reinventing the automotive oem-supplier interface

Beyond C

ost Reduction

Beyond Cost Reduction

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“What Is Globalization Doing to Your Business?”

Opportunities for Action in Industrial Goods, February 2004

“Made in China: Why Industrial Goods Are Going Next”

Opportunities for Action in Industrial Goods, November 2003

“Rethinking Automotive Purchasing: From Price Pressure to Partnership”

Opportunities for Action in the Automotive Industry, November 2003

(This publication summarizes a section of the present report.)

“Innovation to Cash: Orchestrating the Process”

Opportunities for Action in Industrial Goods, September 2003

“Boosting Innovation Productivity”

Opportunities for Action in Industrial Goods, April 2003

“Asset Productivity: A Potent Lever for Competitive Advantage”

Opportunities for Action in Industrial Goods, March 2003

“Competing to Win in China’s Fast-Growing Automotive Market”

Opportunities for Action in the Automotive Industry, December 2002

“Rethinking ‘Made in China’ Cars and Parts”


Steering Carmaking into the 21st Century: From Today’s Best Practices to the Transformed Plants of 2020

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ANDREAS MAURER

FRANK DIETZ

NIKOLAUS LANG

M A R C H 2 0 0 4

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Reinvent ing the Automot ive OEM-Supp l ie r In te r face

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2 BCG REPORT

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3Beyond Cost Reduction

Table of Contents

A Word from the Authors 5

Executive Summary 6

Why Look Beyond Cost Reduction? 9

Ten Megatrends That Affect the OEM-Supplier Interface 12

Trend 1: Supplier Consolidation 12

Trend 2: Suppliers as System Integrators 13

Trend 3: Suppliers as Drivers of Innovation 13

Trend 4: Partnership Programs 14

Trend 5: New Business Models 14

Trend 6: Slower-Than-Anticipated Adoption of E-Procurement 15

Trend 7: Shortening Innovation Cycles 16

Trend 8: Increasing Challenges on Quality 16

Trend 9: Increasing Product Differentiation 16

Trend 10: Global Sourcing 17

Six Levers for Optimizing the OEM-Supplier Interface 18

Lever 1: Stabilization of the Innovation-Purchasing Process 19

Lever 2: Differentiated Remuneration of Suppliers’ R&D Expenses 21

Lever 3: Construction of Innovation Platforms 22

Lever 4: Early Involvement of Suppliers in the Innovation Process 23

Lever 5: Cooperation Between and Collocation of Internal R&D and Purchasing 24

Lever 6: Trend and Supplier Scouting 25

The Six Levers and the Bottom Line 26

Structuring a Supplier- and Technology-Oriented Purchasing Organization 27

The Strategic Objectives of the Purchasing Function 27

How to Position the Purchasing Function? 27

The Four Core Functions of the Purchasing Department 28

Implementing Strategic Supplier Management 30

Four Organizational Models for Purchasing 36

Ensuring a Smooth Innovation-Capture Process 37

The Human Dimension 38

An Agenda for Tier One Suppliers 40

The R&D Challenge: Leveraging the Innovation Potential 40

The Procurement Challenge: Implementing Strategic Subsupplier Management 41

The Production Challenge: Preparing for New Business Models 43

The Sales Challenge: Structuring a Customer- and Product-Driven Organization 45

Reinventing the OEM-Supplier Interface 48

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4 BCG REPORT

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A Word from the Authors


The ideas presented in these pages have grown out of The Boston Consulting Group’s extensive work withthe world’s leading automotive OEMs and suppliers, as well as a detailed analysis of global purchasing prac-tices in the automotive industry. This analysis was based on more than 80 interviews we conducted in 2003with senior executives of over 50 European, Japanese, and North American OEMs and suppliers. The com-panies whose executives we interviewed included most of the world’s leading OEMs, as well as eight of thetop ten automotive suppliers. To get a complete picture of the industry, we also included in our analysissmaller suppliers at the tier two and tier three levels.

We would like to thank all the people who have contributed to the realization of the report, especially

• The senior executives we spoke with at OEMs and suppliers, who generously shared with us their insightsinto the current state and future evolution of the OEM-supplier interface

• Our BCG sponsors and advisers, who made this report possible: Josef Rick, François Rouzaud, GeorgSticher, and Dave Young, as well as our officer colleagues in the Automotive practice

• The project team of consultants and researchers: Pascal Martin, Malte Müller, and Stefan Reiter

• The editorial team of Barry Adler, Kathleen Lancaster, and Sharon Slodki

In our view, collaboration between OEMs and suppliers is the only way the automotive industry can achieveproduct differentiation at competitive cost and thus lay the groundwork for sustainable, profitable growth.We hope that Beyond Cost Reduction, by describing ways that industry participants can overcome today’s dif-ferences, will contribute to that essential collaboration and help strengthen the industry for a bright andthriving future.

Andreas MaurerVice President and Director Dü[email protected]

Frank DietzVice President and [email protected]

Nikolaus [email protected]

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Executive Summary

6 BCG REPORT

Around the world, automotive OEMs face a difficultbalancing act: capturing innovation from their sup-pliers to ensure the product differentiation that isthe lifeblood of the industry, while also keepingcosts within reasonable margins. Many have erredon the side of cost containment. Over the pastdecade, they have put their tier-one suppliers underintense and relentless cost pressure, forcing annualprice cuts that have averaged about 3 percent. As aresult, suppliers have seen their financial perfor-mance erode—to the point where many have beenpushed into consolidation and some to the brink ofbankruptcy. This outcome is costly also for theOEMs, because suppliers have become the primarysource of breakthrough innovation in the industry,and financially strapped companies don’t have thecash to create innovation.

If OEMs are to meet the challenge of producing dis-tinctive, innovative cars at low cost, they must makecertain that their supply base stays diverse andhealthy. Toward that end, they must ensure thattheir purchasing departments are structured andmanaged to master the art of innovation capture. Inother words, they must reinvent the structures andprocesses that directly affect the OEM-supplierinterface.

Ten megatrends are affecting that interface.

• First is a massive wave of supplier consolidation,which shows no signs of abating. The number oftier one and tier two suppliers worldwide is likelyto shrink by decade’s end from between 1,500and 2,000 today to between 500 and 700, of whichonly some 100 will be system integrators that dealdirectly with the OEMs.

• The increasing role of suppliers as system integratorspresents a challenge to OEM purchasing depart-ments, because systems are much harder to priceand evaluate than simple parts. OEMs will need toinclude engineers on purchasing staffs, and sup-pliers will have to orchestrate an increasinglycomplex supply chain.

• The role of suppliers as drivers of innovation meansthat OEMs will become increasingly dependenton suppliers and therefore will need to developfar more sophisticated strategies for capturinginnovation from them.

• Various forms of partnership programs, designed inprinciple to lock suppliers into mutually advanta-geous relationships with OEMs, too often fail tocreate the value they promise.

• Controversial new business models, including build-operate-transfer (BOT) models (also known aspay-on-production models) and supplier parks,offer both advantages and risks for OEMs and sup-pliers alike, and require new sets of competencies.

• The slower-than-anticipated adoption of e-procurementhas surprised many observers; in fact, only a rela-tively small share of parts can be sourced easilythrough online bidding, and even for these theprocess is far from smooth.

• Shortening innovation cycles are driving the needfor ever closer cooperation between OEMs andsuppliers, which now get involved in each other’sdesign and development processes much earlierthan before. One way they do this is by placingresident engineers in each other’s facilities.

• Meanwhile, OEMs and suppliers alike face increas-ing challenges on quality, with the number of costlyrecall actions rising—and damaging OEMs’brands as well as suppliers’ finances.

• Increasing product differentiation, reflected in theproliferation of vehicle types, means that purchas-ing organizations must buy smaller lots of compo-nents, making it harder to keep costs down.

• Finally, global sourcing presents challenges forOEMs and suppliers alike, ranging from local sup-plier development to quality control and logistics.

Against the backdrop of these trends, OEMs mustmanage to balance innovation against cost. Analysis

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of our worldwide survey of automotive suppliersrevealed that most OEMs fall into two groups interms of their purchasing philosophies. The firstgroup—the volume OEMs Ford, General Motors,and Volkswagen—tend to bargain with their suppli-ers primarily by using their market power to exertunilateral price pressure. The second group—German premium OEMs and Japanese OEMs suchas BMW, Honda, Porsche, and Toyota—focus muchmore on using technology-based negotiation andprocess analysis to improve their price positions.Other OEMs—including DaimlerChrysler, PSAPeugeot Citroën, and Renault—use a mix of the twoapproaches. Regardless of their current approach,OEMs can create an innovation-fostering environ-ment, leverage their suppliers’ expertise, and aligntheir organizations for more effective interaction bydeploying six levers:

• Stabilization of the innovation-purchasing process

• Differentiated remuneration of suppliers’ R&Dexpenses

• Construction of innovation platforms

• Early involvement of suppliers in the innovationprocess

• Cooperation between and collocation of internalR&D and purchasing

• Trend and supplier scouting

Many OEMs need to reorganize their purchasingfunctions in order to capture the best possible inno-vations while keeping costs within reasonable mar-gins. The ideal structure depends on the OEM’sbrand positioning and size. Purchasing functionsmust master three key objectives: innovation cap-ture, supplier management, and cost optimization.Toward that end, purchasing can be an indepen-dent, top-level function reporting to the CEO, inwhich case it tends to focus more on cost reduction;or it can be largely or entirely combined with R&D,to generate stronger cooperation between buyersand engineers, as well as more effective technicalcollaboration with suppliers. In either case, the pur-chasing department must fulfill four core func-

tions: systems purchasing, components purchasing,nonproduction purchasing, and strategic suppliermanagement. Differentiating between systems pur-chasing and components purchasing represents asignificant and healthy departure from traditionalpractice, and allows a truly differentiated approach.Each kind of purchasing has particular require-ments in terms of sourcing processes and staff profiles.

For OEMs to have a healthy, diversified, and inno-vative supply base—not only now but for the nextcouple of decades and beyond—they will need toimplement strategic supplier management. Thisconsists of five functions:

• Trend and supplier scouting, which very few OEMscurrently have in their purchasing departments

• Supplier development, which aims at shaping thesupplier landscape by promoting innovation net-works, structuring mergers and acquisitions inthe supply base, and organizing the OEM’s finan-cial participation in selected suppliers

• Cost engineering, which oversees target costing,process redesign, and product redesign

• Multidimensional quality management along theentire supply chain

• Partnership programs that integrate the various ini-tiatives at the OEM-supplier interface into a com-prehensive framework for collaboration

In terms of structure, whether or not the purchas-ing function is integrated with R&D, the functionmust have a strong matrix organization to cutacross traditional departments and commoditygroups. Four basic organizational models can beeffective; which one is most appropriate is deter-mined by whether the OEM is a volume manufac-turer or a premium manufacturer and whether itproduces a single brand of automobile or multiplebrands. Regardless of the structure an OEM adopts,it must ensure a smooth innovation-captureprocess. Key elements in such a process are a strongproject structure that links R&D and purchasingthroughout the process, as well as a clear joint deci-


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sion-making process within the purchasing func-tion, involving both the people in charge of pur-chasing by system or component groups and thosein charge of sourcing for individual platforms ormodels. Finally, OEMs need to develop their pur-chasing personnel and related policies along fivedimensions: cross-functional experience, technicalbackground, equitable remuneration, differenti-ated incentive systems, and training in technologyand supplier management.

On the other side of the OEM-supplier interface,tier one suppliers face the dual challenge of work-ing more closely than ever before with the OEMs,which push them on cost while pressing for innova-tion, and with their tier-two and tier-three suppliers,which are generally not well integrated into effec-tive supply-chain structures. Tier one suppliersshould pay particular attention to four areas. InR&D, they have to understand the OEMs’ innova-tion strategies early on in order to meet theirneeds. In procurement, they need to implementstrategic subsupplier management in order todevelop their own supply base and manage bothquality and costs. In production, they need toacquire the project-management and risk-manage-ment skills that are critical for the new business

models. And in sales, the goal is to structure a cus-tomer- and product-driven organization that per-mits effective communication with the increasinglyglobal OEMs through strong key-account manage-ment and cross-functional sales teams.

Three principles should stand as guideposts forOEMs and suppliers alike:

• Stable development and purchasing processes are essential to the effective exchange of inno-vation

• Virtual and physical innovation platforms mustplay a critical role in capturing innovation insideand outside the traditional automotive sup-ply base

• Intracompany cooperation models are indispen-sable—especially between each OEM’s purchas-ing and R&D departments

None of this will be easy, and it won’t happen fast.But the industry must move in this direction. Theonly way for industry leaders to ensure product dif-ferentiation at competitive cost is by putting OEM-supplier relationships on a new basis—in short, byreinventing the OEM-supplier interface.

8 BCG REPORT

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Why Look Beyond Cost Reduction?

Over the last decade, the relationship between mostautomotive OEMs and their suppliers has centeredon a relentless drive for lower prices. A global analy-sis of OEMs’ negotiations with their tier-one suppli-ers shows that since the mid-1990s, annual pricereductions in the industry have averaged around 3 percent. (See Exhibit 1.) Moreover, many OEMsare engaging in price discussions not once but twoor three times a year, often requesting cuts of 5 to 10percent, and this trend shows no signs of abating.

As a result, suppliers are under intense and con-stant cost pressure that has severely eroded theirfinancial performance, in terms of both return onsales (ROS, defined as EBIT/sales) and asset pro-ductivity (sales/net assets). From 1997 to 2002, theaverage ROS of the leading suppliers we analyzeddecreased from 5.3 percent to 3.8 percent, whiletheir average asset productivity fell from 2.3 per-cent to 1.9 percent. (See Exhibit 2, page 10.)

Notably, this trend afflicts major suppliers across allregions—from the United States, where suppliershave grown accustomed to the tough negotiationstyles of the Big Three, to Japan, where the leadingplayers are still involved to some degree in tradi-tional keiretsu structures. It is not surprising, there-fore, that suppliers around the globe have beenforced into consolidation—and some have evenbeen pushed to the brink of bankruptcy.

Clearly, having many of their tier-one suppliers inperilous financial condition—with some close togoing out of business—is not in the OEMs’ bestinterest. Fewer suppliers means less choice and lesscompetition; weaker suppliers means less invest-ment in innovation. Because tier one and tier twosuppliers are increasingly the primary generators ofbreakthrough innovations, OEMs need to take spe-cial care to ensure that their supply base remainsdiverse and healthy.

Furthermore, OEMs need to maintain good rela-tionships with those suppliers. Our research hasshown that the quality of the OEM-supplier rela-tionship is strongly related to customers’ percep-tion of both product quality and innovativeness.OEMs that have good relationships with their sup-pliers also tend to have higher customer-satisfactionratings on the quality and the innovation content oftheir vehicles. Conversely, OEMs that have lowersupplier-satisfaction ratings also have lower cus-tomer satisfaction in terms of both quality andinnovation. (See Exhibit 3, page 11.)

In an industry in which product differentiation atcompetitive cost is a key prerequisite for sustainablegrowth, OEMs must maintain a difficult balancingact: capturing innovation from their suppliers whilekeeping costs within reasonable margins. Althoughmost OEMs have extensive experience in the areaof cost reduction, they have not yet fully masteredthe art of innovation capture. Their purchasingdepartments in particular often impede, ratherthan actively support, the effective acquisition ofinnovation.


