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:
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.
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.
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.
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…