Striking the right balance in Automotive

Businesses across the UK are facing up to the consequences of rising inflation and will need to reassess their cost base as a result. While cost-cutting is necessary, it is unlikely to be sufficient in isolation. Indeed, poor execution can harm chances of survival. 

Leaders will need, instead, to figure out ways to grow, find new sources of revenue, and consider pivoting their value proposition. This necessitates cutting costs in a manner that does not harm the business, but rather redirects costs to the drivers of growth — the capabilities that differentiate one company from the next. Companies will need to make and execute these decisions swiftly and with agility, as the current political turmoil has created significant volatility and uncertainty in the economy. 

In our report, Striking the Right Balance, we discuss the threats and opportunities presented by rising inflation and recommend three ‘no regret’ actions:

• Revisit strategic priorities
• Look for what’s different across the value chain to reset your cost structure 
• Bring your people with you and drive operational agility

In this article, we explore the specific impact on the automotive industry and the actions those in the sector – OEMs, retailers, and suppliers – should consider. 

The impact of cost pressures on the automotive market

High inflation, rising interest rates, and political instability is exacerbating four pre-existing issues in the automotive industry:

I. Cost increases

According to the SMMT, UK energy costs are already the most expensive of any European automotive manufacturing country. That’s before the sector faces an energy cost increase upwards of £90m. The primary impact will be the accelerated costs for direct materials, as well as energy-intensive activities such as manufacturing, in-house IT hosting, showrooms, and distribution of materials, parts, and finished goods. Over the next six months, UK automotive companies could see prices in these categories increase by 15-20%. Along with slightly gentler increases in other areas, total operational costs for the sector could rise by 10-15% without swift intervention. 

In addition, many automotive companies still hold sizeable legacy defined benefits pension liabilities, most of which are not protected from the current high rates of inflation: The last few weeks have seen considerable pensions volatility and uncertainty, due to financial markets’ response to the government’s announcements and increase in gilt yields. Despite the Bank of England’s interventions to stabilise the market, this volatility is likely to continue.

II. Supply chain disruption

While high inflation will ease some supply pressures as slowing demand reduces the backlog for semiconductors, the risk of unexpected supply chain disruption will increase. Small- and medium-sized suppliers, with previously healthy financials and efficient operations, may find themselves on the brink of insolvency, with ripple effects for OEMs. High fuel prices and shortages could impact logistics, particularly for German-based suppliers with a heavy dependence on Russian oil and gas.

III. Workforce challenges

Automotive companies are facing a widening mismatch between the skills they have and the skills they need. Future success is likely to hinge on capabilities in powertrain electrification, data analysis, customer experience, and servicing. Many of these companies are deeply imbued with a culture that values stability and predictability, making this transition particularly challenging, especially after fire-fighting back-to-back crises in recent years. Against this background, auto companies face rising labour costs, higher risks of industrial action, challenges of making hybrid working effective, and growing scrutiny from customers and investors who expect them to look after employees facing steeply rising costs of living.

IV. Changing demand

The rising costs of energy and fuel – as well as the broader squeeze faced by households across the UK – will impact consumer confidence, and hence automotive demand and revenues. While new vehicle volumes should remain fairly strong in the near term because of order backlogs, these may taper off as more households look to defer purchases, downscale to more affordable models or used vehicles, and seek flexible options such as monthly EV (electric vehicle) subscriptions. Vehicle efficiency – whether miles per gallon or miles per kWh – will become an increasingly important factor in buying decisions. With the current political climate creating uncertainty around policies on household energy costs and EV incentives, the pace of adoption is widely unpredictable. For those who drive a company car, “benefits in kind” taxes will be reduced from April, though this saving is unlikely to offset the rising costs of fuel.

Meanwhile, households under pressure may struggle to honour their PCP contracts. Without payment holidays or financing support, this could result in large volumes of ‘young’ used cars flooding the market, depressing prices of both new and used vehicles, as well as significant loss of customer goodwill.

What automotive firms should do next

1. Revisit strategic priorities

Success is no longer purely defined by short term financial profit: Customers, employees, and investors expect companies to also have a positive impact on society and an ability to weather frequent disruptions. In light of this, automotive firms should revisit their purpose and strategy.

