COVID-19’s impact on auto industry

“15 days to flatten the curve” is approaching its first anniversary. The impact of COVID-19 on the auto industry is far-reaching. The primary consequences are barely understood, let alone the ones further downstream. Restrictions from governments at the local, state, and federal level, around the globe, have made the predictability of assuring manufacturing operations at pre-COVID daily capacity impossible. Capacity restrictions, hourly restrictions, and closures are random, severe, and often based on PCR tests that are bordering on meaningless. Furthermore, these restrictions are based on “re-open criteria” that is ever-shifting and ill defined, if defined at all.

Lets say a customer wants you to quote a part. This part is required to pass both DV and PV testing before it can be approved for production. Traditionally, these tests are based on rigidly defined test procedures and explicit acceptance criteria.

Would you quote a part to a customer whose test acceptance criteria is:

“Pass is whatever I say it is, my criteria can and will change at any time, and full acceptance will never actually be granted. Additionally, there are other people just like me. Pass is whatever they say it is, their criteria can and will change at any time, and full acceptance will never actually be granted by them either. You must satisfy me, plus all the other people just like me, before full approval shall be granted. Furthermore, if you dare to question any aspect of this plan, you will be demonized publicly for literally wanting grandma to die.”

“Following the science” is a phrase completely devoid of meaning. “Following the science” is what people who are utterly clueless about science say about science.

Nobody in their right mind would even think about quoting a part with the test acceptance criteria mentioned above. Why are you so willing to accept that it’s your fault you can’t meet the manufacturing capacity you initially quoted? Your quote was made before governments around the world added the exact same “manufacturing reopen criteria” above to every link in your global supply chain.

Primary impacts are legion: Manufacturing plant closures with non-firm re-open dates. Permanent manufacturing plant closures. Random border restrictions and closures. Flight restrictions. Mandatory quarantines for personnel. Mandatory quarantines for parts in some cases. Social distancing with no correspondingly larger manufacturing areas. Less $ earned per square foot of manufacturing space. These primary impacts are hard enough to model themselves. Add in downstream consequences at the Tier 1, 2, 3, and higher levels, and it becomes a near impossibility to predict the train-wreck headed our general direction.

Secondary and tertiary impacts are even more convoluted. OK – so maybe the miner of the raw materials you need is still able to work at pre-COVID capacity. They just gave you the thumbs up. However, they just learned that the firm that makes the equipment they need had restrictions placed on them, leading to reduced raw material output. Again – this kind of thing is impossible to predict. These are anything but obvious connections.

We can make educated guesses. Anybody who says they know how this all plays out is lying.

All is not lost. To use a popular phrase, we’re all in this together.

Commodity and asset prices

As if the variables above could be accurately modeled (and they can’t), there is also a grand economic experiment being tested – globally.

U.S. M1 Money Stock

It took more than 15 years, from June 15, 2004, to February 3, 2020 to create the last 2.73 trillion dollars. It took only one year, from February 3, 2020 to January 25, 2021, to create the next 2.73 trillion.

Again – anybody who says they know how this all plays out is lying. Unprecedented does not even begin to describe what’s going on.

There are those arguing this may lead to inflation. I disagree. Technically, this is the very definition of monetary inflation. Will it lead to price inflation? I argue it already has.

Many, if not most, people associate inflation with the consumer price index, or CPI. Are your groceries getting more expensive? Is your rent getting more expensive? Gasoline? Clothes?

What is happening with the prices of assets lately? Anybody who is invested in the stock market is seeing a lot of “inflation” in broad categories of asset prices. Anybody who’s sold a house recently is pleasantly surprised at the “inflation” in real estate values. Anyone who’s just bought a house is shocked at how expensive they’ve become.

1 Year Case Shiller National Home price index beats 5 year performance by 63%

I do some remodeling work on my home. I use an outfit called Garvin Industries for some of my electrical work. They overwhelmingly sell galvanized steel electrical boxes, conduit, and fittings to commercial electricians. Here’s the notice I just received:

Garvin notice dated February 15, 2021

Good thing steel or shipping isn’t used in very many things, or this could get serious.

Anybody who already knows the overall size of the molds they might need should be buying the steel now. Speaker baskets? Same instructions. Engine blocks? Heck yes. Body panels: You betcha! Rotors: Certainly.

