Outsourcing vs. Insourcing in the Automotive Industry. The Role and Concepts of Suppliers

Table of Contents

Declaration of original work

acknowledgements

abstract

Opsomming

Table of Contents

list of Figures

list of Tables

list of appendices

CHAPTER 1 introduction and statement of problem
1.1. Introduction
1.2. Definition of Terms
1.3. Statement of the Problem
1.4. Assumptions and Delimitation
1.5. Plan of the Study
1.5.1. Literature Study
1.5.2. Expert Interviews
1.5.3. Case Study

CHAPTER 2 trends in the automotive industry
2.1. The Automotive Industry
2.2. The Automotive Industry viewed in Processes and Value Streams
2.2.1. Business Process Model
2.2.2. The Value Chain
2.3. The Manufacturer Industry
2.3.1. Current Situation
2.3.2. Core Competencies
2.4. The Supplier Industry
2.4.1. Current Situation
2.4.2. Supply Chain Management
2.4.3. The Supply Network
2.5. Automotive Collaboration

CHAPTER 3 Concepts in the automotive industry
3.1. Outsourcing
3.1.1. Definition of term
3.1.2. History of Outsourcing
3.1.3. Reasons and Goals
3.1.4. Outsourcing and the Automotive Industry
3.2. The Innovation Paradox and the Multi-Project-Landscape
3.2.1. Pressure for Innovation
3.2.2. The Innovation Paradox
3.2.3. Mastering Innovation
3.2.3.1. The Framework
3.2.3.2. Disruptive Innovation Model
3.2.3.3. Process and Product Technology
3.2.3.4. Integrated Vehicle Development Process
3.2.3.5. The Project House

CHAPTER 4 supplier in the automotive industry
4.1. Supplier in the Automotive Industry
4.2. Strategy & Competitive Advantage
4.2.1. OEM’s view
4.2.2. Supplier’s Strategy
4.2.2.1. Strategy from a supplier’s point of view
4.2.2.2. The supplier’s resource base
4.2.2.3. The supplier’s role
4.2.2.4. The supplier’s position
4.2.2.5. The supplier’s performance
4.2.2.6. An analytical model of a supplier’s strategic development
4.2.3. A Supplier’s Development
4.3. Overview of Business Concepts for Automotive Suppliers
4.3.1. Introduction
4.3.2. Business Models for the Automotive Parts Industry
4.3.3. Success Factors for Automotive Suppliers
4.3.3.1. Key Success Factors with respect to Outsourcing & Innovation
4.3.3.2. Limitations for small to medium sized Suppliers
4.4. Expert Interviews
4.5. Hans Oetiker GmbH
4.5.1. Introduction
4.5.2. Organisation Situation Analysis
4.5.3. The Hans Oetiker GmbH – What?
4.5.3.1. The Holding – IMC
4.5.3.2. The Business Unit – Production Plant Endingen
4.5.3.3. Strategic Intent
4.5.4. Strategic Issues (SWOT) – So What?
4.5.5. Strategic Activities – Now What?

CHAPTER 5 Conclusions and Recommendations
5.1. Introduction
5.2. Evaluation of Business Models for SME-Suppliers
5.2.1. Overview of Relative Importance of Success Factors
5.2.2. Match of SME’s Capabilities and Abilities
5.3. The New Role of Suppliers in the Automotive Industry
5.3.1. Future Shape of the Automotive Value Chain
5.3.2. Suppliers in the Automotive Industry’s Future
5.4. Indications for further Research
5.5. Annotations from the Author

references

Appendices

Declaration of original work

Hereby I, Christian Nitschke, declare that this study project is my own original work and that all sources have been accurately reported and acknowledged, and that this document has not previously in its entirety or in part been submitted at any university in order to obtain an academic qualification.

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Rochester Hills, MI USA, 8th Dec 2004

acknowledgements

I would like to take the opportunity to express my gratitude and thankfulness to those people who have guided me along my way and supported and encouraged me in personal and academic aspects.

First to mention is my family and especially my parents, Irmgard and Hans-Joachim. Their unconditional support has given me the necessary recourse to always go for the next step. I was only able to go so far under their guidance and with their encouragement. I feel very fortunate to be blessed with such exceptional people close to me. My deepest gratitude lies with them. Additionally I would like to point out the support by my girl friend, Miriam as she has not just been an emotional backup but furthermore she has been a great help in terms of aligning and editing the paper. Furthermore I have to mention Coen who supported me regarding the Afrikaans summary.

Further the people and organisations I have got in touch with during the preparation of this research report also need to be acknowledged. They contributed to this research report in different ways. The Hans Oetiker GmbH with Mr Andreas Plücken as a supervisor, gave me more insights into the automotive supplier industry and supported the initial starting point of my final MBA report. In terms of approving my findings and issues in the report it was very encouraging to speak with Mr Ralf Landmann and Mr Georg Sticher who where my interview partners. Additionally I would like to mention the DaimlerChrysler AG which I joined at the beginning of the report as a member of the corporate management program. My colleagues have always had an open ear and mind for my questions and thoughts.

Lastly the people I have met and who have taught me at the University of Stellenbosch Business School are to be mentioned. What I have learned at the USB is not only about academics but also about people, culture and personality. The different surrounding and various backgrounds coming together in one class and one University have given me an experience I will always gain from for the rest of my live.

The lecturing team has opened my eyes to many new topics, which I have not been in touch with before. Konrad von Leipzig, as my supervisor for this thesis, has always had an open ear for any difficulty during the thesis writing time. I would like to express my thanks for his support.

abstract

The research report takes an in-depth look at the automotive industry and their major participants in the upstream value chain. The different parties involved are the automotive manufacturers (OEMs) and their suppliers. The overall goal of the following report is to identify suitable business models for small to medium sized (SME) automotive suppliers.

As the automotive value chain currently undergoes an evolutionary change towards a diminishing vertical integration of the OEMs, it becomes a challenging issue to reconfigure the responsibilities of the suppliers. Thereby OEMs and their suppliers have to cope with a shift from a functional to a process orientated value chain. During this reorganization of the OEM-supplier interface, enterprises realign their strategic intent towards their core competencies as well. Besides the shifting value chain, both suppliers and OEMs have to cope with a consolidation in their industries. This consolidation is impacted by stagnating traditional markets, an ongoing globalization of the value chain, and an increasing productivity pressure in the automotive industry.

