Dr. Klaus Zehender. SupplierBusiness Analysis. Rolf Geisel. Florian Bovensiepen Head of Purchasing, Alpina

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1 IHS AUTOMOTIVE Issue 8 October 2015 SupplierBusiness Analysis supplierbusiness.com ihs.com Interview special Dr. Klaus Zehender Member of the Divisional Board Mercedes-Benz Cars Also: Rolf Geisel CEO, Friedrich Boysen Florian Bovensiepen Head of Purchasing, Alpina FINANCIAL ADVISORS WITH DEEP AUTOMOTIVE INSIGHTS

2 INTERVIEW Looking at the cost of a vehicle today in the industry, about two-thirds of the added value comes from suppliers. Dr. Klaus Zehender is Member of the Divisional Board Mercedes-Benz Cars, Procurement and Supplier Quality. In this interview, which took place at the 2015 IAA Frankfurt motor show, Julian Buckley speaks with the chief of Mercedes purchasing about supplier strategy, management and how recent growth has affected supply across the carmaker Can you outline the purchasing strategy at Mercedes-Benz? Customers buy a Mercedes-Benz because of the superior innovation and quality experience. This is why our first priorities are to deliver those innovations together with our colleagues from Research & Development, and to ensure top quality across our supplier network. We are also looking at efficiency in the value chain and this comes together with a partnership approach with our suppliers. We routinely ask suppliers for suggestions on how to improve the cost positions of our parts through intelligent technical optimizations. One other point is our global growth. We are increasing production capacities, we already had sites in China, South Africa and the United States and now we are moving into Mexico. To support this expansion of our global production network close to our growth markets, we need localized value chains. There are two aspects: Breadth, increasing the number of tier one in all these regions, and depth, capitalizing on the overall value chain, from tier-two to tier-n. The number of local suppliers has increased to support production of the C-Class across the four build locations. Are these global companies which have moved to support Mercedes-Benz, or are they national companies? Overall, the number of our suppliers has been stable; we have about 1,500 partners around the world. There are two basic trends you can see within this. On the one hand we are employing modular strategies, IHS Automotive SupplierBusiness Analysis Issue IHS

3 DR. KLAUS ZEHENDER, MERCEDES-BENZ Daimler Dr. Klaus Zehender which reduce the number of suppliers in general, as we do more volume with the modularized parts. On the other hand, we are increasing localization in various regions. Our new C-Class with four different production sites around the globe is a perfect example, and our nextgeneration compact cars will be similar. This also brings in new partners. When we localize, we are not aiming to maximize the number of local parts, but to maximize the value. We take into account tooling, savings related to shipping, how local wage levels affect the part price. Each part goes through this evaluation in supplier quotes for all regions and we compute the total landed cost. Sometimes we find it is best to have a global supplier bringing in parts from one location to all the global regions. This often happens in the case of electronics. In other cases we find it is best to have the same supplier in all four locations. And sometimes a local supplier can offer a good quote for supply on one or two regions, but he cannot cover the four regions which would mean we might have to split supply. But in the end, it always comes down to what is the best solution in terms of total landed cost. Having spoken with Boysen (delivering exhaust systems to the new W205 C-Class in all four global build locations), they have made some considerable investments to support Mercedes-Benz. One question they couldn t answer was what happens if Mercedes-Benz decides to use another supplier in the future? Boysen is a great example. I would even describe them as a role model for how a supplier can go global along with our growth. Boysen is a medium-sized, family-owned business located in the Black Forest [of Germany]. We explained to them years ago that we were planning to expand across the globe and we made the offer to join us, which they did. So to supply all four C-Class plants in Bremen, Germany; Tuscaloosa, Alabama; East London, South Africa; Beijing, China, they went on to copy and paste their existing successful German operations across these regions. Now they have efficient operations delivering the highest quality level all around the world. They also minimized complexity by carrying over certain elements which they relocated all around the world. They scaled to our needs very quickly and we re very happy to be working with Boysen. In general, our business relationships with suppliers are based on a very professional and transparent system. Contracts always cover a certain timeframe, and there are no automatic renewals or extensions. Boysen, for example, has been awarded the contract for delivery of parts over the full lifecycle of our new C-Class which we launched in 2014, for all four of our C-Class production locations around the world. With the nextgeneration of the C-Class we will again ask the market for offers and everyone can put forward bids. Boysen can use its existing investment to give itself a very competitive position. So that is an advantage, of course, but no guarantee. It also helps Boysen that related volumes will increase as the GLC and future models will share similar exhaust assemblies? It always helps when you can build on existing investment. But let me point out another aspect: I am convinced that working with Mercedes-Benz is great for any supplier. We are the fastest-growing premium brand, the image is fantastic, so once you re working with Mercedes and you globalize, that can be a powerful marketing tool to convince other OEMs to use your products as well IHS 21 Issue IHS Automotive SupplierBusiness Analysis

