Finding global partners to keep supply chain costs in check

June 29, 2020
Worn down by high tariffs, costly freight and increasing labor rates, the advisory firm Roland Berger says the aftermarket manufacturing base is taking relocation more seriously than ever before about reversing a five-year trend of declining profit margins.

Motorcar Parts of America operates a sprawling plant in Mexico, within driving distance to the United States border. In Malaysia, Panasonic relies on cheap labor to support their operations. To the west in India, Axalta depends on the country's robust infrastructure. 

Worn down by high tariffs, costly freight and increasing labor rates, the advisory firm Roland Berger says the aftermarket manufacturing base is taking relocation more seriously than ever before about reversing a five-year trend of declining profit margins. 

In a webinar presented by the consultancy to the Automotive Aftermarket Suppliers Association in April, the speakers, Barry Neal and Rahul Gangal, revealed their insights on how to select the most compatible location when volatility in the supply chain is too costly to ignore. 

Coincidentally when the joint study with AASA aligned with the coronavirus outbreak in America in February, they emphasized having a readiness plan to cushion against any unforeseen economic shock. Overreactive measures in the worst circumstances they warn, could blow up operating budgets or drain cash reserves. "Companies are seeking guidance to position themselves in the value chain in the next five to ten years,' said Neal during the hourlong presentation, 'to create the best value proposition for their downstream customers."

So long as a company can maintain a sweeping 5 percent to 10 percent cost reduction, they stand to remain competitive, says Gangal. "What's critical is the definition of value-add in the local production that you're affecting."

A global mindset that balances the new factory location relative to the lowest possible cost structure is far from a one-size-fits-all template. To ensure a successful transition to the next region, the advisory firm encourages managers to identify an economically stable host country that guarantees access to their factory systems, including a reliable transport network.

Each manufacturer has a unique set of cost structures, called archetypes, governed by the type of category they produce. These archetypes that fall into three buckets — freight, labor, and capital — influences where a manufacturer should set up operations.  

Unpredictable freight charges can stabilize, if appropriately calibrated, by locating the distribution center to the nearest market, the findings explain. Take filters or tailpipes destined for the United States. While relatively inexpensive and straightforward to make, these cumbersome items by their weight or size lay prone to massive handling fees when transported halfway around the globe. That's why the appeal to ship those categories inside North America, or in a cross-border environment, remains a simplified approach. 

Regarding complex assemblies, The Philippines, Malaysia, Vietnam, or Cambodia are surpassing China, says Gangal. These affordable labor markets are ideal places to assemble the intricate sub-components in braking systems. Besides facing lighter import duties imposed by the United States, the Southeast Asian countries have vastly sweetened their appeal by lowering input costs ranging from raw materials to utilities. 

Gangal references a 12-point checklist of best practices. It explains ways to identify local management experts to recruit a reliable workforce. Further, the blueprint describes how to communicate the move with the key stakeholders such as the customers, who Gangal suggests, should be providing continual input so that their needs do not end up ignored.

Infrastructure rich countries that can support the capital investment to erect foundries to build brake rotors still runs strong in China. Over time, India is proving itself to be a better long-term capital alternative to establish production lines and automation. To make that shift happen explains Gangal, it necessitates winning over the investors who want to see a financial payoff.

Depending on the particularities, how closely the stakeholders involve themselves with their partner from the start of the process, a move can last between six months to five years. 

Messy recessionary events may create barriers to a smooth exit, warns Gangal. Evacuation from an unstable region to a new destination could backfire. Gangal gives a scenario that when the economy recovers in the first country, a competitor may be tempted to seize upon the overcapacity by selling the remaining products at a lower price, thereby repositioning itself into a market leader. 

Sometimes it is prudent to ride out an uncertainty. Gangel suggests alternative sources of goods that are always available for the duration of an economic downtown, which he says applies to the global pandemic. Certain regions of the world over the worst hit countries will always be more accessible to obtain scarce products. Buyers, if they have not done already, should have previously cultivated relationships with multiple suppliers.

Gangal offers one option to bolster its supply chain if a manufacturer finds itself stuck for the long haul. "To ensure the linkage between the footprint and cost efficiency," Gangal urges the leadership to renegotiate the terms with the local government for favorable tax rates and extended incentives. And while at it to bide time, to explore new forms of manufacturing technology and higher levels of automation. "Those elements can be preconditioned before you're affecting a move and shifting the supply chain," concludes Gangal.

Months before Covid-19 had heightened the pipeline's anxiety, manufacturers operating outside of the United States had been feeling the pressure to improve customer service levels. The AASA study revealed that nearly two-thirds of the membership had considered relocation from China to tamp down rising wages heaped upon the tariffs. 25 AASA members interviewed by Roland Berger said that since 2015 that they have been steadily moving nearly 25 percent of their volume away from China and project to hold equal levels through 2030. Roland Berger built this relocation model to satisfy the 50 largest product categories manufactured by AASA's roster of members.    

Speculators wonder if India could supplant China as the better location to erect a factory from scratch or move production into a freestanding facility. Given India’ diversified infrastructure and democratic stability, foreign direct investment continues pour into this massive population center. But time will tell if managers will turn to Indonesia, Thailand, and Cambodia and parts of Latin America to make and supply auto parts. 

One bright side borne out of Covid-19, says Gangal, is that manufacturers are evaluating their pipeline processes breakdowns. "A lot of suppliers are looking at this as an opportunity to correct their business models and affect long-term change. We would encourage the suppliers also to do more."

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