Capacity expansion risks

The automotive market is on a good run with strong consumer demand and numerous new product launches fueling higher vehicle production levels. The IRN Autofutures forecast calls for more than 17.3 million units of North American light vehicle production in 2015 and continued growth (although tapering off) for the 5-year forecast period to 2019.

That’s good news, but it also presents a challenge for automotive component suppliers, who are grappling with how to meet production requirements while minimizing future risks. It may seem counter-intuitive to suggest that good business is a problem, but it is understandable given the context of where the industry has been.
 

Doing more with less

During the economic downturn, North American light vehicle production plummeted from 15 million units in 2007 to 8.6 million in 2009, a 43% decline. Suppliers scrambled to downsize accordingly, laying off workers and closing facilities to reduce overhead. Those that survived came away with a heightened sensitivity to the perils of fixed costs. As a result, they have also been extremely cautious as demand returned.

The initial strategy was to ask for more productivity from current employees, but that policy has natural limits. As one supplier told us, “You can have one person do the work of two for a while, but they can’t do the work of three.”

By 2011, suppliers were adding personnel – in engineering for new programs, inside sales/customer service due to the increased level of quoting and order processing, and on the factory floor.

Even so, approximately one-third of the respondents to the 2014 IRN annual supplier survey said that they had difficulty meeting the production expectations of customers during the past year, mainly because of higher-than-contracted volumes. Suppliers reported schedules 30% to 40% above forecast on certain models and cited “poor customer capacity planning and too little time to react.”
 

Investment concerns

The issue now is shifting to a need for additional floor space, machinery, and equipment for production. Looking ahead, 42% of respondents said that they do not have sufficient capacity to support a sustained increase in demand if production increases beyond 17 million as forecast. Suppliers are reluctant to invest in new capacity, according to comments from the October survey, saying, “Customers are not providing a firm enough commitment in order for us to invest capital for their programs,” and, “We are at a point where we need to add real new capacity and are hesitant to do that, because of customer price pressure [on margins] and fear of a slower market.”

Investments of this nature require a high degree of confidence to implement, both because they are large expenditures and because they involve some lead time during which market conditions could change. This is a cyclical industry (although not always as extreme as in our recent experience), so suppliers must balance the risks involved versus being able to take advantage of the market upswing. The scenario to avoid is waiting too long and making an investment too far into the cycle, leaving excess capacity on hand for the next downturn.

Suppliers that are successful in expanding incrementally and flexibly have the best of both worlds. Use of modular assembly cells, the ability to re-purpose equipment, and other methods can allow companies to take advantage of rising demand without putting too much at stake. Evaluation of capacity expansion will likely be a key agenda item for many suppliers throughout the next year or two.

IRN Inc.
www.think-irn.com

About the author: Melissa Anderson is vice president of automotive research group IRN Inc. Anderson has consulted with automakers and suppliers extensively since 1986. She can be reached at melissa@think-irn.com.