Understanding the-health-of-your-supplier


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Understanding the-health-of-your-supplier

  1. 1. September 2010 Understanding thehealth of your supplier: Is your company fuelled with working capital?At a glanceWith demand hard-hit by the Suppliers looking to increase Suppliers, OEMs, and investorsrecent recession, many suppliers production in response to should consider benchmarkingrestructured their operations and improving market conditions may analysis of working capitaladjusted trade working capital to have capacity challenges and requirements and developingreduced demand levels. pressure on liquidity. strategies to better understand future liquidity prospects. pwc
  2. 2. Understanding the health of your supplier network: Is your company fuelled with working capital? Introduction: cash patterns. These variations can have major impact on a risk With demand hard-hit by the assessment since the evaluation recent recession, many suppliers of currently available liquidity and restructured their operations and future cash requirements may adjusted trade working capital differ significantly depending to reduced demand levels. As a on the business model of the result, suppliers now looking to analysed supplier. increase production in response to improving market conditions may In this article, we look at the impact have capacity challenges and will of the recent market developments often need to finance in advance on working capital requirements significant shares of their purchases, and highlight some of the different putting pressure on liquidity. Thus, trends observed across segments. OEMs and suppliers need to We also describe the advantages of understand and respond to the using benchmarking analysis when resulting risks for their supply chains considering liquidity patterns and or investments. working capital requirements. Thus, Those suppliers that survive the initial phase of an improved market with a solid liquidity cushion could have the financial flexibility to benefit from the recovery afterwards and the opportunity to gain a considerable competitive advantage. While traditionally risk management identifying and including companies has focused attention primarily on of the relevant segment within major suppliers, small and mid- the benchmarking base is critical sized suppliers can also represent to understanding and assessing a key element in the supply chain. the overall risk levels of a specific These small and mid-sized suppliers company. Finally, we provide some may have more limited financing strategies for suppliers, OEMs, resources and other levels of and investors looking to better working capital provision than understand the future liquidity larger players, and correspondingly prospects of their companies and higher risk profiles. Our working competitors, supplier base, or capital analysis shows that different potential investment targets. segments of suppliers have different2 PricewaterhouseCoopers
  3. 3. The economic crisis: Full speed to hard brakeThe global recession had a massive The US market was the first toimpact on the automotive industry. be hit by the economic crisisIn Germany alone, more than in 2007, although the downturn100 suppliers filed for insolvency. quickly spread to European andAcross the Atlantic, two of the Asian markets during the courseso-called Detroit 3 OEMs, General of 2008. Consequently, EuropeanMotors and Chrysler, went through suppliers with a major share of theirbankruptcy that impacted many of business coming from the UStheir suppliers. market generally experienced a greater decline in EBIT in 2008 thanThe impact of the crisis on the did those with a strong focus onP&L was dramatic. Operational the European Market. Our analysisprofitability of European suppliers shows that small and medium sizedfell by more than 70% between companies experienced the smallest2007 and 2009, from 5.3% to 1.4%, impact on margins, possibly asrepresenting the steepest decline they tend to have a smaller globalin the past five years (Figure 1). footprint.Revenue growth came to a virtualhalt in 2008, with an increase of just1.5%, and collapsed in 2009, as Figure 1:revenues declined 21.9%. EBIT margin and revenue growth rate Median, in %While the downturn had a negativeimpact on all segments of the 15%industry, some suppliers wereless able to weather the crisis 8.5% 10% 7.5%than were their industry peers. 5.8% 3.7%Service providers in particular, 5% 1.4% 4.8% 4.4% 5.3%such as engineering companies, 0%experienced a decline in profitability 1.5%of almost 6% from 3.7% to -1.9% -5%in 2009 (Figure 2). When thecrisis began, OEMs and tier-1 -10%suppliers limited their outsourcingof development projects and -15%contracting third parties. As a result, -20%order books of service providers -21.9%dried up after the completion of -25%ongoing projects in 2009. 2005 2006 2007 2008 2009* EBIT margin Revenue growth rate Source: PwC SupplierFacts *2009 based on set of 61 selected suppliers PricewaterhouseCoopers 3