Looking at the automotive supplier, it becomes obvious that the suppliers are on the one hand challenged by productivity pressures and on the other hand have the opportunity to take over more business of the automotive value chain. The growth potential requires changes in the area of supply chain management and new types of collaboration in the supply network. This prospective development is mainly influenced by a trend towards the outsourcing of entire processes by the OEMs and the increasing need for future innovations in the automotive industry.

After discussing the above mentioned issues, the report analyses the role of suppliers with respect to their main customers, the automotive OEMs. Based on the findings business models for suppliers are assessed and key success factors for small to medium sized suppliers are proposed and evaluated. The findings of the evaluation are translated into suggestions for most suitable business models of SMEs. The report concludes with recommendations for the strategy building process indicates problems concerning the shifting value chain, and points out the importance of further research in the field of the small to medium sized automotive supplier industry.

Opsomming

Hierdie studieverslag ondersoek die motorvoertuig industrie met verwysing na die hoof deelnemers in die opwaartse waarde-ketting. Die partye betrokke is die motorvoertuigvervaardigers (OEMs) asook hul verskaffers. Die oorhoofse doel van die verslag is om gepaste sakeplanne vir klein en medium grootte (SME) ondernemeings te identifiseer.

Die motorvoertuig industrie se waarde-ketting ervaar tans ‘n drastiese veranderingsproses – gekenmerk deur afnemende vertikale integrasie vanaf die OEMs – wat voortdurende nuwe uitdagings veroorsaak vir die innoverende verskaffer. Beide die OEMs en hul verskaffers moet dus aanpas met hierdie skuif – van funksioneel na proses-georienteerd – in die waarde-ketting. Tydens hierdie herstrukturering van OEM-verskaffer interaksie, moet deelnemers verseker dat die strategiese bedoeling in fyn ooreenstemming is met hul basiese bevoegdhede. Behalwe die verskuiwing in die waarde-ketting, moet OEMs asook verskaffers aanpas met samesmelting in hulle industrieë. Hierdie proses van samesmelting word beinvloed deur kwynende konvensionele markte, voortgesette globalisasie van die waarde-ketting, asook toenemende drukking om produktief te wees in die motorvoertuig-industrie.

‘n Ondersoek in motorvoertuig industrie verskaffers weergee dat hoewel daar geswig word onder die uitdagings van produktiwiteit, bied dit egter ook geleendhede vir die verskaffer om verder te integreer deur oornames in die waarde-ketting. Om groei potensiaal te verwesenlik noodsaak dit veranderinge in die veld van verskaffingskettingbestuur asook nuwe metodes van samewerking in die verskaffingsnetwerk. Hierdie moontlike tendens van integrasie word hoofsaaklik beinvloed deur ‘n geneigdheid van OEMs om ‘n heel prosesse uitwaarts te sub-kontrakteur asook die toenemende aanvraag vir voortdurende innovering in die die motorvoertuig industrie.

Laastens ondersoek die verslag die rol van die verskaffer vanuit die oogpunt van hul hoof klieënte, die OEMs. Na aanleiding van die verslag se bevindings word verskaffers se sakeplanne en modelle beoordeel evalueer en word sleutel sukses faktore vir die SME verskaffer voorgestel. Die uitslae van die evaluasie word verder verwerk tot in voorstelle wat gepas is vir die sakeplanne van meeste SMEs. Die verslag kom tot voltrekking met aanbevelings in die strategie bou proses rakende die verskuiwende waarde-ketting, en dui ook op die noodsaaklikheid van verdere navorsing onder die SME motorvoertuig industrie verskaffers.

list of Figures

Figure 2.1: World automotive production in 2003

Figure 2.2: The ten largest Automobile-Manufacturing countries in 2003

Figure 2.3: Export Quotas and Value of German cars

Figure 2.4: Automotive Production of German Manufacturers in Germany and abroad

Figure 2.5: Revenues and Employment in the German Automotive Parts Industry

Figure 2.6: Number of Businesses in the Automotive Industry

Figure 2.7: Components of a Business Process

Figure 2.8: Internal and External Customer-Supplier Relationships

Figure 2.9: Porter’s Value Chain

Figure 2.10: The traditional Automotive Value Chain

Figure 2.11: Functional vs. Process Organization in the Automotive Value Chain

Figure 2.12: Vertical Integration of German Vehicle Manufacturers

Figure 2.13: OEM’s share of total value creation

Figure 2.14: Automotive Industry is growing stronger than other industries

Figure 2.15: Growth potential of the automotive supply industry worldwide

Figure 2.16: The Stairs of Transformation in the Automotive Supply Chain Partnership

Figure 2.17: Task Delegation in Development and Production

Figure 2.18: Development of Suppliers to Strategic Partners in networked Supply Chains

Figure 3.1: Reasons for outsourcing

Figure 3.2: Time to Market of Innovations

Figure 3.3: Top Factors for Growth – 2004 to 2007

Figure 3.4: The Twin Challenge of Innovation

Figure 3.5: The Innovation Paradox

Figure 3.6: A Framework for Mastering Innovation

Figure 3.7: The Disruptive Innovation Model

Figure 3.8: Synchronizing the Value Chain: Creating a Profit Cycle

Figure 3.9: Example of a Project House

Figure 4.1: Supplier vs. Sub-Contractor

Figure 4.2: An Analytical Model for a Supplier’s Strategy

Figure 4.3: A Supplier’s Development

Figure 4.4: Business Models for the Supplier Industry

Figure 5.1: Success Factors differ among the Four Businesses

Figure 5.2: Evaluation of Supplier’s Business Models

Figure 5.3: Vision of the Automotive Industry by the year 2010

Figure 5.4: Assessment of the Status Quo: A Role definition Framework

Figure 5.5: Role Portfolio

Figure 5.6: Barriers on the way to a cost optimized value chain structure

Figure 5.7: Ten key trends affecting the OEM-Supplier Relationships

list of Tables

Table 2-1: Industry Trends, Indications and Implications

Table 4-1: SME definition

Table 4-2: SWOT analysis of HOE

Table 5-1: Evaluation of SME’s capabilities

list of appendices

Appendix A – Evaluation of Supplier’s Business Models

Appendix B – Interview Guideline

Appendix C – Marketing Initiative Tooling for Hans Oetiker GmbH, Endingen

CHAPTER 1 introduction and statement of problem

1.1. Introduction

The automotive industry has gone through a big transformation in the 90’s and in the beginning of the new century. The car manufacturers and their suppliers still count to the old industry but they are setting new standards regarding production concepts and the way to do business.