82

100

858891949698

1996 1997 1998 1999 2000 2001 2002 2003a

Index

CAGR –2.8%

E X H I B I T 1

AUTO SUPPLIERS ’ PRICES HAVE FALLEN STEADILYRealized Prices at the OEM-Supplier Interface, 1996–2003

SOURCES: IRN; BCG analysis.

NOTE: Price reduction requests are based on suppliers’ total business volume

with OEMs; prices are those agreed upon after bidding but before series devel-

opment.

aEstimate.

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10 BCG REPORT

E X H I B I T 2

THE FINANCIAL PERFORMANCE OF LEADING EUROPEAN, JAPANESE, AND U.S . AUTO SUPPLIERS HAS DETERIORATEDRONA Values, 1997 and 2002

SOURCES: Thomson Financial Datastream; BCG analysis.

Calsonic Kansei

Koyo Seiko

Magna

Dana

Valeo

Visteon

Denso

Dürr

Faurecia

Continental

Lear

Delphi

Aisin Seiki

–5

0

5

10

15

1.0 2.0 3.0 4.0

0%

10%

20% 1997: 5.3%

2002: 3.8%

EBIT/sales (%)

Average return on sales

Average asset productivity

Return on net assets

(RONA)

Sales/net assets (%)

1997: 2.3%2002: 1.9%

Bosch

1997 2002

Johnson Controls

ZF Friedrichshafen

1997 weighted average 2002 weighted average

An effective innovation-capture process comprisesboth product-development and purchasing activi-ties. Ideally, these two functions should be closelycoordinated throughout the entire innovationprocess—from advanced development and conceptcompetition to series development and ramp-up. In practice, however, many OEMs suffer from a lackof coordination among the principal parties in-volved. All too often, the innovation process is rid-dled with dysfunctional organizational structures,processes, and relationships, which can cause costlyiterations. Frequently, suppliers spend months andeven years developing new systems and compo-nents, working in close cooperation with an OEM’sR&D department but without any real involvementof the purchasing department. Predictably, this ap-proach triggers major process instabilities and set-

backs when the time comes for concept competi-tion, bidding, and contracting—with dire conse-quences for the quality and innovativeness of theOEM’s products.

So, for many OEMs, the main questions are: Howcan we break out of the vicious cycle of uncoordi-nated development and purchasing processes, lowsupplier satisfaction, limited innovation exchange,and insufficient product differentiation at the pointof sale? How can we ensure that we capture—at rea-sonable cost—the innovations that will strengthenour brand in the eyes of customers?

In this report we address these two questions indetail. We begin by outlining ten basic trends thataffect the OEM-supplier interface. Then we identify

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these issues from both sides of the bargaining table:as sellers to the OEMs and also as buyers from theirown subsuppliers.

We hope this report will contribute to deeperunderstanding and more fruitful collaborationbetween OEMs and suppliers. In our view, collabo-ration is the only way the industry can achieve prod-uct differentiation at competitive cost, thus layingthe groundwork for sustainable, profitable growth.


six principal levers that OEMs can wield to optimizethat interface—highlighting best practices aroundthe world. Next we discuss how an OEM can struc-ture a supplier- and technology-oriented purchas-ing organization that allows product differentiationat competitive cost. We pay particular attention tothe art of strategic supplier management, detailingthe five critical functions to be included in such anapproach. Finally, we offer our thoughts on anagenda for tier one suppliers, which face many of

170

180

190

200

210

220

230

20 30 40 50 60 70 80 90 100

OEM B

OEM COEM DOEM F

OEM E

OEM A

Correlation between suppliersatisfaction and quality image . . .

Supplier satisfaction index (SSI)

197

Customer satisfaction index (CSI)/quality

170

180

190

200

210

220

230

10 20 30 40 50 60 70 80 90 10053

. . . and between supplier satisfactionand innovation image

Supplier satisfaction index (SSI)

197

Customer satisfaction index (CSI)/innovation

OEM B

OEM C

OEM DOEM F

OEM E

OEM A

R2= 0.75 R2= 0.79

Premium OEMsVolume OEMs =Average R2=Correlation coefficient

0

0

0

0

0

E X H I B I T 3

SUPPLIERS ’ SATISFACTION WITH OEMS CORRELATES WITH CUSTOMERS ’ PERCEPTION OF QUALITY AND INNOVATIVENESS

SOURCES: Supplier Satisfaction Index, 2003 (Bamberg University); The Best Cars 2003; BCG analysis.

NOTE: Sample sizes were 1,185 suppliers for the supplier satisfaction index and 109,789 customers for the customer satisfaction index.

5415.text 3/4/04 4:30 PM Page 11

In the course of our analysis of the automotiveindustry, we have identified ten megatrends thatare directly affecting the way OEMs and suppliersare currently cooperating—or failing to cooper-ate—across the industry. (See Exhibit 4.) The sup-plier community is particularly affected by three ofthose trends: the consolidation of their ranks into asmaller number of larger suppliers, their increasingrole as system integrators, and their new responsi-bility as innovation drivers. Three trends specifi-cally affect the interface between suppliers andOEMs: the development of partnership programs,the movement toward new business models such asBOT (build-operate-transfer) models and supplierparks, and the slower-than-anticipated adoption ofe-procurement. OEMs, for their part, feel the pri-mary brunt of four additional trends: the shorten-

ing of innovation cycles, the dramatic increase inthe number of quality problems and recall actions,the clear push toward product differentiation andcustomization, and the movement toward globalsourcing and production. While some of thesetrends primarily affect suppliers and others prima-rily affect OEMs, all ten indicate that the OEM-sup-plier interface needs to be reinvented if the indus-try is to pursue sustainable growth.

Trend 1: Supplier Consolidation

Since the mid-1990s, automotive suppliers haveundergone a massive wave of mergers and acquisi-tions, whereby many formerly healthy large andmidsize suppliers have coalesced into fewer mega-suppliers. Examples include Canadian Magna

Ten Megatrends That Affect the OEM-SupplierInterface

12 BCG REPORT

E X H I B I T 4

TEN KEY TRENDS ARE AFFECTING OEM-SUPPLIER RELATIONSHIPS

SOURCE: BCG analysis.

Illustrative suppliers

Supplier trends Interface trends OEM trends

Illustrative OEMs

Sales

Production

Purchasing

Supplier consolidation

Suppliers as system integrators

Suppliers as drivers of innovation

Partnership programs

New business models

Slower-than-anticipated adoption of e-procurement

Shortening innovation cycles

Increasing challenges on quality

Increasing product differentiation

Global sourcing

Development

Production

Sales

Development

Purchasing

1

2

3

4

5

6

7

8

9

10

Delphi

Visteon

Lear

Magna

TRW

Aisin Seiki

Bosch

Denso

Johnson Controls

Continental

Faurecia

Dana

GM

Ford

Toyota

Volkswagen

Renault

Nissan

BMW

DaimlerChrysler

PSA Peugeot Citroën

Fiat

Hyundai

Honda

5415.text 3/4/04 4:30 PM Page 12

International Group’s takeovers of Steyr-Daimler-Puch and Donnelly Corporation, Visteon’s acquisi-tion of LTD Parts, and ZF Friedrichshafen’stakeover of Mannesmann Sachs. Moreover, thistrend shows no signs of abating. It is likely that thenumber of tier one and tier two suppliers world-wide will decrease from between 1,500 and 2,000today to between 500 and 700 in 2010. At thatpoint, only some 100 of the remaining suppliers willbe actual system integrators dealing directly withOEMs. This consolidation will dramatically reducethe OEMs’ choice of suppliers, especially in theleading-edge areas of electronics and mechatronics.

The consolidation of the supply base makes it criti-cally important for OEMs to develop strong rela-tionships with their suppliers. Remaining the “cus-tomer of choice” of the innovation drivers at thetier-one and tier-two supplier levels is key to pro-ducing innovative and high-quality cars. Therefore,OEMs should engage in exclusive R&D partner-ships with their most innovative suppliers to ensurean adequate level of product differentiation. More-over, to avoid overdependence on a few traditionalsuppliers, the OEMs’ purchasing organizations willhave to scout trends and suppliers more proactivelyin order to identify and develop alternativesources—both within and beyond their traditionalautomotive supply base.

Trend 2: Suppliers as System Integrators

Increasingly, suppliers provide not merely smallparts but completely assembled and tested systems,including exhaust systems, cockpits, front ends, andintegrated seats. In the future, as the modulariza-tion of vehicles continues, OEMs will expect suppli-ers to deliver entire roof systems, integrated interi-ors, complete doors, and trunk lids. However, suchintegrated systems are much harder for OEMs’ pur-chasing departments to price and evaluate thansimple parts. So the OEMs’ purchasing functionswill increasingly need to include engineers who arequalified to assess such complex systems.

For suppliers, in turn, the role of system integratorgenerates considerable challenges. Suppliers needto be able to identify subsuppliers and integrate

them seamlessly into their production schedules,logistics streams, and IT platforms, ensuring thattheir assembly of parts into systems and modules iscompetitive on cost with the OEMs’ traditionalassembly.

Overall, the trend toward system integrationrequires a totally new set of competencies on bothsides of the interface. While OEMs need a muchmore technology-driven purchasing function, tierone suppliers have to become orchestrators of anincreasingly complex supply chain.

Trend 3: Suppliers as Drivers of Innovation

The outsourcing trend of the past few decades hasconsiderably increased the share of external valuecreation in the automotive industry. Today mostOEMs create only some 30 to 35 percent of valueinternally and delegate the rest to their suppliers.Moreover, although the industry’s externalizationof core processes appears to have slowed or evenstopped, the fact is that major portions of automo-tive production happen at the supplier level. So it isno wonder that suppliers also play an increasingrole as innovators. Their contributions in this areaare reflected in the dramatic increase in patentsregistered by European and U.S. suppliers over thepast decade: in some product categories, the num-ber of patents registered by suppliers has increasedmore than three times faster than the number ofpatents registered by OEMs. Our research suggeststhat, especially in the area of electronics andmechatronics, suppliers will become the primarydrivers of innovation in the industry.

As OEMs depend increasingly on suppliers’ capac-ity for innovation, they will need to develop farmore sophisticated strategies for managing suppli-ers. For example, as noted above, they will have toestablish a formal supplier-scouting function withintheir purchasing departments to identify anddevelop the relevant technology leaders andinclude them in their supply base. In addition,OEMs will need to provide a stable and coordinatedinnovation process, as well as virtual and physicalinnovation platforms, to ensure the optimal inte-gration of the suppliers’ market-related and prod-


5415.text 3/4/04 4:30 PM Page 13

uct-related know-how. Tier one suppliers, for theirpart, will need to build up their engineering com-petence, either through organic growth or throughthe acquisition of engineering firms. They will alsoneed to form innovation networks with their sub-suppliers to leverage the full potential of their sup-ply chains.

Trend 4: Partnership Programs

The industry has been experimenting with a num-ber of partnership programs between OEMs andsuppliers. Prominent ex-amples include Daimler-Chrysler’s Extended En-terprise and Ford’s TeamValue Management. Mostof these programs aredesigned to raise quality,strengthen innovation, and lower costs. Typically,they focus on a set of suppliers that—theoretically,at least—are rewarded for taking part in the pro-gram. While such programs could be an effectiveplatform for innovation exchange, our research hasshown that in reality many suppliers are quite skep-tical of them, describing them as public relations ormarketing ploys that do not give participating sup-pliers real advantages, such as a genuine preferred-supplier status.

If OEMs really want to increase the impact of theirpartnership programs, they will need to link themmore closely to their purchasing practices. Thismeans that OEMs should offer their preferred sup-pliers truly preferential treatment when the timecomes for negotiations and development opportu-nities. Engaging preferred suppliers in cooperativearrangements such as R&D partnerships, produc-tion-cycle supply contracts, and volume-sensitivepricing would demonstrate the value of such part-nership programs.

Trend 5: New Business Models

A new operational dimension of OEM-supplierpartnerships is exemplified by two approaches:BOT models (also known as pay-on-production models)

and supplier parks. In BOT models, the suppliertakes over parts of the production process, bearingconsiderable operational and market risk. In sup-plier parks, suppliers move their production closeto the OEM’s factory, thus improving their logisticalconnection to the plant but also reducing theireconomies of scale and undertaking substantialinvestments.

BOT models are the subject of much controversy inthe industry. Clearly, there are both pros and consfor OEMs and suppliers alike. For OEMs, BOT mod-

els have the advantages ofrequiring no initial invest-ment, improving theirbalance sheets, increasingefficiency, sidesteppingbudget constraints, andsharing operational and

market risk. But BOT models can also have disad-vantages for OEMs, such as further loss of opera-tions competence, increased unit prices, and ten-sions with the unions. Moreover, because mostsuppliers have less attractive financing conditionsthan OEMs have, such models can turn out to becostlier and riskier than traditional models of own-ership and operations.

On the supplier side, positive aspects of BOT mod-els include chances to expand the range of servicesthat suppliers can offer the OEMs; opportunities togain a better understanding of the productionprocess itself, which in turn can enhance productdevelopment; and possibly higher margins. How-ever, suppliers clearly incur higher risk, includingboth operational and market risk. They must alsobear the financing costs of such models, which canthreaten their financial viability.

Today OEMs are pushing strongly for BOT modelswhen it comes to sourcing large production equip-ment, such as complete paint shops and final assem-bly lines. Suppliers of such production equipmentwill very likely find themselves involved in BOTmodels—as, for example, are the paint system sup-plier Dürr and the assembly automation specialistEisenmann. Suppliers should continually assess therisks related to this type of engagement.

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OEMs should offer preferredsuppliers truly preferential

treatment in negotiations anddevelopment opportunities.

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The concept of supplier parks had strong initialsupport from volume OEMs, including Ford andVolkswagen. Their primary goal in promoting theparks was to ensure just-in-time and just-in-sequence delivery of parts and systems to theirlarger production facilities. Subsequently, premiumOEMs such as BMW and DaimlerChrysler have fol-lowed their example, although the premium OEMs’parks tend to be smaller in volume and narrower inscope. Interestingly, Japanese OEMs have estab-lished very few supplier parks, either in Japan oroverseas. That is because in Japan there is no realneed for such parks, since most suppliers are tradi-tionally located relatively close to the OEMs’ pro-duction facilities. Toyota’s strong supply base inNagoya, close to Toyota City, is a good example ofsuch a production hub.

The increased use of BOT models and supplierparks has had a dramatic impact on relationshipsbetween OEMs and suppliers. For OEMs, thesemodels require much tighter management andstronger support of suppliers, which are now collo-cated with the OEMs, either in the OEM factory orclose to it. Such management is especially impor-tant because, in this setup, OEMs become evenmore dependent on the suppliers’ overall perfor-mance: if large parts of the core production processare transferred to key suppliers, it is essential toensure their economic viability as well as their oper-ations expertise. Even very small deficiencies inthese areas could have drastic consequences for theOEMs’ production flow. The impact on suppliers iseven more dramatic, as they must engage in totallynew ways of operating. Often they must developnew competencies, such as risk management fornew business models, project management to set upnew facilities on the OEM’s premises, and opera-tions expertise to handle parts of the OEM’s pro-duction process.

