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Published: June 4, 2012

 
 

Optimism Returns to the American Automotive Industry

It is not clear whether the industry is now fully prepared for the next black swan event. Risk mitigation measures are expensive, and, in a brutally competitive sector, they eat into margins. Accordingly, companies in the industry must determine an appropriate level of investment — low enough to be cost-effective, and high enough to ease the risk of being surprised by the next supply chain disruption.

Capabilities for Growth

The executives of the auto industry’s leading companies have many reasons to feel proud this year. They haven’t coasted on bailouts; they have learned some hard lessons and built a stable platform for profitable growth. They now face several external risks, including changes in government regulation, potential fuel disruptions from the Middle East, and continued economic woes in Europe. Yet if history is any guide, the greater risk could be from becoming overly optimistic about the market and expanding to meet demand that does not materialize quickly.

“In my experience, after 30 years in this business, every year someone else says, ‘I’m the guy with the great product lineup, and so I’m going to open a new plant, add more shifts,’ ” says Robert Fazio, executive director of sales operations at Edmunds.com. “The high-potential dollars per unit are just too enticing. And the capacity creeps up.” If that happens, and others try to keep pace, supply will begin to overtake demand, steep incentives will reappear, and the industry will be back in a situation of too much capacity, relying on incentives to move cars.

Here’s another scenario, though: If the U.S. auto industry can stay disciplined and preserve the efficiencies it fought so hard to implement, it will remain cost-competitive with the most efficient car markets in the world. It will be smaller than it was in the artificially inflated boom years of the past, but will have a far greater focus on fundamentals. And it will sell higher-quality cars at greater profits. Which path the industry takes lies within its own control, provided it can avoid repeating the mistakes of the past.

Memo to Suppliers: Improve Your Capacity Planning
by Arvind Kaushal and Steven Eldam

As demand rebounds, suppliers are working hard to stretch current capacity further and postpone committing to major capital investments until absolutely necessary. This is a tightrope act in which the consequences of miscalculation are steep — including potentially shutting down vehicle production at a manufacturer and losing that business forever.

An objective, integrated view of short- and long-term demand is a critical first step in developing the right response to the capacity gap challenge. Although it’s important to understand your customers’ view of demand growth projections, that should not be the only major consideration. The key to developing confidence in your demand forecast is to triangulate the external and internal views, gathered from across the organization, using them to develop an integrated view of various demand scenarios. This growth projection capability is at a nascent stage at many suppliers and is often the basis of disconnection between sales and operations.

Once you have a clearer idea of capacity requirements needed to fill the gap in the short and long term, you can consider specific measures to increase capacity while optimizing significant investments in fixed assets. For example:

Increase production hours or staffing levels by using existing shifts to schedule overtime production or adding shifts to increase overall capacity.

Eliminate production bottlenecks by increasing staffing levels, adding equipment, or outsourcing non-core processes to generate better throughput.

Improve overall equipment effectiveness (OEE) by enhancing equipment availability, increasing productivity, and improving quality.

Increase flexibility of existing equipment to provide the capability to shift production between facilities or between production lines within facilities.

Invest in new capacity if needed to meet lasting high demand.

To help you decide on the set of options that would work best for your company, consider formulating responses to the following key questions:

• How confident are you in the demand forecast?

• Is the expected demand–capacity gap short term or long term?

• Would incremental capacity improvements without significant fixed investments increase your capacity enough to meet demand?

• How flexible is your existing production equipment? Are you striking the right balance between focused factories and flexible manufacturing?

• Do your other regional or global facilities have available capacity that can cost-effectively serve incremental demand?

• Will hiring new employees in the short term create long-term liabilities? Are there facilities that offer a lower-risk option?

The key is to invest in new capacity only if you are confident of sustainable demand and sure that the new capacity will be cost advantaged relative to competitors (on the left side of the supply curve). This will help cushion the impact of demand shortfalls. All else being equal, you may prefer adding capacity in regions where you have opportunities to repurpose the capacity to a fast-growing market, in case there are hiccups in the region for which the capacity was initially intended.

  • Arvind Kaushal is a partner with Booz & Company based in Chicago.
  • Steven Eldam is a senior associate with Booz & Company based in Chicago.
 
 
 
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Resources

  1. Ben Klayman, “GM Focusing on Profits, Not Market Share: CEO,” Reuters, January 9, 2012: Describes CEO Dan Akerson’s comments at the Detroit auto show regarding GM’s renewed push on fundamentals rather than sales volume.
  2. Alan Ohnsman, “Hyundai Puts Quality Advances Ahead of 2012 U.S. Sales Goals,” Bloomberg Business Week, January 9, 2012: Describes the automaker’s willingness to sacrifice incremental sales growth and focus instead on improving its quality scores.
 
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