  4. 4. Sidebar heading 1 out of fuel? Scarce liquidity: Running In order to preserve liquidity, While the need to free up cash may many companies looked to have been paramount for some, reduce investments and began cutting R&D can be a risky strategy. reassessing projects in research and Demand trends are shifting and development (R&D). This strategy technology is changing rapidly, was only able to offer limited so suppliers that cut back too potential savings, as projects in significantly on programs which progress were usually finished to drive innovation risk losing their minimise sunk costs. As a means competitiveness. Further, new to increase liquidity, this strategy regulations are creating increased is generally more effective over the technical demands on the industry. mid rather the short-term. Given the Suppliers and car manufacturers precipitous drop in demand and the may need to return to a higher difficulties inherent in cutting on- level of investment in the medium going projects, it is not surprising term to keep up with changing to see an increase in the relation of demands impacted by regulation CAPEX to revenues in 2008. In 2009, and competition. as more programs drew to a close, the level of investments bottomed out, with CAPEX averaging a mere 4.1% of revenues. Figure 2: Figure 3: EBIT—Margin by sub segment EBIT—Margin by size Median, in % of revenue Median, in % of revenue 8% 8% 6% 6.9% 6% 5.8% 5.7% 5.7% 5.4% 4% 5.6% 4.8% 4.5% 1.2% 0.6% 1.2% 1.8% 1.6% 0.8% 4.2% 3.8% 3.7% 4% 3.6% 4.5% 3.5% 3.4% 2% 4.0% 2.3% 2.2% 3.5% 3.4% 2% 2.8% 0% -2.1% 1.3% 0.1% -2% 0% -4% -2% -6% -8% -4% Exterior Chassis/ Powertrain Interior Electrical/ Service Raw <1,000 1,000–5,000 >5,000 Underbody Electronic Provider Materials 2007 Revenue in Mio. € 2007 2008 2008 2009 2009 YoY Change 2008/09 YoY Change Source: PwC SupplierFacts Source: PwC SupplierFacts *2009 based on set of 60 suppliers4 PricewaterhouseCoopers
  5. 5. Figure 4: Figure 5:CAPEX Working capital to salesMedian, in % of revenue Median, in % of revenue7% 18%6% 16% 6.0% 5.5% 5.6%5% 5.1% 14%4% 4.1% 12%3% 10%2% 8%1% 6%0% 2004 2005 2006 2007 2008 2009* 2005 2006 2007 2008 2009* Source: PwC SupplierFacts 500 >5,000 *2009 based on set of 60 selected suppliers 500–1,000 Median 1,000–5,000 Source: PwC SupplierFacts *2009 based on set of 30 selected suppliers Many companies viewed working Furthermore, the first signs of capital as another feasible source recovery at the end of 2009 resulted of liquidity. Facing zero or negative in a restocking. This is reflected growth, working capital was quickly in the year end values of working adjusted to the new levels of capital of the analysed suppliers. demand, and unrealised reserves to cover operational liquidity demand A characteristic of the economic were released. crisis was the limited access to external financing via established As a result, net working capital sources such as banks and capital was reduced to a level below the markets or equity investors due to average in periods of economic the high degree of uncertainty and growth and stability. Working capital disrupted global capital flows. Small to sales was reduced from 13.4% suppliers in particular tend to have in 2006 to 10.7% in 2008. This drop limited access to capital markets is effectively a 20% decline and and often had to rely on internal represents 2.7% of revenue. The sources of financing. Our analysis impact cannot be overstated—the shows that the group of suppliers liquidity achieved from working with less than m€ 500 revenue capital reduction equals 45% of were able to reduce working capital the capital expenditure in 2008 or between 2007 and 2008 more than 30% of the average EBITDA of the their larger competitors; however, European supplier industry. In 2009 with a ratio of 12.7%, the working suppliers continued to draw upon capital of this group of suppliers is working capital as a key source still above the average. In 2009 the of liquidity, however, due to the suppliers had to restock partially, speed of the revenue decline the but nevertheless working capital levels of working capital could remained below pre-crisis levels. not be adjusted simultaneously. PricewaterhouseCoopers 5
  6. 6. First signs of an upswing Some signs of hope for an many industry observers expect improving economic outlook and a decreasing sales volumes as such recovery in automotive demand can initiatives come to an end in most be seen: in the emerging markets of countries. India and China, demand showed a strong jump in August 2010; demand in India was up +34% Markets in Eastern Europe and Russia are still behind the registration levels seen before the crisis. in August and in China demand Recovery would certainly be increased +37% YoY in August. preferable to further stagnation In May 2010 Moody’s Investors or decline; however, increasing Service upgraded the outlook for demand also implies certain near- the global automotive industry to term risks. Following a period of positive, and mature markets such low or negative earnings and limited as the US posted more stable sales access to financing, due to the than expected in the first quarter of restrictive lending policies of banks, 2010. However other major markets suppliers and car manufacturers remain unpredictable. In Western may have tapped every remaining Europe, demand for passenger source of liquidity. Many suppliers vehicles was propped up by may need to reassess their working scrappage schemes in 2009 and capital policies to ensure that these are able to respond to market trends.6 PricewaterhouseCoopers
