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Overcapacity and Overproduction in the Auto Industry (and Healthcare)

I’ve seen this going around social media the past few days, an article with shocking pictures of all of the cars and trucks that have been built, only to sit in huge inventory yards around the world: “Where the World’s Unsold Cars Go To Die.”

The photos are dramatic, including this one:

Screen Shot 2014 05 19 at 7.40.54 AM Overcapacity and Overproduction in the Auto Industry (and Healthcare) lean

Photo via http://www.vincelewis.net/unsoldcars.html

Note: The Jalopnik automotive blog debunks (warning, “BS” word appears) the article and photos, making one point that I make below. It’s worth pointing out that the pictures of unsold cars don’t seem to represent a looming global financial meltdown (as if we need another one).

The vehicles sitting there seem represent the Lean waste of inventory. Unsold inventory is caused by the waste of “overproduction” — producing too much of a product or producing it sooner than customers need.

If you’re not from a manufacturing background, you might wonder why in the world major automakers would crank out vehicles that aren’t needed or wanted… it seems so obvious to only build what your customers need, so let’s explore this (even if the pictures are misrepresented, they are real photos).

Now, it’s quite likely that some of the inventory yards aren’t “permanent” storage (like an aircraft “boneyard” out in the desert). Some of the dramatic-looking pictures could show cars sitting temporarily at ports and other transit points… sitting there for a day or two before being loaded or unloaded. But, when we see lots of cars parked in the middle of nowhere or on oval tracks, it seems like the cars are just being shoved to the side to sit indefinitely.

It’s claimed the volume of unsold cars keeps growing:

It is a sorry state of affairs and there is no answer to it, solutions don’t exist.  So the cars just keep on being manufactured and keep on adding to the millions of unsold cars already sitting redundant around the world.

Why do automakers build cars that customers don’t want? We don’t know it’s “millions” but you can see the data that shows how many “days of inventory” are sitting in auto dealer lots (that is “overproduction” you can go and see for yourself).

How bad is the overproduction and inventory problem? From Jalopnik:

Automakers try to keep levels at between 60 and 65 days supply. This may seem high, but companies don’t want to run out of cars to sell so they try to keep a decent inventory available to ship.

Being unable to predict that winter would slow new car sales below expectations, more cars were produced than could be sold to keep it at that rate and inventory levels in the U.S. rose to about 76 days in March before falling to 69 days in May. Not great, but not terrible (GM’s is fairly bad, it’s worth noting).”

So why do automakers “overproduce” other than ensuring they have enough supply at dealers? They wouldn’t need as much inventory if they could do “build to order cars” more quickly or if they could better predict real customer demand.

Revenue Recognition

GM and the other automakers (other than Tesla) don’t own their own dealers. Many states prohibit automakers from selling direct to customers (thanks to cronyism and the lobbying power of auto dealer middlemen).

One side effect of the factory and the dealer being two different companies is that the automaker, such as GM, gets to recognize revenue when they ship a car or truck to the dealer. That vehicle likely doesn’t have an end customer ready to drive it yet. GM is producing based on a forecast that combines orders from dealers with other predictions of what customers will buy.

Not even Toyota does a lot of “build to order” manufacturing as we used to do at Dell when I worked there 15 years ago. At Dell, nothing was assembled until there was an actual customer order in place. Toyota builds most of its vehicles based on “dealer orders.” This article says Toyota is actually LESS willing to build a “custom” truck than GM or Ford, saying that Toyota pretty much builds to their plan and does their best to match dealer orders to the planned vehicles. See, there is still waste to eliminate, even for Toyota.

“Channel Stuffing”

Automakers can boost their own revenue by forcing product on the dealers. This is called “channel stuffing,” a practice that’s “universal” in the industry. GM has been doing a lot of this recently.

GM makes their numbers look good by building cars that customers aren’t buying. That’s crazy, but those are the legal and accounting standards.

As Jalopnik says:

The [Zero Hedge] author is conflating this with “channel stuffing,” which is when automakers try to make it seem like they’ve sold more of a product than have been purchased by shipping everything to a distribution center, with the effects of the bad winter.P

Indeed, carmakers do all sorts of dumb things to make it seem like they’ve sold more cars, but what you’re seeing is easily explained by first quarter sales and there’s no evidence that we’ve seen to indicate something particularly nefarious.

Distorting the System or Improving the System

As we see with the VA waiting time scandal (I’ll probably blog about that for tomorrow), when it’s easier to distort the system (by forcing cars on dealers) instead of actually improving the system that produces the desired numbers (selling more cars), people and companies will distort the numbers.