These partially transformed or optimized business models are not only new inventions. They are originated in the minds of the former leaders of Toyota like Taiichi Ohno (1988) as well. Toyota started to implement its so called Toyota Production System (TPS) which could stand as a synonym for Lean Manufacturing in 1945. The different parts of this philosophy are concepts like Just-in-Time Production (JIT), Mass Customization and the total elimination of waste in the process of car manufacturing. The automotive world is still trying to adapt concepts of this benchmark to reach the quality and productivity standards set by Toyota. All large car manufacturers, e.g. DaimlerChrysler, Audi and Porsche set up their own Production Systems recently with the aim of copying the elements of the TPS or to implement features of a Total Quality Management Program.

In addition to the statement above the topics reengineering and automation have arisen in the last decade. Nearly all manufacturers and their suppliers had reengineering programs in their factories and are developing concepts to automate their production and service functions to become more efficient. At the same time they are developing new products like the Sports Utility Vehicle (SUV) or City Cars (like the Smart) to meet the customer’s needs. These tasks lead the car manufacturers in a position where they have to improve the overall value for the stakeholders on the one hand and deal with the underlying internal processes on the other hand.

Another trend in the industry is to globalize through mergers, acquisitions or joint ventures. This phenomenon is not only seen at the manufacturers (OEM’s) but on the supplier side as well. Mergers like the fusion between the Daimler-Benz AG and the Chrysler Corp. in the 90’s or Joint Ventures with enterprises from the Asian area were seen several times recently. What are the implications of this development or what is the intent of companies to build alliances? Certainly an underlying issue is ongoing growth and technology & knowledge transfer; but is that all? And what is about alliances between manufacturers and suppliers?

The end of the 90’s hype in the automotive industry was to outsource non core competencies to service providers. This involved mainly functions like IT (Information Technology) or Human Resources. But not only are the supportive functions of the automotive value chain being outsourced by the OEM’s. There is a drift to become a pure assembler. The MCC (Micro Car Corporation/Smart which is integrated in the DaimlerChrysler AG today) has practiced the idea of modular sourcing in an extensive way. Nearly 90 percent of the cost of a car is produced by suppliers which are settled directly on the factory area (Plunkett’s Automobile Industry Almanac, 2003).

In addition to the outsourcing of non-core competencies the newest tendency by car manufacturers is to outsource entire processes and/or business units to system suppliers. These system suppliers either have all the competencies to perform and/or provide the demanded service/product themselves or they subcontract second or third tier suppliers to satisfy the customer. Another kind of cooperation of these system suppliers is to work with strategic alliances or joint ventures between first, second and third tier suppliers.

1.2. Definition of Terms

To get a deeper insight into the automotive industry it is important to understand the current issues which are facing the largest industry in the world. Therefore the reader first has to understand the broad concepts which are applied in that particular industry. Those concepts have not clearly originated from the manufacturer side or from the supplier side; rather they have been developed out of the cooperation between OEMs and suppliers and their relationships. As the concepts can not be directly connected to the type of business, the reader should occupy an unprejudiced view of whether the concepts are in favour of the OEMs or the supplier.

1.3. Statement of the Problem

The unit of analysis of the research report clearly is the supplier of an automotive manufacturer. There is a lot of research done in the field of outsourcing but this research focuses on the perspective of the OEM. The purpose of the research is to identify and analyze current issues and factors facing suppliers in the automotive industry. This base is used to suggest important concepts and capabilities which could give a supplier the crucial competitive advantage for the future.

Therefore it is necessary to distinguish between strategic and operational processes. As shown later in the report the strategic area mainly consists out of the reconfiguration of the automotive value chain. The research in this report will concentrate on the following questions:

- What will the new shape of the automotive value chain look like and what is the role of automotive suppliers in this new business model?
- What will be the optimal organizational type of a manufacturer/supplier-relationship with respect to networked system suppliers/integrators and the trend for business process/business transformation outsourcing?

In the field of operational issues, the core questions are connected to the product/service offered by the supplier and the technology involved in the process of supply. Crucial subjects to the automobile manufacturers are the reduction of development time cycles and order-to-delivery lead times with respect to demanding customers and shortened life cycle times in the car business (Koudal et al., 2003). This target can only be achieved by effectively integrating the multiple suppliers involved in the process of developing a new car. This issue will be viewed by looking at the topic of innovation management as a concurrent concept in the automotive industry.

With respect to the above stated issues, finally the question of suitable business models for automotive suppliers comes up. This point involves all topics mentioned above and has to take into account that a strategy can only be developed by looking at the macroeconomic environment as well as at the particular microeconomic circumstances of an enterprise.
To limit the problem the question of the future role and the hereby involved concepts for suppliers in the automotive industry are the centre of attention.

1.4. Assumptions and Delimitation

As this paper will finally have a closer look at the business models and future competitive strategies of small to medium-sized automotive suppliers it is important to mention that those businesses are mostly reactors which have to follow the concepts set up by the OEMs and first tier suppliers. The strategies of OEMs and first tier suppliers do therefore function as a frame for the strategies of small to medium-sized suppliers and do set minimum requirements and standards.

The second issue to mention is that the literature for the small to medium-sized automotive supplier industry in terms of quantity and quality is limited. Therefore the findings for those particular businesses are based on a small range of newspaper and journal articles as well as on current research of automotive consultants and organizations.

1.5. Plan of the Study

1.5.1. Literature Study

The literature study will concentrate on the explanation of the core concepts in the automotive industry to build a foundation for the reader. Therefore an extensive market watch will be done in the first step which is important to understand the current circumstances in that industry. After having viewed the industry circumstances the foundational business models and concepts of the automotive industry (OEM and supplier) will be discussed and complemented by showing trends. To focus on the supplier, business models for parts manufacturers will be shown in the next part. This part includes the assessment of the supplier’s role and position in the relationship with automotive OEMs.

To conclude with the research the findings from the previous Chapters are applied to the capabilities of small to medium-sized suppliers with the aim to come up with suggestions for appropriate business models for those kinds of suppliers. The last Chapter will then present recommendations and suggestions for further research.

