Reductions & relocations: the suppliers' challenges.

Over the last few years, the car industry's investment focus has rapidly shifted to the new growth regions in Asia and Eastern Europe. In Eastern Europe alone, Hyundai, Kia, PSA, VW, and other manufacturers are building new assembly plants to the tune of over Euro 4 billion. The same applies to OEM suppliers. Virtually every day suppliers are opening new plants in countries such as Slovakia, Hungary and Romania. Around 80% of production from these Eastern European supplier plants is exported to Western Europe and other high-wage regions, while only a fraction is designed to cater to local Eastern European OEMs.

Suppliers have no choice. Labor costs in many Eastern European countries and regions amount to around one-tenth to one-fifth of the Western European level. On average, personnel costs account for 25 to 30% of total production costs. Hence, suppliers can lower total costs by 10 to 15% by shifting production to Eastern Europe, even if increased logistics and complexity costs as well as decreased productivity are taken into account. In the highly competitive supplier market, with increasing cost pressure from OEMs, this could be a life saver.

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It is a widely held belief that labor costs will rise markedly over the next five to 10 years in Eastern Europe and other low-wage countries, thus off-setting Eastern Europe's cost advantages. This is not true. Even though annual wage increases of up to 10 or 15% are commonplace in many Eastern European countries, in absolute terms the gaps will remain constant due to the markedly lower base level. Therefore, capacity expansion in low-wage countries is going to continue over the next few years--and it will accelerate even further, according to a recent study by Roland Berger Strategy Consultants. Ninety percent of the surveyed mid-sized industrial companies said they are planning to shift further elements of their value chain abroad over the next five years. Only 69% of the respondents have already shifted their value chain to low-wage countries. Even components requiring highly complex technology are increasingly produced abroad.

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Existing Plants in High-Wage Countries Need Rethinking

Accumulated expertise, cost of moving and improving efficiencies may spare existing plants in countries such as Germany or France. German suppliers rely heavily on their local personnel's technical expertise accumulated over many decades. For some companies, moving would simply be too expensive. Payback for the complete shifting of a plant often amounts to five to seven years, which is unacceptably long in times of dire financial straits.

Many Western European plants also have significant efficiencies in reserve that need to be tapped. This can be accomplished by optimizing processes, including more flexible working time and shift models, and reducing unit labor costs. In the last few months, many suppliers have led the way. Companies such as Bosch, Continental, Siemens-VDO, Brose as well as many small suppliers have renegotiated terms with their employees at endangered locations. By introducing longer working times of 38, 40 or 42 hours per week without pay increase, labor costs were lowered by up to 15 percent and the competitiveness of these locations was improved.

Suppliers need to tackle their main challenge: Optimizing the complete value chain. If they want to successfully bid for new projects, they cannot do so without creating or expanding plants in low-wage countries. At the same time, they must further reduce production costs at existing plants. It is this combination of actions that creates a reduced cost structure for suppliers to survive in the long run, defying the permanently rising cost pressure from OEMs.

Marcus Berret, Partner, Roland Berger Strategy Consultants ([e-mail])