Trend 6: Slower-Than-Anticipated Adoption of E-Procurement

Whereas for some product categories and produc-tion processes, suppliers and OEMs are comingtogether physically in BOT models and supplier

parks, online procurement represents an alterna-tive, virtual way of sourcing. A few years ago, manymanagers in the automotive industry saw e-procure-ment as the solution for the industry’s cumbersomeand complex purchasing processes. Public market-places such as Covisint and SupplyOn, as well asOEM-specific marketplaces such as Toyota’s WARPand VW Group’s Supply.com, were created in theanticipation that a high percentage of the indus-try’s purchasing—especially of commodities—would flow through such channels. However, theindustry has adopted e-procurement at a far slowerpace than was projected. The main reason for thisslow and partial adoption is that many supplied sys-tems and components are not optimally suited foronline bidding. In fact, the only parts that can besourced easily through online bidding are thosethat can be clearly defined in drawings and specifi-cations, requiring little or no interaction betweenengineers from the supplier and the OEM. In addi-tion, the limited compatibility of the IT systems cur-rently used for purchasing with online market-places represents a considerable hindrance to theadoption of e-procurement.

Even for parts that are suited for e-procurement,most online-bidding processes today are far fromsmooth. Incomplete documentation, the carteliza-tion of suppliers, and a general lack of expertisewith online bidding often make the process ineffec-tive and the results disappointing in terms of priceor product quality. So it is not surprising that lead-ing marketplaces are critically reviewing theironline-auctioning functions with regard to theirfuture scope and relevance.

To tap the real potential of online procurement,suppliers and OEMs will have to determine theproduct categories that are truly suitable for thismedium and train their sales and purchasing per-sonnel to handle the online-bidding process effec-tively. At the same time, the industry would benefitby focusing on an additional key application ofonline platforms: their use as cooperative develop-ment tools. Online platforms have considerablepotential as a base for improving both informationexchange and co-engineering between OEMs andtheir suppliers.


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Trend 7: Shortening Innovation Cycles

The need for close cooperation between OEMs andsuppliers—through partnership programs, BOTmodels, or online platforms—is driven in part bythe dramatic shortening of innovation cycles. Overthe past ten years, the average life span of a carmodel in the developed countries has shrunk byalmost half—from about eight years to about four.Over roughly the same period, the average devel-opment time, from design freeze to start of produc-tion, has decreased from about 48 months to about30; by the end of this decade, it is likely to fall to 18.Because of the dramatic acceleration of develop-ment and the shrinking of production cycles, OEMsand suppliers are getting involved in each other’sdesign and development processes much earlierthan before, blurring the traditional handoff pointsbetween advanced development, concept definitionand competition, series development, and ramp-up.

This trend suggests that OEMs need to structuretheir development processes so that the R&D andpurchasing departments work together early on todefine key parameters, ensure product differentia-tion at competitive cost, and involve suppliers asearly as possible to leverage their market and prod-uct expertise. Thus, in the future, the OEMs’ pur-chasing function will have to play an orchestratingrole at the OEM-supplier interface.

For suppliers, in turn, it is critically important tostay close to the OEMs to capture essential infor-mation on new development projects. Japanese sup-pliers, in particular, have shown how resident engi-neers can be used to better understand the OEM’sdevelopment plans and to influence them to thesupplier’s strategic advantage.

Trend 8: Increasing Challenges on Quality

Ever shorter development cycles, combined withthe OEMs’ insistence on ever lower prices, are con-tributing to rising numbers of quality problems.Our research has shown that in some of the world’score automotive markets, the number of recallactions has more than doubled over the last tenyears—growing far faster than the number of cars

or the number of models produced. In general,most recall actions can be traced back to deficien-cies in suppliers’ parts. For example, of the top tenrecall actions worldwide in 2002, nine were relatedto deficiencies in suppliers’ parts, such as short cir-cuits in ignition locks, problems with automatictransmissions, and deficiencies in brake lights,warning lights, airbags, batteries, and brake pedals.Naturally, these recall actions have damagingeffects on OEMs’ brands, on the particular modelsinvolved, and on suppliers’ finances, since suppliersfrequently must bear the costs of recalls.

To ensure better management of quality along thesupply chain, OEMs must integrate adequateexpertise into their purchasing organizations.Toyota, for example, has installed quality-orientedsupplier production management in its purchasingdepartment. Other OEMs need to go beyond theirtraditional quality auditing to implement moreproactive approaches. Dispatching quality- andprocess-improvement teams to supplier locations—as well as setting up quality circles among suppliers,based on the Japanese concept of kyohokai (OEM-orchestrated supplier associations)—would beeffective ways to improve quality along the supplychain.

Trend 9: Increasing Product Differentiation

Consumers’ desire for cars that reflect their indi-vidual lifestyles, together with the industry’s pushfor variety in design and technology, have dramati-cally increased the number of vehicle models overthe last ten years. From 1996 to 2002, while thenumber of brands remained almost constant, world-wide sales in the niche vehicle segments—car-derived vans, off-road vehicles, and multipurposevehicles—grew by 80 percent, 60 percent, and 14percent, respectively. This increasing variety of vehi-cle types presents a challenge for the OEMs’ pur-chasing organizations, since they must focus onbuying smaller lots of components that are specificto individual niche models, rather than sourcinglarge volumes of identical components.

Some OEMs are responding to this trend by out-sourcing the production of their niche vehicles to

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tier 0.5 suppliers; for example, Porsche does so withValmet and BMW with Magna Steyr. However, OEMsmust also redefine their purchasing strategies tocope with the increasing product differentiation.Rather than negotiating model by model, as theycommonly do today, OEMs should further developtheir common-part strategies in order to be able tobundle their supply streams in so-called cross-model agreements. On the supplier side, itbecomes increasingly important to design systemsand components for complete product families—that is, parts that fit flexibly into all possible varia-tions of a particular base model.

Trend 10: Global Sourcing

Over the past five years, sourcing of automotivecomponents from low-cost countries in Asia,Eastern Europe, and Latin America has risen dra-matically. China, in particular, has become a majorsource of automotive components for European,Japanese, and U.S. OEMs. From the mid-1990s to2002, the value of automotive componentsexported by China increased more than fourfold—from about $350 million to almost $1.5 billion. So itis not surprising that most OEMs have already setup local sourcing organizations in China. In paral-lel, most leading European, Japanese, and NorthAmerican suppliers have set up joint ventures inChina—and also in low-cost countries in EasternEurope and Latin America. The drivers of this glob-alization of the OEM-supplier interface are both

the advantage of low-cost local production and theneed to be close to the OEMs’ own production facil-ities in these developing regions.

Of course, global sourcing involves a number ofchallenges for both sides. For OEMs, they includeidentifying and developing a new set of local sup-pliers, contracting in a sometimes unstable legalenvironment, and ensuring quality as well as logis-tics far from the OEMs’ traditional productionhubs. Similarly, suppliers establishing productionfacilities in low-cost countries need the financialpower, the project management experience, andthe logistical capabilities to replicate their opera-tions far from home—a task that is especially diffi-cult for smaller tier-two and tier-three suppliers.

* * *

The ten trends described in this section show thatthe OEM-supplier relationship is becoming increas-ingly complex in terms of the interrelationships ofall participants, the content and timing of the inno-vation process, and the geographic range of activity.Both sides must now move from sometimes antago-nistic relationships to more cooperative ones inorder to achieve product differentiation at compet-itive cost.

The next section describes six levers that OEMs can use to help bring about economically sustain-able, innovation-oriented cooperation with theirsuppliers.


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In today’s automotive markets, in which productdifferentiation at competitive cost is essential to sus-tainable growth, OEMs must strike a difficult bal-ance between capturing the best possible innova-tion from their suppliers and keeping costs withinreasonable margins. They approach this challengein various ways, as their purchasing negotiationsreveal. Our recent analysis of OEM-supplier rela-tionships around the world uncovered a range ofpurchasing philosophies.

Each OEM’s philosophy could be positioned alongtwo major dimensions: bargaining through marketpower and bargaining through technology andprocess analysis. OEMs whose purchasing functionsbargain through market power use their sourcing vol-ume to exert unilateral price pressure. Those that bar-

gain through technology and process analysis, in con-trast, engage in detailed technical discussions withsuppliers, analyzing product contents and productionprocesses in order to jointly identify opportunities toreduce costs. Needless to say, the latter approach fos-ters a more stable climate for cooperation—and has apositive impact on innovation capture.

At our request, the suppliers we interviewed in thecourse of this study positioned their OEM clients ina matrix that combines the two basic dimensions.The result provides a clear picture of the OEMs’ dif-fering purchasing philosophies. (See Exhibit 5.)

The first group of OEMs contains the volume play-ers Ford, GM, and Volkswagen, which generallyrank high on the dimension bargaining through mar-

Six Levers for Optimizing the OEM-SupplierInterface

18 BCG REPORT

E X H I B I T 5

OEMS ’ PURCHASING PHILOSOPHIES VARY ALONG TWO PRINCIPAL DIMENSIONS

SOURCES: BCG interviews with suppliers; BCG analysis.

NOTE: The center of each name represents the OEM’s position.

HighLow

Low

High

Bargaining through market power

Bargaining through technology and process analysis

Volume players• Cost-based negotiations• Limited relationship building

Premium players• Innovation-driven negotiation• Shared production and development experience • Investment in building long-term relationshipsBMW

DaimlerChrysler

Porsche

Honda

GM

Ford

Toyota

VolkswagenRenault

PSA Peugeot Citroën

5415.text 3/4/04 4:30 PM Page 18

ket power and considerably lower on bargainingthrough technology and process analysis; they also tendto have limited personnel stability in their purchas-ing functions. It is worth noting that although theinterviewed suppliers take a rather critical view ofthe purchasing practices of these volume OEMs, thelatter are currently implementing several coopera-tive product- and process-redesign initiatives withtheir key suppliers. Ford, for example, has TVM(Team Value Management), and Volkswagen hasPPO (Partnerschaftliche Prozessoptimierung, or PartnerProcess Optimization). Moreover, despite these vol-ume OEMs’ tough stance in sourcing negotiations,they remain important customers for automotivesuppliers, since they bring the volume necessary tomake supply production profitable.

Suppliers identified a second group of OEMs—typ-ified by BMW, Honda, Porsche, and Toyota—thatfocus strongly on technology-based negotiation andprocess analysis as ways to improve price positionsin their sourcing negotiations. Whereas for BMWand Porsche this approach is driven primarily bytheir limited volume leverage and strong engineer-ing focus, Honda and Toyota have been practicingthis cooperative negotiation style for decades aspart of the Japanese keiretsu system.

A third group, which includes OEMs such asDaimlerChrysler, PSA Peugeot Citroën, andRenault, adopts both philosophies. These OEMsengage in a differentiated sourcing approach, prac-ticing a cooperative negotiation style for critical,brand-differentiating systems and components, andusing a more cost-driven approach for standardparts. As our analysis suggests, many OEMs haveextensive experience in the area of cost reduction.However, our research revealed that few of theirpurchasing departments have really mastered thevitally important art of innovation capture. Whatcan OEMs do to redress that imbalance?

Drawing on our analysis of purchasing practicesacross the automotive industry, as well as our workwith leading OEMs and suppliers worldwide, wehave identified six levers that OEMs can use to cre-ate an innovation-fostering environment, leveragesuppliers’ expertise, and align their organizations

for more effective interaction. (See Exhibit 6, page20.) Together, these levers can affect the course ofthe entire development and purchasing process,from advanced development through ramp-up:

• Stabilization of the innovation-purchasing process

• Differentiated remuneration of suppliers’ R&Dexpenses

• Construction of innovation platforms

• Early involvement of suppliers in the innovationprocess

• Cooperation between and collocation of internalR&D and purchasing

• Trend and supplier scouting

In this section we describe each of the six levers andoffer examples of best practices. We also enumeratethe positive effects these levers can have on the bot-tom line—when applied in the right way.

Lever 1: Stabilization of the Innovation-PurchasingProcess

In their innovation-purchasing philosophies, mostautomotive OEMs fall into two main camps. (SeeExhibit 7, page 21.) Premium OEMs, which seekdifferentiating systems and components, have along-term orientation that emphasizes process sta-bility and sustained cooperation with a small num-ber of suppliers. Following this philosophy, eachOEM works closely with a particular supplier duringadvanced development and concept definition.Then, at the concept competition stage, the OEMbrings in a second supplier to ensure some level offinancial and conceptual benchmarking. Mostoften, however, the OEM chooses to continue work-ing with the original supplier for series develop-ment, ramp-up, and series production. Needless tosay, this approach fosters a strong relationship oftrust between the OEM and the supplier, allowing afull exchange of innovations.

In contrast, the custom of many volume players,especially in the United States, has been to involve


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20 BCG REPORT

E X H I B I T 6

OEMS CAN USE SIX LEVERS TO OPTIMIZE THE OEM-SUPPLIER INTERFACE

SOURCES: BCG interviews; BCG analysis.

Stabilization of the innovation-purchasing process

Cooperation between and collocation of internal R&D and purchasing

Seriesdevelopment Ramp-up

Differentiated remuneration ofsuppliers’ R&D expenses

Construction of innovation platforms

Early involvement of suppliers in the innovation process

Trend andsupplier scouting

Start of production–12 months–36 months–48 months–120 months

Create an innovation-fostering environment for suppliers

Leverage suppliers’ R&D capacities and product and market know-how

Align the OEM organization for effective interaction with suppliers

2

1

3

4

5

6

Conceptdefinition and competition

Advanceddevelopment

suppliers at a later stage in the process—at conceptcompetition—and in much larger numbers, to gen-erate a maximum level of price pressure. Even later,after the bidding, these OEMs often keep two sup-pliers in the race for some time to provide dualdevelopment. In some cases, shortly before ramp-up, the OEM replaces the selected supplier with alow-cost supplier that takes over the developmentresults and brings the project into series produc-tion. Of course, this approach—which involves fero-cious competition and much uncertainty for suppli-ers—precludes any possibility of continuing,collaborative, trust-based relationships betweenOEMs and suppliers. It also raises difficulties in theareas of intellectual property and the remunerationof suppliers’ investments in R&D.

Nonetheless, both philosophies have their advan-tages and disadvantages. The premium OEMs’approach generates increased supplier loyalty,higher innovation drive, and lower cost increasesbetween bidding and the start of production. On

the other hand, the exclusiveness of this approachalso means less competition and therefore, in somecases, higher initial costs, as well as a substantial riskof missing new ideas and opportunities because ofthe narrower supplier base. In contrast, the volumeplayers’ approach, with its intense competition,does achieve low costs. But the short-term perspec-tive underlying this approach can hinder theexchange of leading-edge technology and thus canlimit opportunities for product differentiation.

It is important that OEMs clearly differentiate theirpurchasing processes according to their brand posi-tioning and the types of systems and componentsthey are sourcing. Ideally, all OEMs, regardless ofsize or market position, should use the collabora-tive approach for sourcing brand-differentiatingsystems and components. For standard compo-nents, such as batteries and tires, the volumeapproach is more appropriate because it allowsprice optimization without compromising the endproduct’s image.

