Digitization Strategy for Automotive Suppliers How to systematically utilize chances and avoid risks

White Paper Digitization Strategy for Automotive Suppliers How to systematically utilize chances and avoid risks Andreas Brauchle Achim Kostron Wolfgang Schlesner 2015 www.horvath-partners.com

Digitization No other technological advance is currently influencing our lives more nor preoccupying both industry and consumers alike. A new age is dawning, or so we are promised. For most people, one thing is clear: We are on the cusp of fundamental change. Digitization has the potential to fundamentally change value chains and to have a decisive influence on business models, especially in the automotive industry. Although there are numerous examples which underline the added value digitization provides, in many cases it still only implemented on a oneoff basis within a specialist function or module. In most cases, there is no recognizable, overarching strategy which would enable the company to safely navigate through these changes in the long term. This white paper is based on a survey among managers in the automotive industry which was carried out in January 2015 and focused on the question of what impacts digitization will have on strategy, especially in the automotive supply industry, and what concrete answers those at the corporate helm must have today concerning the digital future. The aim is to identify which underlying framework conditions need to be created in order to fully utilize the potentials and benefits of digitization, to recognize the associated risks as early as possible, and to initiate countermeasures to avoid, reduce or negate those risks. 1. Automotive Manufacturers and Suppliers Know How Important a Digitization Strategy Is There are a great many facets to digitization and they are expressed in a range of different macro trends. Horváth & Partners questioned decision-makers in IT organizations about the relevance of individual macro trends linked with the mega trend of digitization and when those macro trends first appeared. Based on our survey, we have identified two main clusters in the macro trends: 1. Urgent needs Act now : The macro trends Mobile Devices, Cyber Security and Big Data form cluster number 1. These are seen as very relevant and extremely urgent, and for this reason they are already right at the top of management s agenda today in the automotive industry. 2. Future needs Prepare today for tomorrow : While this cluster consisting of Internet of Things, Interoperability, Digital Business Models and Industrie 4.0 is seen as highly relevant, companies have adopted somewhat of a wait-and-see attitude here, with the majority of those questioned believing them to be topics for the future. Nevertheless, in essence the only difference between this cluster and the first one is that these trends will become relevant a little bit further down the line. High Relevance of Macro Trends Low 2015 Urgent needs Mobile Devices Cyber Security Big Data Social Networking New Working Culture Interoperability Internet of Things Digitale Business Models Industrie 4.0 Time of Micro Trend Appearance Fig. 2: The two clusters of macro trends in digitization Future needs Dominant Digital Champions Megacity Neo-Ecology 2025 Mobile Devices Cyber Security Big Data Internet of Things Interoperability Social Networking New Working Culture Digital Business Models Industry 4.0 Dominant Digital Champions Megacity Neo-Ecology High Relevance 95 89 84 68 61 58 58 58 53 29 26 11 100% Even if these trends will only gain in relevance over the coming years, it is still important to prepare today for the disruptive changes that will accompany these macro trends. The digitization strategy harbors great potential for the future competitiveness of a company 94 percent of the companies surveyed confirm the increasing importance of a digitization strategy for their future success. The term digitization strategy is seen as the conscious, overarching approach to digitization and the derivation of potential actions. Alongside the product and technology strategy, the digitization strategy will become a formative part of a company s overall corporate strategy. Based on a systematic analysis of the impacts of digitization on the individual functions of a company, potential opportunities such as new products and services, more productive processes and more effective customer cultivation can be realized and risks like disruptive technologies or loss of competence can be counteracted. Fig. 1: Relevance of macro trends; figures in percent Horváth & Partners 2015 2

