Suppliers struggled to make money when industry volumes were almost double what they are today, and the consolidation that has occurred has been happening mostly among smaller companies at the lower tiers. Now, we are near a tipping point where the scale and scope of supplier failures at all levels will increase dramatically.

To right-size capacity levels and promote a viable industry, we believe 30 to 40 percent of all suppliers are at risk due to the necessary alignment of capacity with demand, which should stabilize in the 12 to 14 million-unit range by 2010-2011. But if the scenario plays out in an uncontrolled fashion, every automaker will almost certainly lose production and incur steep financial losses. Without a structured approach of consolidation to the benefit of the entire supply chain, the industry may lose critical partners with the technology, scale and geographic footprint that are linchpins in the viability equation.

—Laura Marcero

Automakers have their much-reduced staffs fully subscribed in keeping their own businesses afloat, she said. Meanwhile, adding further downside pressure is that banks in many cases are working to reduce their exposure to the auto industry. Further, the government may be suffering from the early stages of bailout fatigue. All of this suggests that suppliers have to decide their own fates, and recruit reluctant stakeholders to their cause.

Suppliers need to proactively determine whether they are a consolidator or a consolidatee. For those that are best suited to operate as consolidators, they need to step forth and provide solutions to their peers and stakeholders.

—Laura Marcero

The first step for any supplier consolidator is to take stock of its business, right-size its own operations, critically evaluate the industry trends for its particular commodity and the competitive landscape, and develop a strategic plan. The balancing act, and perhaps the most challenging item to work through, is for suppliers to win the active support of stakeholders, including the automakers, the bank and the government. This will require increased involvement by government, trade industry organizations and supply chain experts.

This is clearly a lot to ask of the suppliers in a short period of time, but they know their individual spaces much better than anyone else. Frankly, if another constituent group was going to drive the supply base consolidation, it would have already occurred. Instead, the industry is somewhat paralyzed so the suppliers need to take charge themselves and immediately begin to facilitate this process.

—Laura Marcero

Assuming suppliers can develop credible plans, Grant Thornton has identified contributions and concessions that may be required from other stakeholders in the industry’s future.

The Role of Government. The government can greatly increase the chances for a successful industry consolidation by taking immediate steps to spur confidence among lenders, stimulate consumer demand for vehicles and give some measure of regulatory relief.

• Guarantee Receivables: The optimal way to do this, given the time constraints that exist, is to provide a government guarantee of the OEM receivables and inventory with the assurance from the lenders that incremental funding will flow to the suppliers. This will not alleviate the entire liquidity problem, but it will buy some time for the suppliers to formulate the consolidation plans.

• Stimulate Demand: The programs included in the stimulus bill signed last month may help rebound consumer demand, but more aggressive action to move sales into the 12-14 million-unit range as quickly as possible will help inject much needed liquidity into the entire system.

• Consider Revisions to the Bankruptcy Code: The current bankruptcy laws may need to be reviewed so that mega automotive cases can continue to pay pre-petition debts. Without removing the automatic stay provision of the bankruptcy code, a filing by an automaker could cause a string of other failures.

• Coordinate with Anti-trust Officials: The government should consider the application of certain provisions of anti-trust regulations and how the automakers and interested parties can openly discuss how best to facilitate consolidation in the industry without fear of government or civil legal action. This would help automakers identify and support the most viable companies.

The Role of Banks. The liquidity crisis in the supply base was set in motion by sharp production cuts at the automakers, but it has been exacerbated by the lack of credit available from banks and other lenders.

One of the great ironies of the economic crisis is that TARP-supported banks are reducing their exposure to the TARP-supported auto industry, thereby increasing the likelihood that more TARP money may be injected into both industries. Lenders need to be assured that committing a share of their existing and future TARP funds to immediately increase advance rates and/or loosen covenants to allow funds to flow to automotive suppliers is in the best interest of both parties.

—Laura Marcero

Other key actions for lenders to take include:

• Provide Affordable Financing: The interest rate on loans to finance consolidation efforts should be set at lower lending rates. These low-cost loans would be used to fund new equipment purchases, acquisitions, and the wind-down costs associated with moving one supplier’s production into the consolidator (whether inside or out of a chapter proceeding).

• Amend Loan Terms: Banks could place a moratorium on principal payments and/or renegotiate amortization terms to provide a debt service reprieve until volumes stabilize.

• Lend Through the Downturn: Potentially provide over-formula or “air ball” loans (a loan whose value exceeds the value of the collateral) to allow consolidators to manage through the downturn. The air ball portion would be repaid partially by the government and partially by the supplier. This of course requires OEM buy-in and their assurance that the individual supplier is a critical, long-term player.

The Role of the OEMs. “Automakers will have to cease the current stop-gap solutions for individual companies and help suppliers put together longer-term solutions,” said Marcero. Key initiatives OEMs should implement include:

• End the Game of Musical Chairs: Historically, when a key supplier has reached the brink of bankruptcy and production is threatened, an automaker will move its work to a new supplier if it can or step in with cash injections to keep the foundering company afloat. But in today’s environment, this practice has been overwhelmed by the sheer number of at-risk suppliers. OEMs and suppliers may need to have frank discussions about the financial health of the supply base, consolidation, and must coordinate a forward-looking strategy down to the commodity level.

• Don’t Overreach: With the entire supply chain so vulnerable, automakers should err on the conservative side when forecasting volumes for new or resourced programs. The supply base needs to know what it can realistically count on for production so proper financial business planning can occur. Announcing new downtime on a week’s notice is turning the suppliers inside out.

• Apply Positive Reinforcement: In today’s environment, it is in automakers’ best interest to support consolidators and help them move proactively and strategically to ensure the combined companies have the right product, technology and geographic footprint to meet customer needs.

Getting all of this work done with the clock ticking will be hard, but the task is not insurmountable. The rewards for successful execution will be great. With all of the costs and capacity being wrung out of the system, the auto industry may become spectacularly profitable as demand climbs back toward trend levels.

—Laura Marcero