Otto Deemuth has reason to worry that General Motors Corp. will move into the electrical-motor industry and threaten his business. "They can afford to do anything they want to do," says Deemuth, plant manager at Motronics Corp., a $5-million company. "I just hope that they don't start building motor plants."

Magnet makers probably had the same fears just before GM rolled into their industry last year. Their worst visions came true. The automaker, which posted sales of nearly $84 billion in 1984, is building a factory to produce a new magnet -- called Magnequench -- that can be used for all kinds of motors. "If GM chose to, it could put us all out of business," says Sherman Smith, president of Thomas & Skinner Inc., one of many small magnet companies. "I don't think GM will do that, but I could be wrong."

Until recently, General Motors probably wouldn't have made Magnequench itself. But GM, Ford Motor, and Chrysler have all seen the future, and it is not parked in the garage. During the next decade, the Big Three are sure to continue losing maket share to imports. "The auto industry is going to be a bloody business," says Gregory Macosko, a principal of Easton Consultants Inc., in Stamford, Conn.

The Big Three plan to refuel through diversification and vertical integration, moves that will be unsettling for small companies both inside and outside the car business. The automakers have one of the deepest supplier pools of any industry, comprising about 8,000 companies with sales of roughly $70 billion. Suppliers also face demands by the Big Three that they meet stringent cost and quality standards. The cumulative effect of these pressures could knock out as much as half of the supplier network over the next decade.

The carmakers have aggressive diversification plans. "They've all decided that diversification is the smart way to go," notes Arthur Davis, an analyst with Prescott, Ball & Turben Inc. "They're all moving fast." By the year 2000, GM wants nonauto sales to be 20% of its business, compared with about 4%, or $3.5 billion, in 1984. At the same time, Ford is planning to speed up its nonautomotive businesses from 7% to at least 10%. "We don't want to become a conglomerate," says a Ford spokesman, "but we should have some strengths in other areas, for better balance." Chrysler, which lags in resources, plans "to do a lot of diversification," according to Davis.

Last year's buying spree was the most public display of the automakers' new strategy.They wrote checks for almost $7 billion for acquisitions in financial services, farm equipment, and aerospace, all areas in which foreign competition is weak. Like hood ornaments, the cash outlays are very visible -- but there is more happening underneath. "We have seen only the tip of the diversification iceberg," warns Thomas Nastas, president of Innovative Ventures Inc., a consulting firm in Lansing, Mich. "It is going to produce dislocations in many industries, and a lot of suppliers are going to be awfully shocked."

The initial shock waves have already hit. "Big mergers always cause some consolidation in the existing outside supplier base," says Nastas. When GM acquired Electronic Data Systems Corp. in 1984, one observer notes, "some suppliers that were providing data-processing services [to GM] found that EDS had taken over those responsibilities."

Once diversification has begun, it gathers momentum as the new partners get into other businesses. For example, GM and EDS -- along with Hughes Aircraft Co., a satellite maker and defense contractor that GM acquired last year -- could together develop a telecommunications system that would signal trouble for that industry's suppliers.

The fallout from vertical integration can devastate a supplier network even faster. Magnet makers are worried. Last year, about 40 small domestic manufacturers sold $300 million worth of magnets. GM's factory should be finished in June -- and many magnet makers may be finished soon after, as the industry's biggest customer becomes its fiercest competitor. "When GM decides to go into my business, it scares me," says one industry member. "That company is already bigger than most countries."

Magnequench, which reduces the weight of starter motors by half, will soon appear in cars and perhaps later in robots, disk drives, and home appliances. GM will produce an estimated 180,000 magnets a day, at least half of which will be sold for nonautomotive uses. Once GM is making magnets, the entire electrical motor is a natural next step. "To get the full effect of its advantages, new motor designs will result from Magnequench," says Jeff Day, Magnequench product manager.

The carmakers are also directing many of their subsidiaries to look beyond their parent for business. More of them are selling to other auto companies and to other industries as well. Small companies that haven't had to compete with an auto giant may be shaken when a Big Three division suddenly pushes them onto the shoulder of the road. Chrysler's subsidiary for four-wheel-drive components, for instance, has stepped up business with other carmakers, the military, and offroad vehicle manufacturers. Ford's glass division has seized a window of opportunity by selling architectural glass more aggressively. And a GM division is working on commercializing a metal-stamping process that could hasten a shakeout in that industry, where the average company has 150 employees and sales of $7 million. "It would put a lot of small-company people out of business. There's no doubt about that," says Donald Smith, a product manager of Mills Products Inc., a stamping company.

Survival may require bold new initiatives, as auto suppliers are finding. "For some, this means they will either diversify or go out of business," says Peter Van Hull, a director of automotive consulting practices at Arthur Andersen & Co., the accounting firm. But when they diversify into a "quasi-automotive" industry such as appliances, suppliers -- surprise -- may run into the automakers again. "A supplier that goes knocking on the appliance industry's door may find a GM division is moving into the same area," notes Nastas, who is helping the automakers map out diversification plans.

Suppliers are also jockeying for favored-status agreements, under which carmakers guarantee them business. For some, this means "breaking even until you can catch up with the technology," says Macosko. Even then, a supplier's future is assured only until its next performance review, which in many cases occurs every six months.

Some suppliers are looking for new markets within the automotive industry. One strategy is to sell replacement parts to wholesalers, garages, and retailers. "You can get a better price, and the profits are better," says Macosko. "But it's getting tougher and tougher." Others are trying to shift from supplying parts to providing whole assemblies. They might supply, for instance, a complete air-conditioning unit rather than components of it.

Ironically, foreign competitors may also provide a way out. Chardon Rubber Co., a small Ohio supplier, recently signed an agreement with Kinugawa Rubber Industrial Co., a Japanese company with sales of about $200 million. The two are now building a plant in Winchester, Tenn., not far from Nissan Motor Co.'s factory. "We want to be able to be familiar with the Japanese technology and also learn more about Japanese management," says Jeff Keener, Chardon's president.

Suppliers may also enter into short-term agreements with foreign competitors, hoping to earn enough cash to invest in modern equipment that can improve their chances for long-term survival. "They are disappearing fast," says Eugene Jennings, a professor of management at Michigan State University's Graduate School of Business. "This is a major restructuring.It is not an episode in the life of the auto industry. It is a new life."