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How Are Small Automotive Suppliers Going to Face up to Future Technological Challenges?

Date:10-21 16:24 Source:autochina.comnews.cn Authour:Zhu Shiyun

According to research data recently released by the joint research group formed by the Chinese Automotive Technology & Research Center and China Auto Parts Industry Association, there are currently 100,000 automotive suppliers in China. Small and medium-sized businesses account for around 87%, and the industry average profit margin is 6-8%, only about 50% of that achieved by foreign-owned enterprises. The fact is that the small and medium-sized enterprises which currently account for 87% of the total number are mostly engaged in auto parts processing. So in a future competition oriented towards technology, where will the opportunities be for the Chinese auto parts industry?

Where will the opportunities be for the Chinese auto parts industry?

How Are Small Automotive Suppliers Going to Face up to Future Technological Challenges?

Haval H6 and GAC Trumpchi GS4 seem to have secured first and second place in China’s SUV sales ranking. They have both brought huge economic benefits to their makers, and given Chinese brands a real shot in the arm. However, to achieve sustainable development of the Chinese auto industry, we should also set our sights on the broader domestic auto parts industry. “In the future, the internationalization of Chinese car brands will probably be held back by the weak auto parts industry. If you want to build a factory overseas, you need a bunch of friends to help you out,” said one R&D head of a Chinese brand to International Business Daily.

According to research data recently released by the joint research group formed by the Chinese Automotive Technology & Research Center and China Auto Parts Industry Association, there are currently 100,000 automotive suppliers in China. Small and medium-sized businesses account for around 87%, and the industry average profit margin is 6-8%, only about 50% of that achieved by foreign-owned enterprises.

The Global Automotive Supplier Study 2016 (hereinafter referred to as the “Report”) published by the world renowned research agency Roland Berger also shows that, despite compound annual growth rate (CAGR) of up to 13.5% in operating revenues (from 2007~2015, the same below), Chinese suppliers have seen a decline in margins in recent years due to sharply intensified competition in their home market. Last year, the EBIT margin was 7.4%, while in 2007, it was 8%. The Report also shows that suppliers who focused on product innovation continue to maintain a two percent average margin lead over process-focused suppliers, and only the best-performing process specialists achieve profitability levels comparable to their innovation-focused peers.

The fact is that the small and medium-sized enterprises which currently account for 87% of the total number are mostly engaged in auto parts processing. So in a future competition oriented towards technology, where will the opportunities be for the Chinese auto parts industry?

Small and scattered suppliers face margin pressure

According to the Report, last year was another excellent year for automotive suppliers. Revenues increased by 34% over 2007, global EBIT margins reached 7.4 percent, one percent higher than that in 2007, and ROCE (Return on Capital Employed) was 13.5, only lower than that in 2010 and 2013.

However, good times don’t last long, because a polarization is becoming increasingly obvious.

Geographically, Europe- and NAFTA-based suppliers enjoyed much higher EBIT margins last year - 8.2% and 8% respectively. This can be attributed to their lead in innovative technologies. For example, driven by the currently trending Advanced Driver Assistance Systems (ADAS) and active safety technologies like ESP, chassis suppliers improved their EBIT margins to 7.7%, much higher than those of powertrain, exterior, electric system, information and entertainment and interior suppliers. Powertrain margins were pressurized by intensified competition and the cost of multiple innovations.

Unfortunately, highly profitable products do not come from China.

Their R&D source told International Business Daily that currently Chinese brands are weakest in technologies like automatic transmission and electronic control systems, despite huge demand. “Even now, a set of ESP still costs over one thousand Yuan.” ABS has been popularized among most domestic brands, but the majority of systems are still purchased from foreign suppliers. “Though Chinese suppliers also have ABS technology now, it is still too costly. If domestic brands can achieve annual sales of around 4 million vehicles, they will be able to afford local ABS.”

Among China’s listed companies engaged in auto parts manufacturing, the most profitable are mainly tire and glass suppliers. According to statistics from Gasgoo Auot Research Institute, in the first half of this year, listed companies engaged in auto parts manufacturing had better performance than last year – 22 mainstream automotive suppliers achieved operating revenues of nearly RMB 200 billion Yuan, a year-on-year growth of 16.3%, and net profits of RMB 10.435 billion Yuan, a year-on-year growth of 7.7%. However, their average profit margins fell, by 0.4%-5.2% on a year-on-year basis. 12 suppliers achieved profit growth.

The gap in profitability is gradually widening. According to the Report, innovative products feature higher differentiation potential and greater OEM willingness to pay[1] . Product innovators saw revenue CAGR of 4.4% while process specialists achieved 3.3%. Last year, they achieved EBIT margins of 7.9% and 6.1% respectively, with a gap of 1.8%, which was 0.1% higher over 2007. Meanwhile, in many innovation-driven segments, entry barriers were raised higher through intellectual property and the competitive structure was more consolidated, while in many process-driven segments, the higher fragmentation drove price competition.