With the VA, it’s been easier to distort the waiting lists (keeping patients on alleged “secret waiting lists“) than it is to actually reduce waiting times… people will distort the system and fudge the numbers. It’s not “criminal” as I’ve heard it said… it’s rational human behavior and it happens A LOT.

Spreading out Fixed Costs By Building More

Traditionally, many of the auto industry union contracts have called for workers to be paid whether they built cars or not. So, if you’re paying people, you might as well “move metal” and build something.

Accounting rules also make it seem like it’s cheaper, per vehicle, to produce more, as we’re spreading out fixed costs, including capital and overhead, across a greater number of vehicles… product that customers aren’t buying. Crazy… but rational given the rules of the game.

The Future Tesla Battery Plant

Back to Tesla, the electric vehicle maker owned by Elon Musk is shopping around for a site or two to locate its planned “Gigafactory” that will produce a high volume of batteries for current and future Tesla models. My current home of San Antonio is one of the finalists, supposedly, which would add about 6,500 jobs on top of the 6,000 or so related to the Toyota truck plant and direct suppliers.

The Wall St Journal has an article about the big bet that Tesla is placing. Experts talk about the risks of building battery plant capacity that’s not needed – a problem that led to the downfall and bankruptcy of the stimulus-backed A123 battery plant in my home town of Livonia, MI.

Not surprisingly, a former Toyota executive advises Tesla to go slow:

Bill Reinert was national manager of Toyota Motor Sales U.S.A. Inc.’s advanced-technology group from 1990 to 2013. He co-led the U.S. product-planning team for the second-generation Prius and worked on several advanced hybrid electric products, direct hydrogen fuel-cell vehicles and plug-in hybrid concepts, among others.

We didn’t anticipate Prius would sell like it did. There was at least a year or more where we couldn’t increase sales because not just the battery but a whole host of other parts couldn’t be ramped up quickly enough.

But the worst thing in the world you can do is plan for a high volume and not reach it. Then you’ve got all these factories that are idle, and all these workers who are idle, and all these parts that you ordered. It’s better to slowly add to production when you are making a profit than to shut down lines when you are losing money.

Toyota can take a suspension they use on three million cars and put it on a low-volume car. Volkswagen is the king of this. Tesla doesn’t have that ability. It has to be bespoke, built from the ground up.

If I were in [Tesla Chief Executive Elon] Musk’s shoes, I’d be on a jet tomorrow to go to [battery makers] LG Chem, Panasonic, GS Yuasa, and telling them this is our long-term projection. But if [they couldn't commit to meeting my needs], I wouldn’t be discussing this grand design, this mythical plant.

What I would start out with would be bare-bones manufacturing and make sure that we are making as many of the product as we need.

Also not surprisingly, the former CEO of the now bankrupt A123 says that Tesla needs to take the risk and build their own capacity to “get out in front of demand.” Yeah, he’s an expert in that.

Overcapacity and Overproduction in Manufacturing & Healthcare

Overcapacity creates pressures that lead to overproduction. Toyota is proposing that Telsa avoid overcapacity as a smart business strategy. When you’re a bit capacity-constrained, you will grow slower, but probably at a more sustainable pace.

What happens when we have excess capacity in healthcare for things like MRI studies? Do we get “overutilization” because the capacity is there and we feel pressured to use it?

Gluts or Shortages?

We need to have the right capacity… not too much, not too little. When it takes a long time to increase capacity, this gets really hard to predict. Some industries can’t turn on a dime, so that creates the risk of shortages or the risk of oversupply and a glut in the market. Look at the whiskey and bourbon industries, where it takes YEARS to age the product. You can’t double production overnight. Same is true with champagne… there are occasionally shortages and pressures that drive prices up to better balance demand and supply.

It’s easier to identify situations where you have gluts or shortages than it is to prevent them…


mark graban lean blog Overcapacity and Overproduction in the Auto Industry (and Healthcare) leanAbout LeanBlog.org: Mark Graban is a consultant, author, and speaker in the “lean healthcare” methodology. Mark is author of the Shingo Award-winning books Lean Hospitals and Healthcare Kaizen, as well as the new Executive Guide to Healthcare Kaizen. Mark is also the VP of Customer Success for the technology company KaiNexus.

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11 Comments on "Overcapacity and Overproduction in the Auto Industry (and Healthcare)"

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  1. Gerard says:

    Interesting article. A comment on Tesla: it seems that higher tech US manufacturers have decided that by outsourcing they end up turning their suppliers into competitors by teaching them how to build competing products, see Apple/Samsung and Dell/Acer. For Tesla the battery could be the competitive advantage so I can see why they want to keep it in-house and grow expertise in manufacturing them. I guess the question is does this outweigh the loss of efficiency in not outsourcing to others and ramping up as demand increases.

  2. Graham Canning
    Twitter:
    says:

    Hi Mark, great blog.

