Navigating Automotive and Manufacturing Sector - Inflation and High Input Costs!

When creating automobiles today, the automotive industry must overcome a number of challenges; from?disruption in production schedules due to the pandemic, macro-economic and geo-political issues, inflationary pressures due to rising commodity and gas prices, cross-border trade disruption, semiconductor shortages, labour shortages, rapid electrification, supply chain constraints, pressure on passing the cost to the customers, and at the same time enhancing sustainable product designs for market competitiveness. In fact, the raw material price index for May 2022 in Canada was up by 37.4 percent from a year ago and has risen by two-thirds since 2020 [1]. During such a multiplicity of demands, cost reduction appears to be the biggest obstacle as well as an opportunity for most automotive and component manufacturers.

Manufacturers must emphasize organization-wide cost reduction programs as costs rise due to stricter emission regulations, fluctuating raw material prices, and the need to keep up with industrial and technological advancements. The program will improve not only their market competitiveness but also overall profits without compromising quality, performance, or overall customer satisfaction. Cost transformation has evolved into a strategic imperative than a continuous improvement initiative with the ability to upend the whole sector and radically alter how manufacturing business is conducted. The article attempts to highlight a few perspectives on direct material cost transformation and how some of these levers can be leveraged for overall supply chain cost extraction.

Factors Inhibiting Higher Cost Extraction Challenge

Due to continuous direct and indirect material cost reduction exercises over the years, the product cost has matured significantly, and most manufacturers have limited opportunities for further cost improvements.?Procurement functions claim to have exhausted their levers to further optimize and re-negotiate costs with the suppliers. Further, competition product strategy is compelling companies to upgrade products with improved features, high-end electronics, and technologies. Cost-push on account of these upgradations coupled with regulatory cost increases aren’t fully recoverable due to competitive price positioning in the marketplace. Therefore, OEMs find it challenging to balance the input cost and sales price.

Cost Management Strategy

OEMs and Tier 1 players can adopt a two-pronged approach to reduce or extract costs. The first strategy should focus on long-term "proactive" cost management, and the second should focus on short-term "rapid cost" control. For all upcoming new projects and models, the proactive strategy should concentrate on “Design to Cost” approach. This entails content rationalization as per market needs. A reactive or rapid strategy is focused on delivering immediate results for running models by leveraging conventional cost reduction levers.

Cost Maturity and Competitiveness

Most leading automotive players have improvised their cost transformation journey along with the time scale to remain competitive with the industry. However, in the past, the journeys have focused on traditional cost reduction levers. The focus used to be on operational cost elements and budget-based strategy. A few OEMs have improvised, but with these traditional methods and some cost innovation, the overall cost journey can’t sustain itself in the long run. Building a sustainable program is necessary to absorb the multiplicity of demands in this sector. The approach must cover the entire value chain, i.e., direct and indirect material spend, supply chain costs, and overall manufacturing cost heads. Embedding the cost culture across the organization that thinks, acts, and constantly lives within the value chain of costs is one of the essential recipes for success.

Exhibit 1: Cost Maturity Over Time

Breakthrough Transformation Framework

The framework shown in exhibit 2 has been developed based on various successful direct material transformations. It captures the essential?tenets, further categorized into four significant buckets - Tactical, Bottom Up, Intrinsic, and Strategic. Leading companies are looking to deploy this methodology to identify and prioritize cost reduction opportunities. If not, then they should be. The framework provides some unique levers which can be explored in a structured way for overall cost heads across the enterprise.

The approach mainly focuses on exploring design-based and strategic levers. Where in the supplier universe is fragmented based on business impact and sourcing complexity, aka Category Strategy. This “Category Matrix” is used to develop short- and long-term cost reduction strategies. This holistic framework covers the entire spectrum of levers, from capturing inefficiencies to strategic levers for complex categories such as propriety parts, casting, forging, sheet-metal / fabrications, machining, hardware, plastics, moulding, extrusion, etc. Interestingly the same framework can be used for indirect categories such as marketing, MRO, IT, HR costs, third-party labour, facilities/real estate, manufacturing, logistics, and corporate services.

