Outsourcing the Line
June 1, 2006
Most people who purchase a BMW X3 have no idea that it's not built by the company from Munich, Germany, that claims to provide "the ultimate driving machine." The $36,000 sport utility vehicle is actually assembled by Magna Steyr, a contract manufacturer that builds cars for several other automakers, including DaimlerChrysler (Auburn Hills, MI) and General Motors Corp. (Detroit). Last year, the company assembled more than 100,000 X3s for BMW.
Magna Steyr's flexible assembly lines are located in Graz, Austria, a charming city that boasts some of Europe's finest Renaissance architecture. Ironically, the company has pioneered a new production paradigm that may help solve some of the auto industry's age-old production woes.
Numerous products, from cameras and cell phones to toys and televisions, are assembled by contract manufacturers. However, the concept is viewed with more skepticism in the conservative auto industry. Automakers traditionally do final assembly, even though they outsource many components and subassemblies, such as cockpits, seating and front-end modules.
Unlike the computer industry, for instance, automakers prefer to operate their own final assembly lines, including body and paint shops. A variety of reasons contribute to this philosophy, such as union contracts, quality concerns, liability issues and, of course, the overall complexity of the product.
According to Ron Harbour, president of Harbour Consulting (Troy, MI), "somebody has to make it. In any business, the 'best model' has to give you the lowest cost and best quality. Toyota, for example, believes that with their system they can do that better than anyone else. For others, the model may be different, but they can't get away from the current one because of union issues or lack of suppliers with the capital to do it."
While old habits die hard in the auto industry, a handful of independent European manufacturers have successfully applied the contract assembly concept to low-volume niche vehicles. Most of the companies specialize in building convertibles and roadsters with production volumes under 50,000 vehicles per year. It allows OEMs to get vehicles to market faster without tying up capital and production capacity.
Some experts believe that the contract assembly concept can be tweaked and applied on a wider scale, especially as automakers continue to turn out more and more specialized products to meet unique consumer tastes. In fact, several contract manufacturers plan to set up assembly lines in the United States in the near future.
Economic BenefitsOutsourcing offers numerous advantages for OEMs, especially in today's highly fragmented and competitive auto industry, with more types of cars available than ever. Products continue to proliferate every year. Indeed, there are more niche segments, platforms and nameplates on the market today than 15 years ago, and there appears to be no end in sight.
According to J.D. Power and Associates (Westlake Village, CA), 316 different models will be available in the United States alone in 2008 vs. 216 in 1993. For instance, consider Mercedes-Benz. In 1992, it offered consumers only seven basic products. Today, the German automaker has three times that number and generates approximately 30 percent of its sales from niche models.
Between 1985 and 2004, average annual sales per vehicle nameplate dropped from 106,819 to 48,626. By 2010, that number is expected to drop to 40,000.
A recent study conducted by the Center for Automotive Research (CAR, Ann Arbor, MI) predicts that low-volume vehicle production will increase in the future. In fact, CAR has identified 60 new low-volume products that will be built in North America between 2006 and 2010. "Low-volume often means premium price," says Jay Baron, CAR's director of manufacturing engineering and technology. He defines low-volume as anywhere from 10,000 to 40,000 vehicles.
Paul Wilbur, president and CEO of American Specialty Cars Inc. (ASC, Southgate, MI), believes "the time is ripe in the U.S. right now for Asian automakers, whose lineups all could use a shot in the arm in terms of niche vehicles. It's also ripe for most American brands, and will become more so after GM and Ford get their capacity issues sorted out." Wilbur says ASC plans to open a plant in North America later this year to assemble low-volume vehicles.
As consumers continue clamoring for more distinctive models, automakers are under increasing pressure to develop new vehicles. And, given today's competitive landscape, they're being forced to get those products to market faster than ever. However, even with flexible plants, it can be difficult for automakers to meet production runs that average less than 50,000 vehicles.
