Inflation Ignites Another Supplier Squeeze

Michael Robinet
Executive Director, S&P Global SAE Foundation Trustee
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For more than 100 years, OEMs and suppliers have partnered to build components, engineer and integrate systems, offer services such as logistics, software, and marketing support, and even manufacture complete vehicles. Some of these relationships have lasted decades—transcending corporate buyouts and mergers, new leadership and shifting technology requirements. Others have been, well, short-lived. In the end, OEMs can’t build today’s vehicles without a vibrant and stable supply base. And suppliers have a finite number of OEM customers. It is an ongoing dance, refined over time.

During the past couple of decades, while U.S. inflation roughly averaged 2%, suppliers were integrating economics into the bulk of their production costs over the life of the program cycle when quoting business. A cycle is approximately five years for vehicles and a couple years longer for powertrains. Additionally, many suppliers have enjoyed the reduced risk of material resale programs (the OEM or Tier 1 buys the material) or they are able to adjust pricing on a quarterly cost index structure — popular with plastics-resin buys. Whatever the structure, suppliers still assume numerous risks over the program cycle — everything from unpredictable volume swings, logistics turmoil, labor issues and infrastructure costs.

Until recently, such risks were viewed as ‘controllable.’ But recent gyrations in manufacturing economics are testing even the strongest of these relationships.

As I write this in early May, U.S. inflation is the highest since 1981, and the industry is reeling. From January 2021 to March 2022, the S&P Global U.S. Materials Price Index rose 92%. Cold-rolled steel skyrocketed by 56% and WTI (West Texas Crude) petroleum jumped 108% over the same period. While some readers will note that commodities are inherently volatile, labor costs also have escalated. Wage rates rarely ratchet downward, especially in an economy with sub-4% unemployment.

Rising wages and fuel costs also lead to rising logistics costs. In recent columns, I’ve articulated how suppliers have been impacted by the inflation driven by ILL — Inputs, Labor and Logistics. Russia’s war with Ukraine and its subsequent impact on global supply chains for several key automotive inputs have only extended this problem.

Suppliers are caught in the middle. Raw-material suppliers follow the hills and valleys of market dynamics with variable pricing driven by supply and demand. OEMs can adjust real pricing through modifications in vehicle MSRPs, incentives and adjusting content. But they need to proceed carefully. Though inventory currently is low in historical terms, competition will again heat up as inventories start to rise — we can’t stay at 25 days’ supply forever.

With all or a portion of supply contracts being fixed over a cycle, component suppliers are sandwiched in an increasingly difficult situation.

After close to three years of erratic production volumes and inefficiencies driven by COVID, the chip supply crisis and a host of other factors – suppliers are seeking a stable environment. Secular shifts such as the impact of vehicle electrification ensure that more challenges are looming.

Many Tier 1s and larger Tier 2s have strong balance sheets and are diversified across several automotive sectors, or even have non-auto exposure. The chief concern is the ability of the smaller Tier 2s without deep pockets to weather sustained inflationary pressures.

In the end, the industry must ensure a viable supply base. The ability for suppliers to innovate and invest in new technologies, take advantage of new production structures and react to emerging opportunities is critical for all industry participants.