Shake-up coming for the auto sector
Change is coming to the automotive sector. As the industry shifts away from the combustion engine and toward new technologies, the risk of increased insolvencies rises. Those that successfully navigate the market shift will likely do so because of strong financials and heavy investment in R&D. For Tier 2 suppliers, it will take that, plus an ability to climb up the value chain.
New tech, big changes
It remains to be seen what emerging technologies will become the new norm for vehicles, but regardless, companies must invest in order to adapt to the coming changes. Suppliers that can convert themselves into high-tech firms will survive at least in the mid-term.
One huge potential growth area is in the electric vehicle segment, which is predicted to receive investments amounting to $300 billion over the next five to 10 years and make up 15% of global sales by 2025.
In China, for instance, the overall car market is seeing declining sales, but the electrical car sector is growing. It currently has a 5% market share, and sales rose 62% year-on-year in 2018 and another 50% in the first half of 2019. That said, sales have stuttered in the third quarter, with declines in July and August as the Chinese government scales back subsidies to the industry.
Any advancements toward electric vehicles or other new technologies (such as autonomous and connected driving) represents an opportunity for those firms able to invest, but it’s a big risk for those that cannot, particularly Tier 2 firms that produce basic parts and will be unable to climb up the value chain. Electric engines are far simpler and require far fewer parts than combustion engines, and to meet the requirements of OEMs and Tier 1 players, these suppliers would have to improve their specialization.
Tough times for auto business
Unfortunately, times are currently tough for the sector all around. Widespread trade and economic volatility are largely to blame, as the sector is heavily reliant on exports and cross-border supply chains. According to Atradius economists, in 2019 sales are forecasted to decrease 5%, with the trend continuing into 2020. This applies to most major markets, including China, France, Germany, Italy, the United Kingdom and the United States. Small and medium suppliers are especially at risk, as they’re already grappling with thin margins, even before taking into account deteriorating sales.
Although U.S. tariffs on European vehicles and auto parts has been suspended for now, the threat lingers. The German sector is especially vulnerable should the tariffs move forward, as it is responsible for more than half of all EU auto exports to the U.S.
U.S. tariffs on steel and aluminum are another factor to consider. These, thankfully, have so far barely impacted profits or cash generation of U.S. OEMs and suppliers, as higher commodity prices have been mostly passed along to consumers. The recent end of tariffs on steel and aluminum imports from Canada and Mexico has helped the sector as well, since a high percentage of cars and parts for the U.S. market are manufactured in Mexico.
Brexit continues to carry a high level of uncertainty, as the UK continues to fumble its way through its divorce from the European Union. Whilst the true implications of Brexit for the industry are not clear, a “no deal” Brexit would hurt both producers and suppliers, as the World Trade Organization would immediately impose a 10% tariff on vehicles and a 4.5% tariff on components. This would lead to higher costs and burdens for the already-stressed sector.
Anticipating an end to free and easy trade with the EU, manufacturers are already decreasing investments in the British automotive sector, nearly halving UK car production. In addition, Jaguar Land Rover has announced a major cost reduction project, and Ford and Honda are planning to close UK plants in the next few years. Should a hard Brexit come to pass, the hardship would not be limited to the UK, either, as many Western European markets have close trading ties with the UK automotive sector, including the Netherlands, Spain, and Belgium.
Change, but how fast?
The extent of the market shake-up will depend in part on how quickly a shift away from combustion engines takes place and how far it actually spreads. While climate change and pollution is spurring some governments to consider phasing out new gas engines, government subsidies for R&D and electric vehicle purchase is so far limited.
Other factors that could slow the shift is consumer preference and their confidence in the new technology. Whilst electric vehicles are on average cheaper to operate, they are more expensive to purchase and lack a comparable range to traditional engines. There is also a need for major investment in the charging networks before the new technology is widely adopted. If consumers ultimately reject electric vehicles, it could affect the financial performance for all automotive businesses currently investing in the next-gen technology.