A recent study conducted by Mercer Management Consulting and the Fraunhofer Institute for Production Technology and Automation (Aachen, Germany) predicts that more production will shift to suppliers and service providers for engineering or assembly.
"The decision to engineer and build a vehicle in-house or outsource it to a vehicle integrator is a complex process," says Baron. "OEMs must first decide whether to outsource part or all of the product engineering. Then, a vehicle manufacturer can proceed down two paths-assembling the vehicle in one of their own facilities or outsourcing the assembly. These are all basic 'make or buy' decisions that are a function of availability and cost of required human skills, physical plant capacity, and tooling and equipment capabilities."
If approached the right way, contract manufacturing can provide economic benefits to automakers. For instance, it exposes OEMs to a minimal amount of downside risk.
According to Christian Eick, head of new business development and marketing at Wilhelm Karmann GmbH (Osnabruck, Germany), one of the biggest advantages of contract assembly is the ability for OEMs to balance rapidly fluctuating market conditions. "We offer the expertise to develop and produce entire vehicles," he points out. "[Contract assemblers] can cover the total chain of value-added production, including body-in-white, paint, final assembly and delivery of the vehicle to the customer.
"Time to market is one of our main strengths," claims Eick. "We have the flexibility to cope with different market requirements over the years and over the months."
Karmann recently worked with DaimlerChrysler to produce the Chrysler Crossfire sports car. The partnership enabled the OEM to quickly develop a vehicle that was a popular concept car at the 2001 North American International Auto Show in Detroit. It only took 18 months between the start of the project and the delivery of the first car to a customer. Karmann assembles the vehicle on a standalone line, but employs a shared paint shop using batch production.
Contract manufacturers also offer OEMs short-term buffer capacity during production peaks and model phaseouts. This process is called "peak shaving" and is defined as adding capacity outside of an automaker's assembly system to meet peak demand.
Peak shaving helps avoid production bottlenecks at the beginning or end of a project. For instance, when an OEM is changing over its assembly lines to build a new generation or class of vehicle, a contract manufacturer can assemble the final units of the previous derivative.
On the other hand, contract assemblers can help out when an automaker struggles to keep up with demand for a popular new vehicle. That happened several years ago after Chrysler introduced its 300C sedan. When the vehicle quickly became a hit with consumers, the automaker's Brampton, ON, assembly plant struggled to keep up with demand. Magna Steyr was called in to help reduce bottlenecks and build cars for overseas distribution.
Who Does It?The independent coach-building tradition still thrives in Europe, where there are six active players in the contract assembly market. In addition to Karmann and Magna Steyr, contract manufacturers include Carrozzeria Bertone S.p.A. (Grugliasco, Italy), Heuliez (Cerizay, France), Pininfarina S.p.A. (Turin, Italy) and Valmet Automotive Inc. (Uusikaupunki, Finland).
Each company has carved out a unique niche by building convertibles and other low-volume vehicles. The firms supplement their sporadic assembly work with design, styling and engineering projects.
Magna Steyr is the largest contract car manufacturer in the world. Over the last 5 years, annual production has tripled from 75,000 to 240,000 vehicles. The company has 9,000 employees who can build 1,000 vehicles a day using six body shops, two paint shops and five final assembly lines. Magna Steyr traces its roots to 1899, when it manufactured bicycles. It started building automobiles 102 year ago when the company was called Steyr-Daimler-Puch. The company was acquired by Magna International Inc. (Aurora, ON) in 1998. The "world's biggest automaker without a brand of its own" assembled more than 230,000 vehicles in 2005.
Karmann traces its roots to 1901, when it started building horse-drawn carriages. The company began making automobile bodies a year later. Over the years, Karmann has had a long relationship with Volkswagen. Today, the company operates three assembly lines where it builds the Crossfire, in addition to the Audi A4 cabriolet, the Mercedes-Benz CLK cabriolet and the Spyker C8 Spyder sports car. It has an annual capacity of 100,000 vehicles, but it typically assembles 7,000 to 30,000 units a year.