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Lever 2: Differentiated Remuneration of Suppliers’ R&D Expenses

A clear set of guidelines regarding intellectualproperty and R&D remuneration is essential to sus-tainable cooperation between OEMs and suppliers.As tier one suppliers continue to perform more sys-tem development and integration, their R&D budg-ets are bound to grow considerably. At the sametime, their long-term supply contracts for particularcomponents are at greater risk, because OEMs nowtend to switch suppliers even during a model’s pro-duction cycle. Therefore, suppliers that tradition-ally allocated their R&D costs to the relevant prod-uct’s unit price for the vehicle’s whole productioncycle—generally five to seven years—must now findnew ways to fund their development efforts.

In their collaboration with OEMs, suppliers cur-rently promote three remuneration models: R&Dcontracts, R&D partnerships, and production-cyclesupply contracts.

R&D Contracts. This model lays the groundworkfor tightly defined cooperation between a supplierand an OEM: the supplier carries out a specificdevelopment task, with no automatic link to subse-quent series production. Under this kind ofarrangement, detailed remuneration schemes andprocedures for the transfer of know-how ensurethat the supplier receives adequate compensationfor its R&D efforts. For example, Faurecia, a Frenchautomotive-equipment supplier with global opera-tions, developed seats for a Japanese OEM’s small-car model and also did the European marketresearch that led to their development. In this case,the OEM remunerated the supplier for the wholeactivity under a development contract, with nobinding element regarding series production.

This model does not imply that suppliers’ strategyin working with OEMs should be limited to devel-opment. Naturally, suppliers should continue toaim for series production as well. But, in an increas-ingly uncertain business environment, R&D con-


E X H I B I T 7

OEMS ’ APPROACHES TO THE INNOVATION-PURCHASING PROCESS VARY BETWEEN TWO EXTREMES


1Because the last-minute competitor has not participated in R&D, it has a lower cost structure.

Advanceddevelopment

Conceptdefinition and competition

Series development Ramp-up Series productionPremiumapproach

Volumeapproach

BA

B

ABCD

A XBA B

X

A AB

A

Suppliersinvolved

Supplier involvement in advanced development

Competition intensity in bidding phase

Relationship stability and transparency in development phase

Start of production–12 months–36 months–48 months–120 months

Dualdevelopment

Last-minutecompetitor1

Often Medium

High

High

LowRare

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tracts are an effective tool for ensuring full remuneration of costs incurred in the develop-ment phase.

R&D Partnerships. In this model, the supplier andthe OEM share personnel and equipment for par-ticular development tasks. The supplier invests lessmoney in advanced development than it wouldunder the traditional arrangement, in which thesupplier bears all the risk. In addition, as a benefitof participation in the partnership, the supplier isaccorded “preferred supplier” status when the proj-ect goes into series production. For example,Arcelor, a European steel company, develops newsteel-coating processes together with its OEMclients, using teams of Arcelor resident engineerswho work in the OEMs’ press shops. This approachallows the suppliers to reduce their investments inequipment. It also creates a basis for the effectivetransfer of know-how and increases the likelihoodthat the supplier will play a role in eventual pro-duction.

Production-Cycle Supply Contracts. In this model,the OEM guarantees single sourcing to one sup-plier throughout the entire production cycle of acar model. This approach allows the supplier toallocate its R&D costs to the unit price without therisk of losing money, because the OEM is bound tohonor the supply contract until it discontinues pro-duction of the specified model. The production-cycle supply contract is especially appropriate whenthe OEM wants to ensure the exclusivity of the sup-plier relationship, as well as exclusive access to thegenerated innovation. This is frequently the casewith small, highly innovative suppliers of informa-tion technology and electronics.

Lever 3: Construction of Innovation Platforms

Innovation platforms are institutionalized opportu-nities for the exchange of information in particularareas of innovation. The objective of these plat-forms is to provide a physical or virtual infrastruc-ture for information exchange, as well as a regula-tory framework that defines supplier remuneration,rules regarding intellectual property, and potentialcodevelopment arrangements. Innovation plat-

forms take a number of distinct forms, includingtechnology conferences, collocation of develop-ment engineers, and open Web portals for innova-tion exchange.

Technology conferences are a traditional tool of infor-mation exchange between OEMs and their suppli-ers. In general, OEMs organize topic-related eventsat their headquarters or development centers,where suppliers are asked to present their leading-edge technologies and their perspectives on futuredevelopments. For example, Toyota holds regulartechnology conferences in Toyota City, organizingthem around topics such as interiors, braking sys-tems, and air-conditioning systems. These meetingsallow broader discussion of technology trends thantypically takes place in the course of normal projectwork. They also generate long-term perspectives,identifying innovation trends that might be relevantin five to ten years.

A second kind of innovation platform is the colloca-tion of suppliers’ development engineers with elementsof an OEM’s R&D department, often in so-calledsimultaneous-engineering parks. Several Europeanpremium OEMs collocate their suppliers’ specialistswith their own R&D engineers to work on high-pro-file innovation projects. Here, physical proximityand cross-fertilization between engineering teamsgenerate much more effective innovation processesthan are possible when engineers work in separatefacilities.

A third and the most revolutionary approachamong innovation platforms is open Web portals forinnovation exchange. BMW has pioneered this areawith its Virtual Innovation Agency. (See Exhibit 8.)The VIA is an open Web portal that supports activetrend and supplier scouting by allowing any inter-ested person—whether an individual researcher ora skilled engineer at an automotive or a nonauto-motive supplier—to submit his or her innovationideas over the Internet. The ideas are forwarded toa panel of development specialists in innovationcouncils who review and filter them, seeking a fewcritical ideas that may lead to breakthrough innova-tions. Once the breakthrough innovations havebeen identified, BMW orchestrates the industrial

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production of the resulting system or component.The author of the idea either is engaged in thedevelopment and production process or receivesremuneration for the idea. Thus the VIA allows aneffective capture of innovative ideas, ensuring thatthey do not get lost in the OEM organization andthat the best concepts are selected in a structuredmanner.

Lever 4: Early Involvement of Suppliers in the Innovation Process

Involving suppliers at an early stage is vitally impor-tant because it allows the OEM to tap into theirknow-how—regarding both technologies and con-sumer behavior—in their particular areas of exper-tise. Because increasing numbers of innovationsinclude new, nontraditional technologies, early sup-plier involvement is an important prerequisite to a

successful joint-development process. So it is notsurprising that some OEMs are involving their sup-pliers long before the concept competition stage; infact, with increasing frequency, suppliers are beingasked to participate in concept definition and evenin advanced development.

For example, Johnson Controls has been cooperat-ing closely with Opel in Germany to codevelop thepioneering flexible and integrated interiors of twoOpel models, the Zafira and the Meriva. Usingteams of resident engineers—who were involvedvery early in the process, at the concept definitionstage—Johnson Controls has contributed signifi-cantly to shaping one of the key differentiating fea-tures of this new generation of vehicles. In this case,the supplier brought in not only its technologicalexpertise but also a deep understanding of the endcustomer’s needs.


E X H I B I T 8

BMW HAS PIONEERED THE USE OF AN OPEN WEB PORTAL FOR INNOVATION EXCHANGE

SOURCES: Company information; BCG interviews.

NOTE: If supplier A is involved neither in series development nor in industrializing the innovation idea, it will receive compensation.

BMW

Supplier A

Joint development

Top models

Volume models

Virtual Innovation Agency (Web portal)

2003 2008

Supplier Subsupplier

Input innovation ideas Forward ideas

Developmentspecialists

Review ideas

Select ideas

Innovationroad map

Develop specifications and determine compensation

Networkconfiguration

Develop innovation idea

Placeproduct order

Industrialize innovation idea

Place productorder

Develop and industrialize

innovation idea

Product innovations

A A B

? ?

BMW

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Another example of early supplier involvement isthe close cooperation of the German roof-systemsupplier Edscha with DaimlerChrysler. In fact,shortly after DaimlerChrysler decided to build acabriolet version of the PT Cruiser, it moved toinvolve Edscha in the development process.Cooperating with Edscha at this relatively earlystage allowed DaimlerChrysler to tap the supplier’sproduct and market expertise regarding roof sys-tems, to the benefit of the final car design.

Even earlier in the process, at the advanced devel-opment stage, suppliersare driving an impressiveamount of innovation. Forexample, PSA PeugeotCitroën and Faurecia arelinked in a long-termcooperative approach to do R&D for new seatingconcepts. In another example, Toyota outsourcedlarge parts of its R&D activities on brake, fuel, andradiator hoses to Toyoda Gosei, which now plays akey role in the development of these components.In these two cases, the family and keiretsu ties link-ing these suppliers to their respective OEMs cer-tainly facilitated the comprehensive transfer ofR&D competencies. We believe, however, that thistrend is bound to continue even in less closely knitcommunities.

These examples, drawn from many more, illustratehow important it is to involve suppliers at an earlystage in order to tap the full potential of their tech-nological and market-related expertise. Of course,this kind of long-term collaboration between sup-pliers and OEMs cannot flourish under OEMs’ tra-ditional one-sided, cost-oriented approach to pur-chasing.

Lever 5: Cooperation Between and Collocation ofInternal R&D and Purchasing

Today the innovation process that links suppliersand OEMs is likely to break down at one major junc-ture: the handoff of the project from engineeringto purchasing. Normally, a supplier works with theOEM’s R&D department for one, two, or even threeyears to define and develop a new system or com-

ponent. During this early part of the process, mostOEMs use forward sourcing to implement purchas-ing policies and target costing to control costs.Frequently, however, the rotation of purchasingstaff and a certain technological isolationism on thepart of R&D engineers prevent the purchasingfunction from being effectively involved at thisstage. Little wonder, then, that the handoff of proj-ect leadership from R&D to purchasing often trig-gers an extreme push for cost reduction, callinginto question everything the OEM-supplier team

has developed to thatpoint and generatingnumerous—and costly—iterations.

To avoid such expensivedisruptions to the proc-

ess, it is important to promote close cooperationbetween R&D and purchasing. The objective is toinstall a fast, effective, and binding decision-makingprocess across the OEM’s departments, ensuringconsistent communication with the supplier andpreventing major breaks in the innovation process.(See Exhibit 9.)

Concretely, this means that at the advanced devel-opment stage, while R&D is researching a particularleading-edge technology—either on its own or witha traditional supplier—the purchasing functionshould be actively combing the market for sourcingoptions for that technology and also determiningfirst financial benchmarks. At the concept defini-tion stage, the system-development and system-sourcing functions should work together closely toensure that concepts are defined precisely by bothinternal parties and that technical and financialrequirements are clearly understood. In general,close cooperation of this kind requires either thecollocation of these functions or a permanent com-mittee structure.

Finally, at the series development stage, it is impor-tant to ensure that the relevant representatives ofpurchasing and R&D are cooperating as membersof a platform team, model team, or vehicle-lineteam. Although the names of these teams may vary,they share a common logic: it is important to coun-

24 BCG REPORT

The objective is to install a fast, effective, and binding

decision-making process across the OEM’s departments.

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terbalance traditional thinking along departmentand commodity group lines with thinking that cutsacross those lines and focuses on projects. Whetherthe latter has as its immediate subject a platform, amodel, or a vehicle line, the close cooperation ofR&D and purchasing is critical to ensuring a stableinnovation process.

Examples of successful collocation include themodule and simultaneous-engineering teams atBMW’s research and innovation center in Munich.These teams, organized around individual compo-nents or systems, include representatives from theR&D and purchasing departments, as well as fromsuch functions as quality assurance, marketing, andproduction. All the technicians working with theseteams are located in adjacent buildings, thus allow-ing the immediate testing and implementation of new ideas. By having these teams physically col-located and working together, BMW ensures effi-cient processes, internal coordination, and consis-tency in the way its functions interact with itssuppliers.

Lever 6: Trend and Supplier Scouting

Most OEMs’ purchasing functions are missing keyaspects of trend and supplier scouting. Ideally,trend and supplier scouting should take place evenbefore forward sourcing and should focus on threetasks: working closely with the trend-scouting func-tions in R&D and marketing to identify innovationsthat will have real impact on cars in the medium tolong term; identifying and allocating the right sup-pliers to these innovative ideas; and ensuring thatthe suppliers’ know-how becomes available to theOEM. The two most advanced practitioners in thisarea seem to be BMW and PSA Peugeot Citroën.

To ensure a continuous supply of innovations,BMW actively searches for suppliers that are notpart of its traditional supply base. In addition todeploying its VIA open Web portal for innovationexchange, described in our discussion of Lever 3,BMW’s purchasing department looks for nonauto-motive suppliers with unique competencies. Forexample, to develop its iDrive “infotainment” sys-


E X H I B I T 9

COLLOCATION AND PROJECT LINKAGES CONTRIBUTE TO EFFECTIVE COOPERATION BETWEEN PURCHASING AND R&D


NOTE: The platform dimension can be replaced by a model or a vehicle-line dimension.

Series developmentAdvanced development Concept definition

R&DPurchasing

PlatformA

PlatformB

PlatformA

PlatformB

PlatformA

PlatformB


Advanceddevelopment

Systemsourcing

Systemdevelopment

Cooperation between R&D and purchasing through collocation or permanent committee structure

Continuous cooperation and information sharing in project organization

Systemdevelopment

Systemsourcing

R&DPurchasing


Advanceddevelopment

Systemsourcing

Systemdevelopment

R&DPurchasing


Advanceddevelopment

Groups leading the process at this stage

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tem, BMW identified Immersion, a U.S. companyspecializing in haptic technologies for computerelectronics. By collaborating with both Immersionand Alps, a Japanese supplier of automotive elec-tronics, BMW was able to develop a touch-enableddriver interface, which clearly differentiated theBMW 7 Series from its competitors.

PSA Peugeot Citroën has recently set up a newdepartment—innovation purchasing—within itspurchasing function. The department’s charter isto identify and assess trends, preselect suppliers,and maintain supplier contacts, even if there are noconcrete plans for a project-related contract in theimmediate future. In short, this scouting groupconcentrates on suppliers that might becomeimportant a few years down the road. With theacceleration of globalization and the increasingparticipation of nonautomotive suppliers in innova-tion, trend and supplier scouting will play a criticalrole in the years ahead.

The Six Levers and the Bottom Line

These six levers have considerable impact on therelationships between suppliers and OEMs, not

only qualitatively but also financially. Although onemight expect that using these levers could increaseoverall costs, in most cases the reverse seems to betrue. By ensuring a stable innovation process, re-munerating suppliers adequately, and especiallyinvolving them early on, OEMs can substantiallyreduce the modification costs that typically repre-sent a big portion of the final unit price. Moreover,by simplifying the process of negotiation and opti-mizing internal communication between purchas-ing and R&D, OEMs can significantly reduce pur-chasing process costs. And, finally, by scoutingtrends and suppliers, OEMs can lay the groundworkfor focusing their R&D activities effectively, thusmanaging R&D expenditures much more pru-dently.

While the advantages of these six levers seem obvi-ous, their implementation requires a carefulredesign of OEMs’ purchasing organizations interms of structures, interfaces, processes, andstaffing requirements. To balance innovation cap-ture and cost optimization, OEMs must ensure thattheir purchasing organizations are supplier andtechnology oriented. This new organizational con-cept is the subject of the next section.

