Chip shortage to continue into 2024, EV first movers to face more competitive pressure, warns AlixPartners’ Stephen Dyer
The semiconductor chip shortage that has wreaked havoc on the auto industry over the past couple of years could last until the end of 2024 and is just one of many headwinds dogging the industry that will erode longer-term profitability, according to Stephen Dyer, Managing Director of AlixPartners and co-leader of the global consulting firm’s Greater China Business.
“Things may continue to be a challenge for a couple of years. Beyond that, we hope that the clouds will clear and will be able to see a path back to growth,” Dyer told me in a recent conversation about the state of the industry. “But the chip shortage, we believe, will continue into 2024, maybe even to the end of 2024.”
Our conversation centered on an industrywide analysis recently published by AlixPartners, which indicated that this prolonged supply chain hiccup is fueling pent-up demand but also causing operating inefficiencies and reversing the profit pools between OEMs and suppliers. The current demand-over-supply leverage in the marketplace is driving near-term profitability but is not sustainable in the long-term, according to the study. Inventory is likely to build once demand and supply are even, eroding pricing power, and additional costs to build resiliency into the supply chain adds to pressure that the growing BEV investment (totaling some $526 billion globally) demands are placing on the industry.
“I don’t know if things will get worse, but they won’t immediately get better,” said Dyer. “So especially the chip shortage, it seems very clear it will continue until at least 2024.”
Raw material costs are coming down but won’t go back to where they were a year and a half or two years ago in the next two years, predicted Dyer. “They’ve peaked and they’re coming down now. But we think that’ll be a little bit slow. There are still a lot of geopolitical situations, crisis in Ukraine that’s affecting some aluminum and precious metals and so on,” he said.
The study indicates that raw material cost increases have not yet been fully reflected in automaker and supplier performance, and potential supplier distress combined with the need to have suppliers as partners in the enormous BEV transition should temper expectations of the profitability dichotomy continuing after raw material prices fall and automakers begin to restock and lose pricing power.
“The overall profitability of the auto industry last year increased substantially in the face of all these issues, and the reason is mainly because of price increases, because there’s been a shortage of supply of vehicles and change in product mix,” said Dyer. “The OEMs have allocated those chips to their most profitable vehicles. So as a result, the OEMs have gained almost 3 percentage points of EBITDA, benefiting from these shortages more than suppliers.”
For the first time in many years, OEM profitability on average was higher than supplier profitability, according to Dyer. But he expects that to rebalance in favor of suppliers in the future. For now, OEMs will continue to do well from a profit standpoint through to 2023, then it’ll peak, and then supply and demand will stabilize, and profitability will necessarily go down, he predicted.
That rebalance of the value chain will place a greater emphasis on supply chain assurance, security and availability, and the shift to EVs will cause many both OEMs and suppliers to reevaluate what they should be doing in house versus outsourcing to suppliers or partners, according to Dyer.
“When a battery maker invests in raw material mines, I think that’s a natural strategic move when there are potential supply shortages, or when things might be disrupted by geopolitical events,” he said. “We also see OEMs consider either acquiring or entering the battery manufacturing space or forming joint ventures with battery cell manufacturers. It’s kind of the equivalent to the old times when OEMs would acquire engine manufacturers so that they could have the engine in house, because anything that is as expensive as a battery and as critical to the performance of an electric vehicle in the market as a battery, the OEMs are going to think very hard about should they inhouse that or have more control over that.”
Dyer believes that in the transition from ICE to BEVs, both OEMs and suppliers must proactively manage that shift in their supply base and their product portfolios to lower the cost of transition to BEVs, which is about $70 billion if not proactively addressed. And the ones who have done this well will be the ones that are successful.
With respect to China, Dyers sees a couple of trends related to geopolitical factors.
One is on supply chain, where clients, without exception, are looking for opportunities to re-shore or to localize supply chain to where they manufacture.
“The winners in that reshoring or that reshuffling of the supply chain have been Mexico and Vietnam and Eastern European countries, while China has faced challenges,” said Dyer. “It started suddenly in 2019, when the tariffs were implemented in the U.S. for China imports. But it’s a gradual trend that’s exacerbated by the supply chain, logistics costs increase, freight, bottlenecks, at ports, and pandemic controls affecting travel and shipments.”
The other is foreign companies are more hesitant than before when it comes to all-in investments in China.
“I hear a lot of talking about it. So that’s sort of a pre-signal of what’s on their minds, the minds of leaders, like we have to organize our business in China so that we can deal with any situation whether it’s increase or decrease of tariffs, we can scale it up or down,” he said. “I think companies are looking for flexible ways of operating so that they could deal with any contingency.”
The auto industry in China, though, remained strong and resilient throughout the pandemic, and the rapid rebound after the onset of the pandemic in early 2020 as well as the rapid rise of EV penetration since then surprised Dyer the most.
“I never expected that the auto industry would rebound so quickly in China. The other thing that has really exceeded my expectations is the penetration of electric vehicles,” he said. “The government set a target of 20% of new vehicle sales by 2025 to be new energy vehicles, and by the end of last year, and a few months into 2022, we had already exceeded that.”
That penetration has largely been driven by Chinese smart EV startups, what Dyer refers to as the EV first movers, as well as the traditional Chinese OEMs. But he warns that they will face increasing competitive pressure from global traditional OEMs launching new EVs over the next 2–3 years.
“The Chinese EV players definitely got first mover advantage and took the lead in the race. Even with Tesla coming in, the overall market is dominated by Chinese players,” said Dyer. “But the number of EV models launched will be very high over the next 2–3 years, and we expect by 2024, almost all of the major global OEMs will have a broad portfolio of EV products, and these will be very well engineered and likely competitive. These didn’t exist when the Chinese players launched their products.”
Having said that, Dyer believes that the international expansion of these Chinese players including some of the first movers, will eventually reach North America.
“It’s inevitable. I think the prospects are clear that this will happen,” he said. “It’s a matter of who and when, and I don’t think every Chinese company will be successful at that, but I think some will be.”
Dyer says that even though China is the biggest automotive market in the world, Europe and North America are huge markets and are very attractive. The question is whether they can maintain their value proposition in those markets.
“Can they maintain that cost advantage in these markets? That’s a challenge for them,” he said.
