16 Aug 07 Global automotive companies to increase offshoring

The intense competitive pressures in the automobile industry, especially in the US and Europe are forcing original equipment manufacturers (OEMs) and ancillaries to explore the outsourcing and offshoring options.
The global automotive industry including, vehicle producers and suppliers of auto parts both in North America and Europe are facing several challenges. Ford (NYSE:F), the second largest auto manufacturer in the US reported revenues of $160 billion for the year ending Dec 2006, a 9.5% decrease from the previous year. Similarly, several other auto majors such as General Motors (NYSE:GM) and Chrysler are struggling to increase profitability. This is in turn being transmitted to the suppliers. Several major ancillaries are also experiencing significant problems. Delphi declared bankruptcy, while Visteon had to be bailed out by Ford.

The intense competitive pressures in the automobile industry, especially in the US and Europe are forcing original equipment manufacturers (OEMs) and ancillaries to explore the outsourcing and offshoring options.

Key Challenge

Growing competitive pressures: While competition amongst the US and Europe automobile manufacturers is getting fierce, Japanese companies such as Toyota and Hyundai are adding fresh capacity that is further increasing the price competition.

With the competition intensifying, companies are seen re-locating their production centers to lower cost locations. In North America, companies are moving centers from Detroit to the South and South West while Central Europe (Poland, Czech Republic, Slovakia, etc.) is the preferred location for new production centers in Europe.

Further, to make matters worse for US carmakers, consumer preferences are gradually changing towards the fuel-efficient smaller cars manufactured by Asian and European auto companies.

Cost reduction: Competition and over capacity has kept a lid on the pricing power of carmakers. Thinner margins are forcing global companies to outsource to lower cost geographies like India, China, Eastern Europe, Mexico and Brazil. An auto company can save around 40 to 50% of design and engineering costs by offshoring these services. Labor costs / salaries form a large chunk of the savings.

Shorter product cycles and reduced profitability: Carmakers are required to come out with annual variants of existing models while at the same time a continuous flow of new models is a must. Environmental awareness and growing demand is resulting in shorter design cycles. The product development lead-time has fallen from 30-40 months to 10-20 months. In such a situation, the existing design capabilities of automakers are being stretched beyond their capacity. Outsourcing or offshoring remain the most viable option to keep up the flow of new models / designs.

Expansion of capabilities and win non-domestic business: Companies can benefit enormously due to sharing and pooling of skills from different design locations across the world. This is more applicable for global OEMs and ancillaries who set up subsidiaries in various locations. It is usually beneficial to have a design center at the manufacturing location. This helps in understanding the unique requirements of different local markets and then introducing new models that cater to those requirements. The learning and capabilities developed during the design process for one market often proves useful for design for other markets.

Moreover, given that the growth is expected to come from emerging markets, there is considerable incentive to build local design capabilities. Once these are established, it makes sense to leverage these low cost operations to serve other markets.

Services Offshored

Automobile companies are increasingly outsourcing complex engineering works like designing product components. The design and engineering services offshored can be categorized into either mechanical or electronics design.

Mechanical design services such as data conversion and migration, drafting, detailing and meshing are largely offshored. Concept design is rarely offshored.
Electronics design services that primarily include embedded systems are not as easily offshored, but this is changing.

Future Outlook

The outsourcing of design and engineering services constitutes a market of about $11 billion. We believe that outsourced engineering and design will witness double digit growth per year for the next five years. Within this, offshoring currently accounts for less than 20%, and with revenues in the range of $300 to 380 million for 2006, India is a significant offshore destination. This is primarily due to availability of engineering graduates and offshoring industry maturity. With vendors such as Satyam, Infosys, QuEST, Neilsoft and Onward with strong capabilities in this space, we believe that outsourced engineering and design will witness high growth.

ValueNotes Research
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