4 INTERVIEW Do you have any no bid contracts with any suppliers? If the supplier can meet the price specified by Mercedes-Benz, the company will automatically be awarded that contract? There are various approaches in our purchasing strategy. Sometimes we feel that it is best to do a radical exposure to the market, basically examining what is available. Sometimes, if we are very happy with a supplier and if they are also able and quality experience. Our task is to ensure our high-quality vehicles are loaded with the most innovations in terms of connectivity, autonomous driving etc. So with regard to this two-thirds of the value added, it is quite natural to group innovation, quality and efficiency altogether. Then, looking at the growth of Mercedes-Benz, we are globalizing and localizing which is also attractive for suppliers. In this process, our job is to We are further improving the quality steering process and one of the key aspects is bringing the quality element to all areas of the world. How do we do that? We are responsible for supplier quality from the contract awarding process through to when the part is no longer used. For this, we do a joint assessment in which suppliers have to show us that the localized plants can fulfil the quality requirements. Our quality engineers travel to these sites to carry out an audit In general, we consider the tier-one supplier as the systems integrator; they are responsible for managing their supply chain. We cannot take care of every detail. to meet our future cost expectations, we may choose a direct awarding. We have a very sophisticated benchmark calculation and we know exactly where our future costs should be. Which strategy we are using is decided on a case-by-case basis together with our colleagues from R&D, from logistics, and others. Additionally, as I mentioned, our key focus is to secure innovation. Sticking with one established supplier can be a benefit when they can build on existing investment. In other cases, you may accomplish more by getting some fresh ideas from a new supplier. Can you talk about the recent amalgamation of Procurement and Supplier Quality into one standalone department? Looking at the cost of a vehicle today in the industry, about two-thirds of the added value comes from suppliers. At Mercedes-Benz, this must of course contribute to the superior innovation make sure we maintain and roll out a high quality level beyond the traditional Eurocentric supplier set. Any new suppliers can only gain business if they secure the quality, because that is what our customers expect, no matter where the car is produced. To accomplish this, we have about 400 quality engineers in Purchasing, all university graduates, most with engineering degrees. They are also based in our localized quality hubs in China and in the NAFTA region, and these engineers go out to suppliers to work with them on site to ensure quality. In 2012, Q3.0 was rolled out as part of the overall Q Organization strategy to maintain and improve quality. This was designed to support the introduction of the modular part programme. Can you comment on what area the next Q4.0 will target? of the location before the awarding process. Once the suppliers are awarded, there is a thorough on-site testing and auditing process between that point and ramp up, including so called run-at-rate stress tests of the entire production setup. Our engineers also check on project organization: Is the project wellmanaged? Are there quality controls in place? How is the tooling manufactured? How is training carried out? How is labour retained at the business? We monitor all of this from the beginning to the end of the lifecycle. From the point of view of a supplier, what are the major influences on the development of their business with Mercedes? There are three levers of growth when supplying to Mercedes-Benz. Lever one is volume growth by itself. If you re a supplier, you gain volume and growth simply through the volume and growth IHS Automotive SupplierBusiness Analysis Issue IHS