26 BCG REPORT

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Structuring a Supplier- and Technology-OrientedPurchasing Organization

To capture the best possible innovation from theirsuppliers while keeping costs within reasonablemargins, many OEMs are now rethinking the organ-ization of their purchasing functions. Recognizingthat the traditional organization into commodity-based groups can impede innovation, they areengaged in restructuring and reorienting their pur-chasing functions in various ways. In our view, anumber of organizational models can be effective.The ideal design for a given OEM depends on itsbrand positioning and size. In this section, we dis-cuss several options for organizational design,together with their implications for processes andpersonnel. But first let’s take a look at the overallgoals of the purchasing function.

The Strategic Objectives of the Purchasing Function

To implement innovation-fostering and cost-effec-tive relationships between OEMs and suppliers,each OEM’s purchasing function needs to focus onthree objectives: innovation capture, supplier man-agement, and cost optimization.

Innovation Capture. Purchasing should drive aneffective innovation-capture process. This meansforging and maintaining close links—in the form ofproject teams or committee structures—especiallywith R&D but also with other OEM functions, suchas production and marketing. In addition, the pur-chasing function needs to orchestrate an innova-tion process whereby it identifies innovation driversearly on, through trend and supplier scouting, andintegrates them effectively into the overall develop-ment process.

Supplier Management. Supplier management mustinclude strategies for long-term cooperation, aswell as tactics for operational improvements in thesupply base. This means that OEMs need to engagein supplier development—either by promoting flex-ible supplier networks or by structuring mergers

and acquisitions in their supply bases. In addition,the purchasing function should ensure that costengineering optimizes product contents andprocess structures at the supplier level. Finally, thesupplier management function should coordinatequality management along the entire supply chain.

Cost Optimization. Purchasing must continue tokeep a strong focus on cost optimization by gener-ating synergies—while also ensuring increasedproduct differentiation. This implies that buyers inboth traditional commodity groups and projectteams need to explore all opportunities for cross-model and intraplatform synergies. To balancethose synergies with product differentiation, teamsaligned along both dimensions—that is, commoditygroups and project teams—must work together in aclearly structured joint decision-making process.

With those objectives in mind, OEMs should beginredesigning their purchasing organizations byexploring three broad questions:

• First, how should we position the purchasingorganization vis-à-vis R&D and production?Should it be an independent, top-level functionreporting to the CEO, or should it be integratedwith R&D?

• Second, how should we organize the purchasingdepartment itself to best maintain the balancebetween cost reduction and innovation capture?

• And third, how should we set up each functionwithin the department?

How to Position the Purchasing Function?

There are two schools of thought among OEMs asto how purchasing should fit into the overall struc-ture of the company. (See Exhibit 10, page 28.)Most OEMs position purchasing as an independent,top-level function that reports directly to the CEO.


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This positioning allows purchasing to bundle sourc-ing volume—across multiple brands if necessary—in order to push for companywide synergies. On theother hand, this positioning tends to impede coop-eration between purchasing and R&D. Also, depart-ments positioned in this way typically focus more oncost reduction than on innovation.

The alternative structure, used by some innovation-focused OEMs such as BMW and PSA PeugeotCitroën, combines most of the purchasing functionwith R&D; in some cases, parts of operational pur-chasing activities, such as logistics and supplierquality management, are integrated into produc-tion. This positioning, in which purchasing is notrepresented at the board level but instead is com-bined with R&D, generates much stronger coopera-tion between buyers and engineers. It also con-tributes to more effective technical collaborationwith suppliers, in part because of the absence ofdepartmental conflict on the OEM side, and in partbecause the purchasing staff in this setup tends to

have more sophisticated technical understanding.Naturally, when purchasing is integrated with R&D,there is a tendency to focus more on technicalachievement and less on cost reduction.

So, overall, while the integrated model is more con-ducive to innovation, the segregated model permitsa clearer emphasis on cost reduction. Companiesneed to think carefully about their strategic priori-ties and brand positioning before choosing thestructure that will work best for them.

Regardless of its positioning within the organiza-tion, however, the purchasing department mustperform four core functions.

The Four Core Functions of the PurchasingDepartment

Drawing on our global benchmarking of OEM pur-chasing organizations, as well as the analysis ofstrategic objectives described above, we have identi-

28 BCG REPORT

E X H I B I T 1 0

OEMS HAVE TWO BASIC OPTIONS FOR POSITIONING THEIR PURCHASING ORGANIZATIONS


GM Ford Toyota DaimlerChrysler Volkswagen Renault

Purchasing is an independent, top-level function Purchasing is combined with R&D and production

Pros

Cons

Organizationstructure

CEO CEO

R&D R&DPurchasing PurchasingProduction Production

Allows optimal purchasing integration with R&D and suppliers in order to drive innovation

Allows bundling of purchasing volumes, especially in multibrand companies

Still prevalent at these OEMs Partly implemented at these OEMs

LogisticsStrategicsuppliermanagementProject sourcing Quality management

Generally limits cooperation among R&D, purchasing, and suppliers

Tends to drive cost reduction instead of innovation

Can diminish the drive for cost reduction because of the dominant technology focus

PSA Peugeot Citroën BMW

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fied four core functions that every OEM purchasingorganization needs to fulfill: systems purchasing,components purchasing, nonproduction purchas-ing, and strategic supplier management. (SeeExhibit 11.) The core of this organizational conceptis the differentiation between systems purchasingand components purchasing. Complex systems andmodules, such as integrated interiors and roof sys-tems, for which there are typically only a few sup-pliers and which require intensive cooperation dur-ing the development phase, should fall under thesourcing responsibility of systems purchasing.Components that are largely standardized, such asbatteries and tires, for which there are more poten-tial suppliers and which can also be purchasedthrough online procurement, should be allocatedto components purchasing.

Separating systems purchasing from componentspurchasing is crucial to taking a truly differentiatedapproach to automotive sourcing. This approachconstitutes a significant departure from currentorganizational models, in which complex systemsand standardized components are frequently

sourced by the same entities. Ideally, the two typesof purchasing should be reflected in differentsourcing processes and staff profiles.

Systems purchasing should be staffed with buyers whohave both strong technological backgrounds andexcellent relationship-building skills, in order tosupport a technology-driven and supplier-orientedinnovation process. These buyers should also bewilling to remain in their area of specialization forthree to five years so that they can develop effectiverelationships with suppliers, as well as expertise inthe relevant systems. Because most systems aredeveloped for a particular car model, and smoothcooperation with the supplier is of utmost impor-tance, there should be a horizontal dimension—focused on brands, platforms, or models—that cutsacross the vertical dimension of system groups. Theresulting matrix ensures a balance between aneffective innovation process in brand-, platform-, ormodel-specific teams and a stringent quest for com-panywide synergies within the system groups. Byemphasizing the horizontal dimension of project-related teams—at the level of brands, platforms, or


E X H I B I T 1 1

A BEST-PRACTICE STRUCTURE FOR AN OEM PURCHASING ORGANIZATION INCLUDES STRATEGIC SUPPLIER MANAGEMENT


1Complex systems and modules are provided by a few suppliers—relationship management is needed (for example, integrated interiors).

2Components are provided by a large number of suppliers—sourcing takes place through standardized processes and business-to-business platforms (for example, tires and

batteries).

3This department handles BOT (build-operate-transfer) models and supplier parks.

Purchasing

Component groups2

Regions

Components purchasing

Trend and supplier scouting

Supplier development

Cost engineering

Partnership programs

Quality management

System groups1

Systems purchasing

Brands/platforms/models

Currently in place at most OEMs Partly in place Absent from most OEMs

General supplies

New business models3

Production facilities

Nonproduction purchasing Strategic supplier management

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models—the new organization also lays the ground-work for an effective interface with the R&D depart-ment, which is generally structured along specificdevelopment projects.

Components purchasing should be staffed with buyerswho are more cost-oriented than their colleagues insystems purchasing. These buyers should also havegood negotiating skills, both in face-to-face meet-ings and in virtual procurement settings.

In addition, components purchasing should beorganized differently from systems purchasing.Whereas the verticaldimension should followthe traditional setup bycomponent groups—ascurrently practiced bycommodity groups—thehorizontal dimensionshould be regional. This is because it is generallymore effective to use a regional sourcing infra-structure in buying standardized and relatively low-cost parts, although the OEM defines its overallpurchasing strategy, standards, and volumes on anaggregated level for each component group. Infact, many OEMs have set up purchasing offices inlow-cost countries to gain better access to local sup-pliers, ensure effective quality control, and managethe supply chain locally.

So, while the horizontal, project-oriented dimen-sion in systems purchasing aims at optimizing theinnovation process, the horizontal regional dimen-sion in components purchasing supports a cost-optimizing approach to global sourcing.

Nonproduction purchasing focuses on sourcing itemsnot used in actual vehicles, such as productionequipment and general supplies. While this func-tion will not change dramatically in its core activi-ties, OEMs will need to enlarge its competence baseto ensure the effective establishment and manage-ment of BOT models and supplier parks. In fact,the new-business-models department—whichshould reside within nonproduction purchasing—will have to support much of the logistical coordi-nation associated with BOT models and supplierparks. Moreover, this function will have to handle

the complex financing schemes and the projectmanagement entailed in setting up suppliers’ pro-duction facilities close to or even within the OEMs’factories. As OEMs push for closer physical integra-tion with their suppliers, this interface must becarefully managed—from the contractual, finan-cial, and operational points of view.

Strategic supplier management is the last of the fourcore functions that constitute a best-practice pur-chasing organization in an automotive OEM.Essentially, strategic supplier management works to

optimize the supplierlandscape—from innova-tion capture to cost reduc-tion and quality assur-ance—both today andwell into the future.Because strategic suppliermanagement plays such a

critical role in an OEM’s ability to wield the sixinnovation-fostering levers described in the previ-ous section, and because most OEMs do not cur-rently have the full range of relevant functions inplace, we devote a special section to describing howstrategic supplier management should work.

Implementing Strategic Supplier Management

In our view, strategic supplier management is key toensuring that OEMs have a healthy, diversified, andinnovative supply base—not only in the near termbut 5, 10, or even 20 years from now. Strategic sup-plier management consists of five functions: trendand supplier scouting, supplier development, costengineering, quality management, and partnershipprograms.

Trend and Supplier Scouting. This function drawson deep knowledge of trends in markets and tech-nologies, as well as on familiarity with suppliers andtheir plans, to identify and prescreen suppliers forstrategically important leading-edge technologies.Many years before a particular technology—such asa fuel cell engine—goes into series production,trend and supplier scouting should be identifyingcompetent suppliers, initiating first contacts withthem, benchmarking the technology’s price spot,

30 BCG REPORT

Strategic supplier managementworks to optimize

the supplier landscape both today and

well into the future.

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and managing the OEM’s panel of future key sup-pliers. Toward this end, the function works closelywith R&D, systems and components purchasing,and marketing, since it needs their input for itscore activity. While many OEMs currently seekinput from their established suppliers in formulat-ing their innovation strategies, trend and supplierscouting should enable them to pursue a moreproactive and independent quest for innovativeideas, including at nonautomotive suppliers. (SeeExhibit 12.)

At present, very few OEMs have a function dedi-cated to trend and supplier scouting in their pur-chasing organizations. While traditional commod-ity-group buyers sometimes take on responsibilityfor portions of this activity, they rarely can devoteenough time to the effort to make it successful. Asdescribed above, PSA Peugeot Citroën is one of thefew OEMs that have implemented formal trend and

supplier scouting. Its recently established innova-tion-purchasing department, which reports to thehead of purchasing, is in charge of identifying andassessing technology trends (together with R&D),prescreening qualified suppliers, and managing apool of potential innovation drivers—even if thereare no concrete plans for sourcing from that poolin the immediate future. In essence, this scoutinggroup concentrates on suppliers that might becomeimportant a few years down the road. The groupthen keeps close contact with the suppliers byinvolving them in joint research projects, partner-ship programs, and the like.

With the acceleration of globalization and the in-creasing participation of nonautomotive suppliersin innovation, trend and supplier scouting will playa critical role in the years ahead. Implementing it asa function in its own right in the OEM’s purchasingorganization is therefore of great importance.


E X H I B I T 1 2

TREND AND SUPPLIER SCOUTING BEGINS WELL AHEAD OF THE PRODUCTION CYCLE


Advanced R&D

Supplier trends

Market trends

Trend sources Trend identification Supplier prescreening Supplier monitoring Technology matching

Market research

Strategicsuppliermanagement

Technology trends

Identify new, relevanttechnologies . . .

. . . assess corresponding suppliers and include them in an “observatory panel” . . .

Find appropriate suppliers for identified trends

Initiate first contacts

Assess new suppliers

Determine prices for new technologies

Ensure ongoing supplier benchmarking

Maintain regular contacts

Check financial evolution of suppliers

Adjust prices for technologies

Trend and supplier scouting Project sourcing

Platform engineering

VehicleProject Start

ConceptDefinition Stage

About ten years before the start of production

Four to five years beforethe start of production

Advanced Development Stage

. . . and choose the best to include in new projects

Handoff

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Supplier Development. This function of strategicsupplier management aims at shaping the supplierlandscape by promoting innovation networks, struc-turing mergers and acquisitions in the supply base,and organizing the OEM’s financial participation inselected suppliers. The overall objective of thisactivity is threefold: to enhance innovation poten-tial by linking suppliers together; to ensure the via-bility of economically weakened suppliers byarranging financial and nonfinancial integration atthe supplier level; and to implement control rightsfor the OEM, through either contractual means orfinancial participation schemes. To ensure effectivesupplier development, OEMs should staff this func-tion not only with experienced buyers but also withfinance and M&A specialists who have experiencewith corporate financial analysis at the supplierlevel, as well as a solid understanding of deal struc-turing and network management.

A good example of advanced supplier developmentis BMW’s approach to building flexible suppliernetworks. (See Exhibit 13.) Anticipating that it willincreasingly be using nonautomotive suppliers assources of breakthrough innovation, BMW has setup a series of supplier networks that link nonauto-motive suppliers to traditional suppliers—thus com-bining innovation power with industrial scale. Forexample, BMW developed both the ITS (inflatabletubular structure) airbag system and the iDrive“infotainment” system by creating flexible suppliernetworks of this kind.

In the case of the ITS airbag system, BMW firstidentified the defense industry supplier Simula,which produces crash safety equipment and inflat-able restraint systems for military vehicles and air-craft. BMW then brought Simula together withAutoliv, a traditional automotive supplier that hadthe overall competence in development and assem-bly to incorporate Simula’s specific know-how intothe production of BMW’s airbag system. In thiscase, there was a clear triangular relationshipamong the three players: BMW as the OEM andcoordinator; Simula, which provided the differenti-ating expertise and know-how; and Autoliv, whichcontributed the overall development and assemblycompetence.

As noted in the previous section, BMW created asimilar triangular relationship with Immersion andAlps to develop its touch-enabled driver interfacefor iDrive.

Another outstanding example of supplier develop-ment is Toyota’s new form of Japanese keiretsu, inwhich the OEM brings together different suppliersfrom the same area of specialization into a newjoint-venture entity, with Toyota taking a minoritystake in the venture. Following this pattern, Toyotahas created three companies in recent years. (SeeExhibit 14.)