A new operating model with a robust governance structure is needed to enable this transformation, i,e. a purpose-driven organization with strong involvement of top leadership and well supported by a core team for successful implementation. Exhibit 3 highlights a recommended governance model.

Three key aspects are critical beyond the framework: leadership alignment on target setting and category strategy. Second is the organizational orientation toward cross-functional collaboration between sourcing, design, reliability, customer insights, and other critical teams. And lastly, total transparency and engagement with the supplier community.

Exhibit 2: Cost Transformation Framework

Beyond Traditional Levers

1.?Product Teardown Analysis (Vehicle + Component Level): Competition items are totally dismantled into their component-level pieces. Content per vehicle is analyzed based on reliability, product life, functionality, and overall aesthetics. A three-step systematic strategy is used to deploy the best solutions among competitions.

a) A detailed analysis of the technical and parametric differences between the present and competing components are made, including variations in weights, dimensions, suppliers, production techniques, and design methodologies;

b) Determining areas for technical improvement: All feasible areas for major improvement are listed, and their technical viability is assessed;

c) Implementing potential cost-saving measures: The end result of this approach is adopting the alterations for the most cost-effective and ideal design.

These days technology is used to conduct digital non-destructive product teardowns by some of the leading OEMs. Making it more reliable and cost-effective.

2. Should Cost / Product Cost Modeling: The objective is to determine a part’s potential total cost based on a cost breakdown. It is also feasible to construct and acquire fact-based pricing or a near-based costing approach with the assistance of cost-based price modelling.

a) Develop the supplier’s?cost breakdown based on distinct production processes. Find opportunities on specific process stages rather than on sub-parts right away;

b)?Carry out internal comparisons or gather comparative numbers based on internally accessible cost information for the process value chain;

c) Carry out a cost analysis of the product. Compare the most competitive cost items with one another after cost data has been established.

?3. Collaborative Cost Reduction with Supplier Community: Suppliers’ expertise and intellectual capital may be used through these programmes to enhance OEM’s in-house development capabilities. The process of cutting costs involves suppliers heavily, and in exchange, the savings are distributed to them. The suppliers have a strong incentive to work with OEMs?to identify new cost-cutting opportunities and build a long-term win-win relationship with the OEMs.

a) All suggestions made by suppliers are gathered, and descriptions, potential savings, time and possibility of execution, as well as the work and cost required, are recorded for prioritization and selection;

b) Following this, the viability of the chosen ideas is discussed with representatives from the engineering, quality, production, and other departments. Plans for the business case and its implementation are created, and the right roles are assigned.

?4. Manufacturing Process Benchmark: Process benchmark is best used for products characterized by numerous, relatively simple, clearly defined standardized processes. These standardized processes are mostly available individually in the market. A good example is machine-turned parts or hardware categories, where it is possible to easily switch between individual steps such as cutting, bending, turning, surface finishing, coating, etc. Suppliers are also requested to offer detailed costs for each particular processing step (e.g. gross weight, process cost, surface treatment of turned parts). Based on this information, the purchasing team can negotiate with suppliers regarding process costs. Other than cost structure, alternative manufacturing processes are also explored based on supplier interaction and market intelligence.

The procedure for identifying savings potential by benchmarking the manufacturing processes comprises three steps:

a) Preparation for benchmarking: Identifying the production process or stages that most strongly impact the product price is necessary - existing and new suppliers’ inputs are to be used for the process benchmark;

b) Identify best practice process costs: Check which production steps are the main cost drivers. Detail out the significant cost contributors and compare them with external data sources to determine the best practice process. The difference between each supplier’s process costs and best practices is computed, which determines the amount of potential savings;

c) Implementation of savings potential: Part of the savings potential is achieved directly in negotiations with suppliers. In the case of complex changes in production processes, the suppliers must submit an implementation plan.

