How can suppliers improve EBIT profitability?

The cost pressure in the automotive industry has recently risen enormously: increased material, personnel and energy costs as well as increasingly global and complex supply chains are driving up manufacturing costs and weakening the location. This development is putting pressure on suppliers in particular to continuously increase their profitability. In my experience, this requires improvements in three areas of action:

• product and process quality,
• der Kosteneffizienz und
• der Performance,

Whereby I do not only refer to the operational area in the plants, but also include the administrative and support company units.

To achieve these optimizations, I recommend the following eight measures:

1. Establish consistent liquidity management, including for debtors
2. Conduct a comprehensive working capitalAnalysis
3. In-depth analysis and optimization of contribution margins
4. Consequent implementation of the operational excellence approach
5. Implementation of a "Profit and Cash Improvement Program"
6. Implementation of controlling and margin tracking in project management
7. Detailed cost breakdown of purchase prices
8. Detailed cost-breakdown of sales prices

1. Liquidity management for creditors and debtors

It is always astonishing how carelessly companies handle their financial resources. Suppliers (creditors) pay on time, but customers (debtors) do not practice dunning - even though the saying goes "cash is king". This can be changed:

1. First of all, you should install fine-meshed financial tracking of customers - and use it consistently in the weekly management team meeting.
2. In addition, the support of the sales managers should be requested promptly for accounts receivable management. Liquidity management often fails due to a lack of coordination between project management, sales and finance department.
3. If contractual terms and conditions are not consistently known, this unnecessarily throws a spanner in the works. It is better to make the terms and conditions easily accessible to all parties involved.

2. Working capital analysis

Global supply chains are becoming increasingly complex and demanding. This makes them extremely sensitive and susceptible to disruptions. Events such as flooding, an accident in the Suez Canal or delayed unloading of container ships can paralyze supply from one day to the next.

Disruptions cannot always be explained by missing microchips or supplier insolvencies. They are also caused by unstable and frequently changing OEM call-off figures. The further back you are in the supply chain or tier sequence, the greater the impact.

Optimized inventory management for more liquidity and performance

Supply chain management often relies on staff working overtime to solve supply chain problems, but often also on special trips or air freight. However, these are all cost drivers that further reduce the company's profitability.

Instead, I recommend that the first step is to promote the "just-in-time" philosophy and reduce safety stocks or batch sizes. In a second step, this approach can be further optimized with a "just-in-sequence" strategy - especially as this is unavoidable for certain product groups or with a very high number of variants anyway. Of course, hardly anyone responsible for SCM wants reduced stocks and batch sizes. After all, this immediately causes extensive challenges in the event of disruptions.

However, reducing inventories and batch sizes is a good way to check, accelerate and improve process quality throughout the entire company. This is because process instabilities only become apparent when there are difficulties or bottlenecks and can only be sustainably combated and eliminated afterwards.

In this context, I recommend two things:

1. Establish the Heijunka principle in production, i.e. production smoothing, and the customer-oriented pull principle without overproduction.
2. Set up consignment and supplier-operated warehouses (keyword "Kanban" and "Vendor Managed Inventory").

Further working capital measures

When it comes to working capital, diverse tool stocks should also be taken into account. This includes stocks of old or discontinued tools and their spare parts. Secondly, there should be monitoring of customer tools that have not yet been accepted and invoiced, i.e. are still in the start-up phase or owned by the supplier. Here, project management is required to intervene accordingly.

3. Analysis and optimization of the contribution margin

Optimizing the contribution margin is one of the most important levers for increasing the EBIT, competitiveness and profitability of an organization. This requires a complete analysis of the contribution margin, which identifies the operational cost drivers and their development. In particular, the focus should be on factors such as costs for the use of goods and personnel, machines, tools, quality management and logistics.

Based on these findings, the profit situation can be assessed in detail in a second step and, if necessary, measures can be derived to improve the contribution margin.

An analysis of the contribution margin is essential, particularly in light of the massive increases in costs for materials, personnel, energy and logistics. These have risen massively as a result of the pandemic and the Russian attack on Ukraine. However, suppliers have hardly passed these costs on to customers, if at all - which is a particular challenge given the multi-year contracts that are the norm in the supplier industry. Insufficient activity here can very quickly lead to significant revenue losses.

4. Systematic operational excellence based on the Kaizen principle

All too often, organizations reduce the topic of operational excellence to lean production. However, their impact can be increased many times over by implementing the Kaizen principle and establishing a continuous improvement process throughout the entire company organization.

Experience has shown that the best starting point for this is store floor management and Gemba meetings directly on site - i.e. where value creation takes place. This is where deviations from the target are recognized immediately; they should be rectified quickly. For new projects and product launches in particular, this is a decisive lever for detecting unforeseen costs at short notice and reducing them immediately.

Zero-defect philosophy in production

In production or assembly, the "one-piece flow" and "zero-defect" philosophy should be pursued. This target approach is of course extreme. I readily concede that it is not always fully feasible in terms of costs. But as an ideal it should certainly be followed, especially as it also has a positive effect on inventory management. In any case, you can use this approach to increase production performance and operational plant performance in the short term, but above all in the long term.