The interconnectedness of product and IT continues to grow apace All the companies in the survey expect that the macro trends presented here will result in product and IT becoming even more interconnected. Increasing interconnectedness of product and IT Development and stand-alone digital business models IT as a fundamental element of value chain Own services and business models Rejection: Acceptance: Not at all/not really Full/General Fig. 3: Acceptance and rejection of impacts of micro trends; figures in percent Thus, IT is transforming from an internal service provider to a (co)shaper of future innovations and to an enabler of digital business models. What this means is that IT is maturing into a fundamental element of the value chain with its own independent services and business models. Modularization is increasing based on the use of platforms The underlying framework for business models in the digital age will be standardized platforms. Eight out of ten respondents expect IT structures, processes and interfaces to systems to be greatly simplified and standardized by 2025. A huge 94 percent say that modularized standard solutions based on apps will become the norm. By using platforms, companies will be able to achieve a high degree of stability coupled with great agility thanks to the situational use of apps, while at the same time avoiding the risk that complexity and costs in the application landscape spiral out of control. Data analytics is changing how companies are managed There are new possibilities for the design and performance management of processes arising from the increasing networking and associated digitization of the real world. Gains in productivity in the supply chain thanks to the improved capacity utilization of plant and machinery, to shorter development and production times, or to lower quality costs are a reality today even if as yet only in individual cases through the use of data analytics approaches. In order to keep up with these changes it is imperative that companies both speed up and improve their corporate performance management. The key to doing so lies in the automation of decision-making processes through the use of intelligent algorithms based on the availability of a broad spectrum of different information and the technology for evaluating that data. This transition has the potential to fundamentally and sustainably change the planning and scheduling processes in companies. 23 13 77 87 100 Digital companies are network organizations All the participants on our survey stated that the aforementioned macro trends would result in companies setting up and working increasingly in networks. Additionally, 86 percent of the participants expect that cooperations, for example with Google, will be necessary in order to be able to offer individual products at all. One core effect of digitization is networking across system boundaries interconnectivity leads to a renaissance of the virtual company. It is not simply about connecting systems with one another but rather that the digitization of products and services also leads to a greater convergence of processes and structures. It is important to remember, however, that the clarification of interfaces and the definition of responsibilities is far more important in virtual environments than it is in traditional ones. The dynamics of innovation is increasing in the automotive industry Traditionally, the automotive industry has aligned itself with the lifecycle of a vehicle, introducing new products with their associated technological advances every six or seven years. These cycles have already been softened through modularization. Now, digitization is causing an increasing decoupling of lifecycles from the vehicle, with new demands such as releasability or the integration of communication/ network technology changing the development cycles in the automotive industry. The respondents on the survey also confirmed this view, with 94 percent of them expecting shorter development cycles for products enabled by increasing IT support. If the development cycles change, this will impact on the division of labor in the industry. Thus, digitization has the potential to shatter industry paradigms. This means that the role of the OEM as the sole pacesetter for developments will be weakened in the future. Instead, the digital champions will take on a much more dominant role in vehicle development; automotive suppliers have to prepare themselves and their development processes for this change. Four strategic initiatives for digitization Today, we can already see some of the impacts of digitization (e.g. Internet of Things, Industrie 4.0), while others will play a greater role in the coming years, such as Additive Manufacturing or Artificial Intelligence. These effects can be grouped together into four central, strategic thrusts: 1. Digital business models: The creation of completely new digital business models: e.g. integrated transportation solutions. 2. Digitized products and services: Digitized products and services in the established portfolio: e.g. telematics services. Horváth & Partners 2015 3