5 DR. KLAUS ZEHENDER, MERCEDES-BENZ of Mercedes-Benz. Two, you can profit from localization as we expand our local supply chains. Then there is a third dimension. As we keep growing outside of Europe, we analyse if some things we do in-house, for example in Germany, can be done better by the supply chain in those regions. So there are opportunities to give more to the suppliers in the regions - if we find the right partners which can fulfil the quality, technology and cost expectations. I should add that we are not taking production out of Germany, where our plants continue to be fully utilized. These locations are the backbone of our global production network. At the same time, we are adding additional volumes in other regions where the growth is primarily happening. I ve seen the phrase profitable growth used in describing the future plans for Mercedes-Benz and I hoped you could outline those policies or strategies now in place to reduce the overall Purchasing budget and how this ties in with profitable growth? Beyond innovation and quality, efficiency is another key aspect in our cooperation with suppliers which we manage through a partnershiporiented approach. What does that mean? First, we regularly do technical optimization workshops with our suppliers, we ask where they see potentials for doing better. We have the modular strategy that also supports technical efficiency, where some of the ideas from suppliers go directly into the part lifecycle. It s continuous improvement in technology, with strategic improvements in modular part delivery. We are also capitalizing on the benefits of our partnerships. We have been working with BMW in our procurement cooperation for almost 10 years and we also cooperate with the Renault Nissan Alliance over various projects. Then there are the benefits of localization, and of course our growth plus the scale effects generated by our successful front-wheel drive and rear-wheel drive vehicle architectures with their high volumes. All of this makes for a really good story - interesting opportunities for our suppliers, significant efficiencies on our side. As aluminium usage across Mercedes-Benz vehicles continues to increase, how can you manage any related cost increases in that key material? We have a multidimensional strategy to deal with raw material pricing. The cooperation between Purchasing and R&D helps with this; we have regular meetings covering the use of pricesensitive materials such as copper, aluminum, rare earth metals. If there is a potential risk related to the supply of the raw material, we come up with a strategy to substitute or to reduce our use of that material. As an example, the exhaust system s catalytic converter uses a large quantity of platinum. By optimizing the burning temperature we were able to decrease the amount of platinum needed a good example for technical efficiency. Recycling of raw materials is also very interesting, starting with off-cuts and excess aluminium from our production. Beyond this, we also use hedging. We have the raw material usage within the parts as a floating element and this correlated The 2014 Mercedes-Benz W205 C-Class sedan uses an aluminium hybrid design with the London Metal Exchange (LME) index. For instance, copper goes up and down, and the part price is calculated using quarterly or six-month averages, which further takes into account raw material price volatility. And there is further volatility through the currency exchange rate, as the LME is quoted in dollars, not euros. All of this is professionally hedged at the Daimler group level. The hedging helps to take out the volatility? It helps to alleviate that volatility. Can you explain the division of responsibility between the Purchasing function based in Germany and the regional offices? Is every purchasing contract signed off by the German offices? I prefer to compare the set up to that of a football team. The team has a manager, in this case located in Germany, but then you have Daimler 2015 IHS 23 Issue IHS Automotive SupplierBusiness Analysis