    There’s another reason why cars (yes even Toyotas) are parked on airfields at times, and that is because of Heijunka (Levelling). If the peaks and troughs of demand are smoothed out to create a level schedule, there will be times when stock levels are high as the factory builds ahead of demand. This means that the factory is able to size its operations to a level demand rather than carry the cost of additional capacity, when for most of the year its not required. Its also imperative in large factories that there is an element of levelling, so that takt time changes aren’t happening too often, and focus can be given to muda elimination in a relatively stable environment. It may seem counter intuitive to some, but its right there on the path to becoming truly ‘lean’.

    Any good examples of Heijunka in Healthcare? I’d love to hear about where this is deployed elsewhere.

    • Mark Graban
      Twitter:
      says:

      Graham – you’re right… in an industry where is a high fixed capital cost, level loading is an important strategy.

      It’s, overall, less expensive to produce to a leveled schedule and have some inventory and the risks associated with that than it would be to have idle capacity or to be constantly changing the takt times to adjust the production rate. I know from my time at GM that “re-balancing” or adjusting the production rate on an engine assembly line is not a trivial thing to do. It’s easy to increase production a bit by adding overtime (and I know that’s what the Toyota plant here in San Antonio does when demand is high… they work longer).

      When I worked at Dell, the fixed capital cost for PC assembly was relatively low. Dell was true build-to-order, so they didn’t really level production or demand. It was cheaper and better for THEIR business to be constantly adjusting the production rate by adding people (or reducing the number of employees). There were many downsides to doing this, however, but since they built their business around build to order, they had to do that. Dell’s business, now, is much different.

      Healthcare is more like “build to order” in that services must be provided on customer demand. If a hospital doesn’t have enough capacity (the fixed capital costs can be quite high), then patients have to wait. “Production” of the healthcare services is leveled, but it’s not meeting demand and patients wait. The challenges in healthcare are mainly about adjusting capacity throughout a day, week, or year to handle variation or seasonality. That’s not always easy to do…

      I’ve seen “level loading” of some healthcare work that was more planned… like routine laboratory testing, leveling the scheduling of appointments for chronic condition management, etc. You have more opportunities to level workload when the healthcare isn’t being done on an emergency basis.

      But, the global healthcare problem seems to be a lack of throughput and a lack of capacity. I just had a Skype call today with Lean consultants in Russia and the hospital challenges there are a lack of throughput and long waiting times. A lot of that can be addressed by process improvement… not just spending more money on more capacity and equipment.
      Mark Graban recently posted..UMass Memorial Aims to Become a “World Class” Kaizen OrganizationMy Profile

      • Graham Canning
        Twitter:
        says:

        Great observations Mark, especially regarding the Healthcare examples. I agree there’s some opportunity for levelling in Elective procedures, where a certain amount of waiting might be tolerable. However, in the reactive world of Emergency medicine it could be disastrous!

        I did some consultancy work in a Hospital in the UK that had sized its bed capacity based on average demand through the year. Imagine what happened every winter when flu came around? You’ve guessed it, patients on trolleys in corridors and lots of non-emergency treatments getting cancelled!

        Mind you seeing the problem so clearly did focus the mind on improving the patient flow!!

        • Mark Graban
          Twitter:
          says:

          Yeah, planning based on averages (while ignoring variation and seasonality) is a receipt for disaster!

          To have good patient flow (minimal delays), you need to have excess capacity. You either have some wasted capacity at times (throughout the day or the year) or you get tons of waiting time. A big fallacy is the idea of keeping everyone and everything at 100% utilization. That leads to sooooo many problems.

          I think hospitals should work actively on “demand shaping” for elective procedures. If you have a slow period in the year, try to steer people toward the slow periods if that means offering discounts or incentives of some form. If somebody can wait three months for cosmetic surgery, give them an incentive to wait until the ORs are less crowded perhaps.
          Mark Graban recently posted..Run Fast if You Ever Hear This Phrase from a My Profile

  3. Sami Bahri says:

    Mark,

    Great Post and great comments, as usual!

    I don’t know if we can extrapolate from our dental office to a hospital, but the issue of demand shaping, leveling and capacity has preoccupied us for a long time. I would like to seize this opportunity to share our experience.

    First about demand shaping, we found that it is doable within the patient’s tolerance for delivery time, usually shaped by the average delivery time on the market. As an example, a crown takes two weeks in a traditional setting; we make it the same day if the schedule allows, within one or two days if we are booked to capacity. When patients compare two days to two weeks, they are still willing to accept the delay. If we start going over the two-week period however, they are less willing to accommodate our schedule. To your point, I think that hospitals might be able to shape demand within the patient’s tolerance margins.

