Supply chain problems? This phrase is likely to remind many people of the coronavirus pandemic. Back then, it was primarily disrupted transport routes and production losses in the Far East that caused problems for German car manufacturers in particular. This time, it is the volatile situation in the supply industry. enomyc author Wolfram W. Hackbarth explains why their sandwich position is so dangerous for large suppliers and how manufacturers and large suppliers can take advantage of the wave of consolidation.
Good news from the automotive industry has been few and far between recently. While manufacturers are struggling with sales problems and competition from Asia, suppliers have long been facing a wave of bankruptcies. In Germany alone, tens of thousands of jobs are at risk in the coming years.
The crisis among suppliers – especially small, so-called TIER2 suppliers, who supply the larger (TIER1) suppliers with their preliminary products – is spreading throughout the entire industry, because every TIER2 supplier that gets into trouble can destabilize the supply chain that is so vital to the industry. Instead of being in the comfortable position of bridge builders between OEMs (original equipment manufacturers) and TIER2 suppliers, as was previously the case, many TIER1 suppliers currently find themselves in a highly risky sandwich position: caught between the expectations of car manufacturers, who depend on stable supply chains for their production, and the critical situation of their sub-suppliers, which can escalate at any time.
If a TIER2 supplier suddenly fails – whether due to insolvency, a shortage of skilled workers, or the takeover of an insolvent TIER2 supplier by a financially stricken competitor – all the lights immediately turn red for TIER1 suppliers. Especially in critical phases such as the start-up or ramp-up of vehicle programs and new applications, a failure can have dramatic consequences, as production downtime, delivery delays, and additional time-critical endurance runs can quickly drive up additional costs for suppliers into the seven-digit range. OEMs and TIER1 suppliers must fear failures in ongoing series production, but also in the aftermarket business and other areas.
Cost pressure, complexity, and a shortage of skilled workers are particularly affecting smaller suppliers
But why are so many TIER2 suppliers currently experiencing massive problems?
There are many reasons for this. On the one hand, high margin pressure and rising material costs are increasingly driving smaller suppliers into crisis. The number of insolvencies among German automotive suppliers rose by more than 30 percent last year compared to the previous year.
Another reason is the shortage of skilled workers. Due to a lack of qualified employees, many companies are unable to expand their production capacities – even when their order books are full. However, companies struggling with production bottlenecks are not reliable partners for TIER1 suppliers. In everyday business, too, many foundries, for example, are struggling to find the specialists they need in the machining sector or for highly energy-intensive processes such as heat treatment, hardening, tempering, and furnace processes. Plant operators and skilled personnel for essential night shifts, as well as qualified maintenance and repair specialists, are in short supply in many regions.
Finally, the increasing electrification and digitalization of vehicles is leading to greater complexity in components and assemblies. Suppliers must undergo extensive training to be able to manufacture the relevant parts. This in turn extends the support phase required to ensure that suppliers can work reliably in series production under high volume loads.
Why the sandwich position is so dangerous for TIER1 suppliers
If a TIER2 supplier fails at short notice, TIER1 suppliers must do everything they can to limit the damage as much as possible. New suppliers must be sought and found. Once an alternative supplier has been identified, in most cases it must first undergo a complex qualification process. This is because, in order to meet the safety and quality standards of the automotive industry, the new components must undergo extensive approval and endurance testing, among other things. These tests are specified by the OEMs or by engineering service providers acting on behalf of the OEMs – and they are usually very complex and cost-intensive.
Contractual obligations are another source of potential problems: TIER1 suppliers are often bound by strict delivery guarantees and SLAs (service level agreements). If the supply chain is disrupted, contracts usually cannot be fulfilled. In the worst case, this can lead to conflicts and high claims for damages.