At least it’s only steel we have to worry about right? There are gold bugs and there are silver bugs. The copper bugs have slightly edged out both this past year, even with the short squeeze on silver in recent headlines.

Well, how much of our BOM cost is actually comprised of steel and copper? Not much really. At least what we use most of isn’t increasing in price – right?

I will spare everyone the rest of the commodities, but unless you consider hotel rooms and luxury cruises commodities, they are either doing awesome or terrifying, depending on which side of the transaction you’re on The increase in the PPI will lead the increase in the CPI, at least for the things people are most interested in buying.

Cube farms are so Pre-COVID

From every one of our competitors, to every one of our customers, there will be some firms that lose and others that win. We’ve been forced into a year long experiment we could have attempted at least a decade ago, but didn’t have the nerve to try: Work From Home (WFH): All day. Every day. It turns out we really can work from home efficiently. Knowing this, why on God’s green earth are so many companies holding on to cube farms? What benefit do they provide over WFH? I’m listening. Crickets.

  • Why are you paying rent, or a lease, or a mortgage on that many empty square feet?
  • Why are you heating and cooling that many square feet?
  • Why are you paying property taxes on it?
  • Why are you paying maintenance on it?
  • Why are you paying liability insurance on it?
  • Why are you just asking for a lawsuit over an employee or customer that catches COVID at your facility and later dies? It wouldn’t even need to be proven.
  • Why even bother with this headache? It’s totally self inflicted at this point.

Some companies see the WFH writing on the wall. They refer to it as WFHF (Work From Home Forever). Others (the ones who will lose) think things are going back to normal real soon. May I remind you: 15 days to flatten the curve. Sure it will. Any day now. Right around the corner. Keep telling yourself that. Your competitors will ditch their cube farms and fund only lab space, a few conference rooms, and some flexible work areas. If you want to survive, you must do this as well. The sooner the better. Those that didn’t will be competitively quoting against those that did. You think competition is intense now? Just wait. Sell those cube farms before everybody understands their true value: Approaching zero. Heck – you could convert the spaces to residential or expand your testing facilities if you’re absolutely stuck with the space. Just stop paying for empty cube farms – please. Hear that sound? It’s your valuation slipping away.

I bet your employees would overwhelmingly support this plan. So much so they’d be willing to pay for their own high speed internet and telephones in exchange for potentially never having to commute to the office again. I surely would – and I only had a 13 minute commute. In fact, I have been using my own high speed internet service. I have been using my own monitors. My monitors at home provide me 65% more total pixels than those I had at the office. The bathroom is closer. Less distractions from chatterboxes. More convenient and healthy lunches. Better lighting. No shoes required. I could go on. What are we waiting for? This is a win-win. Employers save overhead cost. Employees are happier and more productive. What – exactly – is not to like about this?

The only downside to this plan is a selfish one: How many million annual vehicle miles are driven by cube-dwelling employees on their daily commutes to the cube farm? This will put some amount of downward demand on new car sales as current vehicles will not rack up as many miles and require replacement as quickly. However, your competitors will do it, if they aren’t actively planning it already. Your choice. Should be an easy one.

Shipping

The overwhelming majority of previous cube dwellers are now working form home, at least some of the time. The overwhelming majority of the office working planet has been forced to spend a lot more time at home. Many are now there both during work hours and afterwards, whether they like it or not.

Disclaimer: I was a borderline recluse before this whole thing started. This has not impacted my life much.

The amount of shipments going to homes all over the world has increased. Many of these shipments are air freight.

Air freight once reserved for things that were relatively urgent (like late car parts) are now used to deliver everything under the sun to every person under the sun. This has resulted in a surge in demand for air freight, with the resulting pricing and availability pressures. Now – the parts keeping 5,000 people from being able to build a car are competing for airplane space with OLED TVs or other electronic gadgets being demanded by adults bored out of their skulls by the lock downs and going crazy from the social isolation.

Speaking of electronic gadgets and OLED TVs, your suppliers of microprocessors and electrical components are now flush with the new customers mentioned above. These electronic gadgets have much less stringent specs than the automotive industry, as well as much shorter production and service support requirements. Your X-box and iPhone don’t need to operate from-40°C to 85 °C and survive thermal shock, vibration, humidity endurance, or any of that nonsense. Furthermore, as long as the device doesn’t literally catch on fire, there are no real high severity failure modes for consumer electronics. Annoyed customer is about the worst it gets.