Advics, which develops innovative brake systems,consists of Sumitomo, with its electric-wiring tech-nology; Denso, with its competence in leading-edgeelectronic controls; and Aisin Seiki, with its exper-tise in traditional brake systems. FTS, which devel-ops and produces resin fuel tanks, brought together

32 BCG REPORT

ITS airbag

iDrive

Technical/process support

Delivery of airbag systems

Components delivery

Innovation powerIT and sensor competence

ScaleOverall development and

assembly competence

Delivery of iDrive modules

TouchSense technology integration

Automotive experienceElectronics systems

development and assembly

BMW

Simula Autoliv

BMW

AlpsImmersion

Nonautomotiveexpertise

TouchSense technology development

Technical/process support

E X H I B I T 1 3

BMW PRACTICES NETWORK BUILDING AMONG AUTOMOTIVE AND NONAUTOMOTIVE SUPPLIERS


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Toyoda Gosei, which has strong expertise in resin,and Horie Metal, a world-class manufacturer of fueltanks. Favess, which develops and assembles elec-tronic power-steering systems, brought togetherKoyo Seiko, Toyoda Machine Works, and Denso.

In all three ventures, Toyota’s objective has been tointegrate the suppliers’ complementary engineer-ing competencies in order to create new, highlyinnovative companies. Such companies not onlyensure an adequate innovation pipeline for theOEM but also assure the participating suppliers ofbetter positioning in global automotive markets. Bycombining their R&D capacities as well as theirdevelopment and production infrastructures, thesuppliers boost their innovation potential and con-siderably improve their cost structures. So this newtype of keiretsu is beneficial for both sides: whilethe OEM secures its innovation pipeline, the sup-pliers profit from enhanced engineering compe-tence and improved cost positions.

In the future, as automotive manufacturers con-tinue to extend their supply chains around theglobe, supplier development will become increas-ingly important. It will play a key role in maintain-ing a healthy and diversified supply base and inintegrating new, nonautomotive innovation driversinto traditional sourcing structures.

Cost Engineering. With a shorter-term focus thanother strategic-supplier-management functions,cost engineering manages suppliers’ costs from thedevelopment stage to series production. This func-tion consists of three elements: target costing,process redesign, and product redesign.

Target costing aims to define a cost range for eachdevelopment project, from small parts to complexsystems. In general, the cost guideline is driven bythe overall business case for the vehicle, as well asbenchmarking of global production costs anddetailed product analysis. In our view, target costingshould be included in strategic supplier manage-ment, where it is relatively independent of R&D,production, and the traditional purchasing organi-zation.

Process redesign, the second element in cost engi-neering, analyzes suppliers’ production processeswith a view to finding effective ways to reduce coststructures in the production of particular systemsor components. While this kind of analysis has beenwell established in the Japanese automotive indus-try for decades, European and U.S. OEMs have onlyrecently initiated a similarly cooperative and proc-ess-oriented approach to cost reduction. Volks-wagen’s PPO initiative is a recent example of this trend.


E X H I B I T 1 4

TOYOTA ’S JOINT-VENTURE APPROACH TO SUPPLIER DEVELOPMENT IS A NEW FORM OF JAPANESE KEIRETSU


Advics FTS Favess

20% 20% 10%

45% 35% 10%30%50%40%20%20%

Brake systems Fuel tanks Electronic power steering

DensoSumitomo Denso AisinSeiki

ToyodaMachine

Works

KoyoSeiko

HorieMetal

ToyodaGosei

Toyota

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OEMs undertake product redesign to reduce the costof planned and current systems and components,reviewing each part for possible overengineeringand for performance that exceeds customers’requirements. Naturally, the most effective time toassess and simplify systems and components is dur-ing a model’s design and development stage. But itcan also be worthwhile to undertake “de-content-ing” initiatives—efforts to reduce the cost of spe-cific components either by changing their materialsor structure or by removing them completely—evenwhen the relevant car model is already in produc-tion. Needless to say, mak-ing such changes after thecar is completely de-signed and in productionis not the most effectiveway to go about cost re-duction. Nonetheless, inview of the high cost pressure in this industry, thepractice will no doubt persist.

One manufacturer that practices extensive costengineering is Ford. In recent years, Ford haslaunched a series of cost optimization initiatives. Inthe late 1990s the company declared that its supplybase was an extension of its own operations andthat it wanted to manage and control that basemore closely in terms of cost and quality. Under abroad initiative it dubbed Total Cost Management(TCM), Ford organized lean-manufacturing work-shops with its key suppliers. Ford engineers in the company’s value-analysis center in Livonia,Michigan, tried to educate these suppliers in costreduction by means of value engineering and value-chain analysis. In 2001 the company enriched theeducational character of TCM by adding a financialincentive. The North American Design CostSharing (DCS) program promised suppliers partici-pation in all cost savings achieved by joint engi-neering teams. Thirty-five percent of the first year’ssavings were paid to the suppliers. Ford assigned agreat number of engineers to work with suppliers tofind ways to use cheaper materials and reduce waste,with the objective of saving $3 billion by 2005.

In Europe, meanwhile, Ford has pursued a differ-ent approach to cost engineering. Rather than shar-

ing cost savings with suppliers, it has set up inter-disciplinary teams that include representatives fromthe purchasing, engineering, manufacturing, andfinance departments to work with suppliers todevelop cost-saving ideas. The participants in theTVM (Team Value Management) initiative focus onprocess and product analysis in certain commodi-ties. Over the past two years, Ford has set up asmany as 65 commodity teams in Europe, with thegoal of taking out 15 percent of materials costs.

By establishing stringent cost engineering—includ-ing target costing, processredesign, and productredesign—OEMs can gofar toward ensuring prod-uct differentiation at com-petitive cost. This kind ofcost engineering should

be part of a structured and transparent approach tocost management, which OEMs should undertakejointly with suppliers.

Quality Management. A primary function of strate-gic supplier management is quality managementalong the entire supply chain. In fact, with morethan two-thirds of production activities currentlybeing outsourced to suppliers, OEMs need to pro-vide multidimensional quality support. Taking as areference the Japanese OEMs’ approach to qualitymanagement, we differentiate among three formsof OEM-driven quality support: traditional qualityauditing, quality teams, and quality associations.

Quality auditing consists of a detailed review of thesupplier’s production process during the ramp-upphase, as well as the ongoing measurement of prod-uct and process quality. While all OEMs conductdetailed quality auditing at the tier-one supplierlevel, many would do well to conduct quality audit-ing selectively also at the tier two and tier three lev-els, because some tier-one suppliers do not have theresources or the expertise to do so.

Quality teams, which OEMs dispatch to suppliers fordefined periods, can help suppliers not only byaddressing acute quality problems but also by train-ing them in quality management techniques. Their

34 BCG REPORT

Stringent cost engineering can help OEMs ensure product differentiation

at competitive cost.

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goal is to strengthen quality management at all sup-plier levels.

Finally, the Japanese concept of quality associations,known as kyohokai, refers to groups of suppliers thatcome together under an OEM’s leadership to focuson developing and improving quality standards.U.S. and European OEMs should consider involv-ing their key suppliers in quality associations ofsome kind in order to improve quality standardsalong the supply chain. Because the quality of prod-ucts and processes is a principal element in the sup-plier’s relationship with the OEM, we suggest thatsupplier-oriented quality management be clearlypositioned within strategic supplier management,as exemplified by Toyota.

Long a pioneer of quality-management techniques,Toyota includes a substantial quality-managementdimension in its purchasing organization. In addi-tion to applying traditional quality control to pur-chased parts and materials, Toyota disseminates itsquality-management techniques through a seconddepartment, called Supplier Production Manage-ment. SPM not only gives Toyota’s suppliers qualitysupport during the ramp-up phase but also sendstask forces of several engineers to key suppliers forperiods ranging from a few weeks to many months,with the goal of transferring Toyota ProductionSystem (TPS) principles to them. In this way, Toyotaensures adherence to its quality standards as well asto its overall production philosophy. This approachnot only cuts costs and boosts quality but alsosmooths the interface between Toyota and its sup-pliers. Today Toyota is experimenting with kyohokai-style quality associations outside Japan. The idea isboth to share knowledge through the exchange ofbest-practice ideas among suppliers and to provideintensive quality training. Among the OEMs re-viewed for this study, Toyota has the most elabo-rate and complete supplier-oriented quality man-agement.

Given the considerable distribution of productiontasks along the automotive supply chain, OEMs canensure quality only by installing multidimensionalquality support that goes well beyond traditionalquality auditing. Quality management should there-

fore be a critical element of strategic supplier man-agement.

Partnership Programs. This function serves to inte-grate the various initiatives at the OEM-supplierinterface into a comprehensive framework for col-laboration. Supplier development, cost engineer-ing, and quality management should take place notin isolation but as key elements within an OEM’scarefully structured partnership program. The roleof this function is to define such dimensions as costreduction, quality management, innovation ex-change, network building, and supply chain man-agement; to integrate the relevant strategic-sup-plier-management functions; and to ensure therelevance of preferred-supplier status in sourcingstrategies and negotiations. Compared with theother four functions of strategic supplier manage-ment, this one is more a support function, acting asa marketing and communication department to-ward suppliers.

In addition to ensuring the significance of pre-ferred-supplier status in OEMs’ purchasing strate-gies and negotiation procedures, partnership pro-grams serve to integrate all the other dimensions ofstrategic supplier management: trend and supplierscouting, supplier development, cost engineering,and quality management. They form a solid plat-form for effective supplier management.

One caveat: if an OEM treats its “preferred suppli-ers” exactly as it treats new suppliers, its partnershipprogram will be seen as merely a marketing gim-mick. To be effective, partnership programs mustgive participating suppliers preferred positioningvis-à-vis nonparticipants.

Four Organizational Models for Purchasing

At the beginning of this section, we outlined themerits of integration versus separation of the pur-chasing and R&D functions, as well as the need fora strong matrix organization to cut across tradi-tional departments and commodity groups. Fol-lowing the logic set forth in that discussion, we havedefined four organizational models for purchasingdepartments. (See Exhibit 15, page 36.) The deci-


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sion as to which model to use depends primarily onwhether the OEM is a volume manufacturer or apremium manufacturer, and on whether it pro-duces one brand of vehicles or multiple brands.

The Single-Brand, Volume-Oriented PurchasingOrganization. This is the traditional structure, inwhich purchasing is a centralized function thatreports directly to the CEO. Locating all purchasingactivities within this department generates clearcost synergies for the OEM. The horizontal plat-form or model dimension is less important becausesystems and components are sourced in common or

in similar ways across all models. This centralizationof purchasing activities ensures an optimalbundling of purchasing volumes across platformsand models, thus contributing to superior cost per-formance. On the other hand, the same strong stan-dardization across models that reduces materialscosts also has the effect of reducing end-productdifferentiation. In addition, the separation of pur-chasing from R&D can hamper innovation capture.

The Single-Brand, Premium-Oriented PurchasingOrganization. Here purchasing is combined withR&D, and the company practices strict collocation

36 BCG REPORT

E X H I B I T 1 5

PURCHASING DEPARTMENTS CAN BE STRUCTURED IN FOUR WAYS


Brand committee Platform committeeMinor roleJoint decisionLeading role

Premium

Volume

Brand positioning

Single Multiple

Number of brands

CEO

CEO

Production

Production

R&D/Purchasing

R&D

CEO

ProductionR&D/Purchasing

Model 1

Model 2

Model 1

Model 2

Purchasing

Brand 1

Brand 2

Model A

Model DModel C

Model B

Model A

Model DModel B

Model CPlatform

1

Platform 2

2 4

1 3CEO

ProductionR&D Purchasing

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of purchasing and R&D personnel. A strongeremphasis on the horizontal (platform or model)dimension promotes better cooperation betweenpurchasing and R&D, which is a prerequisite for aneffective innovation-capture process. In addition,this kind of organization fosters technical compe-tence among purchasing personnel. This approachalso permits clear product differentiation, which isessential if the company is to meet demanding cus-tomer requirements in the premium segment.However, this type of organization carries the riskthat R&D’s considerable influence on the sourcingprocess could curtail the overall push for costreduction at the OEM-supplier interface.

The Multiple-Brand, Volume-Oriented PurchasingOrganization. For volume OEMs that handle severalbrands, it makes sense to keep purchasing as anindependent, top-level function that reportsdirectly to the CEO. In addition, purchasing shouldbe organized in a matrix with a strong horizontalplatform dimension in which each platform teamcovers all relevant models of the different brands.The combination of a centralized purchasing de-partment with a number of platform managers andtheir platform teams creates a strong focus on costsynergies, because while purchasing is in charge ofpushing for cross-platform cost synergies, platformmanagers also have a clear mandate to look forintraplatform synergies. As a result, the wholematrix is focused on cost, and the OEM can becomevery cost-effective. The negative aspect of this ap-proach is that innovation capture is likely to have alower priority than cost cutting. Also, because plat-form managers are looking for intraplatform syner-gies, there can be some blurring of brand differen-tiation.

The Multiple-Brand, Premium-Oriented PurchasingOrganization. Here, too, purchasing is combinedwith R&D, and there is meticulous collocation ofpurchasing and R&D personnel, as well as a strongproject orientation for sourcing activities. The hor-izontal dimension of the matrix is dominated bybrands, which coordinate development and sourc-ing activities for their models. This approach en-sures the clear brand differentiation that is essentialto premium OEMs. At the same time, cross-brand

committees focus on obtaining platform synergies.The overall advantages of this model are that byintegrating R&D and purchasing, it promotes thecapture of differentiating supplier innovation, andthat the strong brand dimension tends to preventcannibalization among several premium brands.On the other hand, this type of organization is like-ly to achieve only limited cost reduction, especiallywhen cross-brand platform committees are notequipped with adequate decision-making power.

The four models described here reflect differentperspectives on how an OEM’s purchasing organi-zation might be structured. They should be seennot as definitive organization charts but rather asconceptual structures that highlight the major deci-sions to be made in designing an organization thatwill promote the best possible balance betweenproduct differentiation and cost optimization.

Ensuring a Smooth Innovation-Capture Process

While the structure of the purchasing departmentand its linkage to other OEM functions are criticallyimportant, another essential consideration is theset of decision-making rules that defines the devel-opment and purchasing process. Here, as mostOEMs and suppliers are well aware, purchasing andR&D have not always cooperated effectively.

Normally, a supplier works with the OEM’s R&Ddepartment for one to three years to define anddevelop a new system or component. Althoughmost OEMs’ purchasing departments try to managethe process through forward sourcing and targetcosting at this early stage, this involvement of pur-chasing is often not very effective, in part becausestaff rotations impair continuity and in part becauseof the tendency of many R&D engineers towardtechnological isolationism. All too often, therefore,the handoff of project leadership from R&D to purchasing triggers an extreme push for cost reduc-tion—calling into question everything the OEM-supplier team has developed to date and gen-erating numerous costly iterations. To ensuresmoother cooperation, it is essential to install astrong project structure that links R&D and pur-chasing throughout the process.


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REPORTBCG 38

tion with a cost-effective sourcing strategy, OEMsneed to develop their purchasing personnel andrelated policies along five dimensions: cross-func-tional experience, technical background, equitableremuneration, differentiated incentive systems, and training in technology and supplier man-agement.