Consolidation wave among TIER2 suppliers: What TIER1 and OEMs need to watch out for
An even more critical event with far-reaching implications for the entire value chain is the complete takeover of a TIER2 supplier. On the one hand, this opens up opportunities to leverage economies of scale and technological synergies or to further optimize production capacities. On the other hand, a takeover also presents comprehensive technical and economic challenges:
- Approval processes and production site changes
OEMs and TIER1 suppliers must approve every new production site. This process involves extensive certification and quality assurance tests that can take months or even years. A production relocation process also requires investment in new machine qualifications, production validations, and process adjustments. Compliance with industry-specific standards such as IATF 16949 and VDA 6.3 must also be ensured.
- Substitution costs when changing subcontractors
If a TIER2 is no longer able to deliver or has been completely changed as a result of consolidation, an alternative supplier must usually be found. Development and validation costs for new tools and manufacturing processes can quickly run into the high double-digit millions. The integration of an alternative TIER2 can also entail high start-up costs because new interfaces to existing ERP, logistics, and quality assurance systems must be programmed.
- Availability of components for series production, aftermarket, and CKD business
One of the biggest risks associated with the failure of a TIER2 supplier is delivery delays due to production changes, as these lead to immediate bottlenecks in ongoing series production. However, the lack of spare parts leads to failures in the aftermarket business, which is particularly problematic in the case of long-term commitments from OEMs and warranty processing. Completely Knocked Down (CKD) programs require particularly stable supply chains. If a TIER2 fails at short notice, TIER1 and OEM assembly plants around the world face production downtime – and horrendous claims for damages.
Breaking free from the stranglehold: How TIER1 suppliers can reduce their risk
To avoid scenarios such as those outlined above, TIER1 suppliers must take active countermeasures. Four measures can reliably reduce the risk of economic difficulties arising from a supply chain failure:
- Early risk detection: Continuous monitoring of TIER2 suppliers is essential. Regular credit checks and supplier evaluations help to identify financial and operational risks at an early stage and take countermeasures. Based on this, enomyc has developed a proven early warning system (PART = Pro Active Radar Tool) specifically for TIER1 and OEMs as an active practical tool and is continuously optimizing it. In addition to master data and information from TIER2 suppliers, the system is based on a structured technical risk and validation analysis, for example using the product modular parts list, the manufacturing and process technology used by TIER2, and a simulation and initial assessment of the costs for testing and endurance testing of the substituted components by TIER1 and OEMs. In addition to the initial cost assessment, the system also provides a realistic estimate of the project timeline with milestones and phases for prototypes, samples, and PPAP target dates.
- Diversification of the supplier base: Concentrating on a small number of suppliers always involves significant risks. A broader supplier base improves resilience against sudden failures. A dual sourcing strategy, i.e., cooperation with at least two independent suppliers, is particularly recommended for TIER1 suppliers of technically sophisticated assemblies or products for which certain TIER2 suppliers have developed special expertise in manufacturing technology during the product life cycle.
- Partnerships and cooperation: When TIER1 suppliers and OEMs work closely together, risks can be identified early on and problems can be resolved jointly. External experts with proven industry and process knowledge can help companies protect themselves against such crises in a targeted manner, for example by developing and implementing early warning systems.
- Digital supply chain solutions: Technologies such as artificial intelligence and blockchain offer new opportunities to monitor supply chains in real time and ensure transparent processes. PART analysis has become established in current business practice because it provides a very quick and targeted initial assessment of TIER2 suppliers.
Fragile supply chains: Prevention is key
The current situation in the automotive industry poses enormous challenges, especially for many TIER1 suppliers. The successful integration of a new TIER2 supplier requires extensive technical approval processes and entails high costs. Without strategic and proactive risk management, the risk of production downtime, financial losses, and lasting damage to the company's reputation in its cooperation with OEMs increases.
In the end, everyone involved benefits from forward-looking risk management and stable, resilient supply chains: TIER2 suppliers, TIER1 suppliers, and OEMs. In the long term, more cooperation, transparency, and openness to new ways of thinking are needed to defuse the current crisis.
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