. In concert with the growth of automated-driving (ADAS) content, one might assume that supplier plates are full. Unfortunately, the industry is grappling with the critical near-term challenge of supply chain outages, labor shortages and the unprecedented economics for virtually every raw material input. This constant cost-and-supply firefight weighs heavily on the suppliers at every tier.

Rising costs are not new. Within the planning process, smart companies account for economics within three key variable-cost drivers: Inputs, Labor and Logistics (ILL). To this point, suppliers would look to the past for economics as well as integrating expected known structural changes into future contracts; this would offer a level of protection from cost increases. Recently, however, the economics facing suppliers are not normal, anticipated nor easily accommodated in this capital-intensive industry.

Michael Robinet

While many will point to the COVID pandemic as the sole driver of unprecedented economics and the variable costs within, the situation has indeed exasperated and revealed the soft underbelly of ongoing industry issues. Labor/skills availability and the fragility of both global logistics and raw material supply chains are all exposed. Adding to the mayhem are man-made issues such as U.S. Section 232 steel/aluminum tariffs artificially inflating costs, or the chip-supply issue spurring ecosystem inefficiencies.

What has impacted suppliers can best be characterized as successive “black swan” events – outside the normal course of business. Shortages of skilled and semi-skilled U.S. labor has driven unprecedented wage hikes ranging from 10-20% over the past two years. Such levels were never anticipated. Government COVID subsidies, competing options for auto labor, early retirements, and the exodus of some workers choosing other occupations are factors reducing the available pool. A core tenet of economics theory states that wages don’t ratchet backwards – only automation or structural shifts can reduce labor costs.

The new ‘stay-at-home’ economy has helped upset the precarious balance of container ships, containers, ports, warehousing and truck/rail capacity. Countless ships waiting to unload and supply chain inefficiencies are raising costs. While one would hope this is transitory, several shippers have signed longer-term contracts at accelerated price levels.

The industry has faced rising raw material costs in the past. This time, however, the situation is different. Steel, aluminum, magnesium, resin, oil, and other key commodities are impacted by the aforementioned labor and logistics issues – all driving prices higher. While the experience is especially acute in North America versus other regions, global input prices are all impacted. According to recent IHS Markit forecasts, prices are expected to settle at new, higher plateaus, at a level of economics not anticipated by suppliers.

Grouped together, these cost impacts are not transitory. Accelerating labor economics, shipping customers signing long-term contracts to guarantee capacity, and surging material input costs are placing significant pressure on suppliers. Unless a supplier is on a commodity resale program (their customer purchases key inputs on their behalf), or can adjust input costs according to an industry index, there are few levers for suppliers to gain price relief due to fixed contracts.

The result of this unprecedented cost squeeze will impact the ability for suppliers to reinvest in their business and develop new technologies. It will impair their capability to withstand future extraneous events. At this industry juncture, with the enormous investment pressures of electrification and ADAS/AV integration, a strong, resilient supply base – not one facing an unprecedented cost crunch – is critical.