1.5.2. Expert Interviews

The expert interviews were conducted to support, as well as to prove, the findings from the literature study and to get insights into the newest tendencies in the automotive industry. The author had the opportunity to speak with Mr Ralf Landmann who is the Head of the Automotive Practice Europe for Deloitte Consulting and Mr Georg Sticher who is a Partner and member of the Core Group for the practice Industrial Goods of Boston Consulting.

The interview results are summarized in Chapter 5 of the report and the interview guideline is attached in the Appendix.

1.5.3. Case Study

To apply the findings from the first two parts, the Hans Oetiker GmbH is chosen to implement the recommended actions in a strategic marketing plan. The Hans Oetiker GmbH is both a first and second tier supplier of clamps, rings and couplings with a main focus on the automotive industry. The Swiss based company has a production plant in the south of Germany which meets the newest quality requirements by the global automotive industry. The management group of this subsidiary was looking for an appropriate strategy to market their tooling for clamps.

CHAPTER 2 trends in the automotive industry

2.1. The Automotive Industry

The worldwide automotive industry is currently in a radical change phase. After Henry Ford’s running assembly production and Toyota’s lean production, insiders talk about the third revolution in the international automotive industry (Wesselhöft, 2003). It is not sufficient anymore to increase productivity and only optimize the processes; instead it’s becoming more important to focus on customer needs and to raise the efficiency in every process of the enterprise. The necessary efficiency increase concerns the factors time and money in particular. Key concepts and success factors in this context are time to market and time to customer. Consequences of these issues are a clearly perceivable shift of tasks from the automotive manufacturers to their strategic partners, a growing concentration on core competencies, and an altering type of relationship between OEMs and suppliers which lead to virtual networks in the automotive industry (Kurek, 2004: 9-10).

Before the report carries on assessing the issues stated above, a market watch is useful to understand the importance of the automotive branch worldwide and especially for the German industry.

The figures and data in the following section which assesses the worldwide automotive market are all taken from the report on automotive business by the VDA – Verband der Automobilindustrie (2004).

2003 saw an increase in overall global demand for automobiles, despite a decline in North American and Western European markets. During the course of the year there was a recovery in sales of motor vehicles in the Mercosur countries, which had been crisis ridden for several years, and developments in the states of Central and Eastern Europe were similarly positive. But the best results came from Asia, where continued growth on many automobile markets boosted overall sales by 2 per cent to 56.3 million vehicles. Demand for passenger cars (a category that in America includes light trucks) grew by 1 per cent to 47.3 million, while at 9.0 million over 6 per cent more commercial vehicles were sold.

Trends varied greatly from one region to another. Within NAFTA (North American Free Trade Agreement, sales were 1 percent down on the previous year at 19.6 million vehicles. Passenger car sales were particularly badly hit (-6 per cent), whereas light trucks were able to repeat the modest growth of previous years (+3 per cent). Sales of medium and heavy trucks were also 2 per cent up. In Western Europe, overall sales declined by 1 per cent to 16.3 million vehicles, mainly as a result of a slump in the economy, and the countries of South America also failed to match the previous year’s result (-3 per cent). By contrast, markets in Central and Eastern Europe proved an important driving force behind the automotive industry, recording 7 per cent growth. The Chinese market has still not reached saturation point, and last year was the most dynamic in Asia, growing by 35 per cent and boosting overall growth in the Asian automotive industry to 11 per cent.

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Figure 2.1: World automotive production in 2003

Source: (VDA, 2004: 29)

In 2003, a total of 59.2 million motor vehicles were manufactured worldwide, improving on the previous year’s already impressive result by 2 per cent. Global passenger car production (including light trucks in America) was up 2 per cent at 50.1 million units, and commercial vehicle production grew by as much as 6 per cent. Automotive production in the NAFTA countries – the USA, Canada and Mexico – was 3 per cent down at 16.2 million units in 2003, reducing that region’s share of global production by 1.5 percentage points to 27.4 per cent. In the countries of the European Union, production declined half a percentage point to 16.8 million units, and the EU countries’ share of global production was down 0.7 percentage points at 28.4 per cent. By contrast, the countries of Asia, including Japan, were able to increase production by 10 per cent to 21.5 million vehicles – boosting their share of global automotive production by 2.5 percentage points to 36.3 per cent.

Mercer Management Group and the Fraunhofer-Institute state the following presence and outlook: automotive OEMs and suppliers employ 8.8 million people and gain 15% of the world’s GDP (Gross Domestic Product) in the year 2003. The automotive value added will grow at 2.6% yearly in the next twelve years and will be at 903 billion Euros in the year 2015. Hereby the segment of the supplier will be 700 billion Euros of the total in 2015 (Mercer Management & Fraunhofer-Institut, 2003). These numbers show the meaning of the automotive business for the worldwide economy. The circumstances are similar if one looks at Germany in particular.

Viewed globally, German automotive OEMs are producing 12.7 million passenger cars which include local production, production abroad and production by businesses abroad which are owned by German OEMs. This is 22.7 percent of the entire world’s production (Radtke, Zielke & Abele, 2004: 16). With the focus on German companies the importance for the German economy is demonstrated by the following numbers of German automotive OEMs from the year 2003: the automotive industry has nearly 800 thousand employees (these are 12.8 percent of all employees in the German industrial business), economizes about 202 billion Euros of revenues and produces 5.5 million vehicles (Radtke et al., 2004: 15).

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Figure 2.2: The ten largest Automobile-Manufacturing countries in 2003

Source: (VDA, 2004: 194)

Figure 2.2 shows the importance of an international comparison. Thereby the value of the automotive industry for Germany is pictured but is hiding the underlying problems. Two of three cars produced by German OEMs in Germany are exported to foreign markets which lead to a strong dependability on foreign exchange (FX) markets and other unsecured political and economical circumstances like trade barriers and other sanctions.

The export quota is been raised to 67 percent since the year 2001. If one takes the German national production of 5.5 million cars into account 3.7 million of the total are exported to foreign markets (VDA, 2004: 46). The ability to export production is a concurrent issue in many industries, especially if goods are produced at high wage sites. But it is not the appearance of end products on worldwide markets, rather it is the dispersion of innovation, technology and know-how.

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Figure 2.3: Export Quotas and Value of German cars

Source: (VDA, 2004: 46)

Considering that the main export markets like USA, Great Britain and Italy which account for 49 percent of the exported value and the Japanese market (10 percent of the value of total exports) are responsible for 40 percent of worldwide revenues of German automotive production the challenge of saturated triad markets becomes a critical factor. Globally seen the German OEMs produce about 10 million cars. 45 percent of this production is located in foreign countries and therefore situated near to the main export markets (VDA, 2003: 44).