5. "Profit and Cash Improvement Program"

In my experience, the core component of an EBIT increase should be business excellence. By this I mean, among other things, the establishment of a Profit and Cash Improvement Program (PCIP). An important factor for the success of such a program is the analysis of other operating expenses (OOE), i.e. all other expenses or cost drivers that are not directly operational. These include expenses for buildings, rents, intercompany charges, purchased services, shared service fees and the costs of licenses and travel.

Many companies fail to critically question these administrative cost factors, to analyse them with the necessary care and to implement appropriate measures in a disciplined manner. There is considerable potential for cost optimization here. I would therefore recommend a very consistent and complete cost analysis across all areas of the company (lean administration) - from the porter to the shipping dock.

6. Controlling and margin tracking in project management

There are also often considerable cost burdens in project budgeting or project management. The reason for this is often that customer orders are accepted in sales-driven organizations without a sufficient overview of total costs. An overall presentation of all costs is often only available after the customer order or the specific project order, which therefore becomes a potential financial risk. Even if it is not always easy, the overall cost planning should be prepared as completely as possible for the RFQ (Request for Quote) and approved as a whole by all departments involved. The progress of the project and the planned results or income are then ensured in regular project controlling (gates).

I would also like to advocate consistent margin tracking of projects. This is because the additional income from a project is all too often used for financial deviations. This embellishes results and is not in the interests of the client.

In fact, all of this also applies to change management. However, there is something else to add here: Sufficient additional cost claims are a prerequisite in change management.

7. Cost-breakdown of purchase prices

As a result of the massive waves of inflation in recent years, many an understaffed purchasing department has reached the limits of its capacity. This can cost a company a lot of money and jeopardize its financial stability.

A well-organized review and approval process established in globally operating units is the best antidote. Such a process answers questions like these:

• How many times has a particular supplier raised its prices?
• Is there a cost-breakdown (CBD) of the prices or increases?
• Are these price increases that can be passed on to customers?
• Has the customer agreed to these increases at short notice or is there a supply risk?
• How are batch sizes handled for supplier managed inventory (VMI) and the respective payment targets?
• Are there alternative suppliers approved by the second source strategy?

The check may lead to the conclusion that the purchase prices are too high. In this case, the purchasing department should try to renegotiate in order to improve the conditions afterwards.

8. Cost-breakdown of sales prices

The growth targets of the sales department are usually derived from the company's balanced score card (BSC). Purely sales-oriented, short-term targets often have a negative impact on a company's earnings situation. Therefore, the bonus should be linked to the sustainable EBIT development of the organization.

Because growth targets alone set wrong and possibly counterproductive incentives: Sales tries to acquire new orders - whatever the cost. The main thing is that the sales target is achieved and the bonus is paid out. The ones who suffer are the operating plants, which may even have to grant price reductions. This happens in the best companies, but can trigger serious crises.

This is where many critical questions arise:

• How are the sales prices structured? Are there volume-dependent graduated prices?
• Do the purchase quantities match the contractual order quantities?
• How have the quantities developed over the product life cycle? Will there be millions or will we only deliver a few hundred thousand units?
• Will the projects run for seven years as announced or have we reached the EOP ("End of Production") prematurely?

There are said to be companies that accept all material price increases in order to win new orders, which could of course prove to be a boomerang given the current inflation. In any case, there are a number of measures that can be taken to counteract this:

1. It is essential to track the development of earnings at project and item level.
2. In addition, cost breakdowns and post-calculations should be easy to create and analyze as needed.
3. It is also important to critically scrutinize the breadth of the item portfolio and the respective call-off lot sizes.
4. It should also be checked whether appropriate spare parts prices have been set.
5. Finally, the approval process for price adjustments should also be reviewed. In the context of energy price control, an adjustment should only be able to go up.

If there is a corresponding need, the only remaining option is to approach the customer with a resilient CBD and demand or implement sufficient price increases. A fair partner should have a great interest in a stable supplier.

Conclusion: Two complementary strategies for increasing the EBIT margin

Medium-sized automotive suppliers are under enormous cost pressure due to their dependence on OEMs, supply chain issues and the rising cost of materials, personnel and energy.

In order to withstand this pressure, they need to sustainably increase the EBIT margin. There are two strategies to achieve this:

The first is to focus the organization on operational excellence - including the establishment of an intensive and continuous improvement process in line with the kaizen principle. The focus here should be on productivity, product and process quality in particular. Key points here are zero defects, the pull principle, one-piece flow and the elimination of waste and inefficiencies.

Secondly, the focus on business excellence with the aim of systematically improving earnings or contribution margins and the equity ratio and/or liquidity. The basis for this is a comprehensive analysis and streamlining of all administrative processes with a focus on added customer value and reducing inefficiencies. Best in class across the entire value chain from order initiation to customer satisfaction.

Both approaches complement each other and should be implemented together.