India’s shifting automotive procurement mandate

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Strategic sourcing will separate leaders from laggards in India’s automotive industry. Several factors are driving this new reality, including the COVID-19 crisis, which disrupted supply chains. Since the first lockdown, Indian manufacturing firms have faced complex, integrated problems regarding access to labor and other inputs, realizing sales, and delivering goods and services. Knocked off balance by changing market conditions, companies must contend with increased prices and weakened demand due to the economic crisis. New government regulations such as restrictions, lockdowns, and stimulus packages are adding to the uncertainty, as are health and humanitarian issues including the illness of workers and the loss of incomes and livelihoods.

Change is the only constant

Assailed by shocks both within the industry and at the macro level, the automotive industry is indisputably changing.

Industry-specific challenges. Critical industry-level challenges include the current contest to replace the internal-combustion engine (ICE) with electric vehicles (EVs), fuel cell electric vehicles (FCEVs), and hybrid electric vehicles (HEVs). Other industry-specific disruptions include the emergence of software as a differentiating factor in automobiles and enhanced vehicle-connectivity innovations. These changes require new procurement capabilities, mainly on software and electronics, that some OEMs have yet to master (Exhibit 1). The Indian EV market is evolving fast, as OEMs sold close to 320,000 vehicles in 2021, up 168 percent over the prior year. By 2030, NITI Aayog (the National Institution for Transforming India) aims to achieve an EV sales penetration of 70 percent for all commercial vehicles, 30 percent for private cars, 40 percent for buses, and 80 percent for two- and three-wheelers.

New technologies and competencies in the automotive industry require the procurement function to react.

Consequently, automakers and their key suppliers are rethinking their supply structures in the face of the global pandemic and increasing political instability. Many are acknowledging the growing need for more localization due to the new global supply risks and tougher regulatory stipulations. What’s more, the continued consolidation of the supply base could give some vendors monopolistic advantages over automakers.

Capital expenditure planning for new projects is not a primary focus for the industry, which assumes it will increase every year. Capital expenditure spending has recently become critical, since models across industries, including cars, two-wheelers, and commercial vehicles, are receiving major styling and performance updates every two to three years. They also receive minor updates involving trim, some performance changes, and other minor upgrades every year. Consequently, capital expenditure investments are rising.

The CFO of a leading passenger car manufacturer in India recently stated, “Inflation pushes up the cost, and it is nearly impossible to pass it all to the customers suddenly. Now, the job here as a CFO is to consistently drive cost-consciousness in the company. The job is also to then take corrective action, and focus on strategies such as product mix, reducing discretionary spending, postponement of capital or revenue spending, and other cost-control activities.”

External challenges. In a recent McKinsey survey on global economic conditions, respondents noted that several trends are affecting value creation, including inflation, geopolitical issues, and supply chain disruptions (Exhibit 2). Other factors that can affect value creation include tightening labor markets in some countries and a lack of specialized talent (for instance, software developers). The accelerating push for sustainability, green-materials usage, and upstream decarbonization among both governments and consumers is also expanding the procurement department’s role in ensuring transparency.

Respondents in a global survey identifed several trends affecting their countries’ economic growth.

With commodities, companies are experiencing both supply and cost issues. For instance, demand for aluminum is increasing and will outstrip supply by 2030 (Exhibit 3). And from March 2020 to April 2022, steel prices rose a staggering 215 percent. The benchmark price for hot-rolled steel hit an all-time high in 2022, climbing to $980 per metric ton from a prepandemic value in the $500 to $800 range. Most of the top auto manufacturers pushed through a second vehicle price hike in the range of 1 to 3 percent in April 2021, after already having taken a 3 to 4 percent hike in the fourth quarter of the fiscal year 2021 to offset the impact of higher steel costs.

The global supply of aluminum is expected to be slightly lower than the demand in 2030.

Current procurement approaches fall short

Many OEM procurement departments have worked to boost their performance (see sidebar, “Progress, but more new procurement thinking required”). However, when it comes to electrification, digitization, and carbon-footprint optimization, the procurement function often lacks technical and commercial capabilities. What’s more, it has not fully involved the suppliers thoroughly in the development process.

Consequently, automakers must source the technology from overseas, which has interfered with many of the low-cost local sourcing strategies developed in response to the pandemic. Many players have failed to move on from their on-time-in-full order delivery supply chains to strategic initiatives such as end-to-end supply chain digitization and connectivity with inventory.

One top passenger car and commercial-vehicle manufacturer commented, “The lockdown was our opportunity to significantly accelerate the adoption of digital technology. The importance of becoming more digital was already obvious pre-COVID-19, but its onset has exponentially catalyzed the need.”

A ‘new normal’ CPO road map in automotive procurement

Companies must deal with these new challenges quickly and effectively to prevent further value erosion. We believe chief procurement officers (CPOs) need a “new normal” road map of key strategic actions to address disruptions and manage uncertainties. This road map typically includes three maturity phases, with the first focused on ensuring supply and mitigating immediate disruptive effects. In phase two, organizations set targets to enable resiliency and launch advanced solutions to reduce costs. They can use a toolbox of approaches to manage volatility, mitigate risk, and reset long-term value-creation targets. That will allow them to address the entire spectrum of total-cost-of-ownership issues. In the third phase, they can build capabilities and infrastructure to ensure continued value creation, which could include embedding and institutionalizing cross-functional processes in a next-generation operating model for procurement.

