Automotive dominoes: As goes GM, so goes Lear ...

On Wednesday, Lear Corp. (LEA) announced that it has filed for Chapter 11. This bankruptcy is supported by key lenders and bondholders; Lear has secured $500 million in debtor-in-possession financing from its creditors, including JP Morgan Chase and Citigroup.

Lear, a Fortune 500 company that supplies auto seats, car interiors and electrical components, is the 11th largest global parts supplier and the second largest automotive seat manufacturer. It is also the most recent of an estimated twenty auto parts suppliers who have had to apply for bankruptcy protection in the last year.

According to the Original Equipment Suppliers Association (OESA), a trade group, 62 percent of parts manufacturers are facing bankruptcy by the end of the year. As the organization's member companies directly employ over 686,000 people, this could be a devastating blow to the economy. The government's auto task force extended $5 billion in treasury loans and guarantees to partsmakers, but when OESA asked for a further $10 billion, it was turned down.

Lear demonstrates the dangers that auto manufacturers were citing when they asked Congress for bailout funds. As GM and Chrysler contracts have dried up, equipment suppliers have seen their business slashed; this, in turn, has led to waves of firing and restructurings. However, as OESA has stated, "Eventually, a 50 percent to 60 percent drop in sales can no longer be offset by staff and other expense reductions without destroying the infrastructure of an organization."

While the symbiotic relationship between suppliers and automakers has worked well in flush times, it currently is acting like a cinder block around the neck of both sides. Just as automaker bankruptcies have placed pressure on suppliers, supplier bankruptcies will drive up the cost of parts, placing further pressure upon automakers.

One obvious solution is for manufacturers to aggressively pursue contracts with car manufacturers outside the U.S. Ironically, Lear has done just that, partnering with Indian car company Mahindra to provide seats for the new "Appalachian" diesel hybrid pickup truck, which should hit the American market in 2010.

Unfortunately, even this potential solution is vulnerable to the shortcomings of the manufacturers. Mahindra chose Lear not because of the company's superior craftsmanship or better price point, but rather because the Michigan-based company has a feel for the American market. However, with U.S. auto sales down and a slew of overseas parts suppliers demonstrating an impressive ability to cater to the American, that justification may seem increasingly threadbare.

To put it bluntly, three things need to happen for U.S. parts suppliers to remain viable. First, U.S. automakers who employ those suppliers need to start producing larger numbers of the kinds of cars that Americans want to drive. While trucks continue to do well in some markets, the overall trend among domestic purchasers is toward cars that get great mileage. In April 2009, for example, the top-selling car was the Honda Accord. While Ford, Dodge, and Chevy each had a truck in the top ten, all seven of the cars got 29 mpg on the highway or better, and they averaged 33 mpg.

Second, in the short term, at least, U.S. parts suppliers will need to deal with a massively scaled-down market. In the last year, Lear has dropped 21 percent of its global workforce and 42 percent of its Michigan employees. Presumably, the company's post-bankruptcy restructuring will lead to further massive layoffs. Among the parts manufacturers that survive the next few years, this will undoubtedly become a common trend.

Finally, more manufacturers need to follow the Lear/Mahindra lead. The American car industry is only a small part of the world market, yet 80 percent of Lear's 2008 sales were from car seats sold to American manufacturers; consequently, as GM has stumbled, so has Lear. In context, it's clear that the tendency of U.S. parts manufacturers to rely on domestic customers is a major shortcoming. As the last few months have shown, placing one's faith in the prescience and prowess of Detroit is a loser's game.

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