The automotive sector is in crisis as the global supply of silicon semiconductors goes through a crunch.
BDO’s Automotive team leads Jon Gilpin and Stephen Cooney, and partners, Chris Marsden and Ross Northall - analyse the situation and go through some of the measures that automotive sector leaders can undertake to remedy it.
What is the issue and why is it taking so long for the supply chain to remedy the shortage?
Ross: During the COVID-19 pandemic, there was an increase in demand for electronic consumer goods as people were forced to stay at home during lockdowns. This led to increasing demand for semiconductors.
Added to that, there were lockdowns in Asia where a significant proportion of these chips are manufactured, so production tightened for a while.
Furthermore, the automotive sector is not a priority for semiconductor manufacturers, since it only represents around 5% of the semiconductor market and the chips it buys are relatively low-tech, with lower margins than those manufactured for the electronics sector.
Hence, at the point when the automotive sector stopped purchasing chips because it was locked down, electronics manufacturers were increasing their demand—and demanding chips that had a higher margin for the semiconductor manufacturers.
When the automotive sector opened up production post-lockdown, their ability to place orders was limited. To make matters worse, automotive OEMs have little control over their chip supplies.
While they may have multi-year contracts with their tier 1 suppliers, chip providers are at tier 2 or even 3 in the supply chain.
Chris: The contracts which the auto manufacturers have with chip suppliers tend to range from a few weeks to a few months, whereas in the consumer electronics industry the contracts tend to be for 12 months plus.
Because of the pandemic surge in demand for consumer electronics—last year, the semiconductor industry grew by about 20%—the vacuum created by auto manufacturers was swallowed up by consumer electronics businesses with longer contractual positions. And the contracts which vehicle manufacturers have had have either been with tier-one suppliers or beneath.
They've not been with the chip manufacturers, so the auto manufacturers have not had the same level of control as consumer electronics businesses.
What has been the impact on the automotive sector in the UK?
Stephen: A typical passenger vehicle has 1,500 sub-assemblies and components, if a supplier fails to deliver components, it’s likely the assembly line is shut down. For example, after the Kobe earthquake in Japan destroyed the factories of several tier 1 suppliers, several Toyota vehicle assembly plants were shut/ran at reduced output for over a year.
Japanese car makers have learnt to apply better risk management techniques to their supply chains and as such have experienced less disruption during the current semiconductor crisis.
In places such as the UK, however, the impact has been significant. In 2018-19, the UK produced about 1.5 million vehicles out of all its production plants. In 2020, the UK produced less than a million; part of that was due to the consequences of Brexit and the pandemic, which closed factories for part of the year. But in 2021 the UK only produced 859,575 cars, this reduction is largely due to chip shortages.
So, we're producing roughly 640,000 vehicles less compared to what we've done historically.
Jon: I work with businesses in the automotive sector who supply to OEMs and have nothing to do with chips. But they're caught up in this storm because they have the same end customer as the chip supplier.
It's an issue with one strand of the supply chain but it's pulling in everything. That's why it's so pervasive and what makes it frustrating for businesses.
Also, an aspect which I think is a little bit hidden is: when we come back up to near capacity, are we able to bring the supply chain with us? What can we do to help them see through this period as well? That needs to be given serious consideration.
What are companies doing to address the issue?
Jon: What we've seen in the short term is businesses having to refinance to shore up the balance sheet and shore up liquidity. That finance is generally readily accessible, whether it's debt or equity. But to a degree, it's emergency finance.
It's probably not the most cost-efficient decision a business has to make, but it is necessary. Banks see the supply chain issue is today but not forever and therefore continue to support the medium-term outlook for the automotive sector.
We are also seeing auto suppliers diversifying away from the sector to reduce their reliance on it. This is a sound strategic market decision but could have a knock-on effect on OEMs’ ability to source components going forward.
Chris: Vehicle manufacturers are now going direct to semiconductor providers, where possible, instead of relying on intermediary suppliers. They're also going with multi-vendor strategies.
Obviously, there's a playoff there between the economies of scale that you can get through going through one supplier versus the risk mitigation that you get through a number of them.
Some of the UK manufacturers have been very focused around just-in-time across their supply chain. But the recognition is now that they need to have buffers in certain critical areas to mitigate the impact of what we're talking about.
Stephen: If you're an automotive company, then the smaller the number of suppliers you've got for a component, the greater economies of scale you will get and the lower the cost.
Therefore, if you are buying something simple, like a nut or bolt, you only want one supplier—if it goes out of business, you can easily switch to another supplier very quickly.
If you are sourcing something more complex, like brake systems for instance, you would tend to have multiple suppliers, one supplying 60% and one providing 40%. In theory, this arrangement should protect against interruptions to supply.
The problem is when it gets to a situation, like now, where you have a lot of distress across the entire industry. There’s little procurement teams can do to cope with the situation, so there is a risk of shutting production down, which runs into hundreds of thousands of pounds per hour in terms of loss.
Ross: I've got clients in the automotive supply chain that for the last few years have been looking at diversifying into aerospace and other sectors with similarly high quality standards.
This is purely so that if there's a bad spell in the automotive industry then they will have something else they can do and it will not be catastrophic.
When will the shortage end and what are the longer-term strategic changes that companies may need to make to prevent supply chain disruption affecting their business?
Ross: We could continue to see issues through to 2023. Japanese manufacturers have experience of managing crises given that they went through the impact of the 2011 Tōhoku tsunami, so they carry greater supplies of stock to see them through any unforeseen issues.
Maybe other manufacturers will have to learn they can't rely on just-in-time to the extent that it has been a part of operations so far. One of the things we're seeing is R&D, either looking at changing the chips to ones that are more readily available or reducing the number of chips that you have in the cars.
Stephen: I'd be creating a realistic business plan that takes off significant (e.g. 50% to 80%) of my volumes to automotive, run that through my P&L and work out how much loss I'm going to make over the next six to 18 months and work out how I'm going to fund it.
I'd be working out how to reduce costs and improve cash flow in the business to help it survive without losing key skills and personnel. This might involve short-term working, delaying or cancelling capital expenditure programmes and so on.
Ross: Another point is that the UK is a small player in the world chip market. This something that we need to focus on in the future, so we've got a robust supply chain in the UK.
Key actions for automotive leaders
- Be realistic. Produce robust forecasts that have been stress tested using different sales volumes, then identify how any potential funding requirements could be managed.
- Protect value. If the business is no longer viable, then identify patents or intellectual property that could be sold to improve the outcome for shareholders.
- Diversify. Identify alternative markets for components. Many automotive manufacturers could supply components to the aviation industry, for example.
- Re-engineer. Assess products to determine if a reliance on chips can be reduced, as well as seeking alternative sources of supply.
For more information, please contact our automotive sector leads Jon Gilpin or Stephen Cooney.