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Figure 2.4: Automotive Production of German Manufacturers in Germany and abroad

Source: (VDA, 2004: 44)

Figure 2.3 and Figure 2.4 give an indication of the growing globalization of the German automotive industry. And this means an accelerating competitiveness amongst OEMs and suppliers. This paper will present a short screening of the macro economic issues – especially of the above mentioned market characteristics – but it will primarily explore the strategies of car manufacturers and their suppliers and give indications for the survival of smaller suppliers in the future. Therefore the following will present the current macro economic situation in the German automotive parts industry.

The latest figures for the German supplier industry show on the one hand a slight decrease of revenues in the last years and on the other hand an ongoing increase in employment. This issue is shown in Figure 2.5.

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Figure 2.5: Revenues and Employment in the German Automotive Parts Industry

Source: (VDA, 2003: 58)

Figure 2.5 shows employment increased as revenues stagnated from the year 2001 to 2002. This can be seen controversy to the actual developments in the parts industry which involve bypassed productivity pressure by the end customer. Bypassing means that the automotive OEMs are passing efficiency potentials directly through to the supplier. An explanation of Figure 2.5 is the provident investments in human capital made to compete with the shift of processes from the manufacturers to the suppliers (Dudenhöffer, 2003).

The automobile industry is being faced with three different components of productivity pressure: the borders of growth, the cost pressure, and the need for innovation (Dudenhöffer, 2002). The identifying factors which influence the three pillars of the increasing productivity pressure can be named as follows.

The growth in the triads in general is faced with a stagnating sales volume which is directly influenced by a shrinking real income. The booming markets as a potential target for new opportunities are considered as strongly competitive. If one looks at the issues of cost pressure there is the need to increase wage productivity because of constant prices for cars and the modest willingness of customers to pay for new technologies. This means that even though vehicles have improved technologically, the prices for the end customer are still the same as years ago. The third point is the demand for innovation. That is articulated in the need for mass customization, to be aligned with the newest governmental requirements regarding safety and environmental issues and the challenge to keep up with the new standards (Radtke et al., 2004: 28).

All those facts are not new in general, but they force the players in the automotive market to react in another way. In the past operational excellence which involves superior product quality combined with high productivity was a critical factor for competitiveness and led to profitable growth. But this issue is becoming a basic requirement. Therefore the increasing competition amongst players in the automotive industry leads to an ongoing concentration in the OEM branch as well as in the supplier industry. This evolvement of a few big players is caused by the above stated issues which force the companies to gather synergies, know how and market power through growth. One of the goals the OEMs try to achieve is the reduction of complexity in their processes by passing on tasks in the supply chain to so called system suppliers. These zero tier suppliers are responsible for the coordination of the supply chain for particular modules or systems of a vehicle.

Figure 2.6 shows the current situation as well as the expected development regarding the consolidation in the automotive industry.

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Figure 2.6: Number of Businesses in the Automotive Industry

Source: (Mercer Management & Fraunhofer-Institut, 2003)

The structural change in the automotive industry causes that the number of suppliers will be cut into half in the next ten years and that ten of twelve OEMs will survive the competition (Mercer Management & Fraunhofer-Institut, 2003). This development is based on the assumption that growth can be achieved only by mergers & acquisitions. If one takes the market view this progress is unlikely to happen because of the market forces which mainly include competition. Especially for the supplier industry the factor of competition plays an important role. The manufacturer industry would mostly be hit by less competition. If there are a smaller number of players in the supply market there will be fewer price wars and less effort to satisfy the customer. This is due to an increasing market power of suppliers in this case.

The factors influencing the consolidation in the automotive industry will be addressed in particular in the Chapters 2.3.1 and 2.4.1 where the current situations of the manufacturer and suppliers will be explained. The issue of automotive collaboration will be picked up in Chapter 2.5 to show factors concerning the change in the industry.

2.2. The Automotive Industry viewed in Processes and Value Streams

2.2.1. Business Process Model

To assist in the understanding of the topic the following will present the business model of the automobile industry. First, the business process concept of a car manufacturer is considered and thereafter transformed into a value chain model. The demarcation of the upstream supply chain takes place on that model because the manufacturer-supplier interface is focused in this elaboration.

A business process model describes an integrated concept of guidance, organization, and control. This concept functions as a tool to align the various processes in an enterprise and to focus the company’s resources to fulfil customer needs and stakeholder interests (Schmelzer & Sesselmann, 2002: 27).

Figure 2.7 shows the general components of a business process.

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Figure 2.7: Components of a Business Process

Source: (Schmelzer & Sesselmann, 2002: 35)

Business processes consist of the concatenation of cross functional value adding activities which produce achievements expected by customers and which results are of strategic importance for the enterprise (Schmelzer & Sesselmann, 2002: 35). The customer illustrated in the representation can be both internal and external. In particular in the automobile industry various internal customer suppliers' relations exist (e.g. the customer "assembly" with the "body parts production" as a supplier). Internal customers are customers of partial results which are used again for the next process step. Thus the internal customer becomes a supplier for the following sub process or process. Suppliers can therefore be differentiated into intra-process, enterprise-internal and enterprise-external suppliers.

A business process consists of a variety of such internal and external customer-supplier relationships as shown in Figure 2.8.

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Figure 2.8: Internal and External Customer-Supplier Relationships

Source: (Schmelzer & Sesselmann, 2002: 41)

The business model of the automobile industry differentiates between primary (core) and secondary (supporting) processes. To the first belong:

- Research and Development (product and process development).
- Procurement (controlling and selection of suppliers).
- Production (production planning and control).
- Marketing and Sales.

These primary processes are supported by the following secondary procedures:

- Enterprise Management (business planning, account system and controlling, etc.).
- Business Support (personnel management, finance management, etc.).

A combination between process organisation and functional organisation prevails in the automobile industry which is illustrated by horizontal procedures, like the product development and a functional organization which covers functions vertically, for instance marketing or sales. The concatenation of these processes can be represented in a process map. This will not be done here as the assessment of the value chain in the next Chapter is explicitly treated and will give a structured overview of the processes in an enterprise of the automobile industry.