If I were a microprocessor manufacturer, I would prefer to supply consumer electronics over automotive – all day – every day. Now we’re competing for micros from that fast growing segment as well.

And you thought your troubles were limited to raw material prices and unpredictability of manufacturing operations.

Mitigating risk?

Again – we are all in this together, It’s not in our interest to bankrupt our suppliers any more than it’s in our customer’s interest to bankrupt us. Nobody wins when that happens.

Expect and prepare for cost increases and margin squeezes. From the furthest tier suppliers to your customers to their customers, everything that there is a strong demand for is going up in price. Hedge what you can with your finance team. Work to improve receivables so the cash can be put to use hedging downstream material and process prices. If there ever was a Force Majeure moment – this is it. Hire legal representation skilled in this law. Pre-COVID contracts are obsolete. If you aren’t even referencing raw material pricing in your latest contracts, how are you still promising year over year cost reductions? Are you nuts? If you are paying to fly parts to your customer because your supplier was facing restrictions illegal to avoid, how exactly is this your problem? If your customer is saying everything that was promised pre-COVID is still in force because we’re “back to normal,” remind them to get their head examined – just do it politely. These are late car parts. Nobody is going to die if they can’t get their car on the same date predicted 20 months ago. 8 months before the entire international supply chain was mangled beyond all recognition by force of law.

Everybody is somewhat lost right now. The smart people with impressive credentials from name-brand universities don’t know. If anything is obvious this past year – it’s that the downside of arbitrary lock downs is supply chain gyrations that will resonate for years to come. This is OK. You don’t need to be the smartest. You do need to understand that it is never going back to normal. The sooner you accept this, the sooner you can address it. You definitely want to be making bold decisions now, since they’ll only be forced on you later, and on much less favorable terms.

Conclusion

The precedent has been set. The public has accepted it with barely a whimper. It is foolish to think this is ever going away. Things are never gong back to normal in the office environment. The new normal is a command from a single local, state, or federal official declaring your production capacity and profitability “nonessential.” It is declaring your office at full capacity illegal. Why expose at least that part of your business to this risk at all? Ditch the cubes. Stick a fork in them. They are done. You have quite enough challenges and risks to voluntarily accept that one.

Things are anything but predictable in the global supply chains. Ditto for commodity prices.

There is global experiment in monetary policy ongoing and how it plays out is anyone’s guess. If you truly believe that more dollars chasing assets, materials and and labor will lead to decreases in prices of these things – ignore everything I’ve said about hedging and buying commodities now. Short them if you truly believe they are already overvalued.

Hire global supply chain experts. Hire expert legal counsel regarding contracts. Force Majeure escape clauses may be buried 3,4,5,6 tiers down the supply chain and you just haven’t unearthed them yet. Anybody arguing things are “back to normal” is ignorant, lying, or posturing. Call their bluff.

You don’t need to be the best and fastest, but you also can’t just close your eyes and make believe some nebulous”back to normal” criteria will ever actually arrive. The dinosaurs clinging to the hope that the all clear siren will soon wail will go bankrupt. Don’t be one of these.

Since intense competition for raw materials, labor, and shipping will only accelerate, you need to take a good hard look at any and all of your internal processes. Streamline these processes now. Reexamine anything that is putting you at a competitive disadvantage since there’s going to be a lot more of these coming your way. Can your competitors do high value add processes in house that you are forced to outsource? Consider looking at what it takes to bring these processes in house. Outsourcing high value added processes is especially risky in this brave new world. You barely understand your local government’s edicts. Concede that you are utterly clueless about forthcoming edicts coming your way halfway around the world, at a supplier whose facility you’re not even allowed to visit in person anymore.. Any link in your supply chain is at risk. Repair the weak links now.

You have 2 choices: Either fight the lock-downers, or fight the customers who pretend the lock-downers don’t exist while forcing you to pay for the consequences of their actions. The lock-downers are here to stay. They will be here as long as we put up with them. They’ve gotten a taste of power and are not about to give it up willingly. You can’t concede to both the lock downers and the customers who pretend they don’t exist and actually stay in business.

Bottom line: Stop conceding to everyone.

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