Tier 1 and tier 2 suppliers

Tier 1 and tier 2 suppliers are the layers of companies that supply a carmaker or aircraft maker. The carmaker, called the original equipment manufacturer (OEM), buys whole systems from tier 1 suppliers, such as seats, braking systems or an entire dashboard. Each tier 1 supplier buys components from tier 2 suppliers, such as a sensor, a chip or a casting. Tier 2 suppliers in turn buy materials and parts from tier 3 suppliers.

Here is how the chain works in general. The OEM designs the vehicle and specifies what each system must do. It chooses tier 1 suppliers by a contract, often for the whole life of a model. The tier 1 supplier designs the system, buys the parts it needs from tier 2 companies and delivers a finished unit to the OEM's assembly line, usually just in time. The OEM deals only with tier 1, so it holds tier 1 responsible for quality, while tier 1 holds tier 2 responsible.

The maker uses tiers because it cannot manage thousands of suppliers directly. It manages a few hundred tier 1 companies, and each of those manages its own suppliers. The maker usually asks tier 1 for a lower price every year, and tier 1 passes that pressure down. A fault deep in the chain can still reach the maker. A defective casting from a tier 3 company can cause a recall of finished cars, which is why parts must be traced to their source. India has a large base of tier 1 and tier 2 component makers that supply carmakers in India and abroad.

Take, for example, a car's braking system. A tier 1 supplier delivers the whole system to the carmaker. Inside it, a tier 2 company supplies the electronic control unit, and a tier 3 company makes the metal casting. Consider an aircraft. The maker buys engines and cockpit systems from tier 1 companies, such as the makers of a jet engine or avionics. Imagine a chip shortage. A tier 2 chip maker delays its delivery, and a car factory stops although it never bought the chip directly.

This structure shapes software too. Tier 1 companies write much of the code that runs in an electronic control unit, and the supply chains are described in inside a new car and building an airliner. Parts must be tracked, as in track and trace, and each system needs safety certification.

How is it different from channel sales? Tiers describe who supplies parts to the maker. Channel sales describes who sells the finished product to buyers.