2.2.2. The Value Chain

The term value chain originally goes back to the consulting company McKinsey (Gluck, 1980) and the Harvard professor Michael Porter (1985). The two ideas pursue different objectives. While a functional starting point is the basis for the model of McKinsey which examines the six basic functions (technology, product design, manufacturing, marketing, distribution and service) of an enterprise with those by competitors on competitive advantages the model of Porter aims at directly uncovering cost and differentiation advantages during the primary and secondary processes of an enterprise.

The following shows the generic form of Porter’s value chain whereby the supporting activities are the secondary processes while the basic activities are represented by the primary processes.

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Figure 2.9: Porter’s Value Chain

Source: (Porter, 1985)

Porter (1985) distinguishes between primary activities and supportive activities. Primary activities are directly concerned with the creation or delivery of a product or service. They can be grouped into five main areas: inbound logistics, operations, outbound logistics, marketing and sales, and service. Each of these primary activities is linked to support activities which help to improve their effectiveness or efficiency. There are four main areas of support activities: procurement, technology development (including research and development), human resource management, and infrastructure (systems for planning, finance, quality, information management etc.).

The term ‚Margin’ implies that organizations realize a profit margin that depends on their ability to manage the linkages between all activities in the value chain. In other words, the organization is able to deliver a product / service for which the customer is willing to pay more than the sum of the costs of all activities in the value chain.

Since the model of McKinsey cannot depict the dominant hybrid form of process and functional organisation in the automotive industry, the model of Porter is used in the remaining part of the research report.

The display format of the value chain by Porter enables the interaction of process and functionally orientated value creating activities of an organization. In the case of an automotive organization the basic activities are linked through the processes of product development and order processing. Value chains can be distinguished in company related or industry related value chains. The value chain of an organization characteristically describes the whole of value adding activities, which take place within the borders of an organization. Those borders are represented by the in- and output activities of the company’s own processes.

The generic value chain model of an organization depicts this deferment. The operational creation begins with the inbound logistics and ends with service. In contrast to the value chain of an organisation the value chain of an industry or industry line demonstrates the value add of all activities which are related to the operational creation for the end consumer (this can be a product or a service). The following graphic illustrates the value chain for the automotive industry.

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Figure 2.10: The traditional Automotive Value Chain

Source: created by author

The value chain for the automotive industry in Figure 2.10, exemplifies the original separation of four value adding activities. This traditional form of the automobile value chain today is supported by service provider and/or broker throughout the complete value adding process.

A major aspect is that the functional value chain of the automotive industry is dominated by processes. For example, here are the activities of product development and order processing. Those overall activities mainly affect the supply chains, which will be focused in the context of this research. The analysis of the outbound logistics will not form part of this research report since this is a service, which has little contact with the production process itself.

The following graphic illustrates collaboration in the automotive industry.

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Figure 2.11: Functional vs. Process Organization in the Automotive Value Chain

Source: created by author

In this form it becomes clear, that the value adding part related to the three core processes (development, production of parts and assembling) in the upstream value chain is affected by a change regarding the automotive producer and the supplier. A critical role in this context is the transition between a functional separation of the activities and an overall process organisation.

Figure 2.12 illustrates the shrinking part of the OEM’s value added to 25% in the current decade. One reason for this is the massive decrease of investments by the manufacturers in the sector of product development. Suppliers are forecasted to be responsible for half of the development tasks in a few years. Through the close relation of development and value add, the increasing differentiation of the product offerings and the concentration of the automotive producer on their core competencies, this hypothesis seems to be very true. The automobile industry also rearranges the tasks regarding the component manufacturing back to their core competencies.

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Figure 2.12: Vertical Integration of German Vehicle Manufacturers

Source: (VDA, 2003: 53)

The manufacturer needs to integrate the systems, which he receives, into his own organisational processes, while the supplier delivers them ready to install into the production of the OEM. This development regarding a process orientated organisation is supported by the statement of the McKinsey Partner Philipp Radtke (2004) regarding the industry structure. He states that “there needs to be a development from a functional orientated value chain towards knowledge based architecture.” Herewith it becomes obvious that the value adding part per segment – segment in this context relates to the various components of an automobile – is placed closer to the direction of the core competencies. The segments powertrain, chassis und body parts are again viewed as core competencies, whereas responsibility of the equipment of an automobile in the form of systems and modules is more and more passed on to the supplier.

In summary, one can see that there is a growing trend towards a process organisation which is supported by focusing on core competencies of the automotive OEMs. This argument is strengthened by the declining vertical integration of automotive manufacturers. At the same time it becomes necessary to re-define the interfaces of the value chain, since processes, as for example, the development of particular parts is no longer only placed with the manufacturer, but more and more with the organization of the supplier.

2.3. The Manufacturer Industry

2.3.1. Current Situation

“From the introduction of mass production in the 20s and the lean production in the 80s, the automotive production currently faces a new change. Until 2015 the supplier organisations of the automotive industry will take over a large part of the development and production from the automotive suppliers and will therefore grow by approximately 70%. The manufacturer at the same time will give away 10% of the value add and raise their outcast by 35%.” (Mercer Management & Fraunhofer-Institut, 2003).

This trend is initiated by new technologies, increased car complexity and tremendous variety of models, which increases the price of development and production. On the other hand, service offerings present a good opportunity for investments for the automotive manufacturers. Therefore car manufacturers will place higher emphasis of their development and production capacities on branding of modules and components (Humphrey & Memedovic, 2003).

The established hierarchy of automotive OEMs and suppliers of the first and second level will stay the dominant form of collaboration. However, through the concentration of the OEMs on the downstream side of the production (sales, services and customer service), the tasks of the supply chain will change.

Through this higher concentration of the automotive OEMs on the downstream business, design and production are increasingly placed with the suppliers. The scope of the outsourced production is dependent on the positioning of the automotive brand as shown in Figure 2.12.

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Figure 2.13: OEM’s share of total value creation

Source: (Mercer Management & Fraunhofer-Institut, 2003)

The value adds of the producer regarding their own organisation is derived from the differentiation of the brands and products. The mass brands reduce their internal contribution by 14 percent whereas in contrast the premium brands are going to have a decrease of only 10 percent (Mercer Management & Fraunhofer-Institut, 2003).

