Grant Thornton LLP Predicts a Collapse of Automotive Supply Chain


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Supply Base Needs to be Reduced by 500 Tier One Suppliers

Government, Automakers, Suppliers and Lenders Need to Sit at Same Table

Firm Calls for Bankruptcy Code Revisions and Anti-Trust Provisions to Allow Collaboration

DETROIT, March 13, 2009: The economic impact of a General Motors or Chrysler bankruptcy is being debated across the country. But the most immediate and pervasive risk is a wholesale collapse of the automotive supply base, according to Grant Thornton LLP partner Laura Marcero.

Marcero, part of the firm's Corporate Advisory and Restructuring Services team based in Southfield, Mich., believes some 500 Tier-One suppliers may be at high risk due to the cascading effect of reduced volumes and uncertainty around government support in the near term. But damage can be mitigated if key suppliers form a coalition with automakers, banks and the government to drive an orderly consolidation of the supply base.

"Suppliers struggled to make money when industry volumes were almost double what they are today, and consolidation has been happening mostly among smaller companies at the lower tiers," Marcero said. "Now, we are near a tipping point where the scale and scope of supplier failures at all levels will increase dramatically.

"To right-size capacity levels and promote a viable industry, we believe 30 to 40 percent of all suppliers are at risk due to the necessary alignment of capacity with demand, which should stabilize in the 12 to 14 million-unit range by 2010-2011," she added. "But if the scenario plays out in an uncontrolled fashion, every automaker will almost certainly lose production and incur steep financial losses. Without a structured approach of consolidation to the benefit of the entire supply chain, the industry may lose critical partners with the technology, scale and geographic footprint that are linchpins in the viability equation.

"Suppliers need to proactively determine whether they are a consolidator or a consolidatee," she said. "For those that are best suited to operate as consolidators, they need to step forth and provide solutions."

  The Role of Suppliers
  --  Right-size operations, evaluate industry trends for its particular
      commodity and the competitive landscape, and develop a strategic plan.

  --  Win the active support of stakeholders, including the automakers, bank
      and government.

  The Role of Government

The government can greatly increase chances for a successful industry consolidation by taking immediate steps to spur confidence among lenders, stimulate consumer demand for vehicles and give some measure of regulatory relief.

  --  Guarantee Receivables: Provide a government guarantee of the OEM
      receivables and inventory with the assurance from the lenders that
      incremental funding will flow to the suppliers.

  --  Stimulate Demand: More aggressive action to move sales into the 12 to
      14 million-unit range as quickly as possible will help inject
      liquidity into the system.

  --  Consider Revisions to the Bankruptcy Code: The current bankruptcy laws
      may need to be reviewed so mega automotive cases can continue to pay
      pre-petition debts.  Without removing the "automatic stay" provision
      of the bankruptcy code, an automaker filing could cause a string of
      other failures.

  --  Coordinate with Anti-trust Officials:  The government should consider
      the application of certain provisions of anti-trust regulations and
      how automakers and interested parties can openly discuss how best to
      facilitate consolidation without fear of government or civil legal
      action.  This would help automakers identify and support the most
      viable companies.

  The Role of Banks

The supply base's liquidity crisis was set in motion by sharp production cuts, but it has been exacerbated by the lack of credit available from banks and other lenders. Other key actions for lenders to take include:

  --  Provide Affordable Financing:  The interest rate on loans to finance
      consolidation efforts should be set at lower rates.  These low-cost
      loans would be used to fund equipment purchases, acquisitions, and
      wind-down costs associated with moving one supplier's production into
      the consolidator (whether inside or out of a chapter proceeding).

  --  Amend Loan Terms: Banks could place a moratorium on principal payments
      and/or renegotiate amortization terms to provide a debt service
      reprieve until volumes stabilize.

  --  Lend Through the Downturn: Potentially provide over-formula or "air
      ball" loans (a loan whose value exceeds the value of the collateral)
      to allow consolidators to manage through the downturn.

  The Role of the OEMs
  Key initiatives OEMs should implement include:

  --  End the Game of Musical Chairs: Historically, when a key supplier has
      reached the brink of bankruptcy and production is threatened, an
      automaker will move its work to a new supplier if it can or step in
      with cash injections to keep the company afloat. But this practice has
      been overwhelmed by the sheer number of at-risk suppliers. OEMs and
      suppliers may need to have frank discussions about the financial
      health of the supply base, consolidation, and must coordinate a
      strategy down to the commodity level.

  --  Don't Overreach: Err on the conservative side when forecasting volumes
      for new or resourced programs so suppliers know what to realistically
      count on for production.

  --  Apply Positive Reinforcement: Support consolidators and help them move
      proactively and strategically to ensure combined companies have the
      right product, technology and geographic footprint to meet customer
      needs.

"Getting this work done with the clock ticking will be hard, but the task is not insurmountable," Marcero concluded. "The rewards for successful execution will be great. With all of the costs and capacity being wrung out of the system, the auto industry may become spectacularly profitable as demand climbs back toward trend levels."

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