Can US auto suppliers stay ahead of Chinese rivals?

Chinese parts producers do have one advantage—cheap labor—but that isn’t the whole game.

The US automotive industry is understandably concerned about the competitive threat of low-cost cars and components from China. The United States already imports almost $4 billion a year in Chinese parts, and that figure grew by an average of 25 percent annually over the past three years.

That rapid increase has sent shivers through the US automotive supply industry, which employs 1.2 million people at 9,000 companies and produces about $250 billion in parts each year. China is at the top of the management agendas of most of these companies, mainly because it is a dangerous new rival whose $2-an-hour labor gives it a significant cost advantage. Some US suppliers are trying to defend themselves by rushing to partner with companies in China or outsourcing work there without fully understanding the long-term wisdom of such moves.

An overstated threat

Clearly, China's vast supply of low-wage workers gives its companies a big edge in labor-intensive manufacturing. However, the magnitude of China's threat appears to be overstated—particularly for the next few years. So far, Chinese parts account for less than 1 percent of the value of the components in US-made cars and light trucks. Imports from China are still small change compared with the $20 billion in parts brought in annually from Canada, the $23 billion from Mexico, and even the $15 billion from Japan. Moreover, an estimated 80 percent of Chinese imports are used to repair cars already on the road, meaning that only 20 percent of them go to factories that assemble new cars. The distinction is critical because replacement parts tend to require less engineering and to be lower in quality than new-car components. The numbers suggest that Chinese manufacturers are not yet fully up to speed.

Many of them lack the scale to produce the large volumes of parts that US carmakers require, and their relatively small production runs mean that per-unit costs are often relatively high. Many are also deficient in the crucial engineering know-how needed to meet complex federal vehicle safety standards, to ensure that prototype parts meet the carmakers' specifications, and to follow stringent automotive quality standards. Moreover, Chinese companies have much to learn about matching parts designs to efficient production processes—a form of expertise that can lower costs significantly but takes years to develop.

US carmakers, meanwhile, face uncertainties about the long-term wisdom of buying parts in China: for example, a permanent revaluation of China's dollar-pegged yuan is a looming possibility. If the yuan were to rise rapidly against the dollar, as some economists predict, that could erase much of the savings from sourcing in China. Such shifting factors are a key concern for carmakers because they tend to stick with individual suppliers for the five- to seven-year life span of a typical model.

Further, China has little or no competitive advantage for parts that account for about 50 percent of the value of the components in a typical car or light truck. For instance, high transpacific shipping costs for bulky items—such as fuel tanks, where transportation would amount to 30 percent of the production cost—mean that carmakers will probably continue to buy them from suppliers near the final assembly plants. Parts (such as molded plastic bumper covers) that must match the color or texture of other components will also continue to be produced nearby because of the need for quality control. So will seats and other interior items delivered to assembly plants, in the exact color sequence of the cars on the assembly line, on short notice.

Finally, China's wage advantage is inconsequential for capital- and material-intensive parts such as steering knuckles, a front suspension component for which direct labor represents about 4 percent of the total cost.

Preparing for the future

While China's near-term threat has been overblown, US suppliers clearly can't afford to be complacent. For parts such as hand-sewn seat covers, where labor accounts for about 45 percent of the total cost, China's advantage is likely to remain significant. The production of certain components, such as car radios, has already shifted almost entirely from North America to China, and others will probably follow over time. Moreover, China's suppliers are improving rapidly.

US companies should use the next few years to prepare for the full brunt of Chinese competition down the road. For starters, they need to wring inefficiency out of their factories—something many have done only halfheartedly since lean manufacturing became a buzzword, more than a decade ago. This effort must also include programs to help subcontractors become more efficient, an approach Detroit has neglected in the past.

US suppliers should concentrate on making components for which they have a technological edge and move the production of labor-intensive parts to low-cost regions. Although China could be one of them, in Central America and Mexico the cost of labor is less than one-fifth of what it is at home, while shipping costs are lower and logistical problems less vexing than they are in China. But for components that China is likely to dominate, such as alloy wheels, the best strategy may indeed be to shutter domestic facilities now and shift production to Asia.

Such steps, if undertaken quickly, will prepare US parts makers for China's long-term competitive challenge. But reacting in panic—for instance, by hastily signing joint-venture deals in China or prematurely abandoning domestic production-hardly seems necessary or wise.

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