This development leads to the following consequences for the organisations strategy of OEM and supplier:

- Premium brands will become raw models for the OEMs and steer the settlement of the core competencies.
- Brands have a specific value adding strategy and the cooperation with the suppliers is managed by module strategies.
- Networks between OEM and supplier emerge, which drastically influence the competitive advantages.
- Component production facilities of the OEMs develop towards direct competition of the suppliers.
- Suppliers will absorb the main part of the investments. (Roland Berger & Partner GmbH, 1999)

Those facts need to be considered in the strategies of both suppliers and OEMs to handle the expected growth.

2.3.2. Core Competencies

The concept of core competencies is presented in this context to better understand the change in the value chain of the automotive industry and the reasons behind this scenery.

The concept of core competencies was introduced in the mid 1980s by Prahalad and Hamel (1990). Based on their studies, they found that there is a distinct difference between the illustration and usage of strategic intent and strategic architecture of organizations spread over many different industries. Prahalad and Hamel’s main point is that long term competitiveness is dependent on the ability to develop core competencies, which enable an organization to present an innovative product offering on the market. Reasons for competitiveness are based on the capability of managers to consolidate the technological and productive skills and develop distinct core competencies in the organization. Prahalad and Hamel (1990) compare the diversified organization with a huge tree. The log and the big perches are the core products, the smaller twigs are the business units and the blooms and fruits are synonyms for the final products. In this metaphor the system of roots, which is necessary for the survival of the tree, are the core competencies. Core competencies are according to Prahalad and Hamel (1990) the collective learning of an organization, which contributes special focus on the coordination of diverse production capabilities and the integration of various technologies.

According to Prahalad and Hamel (1990) the approach to split an organisation into strategic business units, leads to a dangerous dependency of the strategic business units on external sources with regards to critical components. However these critical components can be a key factor for the competitiveness of a variety of end products. If one takes Honda as an example it can be seen that the core competency of the Japanese is the development and production of engines which are built into cars, lawn mowers or high speed trains. This core competency by all means should not be outsourced but rather nurtured and enlarged through the former and current presence in the Formula 1 (Venkatesan, 1992).

Core competencies can be characterized according to the following factors:

- Core Competencies enable organisations a potential entry to a variety of markets.
- Core Competencies contribute a large part to the advantages considered by clients.
- Core Competencies should be difficult to imitate by the competitors.

Scientists call the relation between a core competency and a final product a core product. The semi manufactured products of the supply chain of an organisation form, individually or combined the value of a final product. It is imperative for organizations to reach a market leadership position with these core products in order to influence its further evolution according to their own intentions. Canon for example had a world market share of 84% in laser printer engines, although their own label of laser printers only had a minority share. Canon is the perfect example for the hypothesis that every product is developed on the basis of at least one core competency. The ability of Canon in the field of micro optics and micro electronics enabled the company to produce final products such as cameras, copiers, printers or even navigation systems (Quinn & Hilmer, 1994).

Prahalad and Hamel call the identification of core competencies of an organization, a prerequisite for “strategic outsourcing”. This point is one of the main issues which are currently facing the automotive industry. OEMs as well as system suppliers try to identify and have to focus on their core competencies whereby they outsource the remaining processes to other actors of the value chain. The outsourcing issue will be discussed again in a following Chapter

2.4. The Supplier Industry

2.4.1. Current Situation

The German automotive parts industry is currently in stagnation regarding revenues while capacity has been built up. This capacity increase involves mainly human capital factors. The issue has been shown in Figure 2.5 and has been explained in Chapter 2.1. To get a deeper insight in the developments of this branch the following will give indications for future trends and explore particular facts.

The export business was responsible for up to 40 percent of the total of 56.6 million Euro revenues in the supplier industry in 2002. The industry provided employment for 315 thousand people in that year. Half of these employees were working in Germany while the other half were employed abroad (VDA, 2003: 58). This trend of globalization is similar to the manufacturer industry but not as strong as there. The next paragraph will assess the underlying factors of this issue.

Senter and Flynn (1999) foresee in their report on organisational design, changing patterns in the Automotive Industry of North America. They state that the relationship between OEM’s and Suppliers is going to become more complex. This will affect the nature of the liaison regarding the time horizon as well. Car manufacturers and their system suppliers – or System Integrators as Senter and Flynn title them – will “contract” each other long term. Hereby Senter and Flynn support the statement of Armstrong and Chappel (2003) that there is a decreasing number of direct suppliers which themselves contract suppliers, the so called indirect suppliers. Therefore the number of indirect or second/third tier suppliers will continually grow in respect to the ongoing decrease of first tier suppliers. Lilliecreutz (1998) supports the tendency for system supplier-ships.

Research in the field of Automotive Supply supports the statement that there will be an increase of Top Suppliers. Armstrong and Chappel (2003) found that the largest suppliers are at the same time the fastest growing ones despite the fact that they are concentrating on their home markets. It is of importance to view again the structural change in the supplier industry and confront this issue with the drivers of growth. As mentioned in Chapter 2.1 there is a trend of decreasing numbers of suppliers. If one looks at the different types of suppliers the numbers look like:

- The Tier 1 supplier will decrease from 800 in 2002 to 35 in the year 2010.
- The Tier 2 supplier will decrease from 10.000 to 800 in the same period. (VDA, 2003: 64)
- There are no estimates about numbers of Tier 3 suppliers currently.

Single sourcing initiatives by automotive OEMs, joint ventures between suppliers and the pressure by the financial markets are just some of the main reasons for this estimation. There are reasons which work against that development as it is proposed.

The first one is the competition. The manufacturers and the governmental regulators most likely would not allow the market to slide into an oligopoly where a few players dominate the prices and other issues. Mainly this would put the OEMs into a situation where they have to consider more powerful partners in their supplier relationships.

The second point is that bigger companies often fall into a status of lethargy in which companies tend to be the opposite of agile business units. But the suppliers of automotive components have to be very responsive to changes in the OEM-industry. Therefore, they have a strong dependency on developments in the automotive manufacturer industry which forces them to act quickly and flexibly regarding changing needs of their customers.

The supplier landscape is influenced by developments in the complexity of vehicles as well. The frontiers of modularization combined with cost saving initiatives forces the actors in the automotive value chain to redefine the interfaces of systems in an automobile (Mercer Management Consulting, 2003). This issue offers opportunities for innovative suppliers which adopt the chances for new businesses as the concept develops.

The last eight years show that the automotive industry has by far outstripped other sectors with an average growth of 9 percent per year. Figure 2.14 shows the stagnation beginning in 2001 as well.

