China and other countries with low-cost labor are putting enormous pressure on the tool and die industry in Japan, North America, and Western Europe. As one manufacturing executive recently told us, "I can get tooling in China for half the cost and one-third the time; how can I not buy from them?" The result is a growing threat to the survival of toolmakers in the developed world (see Exhibit 1 for this trend’s effect on the German market). Our research shows that although these toolmakers can hold off their low-cost competitors in the short term, to endure and thrive they will have to offer a broader array of services to their large customers.¹

Several factors contribute to the uncertainty ahead. First, in Japan, North America, and Western Europe, toolmakers are typically independent, family-owned enterprises with annual revenues of less than €500 million. Second, their main customers are automobile manufacturers, for which they develop mostly one-of-a-kind products, such as equipment to form doors for specific auto models. Last, the market is quite fragmented: one company might do tooling for structural stampings, say, while another handled surface parts and a third specialized in software for milling complex parts. Such tools can carry a price tag as high as €3 million.

The good news for toolmakers is that demand for their products is growing faster than demand for those of most other segments of the automotive-supply industry. Toolmaking revenues are likely to increase by 6 to 9 percent annually—two or three times as fast as demand for new vehicles: 3 percent in a good year (Exhibit 2). While total demand for vehicles in Japan, North America, and Western Europe is now flat, automakers are rolling out more niche models for lucrative microsegments, generating greater demand for tooling.

During the past 50 years, toolmakers in the developed world have kept their lead by excelling in a number of ways, including higher quality and innovation, especially for complex tools that shape big auto parts very cost-efficiently, with little margin for error; deep functional know-how; more efficient use of engineering resources; and superior project management.² These companies also boast strong ties with the original-equipment manufacturers they serve, as well as their own well-established supplier networks, which even the best toolmakers in developing countries can’t match. Furthermore, the expense of transporting bulky machines around the world often eliminates the cost advantage challengers gain through low wages.

But more intense competition from Asia and Eastern Europe is taking its toll, and lower wage rates (Exhibit 3) are only one reason. These toolmakers are also competing on turnaround times, an important factor in a sector focused on getting products to market more quickly. And the quality that Asia and Eastern Europe offer is improving, for two main reasons: students from those regions who enroll in the developed world’s engineering schools take their newly acquired skills back home, and companies in emerging markets are benefiting from the kind of education that comes from rapidly rising production. In addition, toolmakers in these regions can take advantage of declining capital costs and a more flexible labor force.

Meanwhile, OEMs are exerting more pressure on the tool industry as their sales strategies evolve. The big car companies used to manufacture relatively few models, which were produced at high volumes, so tool costs have been low as a proportion of overall costs. As carmakers begin producing more lower-volume niche models, however, tools will account for a bigger share of the manufacturing costs, so under this scenario, OEMs will inevitably squeeze toolmakers hard to reduce prices.

Thus in coming years, the developed world’s toolmakers will be less and less able to compete as specialists with the competition in Asia and Eastern Europe on a product-by-product basis. In response, they must expand their services to meet the outsourcing needs of OEMs. Two strategies seem promising. The first is moving higher up on the value chain to cover product development (including the translation of designs into actual auto body parts) as well as prototyping and try-outs for series production, when tools are prepared for error-free large-scale manufacture. The attraction of this approach is that OEMs more frequently desire a one-stop shop to reduce the complexity of their processes, especially for niche models. (Karmann, a 100-year-old German auto supplier, for example, now offers toolmaking and services along the entire value chain.) A second strategy is to integrate horizontally and offer tools for the whole car body and not just specific parts, since OEMs, hoping to reduce both the cost and complexity of their transactions, increasingly want a toolmaker to produce more than one kind of tool.

Our study found that each step of such an expansion—from toolmaking alone to toolmaking plus prototyping, for instance—can add at least 1 to 2 percentage points to a toolmaker’s return-on-sales margins. (Part of the benefit comes from the ability to reuse knowledge all along the value chain.) But both strategies require better project-management skills, including the effective outsourcing of less complex manufacturing jobs to low-cost producers, and further advances in production technology. Either strategy is best carried out through mergers and acquisitions, given the industry’s fragmentation and the difficulty of developing functional expertise quickly. With the valuations of auto suppliers at a low ebb, now is the time to move.