Process benchmarking for purchasing brings a high level of price transparency and fact-based decision-making. Knowing the suppliers’ production processes and the associated costs is an aid for negotiations to determine future target prices for new products.

5. Reduce Dependency on Geogprahic Concentration / Vendor Concentration: Another strategy a company can leverage is best cost geography sourcing (BCG). China is the most prominent example of a whole series of critical low-cost countries, such as Brazil, Russia, India and Turkey. However, in current times for a resilient and sustainable supply chain, OEMs will have to look into a lower dependency of upstream supply chain in one geographic location or/and vendor concentration. To some extent, evaluate the possibility of vertical integration through acquisitions, M&A, or organic investments in high-growth segments. For e.g., Tesla’s upstream supply chain for semiconductor chip manufacturing is a classic example of a vertical integration strategy.

Identifying interesting and qualified suppliers from these countries is challenging. But, their offers are usually far below European or American cost levels. The first obstacle an organization has to overcome is resistance from internal teams. Internal users at the company will have to be convinced of the sustainability of the offers from these diversified new sources. Genuine close collaboration and a long-term partnership approach with these suppliers will ultimately result in greater visibility of other best-cost sourcing options.

6. Design for Sourcing: Design for sourcing increases the engineering and sourcing team’s collaboration, generalizing requirements to the point that they are no longer specific to a single solution. A solution must be designed and developed to satisfy both the needs of end users and the existing solution’s requirements. A matrix of specification data can be designed to comprehend the key distinctions between different product platforms, keeping the essential functionalities as they are.

7. Digital Tools: Most OEMs have challenges in the visibility of their categories' cost and process mapping. Some of them don’t even know who is their tier-end suppliers. Leveraging IT and digital tools for end-to-end visibility and agility across Design, Plan, Source, Manufacture, and Deliver is a super-critical enabler?in today’s digital era. A few use cases are as follows:

a) Design process: use of digital twins, digital non-destructive product tear-downs, IT solutions for specification optimization (such as Optistruct, FEM-based structural analysis), design-based parts rationalization, and master data management are pretty popular

b) Procurement process: use of spend analytics tool, data-driven tail spend rationalization, and e-procurement can help enhance source to contract process

c) Supplier's data: OCR and NLP technology can read and capture contractual information, and AI can validate if the contract is in place for an item or another that would serve the need. Big data, and machine learning analytics, analyze information to develop standardized components and recommend specifications that are not proprietary to one specific supplier.

Governance Structure: A robust governance structure is the pivot point for tracking the progress of various cost-saving initiatives. Since most ideas fall under the design-led bucket, it’s critical to have a strong monitoring process. The tiered governance structure shown in exhibit 3 has been quite successful for continuous review and guidance for cost-focused initiatives across the organization.

Exhibit 3: Governance Model

Conclusion: During these turbulent supply chain times, thinking beyond procurement efficiency and conventional levers is critical to address the multiplicity of demands for C-suites and the supply chain chief officers. The holistic approach of utilizing levers across cross-functional teams, including design, procurement, and manufacturing process, embarks a strong pipeline of ideas for the OEMs for the upcoming 3-5 years. This article attempts one such framework to think beyond the traditional procurement lenses. A robust governance mechanism, cross-functional collaboration, and supplier participation are requisite for program sustainability. The results observed by embarking on these techniques have resulted in a strong pipeline of cost-saving ideas for 3-5 years for OEMs. The impact of about 10-15% impact is realized annually on the financial savings. Supplier management and relationship with strategic suppliers have been enhanced. Further, the structured execution of this approach has also ensured a greater resiliency to maintain market share competitiveness and sales price.

Source:

[1] Canadian Manufacturers & Exporters. (2022, July 13). Soaring Raw Material Costs Causing Pain for Canadian Manufacturers. Cision Canada. https://www.newswire.ca/news-releases/soaring-raw-material-costs-causing-pain-for-canadian-manufacturers-813769591.html

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