6 INTERVIEW players spread throughout the regions. For example, if we award a module, perhaps a seat structure, we ask the established suppliers, but also our regional offices if they can scout potential new suppliers in maybe Mexico or China which are capable of meeting also our high quality requirements. Based on those leads we can include those companies in the overall supplier set. All around the world, this helps us to improve competitive exposure, to bring in the best suppliers, and to increase localization depth. Will there ever be a point where the regional office can run autonomously from Germany? In Mexico, the supply base there is maturing rapidly and so access to quality should also improve. As long as you have global modules utilized throughout the entire production network, the global purchasing approach is the best. If you re talking about specific parts, which are only made and used in one region, then we may allocate specific responsibility there. However, such a decentralization of purchasing only makes sense when it goes together with corresponding R&D. If we think it s best to do local development of specific vehicle content, then Purchasing should follow. This is also crucial with regard to change management. If Purchasing gets too fractured you could risk losing the economies of scale? We have a sound balance between our central and regional offices. In China, we are at the forefront in terms of bringing more local customer influence into the cars we produce there. So the expansion of our autonomous purchasing capacity is directly linked with these R&D efforts. By the way, this link is also the logic we employ in our cooperation projects with the Renault-Nissan Alliance. Some OEMs insist on understanding which upstream suppliers are delivering into tier one companies. Do you feel that is necessary? In general, we consider the tier-one supplier as the systems integrator; they are responsible for managing their supply chain. We cannot take care of every detail. But we want to know, we want to audit and we want to control what our partner is doing. The dimensions of control include quality, so we want to know which tier-n suppliers the tier one has employed. Sometimes we have experience with those tier-n suppliers and perhaps we d prefer another company. Another aspect is flexibility, so we have to ensure not only the tier one has capacity but also its tier-n suppliers are able to increase or reduce capacity. A third aspect is risk management. If you recall the 2011 natural disaster in Japan, one key aspect was to know who was manufacturing the critical processors. Most were coming from Japan, so it was important to find out which of the foundries were able to maintain operations and which were not. Today, we have the full picture, going back up the supply chain. This helps to act quickly and effectively if required. In addition to knowing which company is delivering those upstream parts, that allows you to research additional streams of like parts if there is an issue with supply, such as a natural disaster, fire, etc.? That s the idea we re following up on. One additional aspect a supplier may find it difficult to meet an efficiency target due to their supply chain. In this case we can do joint deep dives to look for potentials. With the modularization process advancing across the MFA (Mercedes Front Wheel Architecture) and MRA (Mercedes Rear Wheel Architecture) platforms, can you say what the current average level of part sharing is across those individual platforms? There is an increasing level of part sharing across those and other product architectures, but we are not disclosing exact figures. Part sharing provides us with major benefits in Purchasing as we are constantly aiming to provide more value to the customer, which meets the expectations of Mercedes-Benz and enhances the overall experience. Quality needs to be secured and the modular strategy also helps with achieving this. We want to deliver a superior experience to our customers, while still offering a reasonable price. Has the introduction of the shared platform strategies simplified the purchasing function for you and your team? On the one hand, we re dealing with a reduced number of suppliers, because the modular strategy reduces complexity. On the other hand, the modular strategy goes hand in hand with the growth strategy around the world and this brings more complexity with the localized value chains. So in this regard, it all equals out. Overall, we are not only becoming more cost efficient with modularization and product architectures but also faster and more flexible. How does that work with Citan and with the future pickup model, in that you re building Mercedes-Benz quality into a volume product? Do Mercedes-Benz suppliers have to develop parts from the ground up to work with those vehicles to deliver the required Mercedes experience? I am not going to comment on individual models, but let me explain in broad terms the scope of our various cooperations. With IHS Automotive SupplierBusiness Analysis Issue IHS

7 DR. KLAUS ZEHENDER, MERCEDES-BENZ Daimler Groundbreaking at the COMPAS Daimler and Renault Nissan JV plant in Aguascalientes, Mexico, in September 2015 BMW, we jointly engineer and purchase premium parts where there is no relevance for the customer experience for example seat structures. In our cooperation with Renault Nissan, we have a purchasing follows engineering approach. In every single project, it is clearly defined in advance who is in charge of engineering which parts, and consequently also for procuring them. If the engine is with us, so is our responsibility for purchasing. These cooperations are very beneficial to us. We can bundle volumes and we can very easily localize together through joint access to the markets, bringing new suppliers, premium suppliers, to the market. Or we can ask local suppliers, as in Mexico, if they can achieve Mercedes-Benz quality levels and if they are successful, we add them to our supplier set. Sharing vehicles is a very good way of building up the range portfolio without having to build a new vehicle from the ground up. Cooperation can provide various benefits and it often accelerates things. It sounds like an overly-simple question, but is being the best supplier a prerequisite to working with Mercedes- Benz? I would say we do not only work with some of the best, we only work with the best. The brand promise is to deliver an innovative, top-quality product. That can only be achieved with capable partners who understand and work with us according to the requirements of our stringent quality management system. Three of your top 10 suppliers in China are national companies and I wanted to find out if they needed any support on the part of Mercedes-Benz to achieve the necessary quality levels? I strongly believe that we should not underestimate China s growth, China s competence. It is and will continue to be the largest vehicle market and they have been producing cars in partnership with some European brands for a very long time. We are very positive about the performance and quality of our Chinese suppliers. We develop and select those companies in partnership with BAIC and our BBAC joint venture. They have great connections in the Chinese market and this helps us a lot. We believe that you will see Chinese companies exporting parts in the near future, the quality is that good. Right now we are importing certain speaker parts and display units from China. Has the learning curve become too steep for a new supplier company to achieve the requirements put in place by Mercedes-Benz, in terms of quality, technology, etc.? No, I don t think so. A significant group within our supplier set still consists of medium-sized, family-owned businesses and they can provide top quality and top innovation. Sometimes the smaller companies are also faster and more flexible in delivering major advances in quality and in high-tech features. We have every confidence in those suppliers, in that they can maintain their leading positions. And we are very open and eager to work with innovative new partners IHS 25 Issue IHS Automotive SupplierBusiness Analysis