    Second, we have balanced leveling and variation through two factors:

    1- We did utilize the average numbers to decide on the number of staff, but we staffed in excess of average demand. Actually, when we compared the previous year’s takt time for the most frequent procedures to their cycle times, we found that we were overstaffed. We kept the excess staff for growth purposes.

    2-Even with the slight excess in capacity, demand exceeds our capabilities at times. That’s when cross training and the right attitudes come into play. Employees move flexibly between the different functions–within the limits of rules and regulations, of course.

    Now here’s what I don’t know: Are hospitals setup to flex resources– mainly human resources– temporarily between departments?

    One Doctor told me that it would require cross training and standardization. “An employee from the second floor would have a hard time working on the third floor” he said, “because the carts are organized differently, for example.”

    I don’t know if some hospitals have worker unions that would challenge policies asking people to move between jobs, and I wonder if some pioneering hospitals have tried it already?

    Thanks
    Sami

    • Mark Graban
      Twitter:
      says:

      Hi Sami-

      Thanks for the comment and questions.

      You’re right, that “demand shaping” should take the customer/patient needs and desires into account.

      You’re very smart to staff based on something HIGHER than average demand. That’s a good principle for dealing with variation… to staff at some level higher than the average. Using “excess time” in constructive ways (learning and improvement) is a smart strategy as well. We can’t expect people to be 100% without having long waiting times and poor customer service.

      Hospitals are trying to get better about “floating” staff between units. That’s one argument for standardizing supply set ups the best they can. It might not be 100% identical, but it’s standardized enough to solve the goal of staff being able to work effectively in different units… eliminating that barrier that would prevent the flexibility in staff assignments. I see that happening out there, already, even if there’s not a broader, more comprehensive Lean initiative.

      Mark
      Mark Graban recently posted..Article about Lean in Two Sioux City Health SystemsMy Profile

  4. Mark Graban
    Twitter:
    says:

    Data from Bill Waddell’s blog post:

    “Some 3.27 million new cars are now sitting on lots across the U.S., more than there have been in almost five years, according to Automotive News.” “General Motors, for example, has enough Cadillacs finished to meet demand for more than four months. It also has 85 days’ worth of Buicks ready to roll. (At the other end of the spectrum, Toyota and Subaru are running lean—current U.S. inventories for both companies should be gone in less than 60 days.)”

    Read more on this at BusinessWeek
    Mark Graban recently posted..Article about Lean in Two Sioux City Health SystemsMy Profile

  5. Robert Baird says:

    Hi Mark

    Excellent comments so far because the article is so representative of the mistakes most organizations make today.

    First, 60 days of finished goods is not lean in any business. The cost of inventory must extremely high when attempting to store >60 days of automobiles. This also presents quality, safety, and cost risks as the longer it takes to get feedback from consumers about quality and safety concerns the higher the remedial costs for the manufacturer, just ask GM! With higher inventories employees will also start to make decisions mis-aligned with known customer values. The one example, from the provided pictures, is Nissan storing autos on their test track that is used for both quality assurance and R&D.

    Second, the pictures in the linked article do not represent the inefficiencies stated. Sales have improved for automakers every year since 2009. The ratio of Inventory Turnover can provide an insight into how efficient the automakers are. Here is what I determined from their 2013 annual reports, GM 11.1 turns, Ford 18.7 turns, and Toyota 12.9 turns. This indicates Ford is doing the best job by turning over their inventory 18.7 times per year. This is very efficient when you consider other industries are usually below 10 turns. Still not lean though.

    Third, capacity planning with an automaker or healthcare should use about 80% utilization in order to absorb variation. It has been shown, planning with higher utilization will increase lead time if throughput remains stable. I agree level loading can help but there are many other losses like non-value added tasks and process steps (typically >80%) which, if improved or eliminated, can achieve stabilized flow related to fluctuating customer demand.

    Lastly, I really enjoyed your Podcast #197 with Kim Barmas, especially about how they increased the value add time of the Nurse with the patient. I am sure this increase in value add also reduced the time a patient spent in the hospital, effectively increasing their capacity.

    • Mark Graban
      Twitter:
      says:

      Thanks for the comment and I”m glad you like the Barnas podcast.

      Two things to keep in mind about auto industry inventory turns:

      1) The dealer inventory is not on their books as an automaker. It’s been sold to the dealer and isn’t an inventory “asset’ to the producer.

      2) The automakers have A LOT of leverage over suppliers to force them to deliver frequently and in small lots… this helps keep inventory low on their books. It doesn’t mean the overall value stream is more efficient, but it means the automakers have power that comes from size. That’s different than being Lean.

      Mark
      Mark Graban recently posted..Podcast #199 – Jeff Gothelf, #LeanUXMy Profile

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