Conditions when supply contracts work

Automotive News Europe

Could OEM supply contracts replace joint ventures?

OEM supply contracts need both the builder and the buyer to believe they benefit before the partners can agree.

The conditions can be complicated, especially for two auto manufacturers that normally compete with each other. But both sides can find a supply-contract advantage when:

• two carmakers share research and development and tooling investments for the new models like in a joint venture but without all the paperwork, formal joint-venture contracts and the expenses of two sets of administrators.
• of scale from higher volumes being built lowers production costs. That sometimes makes projects that would otherwise have been unprofitable financially feasible if built alone.
• vehicles built can have better powertrain choices because two complete ranges of engines and gearboxes are available from the two partners.

For the builder -- the carmaker that builds the vehicles for two parties -- a supply contract boosts capacity use at one of its plants.

In addition, the builder can demand that the buyer pay a premium to access its core technologies, such as four-wheel-drive systems for SUVs and crossovers.

For the buyer -- the carmaker that purchased fully-assembled vehicles from the builder -- a supply contract can mean reaching the market much faster.

And in some cases, the OEM buyer gets immediate access to state-of-the-art technology that is core to the OEM builder, such as 4wd systems.

However, both parties risk a possible brand dilution if the shared products are too much alike. Also, if the products are too similar, consumers would likely choose the strongest brand. But neither brand, even a much stronger marques, could charge much higher prices on a similar vehicle.

For the OEM builder, the biggest risk may be creating another competitor to its new product.

Another potential downside for the OEM builder is immediately giving away its core technology in the supplied vehicle.

For the OEM buyer the main risk of is not having any say in the manufacturing process or quality level.

And if the product is more popular than anticipated, most likely the OEM builder will add capacity faster for its own product. The buyer could be limited to the original agreed volume.