AAP acquisition of GPI: Significant implications for suppliers

The recent news that Advance Auto Parts has acquired General Parts International Inc. will have significant implications to suppliers that, if not managed properly, could further harm the automotive aftermarket supplier community as a whole.

The size and scope of today’s mega-transactions are different from days’ past when significantly smaller, more manageable deals took place. Inventory adjustments, store upgrades, discounts and extended terms for one-time, pipe-line orders, and even modest field sales support were manageable elements of the agreement between suppliers and their channel partners to enable and drive mutual growth and profits. This is different.

The announced acquisition of GPI by AAP, creating the largest aftermarket parts provider in North America, could cause suppliers to shoulder up to $1 billion in concessions at manufacturer’s sales price. The largest component of supplier concessions could come as a result of reverse factoring and extended terms by pushing GPI’s accounts payable to an inventory ratio from an estimated 40 percent today up to a targeted 90 percent. This would effectively generate in the range of $1.2 billion in available cash on an annualized basis ($600 million at manufacturer’s sell price), or 57 percent of the $2.1 billion cash acquisition.

In March 2012, AASA commissioned KPMG, one of the “Big Four” global accounting and consulting firms, to conduct an in-depth study of the practice and growth of extended terms in the aftermarket. AASA’s initial step was to help provide a better understanding of this practice and any potential risks it may carry for the aftermarket supplier community and the overall supply chain.

The following is recap of the key take-a-ways from the KPMG report:

• The conventional wisdom that extended terms (and reverse factoring) is a win-win-win ignores substantive costs and future risks.

            According to KPMG, “net income could be negatively impacted by as much as 5.77 percent to 0.7 percent, (based on the percent of days factored – up to 360 days, interest rates and credit downgrades).

• The long-term impact of extended terms on the aftermarket as a whole is cause for concern. Risks to the aftermarket value chain include:

            • Interest rates

            Rising interest rates will require the industry to reverse extended terms – or come up with billions of dollars of capital to fund this unusual business model.

            • Exposure to the credit cycle

            The preponderance of extended terms means the aftermarket industry is now more sensitive to credit availability and cost. Credit cycles, like economic cycles, are inevitable and hard to predict. This may be a greater near-term risk than interest rates.

            This risk exposure is a sea-change for the historically-stable aftermarket. The aftermarket traditionally has been one of the most resilient industry sectors, highly insensitive to changes in external business conditions. However, this evolving business model makes that less true for all players in the aftermarket.

            • Inventory

            Extended terms has exacerbated the long-standing industry risk of excess inventory in the aftermarket and minimized the focus and need to improve inventory turns.

• Terms of doing business in the automotive aftermarket are unusual versus other industries.

            • According to KPMG, “Payment terms in the automotive aftermarket far exceed those in any analogous industry”.

Other concessions, including the return of excess or redundant inventory, could further impact suppliers by an estimated additional $160-$400 million in reduced profit. In total, this could place considerable risk to the short- and long-term health of suppliers.

There is another way. Channel partners and suppliers have the opportunity to recognize the risk and harm these practices pose to suppliers and the industry as a whole. Instead, they can focus on value creation, driven by meaningful differentiation and innovation that is achieved in real partnership.

This is not about “collaboration” and “working together,” but something much deeper. This is about driving sustainable profits for both channel partners and suppliers. Companies outside the aftermarket (suppliers and mega-channel partners) provide living examples and serve as a testament to the power that new thinking and a new approach can have on value creation and profits.

Full service aftermarket suppliers possess the intellectual knowledge and resources in designing, manufacturing, testing, improving and innovating quality products. This knowledge and investment also apply to market research, application data, product lifecycle management, logistics and all those elements that are necessary for an aftermarket program today. Full-service suppliers can bring vital experience and critical solutions-based thinking that can drive true innovation, which is the catalyst for value creation and sustainable profits.

It’s time for a new approach. Parts proliferation, a shifting vehicle parc, rapidly changing product life-cycles, e-tailing and new technology will continue to impact how we serve customers with the right part at the right place at the right time. We have an obligation to the industry – motorists, repair professionals, distributors and suppliers – and its investors to work together in a new way. This will create real value and diffuse the risks and potential harm to suppliers and the industry as a whole. We will have a bright future by doing so.

AASA stands ready to help drive this badly needed improvement of the status quo.

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