Variability, Risk and the Value Stream

March 1, 2018

Michael Robinet

Near-term profitability vs. long-term viability — suppliers must have both. And for many, bearing the cost of developing new technologies — for autonomous/connected driving, greater safety and reduced emissions — without driving higher cost into the vehicle and threatening affordability, has become a precarious balance.

OEMs constantly try to take a pragmatic view when adding cost into the value stream. Their considerations are extensive and not limited to:

How does this impact our manufacturing footprint – will we have abandoned capital and people?
Can we efficiently spread this technology to other vehicles and segments to improve economies of scale—and what are the global ramifications?
Does this technology have a warranty/reliability track record — am I adding too much risk into the value stream?
Are we increasing our exposure to fluctuating commodity prices with little ability to substitute and reduce risk?

The pace of technological change within the mobility industry drives several new considerations. Smarter companies are those who are good stewards of capital and resources. Chasing the latest trend that’s outside the norm needs careful consideration. If the shift is a ‘one and done’ (not repeated for the next program) the impact on the entire ecosystem is extensive.

Abandoned capital and processes, severed supplier relationships, training/skills efficiency, requirement for long-term service and a host of other issues arise. For example, shifting closures from mild steel to aluminum impacts stamping, design, safety, scrappage, overall system cost and downstream collision, as well as joining and painting requirements.

These are not knee-jerk decisions. Possibly the most significant consideration is orphaned technologies. When an OEM or supplier moves to a leading-edge technology which proves to be sub-optimal compared to other choices, economies of scale may not follow. One cannot underestimate the need for a majority of the industry to eventually move in the same technology direction (either product or process) to increase scale for all involved.

Outside the longer-term technology strategy, some companies are starting to face a near-term cost problem. Rising interest rates make capital more expensive. Shifting currencies, increasing wage inflation and hikes in critical commodity prices are external and beyond the industry’s control.

The IHS Markit Materials Price Index (MPI) has risen 13.4% for 2018 YTD versus the average over the second half of 2017. One may surmise that crude oil is at the root of this, though even the non-energy related index climbed 12% over the same period. Commodity prices bottomed in Q1 2016 — since then they have risen more than 80% to today. While several suppliers have their material costs ‘indexed’ to some industry benchmark as a hedge, be aware of lags and partial adjustments which must be absorbed.

While most market-driven price fluctuations have contractual adjustment mechanisms, a new dynamic has emerged: trade-related impacts. The emergence of possible U.S. steel and aluminum tariffs, as well as costs driven by NAFTA trade structures shifts, are difficult if not impossible to anticipate. Long-established supply chains cannot shift overnight in reaction to significant near-term cost shifts.

Looking ahead, the need to comply with global emissions regulations and the inclusion of more electronic content in vehicles will have cost ramifications. The current ‘basket of commodities’ required to build vehicles is slowing shifting from steel, rubber and various resins towards aluminum, magnesium, silicon, lithium and graphite. Higher-risk commodities are entering the supply chain.

The lack of clarity of how commodity and regulatory-driven costs will impact future profitability is further clouded by the impact of raising vehicles prices to cover these costs. Increased risk will lead to a further bifurcation of future success vs. failure.

Understanding the variability and risk being embedded into the value stream may be just as important as the introduction of any new technology.