To say that the automobile industry has its fair share of acronyms and abbreviations denoting some fundamental concepts is to state the obvious. What is a bit puzzling, however, is the fact that a few of these fundamental terms used in the industry do not have a standard definition or meaning. For example, what or who are Original Equipment Manufacturers, and how are they different from Original Equipment Suppliers? Can one entity be called an OEM in one context but an OES in another? If yes, when and why? What are Tier I, Tier II and Tier III suppliers? How do they interact with the OEMs? Such questions have frequently plagued newcomers to the industry.
This article aims to shed some light on this confounding topic with examples. While one can write learned dissertations on this topic, this article has more modest ambitions. The intent is to draw some high-level differences between these terms, examples, their complex interplay of relationships, the power struggles between the different entities, how they compete in the aftermarket, etc.
“Original Equipment Manufacturers – Who are they?”
Tata Motors is an OEM. Maruti Suzuki is another. Honda is yet another. So, you get the drift? Original Equipment Manufacturers of the auto industry (there are OEMs in other industries, too) are organizations that sell an automobile to an end consumer. That is, to you or me. How do they make these cars before selling them to us? Do they make all the parts themselves – the engine, the gearbox, the wheels, the AC, the music system, and the thousands of other components that go into an automobile? Or do they get these from other companies? If you have ever wondered about this, you have thought about the relationship between an OEM and its suppliers.
The answer to the above question is – no; Tata Motors does not manufacture the music system (to take just one example) that is put in their trucks or cars. They source it from a supplier. The term Original Equipment Manufacturer is vested in them not because they create the product from scratch nor because they conceived and designed every ‘part’ of the vehicle. They depend on a network of other companies (Tier I, Tier II, Tier III) to supply them with materials and parts. For instance, a car has about 30,000 parts, counting every part down to the smallest screws. Some parts are proprietary to the OEM, and some are not. The automobile OEMs, after that, assemble these components (with some that they may make themselves) under their brand name and warranty. There may also be some OEMs who get the complete finished product from the supplier ready for distribution, marketing and whatever else is needed to get the product to the end user (more common in consumer durables).
“Tier I, Tier II – What are these?”
So, here is one crucial difference:
An OEM is a B2C company, while
Tier I, and II, Suppliers are usually B2B
But there is more to this.
Tier I suppliers are those that make components for the OEM. For instance, a Tier I company that produces a particular type of car seat for an automobile OEM might be doing so by complying with the specifications mandated by the OEM. These products may not have any application outside the OEM’s automobile, and/or the Tier I supplier may be obligated to sell it only to them under the terms and conditions of their agreement with the OEM. The OEM makes the product available in the aftermarket as replacement parts. The contract with the automobile OEM of Tier I companies usually determines the quantity demanded from them according to a schedule. As long as the automobile OEM is doing good business, the Tier I suppliers generally thrive.
Similarly, Tier II suppliers sell parts (e.g., frames for the car seat) or raw materials (fabric) to Tier I suppliers. Some supply chains here are Tier III suppliers who sell molds, parts or raw materials (steel to fabricate the frame) to Tier 2 suppliers. The reason for adhering to this kind of supply chain structure is to ensure cost-effectiveness. OEMs can focus on their vehicle’s crucial technological elements and marketing rather than all the other parts that go into the finished product. For example, an automobile OEM focused on researching and manufacturing computer chips will be a wasteful enterprise. Leave that to the experts and collaborate with them for this particular need.
“That is all fine; but what are these Original Equipment Suppliers? Who are these guys?”
Hold on. Let’s shift gears gently.
An Audi might boast of a Bose audio system that the company sourced from Bose (a Tier I supplier). However, everyone knows Bose does not sell their products only to automobile companies. So, what is the difference here?
The difference is that in some cases, the patent or the proprietary design for the product is with the supplier. Companies that own their products’ proprietary designs are called Original Equipment Suppliers. Some of these “supplier” companies might be as big or bigger brands as the automobile OEMs. They get into a collaboration with OEMs as both companies see mutual benefit. The OEM merely integrates the OES’s product into their automobiles. Sometimes, it adds to their brand value. The OES, too, may feel that their brand value goes up by being associated with the OEM, and they get assured business. So, win-win for both. By the way, these are not always visible parts of the vehicle- the OES may be supplying something as simple as a filter to the OEM.
These companies may also supply similar or other products (unrelated to any OEM) directly to the customers. These may be manufactured by assembling parts sourced from their suppliers. In this context, the company (who may be an OES to another company) can now be called an OEM.
These OES (barring some cases of non-compete agreements) often sell their products directly in the aftermarket space. There are multiple reasons for this.
- There is an opportunity to sell their products to customers directly as replacement parts- especially since many vehicles, once out of warranty, leave the OEM’s service network. These vehicles continue to need parts and represent a huge market. The OESs with established brands stand to gain, especially when the OEM spare parts are stocked out in the aftermarket.
- From time to time, the OEMs may not lift committed material from the OES, and the supplier will be forced to liquidate stock in whichever way he can
- Some supplier companies want to depend on more than their OEM for their business. If demand for their automobiles goes down, the OEM will reduce offtake, or there might be an extended credit period, both of which can spell disaster for the supplier.
“You mentioned something about an aftermarket. What exactly is that?”
We buy our cars from an authorized dealer. After that, we have to service the vehicle at frequent intervals or get them repaired at times (perhaps, owing to an accident). While the product is under warranty, these activities are mostly done in the authorized service network of the OEM, for which the OEM supplies the required parts. But after the vehicle leaves warranty, many vehicles may no longer use the authorized service centres. They may approach a local workshop. However, this workshop mechanic will also need to source parts its customers need. These repair shops get these parts from a local auto part retailer. The network comprising these auto part shops, their customers and the distributors or dealers that service the retail stores is known as the ‘aftermarket’. This is a crowded space too, where OEMs, OESs and spurious products compete for business.
As mentioned earlier, OEMs are keen to promote their components but can only sometimes prevent OESs from selling their products directly here (they may be contractually obliged to sell their products at the same price or higher price as sold through the OEMs network). Spurious (or ‘local’) products also compete here. Since they did not have to spend anything on research, they could offer cost-effective products to the end users. Quality may be different from expectations, but that is a different story. They can make their presence felt here because of the huge demand for spare parts (across the country and also because some spare parts may not even be manufactured by the OEMs and OESs anymore as the need for them would have dwindled considerably).
In conclusion, there is a lot of jargon and many more definitions for them in the automobile industry. The opinion is divided as to what some of these terms mean, but this article’s objective is to clarify this basic jargon, along with some examples. This article will be a good starting point for those who wish to understand or study this industry in detail.
About the author
Nikhil Kulkarni (Texas A&M University – Mays Business School) is a management consultant with Vector Consulting Group. Vector helps companies solve chronic operational issues using scientific systems thinking. The automotive companies Vector has worked with include Tata Motors, Ashok Leyland, Royal Enfield, TVS Motors, Fleetguard Filters, International Tractors, J.K Fenner, Volvo Eicher, etc.