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Figure 2.14: Automotive Industry is growing stronger than other industries

Source: (VDA, 2004: 59)

Despite that current stagnation in the automotive industry the VDA proposes a growth potential for the supplier industry based on the following key drivers (VDA, 2003):

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Figure 2.15: Growth potential of the automotive supply industry worldwide

Source: (VDA, 2003: 59)

There is on the one hand the growing demand for vehicles world wide. This increase of revenues of about 10-20% is not in line with the rise in the total number of produced cars because most of the growth will be placed in Eastern Europe and Asia where the total value of a car is not as high as in the triads (Kettner, 2002). On the other hand the share of overall value added taken by the supplier industry is set to increase. This involves outsourcing in different areas of the value chain. Development will be the major scene where parts manufacturers and service suppliers will gain growth. This growth will be based on additional development tasks which come from the increasing differentiation of vehicle models. The OEMs are looking for support from their suppliers in this matter. The most effective part of growth is the increase of the value of a car. This is mainly driven by the electronic components and their total value of the vehicle. Today electronics make up to 25 percent of a car’s value. It is estimated to be 40 percent in 2010 (VDA, 2003: 59). A fifth of the increase is estimated to be the result of the replacement of mechanical with electronical components. The other piece will be further innovation regarding safety and environmental issues.

2.4.2. Supply Chain Management

The shift in the value chain of the automotive industry concurrently led to a reorganization of the collaboration between supplier and producer. The following paragraphs will on the one hand take an in depth look at the rearrangement of the manufacturer industry; on the other hand it will also analyze the transformation process of the supplier industry especially with its impact on the automotive business.

In order to meet the requirements for this kind of collaboration, which will be called “partnership” from this point on, there needs to be a mutual transformation. The partnership as a new way of collaboration in the automotive industry is driven by a tendency to a „sole-global“ – relation (Collins et al., 1997) on the side of the supplier.

This kind of relation is based on three major trends in the producer-supplier-partnership. The first one is the request by the producer that suppliers need to adjust their products according to the requirements of their consumers, which in the 90s led to a turnaround of the production methods of the suppliers. In the past the suppliers mainly offered standardized products (for example car batteries) now they have to adjust to design and produce the goods according to the information and specifications of the manufacturers (Kasouf & Celuch, 1997).

The second major change relates to the network of suppliers. Recently it has become obvious that suppliers develop a desire to have complete modules of products delivered directly to their production sites. This led to the fact that the supplier is not only in charge of the production of particular parts but also for the management of the „second-tier supplier“. Herewith a network of interconnected supplier organizations develops under the leadership of a global system integrator. Through the linkage of producer and supplier of different hierarchy levels a complex web of producer-supplier-network emerges (Liker & Wu, 2000).

The third aspect affects the preferred solution of the producer, namely the “single-sourcing”, which concerns the engagement of the OEM into the production- and quality systems of the supplier. Here the maintenance of critical processes of the automotive producer with high quality goods takes centre stage. This is a consequence of the more complex production and logistics sequences, as well as the pressure to perform an efficient and profitable production.

In the concept of a „sole-global-strategy” of the suppliers, respectively the „single-sourcing strategy” of the producer, there are different aspects of extreme importance of the relation between the partners. For example, the necessary ability of the supplier and required intention of the producer play a critical role. Collins, Bechler und Pires (1997) illustrate this requirement in their graphic „The Stairs of Transformation in the Automotive Supply Chain Partnership“, which is based on the study „Outsourcing in the Automotive Industry: From JIT to Modular Consortia“.

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Figure 2.16: The Stairs of Transformation in the Automotive Supply Chain Partnership

Source: (Collins et al., 1997: 505)

The left side of graphic above describes the necessary transformation steps of an automotive supplier, in order to reach the ideal position as „sole-global“-Partner of an OEM. This position is regarded as the ideal strategic direction, where the supplier will occupy a profitable position in the long run (Liker & Wu, 2000). Each step shows the activity, which the supplier fulfils in cooperation with the producer. Underneath the objectives for the suppliers to the according step are given. This is based on the assumption of a continuous improvement of the already mastered processes, even if the next level of transformation has been reached already.

The right side of the graphic depicts the levels that need to be achieved by the automotive OEM, in order to reach the ideal position of „single-sourcing“. It is obvious that the intention of an OEM is split into different steps. This starts at the operative basis (reduction of costs), over strategic consideration to a newly developed business model, which includes a virtual integration of the partner.

It is interesting to note that outsourcing is considered as a basic requirement for the complete transformation process. The removal process not only relates to the operative intention of the different steps but also becomes a strategic aim. This process leads to the so called business process, respectively business transformation outsourcing.

2.4.3. The Supply Network

After having explored the issues of supply chain management the paper will view the networking issues of the supplier pyramid.

Besides the ability to recognize market needs and to fulfil these expectations it is important to deliver the vehicles in a strategic timeframe. This issue is summarized under the idea of time to market where new product developments are targeted by time restrictions. The time pressure causes an increase of platform strategies und modular concepts as well as an enlargement of parts built by external partners.

Figure 2.17 pictures the task delegation in the automotive industry.

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Figure 2.17: Task Delegation in Development and Production

Source: (Kurek, 2004: 21)

The different levels of the supplier pyramid do not work as independent businesses in the supply chain as in the past anymore, they rather build up well defined supply chains. Those supply chains show networked structures whereas the intensity of the cooperation is dependent on the fit of core competencies between the partners.

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Figure 2.18: Development of Suppliers to Strategic Partners in networked Supply Chains

Source: (Kurek, 2004: 23)

2.5. Automotive Collaboration

Looking at the progress of the value development in the automotive industry, the topic of outsourcing and the obligatory decision, to produce goods and services “in-house” or to place the related activities with an external provider, is ever prevailing. Here it is striking that the primary goals of outsourcing projects take a tendency away from key performance indicators and ratios towards a more strategically oriented direction. Resources and cost flexibility take a lead role. Growth and performance enhancement potential are still an important topic, however they increasingly become secondary (Accenture GmbH, 2002).

A further trend is the transformation from Service-Outsourcing (IT, Personnel) to Business Process or Business Transformation Outsourcing. The last two terms include the outsourcing of complete business processes (functional as well as core processes), with the intention to increase the performance on a mid term basis and the growth potential in the long run. To achieve this it is necessary to strive for cooperation with the suppliers of the related service.

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