Parts companies’ concerns have their roots in the supply chain crises of the early 2020s, beginning with the COVID-19 pandemic and continuing through the semiconductor shortage, the 2023 UAW strike against the Detroit 3, and rising prices for raw materials and other goods. At the same time, suppliers tied their capital up in investments in electric vehicle parts production and other emerging technologies, often without the returns they were hoping for.
“The margins are so much lower than they used to be,” said Daniel Rustmann, co-chair of the automotive law practice department at law firm Butzel. “It’s a volume business, and if the volume isn’t there, you’re not getting your return on investment up and down the supply chain.”
Dwindling profits and higher-than-expected costs have forced suppliers in recent years to turn to their customers for price concessions to help stay afloat and keep parts production flowing. Suppliers have reported mixed success in getting those concessions.
Should U.S. tariffs on Canada and Mexico be enacted in March or at another time, it’s likely suppliers would seek similar concessions. Whether they have any success in doing so will come down to contract language, but also the leverage each company has on the other and the supplier’s finances.
“Those are always the three factors which go into the calculus,” Rustmann said.
Contracts are typically “fixed-price” for long durations, meaning sellers of parts have to incur increased costs for the life of the deal. And historically, automakers and large Tier 1 suppliers have typically refused to absorb increased expenses, he said.
“I believe we can expect the same scenario” if tariffs are imposed, Rustmann said. “However, now that volumes and margins are lower, the pain will be even more impactful and could be the tipping point to insolvency for some suppliers.”
Contracts also usually say the buyer is responsible for paying duties. For example, if a Tier 1 supplier buys components from a Tier 2 company in Mexico, the Tier 1 supplier would pay any tariffs on the imported parts.
An automaker could be more willing to grant the supplier financial relief if it specified the supplier buy its parts from Mexico, said Chauncey Mayfield, who leads law firm Honigman’s commercial transactions practice group. If the supplier made that decision on its own, it would be a harder sell to recoup the higher cost, he said.
The ultimate impact of tariffs on supply contracts will be situational and depend on how they were written, particularly under the backdrop of current and past North American free trade agreements that assume no tariffs between the U.S. and its neighbors, said Sam Fiorani, vice president of global vehicle forecasting at AutoForecast Solutions.
Which party would cover the higher costs and whether tariffs could lead to efforts to renegotiate terms are “kind of uncharted territory,” he said.
“If we learned anything in the last five or six years, prices are not stable, no matter how much you think they might be,” Fiorani said. “After the semiconductor issues and COVID, both sides have to realize that there’s going to be some variability in prices, and it would be in the interest of both sides to have some flexibility into the contracts.”
Fiorani said tariffs in the short term would increase costs on the industry’s just-in-time supply chain with no easy or fast way to change sourcing locations, pushing up prices to the point that they could become uncompetitive or even unprofitable to build. That could lead to a cascade of effects, he said, including potentially idling factories.
“If the tariffs were to hit, the parts flowing between the countries would become very expensive, especially if you’re shipping an engine or a transmission across borders,” he said. “It’s likely that production on some of those vehicles would halt within a week on both sides of the border.”