Restructuring the Auto Industry

8/3/2019 Restructuring the Auto Industry

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Using the Current Crisis to Build a Better Relationship Between OEMs and Suppliers

Dennis Cuneo Remarks

OESA Conference June 3, 2009

Introduction

Thanks Neil for the kind introduction. Im honored to be here.

Its been quite a week. One of the Detroit automakers is coming out of

bankruptcy; another just entered. A Canadian parts maker, with backing from the

Russians, now controls a storied German automaker that had been owned by an

American company for 8 decades. An Italian company - once called the basket

case of Europe - is now the savior of an iconic American company. And the

federal government and UAW are now the majority shareholders of 2 of the 3

Detroit automakers.

If you ever had any doubt, last weeks events confirm how global our industry has

become and how rapidly our industry is changing.

I started in the industry nearly 3 decades ago, during the time of an earlier deep

recession that changed the industry. As an outside attorney, I worked on Toyotasunsuccessful efforts to create a joint venture with Ford in 1981. I then joined

Toyota as part of the management team that started up the NUMMI joint venture

with GM in 1984.

From NUMMI, I joined the team that started up Toyotas North American

manufacturing headquarters in the mid-1990s and then finally to Manhattan,

where I was the Senior Vice President of Toyotas North American holding

company. I retired from Toyota 3 years ago, and continue to consult with Toyota.

Most of my experience in the industry has been on the OEM side but over the

past 3 years, Ive become much more familiar with the supplier side. Ive joined

the Boards of two major auto suppliers AK Steel and Borg Warner and I serve

as Senior Advisor to Toyota Boshoku, a seat and interiors supplier.


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Working on the supplier side has given me more insight and empathy for the

challenges that suppliers face.

Past as Prologue

The conditions that the industry faces today are severebut this isnt the only

time the industry has faced turmoil or change.

Back in the early 1900s, when the industry was in its infancy - it was made up of

scores of small manufacturers, who built their cars one-by-one. Henry Ford

revolutionized the industry with his standardized design and flow production

system that put most of those small manufacturers out of business.

Fords dominant position didnt last long. In the 1920s, under Alfred Sloans

leadership, GM adopted management and marketing techniques that enabled the

company to dominate the industry for most of the 20th

century.

The NUMMI joint venture which I mentioned earlier got its start from the

recession that followed the 1979 Iranian oil shock.

Some of you may remember that time gasoline prices shot up; sales for the

Detroit automakers dropped dramatically; and the Japanese rapidly gained

market share.

Chrysler was saved from bankruptcy through a federal loan guarantee; Ford was

hemorrhaging cash - and GM, which still held over 40% of the market, suffered its

first loss in 6 decades.

The normally free-trade Reagan Administration forced the Japanese to restrict

their imports to give the domestic industry breathing room.

David Halberstam chronicled the changes in the auto industry in the early 1980s

in his book, The Reckoning. He noted that while the rest of the country was in a

recession, the auto industry in 1982 was in a depression with more than a

quarter of a million auto workers unemployed; distressed suppliers; and a

growing angst in the many Midwestern communities that depended so heavily on

the industry.


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Halberstam compared the fortunes of Ford and Nissan as a proxy for the fortunes

of the US and Japan. He wrote:

It was clear that the entire American industrial core was vulnerable to the

relentless challenge from a confident, disciplined Japan.

Over 2 decades have passed since Halberstam wrote his book. If he were writing

the book today, hed probably be talking about the ascendancy of the Chinese

economy. His predictions about the dominance of the Japanese economy reflected

conventional wisdom at the time which turned out to be wrong. And shortly

after the book was written, the fortunes of Ford and Nissan reversed.

Nissan nearly went bankrupt. Ford enjoyed the fruits of the SUV boom in the

1990s. That boom died at the turn of this century, and as Explorer sales dried up,some predicted that Ford was destined for bankruptcy.

Today, Ford is the only Detroit automaker that has avoided bankruptcy. It is

gaining market share, has developed attractive new products and is being

praised by everyone ranging from President Obama to Fortune magazine.

As all of this shows, the only constant in the auto industry is change. Bob Dylans

tuneThe Times They Are A-Changin could be the anthem for this industry.

What the Future Holds

Trying to predict what will happen is a bit of a fools game there are so many

variables, especially with the GM and Chrysler bankruptcies but I will try.

In the North American market which was dominated by GM for most of

the last century 6 or 7 firms with roughly comparable market shares will

slug it out for sales. The Detroit automakers will be leaner and meaner,

with lower cost structures.

The Detroit automakers will also need to attract more capital to fund the

research, development and engineering for new, fuel efficient models.

Edmunds estimates that the new fuel economy standards will add $2300 to

the cost of a vehicle.