The statistics revealed by Gasgoo also show that of the 100,000 automotive suppliers in China, only 13,000 have attained annual revenues of RMB 20 million Yuan. In terms of enterprise scale, small enterprises account for 62%, medium-sized for 25%, and large ones 9%. In 2015, R&D investment accounted for only 2% of total investment in the Chinese auto parts industry.

The future will be all about technology!

Driven by the Chinese market, an electrification revolution has been spreading around the globe, which is affecting the margins of powertrain suppliers.

According to the Report, last year powertrain suppliers achieved EBIT margins of 6.9%, lower than the 8.2% in 2007. Indeed the powertrain was the only one that saw a decline in margins among all types of auto part, partly because the compliance strategies of OEMs led to the increased production of alternative powertrains dominated by electric ones. Last year, ICE powertrain (including mild hybrid and ICE start-stop) production was 85.7 million units while xEV powertrain production was 2.1 million. Roland Berger estimates that by 2025, ICE production will reach 94 million, with a CAGR of less than 1% (2015-2025, the same below), while xEV production will reach 24.9 million, with a CAGR of up to 28%. By 2025, the global powertrain component market is expected to grow to EUR 279 billion, with a substantial shift toward xEVs, and the CAGR will be up to 20.4%.

China will undoubtedly be one of the major markets for electric vehicles in the future, but will Chinese automotive suppliers benefit?

An expert in electric vehicles explained to International Business Daily that currently there are still big gaps between domestic and foreign electric vehicles in batteries, motors and electronic control. A Chinese-made battery can store 2kw of electricity per kilogram of weight, while a foreign one can store 4kw. For motors, the core control unit IGBT (insulated gate bipolar transistor) will cost RMB 6,000-7,000 Yuan per unit, and most of them are imported.

In addition to the powertrain, ADAS and automated driving (AD) will also become a growing source of revenue for automotive suppliers. According to the estimates by Roland Berger, the ADAS and AD component market is expected to grow by 16% per year until 2025 and reach a global volume of almost EUR 30 billion. In terms of CAGR, this indicator will be 23% for adaptive cruise control/traffic jam pilot/highway pilot, 10.8% for blind spot detection, 10.5% for parking assist, 18% for drowsiness detection, 6.6% for night vision and 13.9% for lane departure warning.

Zheng Yun, Executive Director of Roland Berger, tells International Business Daily: “Smart driving is an incremental market, which can be significantly driven by competition between old and new suppliers. This trend requires suppliers to provide package services from hardware to software. With the gap in hardware being narrowed, software has become the key to decide whether a supplier can stand out. So now traditional automotive suppliers not only have to launch supporting hardware for smart driving in order to follow the new trend, but also need to keep a close watch on new software algorithm companies. When finding the targets, they can merge with or acquire these targets to improve their own software strength.”

M&A is perhaps way out

In the face of current market impacts and future technological challenges, one potential solution for the Chinese auto parts industry might be M&A. According to the Report, Chinese players have been an important buyer group, with 19 acquisitions completed since 2011. For example, Chemchina invested RMB 50 billion Yuan to become the major shareholder of the world leading high-end tire supplier Pirelli; and Northeast Industries Group acquired the “Fuba” reception system business from Delphi. This demonstrates Chinese buyers’ strong desire and power to buy.

Per the analysis by Roland Berger, most recent M&A deals were driven by technology and customer/market access. The biggest motivation for M&A is to gain access to new or strengthen existing technology/material or process capabilities to secure or establish unique selling points. Dominant acquirers from China include established, larger suppliers and OEMs in the field of autonomous driving.

According to the forecast by Roland Berger, the ongoing M&A activity in the automotive supplier industry will probably continue to be fueled by high amounts of available liquidity among enterprises and financial investors, as well as by substantial interest from Chinese and Asian buyers. As a result, the price level for automotive supplier acquisitions, which has grown considerably with EBITDA (corporate value, interest, taxes, depreciation and amortization) multiples being up to 50-100% higher than 5-10 years ago, is expected to remain high, especially for attractive assets. Despite current low financing cost, proper business cases based on operational synergies are becoming more difficult to realize. “In an environment of higher technological disruption and more short-term evolution of technologies, active portfolio management through M&A is growing in relevance for building up technological capabilities,” Zheng Yun tells International Business Daily, “Chinese suppliers gain better economies of scale and higher profits through M&A, while suppliers in developed countries that have dumped the burden of traditional business shift their future focus to new business areas with high added value and high technologies.”

Roland Berger also believes that in an environment of higher technological disruption and more short-term evolution of technologies, active portfolio management through M&A is growing in relevance for building up technological capabilities, in comparison with organic development.


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