3. Digitized supply chain: The digitization and networking of the supply chain beyond the borders of the company: e.g. predictive maintenance. 4. Digital business operations: Greater importance of data and information for the operative performance management of companies: e.g. automated sales forecasts. This shows that digitization has immense effects on both the products and the processes of a company, which in turn has decisive implications for corporate strategy, making the elaboration of a digitization strategy an absolute must. Corporate culture/ Value concepts No suitable company organization Required financial resources Lack of networking of IT with product development Available competences Obstacles Very large Large Small 41 35 24 24 24 41 35 71 59 53 None 12 6 24 6 6 18 18 6 2. The Majority of Companies Currently Have no Digitization Strategy Reluctance within industry Insufficient maturity of mega trend 18 59 41 35 41 6 Status quo of digitization strategy Catch-up needed, especially for automotive suppliers Regulation 35 53 12 Even if nearly all the respondents are convinced it is increasingly important to have a digitization strategy, only 35 percent of the participating companies currently actually pursue one. When we take a look at comparison across the whole industry, we also find there is a significant difference between automotive manufacturers and automotive suppliers. While the majority of the OEMs already have a digitization strategy, the survey reveals that the supplier industry is in dire need of playing catch-up. Total Yes No Fig. 5: Obstacles to the implementation of digitization; figures in percent 100% If we take a differentiated look at the companies by volume of turnover, we see that companies with an annual turnover of more than 5 billion see their corporate culture as the biggest obstacle. One reason for this is that so far these companies only employ a low proportion of digital natives. For companies which turn over less than 5 billion per year, their biggest obstacle is having the required financial resources. No 65 35 Yes OEM OES 33 60 67 40 3. Developing an Automotive Digitization Strategy is a Job for the Whole Company Other 20 80 Fundamental strategic orientation for automotive suppliers Fig. 4: Existing digitization strategy; figures in percent Companies are not prepared for the challenges of digitization 100% The participants on the survey named corporate culture, the lack of a suitable company organization, the lack of required financial resources, the lack of networking IT with product development, and the lack of available competences as the biggest obstacles. The starting point for discussing strategy is the company s own ambition for the next five to ten years. How far does digitization go and fundamentally how ready and willing are we to question our own orientation as provider of systems and components? There are two possible options here: 1. Expand the existing business model to include digital elements, especially relating to the product and service portfolio. 2. Set up completely new business models, possibly using existing competences or access to markets. Horváth & Partners 2015 4

Corporate Strategy Creating New Business Models 2 4 Digitally diversified Digital Manufacturing 1 3 Digital Mobility Champion Digitally enhanced Framework Sub- Strategies Technology Digital Business Models Integration and Connectivity Product and Service Strategy and Roadmap Fig. 7: Structure of digitization strategy Digitization Strategy Cyber Security Industrialization, Automation and Operations Strategy Competence Integrated Supply Chain Strategy Culture Enabling Digitalization through IT (IT Strategy) Fig. 6: Digital norm strategies Expanding Products and Services The considerations form the basis for deriving four norm strategies for a company s fundamental orientation as an automotive supplier: 1. Digital Mobility Champion: The optimal combination of further development of the existing portfolio and enhancement with new services and possibly new business fields: e.g. components for autonomous driving and required associated infrastructure services. 2. Digitally diversified: Development of new business fields based on digitization: e.g. infrastructure operations. 3. Digitally enhanced: Focus on digitizing the existing product portfolio. Continued traditional tier 1/2 business model and preparation for digitization of the vehicles: e.g. power management, ability to network the components. 4. Digital Mwanufacturing: Focus on optimizing the supply chain and tapping productivity and efficiency potentials but no additional efforts towards product and service innovations beyond the existing strategy: e.g. predictive maintenance, predictive quality control. What is typical for norm strategies is that they are seldom implemented in their pure form in reality. Nevertheless, they provide a stabilizing framework for kick-starting the discussion on tailoring the company s individual digitization strategy to find the right one. Digitization strategy as connector between corporate strategy and functional strategy The digitization strategy provides the framework for designing further, as a rule functional, sub-strategies. In order to ensure they derive a consistent product and service strategy, in particular, companies must define central fundamental policy decisions at the management level. Additionally, the digitization strategy can also be used to change the vertical consistency of the company if, for example, the corporate strategy is reflected in the digital product portfolio. However, it is also conceivable for the company to achieve horizontal consistency between the sub-strategies by using the IT strategy to enable new digital business models. 