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The federal government will be more actively involved in our business onthe equity side..in fuel economy and safety mandates. and in cap-and-

trade requirements that will affect our manufacturing facilities.

The supply side will continue to consolidate as the OEMs will be seekfinancially stable suppliers who have the resources to share in the costs of

developing new environmentally friendly vehicles.

Need to Restructure Supplier Relationships

Our industry is in the throes a major and disruptive restructuring with

restructured capital structures; restructured labor agreements; restructured

distribution channels; and a restructured supplier base.

Being a supplier in this industry hasnt been much fun over the past decade.

The most recent Planning Perspectives Study on supplier relationships released a

week ago shows new strains in the already tough relationship between the

OEMs and their suppliers.

When I was with Toyota, I gave several speeches on the OEM-Supplier

relationship, and commented on the need for change.

At that time, you could say that I participated in trying to improve supplier

relationships. Now that I have some significant supplier experience under my

belt, Im committed to improving those relationships.

And if I can repeat the fable about the chicken and the pig in a breakfast of

eggs and bacon, the chicken participated; the pig was committed.

In recent surveys, such as the Planning Perspectives study that I mentioned

earlier, suppliers give most OEMs a low rating noting that OEMs have littleregard for their supplierscommunicate poorlyarent willing to share savings

from cost reduction effortsand generally treat suppliers as adversaries rather

than trusted partners.


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A few years ago, Tom Stallkamp, the former President of Chrysler, chronicled the

current state of supplier relations in his bookScore A Better Way To Do

Business. He described OEM-Supplier Relations as adversarial commerce

where OEMs treat suppliers like serfs applying economic leverage in a

dictatorial, arbitrary manner.

These kinds of relationships arent sustainable over the long run and that is

especially true now. More than ever, we need collaborative win-win relationships

to meet the many challenges that this industry faces.

When I joined NUMMI 25 years ago, our Chief Operating Officer was Kan Higashi

who came from Toyotas Purchasing Division. He told me that most people

overlooked one of Toyotas key competitive advantages its relationship with its

suppliers.

He taught me that managing the supply chain is more than simply buying parts.

Most of the value added in a finished vehicle comes from the supply chain. Parts

have to be delivered on schedule to the assembly line, meet exacting

specifications, and be priced at a competitive cost.

Managing the supply chain is probably the greatest challenge for an OEM in

manufacturing motor vehicles.

Nearly 20 years ago, researchers at MITs International Motor Vehicle Program

found that lean producers achieved better quality and lower costs by

collaborating with their supply base instead of relying on the confrontational,

power-based bargaining that had characterized the industry for decades.

But as we can see from the recent surveys it appears that the industry hasnt yet

fully applied this lesson.

Perhaps the current crisis is an opportunity for all of us to change. A crisis does

create a sense of urgency and actions that once lacked a sense of urgency can

become essential.


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This fact wasnt lost on President Obamas Chief of Staff, Rahm Emmanuel, who

noted that on the political scene, a crisis provides an opportunity to do things

that you could not do before.

Lets face it the current relationship between the OEMs and the supply basehasnt worked for the OEMs. or the suppliers and it needs to be changed.

Theres an old Chinese proverb that the only difference between obstacles and

stepping stones is how you use them. The challenges of the current industry crisis

can be used as stepping stones to build a better and more sustainable

relationship between the OEMs and their supply base.

Lessons From AK Steel

With the news on Monday about the GM bankruptcy, it seems that Chapter 11

has become the new business model for this industry. And, if the analysts are

correct, we could see a slew of additional bankruptcies on the supply side.

As I mentioned earlier - Im on the Board of AK Steel a $7 billion company that is

the 3rd largest integrated steel maker in America. AK traces its roots to the former

Armco Steel and started out as a joint venture between Armco and Kawaski

Steel in the 1980s.

The steel industry went through many of the wrenching changes that the auto

industry is now experiencing and came out of those changes as a viable and

sustainable industry.

Beginning in the year 2000, more than 50 steel companies filed for bankruptcy

including such well known names as Bethlehem Steel, National Steel, LTV and

Wheeling Pittsburgh. For some, like LTV, it was their second bankruptcy filing.

The common thread among the failures of these companies that oncesymbolized both Americas industrial strength was their collapse under the

crushing weight of foreign competition, and heavy pension and retiree health care

costs.


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Those legacy benefits were granted decades before, when Americas steel

industry had virtually no competition other than itself. The steel industry was a

classic oligopoly and foreign competition changed that.

Straddled with rigid labor contracts and capital-starved operations, the steelcompanies failed. In the wake of the bankruptcies, tens of thousands of

steelworkers lost their jobs, and hundreds of thousands of retirees lost their

pensions and health care benefits.