Bertone was formed in 1912 to build horse-drawn carriages. It started making sports car bodies for Fiat in 1921. In 2000, the company built 30,450 cars and 19,250 motorcycles. It has an annual capacity of 70,000 vehicles. Bertone is currently assembling a special-edition Mini Cooper S for BMW. The company recently had a big contract with GM to build Astra cabriolets for the automaker's Opel and Vauxhall brands.
Heuliez traces its roots to 1920, when it assembled horse-drawn carts and sleighs. It built its first automobile in 1925. Since 1985, Heuliez has produced more than 400,000 cars. The company is currently assembling the Opel Tigra TwinTop and some models for Peugeot Citroen. Earlier this year, Heuliez opened a new plant in Trencin, Slovakia. The company has an annual capacity of 50,000 vehicles.
Pininfarina was formed in 1930 to make custom bodies for Italian cars such as Alfa Romeo, Fiat, Isotta-Fraschini and Lancia. Over the years, the company has designed numerous vehicles for Ferrari, General Motors, Maserati and Peugeot. It derives 56 percent of its revenue from manufacturing operations and 44 percent from product design and engineering operations. Pininfarina is currently assembling the Alfa Romeo Brera, Alfa Romeo Spider, Ford Focus CC, Mitsubishi Colt CZC and Volvo C70. It expects to build 70,000 vehicles next year.
Valmet calls itself a "brand-independent contract manufacturer of exclusive specialty cars of superior quality." Since the company was founded in 1969, it has built more than 1 million vehicles for customers such as Porsche and Saab. It is currently assembling the Porsche Boxster and Cayman. Valmet built 21,233 cars in 2005.
ASC plans to compete against the Europeans when it jumps into the contract assembly market later this year. The company was founded in 1965 and specialized in sunroofs for many years. Paul Wilbur and his colleagues are currently evaluating whether to buy an existing plant, such as an assembly line idled by Ford or GM, or build a new facility, which would probably measure around 600,000 square feet. The company is evaluating sites in Kentucky, Michigan and several other states, plus Mexico.
"With the continued 'nichification' of the North American automotive market, there is a growing need for efficient, low-volume assembly operations capable of producing complete vehicles in volumes of as low as 5,000 to 10,000 units per year," says Wilbur, who previously worked at Chrysler. "Our vision is to create a highly flexible, low-volume assembly operation with a total capacity of approximately 50,000 vehicles per year and capable of producing three to five different specialty vehicle models at once, for various automakers."
However, unlike European contract manufacturers, ASC's business model is not based on providing extra, overflow capacity to automakers. "Instead, it is based on providing automakers a total, cost-effective solution for bringing low-volume niche vehicles to life for their customers," explains Wilbur. "[That is] something typically not economically feasible in any current or planned North American assembly plants.
"[Our] experience in working with General Motors on the Chevrolet SSR roadster-pickup has proven that specialty vehicles can be effectively created in low volumes," Wilbur points out. Although ASC does not perform final assembly of the SSR, more than 90 percent of the total vehicle content is managed by the company, including subassembly of 42 major vehicle systems.
The heart of ASC's low-volume business model is a highly flexible, low-cost production system that Wilbur calls "humanation." It stresses human ingenuity and low-cost tooling over costly robots, conveyor systems and other production equipment.
For instance, ASC's plant in Lansing, MI, where the SSR subassemblies are produced, uses just five robots and employs laser-guided, battery-powered carts to move work-in-process inventory, rather than conveyors. "Even though it was a UAW plant, we were able to keep total costs to a fraction of what they would otherwise be," claims Wilbur.
How It WorksMost contracts run for the life of a model, which typically is 4 to 7 years. But, if a vehicle fails to live up to expectations, it can create pockets of undercapacity for contract assemblers. For example, DaimlerChrysler has been negotiating a payment to compensate Karmann for a lower than anticipated production run of the Crossfire sports car. Production rates fell to 12,500 units last year from 35,700 units in 2004.