Cross-Functional Experience. While traditionallymost members of the purchasing staff have had astrong departmental focus, we encourage OEMs toinstitute job rotation at both junior and senior lev-

els among purchasing,R&D, production, market-ing, and sales. This pro-gram may take the formof structured short-termexchanges or long-termpersonnel transfer. Com-

panies that offer such cross-functional career pathsreport that their purchasing staff members aremore motivated, acquire more interest in technol-ogy, and display a stronger end-customer orien-tation.

Technical Background. Educational profiles inmany OEM purchasing departments tend to featurestrong economic backgrounds. In fact, with theexception of two companies, all the OEMs wereviewed for this study had purchasing personnelwho held degrees primarily in business administra-tion, accounting, or economics. For the purchasingstaff to play a more active role in the innovationprocess, OEMs must strengthen their technicalcompetence. In our view, OEMs would benefit fromadding more engineers to their purchasing depart-ments—either through focused recruiting efforts attechnical universities or through intracompanytransfers from R&D or production.

Equitable Remuneration. Within most OEMs, thereis still a considerable gap between the wages paid topurchasing staff and the wages paid to their coun-terparts in other departments, particularly R&D. Toattract more technically sophisticated personnel,OEMs will have to provide equally interestingopportunities across departments, in terms of bothwage structures and career options.

Also, OEMs must ensure that there is a clear jointdecision-making process within purchasing, involv-ing the people in charge of purchasing by productgroups—the systems and components purchasers—and those in charge of sourcing for individual plat-forms or models. As the development and purchas-ing process moves forward, the decision-makingpower shifts and roles must be redefined.

• At the advanced development stage, systems pur-chasers need to interact with their suppliers andwith R&D to identify and promote differentiatinginnovations.

• At the stage of conceptdefinition and com-petition, the projectdimension—whetherplatform or model—becomes predominant. Project-specific sourcingmanagers need to decide which systems and com-ponents to incorporate into their respective plat-forms or models, while systems and componentspurchasers should provide them with generalsourcing guidelines and useful input based ontheir particular supply-market expertise.

• During the final negotiation and subsequentseries-development stages, there must be—andthis is particularly important—a joint decision-making structure between systems and compo-nents purchasers on one side and project man-agers on the other. This is essential to ensure thestability of the innovation process.

In summary, over the course of the developmentprocess, decision-making power shifts from the ver-tical to the horizontal perspective, ending up with aclearly defined joint decision-making approach.Only by defining decision-making rules that reflectthis shift—and ensuring that they are honoredthroughout the organization—can OEMs guaranteeboth innovation capture and cost containment.

The Human Dimension

To meet the broad array of challenges related tobalancing an effective process for capturing innova-

OEMs must ensure thatthere is a clear

joint decision-making processwithin purchasing.

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Differentiated Incentive Systems. Traditionally, theprimary measures on which OEMs have assessed theperformance of their purchasing staffs have beenpurchasing price levels and cost-reduction achieve-ments. To promote sourcing that focuses more oninnovation, OEMs need to rework their incentivesystems to include new dimensions such as innova-tion capture rates, supplier quality improvement,supplier productivity improvement, and implemen-tation of supply-chain-management tools.

Training in Technology and Supplier Management.Currently, OEMs offer their purchasing personnelonly limited training in either new technologies orstrategic purchasing techniques. However, tosource complex systems effectively, purchasing staffmembers need to have a good understanding of rel-evant technologies. Moreover, to implement strate-gic supplier management, they should also betrained in areas such as supplier development, costengineering, and quality management. Therefore,in addition to creating cross-functional careerpaths, OEMs should take a diversified approach to

training, ensuring that it covers not only traditionalpurchasing skills but also strategic supplier man-agement and relevant technical know-how.

Only by dramatically enhancing the competence oftheir purchasing personnel can OEMs achieve trulyeffective cooperation with their suppliers. Suchcooperation goes well beyond annual price-reduc-tion rounds to focus on fostering joint innovationprocesses—which in turn are critical to ensuringproduct differentiation at competitive cost.

* * *

In this section we have described how OEMs canbetter wield the six levers of a joint innovationprocess by setting up a supplier- and technology-ori-ented purchasing organization. In the next sectionwe take a close look at the other side of the OEM-supplier interface—focusing on those areas wheretier one suppliers need to take action in order toremain the OEMs’ partners of choice in an industrythat is increasingly driven by innovation.


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An Agenda for Tier One Suppliers

40 BCG REPORT

account management and cross-functional sales teams

The R&D Challenge: Leveraging the InnovationPotential

To fulfill their new role as innovation drivers andorchestrators, tier one suppliers must bothstrengthen their own engineering capacity andleverage their subsuppliers’ technical expertise.Moreover, to do this effectively, tier one suppliersneed to understand their clients’ innovation focusearly on. In this area, Japanese suppliers offer best-practice models. Most Japanese suppliers have sub-stantial numbers of resident engineers at OEMsites. Among the Japanese suppliers that partici-pated in this study, the number of such engineers atOEMs ranged from 15 to 200. (See Exhibit 16.) Ofcourse, these large numbers of resident engineers

On the other side of the OEM-supplier interface,tier one suppliers are facing stiff challenges of theirown. They have to work more closely than everbefore, both with their OEM clients, which askthem for valuable innovations but also pressurethem on cost, and with a multitude of tier two andtier three suppliers, which generally are not wellintegrated into effective supply-chain structures.Unlike tier two and tier three suppliers, tier onesuppliers need to manage their own networks ofsubsuppliers in order to generate innovation andcontrol materials costs. Moreover, they need todefine structures capable of supporting their heavyinvolvement in OEM product-development andassembly processes.

In our analysis of OEM-supplier relationshipsaround the world, we identified four areas that tierone suppliers need to address within their ownorganizations:

• In R&D, it is critical that tier one suppliers under-stand the OEMs’ innovation strategies early on, sothat they can build an adequate engineering baseand develop flexible innovation networks withsubsuppliers

• In procurement, tier one suppliers should imple-ment strategic subsupplier management, similarto the OEMs’ strategic supplier management, inorder to ensure the proactive development oftheir own supply base, manage costs at the tiertwo and tier three levels, and ensure quality alongthe whole supply chain

• In production, tier one suppliers need to acquirethe project-management and risk-managementskills that are critical for the new business modelsthat are likely to become increasingly importantin the industry: BOT models and supplier parks

• In sales, the main challenge is to build a cus-tomer- and product-driven sales organization thatsupports effective communication with theincreasingly global OEMs through strong key-

Number of engineers from major Japanese auto suppliers who reside at selected OEMs1

0

50

100

150

200

250

A B C D E F G

200

80

5030 30

Suppliers

3015

E X H I B I T 1 6

MAJOR JAPANESE SUPPLIERS USE MANY RESIDENT ENGINEERS IN THEIR OEM RELATIONSHIPS


1Average for 2003.

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emanate from the traditional keiretsu structuresand are typically distributed among many projects.

Resident engineers represent a significant invest-ment in personnel. So it is critical that they gener-ate substantial advantages in the advanced-develop-ment, concept-definition, concept-competition,series-development, ramp-up, and productionstages. Toward this end, resident engineers use theadvanced development period strategically to ana-lyze the OEM’s innovation strategy, help focus theOEM’s development of new technologies, andproactively position the supplier’s innovations withthe OEM’s R&D engineers. In addition, residentengineers are important sources of information oncompetitive activities during concept definition andconcept competition. Later in the process, they cancontribute to a smooth interaction between sup-plier and OEM, as their presence “on the ground”helps to minimize any risk of process instability.Especially during ramp-up, resident engineers canplay an important quality-fostering role by ensuringthat the supplier’s systems and components areoptimally integrated into the overall vehicle.

In addition to placing resident engineers at theOEM, each supplier needs to develop a strong pro-prietary engineering base. The growth of tier onesuppliers’ proprietary R&D capacity is reflected intheir increasing R&D investments: many leadingsuppliers are allocating as much as 7 percent oftheir earnings to this activity. Suppliers canstrengthen their innovation capacity in two ways: bygrowing organically or by acquiring engineeringfirms. For example, the acquisition of IVM Auto-motive by Edscha, the German roof-system supplier,was an important cornerstone in making Edscha afull-service provider—as shown by the substantialrole it played in the design and development of thecabriolet version of DaimlerChrysler’s PT Cruiser.

Clearly, tier one suppliers must invest considerabletime and money in pursuing R&D strategies thatwill complement the R&D strategies of their OEMclients. To ensure that they build the necessaryengineering capabilities and deploy them effec-tively, tier one suppliers must implement stringentR&D management based on a detailed innovation

road map for each OEM client. Identifying andassessing internal and external opportunities forgrowth are another important function of R&Dmanagement.

In addition to developing their own innovationbase through organic growth and acquisitions, tierone suppliers should work with tier two and tierthree suppliers to develop flexible innovation net-works. Like the OEMs, tier one suppliers are look-ing for innovation partners both inside and outsidethe traditional automotive supply base. For exam-ple, Valeo, a French supplier of automotive equip-ment, initiated an innovation partnership with Ray-theon, the U.S. aerospace and defense company, topromote its development of parking assistance sys-tems. Delphi, the world’s largest automotive sup-plier, established an innovation network withEricsson, the telecom equipment manufacturer, forits telematics solutions; it also cooperated withPalm, a producer of personal digital assistants, toenlarge the voice recognition functionality of itscar-related “infotainment” systems.

To set up and manage effective flexible-innovationnetworks at the subsupplier level, tier one suppliersneed to act like OEMs, continually monitoring andbenchmarking the innovation potential of theircurrent suppliers as well as new suppliers withunique, complementary expertise. They should alsodevelop alternative network scenarios with bothautomotive and nonautomotive suppliers, carefullyassessing the subsuppliers’ potential for coopera-tion. Finally, they need to do the necessary mana-gerial groundwork, setting up cooperation struc-tures for the innovation networks, such as R&Dplatforms or joint R&D road maps, and managingthem throughout the process.

The Procurement Challenge: Implementing Strategic Subsupplier Management

Although some tier-one suppliers have grown solarge that they are now comparable to small OEMs,a number of them still have traditional, operations-oriented purchasing functions. In particular, thestrategic-subsupplier-management function is notwell developed in tier one suppliers’ purchasing

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departments. For tier one suppliers to fulfill theirrole as innovation drivers and system integrators,they must aim to manage their subsuppliers alongthe same five dimensions that we have identified forOEMs: trend and subsupplier scouting, subsupplierdevelopment, cost engineering, quality manage-ment, and partnership programs. While establish-ing a full-fledged strategic-subsupplier-manage-ment function may not be necessary for all tier-onesuppliers, most such suppliers could benefit fromimplementing some of the following functions,depending on their level of innovation and theirprocess role in the sup-ply chain.

Trend and SubsupplierScouting. This function’sgoal is to identify, at anearly stage, subsuppliersthat can handle the leading-edge technologies thatwill contribute to product differentiation in five toten years. As described in the previous section, thisfunction regularly monitors the supply base, initi-ates contacts with innovation drivers, benchmarkseach relevant technology’s price spot, and managesthe company’s panel of future key subsuppliers. Forexample, Behr, a supplier of vehicle air-condition-ing and engine-cooling systems based in Germany,has set up an “innovation purchasing” function.This effort is dedicated to prescreening new sub-suppliers and conducting worldwide benchmarkingof breakthrough technologies for air conditioningand engine cooling. Only by practicing such proac-tive searches for new suppliers of leading-edge tech-nologies can tier one suppliers ensure a steadystream of differentiating innovations for their OEMclients.

Subsupplier Development. This is a critical func-tion for tier one suppliers, because it allows them toenergize competition at the subsupplier level, totap subsuppliers’ full innovation potential, and toprepare for international business expansion. Ingeneral, tier one suppliers that practice strategicsubsupplier development apply it in three ways.First, they develop alternative sources for raw mate-rials and production technologies as a safeguardagainst monopolistic or oligopolistic market situa-

tions. Second, they play a key role in instigatingjoint R&D structures or financial participationschemes to stimulate the exchange of know-howand innovation. Third, they structure mergers andacquisitions with local players to support expansioninto new regions. Confronted with a business envi-ronment that is increasingly complex—both tech-nologically and geographically—tier one suppliersneed to shape their supply bases strategically inorder to ensure access to differentiating innova-tions and to the markets of the future.

Cost Engineering. Thisfunction focuses on man-aging subsuppliers’ costs,using approaches such astarget costing, processredesign, and productredesign. Especially for

large tier-one suppliers that provide integratedsolutions to their OEM clients, stringent cost man-agement is essential to meet the OEM’s price expec-tations. It is not surprising that Delphi has been oneof the first suppliers to set up such a cost-engineer-ing function. Teams of Delphi engineers carry outdetailed process analyses at their suppliers’ produc-tion sites. They also conduct lean-manufacturingworkshops, in which Delphi and its suppliers jointlygenerate concrete measures to meet Delphi’sannual price reduction goal of 3 percent.

Learning from the OEMs, tier one suppliers shouldset up their own cost-engineering functions to drivedown—in a cooperative way—materials and pro-duction costs at the tier two and tier three supplierlevels. For tier one suppliers, cost engineering is thecritical tool they need in order to avoid beingcaught in a profitability trap between the strongprice pressure of the OEMs, on the one side, andtheir subsuppliers’ less stringently controlled coststructures, on the other.

Quality Management. This function is especiallyimportant for tier one suppliers, which face qualitychallenges from both directions: their subsuppliersand their OEM clients. To improve quality manage-ment among tier two and tier three suppliers, tierone suppliers need to send quality teams to provide

42 BCG REPORT

Tier one suppliers must manage their subsuppliers

along the same five dimensionswe have identified for OEMs.

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on-site support, as well as to hold quality workshopswith key personnel. At the same time, they shouldalso send their own quality-management staff totheir OEM clients to ensure an optimal integrationof their systems and components—especially dur-ing the ramp-up phase and around the start of pro-duction.

To carry out these diverse quality-managementtasks along the whole supply chain, most of thelarge tier-one suppliers analyzed for this study haveseveral dozen quality specialists dedicated to sup-porting their subsuppliers and OEM clients duringcritical stages. As tier one suppliers increasinglyassume the integrator role in the industry, it isessential that they take over a larger share of over-all quality management along the entire supplychain. Of course, these activities need to be closelycoordinated with those of the OEMs.

Partnership Programs. These used to be the soleprerogative of OEMs, which wanted to integratetheir supplier-development, cost-engineering, andquality-management initiatives under an overallpartnership concept. Recently, however, large tier-one suppliers have started to set up similar pro-grams. Visteon, for example, has created a programcalled SAVE (Suppliers and Visteon Excel), which isgeared toward cost management and supplier coop-eration. SAVE aims to support participants in jointlyidentifying opportunities for cost savings in productdesign, materials, and manufacturing processes.The program also encourages communication andinteraction among subsuppliers about technologydevelopment and production optimization. Whilethe jury is still out regarding the success of SAVE, itclearly shows how large tier-one suppliers are repli-cating the strategic-supplier-management practicesof OEMs.