  7. 7. Acceleration needs fuel Optimisation of working capital is with suppliers were maxed out or generally considered essential for renegotiated. Occasionally, car a lean and efficient management manufacturers agreed to settle of companies. Improving capital trade liabilities earlier to support efficiency and thus capital charges their supply base. For example, a remain one of the main issues for German OEM decided to pay its operational management. But what suppliers earlier at the end of 2009, does the observed reduction of eliminating a major share of trade working capital mean? And what receivables—and thus working are the implications for supplier and capital—of the OEM’s suppliers. manufacturers as well as banks and investors? Such measures only offer a stop-gap solution. If demand for In the wake of the recent economic passenger cars and commercial crisis, even small companies are vehicles normalises, levels of actively addressing these questions working capital is expected to revert and working capital management in the direction of the levels seen has become a focal point of before the crisis.While in general the recent reduction in working capital levels is positive,companies may want to ensure that they watch their liquidity closely and to remainfinancially flexible to cover increased liquidity demands when growth returns. interest for nearly every enterprise. This could have a double impact on This renewed attention has led to the liquidity of suppliers. Suppliers the uncovering of hidden reserves may experience an immediate and the optimisation of processes cash outflow due to the additional and stocks. In the long run this working capital requirements of their could result in a leaner organisation, current level of revenues. Further, less capital requirements and an increase in demand could result additional value for shareholders. in the need to allocate additional capital to working capital reserves Indeed, the current levels of working in order to finance the additional capital at suppliers are not likely revenue growth. to be sustainable. In the search for liquidity, terms of payment PricewaterhouseCoopers 7
  8. 8. Assuming that automotive suppliers return to a normalised level of working capital to revenue from 11.7% at the end of 2009 to the average of about 13.2% for the European supplier industry, working capital could need to grow by approximately 28.1% in 2010 compared to 2009. Many of the key forecasting established than those of their larger parameters remain difficult to counterparts. Thus, they may be predict, so projections for 2010 still more sensitive to growing demand. reflect some uncertainty. In this light, the PwC Autofacts Group expects Despite growing revenues, global assembly to be 68.7 million profitability may remain low. Pre- vehicles in 2010. crisis production levels are not expected to be realized for some Smaller sized suppliers may time, while global assembly experience even greater challenges. overcapacity could remain at a high In general they have less negotiating level, particularly in Europe, putting power and are less likely to be pressure on car manufacturers to able to dictate conditions to other demand further price cuts from suppliers and car manufacturers. their suppliers. While investors and Smaller suppliers also showed banks are likely to remain reluctant the highest net working capital to finance automotive suppliers, and reduction in comparison to larger only medium to large sized suppliers suppliers, and they may experience may have direct access to capital a strong rebound effect. And while markets, the quest for liquidity will we have seen impressive success remain on the agenda of automotive in 2008 and 2009 regarding the suppliers. Indeed, for many it may reduction of working capital, the gain in importance and in some working capital management cases additional suppliers may processes at small sized suppliers face illiquidity. are still less robust and well8 PricewaterhouseCoopers
  9. 9. Benchmarking as integral part of financial forecasting Many companies are aware of be grouped and benchmarked to the patterns of working capital reveal the liquidity pattern of the requirements when demand specific sub segment. To assess returns after a downturn, however, the risk of a specific supplier it is they may not have implemented helpfull to map the relative position sufficient tools to monitor and and performance of the company, control the respective risks. Risks as well as its current and future and countermeasures often vary liquidity requirements. depending on a company’s position within the value chain. The benchmark for such evaluation of a supplier can be derived from a Our analysis shows that working comparable peer group to provide capital based liquidity patterns may realistic targets. For example, vary significantly depending on the engineering service providers that size of the company. But size is have a high share of revenues from not the only determiner of liquidity products that are compensated on requirements. Other factors that a per