Relationship of OEMs and components suppliers in auto ecosystem

The auto industry is a significant one for Asia and as Deloitte prepares to moderate a Roundtable for Chinese private sector enterprise leaders at the Boao Forum for Asia 2016 Annual Conference on March 23, we think it timely to share some observations on the changes we are seeing in the auto industry ecosystem.

The expansion by original equipment manufacturers (OEMs) in recent years has led to a rise in quality-related problems, challenging the auto industry's long-term development. Increasing car sales are accompanied by an increasing rate of complaints and the press has reported on a number of recalls of different models of different car brands. The majority of these recalls have been attributed to the quality of auto components, highlighting the need for OEMs to not only maintain excellent product design, customer relationship management, and public relations, but also but also apply new criteria and practices to manage and control their relationships with auto components suppliers, who have become increasingly important members of the auto ecosystem.

We are seeing an evolution in how OEMs are cultivating and governing their auto ecosystem. Based on latest industry best practices and cutting-edge management theories, OEMs have begun to shift their management of components suppliers from contractual cooperation to a coexisting and interdependent relationships, from short-term control to long-term control, from technical quality control to financial and operational control.

The financial performance of components suppliers is a direct reflection of their business performance. Financial performance not only shows previous operating results, but is also indicative of their capability to sustain their business for the long term. A comprehensive and effective financial monitoring system includes assessment of solvency and key performance indicators. Solvency is mainly decided by comparing free cash flows and operating capital with industry-established optimum levels. Solvency assessment results act as a one-vote veto - once the solvency of an enterprise is challenged, the enterprise will fail to maintain daily operations since all operational and investment activities are terminated immediately. Key performance indicators, i.e. identified representative financial indicators, provide a comprehensive evaluation of the financial stability of an enterprise by assessing four dimensions—profitability, asset efficiency, financial structure, and asset "shiftability" — against the optimal level within the industry and a score transformation formula. The optimal level within the industry is, of course, always evolving, making it necessary for participants to keep themselves updated in a timely manner.

While necessary, it is usually not easy for OEMs to obtain the financial data of their upstream enterprises, namely components suppliers, especially during early cooperation as enterprises naturally are concerned to protect their financial data. However, with the trend for increasing cooperation and integration between upstream and downstream enterprises, the auto ecosystem has evolved such that in recent years OEMs have required components suppliers to proactively offer their financial data, cooperate with OEM inquiries, and adopt the internal control measures promoted by OEMs. Due to their active cooperation with OEMs, components suppliers are adopting advanced management tools and the latest industry best practices, leading to win-win situations for both OEMs and component suppliers and a more robust auto ecosystem.

The auto ecosystem is now very different from the early days of cooperation between OEMs and components suppliers which was either in the form of market-based contracts and agreements with European and American enterprises as representatives, or in the form of control—usually direct control through shareholding and investment—with Japanese enterprises as representatives. Today's auto ecosystem is about coexistence and interdependence, placing much greater impetus on constituents have much more to integrate effective management tools.