Reaffirm company purpose, and how it translates into social value objectives. It is more important than ever for automotive companies to ‘do the right thing’ by society in order to attract and retain top talent, to satisfy customer expectations, and to secure financial investment.

Review and refine medium-term investment strategy. Analyse how changing interest rates, inflation, policy movements, and geopolitical events will affect rates of return for different investment opportunities. For example, the government’s capital allowance reversals and introduction of enhanced capital allowance (ECA) and structured building allowance (SBA) from April 2023 could improve the case for investment. Look beyond traditional value pools to identify attractive areas for expansion, such as electric charging or renewable energy.

Review and refine existing commercial strategy.

• Analyse the impact of inflation on different customer groups’ appetite to buy, or willingness and ability to pay. Refine your marketing strategy and tactics accordingly by, for example, targeting particular customer cohorts.
• Revisit volume and product mix strategy to reflect expected changes in demand.
• Make pricing and proposition decisions that reflect social value objectives and customer loyalty opportunities, but also protect against rising inflation. For example, honour quoted vehicle prices or introduce subscription-based pricing for those facing financial uncertainty.
• Initiate or accelerate transformation of channel structure to reduce costs and enhance customer experience. For example, restructure retail and distribution models through agency agreements or vertical integration to create consistency online and offline.
• Develop and strengthen strategic partnerships and alliances upstream (e.g. battery manufacturers), downstream (e.g. customer facing tools, data management technologies), in adjacent value areas (e.g. EV charging infrastructure installation), and beyond (e.g. local and central government).

2. Look for what’s different across the value chain to reset your cost structure

Create spend visibility & build supply chain resilience.

• Model costs, supply security/availability, carbon emissions, and social impact under different inflation and geopolitical scenarios. Use this to inform decisions around spend profile: For example, fuel shortages in Germany, political tensions with China, and the devaluation of the pound could further strengthen the case for localisation of sourcing to the UK
• Work with Tier-1 suppliers to conduct rapid ‘health checks’ on Tier 2-4 companies. Develop tangible solutions to mitigate potential risk by supporting companies, for example, through advanced payments, contract renegotiation, or even acquisition.
• Value engineer cost out of the supply chain: Work collaboratively with suppliers to secure supply, retain and enhance margin, address waste, and improve ease of doing business

Review and realign cost reduction strategy

• Distribution and retail: At a minimum, reduce physical footprint of large, brightly-lit showrooms, nudging potential customers to digital platforms and at home test drives. More radically, transform the retail and distribution structure to a truly ‘opti-channel’ model, using automation to reduce time and cost to serve. 
• Manufacturing: Review make vs. buy decisions, considering in-house component production to reduce costs, improve reliability, and maintain workforce utilisation. Explore ‘off-cycle’ shifts timings, including night shifts, to reduce energy costs while rewarding employees accordingly. Explore renewable energy solutions, such as solar panels on factory roofs, to reduce costs and emission.
• Pensions: Cease build-up of costly defined benefit pensions. Make interventions to reduce legacy liability to free up cash.
• IT infrastructure: Accelerate the shift to cloud. Hosting and data centre costs will rise in line with energy costs, while third-party cloud costs will remain relatively flat due to green energy strategies and scale.
• Managed services: Revisit outsourcing and offshoring decisions to reflect benefits of leveraging managed services relative to rising labour costs. Consider managed services for customer services, IT services, finance, net zero tracking, and third-party logistics benchmarking. For activities retained in-house, drive operational agility with streamlined, technology-enabled processes, and devolved decision rights for teams to solve problems quickly.

3. Bring your people with you and drive operational agility 

Competitive compensation aside, employees give substantial weight to other intangible benefits when considering job options. Successful companies can take meaningful steps to attract, retain, and engage talent.

• Cultivate a continuous improvement mindset – and a culture of curiosity – both for pursuing growth and tackling costs.
• Upskill and reskill employees for future requirements including electrification, data-based decisioning, and customer experience.
• Make necessary redundancies with care and compassion, demonstrating clear decision ownership and communication to minimise anxiety among remaining employees.
• Advocate and communicate social value objectives and commitments, offering clarity on how these translate into employees’ day-to-day activities.