4. Five Guiding Principles for Aligning the Digitization Strategy Strategic guiding principles are always also decisions on general principles for the company: Which product do we offer? In which markets do we want to be active? Companies also face a comparable challenge when it comes to defining the guiding principles for digitization. The difference here is that they do not have to decide in categories such as market or customer but in the following five fields: Technology There will certainly always be digital guiding principles relating to technologies in the conflicting priorities arising from the product, process, IT and communication technologies. At the least, there is a direct correlation to the general technology strategy all the way through to a possible fusion of the two strategies. Integration and connectivity IIntegration and connectivity require the use of minimum standards. These standards permeate deeply into many parts of the company: This includes demands upon master data management, as well as process and interface standards for improving intra-company cooperation. Indeed, digitization will provide a significant new boost to process orientation. When it comes to connectivity, the focus today is mainly on examples of successful platform strategies already in existence, such as ios or Android, which have created the basis for entirely new industries. In this context, digital champions will have more and more influence. However, our survey underlines the existence of an element of skepticism concerning the statement that they will also dominate the automotive industry of the future. Accordingly, only one quarter of the respondents expect dominance by the digital champions in the future. Horváth & Partners 2015 5

Instead, the race for the leading standard setter in the manufacturing industry only just begun. One example of this can be found in the strategy change by SAP and the opening up of the ERP Suite to become an open development platform. We expect programs and systems to continue to grow closer together across all manufacturers and, at the same time, independent of those manufacturers. Cyber security New, stable business models or additional digital product functions will only survive on the markets and among customers if the appropriate level of protection against misuse is guaranteed. Here, cultural, regional and sociological differences play a role in judging what is appropriate. Nevertheless, each and every company must face up to these challenges. Through close cooperation with all involved functions, the digitization strategy must address these challenges and solve them within an end-to-end digital operating model or by establishing the necessary governance. Competence One of the most important challenges from the perspective of competence management will be to find an integrated approach for the digitization strategy in order to recognize gaps in the competence profiles of today and tomorrow. Based on this approach, appropriate transformation, change and personnel development measures, such as job rotation, excellence centers, innovation labs or cooperation projects, can be initiated to set up and develop the competences necessary for implementation. Culture When it comes to culture, it is attitudes which are not typically found among automotive suppliers which are particularly important. Alongside specialized skills relating to technologies and business models, it is often the typical digital mindset which is lacking. Consequently, eight out of ten respondents on the survey are also convinced that the IT function will focus on the competence profiles of the digital champions. There are already isolated initiatives designed to transfer the Silicon Valley mindset to the automotive supply industry. A few companies have already set up units in Silicon Valley, for example, in order to create innovations at the interface between automobile and IT. The challenge here will be to integrate this culture of openness, creativity and the willingness to take risks into their existing structures. 5. Future Role of the CIO Driver of the Digital Strategy Although digitization impacts upon all the functions of a company, its impact upon the IT organization far outreaches the others. Eight out of ten respondents expect the importance of the IT organization within the company to continue to grow. Naturally, the topic of digitization is a very technological and IT-related one. The CIO function appears to be a natural driver of a holistic digitization strategy and a catalyst for the associated transformation process. As a result, the IT strategy must incorporate four core topics: Coalescence of internal IT and product IT Today, there is often still a separation between internal IT and product IT, but digitization causes this line to blur increasingly. In order to ensure corporate success, this development must be shaped actively. When we compare the situation across industries, we see that the automotive producers are pioneers in this field. For automotive suppliers, on the other hand, there are still potentials which could be leveraged through targeted initiatives and organizational or process-related adjustments. This imbalance can also be seen in the numbers: 75 percent of the IT organizations of OEMs contribute to product IT outside of merely providing infrastructure; among suppliers this is only true for 17 percent. Vertical integration in IT The increasing importance of digitization for companies also affects vertical integration in IT. New competences must be developed, as does the pool of suppliers. Our survey shows that manufacturers and suppliers have very different ideas on this topic. While the majority of automotive suppliers expect to provide an increasing proportion of the software products in their companies themselves, all the respondent OEMs are planning for a shrinking proportion. The survey also shows that the programming of applications, which involves less work and hence costs than product development, is increasingly being outsourced by the whole industry. Horváth & Partners 2015 6