part base, when the specific determine the supplier’s business part is used in production of a model such as strategy, global supplier or OEM, generally have footprint and product and service higher working capital requirements portfolio are equally critical. It is than those engineering service obvious that each supplier could providers that focus on pre- react individually on growing production development such as demand; however, certain suppliers prototyping. Thus, comparing the with a similar business profile can current or future cash requirements Figure 6: Implementing benchmarking in a risk management system Combine Define and benchmarking Gather resilient Define peer group calculate data with database relevant KPIs forecasting model • Direct competitors • Standardised • Define KPI relevant • Historic liquidity or companies with structure of for specific segment patterns of sub a similar risk profile collected data • Configure threshold segment combined • Experts judgment • Audited data values for KPIs and with market of comparability preferred sub segments forecasts of peers advisable • Corporate level, • Suppliers, OEMs • Analyse historical where data is and investors/ development of collected, should banks need to set peers to verify be comparable up process based comparability on individual requirements PricewaterhouseCoopers 9
  10. 10. of an engineering service provider different products instead of direct available—individual accounts focused on the development of competitors as part of the peer for companies with no major production parts with the working group. subsidiaries. capital targets of prototyping focused service providers could To ensure a robust analysis, the Subsequently, meaningful key result in an underestimation of future historic performance of identified performance indicators (KPI) have liquidity needs. peer companies should also be to be defined. They may differ for It is therefore essential to adjust the parameters and threshold values of a risk monitoring tool to peer group specific levels to assure a high level of reliability of the monitoring system. The first step in implementing compared to the performance of the specific segments and should a benchmarking analysis as the focus company. This allows a be chosen individually to measure part of the risk management comprehensive peer group with a the relevant value drivers of the and forecasting system is the representative business and risk business. Using the collected data, appropriate definition of a profile to be identified. the historical values of the KPIs can representative peer group. Direct be calculated and segment specific Afterwards, resilient data of the peer patterns identified. competitors would seem to be group needs to be gathered in order the perfect fit, since they bear a to analyse performance. During this Finally, the identified patterns should comparable risk implied in the process particular attention should be combined with forecasting data business model. However, “pure be paid to the following factors: to assess the risk of predicted play” suppliers of a single product or product segment are the exception. market developments. While historic • Data should be gathered in a results will not be a guarantee If the targeted peer companies standardised structure to provide offer a similar product, however, it for future trends, the identified a comparable database; patterns qualify as a suitable early represents only part of revenues for some of these companies and • Audited financial statements indicator. Forecasts should focus the risk profile will differ. The same should be used. Major differences on both the future development of principle holds true for other factors in accounting standards should the automotive market in general such as size or primary customers. be eliminated or considered when and the specific market of the focus In some cases it might be more data is analysed; company. External automotive appropriate to use companies industry production forecasts, with similar business models but • Data should be collected on in combination with macro and a consolidated level or—if not micro economic indicators, are a10 PricewaterhouseCoopers
  11. 11. good foundation for a forecasting • Continuously optimise and reduce • Continuously benchmark datasystem. Based on this data a working capital requirements; with respective peer group tomarket model can be derived for monitor relative performance;the relevant segment. Combining • Implement an integrated cashthe projected market developments flow forecasting methodology • Simulate liquidity risks based onwith the selected, identified cash based on market projections, forecasted market developmentflow patterns (e.g., working capital including working capital and sub-segment industrypatterns) will render possible the requirements; patterns.calculation of how KPIs of the focus • Consider results of integrated Investors face the risk of mispricingcompany are likely to be impacted forecasting in the development a potential investment in theby market developments. of financing strategy and your pre-deal phase. Once they haveThe process of implementation communication with external invested, they may end up