Chief procurement officers need a “new normal” road map of key strategic actions to address disruptions and manage uncertainties.

CPOs should consider the following four actions to make procurement more effective and efficient.

1. Rethink organizational requirements

Companies should rethink their organizational requirements to ensure sustainable growth and support needed cultural changes. The key element of this new governance structure is that the CPO should participate in the monthly steering committee meetings and quarterly executive committee meetings. In interviews, McKinsey experts on the Indian automotive industry noted that companies should track their procurement performance in ways that extend beyond pure cost savings (Exhibit 4).

Automotive companies in India should track procurement performance on dimensions that go beyond pure cost savings.

To be effective, CPOs need to break out of their narrow role in enterprise value creation, where they assume responsibility for part of the company’s cost of goods sold (COGS). Instead, they should begin to see themselves as key protectors of enterprise margins.

Where traditionally CPOs would be satisfied with limited insights into multitiered supply chains, they must now develop deep insights into supply chain market dynamics to ensure the availability of suppliers. Likewise, yesterday’s transactional relationships with most suppliers will no longer work. Instead, the CPO must stand at the center of multiple cross-functional teams coordinating value creation.

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There are four basic procurement models CPOs can choose, based on a company’s needs. At one end of the spectrum is the most centralized approach, with all business functions relying on the procurement unit. Next is the hybrid approach, in which either a business function or procurement supplies each purchasing category, depending on the allocation of spending. The local model integrates procurement with each business function, which split responsibilities based on which function has the highest share of spend. The most decentralized model involves the lead buyer approach, and each business function has buyers for all relevant commodity categories. Automotive companies typically attempt to balance both centralized and decentralized elements.

2. Build new capabilities

OEMs must build new capabilities that enable resiliency and ensure continued value creation. A comparison of best versus traditional practices across several parameters illustrates the potential benefits (Exhibit 5). A tier-one automotive supplier employed cleansheet negotiations to save more than $10 million by focusing on embedded raw materials, currency devaluations, price harmonization, and other techniques. The procurement team used a volume-discount negotiation strategy while it strategically eliminated certain supply partners and increased potential volume discounts.

India OEMs that adopt new practices can increase value creation.

OEMs should develop core capabilities to tackle green-materials sourcing and target net-zero goals across the value chain. They also vitally need the capability to evaluate and buy software at the right cost to keep up with the advanced digital features and driver-assistance systems, especially in times when software cost per vehicle is increasing abruptly as OEMs add new features.

Building a best-in-class procurement function typically requires a company to focus on four strategic elements.

Create differentiated processes. Introduce differentiated, fit-for-purpose processes designed for specific procurement needs of commodity bundles with similar characteristics. This includes clustering individual process designs, roles, and governance structure.

Digitize processes and establish remote governance. Streamline and digitize all procurement processes to enable efficiency gains that the company can reinvest into value-adding activities, such as negotiations.

Actively manage supplier risk and performance. Introduce holistic, technology-enabled supplier risk management capabilities to the procurement function to manage end-to-end supply chain risks and mitigation measures.

Involve procurement in the early development stage. Having purchasing at the table during the early stages of the R&D process can ensure more competition and, hence, a better overall result regarding design and cost issues. It also makes sense to move toward a consumer-focused approach.

Smartphones on wheels: New rules for automotive-product development

Smartphones on wheels: New rules for automotive-product development

Companies should consider adopting a modular, long-term approach for tools, dies, and machines to save capital expenditures in the long run. This will help in saving capital expenditures for model refreshes and facelifts, typically undertaken about two to three years after the launch of a new model. Additionally, many OEMs are moving to modular prototyping using the same basic structure for new models on the same platform. This thinking needs to flow to the supply base through procurement so that companies can avoid new capital-expenditure investments as much as possible and make only necessary changes to existing tools.

3. Focus on processes and supply management

To optimize their current procurement operating models, OEMs and suppliers should concentrate on process and supply management. Most purchasing departments have shifted from basic order taking to functionally advanced positions using some advanced tools. A few have achieved an integrated corporate focus where procurement becomes a strategic business partner to the business functions. But there is still further to go.

The best organizations globally have embraced the philosophy of continuous improvement and employ digital innovations in analytics and automation.

4. Respond to rising prices

The CPO can take several effective actions in response to inflation pressures. Aside from firefighting in the short-term to manage supply chain costs, several actions will have medium- to long-term consequences.

Medium term (three to 12 months). Launching the so-called fourth industrial Internet of Things will help CPOs streamline their operations and make the company more responsive to market changes. Other medium-term steps include focusing on improving workforce productivity and effectiveness via automation, training, and streamlining and expanding the supply base to ensure consistent supply chain resiliency.

Long term (one to three years). The CPO’s long-term goals should include transforming value chain structures to deliver superior value to customers at the lowest possible cost. Companies should revisit their make-versus-buy decisions to determine whether they still make sense in the rapidly changing market environment and perhaps lock in strategic sources of supply by buying or investing in critical vendors.

Despite facing a succession of recent challenges, India’s automotive procurement departments have begun to adapt. However, we believe the pace and nature of the change must shift from employing new tools and methods to rethinking the entire procurement operation in strategic terms. Electrification has surfaced major supply chain discontinuities that require CPOs to recalibrate their thinking and take a strategic approach to procurement to remain competitive.

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