Yet, the timing was perfect for entrepreneurs with cash and a promise. The cash

representing pennies on the dollar, purchased the idled assets. The promise,

made to the unions, put thousands of steelworkers back to work under flexible

new era labor contracts.

Wilbur Rosss International Steel Group re-lit cold blast furnaces and put

thousands of steelworkers back to work. Free of billions of dollars in retiree

pension and healthcare costs, his steel company prospered and he eventually

sold it off to Arcelor Mittal.

By all rights, and in the opinion of many on Wall Street, AK Steel should have

joined that list of Chapter 11 casualties in 2003.

The company racked up more than $1 billion in red ink, had a pension trust

underfunded by $1 billion, another $1 billion of debt, and more than $2 billion in

retiree healthcare liabilities. The companys cash flow had become a cash

trickle.

But rather than filing for Chapter 11 as some had suggested to level the playing

field with its competitors - AK Steels Board of Directors changed the course of the

company by changing the top management, and appointed Jim Wainscott as

president and CEO in the fall of 2003.

Jim set a new course for AK Steel. He established a goal of paying off the

companys debt, funding its pension plans, honoring its health care obligations

and giving AK Steel shareholders long-term sustainable profitability.


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In a manner similar to what Ford is doing today, AK Steel went against the grain

and restructured outside of bankruptcy.

The company took a number of tough actions it dropped unprofitable customer

relationships; it negotiated new labor contracts which precipitated an extendedlock-out at its largest facility; and formed new relationships with raw material

suppliers. These actions werent easy or popular- but they eventually worked.

The past 2 years were the most successful in the companys history with record

revenues and profits; industry leading quality and safety; and a record stock price

for its shareholders.

At the same time, the company honored its pension obligations to its 32,000

retirees without any government bailout; without closing a single plant, andwithout outsourcing any jobs overseas. Today, AK Steel makes every ton of its

steel in the United States and all of its facilities are unionized.

Over the past 5 years, AK Steel was transformed from an industry laggard to an

industry leader and it did so outside bankruptcy.

To be sure, AK Steel hasnt been spared the pain of the current recession.

Shipments this year are the lowest in AKs history and the company has cut its

capacity and made painful layoffs. But AK Steel now has ample liquidity to survive

the downturn and is in a position to thrive when the market returns. And

because it didnt get a government bailout or file for bankruptcy it can control

its own destiny.

Lesson for the Auto Industry

If you believe the analysts and naysayers we are about to see a wave of

suppliers follow GM and Chrysler into Chapter 11.

I hope not and I hope that companies will not jump into Chapter 11 simply

because it looks like the path of least resistance.

Once you go into Chapter 11 you lose control of your own destinyand youll

find yourself at the mercy of the bankruptcy court, specialists and lawyers. I read


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the other day that Delphi has spent over $400 million in professional fees so far in

its bankruptcy. Bloomberg predicted that GMs bankruptcy fees could exceed a

$1 billion dollars.

Ford has received well deserved praise for taking action to avoid Chapter 11proving, like AK Steel, that restructuring can occur outside bankruptcy if

management is willing to make the tough and timely choices.

Closing

We are in difficult times and difficult times require difficult actions. The current

crisis has set off a wave of restructuring that will change our industry.

In spite of the challengesIm optimistic about the future. As an industry we

satisfy that most basic on human needs personal mobility.

And I know this people still need cars and they will eventually buy them at a

much higher rate than the industry has been selling them over the past 6 months.

When that occurs those companies who survive will thrive.

We can look at the last major crisis the recession the early 1980s for an

indication of what might happen. In 1981 and 1982, light vehicle sales fell below

11 million and the Detroit automakers racked up billions in losses. Four yearslater, sales had increased to a record 16.3 million and the Detroit 3 made $45

billion in profits from 1984 to 1988.

That last crisis also forced significant changes in the industry. Competition from

the Japanese automakers forced the Detroit automakers to adopt lean production

techniques that led to better product quality and plant productivity.

For some time, it has been clear that the cost structure of the Detroit 3 was not

sustainable over the long run. GM lost $10 billion in 2005 when industry saleswere close to 17 million vehicles.

This current crisis is forcing a financial restructuring that will bring the industrys

cost structure to a more sustainable level.


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As was pointed out in Mondays Washington Post, the economic downturn has

done what legions of car executives, consultants and policymakers have failed to

do in 3 decades: overhaul the U.S. car industry.

Lets also hope that the current crisis will lead to an overhaul of the relationshipbetween the OEMs and the supply base. Without a healthy supply base, this

industry will continue to struggle. In this industry more than any other the

fate of the customers and suppliers are intertwined.

If I can borrow a quote from Benjamin Franklinif we dont hang together, we

will hang separately.

This concludes my remarks. I appreciate your attention and would be happy to

take your questions and comments.

Documents

Restructuring the Auto Industry