Is USMCA a tipping point for Canada’s auto sector?

Trade changes are creating new opportunities to revisit your strategy

  • 40%

    of vehicles made in North America may not comply with the new USMCA rules

  • US$28.4B

    in vehicle parts output in Canada in 2018

  • 75%

    of a vehicle’s components to be made in Canada, the United States or Mexico

The start of 2020 brought welcome news to the Canadian business community as the United States-Mexico-Canada Agreement (USMCA) moved toward final ratification by the US Congress and Canada’s Parliament. With further changes to clarify labour provisions and other aspects of the 2018 deal, the announcement brought welcome certainty to Canadian businesses, including the automotive sector. But coming on top of existing challenges resulting from the shift to CASE (connected, autonomous, shared and electric) mobility, USMCA is yet another change that will prompt companies to reassess their strategies in 2020 and beyond.

Disruptive forces at play as production falls to 2 million vehicles in Canada

In 2000, Canada, supported by a strong supplier base, produced three million passenger cars and light commercial vehicles (trucks). In 2020, the estimated production volume, following a number of plant closures and model shifts, will be one-third lower. This decline, which has put significant pressure on the supplier base, comes as sales in Canada have remained stable at about two million vehicles per year. 

Adding to this shifting environment is USMCA, which contains many changes that will affect the auto industry. These include regional content rules that will require at least 75% of a vehicle’s components to be made in Canada, the United States or Mexico in order to qualify for tariff-free access. This requirement is up from 62.5% under the current North American Free Trade Agreement (NAFTA). Under new labour rules, 40 to 45% of a vehicle’s parts must come from facilities where assembly workers earn at least US$16 per hour.

These changes, which have significant implications for automakers and suppliers, come amid other challenges for the industry in Canada. They include:

Misaligned product portfolio

 

Even with the overall decline in production by traditional North American automakers in Canada, the Canadian auto industry continues to make a high number of vehicles in declining market segments. About a third of all vehicles produced in this country in 2018 were passenger cars, a segment in which sales across all categories declined in Canada and the United States over the previous five years.

 

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Supply chain impacts

 

The decreased prospects for production in Canada are reverberating throughout the supply chain. Due to the efficiencies of locating activities near final assembly plants, model cancellations and shifts in production to other countries are reducing economies of scale for the remaining producers, shrinking the market for suppliers and adding complexity and cost to the supply chain.

Auto parts suppliers face a number of other changes, including Canadian and US emissions regulations that are increasing the pressure to build cleaner engines. They also operate in a highly competitive market that’s very sensitive to factors like foreign exchange rates. Adding to these shifts is the outsized growth of automotive electronics manufacturing which, while a smaller segment overall than other areas of the parts industry, is seeing revenues rise at a faster rate. It includes the production of electronic and electrical parts like lighting systems, driver displays and sensors.

 

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Disruptive technologies

A number of players, including automakers as well as technology companies and other non-automotive entrants, are putting increased resources into developing vehicles oriented toward the technological shifts that are revolutionizing the automotive market. This typically refers to the so-called CASE model of connected, autonomous, shared and electric vehicles. As markets change rapidly, Canada is likely to shift from its traditional manufacturing role to being more of a hub for research into and development of these disruptive technologies.

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Slowing demand

A number of factors, like changing demographics, weakening consumer sentiment, rising loan delinquencies and economic uncertainty, point to a slowdown in demand for the global auto industry. In response, Canadian automakers and suppliers are looking to cut costs to maintain their margins while boosting cash reserves for investments in new technology.

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A tipping point for Canada

While Canada’s automakers and the Tier 1 and 2 auto supplier industry have been grappling with these changes, they have also dealt with the uncertainties surrounding talks to renegotiate NAFTA and questions about ratification of the new USMCA. Recent moves to end that uncertainty are positive, and the changes—such as the provisions for content made in North America and by workers earning at least US$16 per hour—could lead to positive impacts for Canada. But there could be downsides as well.

This is because, according to some estimates, up to 40% of vehicles made in North America may not comply with the new USMCA rules for labour and/or regional content. Failing to comply with the new rules will increase costs, leading to higher prices for consumers and, possibly, reduced vehicle demand. This, in turn, could cause production of vehicles and auto parts to decline in all three countries. In Canada, our analysis of figures from the International Monetary Fund suggest vehicle production, valued at US$61.4 billion, will fall by about US$1 billion. Looking at auto parts production, valued at US$28.4 billion, the new trade deal is expected to lead to a decrease of about US$300 million. 

Vehicles that don’t comply with the labour and regional content rules will be subject to tariffs of 2.5% for passenger cars and 25% for trucks. This will lead to an estimated US$3 billion in extra costs for automakers over the next decade, according to a recent report by the US Congressional Budget Office.

The cumulative impact of all of these disruptive forces—including USMCA and the broader changes reshaping the industry—could be a tipping point for the auto sector in Canada. With so much change happening, Canadian companies will need to assess their options for remaining competitive and continuing to grow.

How does manufacturing compensation compare across the three USMCA countries?

Hourly compensation costs in US dollars in 2016

Canada

$30.08
United States

$39.03
Mexico $3.91

Source: Conference Board of Canada

Solutions for Canadian automakers and Tier 1 and 2 suppliers

So what can Canadian automotive and Tier 1 and 2 companies do to respond to the changes under USMCA? 

Actions for automakers to consider include:

  • Assessing the origin of the bill-of-material items for every vehicle coming from a production plant.

  • Based on how close they are to the USMCA thresholds, automakers will need to develop a strategy to comply with them or compensate for the additional costs.

  • Making conscious decisions at the level of both product categories and parts. While part of the policy aim behind the new rules may be to spark a shift in Tier 1 and 2 production to the United States and Canada, the new environment will require diligent execution by automakers.

Tier 1 and 2 companies and their suppliers face broader challenges that require them to increase their flexibility and agility. More than ever, Tier 1 and 2 companies will be grappling with changing strategies by the automakers, smaller volumes per new model, new powertrains and geographical considerations under USMCA. To succeed, they’ll need to:

  • Assess the scenarios available to them to hone in on their value proposition with the right portfolio of products to manage and, in the best cases, benefit from the impacts of USMCA.

  • Pursue automation where possible.

  • Explore cost-saving opportunities.

  • Expanding capabilities to boost innovation.

  • Increase their acumen to drive commercial excellence.

Embracing new opportunities

Despite the shifting environment, Canada still has a large industry of both automakers and parts suppliers. In auto parts alone, output in Canada was worth US$28.4 billion in 2018, according to the IMF. That’s not to mention further activities around engine manufacturing, the production of automotive electronics and the continued assembly of vehicles in Canada. The challenge will be to get ahead of the changes playing out in the industry and the disruptive forces at work. Those that do that will be in the best position to thrive as we enter 2020 and adapt to the new realities of USMCA.

Contact us

Neil Manji

Neil Manji

National Energy, Utilities, Mining and Industrial Products Leader, PwC Canada

Tel: +1 416 687 8130

Email
Eduardo Fusaro

Eduardo Fusaro

Partner, Strategy&, PwC Canada

Tel: +1 416 687 8510

Linkedin Follow Email
Dr. Oliver Vollmer

Dr. Oliver Vollmer

Director, Strategy&, PwC Canada

Tel: +1 416 687 9167

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