It's not uncommon for production rates at contract manufacturers to fluctuate widely from year to year. For example, Karmann assembled 54,500 vehicles in 2005 vs. 94,000 in 2004.
Contract manufacturers are trying to avoid that problem by signing more contracts and improving flexibility. "By adding manufacturing flexibility, we are now better equipped to react to the changing landscape of customers' vehicle needs," says Manfred Remmel, president and CEO of Magna Steyr. The company increased the flexibility of its dedicated lines by relying on modular welding stations.
Since 1992, Magna Steyr has assembled more than 900,000 Chrysler Group vehicles in Graz. It currently builds several of the automaker's products that are sold in Europe and other markets outside of North America, including the Chrysler 300C sedan, the Chrysler Voyager minivan and the Jeep Grand Cherokee. Earlier this year, the company began assembling international variants of the new Jeep Commander, such as vehicles equipped with right-hand drive.
All of the Chrysler Group vehicles are built on one production line at Magna Steyr and share the paint shop and interior trim, chassis and final assembly lines. "At the same time, the production of other models can be prepared without disrupting the current assembly process," says Remmel. "This manufacturing flexibility plays a decisive role in [our] success in keeping quality levels consistently high, despite different numbers of units and timing of individual models."
According to CAR's Baron, final assembly for the Chrysler Group vehicles manufactured at the Graz facility presents a "we can assemble anything in-line" approach. The system uses an adjustable, highly flexible, four-arm hanger system.
"The hanger system is the critical element in achieving a varied model mix," says Baron. "It is flexible enough to assemble a sport utility vehicle, a minivan, a sedan and a station wagon, with little restriction in model mix." Assemblers at Magna Steyr can install transverse, longitudinal or four-wheel drivetrains in-line, as needed.
In addition to flexibility, logistics and integration also play a key role in the success of contract manufacturing. Magna Steyr, for instance, manages more than 2,000 suppliers and 1,300 trucks per day at its assembly plants. With more than 40,000 part numbers, more than 650 million parts arrive at the company annually. Its takt times range from 2 to 24 minutes.
Keeping everything running smoothly requires state-of-the-art information technology. Magna Steyr recently began using a new electronic process to exchange car- and part-design information between its customers and suppliers.
"We had a huge challenge, since working with the world's leading automakers means we must rely upon vast amounts of data that historically has been exchanged using proprietary interfaces and partly manual processes," says Helmut Ritter, head of information management engineering. "The dramatic reduction in development times throughout the automotive industry now makes it essential for the development partner to connect quickly and efficiently."
According to CAR's Baron, who has visited several European contract manufacturers, worker flexibility also plays an important role. "These plants are good at human resource management," he points out. "The efficiency of their employees is very impressive. Most operators can work up to six different jobs, depending on ebbs and flows as the assembly lines ramp up or down."
Contract manufacturers typically help defer some of the production cost of the vehicles they assemble. Many OEMs are asking them to help finance new vehicle projects. For instance, Valmet invested 40 million euros in the production lines it operates for Porsche. Pininfarina has invested more than 600 million euros in the facilities it uses to assemble vehicles for several different automakers.
Magna Steyr invested 23 million euros in preparation for production of the Jeep Grand Cherokee, plus an additional 9 million euros for Jeep Commander tooling and equipment.
Future PlansMany observers believe contract manufacturing will become more common in the auto industry in the future. "As automobile makers focus more and more on the downstream end of the business, development and production will be shifted increasingly to the automotive suppliers," claims Jan Dannenberg, director of Mercer's office in Munich, Germany.
"Suppliers will turn into 'little automakers' by offering activities along the value chain, from vehicle engineering to assembly," adds Dannenberg. "[Automakers] will increasingly withdraw from the production and assembly of modules."
According to Dannenberg, few automakers intend to increase their own production through 2015. He believes that mass-market brands will decrease their own production share by up to 30 percent. "All brands will see a significant increase in the volume of outsourced production that has to be managed, which will more than double in some cases," predicts Dannenberg.
