Automotive Suppliers Face Their iPhone Moment

Welcome to Issue #74 of The German Autopreneur!

I usually talk about automaker transformation here. But suppliers are under just as much pressure. Here in Germany alone, nearly 270,000 people work directly for automotive suppliers.

What these companies are going through has its own name: "Stagformation." A mix of stagnation and transformation.

The dilemma? Growth stays out. But they still need to invest heavily in new technologies.

Today we'll look at why the supplier industry is under such intense pressure. And which strategies can actually help them survive.

Margins Are Collapsing

Supplier EBIT margins are now about 2% below pre-COVID levels. For 2024, they're expected to drop further to an average of 4.7%.

For many companies, this is life-threatening. Margins have crashed from over 7% before the pandemic to under 5%.

The 6 Problems Crushing Automotive Suppliers

1) Growth Stays Out

Global auto production is recovering after COVID. But pre-pandemic levels of 93 million vehicles won't return until 2028.

The chip crisis slowed recovery even more. Automakers focused on high-priced models. Suppliers have fixed contracts and got hit when volumes dropped.

And: Regional differences are huge. China and the Global South keep growing. Europe and North America are stagnating. Europe will stay at maximum 16-17 million cars per year until 2030. Well below the 19 million from before COVID.

2) China's Price War Hurts Margins

I talk about this often: the aggressive price war in China. Automakers pass this pressure directly to suppliers.

The result? Already low margins keep falling.

3) EVs Ramp-Up Slower Than Planned

EV predictions have been cut dramatically. In 2023, experts predicted 53% EV share by 2030. Now it's only 41-42%.

The EV transformation varies dramatically by region. In China, every second new car is electric. Europe is stagnating. The US is even going backwards.

Suppliers bet on fast EV growth. Now they must:

• Support multiple drivetrain technologies simultaneously

• Offer different products for each region

This costs serious money. And makes transformation even more expensive.

4) Software Becomes Core Business

OEMs will spend $43 billion annually on automotive software by 2030.

Demand is shifting from hardware to software. Building a car requires more and more software, AI, and chips. And fewer mechanical parts.

For suppliers, this means:

• They need software developers instead of mechanical engineers

• They must build completely new skills

• They suddenly compete with tech companies

Here's where it gets unfair: Semiconductor companies achieve 21.6% EBIT margins. Software firms reach 35.5%. Traditional auto suppliers can't even hit 5%.

The new competitors are financially much stronger. They have the skills that suppliers must build from scratch.

5) China as Ground Zero of Transformation

Traditional suppliers had a safe market in China for decades. That's changing now.

Chinese OEMs have expanded their home market share to 67%. They increasingly use local suppliers. For EVs, the value chain is almost entirely in Chinese hands.

Even German automakers in China are switching to local providers. Audi uses Huawei technology. Volkswagen sources software and chips from Xpeng.

To survive in this environment, Western suppliers must become more "Chinese":

• Move decision-making authority to China

• Switch to "China Speed"

What's "China Speed"? Customers expect responses within 24 hours. And the journey from order to production takes just 6-10 months. In Europe this is often 30 months.

Meanwhile, Chinese suppliers are catching up globally. Their share of Top-100 supplier revenue has nearly doubled since 2018. Battery maker CATL could soon overtake Bosch as the world's largest auto supplier.

6) Trade Wars Make Things Worse

EU tariffs and aggressive US trade policy create problems for globally networked suppliers.

Their value chains are internationally intertwined. Components often cross borders multiple times. Tariffs of 20% or more are impossible to absorb.

The consequence? More production must move to sales markets. This also costs money that's needed for transformation.

Winners and Losers

Not all suppliers are hit equally hard. European suppliers struggle most with margins of only 3.6%. South Korean companies are just as bad at 3.4%.

Chinese suppliers are doing better at 5.7%. They have a strong home market plus government support.

Among product segments, tire manufacturers perform best at 7.4%.

Interesting: Electronics and infotainment suppliers face margin pressure despite high revenue growth. The reason? They must invest heavily.

The Perfect Storm

Over 40% of the 25 largest auto suppliers are now rated "Non-Investment-Grade." Their credit scores are so low that many institutional investors can no longer invest in them.

This makes borrowing extremely expensive. Right now, suppliers desperately need money for transformation. Because without transformation, there's no future. But without money, there's no transformation.

A downward spiral starts:

• Poor credit scores increase financing costs

• Interest costs reduce EBIT by more than 20%

• This means: Less money for innovation

• This leads to: Weaker competitive position

• Result: Even lower credit scores

Plus: Despite stagnating revenue, headcount at big suppliers has been rising since 2016. Thus, revenue per employee has fallen significantly.

The result? Many Tier-1 suppliers are now reducing their workforce by 5-10%. A painful but necessary step.

Survival Strategies for Suppliers

How can suppliers respond? Roland Berger identifies 3 key action areas:

1) Focus Portfolio and Form Partnerships

The market will consolidate. To survive, companies must:

• Streamline their portfolio

• Focus on few, strategically important product segments

Partnerships and acquisitions become crucial. They accelerate innovation and create economies of scale. The Schaeffler-Vitesco merger is one example.

2) Realign Regional Strategies

The era of global value chains is over. Suppliers must think regionally. The focus must be on Europe, USA, and China as core regions.

Especially important: Strong local presence in all relevant markets. "Local for Local" becomes the standard.

3) Cut Costs

This is obvious:

• Move production to lower-cost regions

• Use automation and AI

• Automate internal processes

At the same time, they must strategically invest cash flows from ICE business into future technologies. Finding the right balance is crucial for survival.

My Take

I always talk about 3 simultaneous transformations:

• From ICEs to EVs

• From hardware to software

• From human to autonomous driving

All 3 create problems for auto suppliers:

E-Mobility: The shift is different than expected and varies by region. Suppliers must deliver multiple technologies in parallel for the coming years.

Software Shift: Traditional suppliers come from the hardware era. Now they must compete against software companies and build new skills.

Autonomous Driving: AI becomes a core automotive competency. Just like with software, this is uncharted territory for most suppliers.

And especially for established companies, this leads to a fourth transformation: The organization itself.

The thing is: They have legacy. Bosch exists since 1886, Continental since 1871, ZF since 1915.

This history is an asset on one hand. Experience, know-how, reputation.

But it's also a problem. Because with history come decades-old structures. Established processes. Grown cultures.

All of this must fundamentally change now.

Just like with automakers, this might be the biggest challenge for suppliers.

The hard truth: The classic auto supplier will disappear. Software-first companies will take their place.

This could be their iPhone moment. The moment that hit Nokia when the iPhone arrived.

Or it could be the catalyst for real transformation. It’s up to them. Completely reinvent themselves. Or disappear.

Not all suppliers will survive this change. But those who make it will for sure come out stronger.

🔗 rb | wi | ca | mm | ap | hb | ae

That's all for today.

Feel free to reply to this email with your thoughts.

Until next week,
— Philipp

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