Automotive sector: Repositioning required for Germany's flagship industry players

By Felix Mogge

The automotive industry has for years been undergoing a massive transformation. Alongside the growing demand for electric mobility and the market entry of new competitors like tech giants, the current supply chain problems add another challenge to the mix. In a situation exacerbated by the outbreak of the war in Ukraine, the industry has been struggling with a shortage of intermediate products since the start of the Covid-19 pandemic. Rising inflation and energy shortages could be the harbingers of brand new problems. Nevertheless, thanks to the sustained high demand for new cars in the market, OEMs have come through the crisis well so far. What is striking, however, is that their success has been largely at the expense of suppliers. Roland Berger's automotive and restructuring experts are in no doubt that this will have to change in the upcoming years if the continued successful evolution of Germany's flagship industry is not to be put at risk.

OEM dominance puts a strain on suppliers

The fate of the classic internal combustion engine in the EU is sealed. From 2035, newly registered cars and vans must be emission-free. Even though the automotive industry has already begun the transformation towards electric mobility, the impacts on procurement and production remain challenging. The difficulties are compounded by competitors from beyond the industry coming in with new business models or digital platforms that compete with Germany's incumbent automakers, particularly on software and autonomous driving.

Over the last two years, the pandemic and now the war in Ukraine have further exacerbated the challenges for car manufacturers and their suppliers. But German automakers were still able to increase their margins and generate profits in 2021. The reasons can be found in the sustained high demand for new cars, extensive cost-cutting programs, and a focus on the production of high-margin models. Suppliers, on the other hand, are struggling with massive cost increases and have not seen such good profit development. While German OEMs can currently boast double-digit margins, suppliers are achieving only four to five percent.

The Roland Berger experts believe that this development cannot continue and will by 2030 lead to real structural changes in the industry that will fundamentally alter the way OEMs and suppliers interact. The current crisis has been mainly borne on the backs of suppliers so far, their costs having risen across the board, thus lessening their value creation. OEMs, on the other hand, are benefiting from their market power. To restore the equilibrium and reflect the continuing sharp rise in energy and material costs, the balance of power must shift in favor of the suppliers.

Energy prices and inflation as potential game changers

Rising energy prices represent a particularly high and growing burden for Germany's automotive industry. Many companies have long-term supply contracts that protect them against energy price rises. But the industry is dependent on numerous energy-intensive intermediate products, plus there is no way to rule out the chance that a lack of primary energy in the near future may bring production of certain vehicle components to a halt. So it is feared that automakers and their suppliers will be affected by the energy crisis too. Added to that are the massive increases in the price of raw materials and supplies. Given the time lag between the rise in costs, the renegotiation of prices, and the new prices becoming effective, the supplier industry in particular is being hit very hard.

With regard to the cost of (re)financing, the industry did well out of the low interest rates of recent years. Given the robust demand and record margins being enjoyed by automakers, the rising interest rates will likely have little impact on companies for the time being. However, it remains to be seen how consumer sentiment will develop over the coming months, as rocketing inflation and the rise in the cost of living that comes with it reduce purchasing power across the board. This could have a negative impact on people's longer-term purchase plans for consumer durables such as cars and may jeopardize OEMs' previously strong sales.

Cooperation put to the test

The aftermath of the Covid-19 pandemic continues to be felt, with the periodic lockdowns in China having not only negatively impacted the demand situation in the world's most important automotive market but also permanently disrupted global supply chains. The intermediates and supplies that are missing because they are still on container ships waiting to be cleared in ports are paralyzing production, putting pressure on automakers and suppliers alike. Building additional capacity in other regions or locations could be an alternative, but this transformation is not something that can be accomplished overnight, and it also costs a great deal of money. The balance between OEMs and their suppliers therefore needs to be reset. That said, experience shows that whenever the two lock horns, OEMs usually have the upper hand and often leave the suppliers to solve their own problems.

The geopolitical tension with its increasing polarization may well result in additional upheaval. Economic troubles are foreseeable if there is a further entrenchment of bloc building between Europe and the United States on the one hand and Russia and China on the other. That would, for the time being, prevent companies from relocating production capacities. Raw materials that are essential for production, such as rare earths, are only available in certain regions of the world, which means there are dependencies that can never be fully avoided. A structural transformation towards alternative suppliers and shorter supply chains will thus be necessary, especially since even the OEMs will not have many opportunities to exploit global production cost differentials. Suppliers could benefit from shorter supply chains. But even here it is questionable who will end up paying for the transformation. Faced with the current special situation, supplier takeovers for the purposes of stabilizing supply chains would not be out of the question.

Partnerships are the key

The shrinking market for internal combustion engines and the additional burdens imposed by the Covid-19 pandemic and the Ukraine war emphasize just how explosive the multi-layered transformation is going to be in the coming years. The Roland Berger experts are in no doubt that OEMs and suppliers need to tackle the current challenges they face together. But that can only work if the two sides regain some of their former closeness and reset the balance of power in order to successfully continue their traditional partnerships.

Register now to download our joint study "Compass for Germany - Pressure to act in uncertain times". You can find numerous articles on the current "state of the nation" as well as the global crises and their impact on companies and the economy.