losingof an efficient and reliable risk creditors. the investment or needing to injectmanagement system using historical capital into a troubled investment OEMs also face supply chain risk. due to a misinterpretation ofdata as well as forecasting data While most OEMs monitor the future capital requirements. Theseneeds to be tailored to the individual bigger suppliers, small and medium concerns also apply to banks andneeds of the addressee. Installing sized suppliers, as well as tier-2 other creditors. The following stepsa benchmarking functionality in suppliers, can remain below the could help to reduce such risks:your risk management system radar. Nevertheless, a default bymay contribute significantly to the a specialist supplier may cause • Compare historical capitalquality of the results. Suppliers, major disruption in the supply or development with peer groupOEMs and investors should monitor production process or even halt to assess performance ofthe financial health of the supplier production. The following steps can the company;industry, but they face somewhat help to reduce the risk for the OEMdifferent issues, and will need to • Reflect future business plan with and increase transparency:refine their models accordingly. historical benchmarking data to • Get access to selected, validate plausibility;Suppliers face the risk of limited standardised financial data ofaccess to working capital financing • Simulate cash requirements own suppliers as well as selected,in times of growing demand. based on industry patterns critical tier-2 suppliers (best inPossible countermeasures include and assumptions regarding class processes may requirethe following: market development; critical tier -2 suppliers and those• Analyse and understand working who supply time-critical parts or • Derive impact of cash capital requirements through components to self-provide this requirements on return on industry cycles; information on a regular basis); investment and debt service.• Monitor working capital • Categorise suppliers to pre- on a timely basis as one defined sub segment with of the key KPIs for top individual industry pattern (e.g., management reporting; electronic supplier, engineering service provider, etc.); PricewaterhouseCoopers 11
  12. 12. Gentlemen, keep your engines running While the worst of the economic understanding the numbers may crisis may be behind us, major risks not be enough, though. Automotive for all participants in the automotive players also should consider having value chain lie ahead, even if access to sound forecasting that demand recovers. For this reason, helps anticipate changes in demand. suppliers, OEMs, investors and Combining financial benchmarking creditors should consider further with an integrated forecasting focus on liquidity issues. They methodology can provide a sound could benefit from understanding analytical basis for decision making. the industry patterns for each relevant sub segment, including Those players that survive the crisis capital requirements driven both and the initial phase of an upswing by working capital and by future with a solid liquidity cushion may CAPEX needs, which may have to have the financial flexibility to increase to pre-crisis levels in order benefit from the recovery afterwards to keep up with the technological and the opportunity to gain a progress of the industry. Simply considerable competitive advantage.12 PricewaterhouseCoopers
  13. 13. More about the SupplierFacts Benchmarking ToolWe analysed the influence of the crisis with our SupplierFacts BenchmarkingTool to understand the implications on the financial performance of suppliersand to identify major risks for suppliers, car manufacturers and investors, aswell as external creditors. We drew upon the annual reports of almost 200European automotive suppliers for the period 2004-2008 to create a historicaldataset. For 2009 we analysed a set of 60 automotive suppliers with a globalfootprint.To have a deeper conversation about any of the issues inthis paper, please contact:AuthorsJan Ebertjan.ebert@de.pwc.comPhone: +49 511 5357-5858Dr. Michael Borgmannmichael.borgmann@de.pwc.comPhone: +49 511 5357-5851
  14. 14. pwc.com/autoRegional Automotive Practice Lead PartnersGlobal Automotive Leader North America Automotive LeaderRick Hanna Dave Breenrichard.hanna@us.pwc.com david.j.breen@us.pwc.comPhone: +1 (313) 394 3450 Phone: +1 (313) 394 6559European Leader Asia-Pacific LeaderFelix Kuhnert Graeme Billingsfelix.kuhnert@de.pwc.com graeme.billings@au.pwc.comPhone: +49 711 25034 3309 Phone: +61 (3) 8603 3007Global Automotive Tax Leader South America Automotive LeaderHorst Rättig Marcelo Cioffihorst.raettig@de.pwc.com marcelo.cioffi@br.pwc.comPhone: +49 30 2636 5301 Phone: +55 (11) 3674-2000Automotive MarketingMonika Schwarzermonika.schwarzer@de.pwc.comPhone: +49 711 25034-1262© 2010 PricewaterhouseCoopers LLP. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP,a Delaware limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other memberfirms of the network, each of which is a separate and independent legal entity. This document is for general information purposesonly, and should not be used as a substitute for consultation with professional advisors. DT-11-0020