Comment: Facing automotive supply chain volatility in 2022

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The fast pace and scale of change in the automotive sector presents several significant challenges to management teams in the year ahead, says Jimmy Saunders, managing director, Kroll restructuring advisory.

As 2022 is fast approaching, many companies that operate within the automotive sector have already started to look ahead towards the new year. With a combination of ongoing structural issues along with broader economic challenges, it goes without saying that the industry has major obstacles to overcome. It should be a priority for management teams to start looking at ways in which they can review their business from the ground up to seek to mitigate the impact of the ‘perfect storm’ of current market conditions.

Jumping over the structural hurdle

Over the course of 2019, growing uncertainty around Brexit resulted in numerous vehicle manufacturers announcing the movement of production to mainland Europe. This news came at a time when many customers reported that they were tentative of buying cars because of the evolving electrification of vehicles. There was also ongoing concern surrounding the diesel emissions scandals. Then in early 2020 the pandemic hit, and according to the Society of Motor Manufacturers and Traders (SMMT), between 2019 and 2020 new car registrations fell by 29 per cent.

The impact of this reduction in vehicle sales on the automotive supply chain was in part mitigated by the selection of government support schemes, such as the ability to furlough employees, the government loan schemes and the VAT deferral scheme.

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With countries emerging from lockdown at separate times, the uncertainty of demand and fluctuating availability of supply parts it pushed manufacturers to rationalise their number of vehicle programs to focus their attention on producing core models. This served to create capacity in factories that, as demand improves going into 2022, is being used to encourage the acceleration of electric vehicle production. Recent statistics that came out of SMMT indicate that there will be more electric vehicles registered in 2021 than were registered between the whole of 2010 through to 2019. In the year to October 2021, new car registrations have only grown like-for-like by 2.8 per cent, but behind this number is a decline in petrol and diesel cars (which for now make up the majority of vehicles) of 22.1 per cent, which is offset only by the substantial growth in electric vehicles and hybrids of 65.4 per cent and 82.5 per cent, respectively.

This drastic shift from internal combustion engines to electric vehicles requires substantial investment in both research and development of the new electric technologies and into capital expenditure (capex), particularly powertrain suppliers, at a time when businesses are already struggling. Furthermore, both original equipment manufacturer (OEMs) and lenders are starting to consider environmental, social and governance (ESG) and sustainability matters, potentially bringing a whole new layer of accountability and expense into the supply chain. This focus was intensified after the 2021 United Nations Climate Change Conference taking place in early November.

It’s important to recognise that the landscape for large vehicle manufacturers themselves is also of a very competitive nature as the market is getting increasingly saturated. As a result, this has led to an increased downward pressure on the supply chain to deliver price efficiencies.

Facing supply chain complications head-on

Unfortunately, these structural issues have occurred during the same period as the ongoing global supply chain problems. In addition, the sector has faced another blow due to the chronic semiconductor shortage in the automotive industry, with many commentators indicating that this will not regularise until well into 2023. In addition to this, shipping costs to bring in parts and materials from the Far East have increased considerably to over $15,000 per container, and this follows a period of relative stability over the course of the last 10 years when the price didn’t surpass $2,000 per container.

It is a well-documented that there is a labour shortage, especially in the UK. It was reported in summer that the UK is needed another 100,000 heavy goods vehicle (HGV) drivers albeit additional testing centres and higher wages have seen this number start to reduce recently. This is all contributing to delays in distributing goods from port to Tier 1 and 2 suppliers and difficulties dispatching finished goods to the OEMs. Furthermore, steel, and aluminium prices hit ten-year highs in October 2021 with most other commodity prices following a similar trend, partly due to the dramatic increases in energy prices, which, in turn, impacts suppliers both directly and indirectly. All these factors cause concerns regarding the impact of inflation on interest rates and future debt servicing costs for businesses.

Various OEMs operate on a just-in-time basis on a rolling 13-week production cycle; this allows the Tier 1 or 2 suppliers time to order in raw materials and parts and to schedule their production and staffing. With the shortages in supply of key components, when the production lines are brought to a halt, this then creates a ripple effect, going back through the entire supply chain. The problem is that the reduction in order volumes come late, sometimes in the week an order is expected to be delivered; this means that the supplier has already invested in both materials and labour, tying up vital working capital. This level of volatility is very difficult to plan for. Pressure falls on the management team to juggle all these issues together. As a result, the day-to-day running of the business might not get the direct focus it needs.

Act now and get ahead

The fast pace and scale of change in the automotive sector presents several significant challenges to management teams.

Many businesses that are already dealing with these severe financial and operational challenges are also having to find alternative ways to transition towards electrification in an efficient manner.

Many balance sheets today carry increased amounts of debt because of the Covid 19 pandemic, and there is less capacity to deal with additional borrowing to fund working capital and capex needs.

Management teams should act now to address challenges to ensure the security of their businesses in the future.

Jimmy Saunders, Managing Director at restructuring agency Kroll