Globally, the recent—and historic—raw material deflation has generated an incredible profit improvement opportunity. In North America alone since September 2014, the price of every major raw material used in automobiles has fallen significantly. And that deflation has accelerated in recent months for most materials. The $1-billion question that original equipment manufacturers (OEMs) and in turn their suppliers face is whether they're capturing their fair share of the potential savings. Most of the global executives we've spoken with admit it's a question they cannot answer adequately.
During the past five years, with the exception of a very short-lived commodity price spike and a rapid de-escalation, commodity prices in aggregate have been remarkably stable (figure 1). OEMs and suppliers have gotten used to that stability. And because the vast majority of vehicles produced in North America today were developed and launched during that plateau, their bills of material therefore reflect those high prices.
Figure 1: AlixPartners Per-Passenger-Vehicle Raw Material Index
Since September 2014, however, commodity prices have fallen at an unprecedented rate—for a nonrecessionary economy (figure 2)—and the deflation has accelerated in recent months: plastics saw double-digit declines in December and January after little movement previously; steel prices dropped 8% through year-end before plummeting by 22% in the first quarter; copper fell every month since August and then by double digits in January. In aggregate, commodity prices are down 23.3% since their August 2014 peak.
Figure 2: Aggregate Raw Material Cost per Vehicle
A number of factors are causing this historic deflation: the rapid appreciation of the dollar, the US oil and gas boom, the slowdown of the Chinese economy, and massive investments in new supply. And the deflation's effects can be felt not just in North America but in Asia and Europe as well.
So, what does this mean for your company, and what should you do about it? AlixPartners' analysis shows that the cost to produce the average North American vehicle has dropped by $460 due to commodity-price change. At Detroit 3 North American production volumes, this represents a $1-billion to $1.2-billion opportunity. That opportunity ripples through every tier of the supply base.
But even the best-positioned OEMs are likely to recover only 70% of the deflation through autorecovery mechanisms (e.g., indexed contracts), leaving approximately $300 million to $450 million subject to negotiated recovery—or no recovery at all. Furthermore, we've found that, for the following reasons, most companies will struggle to capture that deflation value.
Few companies can answer for where every dollar (or pound) of material is in their vehicles, modules, and components at the tier 1 through tier X levels, making recovery highly unlikely. Data on part weights, commodity volumes, take rates, vehicle configurations, and so on are spread across multiple systems and are hard to aggregate. Buying organizations are built around an annual cadence of sourcing and incremental negotiation targets and are not geared to react quickly to a price shock. There is a lack of resources.
To capture that deflation value, companies should put in place dedicated surge-capacity resources able to perform advanced data analytics that support expert, fact-based, and highly credible negotiations throughout all levels of the value chain. Those resources would be deployed within a program structure that ensures accuracy, consistency in approach and outcomes, urgency to achieve results, and an accelerated escalation path to bring negotiations to a successful conclusion with the least amount of friction with suppliers.
Contributed by Alix Partners members:
Andrew Bergbaum, Managing Director
Shiv Shivaraman, Managing Director
Mark Wakefield, Managing Director
Steve Dubuc, Director