Of course, partnership programs may not makesense for all tier-one suppliers. Each suppliershould evaluate the potential for such a program,given the scale and nature of its subsupplier base.As with OEM-sponsored programs, the success ofsuppliers’ partnership programs will depend onwhether they genuinely benefit the participatingsubsuppliers, either by giving them real support on

innovation, processes, and quality or by ensuringthat they receive preferential treatment in sourcingnegotiations.

Not all tier-one suppliers have the scale orresources to implement full-fledged strategic-sub-supplier management. However, depending ontheir innovation capacity and their role in the sup-ply chain, all suppliers should think about institut-ing at least some of the functions described above,as they are critical to ensuring a healthy, diverse,and competitive supply base in the future.

The Production Challenge: Preparing for New Business Models

In the production area, the key challenges for tierone suppliers are not so much technical as opera-tional. Here their task is to make the new coopera-tion structures—the build-operate-transfer (BOT)models and supplier parks—work without pushingthemselves over the financial edge. Traditionally,suppliers used to produce systems and componentsat production sites of their own choosing. Withincreasing globalization, they have been movingtheir production facilities to other countries andcontinents to be closer to their OEM clients and toreduce costs. The increasing number of BOT mod-els and supplier parks has taken the trend towardever closer involvement in the OEMs’ productionprocesses to an entirely new level.

BOT Models. BOT models represent the tightestform of OEM-supplier cooperation. As describedabove, in this model the supplier takes over parts ofthe OEM’s production process, owning the produc-tion equipment and sometimes managing the paint-ing or final assembly process itself. By performingthe OEM’s traditional manufacturing role in theOEM’s factory, the supplier increases its businessscope; but it also takes on the full burden of marketand operational risks that were formerly borne bythe OEM.

BOT models are based on a quite complex networkof relationships. (See Exhibit 17, page 44.) Tra-ditionally, a tier one supplier used to sell, forinstance, a complete paint-shop system to an OEM

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44 BCG REPORT

and receive payment for that system. In BOT mod-els, this simple transaction is replaced by a complexinteraction among the supplier, a specially createdoperating company, the OEM, and the financingbank. The supplier owns the operating company,which in turn owns the asset—the paint shop sys-tem—which is financed by the bank.

The main difference between the traditionalarrangement and the new one is that rather thanpaying the supplier for a paint shop system, theOEM now compensates the supplier, through itsoperating company, on a per-painted-vehicle basis.So the supplier takes over a large part of the entre-preneurial risk if, for example, a particular modelfails to meet planned sales targets or if there areproduction disruptions in the factory.

As discussed in earlier sections, BOT models are thesubject of much controversy. Clearly, they hold bothadvantages and drawbacks for all players. ForOEMs, the new business models have the advan-tages of requiring no initial investment, improvingtheir balance sheets, increasing efficiency, sidestep-ping budget constraints, and sharing risk. But, ofcourse, these models can also have disadvantages forthe OEMs, such as further loss of operations com-petence, increased unit prices, and tensions withunions—as well as the risks entailed in supplier-

related financing, which is likely to be less advanta-geous than traditional OEM-related financing.

For suppliers, BOT models allow them to expandthe range of services they can offer the OEMs, thusdifferentiating themselves from the competition; togain a better understanding of the productionprocess itself, which in turn can enhance productdevelopment; and possibly to earn higher margins.However, suppliers clearly incur higher risk, includ-ing both operational and market risk. And theymust bear the financing costs of BOT models,which can easily exceed their financial resources.

Supplier Parks. These represent a less extreme butstill significant change in the traditional OEM-sup-plier relationship. Initially, the concept of supplierparks was strongly promoted by volume OEMs,including Ford and Volkswagen—mainly to ensurejust-in-time and just-in-sequence delivery of partsand systems to their larger production facilities.Premium OEMs such as BMW and DaimlerChryslerhave followed this example, although their parkstend to be limited to a smaller number of suppliersbecause scale effects are lower in the premium seg-ment. Today there are dozens of supplier parksacross Europe and the United States, ensuring bet-ter information exchange, smoother logistics, and shorter reaction cycles between suppliers and OEMs.

While the closer interaction generated by theseparks has positive effects on product developmentand series production, there are drawbacks as well.When a supplier moves close to several OEMs, itsformerly centralized production structure becomesfragmented, eroding economies of scale. Moreover,in producing literally at the doors of the OEM’s fac-tory, the supplier becomes far more dependent onthe success of the OEM’s local production than wasthe case under the traditional centralized location.

To function successfully in these new business mod-els, suppliers must master the disciplines of modelassessment and risk management.

Model Assessment. When asked to participate in aBOT model or a supplier park, suppliers need tocarefully assess these arrangements in terms of the

OEM

Operation contract

Operation of asset

Payment per produced vehicle

Loan to buy assetRepayment of loan

Security for loan

Operatingcompany

Saleof

asset

Ownership

Paymentfor asset

Guarantee for operation

Financingbank

Supplier

E X H I B I T 1 7

BUILD-OPERATE-TRANSFER (BOT) MODELS INVOLVE COMPLEX RELATIONSHIPS


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OEMs involved, the underlying business logic, andthe local production structures. For example, par-ticipating in one OEM’s supplier park that serves asingle-model factory is far riskier than participatingin a supplier park that supplies several multimodelfactories belonging to various OEMs, such as theRosslyn supplier park in South Africa. In makingthese assessments, suppliers also need to develop aclear understanding of the cost structures in therelevant countries, including potential expatriate-remuneration packages, local trade-union require-ments, and their own supply logistics. When engag-ing in this type of cooperation, it is essential thatthe OEM, the participating suppliers, and thefinancing banks work together closely and ensuremaximum transparency.

Risk Management. In addition to performing thisoverall assessment of new business models, suppli-ers should carefully limit their risk exposure bycrafting meticulously detailed contracts with OEMsand subsuppliers. Toward this end, they need todevelop proprietary legal resources with the skilland experience to handle the risks involved. Eachsupplier’s legal team should secure the supplier’sposition through contractual clauses covering suchissues as minimum sales volumes, production cyclecontingencies, preferred-supplier status for next-generation vehicles, and volume-sensitive pricingschemes. In addition, each supplier should be sureto establish flexible contracts with its own subsup-pliers. The purpose of such contractual safeguardsis to guarantee the supplier a minimal return on itsinvestment and to share with subsuppliers some ofthe uncertainty inherent in these models.

These new business models represent a seriouschallenge to suppliers’ economic viability. As OEMsare increasingly pushing for these models, suppliersmust protect their own interests by performing thedetailed assessment described above, as well asengaging in proactive risk management.

The Sales Challenge: Structuring a Customer- andProduct-Driven Organization

In our discussions with suppliers and OEMs, it hasbecome clear that many suppliers’ sales organiza-

tions are not structured to support effective inter-action with OEMs. Suppliers can address this issueby redesigning their sales organizations. (SeeExhibit 18, page 46.) The redesign should followthree key principles:

1. Bundling key-account-management activities atthe executive level

2. Ensuring strong linkages between key-accountmanagement and engineering

3. Mirroring the OEMs’ purchasing organizationsin their own sales organizations

Bundling Key-Account-Management Activities at theExecutive Level. While divisional key-account man-agement will remain the backbone of ongoing salesactivities, large suppliers should also have one pointin the organization that oversees all negotiationsand all contracting for a given OEM. Establishingexecutive-level key-account management allows thesupplier to present a single, unified face to theOEM customer. It also provides centralized deci-sion-making authority, making it possible for thesupplier to respond quickly to OEMs’ requests forcross-divisional bids—for example, in e-procure-ment processes.

Some large suppliers with numerous divisions haveimplemented the concept of a cross-divisional “Mr.Ford,” “Mr. Volkswagen,” or “Mr. Toyota,” who over-sees all sales activities with these OEMs. Others,however, still fragment their decision-makingauthority—a practice that allows them to apply dif-ferent pricing models in different regions and dif-ferent product categories. But in view of the global-ization under way among OEMs, it will beincreasingly important to give one person—it couldbe a board member or even the CEO—clear over-sight of all the company’s activities with the mostimportant clients.

Smaller suppliers with fewer divisions may not feelthe need for executive-level key-account manage-ment at the board level. Instead, they may prefer toimplement this function within a particular divi-sion. For example, the key-account manager of thedivision that does the most business with a given

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46 BCG REPORT

OEM could also be the executive-level key-accountmanager for that OEM, thus filling a double role.

The ideal design for a key-account-managementorganization will of course depend on the size ofthe organization and the number of divisions it has.Suppliers with many business units generally needexecutive-level key-account management that tran-scends the divisions; those with one or two businessunits should integrate executive-level key-accountmanagement within the divisional structure.

Ensuring Strong Linkages Between Key-AccountManagement and Engineering. Suppliers’ salesteams will increasingly need technical sophistica-tion and competence, especially if the productsthey are selling are relatively complex and requireintense interaction with the OEM’s R&D depart-ment. So suppliers need to create, within each divi-sion, a sales team structure that links engineeringwith divisional key-account management by puttingengineers with relevant technical expertise on eachsales team. In this way, each team will have both in-depth technical expertise and a detailed under-

standing of the client’s purchasing organizationand sourcing strategy. Of course, suppliers that sellrelatively simple, standardized products may notneed to incorporate engineers in their sales teamsbut can continue to sell through key-account man-agement alone, thus integrating product and clientknow-how in one person.

Mirroring the OEMs’ Purchasing Organizations inTheir Own Sales Organizations. To create an effec-tive interface with their OEM clients, best-practicesuppliers have organized their key-account manage-ment to mirror the OEMs’ purchasing organiza-tions. This implies that, for example, if an OEMsources by commodity groups, the supplier’s salesorganization should be organized by commoditygroups, whereas if an OEM buys principally on thebasis of platforms or models, the supplier’s key-account management should be structured accord-ingly. This approach can trigger different key-account-management structures within onesupplier—each mirroring the specific setup of therespective OEM client. Although such a setup mayincrease the organizational complexity of the

E X H I B I T 1 8

TIER ONE SUPPLIERS SHOULD STRUCTURE THEIR KEY-ACCOUNT-MANAGEMENT ORGANIZATIONS TO MIRROR THE OEM ’S PURCHASING ORGANIZATION


Regions

Set up executive key-account management (KAM) with central decision-making power across divisions

Create a powerful project structure between engineering and divisional KAM

Mirror the structure of the OEM’s purchasing organization in the KAM organization

Platforms or models

Division nDivision 1 Division 2

Board

Executive KAM

Engineering KAM Engineering KAM Engineering KAM

1a

1b

2

3

Sales team

Combine responsibilities where possible (for example, integration of executive and divisional KAM for smaller suppliers)

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supplier’s sales organization, it contributes to farbetter communication and smoother cooperationat the OEM-supplier interface. In general, it willbecome increasingly important for suppliers toadapt their sales organizations to the dynamics ofthe OEMs’ purchasing functions.

* * *

As indicated by the four types of challengesdescribed in this section, tier one suppliers around

the world face a broad array of issues that requireskillful management. Urgent tasks include leverag-ing subsuppliers’ innovation potential, designing astrategic-subsupplier-management function, pre-paring for new business models, and setting upeffective sales interfaces with OEMs. In short, to ful-fill their daunting new charter as system integratorsand innovation drivers—and thus become theengines of the automotive industry’s growth—tierone suppliers will need to rethink their roles.

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Reinventing the OEM-Supplier Interface

48 BCG REPORT

Throughout this report, we have argued that thefuture of the automotive industry depends on rela-tionships between OEMs and their suppliers thatare stable, innovation oriented, and cost-effective.Although those relationships have recently beenmarked by a relentless, unilateral drive for lowerprices, it is our deep conviction that the industrynow needs to move beyond cost reduction if it wants toachieve product differentiation at competitive cost.Toward that end, we have identified three princi-ples that should stand as guideposts to OEMs andsuppliers alike.

1. Stable development and purchasing processesare essential to the effective exchange of innova-tion. Such processes foster trust and promote cross-fertilization. Only by ensuring a certain level ofprocess stability—free of negotiating ploys and self-serving business tactics—can OEMs manage to cap-ture innovations that will allow them to differenti-ate their products in the eyes of consumers.

2. Virtual and physical innovation platforms mustplay a critically important role. Innovation plat-forms enable OEMs to identify new suppliers—especially in nonautomotive areas—and to set upearly, effective interactions with innovation drivers.Whether these platforms take the form of openWeb portals for innovation exchange, specializedR&D partnerships, or joint development teams,they all contribute to the development of new,brand-differentiating systems and components.

Only by providing such an innovation-fosteringenvironment can OEMs truly leverage the productand market expertise of their suppliers—an essen-tial undertaking, given the high level of specializa-tion and outsourcing in the industry.

3. Intracompany cooperation models are indispens-able. Such models, which are currently underused,play a vitally important role in promoting betterrelationships between OEMs and suppliers. On theone hand, cooperation and collocation modelsbetween R&D and purchasing can contribute to amuch more stable innovation process within anOEM. On the other hand, staffing sales teams withspecialized engineers as well as key-account man-agers can bring the impact of the supplier’s fullrange of knowledge to the point of sale. The criticallesson here is that in order to improve their inter-face, OEMs and tier one suppliers need to work ona better internal alignment of their own functions,while also working to improve external rela-tionships.

Obviously, the changes described above will nothappen overnight. However, if the automotive in-dustry wants to remain a cornerstone of nationaleconomies around the globe, it will have to ensureproduct differentiation at competitive cost. Indus-try leaders can achieve this goal only by puttingOEM-supplier relationships on a new basis—inother words, by reinventing the OEM-supplierinterface.

5415.text 3/4/04 4:31 PM Page 48

The Boston Consulting Group is a general management consulting firmthat is a global leader in business strategy. BCG has helped companiesin every major industry and market achieve a competitive advantage bydeveloping and implementing winning strategies. Founded in 1963, thefirm now operates 60 offices in 37 countries. For further information,please visit our Web site at www.bcg.com.

“What Is Globalization Doing to Your Business?”

Opportunities for Action in Industrial Goods, February 2004

“Made in China: Why Industrial Goods Are Going Next”

Opportunities for Action in Industrial Goods, November 2003

“Rethinking Automotive Purchasing: From Price Pressure to Partnership”

Opportunities for Action in the Automotive Industry, November 2003

(This publication summarizes a section of the present report.)

“Innovation to Cash: Orchestrating the Process”

Opportunities for Action in Industrial Goods, September 2003

“Boosting Innovation Productivity”

Opportunities for Action in Industrial Goods, April 2003

“Asset Productivity: A Potent Lever for Competitive Advantage”

Opportunities for Action in Industrial Goods, March 2003

“Competing to Win in China’s Fast-Growing Automotive Market”


“Rethinking ‘Made in China’ Cars and Parts”


Steering Carmaking into the 21st Century: From Today’s Best Practices to the Transformed Plants of 2020

A report by The Boston Consulting Group, November 2001

For a complete list of BCG publications and information about how to

obtain copies, please visit our Web site at www.bcg.com.

To receive future publications in electronic form about this topic or others,

please visit our subscription Web site at www.bcg.com/subscribe.

The Boston Consulting Group publishes other reports and articles that may be of interest to automotive industry

executives. Recent examples include:

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Beyond C

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reinventing the automotive oem-supplier interface

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