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Realignment of the Automotive Supply Base

The USMCA as well as vehicle electrification will have substantial impacts on the automotive supply base in the United States.

Q1 2020
Tesla, which only manufactures BEVs, is a prime example of the move toward electric vehicles.
Tesla, which only manufactures BEVs, is a prime example of the move toward electric vehicles.
The auto industry is undergoing a period of tremendous disruption, caused by new technology, new entrants, and changing government policies around the globe. This disruption is already causing a significant upheaval in the automotive supply base, which is changing and consolidating. This article will focus on two recent developments that will have an immediate impact on automotive suppliers and communities that host them.

The first significant development is the United States-Mexico-Canada Agreement (USMCA), which was signed by President Trump on January 29, 2020. USMCA was a renegotiation of the North American Free Trade Agreement (NAFTA) that has been in effect since 1994. NAFTA eliminated tariffs on vehicles and vehicle parts traded among the three North American countries and facilitated an integrated auto market in North America. NAFTA also facilitated the rapid growth of the Mexican automotive sector, which drew criticism from Donald Trump during his presidential campaign. He called NAFTA “a terrible deal” and promised to renegotiate the treaty if elected.

After Trump took office, his administration initiated negotiations with Canada and Mexico for a new trade agreement, and one of the objectives was to increase vehicle and vehicle parts manufacturing in the United States. To that end, USMCA changes the rules of origin (for duty-free treatment) by increasing North American vehicle content from 62.5 percent to 75 percent. It also requires that at least 40 percent vehicle content originate in high-wage areas (i.e., not Mexico), where workers earn at least $16 per hour.

According to the Office of the United States Trade Representative (USTR), over a five-year period, USMCA is expected to result in:
  • $34 billion in new automotive investments in the U.S.;
  • $23 billion in new annual purchases of U.S.-made automotive parts; and
  • 76,000 jobs in the U.S. automotive sector.
These are projections, and some trade experts believe that the actual impacts will be more modest than forecasted by the USTR. But there is a general sense that USMCA will bring more auto-related jobs and investment to the United States.

In a recent online survey by LevaData, 61 percent of the automakers surveyed said, as a result of USMCA, they may increase sourcing from suppliers located near their assembly plants; 78 percent said that finding new North American suppliers is a priority for their supply chain.

The USMCA is in the process of being ratified by the Canadian Parliament. Assuming that happens, the treaty will eliminate the uncertainty about North American trade that has hung over the auto industry for the past three years. Removing uncertainty bodes well for future investment here.

The Boston Consulting Group recently predicted that the sale of BEVs and plug-in hybrids will account for almost 25 percent of global auto sales within a decade. Vehicle Electrification
The second major development impacting automotive suppliers is the acceleration of vehicle electrification. Battery electric vehicles (BEVs) are still a small part of the vehicle market, which is dominated by internal combustion engines (ICEs), but the growth rate for BEVs is expected to accelerate.

For example, the Boston Consulting Group recently predicted that the sale of BEVs and plug-in hybrids will account for almost 25 percent of global auto sales within a decade. As reported by Forbes magazine, while there is no consensus among forecasters about the rate of adoption of electric vehicles, one indicator has remained consistent — no matter who is predicting, each new forecast gets bigger. Even OPEC forecasts the rapid acceleration of BEV sales.

All of the major automakers have announced plans to electrify their fleets. Reuters reported that automakers have already committed over $90 billion toward electrification, in what it described as an “investment tsunami in batteries and electric cars.”

The move towards electrification is driven by government policies across the globe and improving consumer sentiment toward electric vehicles, as best exemplified by the success of Tesla, a relatively new automaker that only makes BEVs. Tesla sold 376,500 electric vehicles last year. At the end of January 2020, Tesla’s market capitalization had reached $117 billion, making it the second-most-valuable automaker in the world. Tesla employs 10,000 people at its Fremont, California, assembly plant, and another 7,000 people are employed by Tesla and its partner Panasonic at Tesla’s battery Gigafactory, near Reno, Nevada.

While Tesla is perhaps the most publicized example of the move toward vehicle electrification, there are several other prominent examples of recently announced EV-related investments in the United States:
  • General Motors is retooling its Detroit Hamtramck assembly plant to switch from ICE vehicles to EVs, where GM will build the Hummer EV. Together with LG Chem, GM will also build a $2.3 billion vehicle battery plant near its closed assembly plant in Lordstown, Ohio, which will employ 1,000 people.
  • Ford recently announced plans to partner with Rivian, a new entrant, to build a new electric vehicle for the Lincoln luxury brand, using Rivian’s electric vehicle platform. Ford also announced plans to build an all-electric Mustang Mach E, for which it has already received over 32,000 customer deposits.
  • Volkswagen has embarked on a $800 million expansion of its Chattanooga, Tennessee, assembly plant to build electric SUVs, which will add 1,000 new jobs.
  • SK Innovation is building a $1.7 billion vehicle battery plant in Georgia that will employ 2,000 people.
  • Lucid Motors, which secured a billion dollar investment from Saudi Arabia’s Sovereign Wealth Fund, broke ground on a $700 million BEV plant in Casa Grande, Arizona, that is projected to employ 2,000 people at full production.
To be sure, the internal combustion engine will continue to propel a vast majority of vehicles for the foreseeable future — but, over time, vehicles will shift to electric propulsion. The impact of this transition on the automotive supply base will be substantial. ICEs are made up of thousands of parts, ranging from spark plugs to exhaust systems. Approximately a quarter of the employees engaged in vehicle parts manufacturing make components for ICEs. BEVs are made up of fewer and different parts — ranging from electric motors to batteries.

As vehicles shift to BEVs, employee skill sets will change, and many ICE parts plants will face future obsolescence if they aren’t transitioned to EV parts. Traditional ICE suppliers that aren’t able to pivot to BEV parts will struggle to survive. Those suppliers that can make the transition, along with some of the new entrants, will thrive. This has obvious implications for communities that currently host ICE suppliers…and for those that hope to attract EV suppliers.

For those communities seeking to capitalize on the move to electrification, the Reno-Northern Nevada area is an excellent case study. For years, Reno’s economy was based on gaming and tourism, which was hard hit by the Great Recession. The region developed a strategic plan to attract advanced manufacturing, which is now a primary driver of economic growth — led by Tesla’s battery Gigafactory. A decade ago, Northern Nevada wasn’t a player in automotive manufacturing. Today, it is the home of a $6 billion vehicle battery plant that employs more than 7,000 people.

Together, the USMCA and vehicle electrification will have substantial impacts on the automotive supply base in the United States. Communities that host — or seek to host — vehicle parts plants would be well advised to stay abreast of these new developments.

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