Product App Product App Product App Decrease/Decrease strongly 100 33 57 43 80 20 50 75 25 Increase/Increase strongly 50 67 OES OEM Others Fig. 8: Decrease and increase in in-house workload for products and applications; figures in percent As a result, we recommend that automotive suppliers conduct a far-reaching examination into which programming can be seen as a differentiating factor and thus should remain in-house and which topics can be externalized. Decentralization of the IT organization Digitization will also affect how IT is organized, although individual factors play a major role. There are different developments in this field, depending on the current state of the specific organization. Concerning the issue of further decentralization, overall there is a neutral picture. The only factor which seems to have an influence here is the size of the company. 66 percent of the companies with turnover of over 5 billion expect greater decentralization in IT, for example in think tanks. For companies which fall below this threshold, only 16 percent agree with this. 6. Summary and Recommended Actions We have shown that there is widespread agreement concerning the importance of having a consistent and end-to-end digitization strategy for the future success of automotive suppliers. However, today only very few companies are already adequately prepared for the challenges of the coming years. What is lacking is a consistent digitization strategy which is focused on the specific needs of the company and which incorporates the new business models, digital product and service innovations, and process automations. The most important task of top management is to tackle the topic of digitization and to lay the proper foundations for the future. Here, the focus of general decisions on principles lies on the topics of technology, integration and connectivity, security, competence and corporate culture. The starting point for digitization is for the company to define its own digitization vision as an expression of its aims internally for employees and externally for customers or suppliers. Typically, companies do not really question the business model automotive supplier, nevertheless, it must be made fit for the future. The CIO organization will take on a central role: It will have to create and provide the underlying framework for other functions to base theirs on. Have we aroused your interest? We are at your disposal to discuss ideas on the impacts of digitization on your company. Complexity and costs in IT Digitization and the associated increasing importance of the CIO organization will continue to raise complexity in IT. According to the companies surveyed, there will be a tendency for the number of both applications (90%) and IT service providers (55%) to increase. Additionally, the participants agree that complexity will also be linked with rising costs, with the emphasis here in particular on the external costs of IT. Horváth & Partners 2015 7

Imprint/Contact Editor Horváth & Partner GmbH Phoenixbau Königstr. 5 70173 Stuttgart Tel: +49 711 66919-0 automotive@horvath-partners.com Horváth & Partners Management Consultants Horváth & Partners are independent, international management consultants with over 600 highly qualified employees. Founded in 1981 and headquartered in Stuttgart, Germany, we have offices at locations in Germany, Austria, Hungary, Romania, Saudi Arabia, Switzerland and the United Arab Emirates. Moreover, Horváth & Partners are a proud member of the Cordence Worldwide global management consulting partnership, which strengthens our ability to undertake consulting projects in important economic regions of the world with the highest professional expertise and precise knowledge of local circumstances. Our core competences lie in the fields of Corporate Performance Management and Performance Optimization both for the entire company and for the business and functional areas of Strategy, Organization, Sales, Operations, Controlling, Finance and IT. Horváth & Partners stand for project results which create sustainable benefit, which is why we accompany our clients through the entire process from developing the business concept through to anchoring via integration into processes and systems. Ralf Gaydoul Competence Center Automotive RGaydoul@horvath-partners.com Achim Kostron Competence Center Automotive AKostron@horvath-partners.com Andreas Brauchle Competence Center Automotive ABrauchle@horvath-partners.com Wolfgang Schlesner Competence Center Automotive WSchlesner@horvath-partners.com