With Ford and General Motors closing assembly plants, there's plenty of opportunity for companies such as ASC, Karmann and Magna Steyr to step up to the plate. As ASC forges ahead with plans to open a plant later this year, the Europeans are also keeping a close eye on Detroit.
Karmann already has an operation in Plymouth, MI, that develops and builds roof systems for the U.S. auto industry. "It is [possible] that we will also build entire vehicles in the U.S.," says Christian Eick.
Magna Steyr is also looking to expand operations in North America. The company currently operates an engineering center in Rochester Hills, MI, and has been attempting to set up a contract assembly operation in the United States.
However, contract manufacturers face an uphill struggle trying to convince OEMs that they can build cars as well as they can, and that it can be done under terms agreeable to the United Auto Workers (UAW) union. The UAW vehemently opposes the shift of work from OEMs to suppliers, because average wages are typically much lower.
Some observers believe Ford and GM may be receptive to the contract assembly idea as they downsize their manufacturing operations and attempt to cut operating costs. However, not everyone thinks that's a wise business strategy.
"The last thing most OEMs in America need right now is more assembly capacity, at least not for mainstream products," argues ASC's Wilbur. "In fact, if anything, the Big Three can't close their plants fast enough. So we're not sure opening another mainstream plant, as some of our competitors have talked about, makes all that much sense.
"What does make sense is 'helping the OEMs around the edges,' with low-volume niche vehicles that they, for a variety of reasons, aren't able to build themselves," adds Wilbur. "In that sense, you'd be bringing to life cars that might not otherwise exist, such as some of the many cool models that get shown at auto shows each year. Too many brand-defining and potentially very profitable cars never leave the cradle of auto shows simply because no one has yet thought up a viable manufacturing business plan to build them."
American and European automakers share different philosophies on contract manufacturing. "European producers have typically used a mix of internal and outsourced engineering programs that have lead to both internal and outsourced assembly," says CAR's Baron. "In North America, [automakers] have utilized significant engineering outsourcing and have tended to use internal assembly capacity almost exclusively.
"For North American manufacturers, 'low volume' has meant significantly larger volumes than European niche volumes, and the domestic manufacturers, with their large installed assembly capacity and declining market share, have ample internal capacity available," says Baron. "This is particularly true since recent union contracts have made assembly labor a fixed cost."
In addition to labor unions, the biggest challenge to European-style contract manufacturing is the growing flexibility of U.S. assembly lines. The Big Three have invested heavily in flexible factories. Over the last 5 years, U.S. automakers have spent millions of dollars on new assembly lines, such as DaimlerChrysler's Belvidere, IL, plant; Ford's Chicago operation; and GM's Lansing Grand River plant. Each of those facilities can produce several different platforms and derivatives. They can also adapt quickly to changing market conditions.
"As companies put in more flexible assembly lines, the business case isn't always there to contract it out," says Ron Harbour. "With more flexible lines, it becomes harder to justify contract assembly."
Harbour says Japanese automakers are even less likely to go for contract manufacturing. "They like to control quality," he points out.
In addition, many Japanese auto-makers already operate in-house companies that build bodies and assemble low-volume vehicles on a "contract" basis. For example, Nissan Shatai Co. Ltd. (Hiratsuka, Japan) builds bodies and assembles vehicles such as the Nissan Serena minivan and the Infiniti FX 45 sedan. Kanto Auto Works Ltd. (Yokosuka, Japan) builds bodies for various Lexus and Toyota models, while Toyota Auto Body Co. Ltd. (Kariya, Japan) assembles minivans, compact trucks and specialty vehicles.
As European contract manufacturers expand into the United States, Harbour says he expects their early work will be for European automakers. Several good candidates would be Alfa Romeo, Audi, Peugeot and Porsche, which currently don't operate assembly plants in North America. Their efforts to bolster sales in the lucrative U.S. market have been hindered by exchange rates and currency fluctuations. Alfa Romeo and Peugeot are not currently active in the marketplace, but contract manufacturing might give them an opportunity to establish a foothold.